TAX

STUDY GUIDE

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Published 2023 by John Wiley & Sons Australia, Ltd,
310 Edward Street Brisbane, Qld, 4000 Australia.
on behalf of Chartered Accountants Australia & New Zealand
Copyright © Chartered Accountants Australia and New Zealand 2023. All rights reserved.
This publication is copyright. Apart from any use as permitted under the Copyright Act 1968 (Australia) and Copyright
Act 1994 (New Zealand), as applicable, it may not be copied, adapted, amended, published, communicated or otherwise
made available to third parties, in whole or in part, in any form or by any means, without the prior written consent of
Chartered Accountants Australia and New Zealand.
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Contents

Introduction v 2.1.2 Taxable income/(loss) and tax

Acknowledgements vi payable/(refundable) 43
2.1.3 Assessable income 45
2.1.4 Deductions 54
CHAPTER 1
2.1.5 Tax offsets 75
Tax administration and controls 1
2.1.6 Tax rates 78
2.1.7 Tax reconciliation 80
Chapter introduction 1
2.2 Property and capital transactions 82
1.1 Tax management and controls 1 2.2.1 Capital allowances
1.1.1 Tax planning, avoidance application and deduction 89
and evasion 2 2.2.2 Capital works application
1.1.2 Professional conduct (code of and deduction 101
ethics, tax agent and other 2.2.3 Trading stock 103
professional requirements 2.2.4 Capital gains tax (CGT)
including corporate social application 108
responsibility (CSR)) 2
2.2.5 Capital gain/(loss) and
1.1.3 Tax risk and governance 7 discount capital gains 118
1.1.4 Tax administration 2.2.6 Net capital gain/(loss) 121
(self-assessment,
2.2.7 CGT exemptions and
administration and collection
anti-overlap provisions 124
of taxes) 14
2.2.8 Other CGT measures 139
1.1.5 Tax sources, guidance,
2.2.9 Record-keeping requirements 142
avoidance and evasion 18
1.1.6 Tax technology (data, Chapter summary 142
analytics and data matching,
automation and other
technology including robotic CHAPTER 3
process automation) 24
Income tax – taxation of structures
Chapter summary 28 and transactions 145

CHAPTER 2 Chapter introduction 145

Income tax – general rules 31

3.1 Tax structures 145
3.1.1 Company 149

Chapter introduction 31 3.1.2 Individual 183

3.1.3 Partnership 196
2.1 Income tax 32
3.1.4 Trust 208
2.1.1 Application (including
3.1.5 Small business entity 232
residence and source) 32
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3.2 International and other structures 244 4.1.4 Creditable acquisitions, and
3.2.1 Taxation of foreign income of creditable importations 291
residents, and foreign income 4.1.5 Other special rules 295
tax offsets 245
4.2 Employment remuneration and
3.2.2 Taxation of Australian-
fringe benefits tax (FBT) 300
sourced income of
non-residents 263 4.2.1 Employees and contractors
(including PAYG rules) 300
3.2.3 Other international measures
to be dealt with in 4.2.2 Allowances 303
Advanced Tax 270 4.2.3 Superannuation 304
4.2.4 FBT application 305
Chapter summary 271
4.2.5 FBT taxable value 310
4.2.6 FBT payable 336
CHAPTER 4
4.3 Interactions between taxes and
Other taxes and interactions 273
transactions 340
4.3.1 Deductibility and
Chapter introduction 273 assessability of taxes 340
4.3.2 Interaction between taxes
4.1 Goods and services tax (GST) 274 and transactions 342
4.1.1 Describe the administration
and compliance of GST 274 Chapter summary 345

4.1.2 Calculate net GST Index 347

payable/refundable 279
4.1.3 Taxable supplies, GST-free
supplies, and input-taxed
supplies, taxable and
non-taxable importations 279

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iv Contents
Introduction

This study guide presents the core content of CACC1503AU: Tax. It is designed to be your primary point of
reference for the core knowledge-based content of the program.
Tax aims to advance your technical knowledge and skills for matters relating to tax, including tax
administration and controls, income tax, taxation of structures and transactions, interactions with taxes,
and other taxes.
In this subject, you will learn about the necessity of being aware of how tax impacts transactions, being
responsive to these impacts, and being able to identify when you need to seek the advice of tax specialist
for more complex tax issues.
Tax teaches you how to evaluate and explain the ways that tax practice is connected to a broad range of
areas and impacted by changes to those areas.
This subject provides you with an opportunity to apply your technical knowledge and skills in the form of
activities and assessments related to relevant case studies. These activities and assessments also
encourage you to develop and demonstrate your skills for professionally communicating tax-specific
information to a variety of stakeholders.
This subject is a prerequisite for the Advanced Tax subject. Should you wish to pursue a specialisation in tax,
Advanced Tax further develops the competencies you require to provide professional advice and services
relating to tax.
Your learning is supported by online tools, which may include microlearning videos, podcasts, infographics,
case studies, practice questions and interactive examples to help you see the technical material applied in
practical, real-world contexts. In this way, you will not only build your technical knowledge, but will also
have opportunities to further develop, practise and apply critical professional skills that will future-proof
your career as a difference-maker.
All of the learning materials in the program – including this study guide – are regularly updated to ensure
that they remain current.
Legislation changes constantly. In the CA Program, you are expected to be up to date with the relevant
legislation, standards, cases, rulings, determinations and other guidance as they stand six months before
the exam date unless otherwise stated, however you are always encouraged to be aware of current
developments. The relevant date for legislation is the date the legislation receives royal assent. The
relevant date for cases is the date the case decision was handed down. Accordingly, the announcements in
the Federal Budget are outside the scope of the program as these changes have not been legislated.
A summary of the proposed changes as announced in the Federal Budget that impact the Study Guide are
available in My Capability. It has been prepared as at 31 May 2023 but is subject to change.
We wish you all the best with your studies.

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Introduction v
Acknowledgements

Chapter 1
Extracts
© Australian Taxation Office for the Commonwealth of Australia
© Tax Practitioners Board – https://www.tpb.gov.au
© 2018 Accounting Professional & Ethical Standards Board Limited Source: APES 211 Code of Ethics for
Professional Accountants (including Independence Standards) Issued: July 2019.

Table
© Australian Taxation Office for the Commonwealth of Australia

Chapter 2
The author for this chapter is Rhonda Robinson (Griffith University).

Tables
© Australian Taxation Office for the Commonwealth of Australia

Chapter 3
Tables
© Australian Taxation Office for the Commonwealth of Australia

Chapter 4
The author for this chapter is Nick Jinoh Park (Partner, Business Advisory for Crowe Australasia, Findex
Group).

Tables
© 2020 CCH Australia Limited
© Australian Taxation Office for the Commonwealth of Australia

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vi Acknowledgements
CHAPTER 1

Tax administration and controls

Chapter introduction
The Australian taxation system includes the following separate taxes:
• Income tax – applied to taxable income and capital gains.
• Goods and services tax (GST) – applied to transactions.
• Fringe benefits tax (FBT) – applied to non-cash benefits provided to employees.
In addition to income tax, GST and FBT, Australia imposes various other taxes at both the federal and state
levels (eg payroll tax, stamp duty and land tax).
This chapter provides an awareness of professional conduct requirements, tax risk management and
governance, and Australia’s tax collection mechanisms.
Furthermore, this chapter reflects on the boundaries of tax planning and asks you to consider the lines
between tax planning, tax avoidance and tax evasion. Tax planning involves organising tax affairs to achieve
the most tax effective and efficient outcome. Effective tax planning generally means legally reducing
(or minimising) the amount of tax that is payable. However, because taxes underpin our society, there are
limits on the way taxpayers (with or without the help of tax advisors) can minimise taxes. Although most
tax advisors can spot examples of tax evasion, identifying the line between legitimate tax planning and tax
avoidance arrangements can be a challenging task. The guidance in this area mostly comes from judicial
decisions rather than tax legislation.
The provision of taxation services by tax advisors is a highly regulated profession with complex guidelines,
rules and regulations that control professional conduct. Understanding these rules and regulations is
crucial. You cannot assume that an action (eg a tax planning strategy) is acceptable just because it follows
those rules and any specific tax legislative requirements.
Ethics involves more than decisions about right or wrong. Ethics helps a tax advisor to navigate through
situations where the rules and regulations are absent, or do not seem to give the guidance required.
This chapter also considers the ATO’s use of technology and data to help with its collection and enforcement
functions. The ATO uses this technology to help determine whether tax planning has become tax avoidance.

1.1 Tax management and controls

Tax management and controls considers:
• tax planning, avoidance and evasion
• professional conduct
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Tax administration and controls 1

• tax risk and governance
• tax administration
• tax sources, guidance, avoidance and evasion
• tax technology.
Professionals and the ATO are required to operate within these principles (both legally and ethically).

1.1.1 Tax planning, avoidance and evasion

Tax is a cost of doing business. Therefore, taxpayers are motivated to minimise their amount of tax payable.
The boundary between tax minimisation and tax avoidance is hard to recognise. At its core, there is a
conflict between the interest of the immediate taxpayer and the interest of the community of which the
taxpayer is part. Most tax advisors use the ‘reasonably arguable position’ as a rule of thumb to test if they
have strayed too far into tax avoidance territory. Most tax advisors do not consciously stray into tax evasion.
Tax planning (sometimes called tax minimisation) involves organising one’s tax affairs in such a way that the
minimum tax liability is achieved while acting within both the letter and spirit of the tax law. The law
contains many legitimate avenues to reduce tax. For example, renting a business premises may be financially
more attractive than buying the premises, partly because of the deduction available for rent payments.
Tax avoidance involves arrangements that appear to comply with the letter of the law but not its intent. It
often involves the exploitation of loopholes that were not intended by government, and it can also involve
manipulating a taxpayer’s affairs just to satisfy the law. For example, paying above market rates to a related
entity to claim a bigger tax deduction. Tax law targets tax avoidance using both specific and general
anti-avoidance provisions (‘catch all provisions of last resort’ – see Topic 1.1.5).
Fraud or evasion is dealt with severely under tax law. It broadly involves making false or recklessly careless
statements regarding a taxpayer’s affairs. If fraud or evasion is proven, the tax consequences for the
taxpayer include an unlimited time for the Commissioner to amend an income tax assessment as well as
penalties of up to 75% of the tax shortfall. There may be further consequences under the various Crimes
Acts which can include jail sentences and fines.

1.1.2 Professional conduct (code of ethics, tax agent and

other professional requirements including corporate social
responsibility (CSR))
Professional and ethical requirements
Ethics involves more than decisions about right or wrong. Ethics helps a tax advisor navigate through
situations where the rules and regulations are absent, or do not seem to give the required guidance.
Chartered Accountants Australia and New Zealand (CA ANZ) has codes and professional standards that all
members must follow. These codes and standards, and related ethical guidance, are used to assess a
member’s professional conduct in the event of a complaint by a client or third party. A failure by a member
to meet the standards may result in disciplinary proceedings. Those applicable to members providing
taxation services include the following.

APES 110 Code of Ethics for Professional Accountants (including Independence

Standards) – issued November 2018 (APES 110)
The code adopts a conceptual framework approach to ethics. It is based on fundamental principles that
express the basic tenets of ethical and professional behaviour and conduct. Observing these fundamental
principles is central to the public interest and all members must follow them at all times. Members should
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2 Tax
be guided, not merely by the terms, but also by the spirit of the code and should be prepared to justify any
departure from the provisions or spirit of the code.
Under APES 110, a member shall comply with the following fundamental principles:

• integrity – to be straightforward and honest in all professional and business relationships

• objectivity – not to compromise professional or business judgments because of bias, conflict of interest or
undue influence of others
• professional competence and due care – to:
(i) attain and maintain professional knowledge and skill at the level required to ensure that a client or
employing organisation receives competent professional service, based on current technical and
professional standards and relevant legislation, and
(ii) act diligently and in accordance with applicable technical and professional standards.
• confidentiality – to respect the confidentiality of information acquired as a result of professional and business
relationships
• professional behaviour – to comply with relevant laws and regulations and avoid any conduct that the
professional accountant knows or should know might discredit the profession.

In practice, this means that we should ask ourselves whether we would be happy for our conduct to be
published on the front page of a major newspaper. We must approach all matters with honesty and without
bias, with due skill and care, in confidence, and in compliance with laws and professional obligations. Failure
to maintain these standards does not meet the ethical requirements.
Accountants in practice often encounter situations where they need to weigh up many ethical
considerations and adopt the appropriate behaviour. For example, an accountant may, in an attempt to help
their client, create backdated documents in a bid to evidence a transaction for the Tax Office. However, not
only is this illegal, but it also breaches their ethical obligations. Would the accountant want this published
on the front page of the paper? Is the accountant aware that they could also be charged with fraud or
conspiracy to defraud the Commonwealth, potentially resulting in a prison sentence?
Consider another example. An accountant suspects that there is inappropriate activity but says to their
staff, ‘I don’t want to know about that issue’. Turning a blind eye creates the illusion of innocence. However,
such action causes the accountant to become an enabler and actually encourages more inappropriate
behaviour, including from their staff.

APES 220 Taxation Services (2019) – Revised July 2019 (APES 220)
This standard relates to the provision of taxation services and applies to members in business (if they
supply taxation services to employers) and public practice.
Under APES 220, a member shall at all times safeguard the interests of their client or employer if such
services are delivered in line with APES 110 and relevant law, including applicable taxation law. In doing
this, a member shall comply with the following fundamental responsibilities:
• public interest – in line with APES 110, to observe and comply with their public interest obligations
• integrity and professional behaviour – in line with APES 110, to ensure that their own professional
tax obligations and those of any associated entities for which the member is responsible are
properly discharged
• objectivity – in line with APES 110, to maintain an impartial attitude and recommend options that meet
the client’s or employer’s interests, consistent with the requirements of the law. Objectivity is also
required if a conflict of interest arises due to the member being asked to act as an advocate for a client or
employer before a court or tribunal regarding professional activities the member provided
• independence obligations – in line with APES 110, when a member in public practice is providing
taxation services to a client and the member’s firm is also engaged to conduct an assurance engagement
for the same client
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Tax administration and controls 3

• confidentiality – in line with APES 110, unless the member has a legal obligation of disclosure, a member
shall not:
(i) convey any information about a client’s or employer’s affairs to a third party without the client’s or
employer’s permission.
(ii) furnish to the revenue authorities any opinions or written advice of a third party who is acting in a
specialist capacity on specific aspects of the engagement, without the prior knowledge and express
consent of that third party.
• professional competence and due care – in line with APES 110:
– A member should maintain open, frank and effective communications with a client or employer;
concerning rights, obligations, options, penalties and other legal consequences.
– A member in public practice has additional obligations to communicate in writing with a client; about
responsibilities, basis of advice and the self-assessment system.

You will note that these requirements overlap with ethical responsibilities. However, they go further.
Where the application of the taxation law is not certain, a member should tell a client or employer that the
results of a taxation service could be challenged. The member must identify the arguments for and against
a position. The client should be informed of the risks.
Professional opinions can differ about how strong a technical argument is. Forming a robust view on a tax
matter is only a part of the responsibilities of a tax advisor. Clients expect their tax advisor to provide
appropriate information about risk so they can make an informed decision about whether or not to accept
the advice.
In other words, informing a client of the risk of the ATO taking a different view and quantifying that risk are
equally important responsibilities of a tax advisor. This is because the ATO is often combative and
adversarial, and risk mitigation is paramount when advising on tax issues.
This is similar to the responsibility of the medical profession. Doctors are often called on to advise patients
about the benefits of having an operation or surgery, which inherently carries risk, sometimes life or death.
Patients expect doctors to quantify the likelihood of things going wrong so they can make a fully informed
decision about whether or not to proceed.
A similar risk transparency expectation rests with tax advisors. This is because many tax issues carry risk in
the form of additional primary tax, penalties, interest and litigation costs, and the ATO will often adopt a
pro-revenue approach to tax collections.
Therefore, providing a client with full information about this downside risk goes together with providing
the tax advice in the first place.
Under APES 220, a member shall prepare and/or lodge returns and other relevant documents required to
be lodged with a revenue authority in line with the information provided by a client or employer, their
instructions and the relevant taxation law.
Under APES 220, members also have professional and ethical obligations regarding association with tax
schemes and arrangements, the use of estimates, false and misleading information, professional
engagement matters, client monies, professional fees and documentation.

Criminal legislation
The Crimes (Taxation Offences) Act 1980, Crimes Act 1914 and Criminal Code apply to those who have aided,
abetted or conspired with another to commit the relevant offence. For example, s 6(1)(a) of the Crimes
(Taxation Offences) Act 1980 talks about a person who ‘directly or indirectly, aids, abets, counsels or
procures another person (including a company) to enter into an arrangement or transaction’. This legislation
may be applied, for example, if a taxpayer winds up a company knowing that the company has a pending
tax liability (commonly referred to as bottom of the harbour schemes).

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4 Tax
Common law duty of care
Professional tax advisors have a common law duty towards their client to exercise proper care and skill.
They can be held liable if they are negligent in providing (or failing to provide) advice which causes their
client damage, injury or loss. The standard of care required is typically determined by looking at what a
reasonable person would have done (or not done) in the same circumstances.

Tax agent conduct

Tax agents play an important role in the tax system, preparing the majority of income tax returns lodged by
taxpayers and advising clients on how to comply with the tax law in a self-assessment environment.

Concessions

Tax agents have a privileged position under the tax law. For example, expenditure incurred in seeking tax
advice is deductible under s 25-5 only if the advice is provided by a recognised tax advisor, defined in
s 995-1(1) as a registered tax agent, business activity statement (BAS) agent or a legal practitioner.
A taxpayer who uses a registered tax agent also benefits from a safe harbour from certain administrative
penalties in circumstances where:
• a false or misleading statement is made carelessly even though the taxpayer has taken reasonable care to
comply with their tax obligations by giving their tax agent or BAS agent the information necessary to
make the statement
• a document (such as a return, notice or statement) is not lodged on time in the approved form due to the
tax agent’s or BAS agent’s carelessness, if the taxpayer gave the agent the necessary information in
enough time to lodge the document on time and in the approved form. If the agent was reckless or has
intentionally disregarded the law, the safe harbour is not available.
Due to confidentiality provisions in tax law, the ATO will only discuss a taxpayer’s affairs with the taxpayer,
or the tax agent who has been appointed to act on behalf of the taxpayer.
Finally, the ATO also allows tax agents to spread their workload beyond the standard 31 October tax return
lodgement date (ie taxpayers who use a tax agent are permitted to lodge later). The ATO provides tax
agents with electronic access to client data and has dedicated enquiry lines.
It is not surprising that tax agents are subject to regulatory requirements which aim to ensure that they are
competent and act with integrity.

Regulations

From 1 April 2022, the provision of tax agent services is regulated by the Tax Agent Services Act 2009
(TASA) and Tax Agent Services Regulations 2022 (TASR). This Act covers both tax agents and those who
prepare business activity statements (BAS agents).
The Tax Practitioners Board (TPB) administers the TASA legislation. If an individual is not registered as a tax
agent, they cannot provide tax agent services (ss 50-5 and 90-5 TASA), advertise themselves as a tax agent
(s 50-10 TASA) or hold themselves out as a registered tax agent (s 50-15 TASA). Breach of these
requirements will attract civil penalties.
An individual can be registered as a tax agent if (s 20-5 TASA):
• the person is a fit and proper person having regard to the criteria in s 20-15 TASA
• the person is suitably qualified and has the relevant work experience as a tax agent (see Regulations 19,
20 and 21, and Schedule 2 of TASR).
An individual can also be registered if they are a member of a professional association accredited by the TPB
and have the required number of years of experience. CA ANZ is an accredited professional association.
Registered tax agents are subject to the statutory Code of Professional Conduct under s 30-10 TASA.
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Tax administration and controls 5

There are 14 codes of conduct organised around five principles, as follows:
• Honesty and integrity – a registered tax agent must:
– act honestly and with integrity
– comply with the taxation laws in the conduct of their personal affairs
– account to their client for money or other property that the agent receives or holds on their
client’s behalf.

• Independence – a registered tax agent must:

– act lawfully in the best interests of their client
– have in place adequate arrangements for the management of conflicts of interest.

• Confidentiality:
– unless a registered tax agent has a legal duty to do so, they must not disclose any information about a
client’s affairs to a third party without their client’s permission.

• Competence – a registered tax agent must:

– ensure that their service is provided competently
– maintain knowledge and skills relevant to the services they provide
– take reasonable care in ascertaining a client’s state of affairs, to the extent that the information is
relevant to the work being done for the client
– take reasonable care to ensure that taxation laws are applied correctly when they are providing advice
to a client.

• Other responsibilities – a registered tax agent must:

– not knowingly obstruct the proper administration of the taxation law
– advise their client of the client’s rights and obligations under the taxation laws that are materially
related to the services the tax agent provide
– maintain professional indemnity insurance that meets the TPB’s requirements
– respond to requests and directions from the Board in a timely, responsible and reasonable manner.

Failure to follow the code of conduct may cause the TPB to:
• caution the agent (s 30-15(2)(a) TASA)
• require the agent to undertake further training (ss 30-15 and 30-20 TASA)
• impose restrictions on the agent’s practice (ss 30-15 and 30-20 TASA)
• suspend the agent’s registration (ss 30-15 and 30-25 TASA)
• terminate the agent’s registration (ss 30-15 and 30-30 TASA).
Further guidance is available on the Tax Practitioners Board website: www.tpb.gov.au.
Note: The TPB code of conduct does not replace or mitigate the more stringent professional and ethical obligations of a Chartered
Accountant. You may be subject to disciplinary action by CA ANZ, even when you adhere to the TPB code of conduct.

Proof of identity requirements for client verification

The Tax Practitioners Board has released a practice note (TPB(PN) 5/2022) that outlines the requirements
for tax practitioners to verify client identities. These measures are designed to ensure that only authentic
and verifiable clients are accepted.

Required reading
Sections 30-10 to 30-30, 50-5 to 50-15, 90-5 of the Tax Agent Services Act 2009.

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6 Tax
1.1.3 Tax risk and governance
Introduction
Tax risk management and governance is the cornerstone of effective and constructive relationships with
the ATO. Directors need to ensure that companies have procedures and policies in place to create justified
trust with the ATO. The ATO has powers of enforcement. Therefore, taxpayers need to not only document
their controls and governance procedures, they must also ensure that the correct amount of tax is
computed and paid on time, and the correct forms are lodged on time.

ATO guide
The ATO has published a Tax Risk Management and Governance Review Guide. It sets out the recommended
best practice to ensure that directors and management are held to account for the taxation and
superannuation risk management of their business. While the responsibilities have always been made clear
in legislation, the ATO requires a specific framework to be in place to identify, assess and manage tax and
superannuation risks during the course of business.
The ATO sees tax risk management and governance as best practice for companies to adopt in managing
their tax risk management and governance. The ATO also uses the guide when reviewing companies to
determine what the current control environment is and whether it is operating effectively, which is part of
seeking justified trust. Making directors and management accountable for the tax practices of their
employers and having clear delegated authority procedures is the cornerstone of best practice.
The Tax Transparency Code (TTC) contains a set of principles and minimum standards to guide medium and
large businesses on public disclosure of tax information. Adoption of the TTC is voluntary. However,
compliance with the TTC is highly advisable because the ATO will view non-compliance as a reason to
increase the scope of a tax audit.
In addition to this framework (ie the recommended best practice), the ATO has specific powers of
enforcement. Therefore, taxpayers must ensure that they have correctly computed their tax liability, lodged
the correct forms on time and complied with the other requirements of the Tax Act.

Power to access, request information and retain funds

The Taxation Administration Act 1953 (TAA 1953) gives the Commissioner powers of access, the power to
request information and the power to retain tax amounts or refunds (including income tax, FBT and GST).
The ATO exercises these powers when conducting income tax and GST audits or reviews.

Access

Under Schedule 1 s 353-15(1) TAA 1953, the Commissioner has full and free access to all premises, places,
documents, goods and other property for any purpose of the Act and may make extracts or copies of them.
Note that the Commissioner’s powers under this section do not extend to the seizure of documents, which
generally requires a search warrant. The courts have always interpreted this section very widely (Industrial
Equity Ltd v Crawley & DCT (NSW) (1989) 90 ALR 603).
Schedule 1 s 353-15(2) TAA 1953 provides that an officer must produce an authority signed by the
Commissioner to enter or remain on any premises. This is referred to as black wallet authority.
Schedule 1 s 353-15(3) TAA 1953 explains that the taxpayer must provide the officer with facilities and
assistance for the effective exercise of the officer’s powers. This includes the use of photocopiers, providing
advice on locating documentation and ensuring there is enough lighting for officers to perform their duties.

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Tax administration and controls 7

Request information

Under Schedule 1 s 353-10 TAA 1953, the Commissioner has the power to request, by written notice, that
any person:
• give the Commissioner such information as the Commissioner may require
• attend and give evidence before the Commissioner and produce any documentation in the person’s
possession.
The Commissioner’s power under this section overrides a banker–client contract. A bank is required to
open safety deposit boxes if the ATO requests it to do so (Federal Commissioner of Taxation v Australia &
New Zealand Banking Group Ltd; Smorgon v FCT (1979) 143 CLR 499).
Taxpayers cannot rely on the privilege against self-incrimination (Stergis v FCT & Boucher (1989) 86 ALR 174).
Receiving a s 353-10 notice can be quite intimidating because it is written in fairly threatening language –
for example, you must comply or sanctions/penalties will apply. However, the ATO justifies issuing these
notices on the basis that:
1. they protect the taxpayer because the taxpayer may otherwise be in breach of their confidentiality
responsibilities by disclosing the information on a voluntary basis
2. it shortcuts the more-friendly approach of asking politely.

Under Schedule 1 Subdivision 353-B TAA 1953, the Commissioner may also issue an offshore information
notice. The notice requests information or documents where the Commissioner believes the information or
documents are located outside Australia. If information or documents are not provided, they are
inadmissible in any subsequent dispute.

Retain funds

The Commissioner has the power to retain funds where a taxpayer has failed to lodge a return or provide
other information, which may affect the amount the Commissioner can refund. Where a liability owing by a
taxpayer arises before the Commissioner repays a refund, the Commissioner may refund the balance of the
refund less the liability.

Limits on the Commissioner’s powers – legal professional privilege

The only restraint on the Commissioner’s powers under Schedule 1 ss 353-10 and 353-15 TAA 1953 is the
doctrine of legal professional privilege. The Commissioner is obliged to give taxpayers the opportunity to
claim this privilege. Legal professional privilege belongs to the client (ie the taxpayer), not the lawyer
(Federal Commissioner of Taxation v Citibank Ltd (1989) 85 ALR 588).
Legal professional privilege applies to:
• confidential communications between a lawyer and a client produced in the context of the
lawyer–client relationship
• communications consisting of legal advice or legal services relating to litigation
• communications created for the dominant purpose of providing that legal advice (Esso Australia
Resources Ltd v FCT (1999) 201 CLR 49).
Legal professional privilege can be extended to documents that are given to an accountant by a legal
advisor to aid such legal advice. This was confirmed in Pratt Holdings Pty Ltd v FCT (2004) 207 ALR 217.
It is, however, unlikely to extend to the accountant’s confidential communications with the client.
When access is exercised, the ATO must give taxpayers the opportunity to claim legal professional privilege
(JMA Accounting Pty Ltd and Entrepreneur Services Pty Ltd v Carmody [2004] FCA 896).
After the ATO’s raid in FCT v Citibank Ltd, the ATO issued access guidelines granting an administrative
privilege to accountants. These are contained in the ATO’s Approach to Information Gathering. Although
accountants’ administrative privileges lack legislative force, taxpayers have a legitimate expectation that
they will be followed. The administrative extension of privilege by the ATO covers communications
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8 Tax
between taxpayers and their accounting advisors. Set out in the Guidelines to Accessing Professional
Accounting Advisers Papers, the accountants’ concession states that ATO officers are restricted from
accessing communications between clients and accounting advisors unless there are ‘exceptional
circumstances’.
Legal professional privilege is lost when disclosure is made to a third party. At times, taxpayers choose to
waive their claim to this privilege. Privilege is not available where the communication is calculated to further
an illegal object. This exception to legal professional privilege is called the fraud-crime-illegality exception.
As a practical matter, it is very difficult to determine what documents are subject to legal professional
privilege. This often requires extensive legal input. In addition, because the onus is on the taxpayer to
prove their assessment, placing documentation under legal professional privilege may unduly handicap the
taxpayer or may result in the ATO becoming increasingly sceptical about what the taxpayer is seeking
to hide.
The ATO has released a draft protocol containing the ATO’s recommended approach for identifying
communications covered by legal professional privilege and making LPP claims to the ATO. Taxpayers
seeking LPP should refer to this document. The recent case of Commissioner of Taxation v
PricewaterhouseCoopers [2022] FCA 278 shows how difficult it is for multi-disciplinary firms to
obtain LPP.

Remedial power
Under Schedule 1 s 370-5 TAA 1953, the Commissioner has the power to make a legislative instrument to
modify the operation of a taxation law to ensure the law can be administered to achieve its intended
purpose or object.

Third-party reporting power

Under Schedule 1 s 396-50 TAA 1953, the Commissioner has the power to require taxpayers to give
information about transactions that could reasonably be expected to have tax consequences for
other entities.
The taxable payment reporting system requires certain taxpayers to lodge an annual report by 28 August
each year detailing taxable payments made to contractors for providing services. The ATO uses the
information gathered to identify contractors who may not be correctly reporting their assessable income.
Contractors can include subcontractors, consultants and independent contractors. They can be operating as
sole traders (individuals), companies, partnerships or trusts. The reporting system applies to the following:
• government-related entities and taxpayers in the building and construction industry
• courier and cleaning industries
• security, road-freight transport and computer system design industries.
All business-to-business payments above $10,000 (and certain other transactions) must be made through
the banking system (ie cash transactions are not allowed for tax purposes).

Record keeping
Taxpayers are required to keep certain taxation records. The major record-keeping rules are as follows.
• Section 262A of the Income Tax Assessment Act 1936 (ITAA 1936) requires those carrying on a business
to keep records that record and explain all transactions that may be relevant for the purposes of the
taxation Acts. The records must be kept in writing and in English (or readily convertible to English), and
they may be retained electronically.
• Records must generally be retained for five years after the records were prepared (s 262A(4)(a)
ITAA 1936). However, most individual taxpayers and businesses lodging under the small business entity
(SBE) regime only have to keep certain records for two years.
Pdf_Folio:9

Tax administration and controls 9

• There are special transfer pricing documentation rules in Schedule 1 Subdivision 284-E TAA 1953.
Specifically, transfer pricing documentation must be prepared before lodging the tax return and it must
be maintained in Australia.
• There are penalties for failure to keep the appropriate records.
The general application of the record-keeping requirements that apply to business taxpayers is explained in
TR 96/7. The application of the record-keeping requirements and Commissioner’s access powers regarding
electronic records are explained in TR 2018/2.
As a practical matter, it is in the taxpayer’s interest to maintain relevant tax records so that they can satisfy
their burden of proof. The burden of proof is always on the taxpayer. If they fail to prove their position,
they will generally not be able to defend their claim. The key is ‘evidence, evidence, evidence’. File
documents, keep them and use them to discharge the taxpayer’s evidentiary burden.

Uniform administrative penalty regime

The uniform administrative penalty regime applies to all taxation laws (eg income tax and GST). It consists
of three distinct components, contained in Schedule 1 TAA 1953:
• Penalties relating to statements and schemes (Schedule 1 Division 284 TAA 1953), including:
(i) making a statement that is false or misleading, or does not apply the income tax law in a way that is
reasonably arguable (Schedule 1 Subdivision 284-B TAA 1953)
(ii) participating in schemes (Schedule 1 Subdivision 284-C TAA 1953).
• Penalties for late lodgement of returns and other documents (Schedule 1 Division 286 TAA 1953).
• Penalties for failing to meet other taxation requirements (Schedule 1 Division 288 TAA 1953).

Penalties relating to statements

An administrative penalty applies under Schedule 1 Subdivision 284-B TAA 1953 when a statement made
to the Commissioner by either the taxpayer or their agent:
• regarding any taxation law is false or misleading in a material particular (Schedule 1 s 284-75 (1)
TAA 1953), or
• does not apply the income tax law in a way that is reasonably arguable (Schedule 1 s 284-75(2) TAA 1953).
Alternatively, an administrative penalty applies where the taxpayer has failed to make a statement to the
Commissioner about any taxation law, which has resulted in the Commissioner determining a tax-related
liability (Schedule 1 s 284-75(3) TAA 1953). For example, this penalty would apply in a situation where the
taxpayer has not lodged an income tax return.
However, an administrative penalty is not applicable for false and misleading statements where:
• the taxpayer and the agent (if relevant) took reasonable care in connection with the making of the
statement (Schedule 1 s 284-75(5) TAA 1953)
• the taxpayer engages an agent and provides them with all relevant taxation information, if the false or
misleading nature of the statement did not result from intentional disregard or recklessness by the agent
(Schedule 1 s 284-75(6) TAA 1953). In practice, this concession is hard to obtain.
A reasonably arguable position applies an objective standard involving an analysis of the law, relevant
authorities and the application of the law and authorities to the relevant facts.
For the purpose of determining whether an entity has a reasonably arguable position, relevant authorities
include: taxation law, material used for the purposes of s 15AB of the Acts Interpretation Act, AAT decisions,
Board of Review decisions and public rulings (s 284-15(3)). Examples of material used for the purposes of
s 15AB of the Acts Interpretation Act include:
• explanatory memoranda
•
Pdf_Folio:10
second reading speeches

10 Tax
• certain parliamentary reports
• court decisions (both in Australia and overseas).
It is irrelevant whether a person thinks or believes that a position is reasonably arguable (ie it is not a
subjective test), but simply whether it is reasonably arguable as an objective fact.
Essentially, the test is whether, having regard to the relevant authorities, it would be concluded that what is
argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect. In other
words, there is a need for the balancing of competing arguments, with the consequence that there must be
room to argue which of the two positions is correct so that, on balance, the taxpayer’s argument can
objectively be said to be one that, while not necessarily correct, could be argued on rational grounds
to be correct.
The reasonably arguable standard applies to income tax law (s 284-75(2)) but does not apply to GST.
The reasonably arguable standard only applies to taxpayers with a shortfall amount that exceeds the
reasonably arguable position threshold (Schedule 1 s 284-90(1) item 4 TAA 1953), as follows:
• for taxpayers other than a trust or partnership – the greater of $10,000 or 1% of the income tax payable
by the taxpayer based on their income tax return
• for a trust or partnership – the greater of $20,000 or 2% of net income of the entity based on the entity’s
income tax return.
Note that, where the taxpayer has used a tax agent, the taxpayer may still be vicariously liable for any
penalties as a result of the agent’s conduct on their behalf (subject to the tax agent safe harbour
concession, which allows taxpayers to be relieved of penalties where errors have been made by the tax
agent). A statement made by an agent in the approved form is taken to have been made by the taxpayer
(Schedule 1 s 284-25 TAA 1953).
Key terms applicable to the determination of the administrative penalty are:
• shortfall amount – arises where the amount of the relevant liability, payment or credit is not equal to the
proper tax payable if the tax had been calculated under the law (Schedule 1 s 284-80 TAA 1953), ie the
amount of tax avoided
• penalty unit – from 1 January 2023 one penalty unit is $275 (s 4AA Crimes Act 1914) ($222 from 1 July
2020 to 31 December 2022). Note that the penalty unit payable may differ depending on the date the
penalty notice was received. The amount is indexed every three years based on the consumer price
index. The penalty unit applied is based on the time of the penalty notice, it is not based on the relevant
income year
• base penalty amount (BPA) – percentage of the shortfall amount based on the behaviour that led to the
shortfall amount.
Under Schedule 1 s 284-85 TAA 1953, the formula for calculating the administrative penalty amount is:

BPA + [BPA × (Increase % – Reduction %)]

‘Increase %’ is the percentage increase (if any) under Schedule 1 s 284-220 TAA 1953. It is an adjustment
to the BPA based on the taxpayer’s degree of culpability.
‘Reduction %’ is the percentage decrease (if any) under Schedule 1 s 284-225 TAA 1953.
The administrative penalty varies depending on the entity’s behaviour and the shortfall amount or part
thereof that resulted from the behaviour to avoid tax. Examples of the BPA applicable to entities that are
not a significant global entity are shown in the following table along with a reference to the relevant
section of TAA 1953.

Pdf_Folio:11

Tax administration and controls 11

 Behavioural situation BPA Section reference

Intentional disregard of a taxation law (other than the 75% of your shortfall s 284-75(1) or (4)
Excise Acts) amount or part

Recklessness as to the operation of a taxation law (other 50% of your shortfall s 284-75(1) or (4)
than the Excise Acts) amount or part

Failure to take reasonable care to comply with a taxation 25% of your shortfall s 284-75(1) or (4)
law (other than the Excise Acts) amount or part

False or misleading statements because of intentional 60 penalty units s 284-75(1) or (4)

disregard of a taxation law (other than the Excise Acts)
that did not result in a shortfall amount

False or misleading statement because of recklessness as 40 penalty units s 284-75(1) or (4)

to the operation of a taxation law (other than the Excise
Acts) that did not result in a shortfall amount

False or misleading statement because of a failure to take 20 penalty units s 284-75(1) or (4)
reasonable care to comply with a taxation law (other than
the Excise Acts) that did not result in a shortfall amount

Treating an income tax law or the petroleum resource rent 25% of your shortfall s 284-75(2)
tax law as applying to a matter or identical matters in a amount or part
particular way that was not reasonably arguable, and that
amount is more than your reasonably arguable threshold

You have a trust shortfall amount due to: 25% of your shortfall s 284-30
(a) treating an income tax law as applying to a matter or amount or part
identical matters in a particular way that was not
reasonably arguable; and
(b) the trust’s net income would have been reduced, or
the trust’s tax loss would have been increased, for
the income year by more than the trust’s reasonably
arguable threshold

You have a partnership shortfall amount due to: 25% of your shortfall s 284-35
(a) treating an income tax law as applying to a matter or amount or part
identical matters in a particular way that was not
reasonably arguable; and
(b) the partnership net income would have been
reduced, or the partnership loss would have been
increased, for the income year by more than the
partnership’s reasonably arguable threshold

You are liable to an administrative penalty 75% of the tax-related s 284-75(3)

liability concerned

Source: Adapted from www.ato.gov.au/law/view/document?docid=PAC/19530001/Sch1-284-90

Where the taxpayer is a significant global entity (SGE), the rates are doubled.
For example, the failure to lodge BPA is calculated at 50% of the tax shortfall amount. The BPA is increased
by 20% where the taxpayer obstructs the ATO, did not inform the ATO of a shortfall amount within a
reasonable time, or has repeat offences. The BPA is reduced by 20% where the taxpayer voluntarily tells
the ATO about a shortfall amount.
Pdf_Folio:12

12 Tax
The ATO has provided guidance on the interpretation of the terms reasonable care, recklessness and
intentional disregard in MT 2008/1. For example, the reasonable care test considers the taxpayer’s
individual circumstances (eg the taxpayer’s knowledge) and whether a taxpayer in similar circumstances
would have exercised greater care. Unfortunately, the greater the taxpayer’s knowledge, the greater the
reasonable-care onus.
As noted above, a BPA can be increased or based on the culpability of the taxpayer. For example, where a
BPA was applied in a prior period for a transposition error on a BAS, and an error of the same nature was
then made in the subsequent period due to a failure to take reasonable care, the BPA would be increased
by 20% (Schedule 1 s 284-220(1)(c) TAA 1953).
Note: The BPA can be reduced by up to 80% where the taxpayer makes a voluntary disclosure before the Commissioner starts an
investigation into the taxpayer’s affairs. However, once an investigation begins, the base penalty amount can normally only be reduced by
up to 20%, even where the taxpayer helps the Commissioner.

Risk mitigation

Clearly, the more aggressive a tax position, the greater the risk of penalty exposure. In this context,
taxpayers would need to consider their risk appetite, their previous compliance history and the taxpayer’s
reputation as well as other commercial factors. Taxpayers may seek to obtain guidance from the ATO
(eg a private ruling) for a greater level of comfort to mitigate penalty exposure and reduce the risk of ATO
review and adjustment. In general terms, the more aggressive or complicated the transaction, taxpayers
would generally be expected to have:
1. a reasonably arguable position paper
2. an opinion from a tax advisor
3. an opinion from a tax barrister
4. a ruling from the ATO.

The more contentious the issue, the higher the penalty risk and the greater the likelihood of ATO scrutiny.

Penalties for failing to lodge returns and other documents

An administrative penalty is generally imposed when a taxpayer fails to lodge a taxation document with the
Commissioner by a particular date or in an approved form (Schedule 1 s 286-75 TAA 1953).
The amount of the penalty is calculated under Schedule 1 s 286-80 TAA 1953, and has two components:
• BPA based on the timing of the lodgement of the approved form
• increase (if any) in BPA based on the size of the taxpayer.
All entities are liable for the base penalty amount where the approved form is not lodged by the required
time. Schedule 1 s 286-80(2) TAA 1953 identifies that base penalty amounts are calculated as one penalty
unit for each period of 28 days or part of a period of 28 days during which the documents remained
outstanding or were not lodged in the approved form (up to a maximum of 5 penalty units).
Entities are classified as small, medium or large. For the threshold test classification of entities, see
Schedule 1 ss 286-80(3) and (4) TAA 1953. The amount of the BPA is increased as follows:
(i) small entity (which includes most individuals) – no increase in the BPA
(ii) medium entity – the BPA is multiplied by two (Schedule 1 s 286-80(3) TAA 1953)
(iii) large entity – the BPA is multiplied by five (Schedule 1 s 286-80(4) TAA 1953)
(iv) significant global entity (SGE) – the BPA is multiplied by 500 (Schedule 1 s 286-80(4A) TAA 1953).

If a large entity is late in lodging by 28 days or less, the penalty will be $1,375 ($275 × 5) from 1 January
2023. However, for an SGE, the penalty will be $137,500 (ie $275 × 500). An SGE which lodges more than
112 days late will be up for a penalty of $687,500 (ie $275 x 5 x 500). SGEs are therefore under enormous
pressure to have perfect compliance.

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Tax administration and controls 13

Penalties for failing to meet other taxation requirements

Schedule 1 Division 288 TAA 1953 incorporates miscellaneous penalties that apply under various taxation
laws into three key penalty provisions. A taxpayer will be liable for a penalty of 20 penalty units where they
have failed to:
• keep or retain records (Schedule 1 s 288-25 TAA 1953)
• retain or produce declarations (Schedule 1 s 288-30 TAA 1953)
• provide access to help a taxation officer carry out their duties.

Tax agent safe harbour

Under the safe harbour provisions, a client will not be liable to certain administrative penalties if they
provide all the relevant tax information to their tax agent, and the tax agent:
• does not take reasonable care and makes a false or misleading statement that results in a shortfall amount
• takes reasonable care or lacks reasonable care and fails to lodge a document by the due date.

Interest regime
Where a taxpayer has underpaid tax or a tax shortfall exists, the taxpayer would generally be liable
to pay the:
• general interest charge (GIC)
• shortfall interest charge (SIC).

General interest charge

A GIC is payable on an outstanding tax debt (and an outstanding SIC amount) where payment has not been
made by the due date (s 8AAB TAA 1953). GIC applies for each day the debt remains unpaid and is
calculated on a compounding daily basis (s 8AAC TAA 1953) based on a markup of the average yield of the
90-day bank-accepted bill rate published by the Reserve Bank of Australia (s 8AAD TAA 1953).
The GIC applies to most taxes, including income tax, GST, FBT and PAYG. The rate generally changes each
quarter. The GIC is tax deductible under s 25-5.

Shortfall interest charge

Where the Commissioner issues an amended assessment increasing an income tax liability, the taxpayer
may be liable to pay an SIC on the additional amount. The SIC operates in a similar way to the GIC
(ie compounded on a daily basis under Schedule 1 s 280-105 TAA 1953) but at a lower rate. The rate
generally changes each quarter.
It applies to the additional amount from the payment due date of the income tax liability under the original
assessment until the day before the amended assessment is issued. It does not apply to other taxes. The
amended income tax assessment or income tax shortfall and the related SIC are due 21 days after the
amended income tax assessment is issued. The SIC is tax deductible under s 25-5.

1.1.4 Tax administration (self-assessment, administration

and collection of taxes)
Pay as you go (PAYG) tax collection process
If income tax was only collected on assessment, taxpayers would enjoy a substantial timing advantage and
the Government would not receive a regular inflow of income tax throughout the year. The PAYG system

Pdf_Folio:14

14 Tax
addresses this by collecting income tax on a regular basis and crediting taxpayers with the tax collected at the
time of their annual income tax assessment. PAYG is imposed under Schedule 1 TAA 1953 and comprises:
• PAYG withholding
• PAYG instalments.

PAYG withholding

PAYG withholding requires tax be withheld by the payer from specified types of payments to a recipient.
The most common example is salary and wages.
Exempt income, non-assessable non-exempt income (NANE) income, and expense reimbursements that
have been subject to FBT are excluded from the operation of the PAYG withholding provisions.
Section 10–5(1) in Schedule 1 TAA 1953 lists the various PAYG withholding events and directs the reader
to specific sections that set out the circumstances in which PAYG withholding is required. The most
significant withholding events are set out in the table below.

Significant PAYG withholding events

TAA 1953 Schedule 1 provision Withholding event

s 12-35 Salary, wages, commission, bonuses or allowances paid to employees

s 12-40 Remuneration payments to company directors

Subdivision 12-C Superannuation income stream or annuity, employment termination

payments and unused leave payments

Subdivision 12-D Social security benefits, work-related compensation, sickness or

accident payments

s 12-140 Payments where the recipient fails to quote a tax file number (TFN) or
Australian business number (ABN) to a financial institution (eg a bank),
unit trust or public company

s 12-175 Distributions from closely held trusts (eg family trusts) to beneficiaries
who have not quoted their TFN to the trustees

s 12-190 Suppliers carrying on a business who do not quote their ABN number
to payers. This provision targets the cash economy (ie businesses that
avoid paying tax by requesting cash payments)

Subdivision 12-F Dividend, interest and royalty payments made to an overseas person
or entity (Australia waives its right to withhold tax on the franked
component of a dividend – see Topic 3.2.)

Subdivision 12-FB; Taxation Payments to foreign residents who are:

Administration Regulations 2017 • engaged in construction and infrastructure projects
(TAR 2017) rr 31, 32 and 33 • involved in sporting and entertainment activities
• paid by casino operators to come to Australia on a gaming junket, ie
when foreign gamblers are paid to come to Australia for the
purpose of gaming at casinos.

The rate of PAYG withholding is published by the Commissioner (eg for PAYG withheld from wages) or in
the tax law (eg failure to quote a TFN or ABN to a financial institution triggers withholding at the highest
personal marginal tax rate, currently 47% including the Medicare levy).
Pdf_Folio:15

Tax administration and controls 15

For the significant PAYG withholding events described above, the payer must not only remit the PAYG
withheld to the ATO, but also provide information electronically about the parties to whom payments were
made (including TFN and ABN information where available).
Where the payer is an employer, the payer must report their salary and wage amounts, PAYG withholding
amounts and compulsory superannuation contributions to the ATO at the time of payment using single
touch payroll (ie a payroll or accounting software product that automatically provides information to the
ATO each time a payment is made).
There is generally a requirement to use single touch payroll. Employers that have implemented single touch
payroll are not required to complete annual reports or to issue employees with a payment summary.
Instead, employees will interact directly with the single touch payroll system administered by the ATO.
PAYG withholding amounts are required to be remitted to the ATO according to a schedule that is based on
the size of the taxpayer’s payroll. For example, large withholders (ie, organisations with more than $1 million in
PAYG withholding for the prior 12-month period) must remit the amount by electronic funds transfer within
a week of the withholding event. Medium-sized and smaller businesses receive extended time to remit.
Taxpayers are required to comply with their PAYG withholding requirements when paying interest or
royalty payments to non-residents before they can claim an income tax deduction for such payments.
A deduction is not allowed for payments to employees and contractors who have not quoted an ABN if the
payer has not complied with the PAYG withholding rules. Amounts where the payer has not complied with
their PAYG withholding obligations are called non-compliant payments.
A taxpayer is entitled to a credit for PAYG withholding amounts (eg PAYG withheld on salary and wages) at
the time the Commissioner makes an income tax assessment. In other words, the PAYG withholding
amounts reduce the income tax payable by, or increase the income tax refundable to, the taxpayer.
However, not all PAYG withholding amounts are used in this way. For example, PAYG withholding amounts
regarding dividends, interest and royalties paid to a non-resident are treated as a final tax. The taxpayer
does not include the income in their assessable income and is not entitled to reduce their income tax
payable by the related PAYG withholding amounts.

PAYG instalments

The PAYG instalment system collects income tax on a regular basis from business taxpayers,
superannuation funds and individual taxpayers with non-employment income (eg investors whose
investment income disclosed in the most recent tax return is $4,000 or more).
Taxpayers enter the PAYG instalment system by being issued a PAYG instalment rate by the ATO. This rate
is calculated by reference to data on the taxpayer’s most recently lodged income tax return and takes
account of their income, deductions and offset entitlements.

Example 1.1 – Consequences of entering the PAYG instalment system

After several years employed as a director of ABC Accountants, Jalpa is admitted as a partner on
1 July 2022. Up until that date, a PAYG withholding amount was deducted from her salary paid by
the partnership. From 1 July 2022, however, she is no longer an employee and no PAYG withholding
event applies to the monthly partnership distributions she receives.

When Jalpa lodges her tax return for the income year ended 30 June 2023, the ATO will learn for the
first time that she earns partnership income and will issue:

• an income tax assessment relating to the income year ended 30 June 2023
• a PAYG instalment rate notification. The rate will be calculated by reference to the income,
deductions and tax offset information provided in her tax return for the income year ended 30 June
2023. From the quarter in which Jalpa receives this rate notification, she will be obliged to pay
quarterly PAYG instalments.
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16 Tax
 This example also illustrates the important role that tax advisors play in informing their clients when
large payments are due and about cash flow planning. Jalpa should keep money aside from her
partnership income to meet the large tax liability that will arise when she receives her 2023 income
tax assessment. She should also budget for her quarterly PAYG instalments.

Most taxpayers pay PAYG instalments quarterly, either 21 or 28 days after each quarter ends (the exact
date is advised by the ATO).
However, PAYG instalments are payable monthly (instead of quarterly) for all entities with a turnover of
$20 million or more.
On the other hand, concessionary arrangements apply to the following taxpayers:
• Those who are not carrying on a business that requires them to be registered for GST (or are not partners
in a GST-registered partnership) and whose income tax for the previous year was assessed at less than
$8,000 – may pay one annual instalment
• Primary producers, authors, artists and sports persons – may pay two instalments.
A quarterly PAYG instalment may be calculated using either the:
• instalment income method
• gross domestic product (GDP)-adjusted notional tax method.
All taxpayers are entitled to use the instalment income method, but access to the GDP-adjusted notional
tax method is typically restricted to:
• individuals
• companies and superannuation funds that recorded a business or investment income of $10 million or
less in their most recently assessed income tax return.
From 1 July 2021, eligible entities with an aggregated turnover of $10 million or more and less than
$50 million will be able to access the ability to pay PAYG instalments based on GDP-adjusted notional tax.
In the instalment income method, instalments are calculated using the following formula:

Instalment income for the quarter × PAYG instalment rate

Instalment income method

Instalment income for the quarter PAYG instalment rate

For all taxpayers, instalment income is the sum of: The ATO advises the taxpayer of the PAYG instalment
• ordinary income, and rate. It is calculated by reference to the taxpayer’s data
• net gains from Division 230 financial arrangements (ie income, deductions and tax offset entitlements) in
in the quarter for which an instalment is due. the most recently lodged tax return.

Note: Expenses incurred in deriving ordinary income do not The instalment rate can be varied down by the
reduce the instalment income amount because such expenses taxpayer using calculations that are based on their
are taken into account by the ATO in calculating the PAYG current year’s tax data, but excessive variations will
instalment rate. attract an interest charge on the tax shortfall.

PAYG instalments calculated under the GDP-adjusted notional tax method are based on the income tax
liability that arises from the taxpayer’s most recently lodged income tax return adjusted for movements in
GDP (published by the Australian Bureau of Statistics). The ATO notifies taxpayers of the amount and
frequency of GDP-adjusted PAYG payments.
Pdf_Folio:17

Tax administration and controls 17

A taxpayer who considers the amount advised by the ATO as excessive can vary down their PAYG
instalments. Again, excessive variations will attract an interest charge.
PAYG instalments are usually paid either monthly or quarterly to the ATO. Interest can be imposed for
late payment.
For non-business taxpayers, an instalment activity statement (IAS) is used to report PAYG instalment
amounts to the ATO and to allow taxpayers to vary their PAYG instalments.
For business taxpayers, a business activity statement (BAS) is used to report PAYG instalments. It also
records details for other taxes that are administered by the ATO, such as GST and FBT. Business taxpayers
with an annual turnover of $20 million or more must lodge a BAS on a monthly basis. For other business
taxpayers, the BAS is lodged quarterly.
Penalties can apply when a BAS is lodged late.

Inspector-General of Taxation
The office of Inspector-General of Taxation (IGT) is an independent statutory agency which investigates
complaints about the administrative actions of the ATO and TPB. Generally, administrative actions relate to
the conduct of the ATO and the TPB in their interactions with you, including the policies and procedures
which guide these actions.
The IGT also seeks to improve the administration of the tax system for the benefit of all taxpayers by
undertaking broader reviews and making recommendations to the ATO, TPB and to the Government. The
analysis of complaints data can also lead to reviews and drive a culture of continuous improvement and
engagement within the tax system.

1.1.5 Tax sources, guidance, avoidance and evasion

Specific anti-avoidance rules
Overview

A policy statement from the government or an interpretative stance from the ATO will sometimes be
described as an anti-avoidance or integrity measure. In other words, it is aimed at an activity within the
community that, while not necessarily illegal, threatens the revenue base. The government or ATO
announcement will either seek to stop the particular activity or allow the tax benefits to be obtained only if
the taxpayer satisfies specific criteria. For example, in 2022 the ATO announced a crackdown on trust
distributions to family members (eg teenage children and parents) where the controller keeps the cash
(refer s 100A). Another example is the practical compliance guide (PCG 2021/4), which provides safe
harbour guidelines about how much profit professional services firms (eg accountants, lawyers, engineers
etc) can distribute to non-partners. These sorts of announcements effectively provide guidelines which
allow taxpayers to ‘swim between the flags’. In addition, there are also the anti-avoidance provisions in the
tax law. These provisions take three main forms:
1. Provisions with ‘built-in’ anti-avoidance mechanisms, such as s 8-1 which requires an examination of the
taxpayer’s purpose. Where the taxpayer’s subjective purpose is to avoid tax rather than derive
assessable income, no s 8-1 deduction is allowed (refer Federal Commissioner of Taxation v Ilbery (1981)
38 ALR 172, Ure v FCT (1981) ATR 484 and Fletcher v FCT (1991) 22 ATR 613).
2. Specific anti-avoidance legislation that deals with particular types of planning. These include (but are not
limited to) the following:
• General value shifting rules, which address arrangements that shift value out of assets, distorting the
relationship between their market values and their values for tax purposes. Without such a regime,
arrangements could create artificial losses or defer the taxing of gains. There are exclusions to the
regime, thereby targeting more substantial value shifts.

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18 Tax
 • Commercial debt forgiveness rules broadly occurs where a creditor forgives a ‘commercial debt’ owing
by a debtor. Division 245 sets out for tax purposes how the rules may apply where a debt owed by a
taxpayer is forgiven. Where the commercial debt forgiveness rules are triggered, the taxpayer is
required to reduce certain amounts (eg tax losses, net capital losses or the CGT cost base of assets) by
the ‘net forgiven amount’.
• Personal services income (PSI) rules which are contained within Divisions 84 to 87. These provisions
deal with two primary issues relating to PSI and aim to limit the entitlement of individuals to
deductions relating to their PSI and prescribe tax consequences where PSI is diverted to other entities
(referred to as ‘alienation of income’). The provisions do not apply where an individual or interposed
entity is conducting a ‘personal services business’.
3. The tax legislation also contains specific provisions that do not directly deal with particular types of
planning (they are disclosure requirements), but which exist for anti-avoidance purposes. These include:
• the requirement for the Commissioner to publish tax information about certain corporate tax entities
that report total income of $100 million or more. This information includes total income, taxable
income or net income, and income tax payable (s 3C TAA 1953)
• the requirement for Australian businesses of significant global entities to prepare and lodge general
purposes financial statements (s 3CA TAA 1953).
4. A general anti-avoidance rule (GAAR) in Part IVA ITAA 1936, which acts as the ATO’s last line of defence
against anti-avoidance activity and is deliberately framed in broad terms so it can act as a backup. If a
taxpayer manages to circumvent a specific anti-avoidance measure, the general anti-avoidance rules
could still apply. The GAAR is discussed in detail later in this section.

Example 1.2 – Built-in anti-avoidance mechanism under s 8-1

In Fletcher’s case, the court held that s 8-1 should be applied to the taxpayer’s subjective purpose,
particularly in circumstances where the deductible outlay claimed is more than the actual or
expected assessable income.

The case involved the promotion of an annuity plan to individuals who formed a partnership that
paid a large upfront amount (using mostly borrowed funds) to purchase an annuity over 15 years. The
amounts receivable under the annuity were comparatively low in the initial years, resulting in a net
partnership loss that was shared among the partners and claimed as a deduction in their personal tax
returns. The agreement provided that the promoter would redeem the annuity on receipt of a notice
from the partnership indicating that the arrangement could be wound up before the arrangement
ever produced a net profit.

Example 1.3 – The nexus test

Consider a beneficiary of a discretionary trust which borrows at interest and lends interest free to
the discretionary trust. The interest free loan will allow the trust to be more profitable and may
thereby distribute more income to that beneficiary. However, the nexus test in s 8-1 will not be
satisfied because the distribution is at the discretion of the trustee, and this lack of fixed entitlement
to income breaks the nexus chain (refer Taxation Determination TD 2018/9).

General anti-avoidance rules (Part IVA)

General rules

Part IVA ITAA 1936 contains the general anti-avoidance provision which gives the Commissioner the
discretion to cancel a tax benefit that would otherwise be obtained by a taxpayer as a result of a scheme. It
is a provision of last resort, and only applies if the Commissioner makes a determination under
s 177F ITAA 1936 (ie the provision is not self-executing as it needs the Commissioner’s determination
before it is applied). Practice Statement Law Administration (PSLA) 2005/4 contains guidance for the
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Tax administration and controls 19

Commissioner when proposing to make a determination under s 177F ITAA 1936. Taxpayers bear the
burden of proof when contesting an amended assessment resulting from a Part IVA ITAA 1936
determination. Tax practitioners need to carefully consider the possible application of Part IVA ITAA 1936
to income tax planning arrangements, including the higher penalty regime.
Other tax laws such as A New Tax System (Goods and Services Tax) Act 1999 (GST Act) and the Fringe Benefits
Tax Assessment Act 1986 (FBTAA 1986) also contain general anti-avoidance rules. Note that this chapter
focuses solely on Part IVA ITAA 1936.
The three legislative elements of Part IVA are a scheme, a dominant purpose and a tax benefit.
A scheme is defined in s 177A ITAA 1936. It can include a single step in an arrangement Commissioner of
Taxation v Hart (Hart’s case) (2004) 217 CLR 216) or failing to do something (Corporate Initiatives Pty Ltd v
Commissioner of Taxation (2005) 219 ALR 339). In other words, a scheme may be as broad or as narrow as
the Commissioner likes. The Commissioner can also select multiple schemes (refer Minerva Financial Group
Pty Ltd v Commissioner of Taxation [2022] FCA 1092) A scheme does not have to be commercial.
The dominant purpose test in s 177D ITAA 1936 is the key principle (ie the fulcrum) around which Part IVA
is generally based (see later in this chapter for the principal purpose test applicable to members of
significant global entities).
The question is whether a person who entered into or carried out the scheme did so for the dominant
purpose of enabling a taxpayer to obtain a tax benefit. This can be the dominant purpose of the tax
advisors (Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (No 1) (1999) 166 ALR 1) or the
participants in their own right (Hart’s case).
The dominant purpose question is answered by considering the eight factors in s 177D ITAA 1936.
Factors 1 to 3 are concerned with how the scheme was implemented, while factors 4 to 8 are concerned
with the effects of the scheme (see diagram below for details). The eight factors can be considered
together and need not have equal weight (Hart’s case), but they all must go into the consideration mix.
Dominant purpose is determined objectively; the person’s actual subjective purpose is irrelevant
(Hart’s case).
Tax benefit is defined in s 177C ITAA 1936. A tax benefit must arise in connection with a scheme. It does
not include benefits arising from making a choice allowed by the tax legislation, such as the choice to use
diminishing value depreciation rates rather than prime cost or the choice to take advantage of the CGT
rollover provisions (the choice principle) (s 177C(2) ITAA 1936). However, s 177C(2) ITAA 1936 does not
apply if a scheme was done to create circumstances such that the choice could be made (Macquarie Finance
Ltd v Commissioner of Taxation [2004] FCA 1170).
Implicitly, Part IVA ITAA 1936 asks what would have happened, or might reasonably be expected to
happen, if the tax scheme had not been entered into (the counterfactual):

Possible counterfactual When relevant

If scheme did not occur When the scheme has no material non-tax effect (ie the scheme can only be
(annihilation) explained by the creation of the tax benefit). For example, in the context of
(s 177CB(2) ITAA 1936) the making of a tax deductible prepayment, the prepayment scheme is simply
ignored in working out what would have happened if the scheme had not
been entered into (ie the counterfactual)

If scheme did not occur but When the scheme has a material non-tax effect, the taxpayer needs to
something else did (annihilate reconstruct the arrangement to preserve the non-tax effect
and reconstruct) (s 177CB(4) ITAA 1936)
(s 177CB(3) ITAA 1936)
Note: A taxpayer cannot say that a counterfactual is unreasonable simply because of its
tax effect (eg a taxpayer cannot say that the counterfactual was to do nothing)

In effect, the elements are considered together.

Pdf_Folio:20

20 Tax
 Counterfactual
(Must be reasonable and preserve non-tax effect)

Informs Compare to Informs

Scheme:
s 177A
Dominant purpose (s 177D) Tax benefit (ss 177C, 177CB)

Having regard to these factors, it would be Compared against counterfactual, the following
concluded that a person entered into or carried would have occurred, or might reasonably be
out the scheme for the purpose of enabling the taxpayer expected to have occured (s 177CB):
(either alone or not) to obtain a tax benefit (s 177D): • An amount is not assessable but otherwise
1) Manner the scheme was entered into or carried out would be: s 177C(1)(a)
2) Form and substance of the scheme • An amount is deductible but otherwise
3) Time of entry into the scheme and the duration would not be: s 177C(1)(b)
it was carried out • A capital loss is incurred but otherwise would
4) Income tax result achieved but for Part IVA not be: s 177C(1)(ba)
5) Change in financial position of the taxpayer • A foreign income tax offset is available but
6) Change in financial position of anyone connected otherwise would not be: s 177C(1)(bb)
to the taxpayer • Withholding tax is not payable but otherwise
7) Any other consequence to the taxpayer or would be: s 177C(1)(bc)
connected persons • Assessable income is converted to a
8) The nature of any connection between parties discounted capital gain: s 177C(4)
whether business, family or other

The 2023 Budget announced that Part IVA will include a tax benefit where a taxpayer accesses a lower
withholding tax rate. There will also be a tax benefit where the dominant purpose is to reduce foreign
income tax.
When dealing with a Part IVA problem (for entities other than significant global entities), the following
methodology may be useful.
Step 1: Identify the tax effect and the counterfactual.

Example 1.4 – Tax effect and counterfactual: Hart’s case

Mr and Mrs Hart took out a loan to fund both their private home and rental property. The loan had a
special feature that allowed them to direct their monthly repayments to reduce the debt on their
private home and capitalise the interest from the investment property. As a result, the Harts got a
greater deduction than if the repayments reduced both the private and investment
portion respectively.

Tax effect: Deduction for the interest.

Counterfactual: The counterfactual must preserve all the non-tax effect of the arrangement (ie the
borrowing itself) because the scheme has both a tax element (the deduction) and a commercial
element (the borrowing). This means there must still be a loan taken out to fund the two properties
when applying the counterfactual test. The counterfactual must therefore be about the special feature
of the loan – that is, a loan without the special feature. Note the result is the same whether you:
(a) simply delete the special feature and have no substitute, or
(b) delete the loan with the special feature and substitute it with a loan without the special feature.

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Tax administration and controls 21

Step 2: Identify the scheme, dominant purpose and tax benefits.

Example 1.5 – Scheme, purpose, and tax benefit: Hart’s case:

Following the discussion of the Hart’s case above:

Scheme: The counterfactual is a loan without the special feature. The scheme therefore must include
the special feature.

Dominant purpose: The Harts sought and took advantage of the special feature in the loan to obtain
a tax advantage.

Tax benefit: The tax benefit is the extra interest deductions in addition to what they would have
obtained if the loan had no special feature and all repayments reduced the private and investment
portion respectively (see s 177C(1)(b) ITAA 1936).

Step 3: Identify the taxpayers that obtained the tax benefit.

It is important to identify the correct taxpayers who obtained the tax benefit because failure to do so may
result in Part IVA being frustrated: Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359, AXA
Asia Pacific Holdings Ltd v Commissioner of Taxation [2009] FCA 1427. The tax benefit may be shared
between more than one taxpayer (s 177D(1) ITAA 1936).

Example 1.6 – The taxpayer: Hart’s case

Taxpayer: The Harts were the taxpayers who obtained the tax benefit.

Where the Commissioner determines that Part IVA ITAA 1936 applies, the consequences are as follows:
• A tax benefit may be cancelled under s 177F ITAA 1936 and compensating adjustments made, if
necessary. The Commissioner has up to four years (not the usual two for some taxpayers) to amend an
assessment (s 170(1) Item 4 ITAA 1936).
• A penalty may be imposed under s 284-155 of Schedule 1, TAA 1953 (see Topic 1.1.3) of 50% of the
scheme shortfall amount (25% if the tax position is reasonably arguable). This amount is doubled for
significant global entities unless the tax position is reasonably arguable.

Example 1.7 – Evidence which may trigger a Part IVA issue

A taxpayer asks their accountant about how they could sell their company and minimise tax. The
accountant writes an email which starts off:

‘Dear Fred, I understand that you would like to sell your shares in XYZ and that you would like to
structure the sale so as to minimise your tax. I recommend that you structure the sale as follows so
as to reduce your tax …’

This sort of statement is highly probative evidence that would be used by the Commissioner to start
a Part IVA investigation.

Example 1.8 – Proceeds conversion transaction with potential to trigger Part IVA
investigation
A company wants to sell another company (X). Rather than selling X and paying capital gains tax,
franked dividends are paid pre-sale by X for the dominant purpose of reducing the sale price and
hence the capital gain. In other words, there has been a tax benefit by converting a taxable gain into
a dividend which would be subject to an offset (ie an assessable income substitution can be a tax
benefit). Part IVA can apply to this sort of transaction (refer IT 2456).
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22 Tax
 A similar concern would arise if the capital gain was converted into an exempt section 768-5
dividend (eg if shares in a CFC were sold).

On the other hand, if the dominant purpose of converting the one type of assessable income to
another was motivated by sound commercial considerations, Part IVA would not apply.

Required reading
ITAA 1936, Part IVA: Sections 177A(1), 177A(3), 177C, 177CB and 177D.

Significant global entity rules

Under s 960-555 of the Income Tax Assessment Act 1997 (ITAA 1997), an SGE includes:
• a global parent entity that has annual global income of $1 billion or more (ie total annual income as shown
in its audited global financial statements), or is the subject of a determination by the Commissioner
• a member of an accounting consolidated group where one of the other members is a global parent entity
that is an SGE
• a member of a notional listed company group (NLCG) where one of the other members is a global parent
entity that is an SGE.
Under s 960-575, an NLCG is a group of entities that would be required to consolidate for accounting
purposes if it was headed by a listed company rather than another type of entity (eg a trust, partnership or
investment company).
Note: A higher penalty regime applies to SGEs.

As noted above, the three legislative elements of the general anti-avoidance rules in Part IVA ITAA 1936
are a scheme, a dominant purpose and a tax benefit. When applying these elements to an SGE entity, the
dominant purpose test may be replaced by the principal purpose test in s 177DA ITAA 1936.
Section 177DA is commonly referred to as the multi-national anti-avoidance law (MAAL). It is targeted at
artificial or contrived arrangements used to avoid having a taxable presence in Australia.
Section 177DA applies if, under a scheme or in connection with a scheme:
• a foreign entity (that is an SGE) makes a supply to an Australian customer
• an Australian entity (or permanent establishment), that is an associate of, or is commercially dependent
on the foreign entity, undertakes activities in Australia directly in connection with the supply
• some or all of the income derived by the foreign entity is not attributable to an Australian permanent
establishment
• the principal purpose, or one of the principal purposes of the scheme, was to obtain an Australian tax
benefit or to obtain both an Australian and foreign tax benefit.
When applying the above requirements, supplies made by a trust or partnership to Australian customers
and income received from these supplies are treated as being made or received by a foreign entity if the
trust or partnership satisfies certain conditions. The trust or partnership will satisfy these conditions if it:
• has at least one foreign entity participant (broadly, a potential ultimate recipient of income of the trust or
partnership that is a foreign entity)
• is connected with the foreign entity, would be an affiliate of the foreign entity if the trust or partnership
was an individual or a company, or is part of a global group that also includes the foreign entity.
The principal purpose is determined under s 177DA(2) ITAA 1936 by considering:
• the eight factors in s 177D ITAA 1936 (see earlier under the general anti-avoidance rules)
• the extent to which the activities are performed, and can be performed by the foreign entity, associated
Australian entity or permanent establishment
• the result, under a foreign tax law, that would be achieved by the scheme (ignoring the application of this
provision).
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Tax administration and controls 23

For further ATO guidance on the application of the principal purpose test to significant global entities see
LCR 2015/2 and TD 2018/12.

Required reading
ITAA 1936, Part IVA: Section 177DA.

The diverted profits tax (DPT) is included in the legislation as an extension to the general anti-avoidance
measures in Part IVA ITAA 1936. The purpose of the DPT is to prevent significant global entities from
reducing the amount of Australian tax they pay by diverting profits offshore through contrived
arrangements between related parties.
Under s 177J ITAA 1936, the DPT is broadly applicable:
• to Australian resident entities (or permanent establishments of foreign entities) that are members of a
multi-national group that is an SGE
• where there is a scheme entered into with a foreign related party (within the meaning of associate in
s 318 ITAA 1936) for the principal purpose of obtaining a DPT tax benefit
• where it is reasonable to conclude that none of the following tests are satisfied:
– $25 million income test (s 177K ITAA 1936)
– a de-minimis threshold that exempts Australian subsidiaries of offshore companies with combined
Australian turnover of less than $25 million, except where income is being artificially booked offshore.
– sufficient foreign tax test (s 177L ITAA 1936)
– the profit is diverted to a country where the tax paid on that income equals or exceeds 80% of the tax
that would have been paid in Australia.
– sufficient economic substance test (s 177M ITAA 1936)
– where it is reasonable to conclude that the arrangement was not designed to secure a tax reduction.

Under s 177P ITAA 1936, a DPT liability will only arise when the Commissioner issues an assessment, it is
not a self-assessed tax. If the DPT applies, the Diverted Profits Tax Act 2017 will impose tax on the amount
of the diverted profit at a rate of 40%.
For example, these rules may apply when there is a foreign company that engages an Australian agent to
make sales to Australian entities, and therefore only a small percentage of the profit is taxed in Australia.

Global minimum corporate tax rate

On 20 December 2021, the OECD released the Pillar Two Model Rules for reforms to the international tax
system, which will introduce a global minimum corporate tax rate of 15% for certain multinational
enterprises. The 2023 Budget announced that Australia will adopt legislation to implement the OECD Pillar
Two rules, effective for income years commencing on or after 1 January 2024.

1.1.6 Tax technology (data, analytics and data matching,

automation and other technology including robotic process
automation)
Overview
The ATO has two aspirations for 2024 as outlined in the ATO Corporate Plan 2020–21, which includes
building trust and confidence, and being streamlined, integrated and data driven. Underpinning the ATO’s
purpose are eight key strategic objectives of which technology, digital services and the use of data is a key
focus area. The following comments briefly summarise how the ATO is using technology and data based on
publicly available information.
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24 Tax
Data and analytics
Digitisation, data matching and analytics capability have changed the way the ATO does business.
Digitisation has created huge benefits for the ATO, taxpayers and tax practitioners. It allows the ATO to
deal with taxpayers in real time.
Data and analytics help the ATO receive, match and pre-fill large volumes of data from third-party providers.
For example, third-party information is compiled electronically, validated, analysed and used for a range of
education and compliance activities and allows the ATO to:
• pre-fill tax returns
• protect honest people and businesses from unfair competition
• ensure tax returns and activity statements are lodged on time
• ensure taxpayers correctly declare their income and claim offsets and other benefits
• ensure taxpayers comply with their obligations.
The data helps the ATO make better, faster and smarter decisions with measurable results and to solve
problems. Data and analytics provide the ATO with a real-time view of a taxpayer’s:
• tax and super position
• current circumstances
• previous history with the ATO.
The data and analytics helps the ATO to find taxpayers who are not doing the right thing. Data matching
identifies taxpayers which:
• are understating their income
• operate outside of the system
• are not lodging returns or other documents.
It also allows the ATO to offer digital services which reduce the time spent on tax by taxpayers, thereby
simplifying compliance and helping meet community expectations.
Data is used to understand emerging trends and patterns in industries and businesses. It also identifies
where products need to be developed to help taxpayers understand their tax obligations.
The ATO uses nearest neighbour methods to compare amounts being entered into myTax with those of
similar people. If a disparity arises, a warning message appears on the screen prompting them to
double check.
Single Touch Payroll (STP) brings in real-time reporting of employment data in line with pay cycles. It
provides greater insights during the year and gives employees greater visibility of their pay and
superannuation in myGov.
Country-by-Country (CbC) reports are interfaced and exchanged electronically with partner jurisdictions.
This allows fast and flexible data mining, and visualisations across datasets and jurisdictions so resources
can be allocated appropriately.
Robotic process automation is replacing repetitive factual tasks, freeing tax officers for higher-value work.
Virtual assistants, agents and chat-bots are used to find answers to simple queries.

Validating source information

Integrity checks are conducted to confirm the quality of data received from third parties. This includes:
• identity checks
• duplicate checks
• matching data to records on the ATO systems
• integrity checks.
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Tax administration and controls 25

If source data passes the ATO checks, the ATO uses algorithms and other analytical methods to refine the
data. This validated data is then matched to information reported in tax returns and other documents
which are provided by taxpayers.

Example 1.9 – Data matching reveals dishonest business

A business selling horse-riding equipment on an online selling platform with sales of $1,280,003 was
selected for review. The ATO discovered the owner had registered the account in another person’s
name and was selling unbranded horse saddles made by his parent’s company in China. The ATO also
found another online selling account and a website where no income was reported from either source.
A specialised payment system account linked to this account and the website were linked to the
owner’s personal bank account and showed significant AUSTRAC activity to Chinese bank accounts.

An audit determined the entity had been under-reporting income and over-reporting expenses for
the life of the business. The entity did this by never declaring income on export sales, including
unsubstantiated expenses in their income tax return and non-business activity statement expenses in
activity statement purchases.

The owner had to pay $103,263 in GST, $259,298 unpaid income tax and penalties of $181,280.
Source: ATO website: www.ato.gov.au/About-ATO/Commitments-and-reporting/In-detail/Privacy-and-information-
gathering/How-we-use-data-matching/?page=5

Example 1.10 – Deleted emails

Combstock Pty Ltd entered into a transaction many years ago which was driven by tax
considerations. There were numerous emails between Combstock and its tax advisor where the tax
avoidance purpose was made fairly clear. These emails were subsequently deleted.

Combstock is subject to a tax audit. The ATO inquired about the purpose of the transaction.
Combstock provided some minutes which implied that there was a commercial purpose behind the
transaction.

The ATO audit team engaged its IT specialists to reinstate all deleted emails in the 6-month period
before the transaction. An algorithm was used which flagged all emails with certain keywords; all
emails with the tax advisor and all emails with the word tax in them.

The ATO then reviewed each flagged email and quickly discovered that the minutes did not reflect
the real tax-driven purpose. In fact, the ATO found that the minutes were written by the tax advisor.

Armed with this information, the ATO issued Combstock with a Part IVA assessment.

Automated intelligence

Taxpayers call the ATO for advice and information. These calls are transcribed using speech recognition.
Transcripts are used for quality assurance and to detect patterns and trends in the caller topics. For
example, a spike in calls on a particular matter will alert the ATO of a pending issue to review. Caller
sentiment is also monitored.

Training algorithms

Machine learning is a form of artificial intelligence which is used to make sense of large amount of data
from emails, word documents and other source material.
Data sets are created to train machine learning models which detect patterns and relationships (eg key
words) between people and entities. Algorithms categorise trends by, for example, searching for keywords
and training an algorithm to categorise them in a certain way.
Call centre volumes are also subject to machine learning algorithms.

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26 Tax
Security

The ATO ensures the integrity and security of client data. Digital service providers (DSPs) must meet
various requirements by providing:
• data encryption to protect the confidentiality and integrity of client data
• multi-factor authentication for users who can access tax or superannuation-related information of other
entities or individuals
• onshore data hosting by default, to limit the risk of non-authorised access to client data.
There is a comprehensive cyber security framework, ensuring the confidentiality and reliability of
digital services.

ISRA tool

The ATO has an Information System Risk Assessment (ISRA) tool which is available for business clients and
advisors to self-assess the integrity of their IT systems. The risk-assessment tool helps establish if the IT
systems are well governed with appropriate controls to help a business meet their tax and superannuation
reporting obligations.

Information exchange with other government agencies

The ATO provides income information derived from tax returns to other government departments to
determine the eligibility criteria for benefits and to help detect fraud.
Other government departments also share information with the ATO (such as tax file number (TFN) and
identity details).
The following types of information are typically exchanged:
• personal identity
• declared income
• date of most recent taxation assessment
• amount of the spouse tax offset
• surname and any other name details of the spouse where a spouse offset has been claimed
• surname and any other name details
• an indicator, if the TFN is compromised.

Example 1.11 – Flights to and from Australia

The ATO recently audited a former taxpayer who is now purportedly living overseas. However, the
ATO noticed that she was often in Australia on business and that there are personal assets and family
ties in Australia. With this in mind, the ATO decided to test whether she was a resident.

Data was obtained from customs which showed that the taxpayer travelled to Australia 20 times
during the last financial year and from Australia 20 times. They also established that the taxpayer
stayed in Australia for around 10 days on each occasion, including weekends and public holidays.

Based on the data received from customs, the ATO issued the taxpayer an assessment on the basis
that she was an Australian resident. The ATO then goes back and repeats the same exercise for
earlier years.

Example 1.12 – Money from Russia

The ATO recently audited a Russian national who is now residing in Australia. The ATO obtained
bank transactions from their bank and they noticed that there were numerous deposits which
represent money transfers from Russia.

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Tax administration and controls 27

 The ATO contacted AUSTRAC which provided the ATO with a summary of all transactions exceeding
$10,000 which came into Australia through Russian money exchange agents.

The ATO tried to match the AUSTRAC information with the bank details.

There were a number of deposits which do not match.

The ATO extended its audit to other family members, including spouses and children. The deposits
now match up.

The ATO asked the Russian national what the amounts represent. The Russian national said that they
did not know and the ATO made the assumption that the amounts were income. The onus of proof was
on the Russian national to prove that the amounts were not income. In the absence of such proof, the
ATO issued them with an assessment on the basis that the amounts represented assessable income.

Chapter summary
This chapter covered various aspects of professional conduct, tax risk and governance, tax administration,
tax sources, guidance, avoidance and evasion and tax technology.

Professional conduct
As discussed, professional conduct is represented in the codes by which members and tax advisors are
obliged to comply, including their ethical responsibilities. This chapter covered the professional and ethical
requirements, criminal legislation and common law duty of care. It also covered the conduct of tax agents
including their safe harbour concessions and regulations.
Clients typically expect their tax advisor to have an appropriate risk transparency in place to help them
make an informed decision about whether or not to accept the advice provided. Fully appraising a client of
the risk of the ATO taking a different or opposite view and, where necessary, quantifying that risk, are
important responsibilities of a tax advisor.

Tax risk and governance

Having a reasonably arguable position is a pivotal requirement in most tax matters. This chapter discussed
the ATO’s Tax Risk Management and Governance Review Guide and its use when reviewing companies to
determine what the current control environment is and whether it is operating effectively. The ATO’s
specific powers of enforcement and the limits of the Commissioner’s powers due to legal professional
privilege were discussed. After outlining a taxpayer’s record-keeping requirements, this chapter discussed
the uniform administrative penalty regime and the interest regime.

Tax administration
Next, this chapter examined tax administration covering the pay as you go (PAYG) collection process which
is comprised of PAYG withholding and PAYG instalments.

Tax sources, guidance, avoidance and evasion

There are numerous anti-avoidance and integrity provisions which are designed to maintain the integrity of
the tax system. This chapter introduced specific anti-avoidance provisions such as the value shifting and
Pdf_Folio:28

28 Tax
commercial debt forgiveness rules and covered the general anti-avoidance rules under Part IVA. In particular,
the three legislative elements of Part IVA were explained, ie a scheme, a dominant purpose and a tax benefit.

Tax technology
Finally, the chapter highlighted how the ATO is using technology, digital services and the use of data as
outlined in the ATO Corporate Plan 2021–22. Technology and data are used by the ATO to help streamline
the collection and enforcement of various functions. The ATO also uses technology to help determine
whether tax planning has potentially transcended into avoidance and where further investigation is
required. By sharing information between government departments, the ATO has a wealth of information
which it can access.

Pdf_Folio:29

Tax administration and controls 29

Pdf_Folio:30
CHAPTER 2

Income tax – general rules

Chapter introduction
A fundamental feature of Australian income tax law is the framework for calculating an entity’s taxable
income and income tax payable or refundable. The Income Tax Assessment Act (ITAA) requires this
calculation each financial year by each individual and company, and by some other entities. Taxable income
is the tax base upon which income tax payable is calculated, by applying the relevant income tax rates and
subtracting applicable offsets.
Taxable income is comprised of two elements, assessable income and deductions. For most taxpayers
calculating taxable income is relatively straightforward. However, for high-wealth individuals and business
taxpayers, more complex scenarios can arise for both elements of taxable income. This chapter builds on
your knowledge of assessable income and deductions by focusing on items such as reimbursements, sale of
WIP, profit-making undertakings, lease payments, entertainment and mortgage discharge expenses.
Most taxpayers have property and enter into capital transactions. The tax treatment depends on the type
of property and the application of the specific provisions of the Tax Acts.
For example, if the property is plant, the cost of the plant is claimed as a tax deduction over its useful
life. However, this principle is often overridden by special tax concessions which are designed to provide
tax incentives to acquire equipment and stimulate the economy.
Temporary full expensing is an example of such a measure. By allowing an outright deduction for plant, it
encourages taxpayers to spend, which in turn stimulates demand.
Taxpayers therefore need to understand the broad policy objectives underpinning the application of the
tax law.
The cost of trading stock is typically matched against the revenue from the sale of stock. Again, there are
special rules which deal with unusual circumstances such as a change in the ownership of stock, non-arm’s
length transactions and a range of other circumstances.
In practice, capital gains tax (CGT) is the most common tax that applies upon the acquisition or disposal of
an asset. Whenever there is an acquisition or sale of an asset, the CGT provisions are enlivened in one form
or another. Not only are there basic rules dealing with cost base and capital proceeds, there is a range of
integrity measures which complicate matters. A comprehensive understanding of CGT is critical.
Understanding the interaction between the various property provisions and the CGT provisions is
complex. The interaction and co-existence of these provisions, and how they work together, will make the
tax advisor a better tax advisor and provide better tax outcomes for clients.
This chapter explores all these types of issues.

Pdf_Folio:31

Income tax – general rules 31

2.1 Income tax
This topic builds on the candidates’ knowledge of the fundamental features of the Australian income tax
law, through the framework for calculating an entity’s taxable income and tax payable.
The basic tax equation in s 4-10(3) ITAA 1997 is the core income tax principle. Chapters 2 and 3 build on
your assumed knowledge of these topics.
Taxable income s 4-15(1):

Taxable income = Assessable income – Deductions

Ordinary income Statutory income General deductions Specific deductions

General principles
Specific inclusions
[2.1.3]
[2.1.3 ] Specific inclusions
Employment General principles
Capital gains [2.2.4 [2.1.4]
remuneration [4.2] [2.1.4]
–2.2.5] Capital allowances
International issues Tax structures [3.1]
Trading stock [2.2.1–2.2.2]
[3.2.1]
[2.2.3]
Tax structures [3.1]

Income tax payable = Taxable income × Tax rates – Offsets – Credits

Tax administration Tax offsets [2.1.5]

& collection [1.1.4] Tax rates [2.1.6] Imputation [3.1.1]
Tax structures [3.1] FITO [3.2.1]

2.1.1 Application (including residence and source)

To be able to calculate the assessable income of a taxpayer, it is necessary to have an understanding of
two key concepts:
• residence
• source of income.
These concepts are important because Australian tax residents are generally taxed on income from all
sources worldwide, whereas non-residents are only taxed on Australian-sourced income. Income tax rates,
tax offsets and levies are also dependent on whether the taxpayer is a resident or non-resident.

Australian resident Foreign resident

taxpayer taxpayer

Assessable income includes Assessable income includes

ordinary income and statutory ordinary income and statutory
income from all sources income from Australian sources
(ss 6–5(2), 6–10(4)) (ss 6–5(3), 6–10(5))
Pdf_Folio:32

32 Tax
Source of income
Determining the source of income is a matter of fact and different source rules are applied to different
types of income. Because of the increasing globalisation of business and developments in e-commerce and
cloud computing, this area of tax law is evolving. You should be familiar with the sources of common types
of income. Taxation of Australian-sourced income for non-residents is covered in Chapter 3.

Resident individual
Four tests in s 6(1) ITAA 1936 are used to determine whether an individual is a resident on a year-by-year
basis. You should be familiar with these tests; to recap, a person who satisfies any of the four tests will be
categorised as a resident. If all four tests are not satisfied, the person will be a non-resident. The four
tests are:
• resides test
• domicile test
• 183 day test
• superannuation fund test.
Topic 3.2 discusses more complex issues.

Residency test for individuals

There are a number of steps involved in testing individuals for residency. These steps are detailed in the
text and figure below. Also refer to taxation ruling TR 2023/1 for a detailed overview of the residency tests.

Step 1 – Ordinary concepts test

Apply the ordinary concepts test (s 6(1) ITAA 1936). If the individual is a resident of Australia under the
ordinary concepts test, go to Step 5. Otherwise, proceed to Step 2.
The ordinary concepts test is the primary test. A person will be a resident of Australia if they reside in
Australia within the ordinary meaning of ‘resides’.
The relevant factors to consider when determining where the person resides include:
• the purpose or intention of their presence in Australia — it is necessary to consider actual behaviour as
well as subjective intention
• the person’s family and business/employment ties
• where their assets are located and maintained — a person can maintain residences in more than one
country but not necessarily reside in all of them
• the person’s social and living arrangements — this indicates the place where the person lives the ordinary
course of their life.

Step 2 – First statutory test (the domicile test)

Apply the first statutory test – the domicile test (s 6(1) ITAA 1936). If the individual is a resident of
Australia under the domicile test, go to Step 5. Otherwise, proceed to Step 3.
A person will be a resident if their domicile is in Australia, unless the Commissioner is satisfied that the
person has a permanent place of abode outside Australia.
A person’s domicile is the place that is:
• considered by law to be their permanent home; and
• usually something more than a residence.
Pdf_Folio:33

Income tax – general rules 33

Domicile is a legal concept determined under the Domicile Act 1982 and the common law rules that have
been developed. The general rules are:
• a person’s domicile by origin is acquired at birth and is the country of their father’s permanent home
• a person may change their domicile and acquire a domicile of choice by choosing to live permanently and
indefinitely in another country
• a domicile can be imposed by operation of law where, for example, an infant’s parents change their
domicile or when a person marries
• there is no requirement that the person have a permanent fixed address in a particular location to have a
domicile. A domicile can be a city, town or country.
The domicile test extends the concept of residence so that a person who is not a resident of Australia
under the ordinary concepts test may nonetheless be a resident under the domicile test.

Step 3 – Second statutory test (the 183-day test)

Apply the second statutory test – the 183-day test (s 6(1) ITAA 1936). If individual is a resident of Australia
under the 183-day test, go to Step 5. Otherwise, go to Step 4.
A person will be a resident if they have been in Australia continuously or intermittently during more than
one half of the year of income – unless the Commissioner is satisfied that:
• the person’s usual place of abode is outside Australia; and
• they do not intend to take up residence in Australia.
The phrase ‘usual place of abode’ should not be given the same or similar meaning as the phrase
‘permanent place of abode’, which is used in the first statutory test.
The terms usual and abode should be given their ordinary meaning.
‘Usual’ means current, ordinary, customary; ‘abode’ means habitual residence, place of habitation, house or
home. For example, a foreign visitor enjoying an extended holiday in Australia would not ordinarily be
treated as a resident of Australia.

Step 4 – Third statutory test (the superannuation test)

Apply the third statutory test – the superannuation test (s 6(1) ITAA 1936). If the individual is a resident of
Australia under the superannuation test, go to Step 5. Otherwise, the person is a non-resident. Refer to the
discussion below regarding non-residents.
A person (and their spouse and children under 16 years of age) will be a resident of Australia if they are:
• members of the superannuation scheme established under the Superannuation Act 1990; or
• an eligible employee for the purposes of the Superannuation Act 1976.
The third statutory test is designed to ensure that the Commonwealth government employees working at
Australian posts abroad (such as diplomats and officials of the Department of Foreign Affairs and Trade) are
treated as Australian residents. Both the Superannuation Act 1990 and the Superannuation Act 1976 include
permanent and some categories of temporary employees in their definition of member or eligible
employee. A person who is not employed by the Australian Public Service would generally fail this test.

Step 5 – Temporary resident test

If the taxpayer is a temporary resident (Subdivision 768-R ITAA 1997), go to Step 6. Otherwise, go to Step 7.
An individual is a temporary resident if:
• the individual holds a temporary visa granted under the Migration Act 1958 – such temporary visas may
not have any time limits;

Pdf_Folio:34

34 Tax
• the individual is not an Australian resident within the meaning of the Social Security Act 1991 (refer
below); and
• the individual’s spouse (if applicable) is not an Australian resident within the meaning of the Social
Security Act 1991).
For the purposes of the Social Security Act 1991, an Australian resident is generally a person who resides in
Australia and:
• is an Australian citizen;
• holds a permanent resident visa; or
• was in Australia on or before 26 February 2001 on a protected special category visa.

Step 6 – Paying tax on income earned in Australia

For tax purposes, temporary residents (Subdivision 768-R ITAA 1997) are generally required to pay tax on
income earned in Australia. They do not have access to social welfare benefits or national public health cover
(eg Medicare). Temporary residents are generally subject to tax on income earned in Australia at ordinary
marginal rates and can access the tax-free threshold as if they are an Australian resident (see Step 7).
Temporary residents are generally not subject to tax in Australia on foreign source income (with the
exception of foreign source employment or services income). Moreover, capital gains derived by temporary
residents are generally not subject to tax in Australia where the capital gains relate to an asset which is not
taxable Australian property (s 855-15 and 855-20 ITAA 1997).

Step 7 – Include all ordinary and statutory income

An individual is an Australian resident taxpayer and is required to include in their assessable income all
ordinary and statutory income derived both in Australia and overseas (s 6-5(2) ITAA 1997). A foreign
income tax offset may be available to reduce the Australian tax payable on foreign income where foreign
income tax has been paid on that foreign income (Subdivision 770-B ITAA 1997).
The following figure provides an overview of the steps for determining residency of an individual.

Pdf_Folio:35

Income tax – general rules 35

 Pdf_Folio:36

36
Tax
Apply the ‘ordinary Apply first statutory test – Apply second statutory Apply third statutory Is the taxpayer a Temporary residents are Australian resident
concepts test’ (s 6(1) the domicile test (s 6(1) test – the 183-day test test – the superannuation temporary resident generally subject to tax on taxpayers are required to
ITAA 1936). If individual ITAA 1936). If individual is a (s 6(1) ITAA 1936). If test (s 6(1) ITAA 1936). (Subdivision 768-R income earned in Australia include all ordinary
is a resident of Australia resident of Australia under individual is a resident If individual is a resident ITAA 1997)? at ordinary marginal rates and statutory income
under ordinary concepts domicile test go to Step 5 of Australia under the of Australia under the and are able to access derived both in Australia
test go to Step 5 otherwise otherwise go to Step 3. 183-day test go to Step 5 superannuation test go to If yes, go to Step 6, the tax-free threshold and overseas (s 6-5(2)
go to Step 2. otherwise go to Step 4. Step 5 otherwise the otherwise go to Step 7. as if they are an Australian ITAA 1997) in their
person is a non-resident. resident, see Step 7. assessable income.

APPLY THE
APPLY THE ‘ORDINARY APPLY THE APPLY THE ‘THIRD IS THE TAXPAYER A PAYING TAX ON INCLUDE ALL ORDINARY
‘SECOND STATUTORY
CONCEPTS TEST’ ‘DOMICILE TEST’ STATUTORY TEST’ TEMPORARY RESIDENT? INCOME EARNED AND STATUTORY INCOME
TEST’

Step Step Step Step Step Step Step

1 2 3 4 5 6 7

ORDINARY CONCEPTS TEST DOMICILE TEST SECOND STATUTORY TEST THIRD STATUTORY TEST TEMPORARY RESIDENT? TAX ON INCOME EARNED ORDINARY AND
STATUTORY INCOME

This is the primary test. A person will be a resident A person will be a resident A person (and their spouse An individual is a temporary Temporary residents are A foreign income tax offset
A person will be a resident if their domicile is in if they have been in and children under 16 years resident if the individual generally not subject to tax in may be available to reduce
of Australia if they reside Australia, unless the Australia continuously or of age) will be a resident of holds a temporary visa Australia on foreign source the Australian tax payable on
in Australia within the Commissioner is satisfied intermittently during more Australia if they are members granted under the Migration income (with the exception of foreign income where foreign
ordinary meaning of that the person has a than one half of the year of of the superannuation scheme Act 1958, the individual is foreign source employment or income tax has been paid on
resides. permanent place of abode income – unless the established under the not an Australian resident services income). that foreign income
outside Australia. Commissioner is satisfied Superannuation Act 1990 or within the meaning of the (Subdivision 770-B of
that: an eligible employee for the Social Security Act 1991 the ITAA 1997).
1. the person’s usual place purposes of the and the individual's spouse
of abode is outside Superannuation Act 1976. (if applicable) is not an
Australia; and Australian resident within
2. they do not intend to the meaning of the Social
take up residence in Australia. Security Act 1991.
As part of the 2021–22 Federal Budget, the government announced that it will replace the individual tax
residency rules with new primary and secondary tests to determine residency, based on the Board of
Taxation’s recommendations.
The primary test will be a simple ‘bright line’ test under which a person who is physically present in
Australia for 183 days or more in any income year will be an Australian tax resident.
Individuals who do not meet the primary test will be subject to secondary tests that will depend on a
combination of physical presence and measurable, objective criteria.
The new tests are proposed to commence from the first income year after Royal Assent of the enabling
legislation.

Required reading
Section 6(1) ITAA 1936 – definition of a resident individual.

Resident company
Under the definition of resident in s 6(1) ITAA 1936, a company is resident in Australia if it meets the
requirements of either of the statutory tests outlined in the following table. It is important to note that
double tax treaties may impact the tax treatment of companies that are considered to be tax resident under
more than one country’s domestic law. The comments below do not consider the impact of double tax
treaties, which is outside the scope of this subject.

Tests of company residency

Test Explanation

First statutory test – A company Place of incorporation is a question of fact, ascertained by searching
incorporated in Australia the company register maintained by the Australian Securities and
Investments Commission (ASIC).

Second statutory test – A company Place of carrying on business is a question of fact, ascertained by
not incorporated in Australia but which looking at the relevant facts and circumstances. Business can include
carries on business in Australia and both active operations (eg selling goods or services, manufacturing
either (a) or (b) below applies: or mining operations) and passive operations (eg investments in
property or shares).
A passive investment business tends to be carrying on business
where the central management and control is undertaken (Malayan
Shipping Co Ltd v FCT (1946) 71 CLR 156). The same position may
also apply for an active trading business (see below for the
ATO’s view).

Pdf_Folio:37

Income tax – general rules 37

 Tests of company residency

Test Explanation

(a) central management and control This requirement focuses on the who, when and where of a
(CMC) are in Australia company’s strategic decision-making (ie where management and
control decisions at the highest level are made (Koitaki Para Rubber
Estates Ltd v FCT (1941) 64 CLR 241)). Where effective control and
decision-making is in Australia, and the offshore board is a mere
rubber stamp, central management and control will be in Australia
(see Bywater Investments Ltd v FCT (2016) 260 CLR 169, which
distinguished the decision in Esquire Nominees Ltd v FCT (1973) 129
CLR 177 in the context of an offshore company that was controlled
in Australia).
This area of law is evolving. Because of the advances in technology
and e-commerce, many of the old cases are now outdated. Physical
location is becoming less relevant. Many board meetings are now
held by phone or via email exchange.
The ATO has released its view on central management and
control and whether a company carries on business in Australia in
TR 2018/5. In the ATO’s view, if the central management and
control of a company is in Australia, then the company is
carrying on business in Australia, and is thus a resident. Previously,
the ATO’s view was that the location of central management and
control of a company and where that company carries on business
could be different (eg central management and control could be in
Australia without the company carrying on business in Australia) –
see withdrawn taxation ruling TR 2004/15W.

The ATO has also released additional guidance on where a company’s

central management and control is located in PCG 2018/9.
In the 2020–21 Federal Budget, the government announced the
intention to amend the law to provide that a company that is
incorporated offshore will be treated as an Australian tax resident if
it has a ‘significant economic connection’ to Australia. This test will
be satisfied where the company’s core commercial
activities are undertaken in Australia, and its central management
and control is in Australia. This is proposed to take effect from the
first income year after the date of Royal Assent. No further
comment can, as yet, be made about these new measures until these
new rules are enacted. Given the change of government, the
enactment of this legislation is a ’wait and see’.

(b) voting power is controlled by The residence of the shareholders who control the voting power is a
shareholders who are Australian question of fact. A change of shareholder residence may trigger a
residents. change of residence for the companies they control.

Required reading
Section 6(1) ITAA 1936 – definition of a resident company.

The next example illustrates the application of the statutory tests.

Pdf_Folio:38

38 Tax
 Example 2.1 – Tax residence of company

Energy Inc (Germany)

Energy Inc branch (China) Subsidiary company

(Permanent establishment) (Netherlands)

Energy Inc (Energy) is a renewable energy company incorporated in Germany, with a solar panel
manufacturing plant in China (a permanent establishment). The majority of Energy’s shareholders are
resident in Germany. Energy has nine directors, two of whom reside in Australia. The board meetings
are held in Sydney because the two Australian directors are renewable energy experts and make all
the high-level decisions for Energy. The other directors reside in Germany, where the head office is
located, and these directors implement all the high-level decisions made by the Australian directors.

Energy fails the first statutory test of tax residence in s 6(1) as it is not incorporated in Australia. It
appears that Energy carries on business in China where its manufacturing plant is located however,
based on the decision in Bywater Investments Ltd & Ors v FCT and TR 2018/5, central management
and control (CMC) is located where the real decision makers are located. The key element in control
and management of a company is making of high-level decisions, rather than the physical location of
the directors. Because the Australian directors make the high-level decisions for Energy, the CMC is
in Australia.

Accordingly, while Energy is not incorporated in Australia, it is an Australian tax resident because its
CMC is in Australia, and therefore it carries on business in Australia.

Note that the amendment announced in the Federal Budget would result in Energy not being
considered a resident as it does not have a ‘significant economic connection’ to Australia. In this case,
Energy would only be taxed in Australia on Australian-sourced income. As this is not yet law, further
consideration of the Budget announcement is outside the scope of this topic.

Below is a summary of the income tax treatment of several of Energy’s income and deductions:

Issue and explanation Reference Explanation

1. Sale of solar panels

Energy is assessable on its s 6-5 ITAA 1997 Australian tax residents are
worldwide income assessable on their worldwide
income. Therefore, if Energy is
an Australian tax resident, it is
assessable on the worldwide
sale of the solar panels.

Income is non-assessable s 23AH ITAA 1936 Energy’s sales income is foreign

non-exempt income (NANE) to income and attributed to
the extent that the income is carrying on a business through
foreign and attributed to an overseas branch, the income
a branch is NANE income under s 23AH.

2. Cost of manufacturing facilities

Expenses incurred in deriving s 8-1 ITAA 1997 Energy’s operating costs are
s 23AH NANE income are not incurred in deriving foreign
deductible branch income that is NANE
income, the costs are not
deductible under s 8-1.

Pdf_Folio:39

Income tax – general rules 39

 Issue and explanation Reference Explanation

3. Dividends from Netherlands subsidiary

Foreign dividend income from a s 768-5 ITAA 1997 Energy holds all of the shares in
non-portfolio interest is NANE the Netherlands subsidiary (ie it
income holds a non-portfolio interest
equal to 100%, which is ≥ 10%),
the dividends received by
Energy will be NANE income
under s 768-5.

4. Interest expense

Deductible to the extent s 8-1 ITAA 1997 Interest incurred in deriving

working capital is used to assessable sales income is
derive assessable income deductible under s 8-1.
(eg Australian-sourced sales
income)

Not deductible to the extent s 8-1(2)(c) ITAA 1997 Interest incurred in deriving
incurred in deriving s 23AH s 23AH NANE branch income is
NANE branch income not deductible under s 8-1(2)(c).

Deductible to the extent s 25-90 ITAA 1997 Interest incurred in deriving the
incurred in deriving the Netherlands dividends is
Netherlands NANE dividends deductible under s 25-90 as a
debt deduction incurred in
relation to deriving s 768-5
NANE income.
Note: In the May 2023 Budget, the
government announced that this
deduction would be removed from
1 July 2023.

Residency test for companies

Similar to determining residency for individuals, there are a number of steps involved in testing companies
for residency. Steps 1-4 below expand on the tests outlined in the company residency table above. It is
important to note the sequence in applying residency and tax rate tests for a company.

Step 1 – Incorporated

If the company is incorporated in Australia (s 6(1) ITAA 1936), go to Step 5. Otherwise, go to Step 2.
The first statutory test is place of incorporation. Incorporation in Australia is decisive of a company’s
residence for tax purposes – ie the company is automatically a resident of Australia for tax purposes.

Step 2 – Carrying out business

If the company carries on business in Australia (s 6(1) ITAA 1936), go to Step 3. Otherwise, refer to
section on non-resident companies.
A company that is incorporated in a foreign country may be a resident of Australia if:
• it carries on business in Australia; and
• has its central management and control in Australia or its voting power is controlled by shareholders who
are residents of Australia (s 6(1) of the ITAA 1936).

Pdf_Folio:40

40 Tax
Generally, a company is likely to carry on business where it is established or maintained to make profits or
gains for its shareholders. This occurs even if the company’s activities are relatively limited, and primarily
consist of passively receiving rent or returns on its investments and distributing them to its shareholders.
Note: From 15 March 2017, a foreign company is considered by the ATO to carry on business in Australia
for the purposes of the residency test if its central management and control (see Step 3) is located in
Australia, even where it has no physical operations in Australia. This is based on the ATO’s view that the
central management and control of a business is factually part of carrying on a business.
However, the government announced in the 2020–21 Federal Budget that it was proposing to amend the
law to provide that a company that is incorporated offshore will be treated as an Australian tax resident if it
has a ‘significant economic connection to Australia’. This test will be satisfied where both the company’s
core commercial activities are undertaken in Australia and its central management and control is in
Australia. The measure will have effect from the first income year after the date of Royal Assent of the
enabling legislation, but taxpayers will have the option of applying the new law from 15 March 2017.
Having said that, with the change of government, this change will require a ‘wait and see’ approach.

Step 3 – Central management and control

If the central management and control (CM&C) is in Australia (s 6(1) ITAA 1936), go to Step 5. Otherwise,
go to Step 4.
CM&C is the control and direction of a company’s operations. The key element of CM&C is the making of
high-level decisions that set the company’s general policies, and determine the direction of its operations
and the type of transactions it will enter. The CM&C requirement focuses on the what, who and where
management and control decisions that guide and control the company’s business activities are located.
Generally, the directors of a company would undertake the CM&C. Accordingly, the location where the
directors make their high-level decisions would generally be the location of CM&C.

Step 4 – Voting power

If voting power controlled by Australian residents (s 6(1) ITAA 1936), go to Step 5. Otherwise, refer to
section on non-resident companies.
‘Control’ normally requires ownership of > 50% of the voting rights.

Step 5 – Current year aggregated turnover

If the company’s current year aggregated turnover is more than $50 million (s 23 of the Income Tax Rates
Act 1986), apply the tax rate for all other companies (see Topic 2.1.6). If the company’s current year
aggregated turnover is less than $50 million, go to Step 6.
A base rate entity is a company that both:
• has an aggregated turnover of less than $50 million; and
• 80% or less of its assessable income is base rate entity passive income.
Aggregated turnover includes the annual turnover of the company in question, plus the annual turnover of
all the entities that are ‘connected’ or ‘affiliated’ with the company. These connected or affiliated entities
may be based in Australia or overseas (Division 328 ITAA 1997).

Step 6 – Assessable income base rate entity passive income

If 80% or less of the company’s assessable income base rate entity is passive income (s 23 of the Income
Tax Rates Act 1986), apply the tax rate for base rate entities. Otherwise, apply the tax rate for all other
companies (see Topic 2.1.6).
Base rate entity passive income is:
• corporate distributions and franking credits on these distributions (other than dividends from companies
Pdf_Folio:41
the taxpayer holds a voting interest of at least 10% in)

Income tax – general rules 41

• royalties and rent
• interest income (some exceptions apply)
• gains on qualifying securities
• a net capital gain
• an amount included in the assessable income of a partner in a partnership or a beneficiary of a trust, to
the extent it is traceable (either directly or indirectly) to an amount that is otherwise base rate entity
passive income.
Aggregated turnover includes the annual turnover of the company in question, plus the annual turnover of
all the entities that are connected or affiliated with the company. These connected or affiliated entities may
be based in Australia or overseas (Division 328 ITAA 1997).
See Topic 2.1.6 for company tax rates for both base rate entities under the threshold, and the rate for all
other companies.

Key differences in taxation between resident and non-resident companies

The following table summarises key differences in taxation between resident and non-resident companies

Resident company Non-resident company

Worldwide income assessable to Australian tax – s 6-5(2). Generally, only Australian sourced income is subject
to Australian tax at the same rate as applies to
resident companies. Excluded from such income are
dividends, royalties and interest, which may instead
be subject to withholding tax.

The company is taxed at its applicable tax rate –

s 23 of the ITR Act.

The resident company can pay franked dividends – Only an Australian corporate entity can frank a
s 202-20. distribution under the imputation system.

Resident companies with a direct voting interest of at Foreign residents are taxable only on capital gains
least 10 per cent in a foreign company that carries on an made in relation to Taxable Australian Property.
active business may benefit from a reduction in the
capital gains or losses that arise when a CGT event
happens to the shares in the foreign company.

Subdivision 768-G Division 855

Other resident entities

The residency of a trust (ss 95(2) and (3) ITAA 1936) depends on the:
• residence of the trustee, or
• central management and control of the trust.
There is a separate definition of resident trust that applies for CGT purposes (s 995-1(1)).
Residency is not relevant to partnerships, it is the status of each partner that is relevant.

Double tax agreements

Double tax agreements (DTAs) generally give the country in which the income is sourced (the source
country) the right to tax certain types of income, profits or gains. Sometimes the rate of tax that can be
imposed on such income is also limited by the DTA. It is therefore important to also consider the
distributive rules, or the words used to allocate the taxing rights between the countries, in the DTAs.
Pdf_Folio:42

42 Tax
Further, it is possible that a taxpayer could be a resident of Australia under Australia’s domestic tax law and
a resident of another country under that other country’s domestic tax law. To prevent double taxation in
such situations, Australia’s double tax agreements (DTAs) generally contain a ‘tie-breaker’ article which sets
out the rules for determining which country the taxpayer will be regarded as a resident of (to the exclusion
of the other) for the purposes of the DTA.

Role of double tax agreements

Where a double tax agreement exists between Australia and another country, the agreement will usually
contain tie-breaker rules that help to decide scenarios in which a taxpayer might be resident in both
jurisdictions. However, even if a double taxation agreement deems a taxpayer to be a resident of a
particular country, this is only for the purposes of applying the double taxation agreement. The taxpayer
will still be a resident of their home country for domestic tax law purposes.
Where a double tax agreement exists between Australia and another country, the agreement may allocate
the source of particular types of income or gains to Australia or the treaty partner country. This overcomes
scenarios where a taxpayer has income or gains sourced in both jurisdictions.

Non-residents
Foreign residents for tax purposes are only required to include ordinary and statutory income from sources
within Australia in their Australian assessable income (s 6-5 ITAA 1997).
Foreign residents generally do not:
• get access to the tax-free threshold
• pay Medicare levy
• get access to the general 50% CGT discount (for assets acquired after 8 May 2012) (s 115-105 ITAA 1997)
• get access to the main residence exemption (for CGT events or disposals after 30 June 2020)
(Subdivision 118-B ITAA 1997).
Non-residents are generally not required to include interest, royalties, or dividends in their assessable
income. Unfranked dividends, interest and royalties are generally subject to withholding tax (s 128B ITAA
1936). The rate of tax differs depending on whether the recipient is a resident of a jurisdiction which has a
DTA with Australia.
Where the non-resident is from a jurisdiction that does not have a DTA with Australia, the rates for
non-resident individuals under the domestic legislation apply. See Topic 2.1.6 for further detail.

Working holiday makers

Special rates of tax apply to working holiday makers. Generally, a taxpayer will be a working holiday maker
if they have a visa subclass:
• 417 (Working Holiday)
• 462 (Work and Holiday).
These rates apply to working holiday maker income regardless of residency for tax purposes (s 3A of
Income Tax Rates Act 1986).

2.1.2 Taxable income/(loss) and tax payable/(refundable)

Section 4-1 of the ITAA 1997 requires income tax to be payable each financial year by each individual and
company, and by some other entities.

Pdf_Folio:43

Income tax – general rules 43

Calculation methodology
A fundamental feature of Australian income tax law is the framework for calculating an entity’s taxable
income and tax payable. An entity’s taxable income must first be ascertained before its income tax liability
can be calculated. A separate calculation framework applies for tax losses.
The below diagram represents a roadmap to assist in calculating income tax payable.

Taxable income Assessable income Deductions

= –
s 4-15 ITAA97 (Division 6) (Division 8)

Income tax payable

= Taxable income × Tax rates – Offsets – Credits
s 4-10(3) ITAA97

Tax loss (s 36-10)

Income tax law recognises that some taxpayers may make a tax loss. A tax loss is calculated using the
following formula from s 36-10:

Tax loss Deductions Assessable income Net exempt income

= – –
(s 36-10) (Division 8) (Division 6) (Division 36)

See Topic 2.1.4 for further information on the tax loss calculation.
The next example illustrates the calculation of tax payable for a resident company.

Example 2.2 – Tax payable in a complex situation

Doner Pty Ltd is a resident company, which is not a base rate entity and so pays tax at the 30%
company tax rate. Doner operates a coal mine in central Queensland and has a head office based in
Brisbane. The following is a calculation of the company’s taxable income and tax payable for the
income year ended 30 June 2023. Note all amounts exclude GST where applicable.

Description Reference $ ‘000s

Sales revenue s 6-5 1,300,000

Interest received Australian sourced s 6-5 20,000

Interest received foreign sourced, grossed up for foreign s 6-5 10,000

withholding tax of $1 million

Foreign non-portfolio dividends - NANE s 768-5 0

Fully franked dividend s 44(1) 7,000

Gross up / imputation credit s 207-20 3,000

Trading stock adjustment (excess of closing stock over s 70-35 12,000

opening stock)

Net capital gain s 102-5 18,000

Total assessable income 1,370,000

Pdf_Folio:44

44 Tax
 Deductions:

Bad debts s 25-35 6,000

Capital allowances (tax depreciation) s 40-25 270,000

Entertainment – subject to FBT s 32-20 180

Employee annual and long service leave paid s 26-10 30,000

Fringe Benefits Tax s 8-1 7,000

Insurance – apportioned under prepayment rules s 8-1 15,000

Office expenses s 8-1 20,000

Operating expenses (including lease payments) s 8-1 198,000

Repairs s 25-10 5,000

Superannuation guarantee paid s 290-60 23,750

Wages and other employee remuneration s 8-1 250,000

Total deductions 824,930

Taxable income 545,070

Income tax payable $ ‘000s

Tax at 30% 163,521

Less offsets:

Imputation credits (3,000)

Foreign income tax offsets (1,000)

PAYG instalments (80,000)

Income tax payable $79,521

2.1.3 Assessable income

Assessable income is defined in Division 6 and includes:
• ordinary income when it is derived (s 6-5)
• statutory income (s 6-10).
However, assessable income excludes exempt income and non-assessable non-exempt (NANE) income.
Pdf_Folio:45

Income tax – general rules 45

This diagram below signposts items of ordinary and statutory income that are covered in this chapter.

Assessable income = Ordinary income + Statutory income

General principles [2.1.3]

Specific inclusions [2.1.3 ]
Employment remuneration [4.2]
Capital gains [2.2.4 – 2.2.5]
International issues [3.2.1]
Trading stock [2.2.3]
Tax structures [3.1]

The following flow chart sets out an approach for determining whether an amount should be categorised
as assessable income, linking the concepts of residency and source.

Is it ordinary income? Is it:

Yes • Exempt income?
• Non-assessable non-exempt income?
No
If a CGT gain – is it ‘disregarded’?
Yes
Is it statutory income?
No
Yes

Residency and source

rules satisfied?
No

No Yes

Not Assessable
assessable

Income tax is calculated on a financial year basis, therefore, derivation or the time at which income must be
brought to account as assessable is critical. Note that derived is not defined in the ITAA, and its meaning
for s 6-5 relies on case law. Cash and accruals are the two methods of derivation used for assessable
income. The choice between these methods depends on the type of income the taxpayer is deriving.
Specific rules, such as taxation of financial arrangements (TOFA), override the general rule in s 6-5 and
specify in which income year(s) gains must be included in assessable income.

Common assessable income sections

To determine the taxable income for a business, you need to be able to apply the common tax rules and
principles related to assessable income outlined in the following table.

Pdf_Folio:46

46 Tax
 Section
ITAA 1997
unless
otherwise
Item stated Guidance

Ordinary income 6-5 Assessable income when derived based on residency of taxpayer and
source of income:
• Source:
– Resident – all sources (ie worldwide)
– Non-resident (and temporary residents) – Australian source.
• Derived:
– Cash basis (ie received / constructively received) – non-business
income (eg interest and rent from passive investment)
– Accruals basis (ie earned = invoice issued or customer has
obligation to make payment) – business income (unless small
business without trading stock).
• Includes income from:
– Personal exertion
– Business
– Isolated transactions:
◦ Mere realisation (Whitfords Beach case)
◦ Profit making intention (FCT v Myer Emporium)
– Property.
Special rules:
• WIP of services firm (not yet invoiced) = not earned
• Service income received in advance (refundable) and recognised for
accounting as unearned income = not derived until services have
been rendered (Arthur Murray (NSW) Pty Ltd v FCT).

Statutory income 6-10 Assessable income as specifically included under ITAA 1936 and ITAA
1997.

Exempt income 6-20 Not included in assessable income. However, net exempt income
reduces amount of a tax loss (see below).

NANE income 6-23 Not included in assessable income. Does not reduce amount of a tax loss.

Allowances and 15-2 Assessable income when provided to taxpayer (excludes certain
other things amounts that are specifically included under other sections).
provided in respect
of employment

Bounties and 15-10 Assessable income when received in carrying on a business.

subsidies

Royalties 15-20 Assessable income when received.

Interest on 15-35 Assessable income when paid to taxpayer or when applied to

overpayments and discharge a tax liability.
early payments
of tax

Reimbursed car 15-70 Assessable income where expense would have been a fringe benefit
expenses but for the FBT exception (in s 22 FBTAA 1986).
Refer to FBT topic.

Trading stock 70-35 Assessable income arises if the value of opening stock is less than the
movement value of closing stock.
Pdf_Folio:47
Refer to property and capital transactions topic.

Income tax – general rules 47

 Section
ITAA 1997
unless
otherwise
Item stated Guidance

Net capital gain 102-5 Assessable income when CGT event happens. Each event has
different timing – eg CGT event A1 disposal = when the contract is
entered into (ie not settlement).
Refer to property and capital transactions topic.

Dividends 44(1) Assessable income when received.

ITAA 1936
Assessable income of a resident taxpayer also includes a gross-up for
franking credits (s 207-20 / s 207-35).
Refer to tax structures topic.

Partnership net 92 Assessable income of a partner includes their share of the net income
income ITAA 1936 of the partnership.
Refer to tax structures topic.

Trust net income 97 Assessable income of a beneficiary includes their share of the net
ITAA 1936 income of the trust.
Refer to tax structures topic.

List of exempt 11-15 For your awareness only – useful as an index to search when
income preparing income tax calculations.

List of NANE 11-55 For your awareness only – useful as an index to search when
income preparing income tax calculations.

Gain on 15-15 Assessable income, unless assessable as ordinary income or is in

profit-making respect of post-CGT property (ie acquired on or after 20 September
undertaking or plan 1985).

Sale of WIP 15-50 WIP includes services performed / excludes goods in the process of
being manufactured.
Assessable income when received.

GST and increasing 15-17 GST component of price collected on behalf of the ATO is NANE income.
adjustments
Refer to GST and interactions between taxes and transactions topic.

Assessable 20-20 Generally assessable income when received if recoupment of an

recoupments amount previously deducted.

Capital allowances - 40-285 Assessable income when balancing adjustment occurs.

Gain on disposal of
Refer to property and capital transactions topic.
a depreciating asset

Cash flow boost 59-90 NANE income of business.

Non-cash business 21A Deemed convertible to cash and therefore value included in ordinary
benefits income unless:
• One-off deduction
• Entertainment
• Does not exceed $300 (s 23L(2)).

Pdf_Folio:48
Refer to FBT and interactions between taxes and transactions topic.

48 Tax
 Certain benefits 23L Includes:
exempt or NANE ITAA 1936 • Fringe benefits are NANE income of the employee – s 23L(1)
income • Benefits that are exempt from FBT are exempt income of the
employee – s 23L(1A)
• Non-cash business benefits under s 21A where total amount does
not exceed $300 are exempt income of the business – s 23L(2).
Refer to FBT and interactions between taxes and transactions topic.

Excessive payments 109 Private company payments of excessive remuneration are a deemed
to shareholders, ITAA 1936 dividend and not deductible.
directors and
Refer to tax structures topic.
associates

Deemed dividend 109C, Private company payments, use of assets, loans and foreign amounts
109CA, to certain shareholders are deemed dividends under Division 7A.
109D, 109E,
Refer to tax structures topic.
or 109F
ITAA 1936

Various sections 23AH Refer to international transactions topic.

related to foreign ITAA 1936 /
source income 768-5 /
768-505

Various sections 128D Refer to international transactions topic.

related to
exemptions
related to

Ordinary income
Briefly, s 6-5(1) defines ordinary income as income according to ordinary concepts.
Courts have traditionally categorised ordinary income as income from:
• personal exertion
• business
• isolated transactions, including income from profit-making undertakings or schemes
• property.
The second element of assessable income under s 6-10 is statutory income. Statutory income includes
amounts that are specifically included under the Acts.
Where an amount could be included as either statutory income or ordinary income, the more specific
statutory income provision prevails (s 6-25). This is particularly relevant where there is a difference in the
method of calculation of the amount that would be included in assessable income.
The most common example of statutory income is a net capital gain under s 102-5 (and discussed in
Topics 2.2.4–2.2.8). The paragraphs below include discussion of reimbursements (Subdivision 20-A),
sale of work-in-progress (s 15-50) and profit-making undertakings or schemes (s 15-15).

Exempt income
Exempt income is an amount that is classified as either ordinary income or statutory income but is exempt
from income tax under tax or other legislation (s 6-20). Therefore, exempt income is excluded from
assessable income. However, net exempt income is taken into account in specific circumstances – for
example, when calculating a current year tax loss (s 36-10), or a prior year tax loss that can be claimed in
the current year (ss 36-15–20).
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Income tax – general rules 49

A detailed understanding of all the items of exempt income (which are listed in s 11-15) is outside the
scope of this subject. However, this list of exempt ordinary and statutory income should be reviewed.

NANE income
NANE income is an amount that is classified as either ordinary income or statutory income, but the
definition under s 6-23 has been carefully crafted so that the income is not assessable (ie not taxed), and
not exempt, which means it is not taken into account – for example, when calculating a tax loss or claiming
prior year tax losses.
Examples include:
• a fringe benefit received by an employee (s 23L(1) ITAA 1936), as detailed in Chapter 4
• a non-portfolio return (eg dividend) paid by a foreign company to an Australian resident company, where
the recipient company holds a participation interest of at least 10% in the foreign company and the
return relates to an instrument that is treated as an equity interest under the debt–equity rules (s 768-5
ITAA 1997).

Required reading
Section 11-15 ITAA 1997.

Section 23L(1A) ITAA 1936.

Section 11-55 lists provisions from ITAA 1997 and ITAA 1936 that categorise certain amounts as NANE.
A detailed understanding of all the listed items is outside the scope of this subject. However, the list of
NANE ordinary and statutory income items should be reviewed.

Reimbursement of deductible expenditure

There is no general principle that the reimbursement of a previously deductible amount is assessable
(FCT v Rowe). However, consideration should be given to whether such a payment is ordinary income, or
statutory income, either under; a specific provision, or the statutory recoupment rules in Subdivision 20-A.
The approach to adopt for the reimbursement of deductible expenditure is best illustrated by the following
examples:

Reimbursement of deductible expenditure

Treatment Example

Ordinary income (s 6-5) ABC Accountants (ABC) pays an annual premium for professional
indemnity insurance. This is clearly a business-related expense and is
deductible. Based on ABC’s claims history, the insurance company later
pays a premium rebate to ABC. The transaction giving rise to the rebate is
itself a part of ABC’s day-to-day business, giving the rebate the character
of ordinary income.

Statutory income (specific Peter works for ABC and is reimbursed on a cents-per-kilometre basis
provision) because he sometimes drives his own car to a client’s premises to
undertake audit work. Section 15-70 includes the reimbursement in
Peter’s assessable income.
(Note: FBT does not apply to cents-per-kilometre reimbursements – see s 22
FBTAA 1986).

Peter can claim a deduction for work-related car expenses.

Pdf_Folio:50

50 Tax
 Statutory recoupment rules ABC successfully contests an FBT dispute with the ATO and receives a refund for
(Subdivision 20-A) overpaid tax. The earlier FBT payment would have given rise to a tax deduction
for ABC under s 8-1. The ATO refund is an assessable recoupment (s 20-20(3),
Under s 20-20(1), these
read together with item 1.2 of the table in s 20-30(1) and with s 20-35(1)).
rules only apply if the
amount is not: Instead of paying the FBT refund, if the ATO applied it against ABC’s other tax
liabilities, the refund would be derived under the constructive receipt approach
• ordinary income
(s 6-10(3)).
• statutory income under a
specific provision.

The next example considers legal costs as assessable income or deductible expenditure.

Example 2.3 – Entitlement to income under an employment contract

Leigh takes legal action against her former employer to enforce her entitlement to income under her
employment contract. Leigh’s legal costs are incurred in gaining or producing assessable income and
are therefore deductible under s 8-1. The court ruled Leigh was entitled to the income due under her
employment contract, and also awarded Leigh legal costs to indemnify her for the cost of the litigation.
The legal costs paid to Leigh are not ordinary income or an employment termination payment (ETP).
It is an assessable recoupment under s 20-20(2) as a recoupment of a deductible loss or outgoing.

Gain or loss resulting from a profit-making undertaking

Generally, the profit arising from a profit-making activity would be treated as ordinary assessable income of
the taxpayer even where the profit arises from an isolated or one-off transaction (FCT v Myer Emporium).
Section 15-15 specifically includes the profit arising from carrying out a profit-making undertaking or plan
in assessable income. Conversely, a loss in such circumstances is deductible (s 25-40).
However, s 15-15 does not apply:
• to assets subject to CGT, property acquired on or after 20 September 1985
• where the profit is ordinary income, assessable under s 6-5.
Section 15-15 may apply if an entity entered into a profit-making undertaking or plan for property acquired
pre-CGT. In practice, this section rarely applies.
Similarly, losses on sales of post-CGT property would be deductible under s 8-1 where there was a
profit-making undertaking or plan. Section 25-40 only applies to a sale of pre-CGT property. In practice,
this section rarely applies.

Required reading
Sections 15-15 and 25-40 ITAA 1997.

The following examples discuss the assessability of profit arising from a profit-making activity.

Example 2.4 – Profit-making undertaking

Karl was a self-employed builder who worked on large construction projects. In 1984, he created a
building project design which was a pre-CGT intellectual property asset for Karl. In July 2022, Karl
commenced working on a government infrastructure project with a construction company. As part of
this project, Karl signed a contract to transfer his ownership in the intellectual property to the
construction company for $1.2 million. Karl argued the proceeds were capital and not assessable.
The Commissioner successfully argued (based on the particular facts) that, while selling intellectual
Pdf_Folio:51

Income tax – general rules 51

 property was not part of Karl’s usual business, it was the profit from carrying on a profit-making
scheme and was assessable under s 15-15. (See Case 3/2005 ATC 127).

Example 2.5 – Ordinary income when s 15-15 does not apply

Ernie owned and worked on his farm since the 1960s. In January 2023, Ernie ceased farming and
decided to sell the farm as his children did not want to continue in the farming business and Ernie
needed to retire. The property developers Ernie approached were not willing to pay his asking price
for the land, so Ernie decided to subdivide and sell the land himself. As part of the subdivision
approval, the local Council required substantial development work to be carried out to provide water
and sewerage to the subdivided blocks. Ernie had to borrow funds to finance the extensive
development work. Upon completion of the subdivision, Ernie listed the blocks of land for sale with
real estate agents and also advertised in a national newspaper.

Based on the decision in Stevenson v FCT, the extent of the subdivision project involved a degree of
system and organisation, planning, management, and repetition of profit-making activity. Ernie is
likely to be carrying on a business of property development, meaning the proceeds of the sale of the
land is ordinary income and assessable under s 6-5 (the land is likely to be given a market value cost
at the time the land was ventured into the profit-making transaction). As ordinary income, the
proceeds on sale of the land is excluded from being assessable under s 15-15.

Sale of work-in-progress (WIP) amounts

Under s 15-50, an amount that is received from the sale of WIP to another entity will be included in the
assessable income of the recipient (ie the seller) in the income year in which it is received.
WIP is the value of services performed where circumstances do not yet allow demand for payment. For
example, where work has been carried out by an accounting firm but not yet invoiced, recorded billable
hours against a client code are commonly referred to as the firm’s WIP. WIP does not include goods that
are in the process of being manufactured.
See later in this chapter for discussion on the deductibility of amounts paid for the acquisition of WIP, and
Topic 3.1.3 for the application of the WIP provisions to changes in partnership interests.
The following example illustrates the calculation of the amount included in assessable income.

Example 2.6 – Sale of work-in-progress amount

IT Analytics Pty Ltd, an Australian resident company, operates an information technology business.
During the current income year, it sold the website development part of its business. As part of the
sale, it sold unbilled WIP of $30,000.

Under s 15-50, IT Analytics’ assessable income includes the $30,000. Assuming the $30,000 has
been included in IT Analytics’ accounting profit, no adjustment is required when it prepares its
reconciliation of accounting profit to taxable income for the current income year.

Note, if the sale occurred on 30 June 2023, the gain would be assessable in the income year ended
30 June 2023. However, if the sale occurred on 1 July 2023, the gain would be assessable in the
income year ended 30 June 2024, providing a one year timing advantage.

Required reading
Section 15-50 ITAA 1997.

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52 Tax
Other types of statutory income
Section 10-5 provides a summary list of the legislative provisions that require certain income amounts to
be included in assessable income. A detailed understanding of all the listed items is outside the scope of
this subject. However, this list should be reviewed.
A range of other statutory income provisions that you should be familiar with are discussed in various
chapters in this subject, including the following.

Signpost to statutory income provisions in this subject

Act Provision Details Tax topic

ITAA 1997 s 15-2 Allowances and other things provided in respect of Topic 4.2
employment and services:
• includes gratuities, compensation, bonuses, etc
• excludes amounts assessable under another statutory
income provision or ordinary income under s 6-5.

s 15-10 Bounties and subsidies included in assessable income Assumed

when received in carrying on a business knowledge

s 15-20 Royalties included in assessable income when received Assumed

knowledge

s 15-35 Interest on overpayments and early payments of tax Assumed

knowledge

s 15-70 Reimbursed car expenses Topic 4.1.2

s 40-285 Gain on disposal of a depreciating asset Topic 2.2.1

s 70-35(2) Trading stock – assessable income arises if the value of Assumed

opening stock is less than the value of closing stock knowledge

Division 82 / Employment termination payments Advanced Tax

s 82-130

Division 83A Employee share schemes Advanced Tax

s 102-5 Net capital gain Topics 2.2.4 –

2.2.5

s 230-15 Gain on a Division 230 financial arrangement Advanced Tax

Divisions Superannuation benefits Topic 4.2.3

301–307

s 775-15 Foreign exchange gains Advanced Tax

ITAA 1936 s 44 Dividends Assumed

knowledge

s 47 Distributions by liquidator Outside

scope

Division 5 / Partnership income, and treatment of partners Topic 3.1.3

s 92

Division 6 / Trust income, and treatment of beneficiaries Topic 3.1.4

s 97

s 109 Deemed dividends – excessive payments by a private Topic 3.1.1

company to shareholders or associates
Pdf_Folio:53

Income tax – general rules 53

 Signpost to statutory income provisions in this subject

Act Provision Details Tax topic

Division 7A Deemed dividends – disguised profit distributions by a Topic 3.1.1

private company to shareholders or associates

ITAA 1997 Various Foreign-sourced income and gains made by Australian Topic 3.2.1
and resident taxpayers
ITAA 1936

Required reading
Section 10-5 ITAA 1997.

2.1.4 Deductions
Returning to the calculation of taxable income, deductions are subtracted from assessable income as
shown in the diagram below. This diagram also signposts general and specific deductions that are covered
in this subject.

Taxable income = Assessable income – Deductions

General deductions Specific deductions

Specific inclusions
General principles
[2.1.4]
[2.1.4]
Capital allowances
Tax structures [3.1]
[2.2.1–2.2.2]

Common deductions
To determine the taxable income for a business, you need to be able to apply the common tax rules and
principles related to deductions outlined in the below table.

Section ITAA 1997

unless otherwise
Item stated Guidance

General deduction 8-1 Deductible when incurred

• Nexus
– For non-business taxpayers = direct nexus between
assessable income and expense
– For business taxpayers (TR 97/11) = no direct nexus,
simply has to be for purpose of gaining or producing
assessable income.
• Incurred – Definitively committed or liability enforceable at
law (FCT v James Flood)
– Paid
– Presently existing liability
– Liability can be reasonably estimated
– No genuine dispute over existence.

Pdf_Folio:54

54 Tax
 • Excludes:
– Capital (Sun Newspapers Ltd and Associated Newspapers
Ltd v FCT) – however may be deductible under another
section
– Private or domestic nature (applicable for individual
taxpayers and partnerships with partners who are
individuals)
– Incurred in relation to exempt or NANE income (unless a
specific provision applies to allow – eg s 25-90 interest
related to certain types of NANE foreign income)
– Prevented by a specific deduction provision (ie expenses
that are generally deductible may have the deduction
denied or limited by a more specific provision).
Special rules:
• Interest expense – deductible when incurred subject to use
and purpose test
• Discounts on commercial bills and promissory notes –
deductible over term of the instrument
• Pre-commencement and post-cessation expenditure –
deductible where connection between expenditure and
income-producing activity.

Specific deductions 8-5 Deductible as specifically included under ITAA 1936 and
ITAA 1997.

Tax-related expenses 25-5 Deductible when incurred:

and interest paid to • Includes expenditure related to managing income tax affairs
ATO or complying with an income tax obligation (eg preparing an
income tax return, obtaining income tax advice, etc.) if:
– it is paid to a recognised tax advisor (ie. a tax agent), and
– it is not associated with an offence.
• Includes expenditure for general interest charge (GIC) or
shortfall interest charge (SIC)
• Excludes expenditure related to GST (as it is not an income
tax), tax payments, and interest on money borrowed to pay
tax/PAYG.

Repairs 25-10 A repair is deductible when incurred if it (TR 97/23):

• Restores the function and does not significantly improve it
• Renews or replaces parts and not the entire asset
• Does not change the character of the asset.

A repair is not deductible if it relates to:

• The replacement of an entirety
• An improvement
• An initial repair (ie damage/deterioration of an asset that
existed at the time it was purchased)
• Preparing an asset for sale.

Borrowing expenses 25-25 Expenditure incurred in borrowing money (eg legal, valuation
and survey fees, loan guarantee fees, insurance, etc) is
deductible:
• Over the period of the loan or 5 years, whichever is the
lesser (using a day basis)
• Unless total expenditure is < $100, then deductible
immediately.

Mortgage discharge 25-30 Deductible when incurred.

expenses

Pdf_Folio:55

Income tax – general rules 55

 Section ITAA 1997
unless otherwise
Item stated Guidance

Bad debts 25-35 A debt is deductible if:

• there is an existing debt
• the debt is bad (not just uneconomic to recover, it must be
realistic to conclude that it won’t be recovered)
• the debt must have previously been bought to account as
assessable income, and
• the debt must be actually written off by the end of the
income year.

Travel between 25-100 Deductible where the travel is between certain locations.
workplaces

Trading stock 70-15 Deductible when stock is on hand (ie when taxpayer has
deduction dispositive power).
Refer to property and capital transactions topic.

Trading stock 70-35 Deductible amount arises if the value of closing stock is less
movement than the value of opening.
Refer to property and capital transactions topic.

Partnership net loss 92 ITAA 1936 Deductions of a partner includes their share of the net loss of
the partnership.
Refer to tax structures topic.

Trust net loss 97 ITAA 1936 Not deductible to beneficiary. Remains in the trust and can be
used by the trust to reduce future trust net income.
Refer to tax structures topic in study guide.

Lease payments 25-20 Expenditure incurred in preparing, registering or paying

stamp duty on a lease is deductible when incurred.

Loss on profit-making 25-40 Deductible if a profit would have been included in

undertaking assessable income under s 15-15, unless it is in respect
of post-CGT property (ie acquired on or after 20
September 1985).

Loss by theft or 25-45 Deductible if money included in assessable income.

embezzlement

Acquisition of WIP 25-95 Deductible in the income year it is paid where:

• a recoverable debt has arisen, or
• reasonable to expect a recoverable debt to arise within
12 months from when paid.
Any amount that is not deductible in the year paid is
deductible in the next income year.

Capital expenditure 25-110 Deductible on a straight line basis over 5 years, where
to terminate a lease relates to an operating lease (ie not a finance lease for
accounting purposes).

Fines and penalties 26-5 Not deductible, if payable under an Australian or foreign
law even if related to legitimate income producing
activity (eg parking fine incurred by a courier business).
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56 Tax
 Leave payments 26-10 Annual leave, long service leave, sick leave and other
leave in respect of employees is not deductible until paid.

Interest or royalty 26-25 Not deductible unless the payer has complied with
withholding tax (WHT) obligations (ie WHT is paid).

Travel related to 26-31 Not deductible where travel relates to residential rental
residential rental property, unless:
property • the taxpayer is carrying on a business or
• the taxpayer is a company (or other specifically listed
entity).

Bribes 26-52 & 26-53 Not deductible.

Limit on 26-55 Amounts that cannot create or increase a loss:

deductions – tax loss • Personal superannuation contributions
calculation • Gifts (s 30-5).

Superannuation 26-95 Compulsory superannuation contributions that an

guarantee charge employer is required to make are not deductible where
(SGC) the payment is not made by the required time.

Vacant land expenses 26-102 Not deductible, unless:

• Land used in carrying on a business
• The taxpayer is a company (or other specifically listed
entity)
• Reason vacant is beyond control of taxpayer and that
event happened within 3 years
• Leased land used in primary production or carrying on
a business.

Input tax credits and 27-5 GST component of acquisition price not deductible to
decreasing the extent of GST input tax credit entitlement.
adjustments
Refer to GST and interactions between taxes and
transactions topic.

Entertainment 32-5 Not deductible, unless an exception applies.

Entertainment defined as (s 32-10):
• Entertainment involving food, drink or recreation
• Accommodation or travel in connection with the
provision of entertainment.
Refer TR 97/17 for further guidance:
• Includes business lunches and social functions
• Excludes meals on business travel overnight, and mere
sustenance (eg sandwich lunch, tea and coffee in office
kitchen, etc).

Entertainment that is 32-20 Deductible where it is a fringe benefit (ie this section
a fringe benefit overrides the s 32-5 deduction denial).

Tax loss calculation 36-10 A tax loss is reduced by net exempt income.

Tax loss deduction 36-15 A tax loss is carried forward and is claimed as a
deduction against future assessable income (subject to a
choice where the taxpayer is a company s 36-17). Tax
losses must be used in the order in which they are made
(ie oldest tax loss first).

Pdf_Folio:57

Income tax – general rules 57

 Section ITAA 1997
unless otherwise
Item stated Guidance

Net exempt income 36-20 Separate calculation components for residents and
non-residents. Reduces the amount of a tax loss.

Capital allowances – 40-25 Decline in value deduction under prime cost or

Decline in value diminishing value method.
(general rules)
Refer to property and capital transactions topic.

Capital allowances – 40-27 Decline in value not deductible for second-hand goods
Decline in value of used in residential rental property, unless the taxpayer is
second hand goods carrying on a business, the taxpayer is a company (or
other specifically listed entity), or the asset is part of the
supply of new residential premises.
Refer to property and capital transactions topic.

Capital allowances - 40-80(2) Decline in value deduction for a non-business taxpayer is

Deduction for asset’s the depreciating asset’s cost, if that cost does not exceed
cost $300.
Refer to property and capital transactions topic.

Capital allowances – 40-160 IT(TP)A Decline in value deduction for most business taxpayers is
Temporary full 1997 the depreciating asset’s cost (subject to eligibility criteria
expensing for the asset and the taxpayer).
Refer to property and capital transactions topic.

Capital allowances - 40-285 Deductible when balancing adjustment event occurs.

Loss on disposal of a
Refer to property and capital transactions topic.
depreciating asset

Capital works 43-10 Deduction of 2.5% or 4% of construction costs in respect

of:
• Buildings, extensions or alterations
• Structural improvements such as sealed roads,
driveways and car parks.
Refer to property and capital transactions topic.
Note: The government has announced that the 2023–24 Budget
will increase the depreciation rate from 2.5% to 4% per year for
eligible new build-to-rent projects where construction
commences after 9 May 2023, to boost the supply of rental
housing.

Black hole 40-880 Business related expenditure that is not dealt with in any
expenditure other way (eg is not deductible, is not included in cost
base of CGT asset, etc) is deductible:
• On a straight line basis over five (5) years
• Unless concession taxpayer and eligible start up
concession under s 40-880(2A) and (2B), then
immediately deductible.
Type of expenditure includes:
• Expenditure to establish a business structure, convert
a business structure, raise equity, or defend against a
takeover
• Costs of an unsuccessful takeover attempt, to stop
carrying on a business, of liquidation and deregistration,
and of feasibility studies and market research.
Refer to property and capital transactions topic.
Pdf_Folio:58

58 Tax
 Net capital loss 102-10 Not deductible. Can only be used to reduce capital gains
made in a future income year.
Refer to property and capital transactions topic.

Superannuation 290-60 Deductible when paid (eg prepaid superannuation

contributions contributions deductible irrespective of the period to
which they relate, however accrued superannuation
contribution liability is not deductible).

Small business entity 328-180 / 328-181 Decline in value deduction for SBE taxpayers is the cost
(SBE) – Capital IT(TP)A 1997 of the asset (subject to eligibility criteria for the asset and
allowances: the taxpayer).
Deduction for asset’s Refer to tax structures topic.
cost

Small business entity 328-190 Deduction rate:

(SBE) – Capital • Opening pool balance × 30%
allowances: Decline • Acquisitions and improvements × 15%.
in value deduction
Refer to tax structures topic.

Expenses related to 51AAA ITAA 1936 Expenses incurred in relation to a CGT asset are not, for
net capital gains that reason alone, tax deductible (Expenses may be
included in cost base of CGT asset).
Refer to property and capital transactions topic.

Deduction for meal 51AEA ITAA 1936 Deductible amount is equal to the amount that is subject
entertainment fringe the FBT.
benefits under 50/50 Refer to FBT and interactions between taxes and
method transactions topic.

Deduction for meal 51AEB ITAA 1936 Deductible amount is equal to the amount that is subject
entertainment fringe the FBT.
benefits under Refer to FBT and interactions between taxes and
12-week register transactions topic.
method

Prepayments – non- 82KZMA ITAA For expenditure that would otherwise be deductible
concession taxpayers 1936 when incurred under s 8-1, the deductible amount
spread over the eligible service period on a day basis.
Does not apply to:
• Expenditure deductible under a specific deduction
provision (eg tax-related expenses where s 25-5
applies, superannuation contributions where s 290-60
applies, borrowing costs where s 25-25 applies, etc.).
• Excluded expenditure under s 82KZL:
– Less than $1,000
– Required by law (eg workers compensation
insurance)
– Paid under a service (ie employment) contract
(eg salary and wages for employees).

Prepayments – 82KZM ITAA 1936 As above for general prepayment rules. However, the
individuals and prepayment rule also does not apply where:
concession taxpayers • The period covered by the prepayment is 12 months
(generally where or less (in total).
aggregated turnover
less than $50 million)

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Income tax – general rules 59

General deductions – overview
Deductions can arise in one of two ways:
• general deductions (s 8-1)
• specific deductions (s 8-5).
The provisions that allow specific deductions are listed in s 12-5. Certain amounts are not allowed as
deductions, even though they fall within the deduction rules (s 8-5(2)). Where an amount could be
deductible under two different provisions, the most appropriate provision applies and the amount cannot
be claimed twice (s 8-10).
Section 8-1 is often described as having:
• two positive limbs, which allow a deduction (s 8-1(1))
• four negative limbs, which deny a deduction (s 8-1(2)).

Positive limbs: s 8-1(1) Explanation

A taxpayer can deduct from assessable income The first part of this limb is applicable for non-business
any loss or outgoing to the extent that it is: taxpayers. It requires a direct connection between the expense
incurred and the assessable income derived.
• incurred in gaining or producing the
taxpayer’s assessable income (s 8-1(1)(a)), or The second part of this limb relates to business taxpayers.
• necessarily incurred in carrying on a There is no direct connection requirement for businesses.
business for the purpose of gaining or
producing the taxpayer’s assessable income Note that the term incurred is not defined in the ITAA, and its
(s 8-1(1)(b)). meaning for s 8-1 relies on case law. Specific rules, such as
TOFA, override the general rule in s 8-1 and specify in which
income year(s) deductions are allowed to be claimed.

Negative limbs: s 8-1(2) Explanation

A taxpayer cannot deduct a loss or outgoing Capital expenditure might need to be considered under
under s 8-1 to the extent that it is: another income tax provision. For example:
• capital, or of a capital nature • CGT assets (see Topics 2.2.4–2.2.5)
(s 8-1(2)(a)) • depreciating assets (see Topic 2.2.1)
• of a private or domestic nature • capital works – buildings and structural improvements (see
(s 8-1(2)(b)) Topic 2.2.2)
• incurred in relation to exempt income or • blackhole expenditure.
NANE income (s 8-1(2)(c))
Specific deduction provisions can override the general
• prevented from being claimed as a
deduction provision to allow a deduction otherwise prevented,
deduction by a provision in the tax
deny a deduction otherwise allowed, impose addition
legislation (s 8-1(2)(d)).
conditions that must be satisfied, or limit the amount that can
The decision in Clough Limited v Commissioner be claimed. (See discussion later in this chapter).
of Taxation 2021 ATC 20-805 provides a
good summary of both the positive and
negative limbs.

Key issues regarding deductions

Interest expenses

Generally, loan funds would be treated as capital, particularly where the loan finances the purchase of a
capital asset. Interest expenses, however, do not secure an enduring benefit but simply reflect the use of
the funds for the term of the loan. Ordinarily, interest is a revenue item (Steele v DFCT). The following two
key tests have been developed by the courts for determining the deductibility of interest under s 8-1:
• Use test – which considers whether the borrowed funds have been put to an income-producing use
(FCT v Munro), although a strict tracing approach is not necessary where one loan replaces another
Pdf_Folio:60 (ie refinancing) (FCT v Roberts and Smith).

60 Tax
• Purpose test – which considers the taxpayer’s purpose in borrowing the funds, particularly where the
interest expense exceeds the income generated (Fletcher v FCT).
Like other outgoings, interest is deductible when incurred (ie when a presently existing liability to pay
exists), although taxpayers with Division 230 financial arrangements will typically use the default accruals
method of accounting for claiming deductions (described below).

Discounts on commercial bills and promissory notes

For commercial bills and promissory notes where Division 230 does not apply, the decision in Coles Myer
Finance v FCT, a case decided before the introduction of Division 230, is still relevant. The High Court held
that discounts on commercial bills and promissory notes were allowed as deductions on a straight-line
accruals basis over the term of a financial instrument, being the period to which the discount was properly
referable (see example below). Following this decision, the ATO accepted that the properly referable test
applied to all taxpayers (not just financial institutions) claiming deductions for bill discounts (TR 93/21).
The next example illustrates the interest charged on commercial bills.

Example 2.7 – Commercial bills

A business taxpayer takes out a bank bill loan on Day 1 with a face value of $100,000 for a period
of 90 days. Based on the business’s turnover, Division 230 does not apply. The bank quotes a rate of
5.25%. Also on Day 1, the taxpayer receives the discounted amount of $98,722. On Day 90, the
taxpayer pays the bill holder $100,000. The total interest charged is $1,278, which is the same as
saying that $98,722 has been borrowed for 90 days at 5.25%.

90-day bank bill

(Face value $100,000, rate 5.25%)

DAY 1 DAY 90
Receive At maturity, pay
$98,722 $100,000

30 June

Deduction spread over loan period

(Coles Myer Finance)

Division 230 financial arrangements

As discussed above in the topic on assessable income, if the taxpayer is an entity to which Division 230
applies, the accruals method is the default mechanism for claiming deductions on financial arrangements
where there is a sufficiently certain expectation that there will be a loss during the period of the
arrangement. These arrangements are discussed in detail in the Advanced Tax elective.

Non-commercial business loss rules

Where the taxpayer is carrying on a business, either as a sole trader or in partnership, any tax losses arising
from that activity may be affected by the non-commercial business loss rules in Division 35.
Division 35 is designed to prevent revenue leakage from individuals who are involved in unprofitable
activities. It sets out a series of tests, which must be satisfied in order for the loss from the activity to be
claimed as a deduction. If the tests are not satisfied, the deduction for the loss will be deferred. Division 35
is also discussed in more detail in the Advanced Tax elective.

Pre-commencement and post-cessation expenditure

The indicators of a business or income-earning activity are particularly relevant in determining whether tax
deductions are available in the pre-commencement or winding-up phases of a business or income-earning
activity, such as the acquisition of an income-producing asset.
Pdf_Folio:61

Income tax – general rules 61

When applying s 8-1, ‘the temporal relationship between the incurring of an outgoing and the actual or
projected receipt of income may be one of a number of factors relevant… but contemporaneity is not legally
essential’ (Steele v DFCT). The key issue is whether there is a connection between the expenditure and the
income-producing activity. The following example illustrates two cases where there was no such connection.

Example 2.8 – Pre-commencement and post-cessation expenditure

Example Example
In Federal Commissioner of Taxation In Federal Commissioner of
v Maddalena (1971) 45 ALJR 426, Taxation v Riverside Road Pty Ltd
a professional footballer’s costs (1990) 23 FCR 305, interest on
in securing a job at a new club funds borrowed to build a motel
were incurred too soon to be ceased to be deductible when
regarded as incurred in the course the taxpayer sold the motel to
of gaining his income a trust, then leased it back

Expenditure in the course of Expenditure after cessation of

Expenditure prior to starting
carrying on a business, or from a business or income-producing
a business of producing income
an income-producing activity activity

Timeline

Further, s 8-1 has a built-in anti-avoidance mechanism and, where the taxpayer’s subjective purpose is to
avoid tax rather than derive assessable income, no s 8-1 deduction is allowed. In Ure v FCT, the taxpayer
borrowed funds at a commercial rate of interest (around 12%) and on-lent the funds to his family at 1%.
The court held that the taxpayer had a dual purpose in incurring interest on a loan, partly to derive
assessable income and partly for his family’s benefit and to reduce his tax liability. The interest deduction
was apportioned so that only the amount returned as assessable income (1% interest) was deductible
under s 8-1.
Note that a company’s subjective purpose is determined from the views of directors and senior company
officers, as evidenced by minutes of board meetings and other relevant documentation.

Incurred in relation to gaining or producing exempt or NANE income

Generally, expenses related to income that is not assessable income are not tax deductible.
In some cases, however, a specific deduction provision allows a deduction even when the expenditure
relates to income that is not assessable. For example, s 25-90 allows Australian companies to claim interest
deductions in Australia for borrowed funds that are used to establish offshore subsidiaries that yield NANE
income under s 768-5. Note, however, that outbound thin capitalisation rules restrict the level of gearing
under s 25-90.
The way in which s 25-90 allows Australian companies to claim interest deductions on borrowed funds for
offshore subsidiaries is illustrated by the following diagram.

Loan
Lender Australian parent company
Interest

Section 25–90 allows 50% participation interest

deducion for interest Dividend paid to
parent company
in NANE income
(s 768–5)

Pdf_Folio:62
Fiji subsidiary company

62 Tax
The exemption in s 768-5 is covered in more detail in Chapter 3 and the thin capitalisation rules are
analysed in detail in the Advanced Tax elective.
In the May 2023 Budget, the government is proposing to limit deductions under section 25-90 against
s 768-5 income from 1 July 2023.

Expenses relating to net capital gains

Although net capital gains are included in assessable income under s 102-5 ITAA 1997, s 51AAA
ITAA 1936 ensures that expenses incurred in relation to a non-income producing CGT asset are not tax
deductible against the s 102-5 assessable income.

Specific deductions
The tax law may allow specific deductions under s 8-5 for certain types of expenses. A specific deduction
provision might reflect a policy decision to:
• allow a deduction in circumstances where it would otherwise be prevented by the general deduction
provision (s 8-1) (eg s 25-5 allows a tax deduction for tax return preparation expenditure)
• impose conditions that must be satisfied before a deduction is allowed (eg s 25-35 contains rules for bad
debts).
Candidates should be familiar with the following specific deductions, which are often encountered in
practice:
• repairs (s 25-10)
• borrowing expenses (s 25-25)
• bad debts (s 25-35)
• leave payments (s 26-10)
• tax-related expenses (s 25-5)
• work, self-education, car and business travel expenses.

Deduction denial and limitation provisions

Deduction denial and limitation provisions, include:

• fines and penalties (s 26-5), and bribes (s 26-52 and s 26-53)
• interest and royalty payments to non-residents where withholding tax has not been withheld by the
payer (s 26-25)
• travel expenses related to residential rental properties incurred after 1 July 2017 (s 26-31)
• expenses associated with holding vacant land (s 26-102)
• higher education contribution payments, except when incurred in the provision of a fringe benefit
(s 26-20)
• entertainment expenses, except when incurred in the provision of a fringe benefit (Subdivisions 32-A
and 32-B)
• prepayment rules, which limit the deduction over the eligible service period (ss 82KZL–82KZO
ITAA 1936).
The following specific rules in relation to deductions are discussed in this chapter:
• acquisition of work-in-progress (s 25-95)
• specific deduction denial and limitation provisions, such as s 32-5 ITAA 1997 (discussed below)
• superannuation contributions for employees (s 26-95)
• lease arrangements (s 8-1)
• mortgage discharge expenses (s 25-30)
•
Pdf_Folio:63
other provisions that limit the amount that can be claimed.

Income tax – general rules 63

 Required reading
Section 8-5 ITAA 1997.

Interaction between GST and deductions

GST-registered taxpayers who buy goods and services to which GST applies can claim an input tax credit
for the GST component where the acquisition is a creditable acquisition (refer to Topic 4.1.4). This
component is effectively recouped from the government, and therefore is not deductible (s 27-5).

Required reading
Section 27-5 ITAA 1997.

Particular types of deductions

Entertainment expenses
Scope

Section 32-5 denies a tax deduction for expenditure in respect of providing entertainment, unless the
entertainment falls within one of the exceptions in Subdivision 32-B. The words ‘in respect of’ are very
wide and require a sufficient and material relationship between the expenditure and the entertainment. In
other words, but for the entertainment, would the expenditure have been incurred?
Section 32-10 defines entertainment to mean:
• entertainment involving food, drink or recreation
• accommodation or travel in connection with the provision of entertainment.
For example, restaurant meals and taxi travel in relation to a meal with a customer are entertainment.
However, sustenance is excluded. The cost of sandwiches provided at an internal staff or client meeting,
morning and afternoon teas, meals while travelling on business or for work, etc are not entertainment.
Entertainment is provided even though business discussions or transactions occur (s 32-10(2)). For
example, a lunch meeting with a client at an exclusive restaurant is entertainment, even where there is a
clear connection with deriving assessable income from this meeting.
The definition is circular (‘entertainment means entertainment …’) and begs the question: ‘What is
entertainment?’ In TR 97/17, the ATO has published the Why, What, When and Where test, which is helpful
in identifying entertainment scenarios. This test illustrates that entertainment does not occur every time
that food, drink or recreation is provided. Rather, it is necessary to form a conclusion whether the food,
drink or recreation was provided in an entertainment context, as illustrated by the next example.

Example 2.9 – Entertainment context

Damian is a self-employed salesman who travels frequently and for long periods through regional
Australia selling toys on behalf of various wholesalers. He applies the ATO’s ‘Why, What, When and
Where’ test in TR 97/17 to assess whether his entertainment expenses are deductible:

Pdf_Folio:64

64 Tax
 Test Scenario 1 Scenario 2

Damian spends the evening in his motel Damian invites a local toy store retailer
room, orders a room service dinner out to dinner, hoping to generate
(including wine), and watches television business. He pays for dinner and wine at
the best restaurant in town

Why? Travelling on business Seeking to attract new business

What? Room service meal with wine Restaurant-quality meal with wine

When? After business hours After business hours

Where? In a motel room, alone In an upmarket restaurant, with a client

Conclusion Not an entertainment context (ie mere Entertainment context. Section 8-1
sustenance). Deductible under s 8-1 deduction denied by s 32-5

Exclusions

Section 32-5 will not deny a deduction for entertainment expenses that meet various exception criteria in
Subdivision 32-B.
The main exception in this subdivision is s 32-20, which applies where the entertainment provided is a
fringe benefit, as defined in the FBTAA 1986 (see Topic 4.2.4). It is important to note that the FBT law
defines fringe benefit in a way that excludes benefits that, under the FBTAA 1986, are exempt benefits. In
other words, entertainment that gives rise to an exempt benefit under the FBT law will be non-deductible.
The s 32-20 exception gives rise to obvious compliance problems for employers because meal
entertainment usually involves both employees and non-employees (eg a business lunch at a restaurant).
Rather than keep a per-head record of the meal entertainment costs attributable to the employees
(deductible and subject to FBT) and non-employees (non-deductible and not subject to FBT) to calculate
the deductible entertainment expenditure (often referred to as the ‘actual method’), employers can choose
to claim a deduction using either:
• a 50/50 split method (s 51AEA ITAA 1936)
• a 12-week register of expenditure to establish a representative percentage (s 51AEB ITAA 1936).

Other exceptions that allow deductions

Other exceptions allowing deductions for entertainment include:

• entertainment that is provided by taxpayers who carry on a business providing entertainment, or where
part of their business provides entertainment (eg hotels, restaurants and airline companies)
• promotions that are offered to the public at large
• providing food and drink to employees on ordinary working days at an in-house dining facility –
excluding a party, reception or social function
• providing food and drink to non-employees in an in-house dining facility – excluding a party, reception or
social function – if the employer chooses to include a deemed amount of $30 in assessable income for
each meal (s 32-30 item 1.2 and s 32-70)
• providing food and drink at an eligible training seminar lasting at least four hours
• charitable entertainment (eg free entertainment that is provided to the sick or disabled).

Pdf_Folio:65

Income tax – general rules 65

Calculation method

The following example illustrates how to calculate the deductible amount for entertainment and its
interaction with FBT. Note, this interaction does not exist for other types of benefits.

Example 2.10 – Entertainment: Interaction between income tax and FBT

ABC Accountants provides two different types of benefits to its staff. It applies a two-step test to
assess whether the benefits are deductible or subject to FBT.

Test Benefit 1 Benefit 2

A $3,000 holiday package for two An employee-only annual Christmas

awarded to the staff member whose party at a local club. The all-inclusive
results achieved Merit List status in the price works out at $280 per employee.
Chartered Accountants Program.

Step 1 – Is this Yes – entertainment includes the Yes – entertainment includes the
entertainment? provision of food, drink and recreation. provision of food, drink and
Applying the test in TR 97/17, this benefit recreation. Applying the test in
is provided in an entertainment context. TR 97/17, this benefit is provided in
an entertainment context.

Step 2 – Yes – this will be either an expense No – this will be an exempt benefit
Is this a fringe payment or residual fringe benefit under s 58P FBTAA 1986 (a minor,
benefit as (depending on how it is structured). infrequent benefit valued at less than
defined in the No FBT exemption applies. $300 inclusive of GST). An exempt
FBTAA 1986? benefit is excluded from the definition
of fringe benefit.

Conclusion FBT is payable by the employer. No FBT is payable by the employer.

The cost of the holiday is deductible The cost of the Christmas party is not
under s 8-1 (s 32-20 exception applies). deductible under s 32-5 (s 32-20 does
not apply).

Required reading
Sections 32-5 and 32-20 ITAA 1997.

Prepayments
Scope

Section 82KZMA ITAA 1936 requires deductions for prepaid expenses that would otherwise be deductible
when incurred under s 8-1 ITAA 1997, to be spread over the eligible service period. However, there are a
number of exceptions.

Exclusions

The main exclusions from the prepayment rules and examples of when those exclusions apply are set out
next. They provide a legitimate tax planning avenue for eligible taxpayers.

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66 Tax
 Immediate prepayment deductions

Eligibility Example

Expenditure that is deductible under a provision other A business prepays fees for its tax return preparation.
than s 8-1. The prepayment rules only apply to
As this expenditure is deductible under a specific
expenditure that would otherwise be claimed as a
provision (s 25-5), the prepayment rules do not apply.
deduction under s 8-1. Where a specific provision
The timing of the deduction is determined under the
applies to an item of expenditure, the specific
specific provision.
provision overrides the s 8-1 deduction, and the
prepayment rules are not applicable.

Individuals who are not carrying on a business, where An employed accountant borrows money to acquire
the period covered by the expenditure is 12 months or dividend-yielding shares and prepays interest for
less and ends in the income year after the income year 9 months.
the expenditure is incurred (s 82KZM ITAA 1936).
As the taxpayer is an individual and the prepayment is
for 12 months or less, the prepayment rules do not
apply. The taxpayer can claim an immediate deduction
for the full amount under s 8-1.

Small business entities (SBEs) and eligible small and Small Pty Ltd prepays rent on its business premises for
medium enterprises (SMEs) (aggregated turnover less 12 months.
than $50 million) where the period covered by the
As the taxpayer is a small business entity and the
expenditure is 12 months or less and ends in the
prepayment is for 12 months or less, the prepayment
income year after the income year the expenditure is
rules do not apply. Small Pty Ltd can claim an
incurred (s 82KZM ITAA 1936).
immediate deduction for the full amount under s 8-1.
Note: If Small Pty Ltd prepays rent on its business premises
for 14 months, where two months relate to the current year
and 12 months relate to the next income year, the
prepayment rules apply (ie the entire period of the
expenditure must be 12 months or less).

Expenditure that is less than $1,000 (net of any input Large Limited takes out a two-year subscription to a
tax credits to which a business taxpayer may be business magazine that costs $995.
entitled).
As the expenditure is for less than $1,000, the
prepayment rules do not apply. Large Limited can
claim an immediate deduction for the full amount
under s 8-1.

Expenditure that is required by law (s 82KZL Large Limited prepays the premium for its workers’
ITAA 1936 – definition of excluded expenditure). compensation cover, compulsory third party
insurance, motor vehicle registration, land tax, interest
withholding tax, etc.
As the expenditure is required by law, it satisfies the
definition of excluded expenditure and the
prepayment rules do not apply. Large Limited can
claim an immediate deduction for the full amount
under s 8-1.

Expenditure that is paid under a service (ie Large Limited is winding down its business and
employment) contract (s 82KZL ITAA 1936 – negotiates a new service contract to retain the services
definition of excluded expenditure). of its chief executive officer (CEO) until the company
is liquidated. The contract includes an upfront
retention payment to the CEO for the next two years.
As the expenditure relates to an employee contract, it
satisfies the definition of excluded expenditure and
the prepayment rules do not apply. Large Limited can
claim an immediate deduction for the full amount
under s 8-1.

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Income tax – general rules 67

Calculation method

Where the prepayment rules apply, the s 8-1 deduction is spread over the period to which the expenditure
relates (called the eligible service period) using a daily apportionment basis.
If the prepayment relates to a longer period, the eligible service period is capped at 10 years.
For business expenditure, the formula in s 82KZMD ITAA 1936 for calculating the deduction is:

Expenditure × Number of days of eligible service period in the year of income

Total number of days of eligible service period

The following example illustrates how to calculate the amount of a prepayment that is deductible.

Example 2.11 – Prepayments

Big Accounting operates from rented business premises that are owned by Aussie Property Trust.
Due to difficult economic times, the banks that lent money to Aussie Property Trust want it to reduce
its debt levels.

In order to generate cash to repay its debt, Aussie Property Trust approaches Big Accounting with an
offer: if Big Accounting will prepay its rent for one year ($10 million) on 1 May 2023, it will receive a
5% discount and pay only $9.5 million. Big Accounting accepts the offer.

Assuming that Big Accounting’s turnover is over $50 million in the income year ended 30 June 2023,
the deduction available to Big Accounting will be $1,587,671 ($9.5 million × 61 days ÷ 365 days).
The balance will be deductible in the income year ended 30 June 2024.

Assuming Big Accounting has included the prepaid portion of the expenditure as an asset for
accounting purposes (ie it is not included in accounting profit), no adjustment is required when it
prepares its reconciliation of accounting profit to taxable income for the current income year.

Required reading
Section 82KZL ITAA 1936 – definition of ‘excluded expenditure’.

Sections 82KZMD and 82KZMA ITAA 1936.

Acquisition of work-in-progress (WIP) amounts

Scope

Section 25-95 allows a deduction for the payment of an amount to acquire WIP from another taxpayer.
Note that this section is not relevant when determining the derivation of income from services performed
or provided by the taxpayer, as discussed earlier in this chapter.
As noted under the sale of WIP amounts, WIP is the value of services performed where circumstances do
not yet allow demand for payment. An amount is a WIP amount under s 25-95(3) when:
• an entity agrees to pay the amount to another entity (the recipient)
• the amount can be identified as being for work (but not goods) that has been partially performed by the
recipient for a third entity but not yet completed to the stage where a recoverable debt has arisen for the
completion or partial completion of the work.
The definition is based on the premise that the entity paying for the WIP will attempt to complete it and
invoice for it.

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68 Tax
Calculation method

A deduction for the payment of an amount to acquire WIP is available to a taxpayer in the income year in
which it was paid, to the extent that, as at the end of that income year:
• a recoverable debt has arisen in respect of the completion or partial completion of the work to which the
amount related, or
• the taxpayer reasonably expects a recoverable debt to arise in respect of the completion or partial
completion of that work within 12 months after the amount was paid.
If the recoverable debt for the completion or partial completion of the WIP cannot reasonably be expected
to arise within 12 months of the date of the payment, that amount will be deductible in the following
income year (s 25-95(2)).
If none of the WIP amount is deductible in the income year in which the payment is made, the entire
amount is deductible in the following income year. This is the case even if no recoverable debt is expected
to arise in the future.
Refer to Topic 3.1.3 for the application of the WIP provisions to changes in partnership interests.

Required reading
Section 25-95 ITAA 1997.

Deduction denial and limitation provisions

A range of provisions prevent taxpayers from deducting a loss or outgoing, either in whole or in part. A list
of provisions that prevent or modify deductibility is included in s 12-5. The most common of these are
found in Division 26.

Expenses associated with holding vacant land

A taxpayer cannot claim deductions for losses or outgoings incurred on or after 1 July 2019 that relate to
holding vacant land. However, the amendments do not apply to any losses or outgoings relating to holding
vacant land to the extent the land was used or held available for use by the taxpayer in the course of a
business carried on by the taxpayer, their spouse or child under 18 years, affiliate or connected entity.
The amendments do not apply to:
• corporate tax entities, superannuation plans other than self-managed superannuation funds, or managed
investment trusts or public unit trusts
• unit trusts or partnerships of which all the members are entities of the above types.

Required reading
Section 26-102 ITAA 1997.

Superannuation contributions for employees

Under s 290-60, superannuation contributions for employees are generally deductible when paid (see
Topic 4.2.3).
However, an employer has an obligation to make minimum superannuation contributions. Where all or part
of the required contributions are not made within the specified time frames, the employer must pay a
superannuation guarantee charge (SGC) that is imposed under the Superannuation Guarantee Charge Act
1992 (SGCA).
The SGC is equal to the contribution shortfall plus interest and penalties. Under s 26-95, a SGC payment is
specifically not deductible.
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Income tax – general rules 69

Deductibility conditions

Contributions that are included in the assessable income of a superannuation fund are called concessional
contributions (s 291-25). These can include both employer and personal contributions. The key conditions
for concessional contributions to be deductible in an income year are as follows:
• The contribution must be made to a complying superannuation fund (ss 290-75 and 290-155).
• The contribution must be actually paid to and received by the superannuation fund (ss 290-60 and
290-150) and not accrued.
• The employee or individual contributor must be less than 75 years old (ss 290-80 and 290-165).
• For an employer contribution:
– the employee must satisfy the employment activity conditions (s 290-70)
– the employer must make compulsory contributions within the timeframes specified under the law. If
this does not happen, an employer should lodge an SGC statement with the ATO, and pay SGC under
the SGCA 1992. The SGC is equal to the contributions the employer should have made plus penalties
and interest, and is not deductible to the employer (s 26-95 ITAA 1997).

• For a personal contribution:

– an individual contributor must notify the superannuation fund that a deduction is being claimed and
have received an acknowledgment from the superannuation fund (s 290-170). The deduction is limited
to the amount stated in the notice (s 290-175)
– an individual cannot create or increase a tax loss by claiming a deduction for personal superannuation
contributions (s 26-55).

TR 2010/1 states that if an electronic funds transfer is made to a superannuation fund, then it is deductible
when credited to the superannuation provider’s account. In practice, this may mean that a payment made
on 30 June would not be credited until the following day due to bank processing times, and in that case
would not be deductible until the following income year. Given the developments in banking since that
ruling was introduced (where funds are often transferred instantaneously), this ruling is likely to have
limited application.
The income tax law places very few restrictions on the amount that can be claimed as a deduction for a
superannuation contribution. However, it should be noted that:
• The personal services income (PSI) rules may deny or limit the deduction (this will be discussed further in
the Advanced Tax elective)
• An effective limit is placed on both concessional (deductible) and non-concessional (non-deductible)
superannuation contributions by the operation of caps (see Topic 4.2.3).
The next example illustrates the application of these rules.

Example 2.12 – Employer contributions

On 30 June 2023, an Australian employer prepays an estimate of the employee superannuation
guarantee contributions of $20,000 for the three-month period ended 30 September 2023. The
payment is received by the superannuation fund on the same day. Under s 290-60, the employer can
claim an income tax deduction for the full amount of superannuation contributions actually paid, that
is $20,000, in the income year ended 30 June 2023. The prepayment rules discussed above do not
apply because the deduction for superannuation contributions is made under s 290-60, and not s 8-1.

Conversely, on 30 June 2023 an Australian employer raises an accrual of $20,000 for financial
accounting purposes for employee superannuation contributions for the three-month period ended
30 June 2023. The contributions are not paid to the superannuation fund until 28 July 2023. Under
s 290-60, the employer is not entitled to an income tax deduction for the $20,000 accrued
superannuation contributions in the income year ended 30 June 2023 because no payment is made
to, and received by, the superannuation fund. The employer will be entitled to an income tax
Pdf_Folio:70
deduction in the following income year when the superannuation contributions are actually paid

70 Tax
 (ie the income year ended 30 June 2024). In reconciling accounting profit to taxable income for the
income year ended 30 June 2023, accrued superannuation must be added back to accounting profit
and contributions paid deducted.

Required reading
Sections 290-60, 290-150 and 26-55.

Non-concessional contributions

Non-concessional superannuation contributions are not assessable income for the superannuation fund
and are not deductable for the contributor. A contribution is non-concessional to the extent it is
attributable to a capital gain that is disregarded under the CGT small business retirement concession in
s 152-305 (covered in the Advanced Tax elective).

Lease arrangements

Lease financing is a common way for business owners to obtain the property or equipment they need to
operate their business without incurring large upfront costs in purchasing the assets.

Accounting issues for lessees

When a taxpayer has equipment or property leases and acts as a lessee, it must comply with AASB 16
Leases. Under AASB 16, from 1 January 2019, such leases must be accounted for on balance sheet
(regardless of whether they may be operating leases or finance leases). In general terms:
• Right-of-use assets and lease liabilities will be recognised on the balance sheet, initially measured at the
present value of unavoidable future lease payments.
• Depreciation on right-of-use assets and interest on lease liabilities will be recognised in the income
statement over the lease term.
• In the cash flow statement, the total amount of cash paid will be separated into principal and interest.
• Lessees with short-term leases (less than 12 months) and leases of low-value assets (eg personal
computers) do not need to recognise assets and liabilities.
• Where there are material off-balance-sheet leases, financial metrics derived from assets and liabilities
(eg leverage ratios) will change, meaning that debt covenants etc may not be complied with. From a tax
perspective, this can also have an impact on an entities thin capitalisation position and unintended
transfer pricing implications.

Accounting issues for lessors

Broadly, AASB 16 still requires lessors to classify leases as either an operating lease or finance lease. The
primary distinction relates to whether the lease transfers substantially all the risks and rewards of
ownership of the underlying asset to the lessee.
The accounting issues and entries for lessors are not explored as they are beyond the scope of what is
required to understand the related tax rules for this subject.

Tax issues for lessees

Except where luxury car leases are involved (covered in the Advanced Tax elective), there is no definition of
the term lease in Australian income tax law.
In general terms, a lease is an agreement between two individuals or entities where one party is granted a
legal right to use or occupy the property of the other party for a specified period in return for payment.
For tax purposes, there are two types of leases:
1. genuine leases
2. hire purchase agreements.
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Income tax – general rules 71

Division 240 applies to hire purchase agreements. A hire purchase agreement is defined in s 995-1 to mean:

(a) a contract for the hire of goods where:

(i) the hirer has the right or obligation to buy the goods; and
(ii) the charge that is or may be made for the hire, together with any other amount payable under the
contract (including an amount to buy the goods or to exercise an option to do so), exceeds the price of the
goods; and
(iii) title in the goods does not pass to the hirer until the option to purchase is exercised; or

(b) an agreement for the purchase of goods by instalments where title in the goods does not pass until the final
instalment is paid.

Where a taxpayer’s leases do not fall within Division 240 (ie there is no right to acquire the property) and
they are otherwise on normal commercial terms, they would be treated as genuine leases.
The ATO also has guidelines on what it regards as a genuine lease arrangement. In broad terms, the ATO
requires that (see IT 28 and IT 2051):
• there must be no agreement under which the property in the asset can pass from the lessor to the lessee
(ie it is not a disguised sale and purchase agreement)
• for leases of depreciating assets, minimum residual values should exist (ie a very low or nominal residual
value in a lease, eg $1, suggests to the ATO that the transaction is a disguised sale and purchase
agreement on credit terms)
• a hire purchase agreement is treated differently to a lease agreement for income tax purposes. A hire
purchase agreement is defined in s 995-1 as a contract for the hire of goods where:
– the hirer has the right or obligation to purchase the goods (as distinct from a leasing arrangement
where this right or obligation does not exist)
– the charge that is made for the hire, together with any other amount payable under the contract,
exceeds the price of the goods.

Lease payments

The general tax treatment of leases, if both parties are carrying on business and the leased asset is used
solely to produce income, is as follows:
• Lessee – the lessee generally receives a tax deduction under s 8-1 for lease payments incurred during
the year.
• Lessor – the lessor is assessed on lease payments derived during the year and claims a Division 40 decline
in value deduction for the asset under the lease (subject to the motor vehicle cost limit where applicable),
with a balancing adjustment on disposal (this is sometimes referred to as the asset method). The lessor is
entitled to the Division 40 deduction because it will be the holder of the asset under s 40-40.

Tax adjustments for lessees

In order to unwind the accounting entries and reflect the correct tax result, the following tax adjustments
are required by a lessee:
• back out the accounting depreciation/amortisation
• back out the interest expense
• claim the actual lease payments (including any unpaid accruals).
Consider the following example.

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72 Tax
 Example 2.14 – Tax adjustments for lessees

Facts $

Right of use asset: 100

Depreciation Year 1: (20)

Net book value 80

Lease liability: 100

Rental payment (principal 13 interest 5 = 18): (13)

Net book value 87

Statement of taxable income

Accounting loss (20 + 5): (25)

Add: Depreciation 20

Add: Interest 5

Less: Payments (18)

Tax loss (= Rental payment) (18)

proof

Accounting loss (20 + 5): (25)

Add: NBV liability − NBV asset (87 − 80) 7

Tax loss (= Rental payment) (18)

Lease termination payments

Section 25-110 allows taxpayers to deduct capital expenditure to terminate a lease or license over five
years (unapportioned, ie 20% in the first year) if the expenditure is incurred in the course of carrying on a
business (or ceasing to carry on a business).

Lease documentation expenses

Section 25-20 allows taxpayers to deduct expenditure incurred for preparing, registering or stamping a
lease of property (or an assignment or surrender of a lease of property) to the extent the taxpayer uses the
property for the purpose of producing assessable income. For example, assume John pays $5,000 to
prepare and register a lease document for a warehouse used in his manufacturing business. A deduction of
$5,000 is available in the year the expenditure is incurred and no apportionment is required. However, if
John used 15% of the warehouse for private purposes, the deduction would be $4,250 (85% × $5,000).

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Income tax – general rules 73

Mortgage discharge expenses

Section 25-30 allows taxpayers to deduct expenditure incurred on discharging a mortgage given as security
for a loan. The loan funds must have been used for the purposes of producing assessable income or for the
purchase of property which was used for the purpose of producing assessable income. Apportionment of
the deduction is required where the loan or property is not wholly used for producing assessable income.
Penalty interest incurred to discharge a mortgage, which is capital in nature, is also deductible under
s 25-30 to the extent that the loan was used to produce assessable income (see TR 2019/2), as illustrated
by the next example.

Example 2.15 – Mortgage discharge expenses

Maeve incurs penalty interest when she sells her business premises and repays the loan to discharge
the mortgage secured over the property. The interest is connected to the sale of a capital asset and is
therefore capital in nature and not deductible under s 8-1. However, Maeve can claim a deduction
under s 25-30 as an expense of discharging the mortgage.

Tax losses (Division 36)

The tax loss rules apply to all taxpayers regardless of whether they are individuals, partnerships, trusts or
companies.
Note: There are additional tax loss rules relating to particular entities that are discussed in other chapters of this subject.

Under s 36-10, the steps to calculate a tax loss for an income year are as follows:

Tax loss = Deductions – Assessable income – Net exempt income

Limit on deductions (s 26-55)

Certain deductions which are not otherwise deductible under s 8-1 cannot increase a tax loss or put the
taxpayer in a tax loss position. These deductions include:
• pensions, gratuities or retiring allowances (s 25-50)
• gifts or contributions (Division 30); however, gift deductions can be spread for up to five years if they
would otherwise waste a tax loss (Subdivision 30-DB)
• personal superannuation contributions (s 290-150).
Net exempt income is defined at s 36-20 and, for a resident taxpayer, is summarised as:
• total exempt income from all sources
• less: non-capital losses incurred in deriving exempt income
• less: any taxes payable outside Australia (ie non-Australian taxes) on exempt income.
Note that under s 6-20(4), an amount that is NANE income is not exempt income. Therefore, it does not
reduce tax losses. NANE income is listed in s 11-55.
For non-corporate entities, s 36-15 sets out how tax losses are carried forward for deduction in
subsequent income years. Broadly, a tax loss is used to offset any excess of total assessable income for a
subsequent income year over the total deductions for that year (ignoring the tax loss) (s 36-15(2)). In
contrast with corporate taxpayers, a non-corporate taxpayer cannot choose to carry the loss forward if an
excess of assessable income exists. If the taxpayer has net exempt income in a subsequent income year, the
amount of the tax loss is reduced by the amount of that net exempt income.
If a taxpayer incurs a tax loss in more than one year, the losses are utilised in the order in which they were
incurred – the oldest is utilised first (s 36-15(5)).
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74 Tax
Loss carry back provides a refundable tax offset that eligible corporate entities can claim:
• after the end of their 2020–21, 2021–22 and 2022–23 income years
• in their 2020–21, 2021–22 and 2022–23 company tax returns.
Eligible entities get the offset by choosing to carry back losses to earlier years in which there were income
tax liabilities. The offset effectively represents the tax the eligible entity would save if it was able to deduct
the loss in the earlier year using the loss year tax rate. As it is a refundable tax offset, it may result in a cash
refund, a reduced tax liability or a reduction of a debt which is owed to the ATO.

Required reading
Sections 36-10, 36-15, and 36-20 ITAA 1997.

2.1.5 Tax offsets

Returning to the calculation of income tax payable, offsets are subtracted after multiplying the taxable
income by tax rates, as shown in the diagram below. This diagram also signposts offsets that are covered in
this subject.

Income tax payable = Taxable income × Tax rates – Offsets – Credits

Tax offsets [2.1.5]

Imputation [3.1.1]
FITO [3.2.1]

As a brief overview, a tax offset reduces the amount of income tax an individual or entity must pay. Tax
offsets result in a benefit to the taxpayer that is equal to the amount of the credit or offset. A tax offset
should never be confused with a tax deduction, which is subtracted from assessable income to arrive at
taxable income. The benefit resulting from a deduction will depend on the marginal tax rate applicable to
the taxpayer.
The term tax offset is used in ITAA 1997, while the terms rebate and tax credits are used in ITAA 1936.
However, the terms all have the same impact, they reduce tax payable.
Tax offsets have been introduced for the following reasons:
• to provide a tax benefit to a specific group within the community (eg those on low incomes or carers)
• to recognise the tax that has already been paid on assessable items (eg the foreign income tax offset
recognises income tax levied by a foreign jurisdiction)
• to encourage activities that the government considers desirable (eg the research and development (R&D)
tax incentive provides a tax offset to eligible companies)
• to reflect a resident company’s tax that is imputed, or attributed, to Australian shareholders, under what
is commonly called the dividend imputation system (ie franking tax offsets).
Some tax offsets are refundable if they exceed the amount of income tax that is otherwise payable
(Division 67).
The order in which tax offsets must be applied is set out in s 63-10. Tax offsets that are non-refundable to
the taxpayer are applied before tax offsets that are refundable. For example, an individual taxpayer would
apply a non-refundable foreign income tax offset before they apply a refundable franking offset.
A full list of tax offsets is provided in s 13-1. A detailed understanding of all tax offsets is outside the scope
of this subject. However, you should ensure that you review the list of tax offsets and are familiar with the
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Income tax – general rules 75

types of tax offsets. The tax offsets that you are required to know in detail (eg franking tax offsets and
foreign income tax offsets) are introduced in this topic and covered in more detail in Chapter 3.

Required reading
Section 13-1 ITAA 1997.

Individual tax offsets

Some of the key tax principles applicable to the calculation of tax offsets for an individual taxpayer
(including an individual carrying on a business as a sole trader, a partner in a partnership or who is a
beneficiary of a trust) are as follows:

Tax offset How it relates to individuals Refer to

Dependent (invalid An individual maintaining dependents who Detailed knowledge is outside the
and carer) tax offset are genuinely unable to work due to scope of this subject.
(DICTO) invalidity or carer obligations may be
eligible for this offset.

Franking tax offset A resident individual receiving franked Topics 3.1.2, 3.1.3 and 3.1.4.
dividends is entitled to a franking tax
offset. Franking credits received by a
partnership or trust can be distributed to
individuals who are partners or
beneficiaries.
Excess franking tax offsets can be
refunded to individuals.

Foreign income tax If foreign tax paid is $1,000 or less, FITO is Topic 3.2.1.
offset foreign tax paid. If foreign tax paid is more
than $1,000 detailed calculations are
required. Resident individuals are not able
to claim a refund for excess foreign income
tax offsets. They either use it or lose it.

Low income tax offset Detailed knowledge is outside the

(LITO) and the low and scope of this subject.
middle income tax
offset (LMITO)

Small business entity Where the business operations of an See below.

(SBE) tax offset individual satisfy the requirements of
being an SBE, the individual may be
entitled to an additional offset.

Zone rebate An individual living in certain prescribed Detailed knowledge is outside the
areas of Australia may be eligible for a scope of this subject.
Zone rebate.

Small business tax offset

An individual taxpayer pays tax on their taxable income at marginal tax rates, irrespective of the type of
income derived (see Topic 3.1.2). However, an individual is entitled to a small business income tax offset
under Subdivision 328-F when calculating their net tax payable where:
•
Pdf_Folio:76 the individual is an SBE (ie as a sole trader)

76 Tax
• the individual’s assessable income includes a share of the net income of an SBE (eg a partner distribution
from a partnership that is an SBE, or a trust distribution from a trust that is an SBE).
This offset corresponds to the reduced tax rate available for SBEs that are incorporated (see Topic 3.1.5).
For the purposes of this offset, the SBE aggregated turnover threshold is $5 million (ie in the aggregated
turnover provisions, replace all references to $10 million with $5 million).
The amount of the tax offset for the 2022–23 income year is 16% of the income tax payable on the portion
of the individual’s income that is small business income, capped at $1,000. For example, an individual
taxpayer with $6,000 of tax payable on SBE income is entitled to a tax offset of $6,000 × 16% = $960. An
individual taxpayer with $50,000 of tax payable on SBE income is entitled to a tax offset of $1,000 (the
maximum amount, as $50,000 × 16% exceeds $1,000).

Company tax offsets

Some of the key tax principles applicable to the calculation of tax offsets for a company taxpayer are as
follows:

Tax offset How it relates to companies Refer to

Franking tax offset A company may be entitled to a Topic 3.1.1 ‘Company’

franking tax offset
Excess franking tax offsets cannot be
refunded. However, they can be
converted into tax losses.

Foreign income tax A company may be entitled to a FITO Topic 3.2.1 ‘Foreign income of
offset (FITO) residents’
Like other taxpayers, excess FITOs
cannot be refunded or converted into
tax losses, a company must use it or
lose it.

Loss carry-back offset Under Division 160 (loss carry back Topic 3.1.1 ‘Company’
rules), losses can be carried back in
certain circumstances. Specifically,
corporate tax entities with an
aggregated turnover of less than
$5 billion can apply tax losses against
previously taxed profits. Loss carry back
provides a refundable tax offset that
eligible corporate entities can claim:
• after the end of their 2020–21,
2021–22 and 2022–23 income years
• in their 2020–21, 2021–22 and
2022–23 company tax returns.

R&D tax offset

The research and development (R&D) tax incentive provides a tax offset where an eligible R&D company
incurs expenditure of at least $20,000 on eligible R&D experimental activities. The tax offset is refundable
for eligible R&D companies with aggregated turnover of less than $20 million. In all other cases, the tax
offset is not refundable.
A detailed understanding of the R&D tax incentive is outside the scope of this subject.

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Income tax – general rules 77

Superannuation tax offsets
Spouse superannuation contribution tax offset

A tax offset of up to $540 is available for a contribution to a superannuation fund on behalf of a spouse (of
any gender). To be eligible the following conditions must be met:
• The spouse must have total income (assessable income, reportable fringe benefits and reportable
employer superannuation contributions) of less than $40,000 (s 290-230).
• The spouse must not have exceeded their non-concessional contributions cap for the relevant year.
• The spouse must have a superannuation balance of less than the general transfer balance cap
immediately before the start of the income year in which the contribution was made. The general
transfer cap for the 2022–2023 income year is $1.7 million.
This tax offset is calculated as 18% of the lesser of:
• $3,000, reduced by $1 for every dollar that the sum of the spouse’s total income exceeded $37,000
• the total amount of spouse contributions made for the year.
The maximum offset is therefore 18% × $3,000 = $540.

Superannuation offsets for benefits and income streams

Individuals under 60 years of age and receiving a superannuation lump sum or income stream benefit
include the taxable component of that lump sum or income stream in their assessable income. However,
that individual may be entitled to a tax offset equal to 15% of the taxable component of that benefit under
ss 301-20 and 301-25 (for taxpayers over the preservation age) and ss 301-35 and 301-40 (for taxpayers
under the preservation age).
Note that, for individuals over 60 years of age, superannuation lump sum and income stream benefits from
a taxed source are NANE.
Tax-free components are NANE regardless of the age of the recipient.
A detailed understanding of this offset is outside the scope of this subject.

Foreign income tax offsets (FITO)

Exempting foreign income from Australian tax is one way to avoid double taxation. Giving a tax offset for
foreign taxes paid on that foreign income is another way.
Division 770 deals with foreign income tax offsets (FITOs). Sections 770-1 and 770-5 set out the basic
principles of the Division. FITOs are covered in Topic 3.2.1. In addition, the ATO’s Guide to Foreign Income
Tax Offset Rules provides a useful summary.
A FITO reduces the Australian tax that would be payable on foreign income by an amount up to the foreign
income tax paid, and the amount of the FITO is dependent on whether the foreign tax paid for the year in
question is more than $1,000.

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78 Tax
2.1.6 Tax rates
Returning to the calculation of income tax payable, the taxable income of a taxpayer is multiplied by
applicable tax rates, as shown in the diagram below. The tax rates applied depend on the type of taxpayer,
and are summarised in the tables in this topic.

Income tax payable = Taxable income × Tax rates – Offsets – Credits

Tax rates [2.1.6]

Individuals
Progressive tax rates are applied to individual taxpayers, whereby the marginal tax rates increase as taxable
income increases. Different tax rate schedules exist for resident and non-residents. Taxpayers under the
age of 18 may be taxed at penalty rates where the income is ’unearned income’ of a minor (Division 6AA
ITAA 1936).
Resident individuals are entitled to a tax-free threshold of $18,200 per annum.

Income tax rates 2022–2023 for a resident individual

Taxable income $ Tax rate % Tax

0–18,200 0 $nil

18,201–45,000 19 19c for each $1 over $18,200

45,001–120,000 32.5 $5,092 plus 32.5c for each $1 over $45,000

120,001–180,000 37 $29,467 plus 37c for each $1 over $120,000

180,001 and over 45 $51,667 plus 45c for each $1 over $180,000

Source: Australian Taxation Office 2023.

Note: Division 6AA applies to certain unearned income of minors.

Non-resident individuals are not entitled to a tax-free threshold and pay tax at 32.5% from the first $1 of
taxable income.

Income tax rates 2022–2023 for a non-resident individual

Taxable income $ Tax rate % Tax

0–120,000 32.5 32.5c for each $1

120,001–180,000 37 $39,000 plus 37c for each $1 over $120,000

180,001 and over 45 $61,200 plus 45c for each $1 over $180,000

Source: Australian Taxation Office 2023.

Companies
The tax rate of a company depends on whether it is classified as a ‘base rate entity’. See Topic 3.1.1 for
determining when a company qualifies as a base rate entity.
• Tax rate for a company that is a base rate entity: 25%.
•
Pdf_Folio:79
Tax rate for all other companies: 30%.

Income tax – general rules 79

2.1.7 Tax reconciliation
Reconciliation from accounting profit to taxable income
Practically, most businesses do not use the formula specified in s 4-15 to calculate taxable income. The
method they use to calculate taxable income is to prepare a reconciliation from their accounting profit to
taxable income (sometimes called a statement of taxable income). To do this, they analyse their financial
statements (eg profit and loss statement, statement of other comprehensive income, and balance sheet).
This is to identify any differences between what is recognised for accounting purposes in accounting profit
and what is assessable income or a deduction for tax purposes in a particular income year. All identified
differences are added to, or subtracted from, accounting profit to determine taxable income.
You should be familiar with this approach and have the basic accounting skills to analyse financial
information from your prior studies.
The following table provides an overview of how a business calculates taxable income.

Reconciliation of accounting profit to taxable income

Item $

Accounting profit/(loss) (P/L) xx

Add/(less): Adjustments

Add: Expenses in P/L but not tax deductible xx

Less: Expense not in P/L but tax deductible (xx)

Less: Income/gains in P/L but not assessable (xx)

Add: Income/gains not in P/L but assessable xx

Equals: Taxable income $xxx

Using the example of Doner Pty Ltd in Topic 2.1.2, the following example shows Doner’s taxable income
calculated using the reconciliation method.

Example 2.16 – Tax reconciliation

Step 1: Obtain the accounting profit before income tax expense from Doner Pty Ltd’s financial
statements. A review of the financial statements indicates profit before tax expense is $639,490,000.

Step 2: Applying the ITAA provisions, adjust items of revenue and expense in the accounting profit
that are either temporary and/or permanent differences between accounting profit and taxable
income to calculate taxable income.

Please note that the purpose of this calculation is to demonstrate the reconciliation method rather
than for candidates to understand how the amounts are derived.

Put another way, Example 2.2 calculates taxable income by subtracting deductions from assessable
income.

This example calculates the same taxable income by starting at accounting profit and making tax
adjustments.
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80 Tax
 Whilst the taxable income is the same under both methodologies, the reconciliation differ.
Note: all amounts exclude GST where applicable.

Description Reference $ ’000s $ ’000s

Accounting profit before tax 639,490

Add/(less): Adjustments

Add: Expenses in P/L but not tax deductible

Interest and depreciation expense for AASB 16 45,000

leased asset

Capital repairs s 25-10 400

Accounting depreciation s 40-25 200,000

Entertainment 50% not subject to FBT s 32-5 180

Doubtful debts expense s 25-35 12,000

Accrual for employee leave s 26-10 32,000

Accruals for future rehabilitation expenses s 8-1 15,000

Superannuation contributions accrued but s 290-60 7,000

not paid

Total non-deductible expenses 311,580

Less: Expense not in P/L but tax deductible

Tax depreciation / Capital allowances s 40-25 270,000

Bad debts written off s 25-35 6,000

Employee leave paid s 26-10 30,000

Lease payments s 8-1 20,000

Total deductible expenses not in P/L? (326,000)

Less: Income/gains in P/L but not

assessable

Foreign exempt dividend s 768-5 80,000

Accounting gain on sale of capital asset 22,000

Total non-assessable income/gains (102,000)

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Income tax – general rules 81

 Description Reference $ ’000s $ ’000s

Add: Income/gains not in P/L but

assessable

Net capital gain s 102-5 18,000

Franking/imputation credit s 207-20 3,000

Foreign withholding tax s 6-5 1,000

Total assessable income/gains 22,000

Taxable income 545,070

Income tax payable

Description Reference $ ’000s

Tax at 30% 163,521

Less offsets:

Franking/imputation credits (3,000)

Foreign income tax offsets (1,000)

PAYG instalments (80,000)

Income tax payable $79,521

2.2 Property and capital transactions

This topic covers:
• Decline in value deduction (ie tax depreciation) and balancing adjustments (ie gain or loss on disposal) for
depreciating assets (eg plant and equipment) under the capital allowance rules (Division 40).
• The interaction between the CGT provisions and Division 43.
• Trading stock.
• Capital gains tax (CGT) including:
– exemptions
– concessions
– other special topics that are relevant to CGT.

Completing this topic should provide a clear understanding of how the property and capital rules fit
together, and the ability to apply this understanding to resolve complex, practical problems.

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82 Tax
Property and capital transactions – overview
Common tax rules and principles that apply to particular types of property and capital transactions are
used by tax practitioners to determine the taxable income for a taxpayer.
The following table provides an overview of key guidance and related sections connected to property and
capital transactions that might be used to determine taxable income.

Section ITAA
1997 unless
otherwise
Item stated Guidance

General deduction 8-1 Capital expenditure is not deductible. Key tests to determine
whether capital or revenue (Sun Newspapers Ltd and Associated
Newspapers Ltd v FCT):
• Character of the advantage sort – enduring benefit more likely
to be capital
• Manner advantage used or enjoyed – once-and-for-all benefit,
as opposed to short term, more likely to be capital
• Means to obtain advantage – single lump sum, as opposed to
series of recurrent payments, more likely to be capital. However,
capital can be paid in instalments.
Refer to income tax topic.

Repairs 25-10 A repair is deductible when incurred if it (TR 97/23):

• Restores the function and does not significantly improve it
• Renews or replaces parts and not the entire asset
• Does not change the character of the asset.

A repair is not deductible if it relates to:

• The replacement of an entirety
• An improvement
• An initial repair (ie damage/deterioration of an asset that existed
at the time it was purchased)
• Preparing an asset for sale.

Refer to income tax topic.

Capital allowances – Division 40 A depreciating asset is defined as (s 40-30):

Depreciating assets and Division • an asset that has a limited effective life, and
328 • can reasonably be expected to decline in value over the time it
is used.
The definition specifically excludes:
• Land (but can include an improvement to land or a fixture on
land)
• Trading stock
• Intangible assets, with the exception of the specifically listed
types (all other types will be part of the CGT asset goodwill).
The definition specifically includes (where they are not trading
stock):
• Mining, quarrying and prospecting rights
• Intellectual property that is a patent, registered design or
copyright (therefore, a brand name is not a depreciating asset)
• In-house software
• Spectrum and datacasting transmitter licences.

Other assets also specifically excluded are (s 40-45):

• An asset provided to an employee as a fringe benefit that is an
eligible work-related item under s 58X FBTAA 1986
• Building and structural improvements to which a Division 43
capital works deduction applies.

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Income tax – general rules 83

 Section ITAA
1997 unless
otherwise
Item stated Guidance

Capital works – Division 43 The capital works rules apply to:

buildings and structural • Buildings, extensions and alterations
improvements • Structural improvements such as sealed roads, driveways and
car parks.
A capital works deduction claimed by a taxpayer may decrease the
cost base of the asset for CGT purposes.

Trading stock Division 70 Trading stock is defined to include (s 70-10):

• Anything produced, manufactured or acquired that is held for
the purposes of manufacture, sale or exchange in the ordinary
course of a business
• Livestock.

Capital gains tax (CGT) Part 3-1, A CGT asset is defined as (s 108-5):
asset Divisions • Any kind of property, or
100–121 • A legal or equitable right that is not property.

Examples of CGT assets included in the definition are:

• Goodwill
• Land and buildings
• Shares and options
• Debts owed to the taxpayer
• Rights to enforce contractual obligations
• Foreign currency
• An interest (or a part interest) in an asset.
However, a capital gain or loss is disregarded to the extent that:
• It is a capital gain that is assessable under another provision
(s 118-20). Where there is a loss, s 110-55(9) reduces the cost
base of the revenue asset to ensure there is no double deduction
• It relates to a depreciating asset where the decline in value of
the asset is fully tax deductible (s 118-24). Both the capital
allowance rules and CGT event K7 may apply where the decline
in value is only partly tax deductible
• It relates to the disposal of trading stock (s 118-25).

Blackhole expenditure Business related capital expenditure that is not dealt with in any
other way (eg is not deductible, is not included in cost base of CGT
asset, etc) may qualify for deduction as black hole expenditure.

Capital allowances (Division 40 and Division 328) – overview

Common tax rules and principles that apply to particular capital allowances are used by tax practitioners to
determine the taxable income for a taxpayer.
The following table below provides an overview of key guidance and sections related to capital allowances
that might be used to determine taxable income.

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84 Tax
 Section ITAA
1997 unless
Item otherwise stated Guidance

Decline in value 40-25 Decline in value deduction is available if:

(general rules) • there is a depreciating asset
• the taxpayer holds the asset, and
• the asset is used or installed ready for use for a taxable
purpose (s 40-60 Start time).

Depreciating asset 40-30 Refer above under the property and capital transactions overview

Hold 40-40 The taxpayer who holds a depreciating asset is:

• General rule = Legal owner
• Exceptions:
– Luxury car lease = Lessee
– Other leased asset where, the lease agreement allows the
lessee to become the economic owner, and it reasonable to
expect them to do so (eg as the lease has a nominal residual
value of $1) = Lessee (ie economic user/owner).

Choice of decline in 40-65 A taxpayer has a choice of the diminishing value (DV) method or
value method the prime cost (PC) method for each asset, unless:
• Acquired from an associate = Method used by associate
• Intangible asset = PC method
• Low-value pool chosen for low-cost assets (ie cost < $1,000) or
low value assets (ie adjustable value < $1,000) = Rates as
applicable for pool
• The taxpayer is a small business entity (SBE) that has chosen to
apply the SBE capital allowance rules to all eligible assets.
• Also, assets subject to 100% write-off, such as under the
temporary full expensing rules, are implicitly outside of
these rules.

Diminishing value 40-72 Decline in value = Base value × Days apportionment × 200% /
method Effective life
Where, base value:
• Year 1 = Cost
• Subsequent years = Opening adjustable value + Second
element additions to cost.

Prime cost method 40-75 Decline in value = Cost × Days apportionment × 100% /
Effective life.

Deduction for asset’s 40-80(2) Decline in value deduction for a non-business taxpayer is the
cost depreciating asset’s cost, if that cost does not exceed $300.

Choice of effective 40-95, 40-100 A taxpayer has a choice of the Commissioner’s determination (for
life and 40-105 the income year ended 30 June 2023 see TR 2022/1) or to
self-assess effective life, unless:
• Asset acquired from an associate = Same basis as associate.
• Asset has a statutorily prescribed effective life. For example:
– Intangible assets
◦ Standard patent = 20 years
◦ Copyright = lesser of 25 years and period until it ends
◦ Registered designs = 15 years
◦ In-house software = 5 years
◦ Other licences = term of licence.

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Income tax – general rules 85

 Section ITAA
1997 unless
Item otherwise stated Guidance

– Certain other assets capped life (s 40-102):

◦ Bus > 3.5 tonnes = max 7.5 years
◦ Light commercial – max 7.5 years.
◦ The taxpayer is a small business entity (SBE) that has
chosen to apply the SBE capital allowance rules.

Cost 40-175, 40-180, The cost of a depreciating asset includes:

40-185 and • First element = Amount paid for the asset
40-190 • Second element = Expenses to bring the asset to its present
condition and location
– Includes - Freight and delivery costs, customs and import
duties, modifications and alterations, cost of minor
rearrangements to allow the asset to be installed, and initial
repairs to an asset
– Excludes - Structural alterations to a building (Division 43),
post-installation costs, GST input tax credit entitlement
(s 27-80), otherwise deductible amounts such as repairs
(s 40-215), and non-capital expenses such as interest
(s 40-220).
Special rules exist for cost where:
• Asset is brought into a partnership = Market value
• Non-arm’s length purchase > market value = Market value
• Car acquired at a discount because of a trade-in on another
car = Cost increased by discount.
• Car acquired where cost (exclusive of GST claimable as an
input tax credit) > car cost limit = Car cost limit, of:
– Income year ended 30 June 2023 = $64,741.

A car as defined means a motor vehicle (except a motorcycle or

similar vehicle) designed to carry a load of less than one tonne
and fewer than nine passengers (s 995-1).

Gain/(loss) on 40-285 Balancing adjustment = Termination value – Adjustable value.

disposal of a
When a depreciating asset (other than a car) is sold:
depreciating asset
• Termination value = Sale price (s 40-300)
• Adjustable value (s 40-85) = Cost – Total decline in value
(regardless of whether the decline in value has been claimed as
a deduction by the taxpayer).

Cost reduced for 27-80 A depreciating asset’s cost is reduced by the GST component of
input tax credits the acquisition price that the taxpayer is entitled to claim as an
input tax credit.
Refer to the topics on GST and interactions between taxes and
transactions.

Cost reduced for 27-100 Where a depreciating asset is allocated to a low value pool or
input tax credits pool under Division 328, the amount allocated is reduced by the
GST component of the acquisition price that the taxpayer is
entitled to claim as an input tax credit.
Refer to the topics on GST and interactions between taxes and
transactions.

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86 Tax
 Decline in value 40-25 Total decline in value is calculated under the prime cost (PC)
(general rules) method or diminishing value (DV) method.
However, the amount of the deduction that the taxpayer is
entitled to claim is reduced for:
• Non-taxable use
• Second-hand assets in certain residential rental properties (see
below).

Decline in value of 40-27 Decline in value not deductible for second-hand assets used in
second-hand assets / residential rental property, unless:
goods • The taxpayer is carrying on a business
• The taxpayer is a company (or other specifically listed entity)
• The asset is part of the supply of new residential premises.

Medium sized 40-82 Decline in value deduction for a medium sized business taxpayer
business deduction is the depreciating asset’s cost, if the $50 million turnover
for asset’s cost threshold is satisfied under the temporary full expensing rules
(see below) (subject to eligibility criteria for the asset).
Up to 31 December 2020, a medium sized business must have
aggregated turnover of $10 million or more but less than
$50 million or $500 million for the applicable period. Therefore, a
small business entity (ie an entity with an aggregated turnover of
less than $10 million) cannot apply this concession. The
temporary full expensing provisions effectively make this
provision obsolete until 30 June 2023 (see below).
Refer to QRG: Summary of capital allowance concessions.

Temporary full 40-160 IT(TP)A Decline in value deduction for most business taxpayers is the
expensing 1997 depreciating asset’s cost (subject to eligibility criteria for the
asset and the taxpayer).

Gain/(loss) on 40-285, 40-290, There are special rules that apply to balancing adjustment
disposal of a 40-300, 40-325 calculations for the following:
depreciating asset and 40-365 • Where the cost of a car for decline in value purposes is capped
at the car depreciation cost limit, the termination value used in
the calculation of the assessable/(deductible) balancing
adjustment is proportionately adjusted.
• Where the decline in value amount that is actually claimed as a
deduction is reduced for non-taxable use, the balancing
adjustment amount is also proportionately reduced. However,
CGT event K7 will apply.
• Where the decline in value amount is reduced to nil for
second-hand assets in a residential rental property, the
balancing adjustment amount is also reduced. However, CGT
event K7 will apply.
• Where there is an involuntary disposal, the taxpayer can
choose to reduce the cost of a replacement asset by some or
all of the balancing adjustment.

Low-value pool 40-425 Taxpayers can choose to establish a low-value pool for:
• Low cost assets = Assets that cost < $1,000, however once
one low cost asset is allocated to a pool all subsequent low
cost assets must also be allocated (s 40-430).
• Low value assets = Asset with opening adjustable value
< $1,000 that have declined in value under the DV method.
Where a pool is chosen, the rate of decline in value is (s 40-440):
• Current year additions = 18.75% of taxable purpose portion
• Subsequent years and reallocated assets = 37.5%

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Income tax – general rules 87

 Section ITAA
1997 unless
Item otherwise stated Guidance

When a balancing adjustment event occurs for a pooled

depreciating asset the depreciating asset’s termination value (as
reduced for any non-taxable use) is subtracted from the pool
balance. However, CGT event K7 will apply.
The temporary full expensing provisions effectively make this
provision obsolete until 30 June 2023 (see below).

A taxpayer that is a small business entity (SBE) can choose to apply the SBE capital allowance rules in
Division 328. However, the concepts in Division 40 (as outlined above) continue to apply to these taxpayers
to the extent they are consistent. The SBE capital allowance rules are covered in section 3.1 (Tax structures).

Section ITAA
1997 unless
Item otherwise stated Guidance

Small business 328-110, 328- To be an SBE as defined, a taxpayer must (s 328-110):

entity (SBE) 115, 328-120, • Carry on, or be in the process of winding up, a business
328-125 and • Satisfy the less than $10 million aggregated turnover test.
328-130
The aggregated turnover test will be satisfied if any of the
following tests are satisfied (s 328-115):
• Prior year test = Aggregated turnover for the prior year is
< $10 million, as determined on the first day of the current
income year
• Current year test
– Aggregated turnover for the current year is likely to be
< $10 million, as determined on the first day of the current
income year
– Aggregated turnover for at least one of the two prior years
was < $10 million.
• Additional test = Actual aggregated turnover, calculated at the
end of the current income year, is < $10 million.
Aggregated turnover as defined under s 328−120 includes the
entity’s annual turnover and the annual turnover of all connected
entities (s 328−125) and affiliates (s 328−130).

Choice to apply SBE 328-175 An SBE taxpayer can choose to apply the SBE capital allowance
capital allowance rules to all eligible depreciating assets that it holds and uses (or
rules has installed ready for use) for a taxable purpose. However, not all
assets are eligible.

Deduction for 328-180 / The decline in value deduction for an SBE taxpayer is the
asset’s cost 328-181 IT(TP)A depreciating asset’s cost, if that cost does not exceed $1,000.
1997 However, for the income year ended 30 June 2023, an SBE
taxpayer can claim an immediate deduction for the cost of a
depreciating asset, regardless of its cost, under the temporary full
expensing rules.
Refer to QRG: Summary of capital allowance concessions.
Note: In the May 2023 Budget, the government announced that the instant
asset write-off threshold for small businesses applying the simplified
depreciation rules will be $20,000 for the 2023–24 income year.

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88 Tax
 Pooling 328-185 Under the SBE pooling rules:
• When pooling is first chosen, the taxable purpose portion of all
existing eligible assets are allocated to the SBE pool (ie decline
in value is no longer calculated under the DV method or PC
method)
• Even if pooling does not apply in a later income year, once an
asset is allocated to the pool it remains in the pool (s 328-220).

Decline in value 328-190 Deduction rate:

deduction • Opening pool balance × 30%
• Acquisitions and improvements × 15%

Refer to QRG: Summary of capital allowance concessions.

Opening pool 328-195 Opening pool balance is:

balance • In the first year, the sum of the taxable purpose portions of the
adjustable values of depreciating assets allocated to the pool
• In other years, the closing pool balance for the previous year
reduced or increased by required adjustments.

Closing pool 328-200 and The taxable purpose portion of a depreciating asset’s termination
balance / Disposal 328-215 value is:
of assets • Subtracted from the pool balance where the asset was previously
allocated to the pool. However, if the pool balance is < $0, then
the excess is included in the taxpayer’s assessable income
• Included in assessable income where the asset was not
previously allocated to the pool.

Low pool balance 328-210 In the year the notional closing pool balance falls below the low
pool balance threshold, it is written off as a low pool balance.

2.2.1 Capital allowances application and deduction

Decline in value (ie tax depreciation)
General rules

A taxpayer can generally choose one of two methods to calculate the decline in value for depreciating
assets that are held during an income year (s 40-65). These methods are the prime cost (PC) method and
the diminishing value (DV) method. Key points to note for the taxpayer’s choice of method are as follows:
• The taxpayer must choose one of these methods for the first income year in which they are allowed a
decline in value deduction for the depreciating asset.
• The choice is made on an item-by-item basis.
• Once the taxpayer has chosen the method of calculation for a particular depreciating asset, the method
cannot be changed (s 40-130). However, assets that were depreciated using the DV method and have
become low-value assets can be allocated to a low-value pool.
The choice of method is not available for:
• certain intangible assets, which must be depreciated using the PC method (s 40-72(2))
– certain intangible assets also have a prescribed effective life under s 40-95(7) and a taxpayer cannot
choose to self-assess the effective life of those assets. For example, in-house software (defined as
expenditure on developing, or having another entity develop, computer software that is intended to be
used solely for a taxable purpose) is prescribed an effective life of 5 years and is therefore depreciated
at a rate of 100% ÷ 5 years = 20% of its PC each year, subject to the number of days in each year.

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Income tax – general rules 89

• assets acquired from an associate generally must be depreciated on the same basis as used by the
associate (s 40-65(2)) and with the same effective life (s 40-95(4)). For example:
– if the associate was using the DV method for the asset – the taxpayer must use the DV method and
the same effective life that the associate was using
– if the associate was using the PC method for the asset – the taxpayer must use the PC method and an
effective life equal to any period of the asset’s effective life that is yet to elapse at the time the
taxpayer started to hold it.

Unlike accounting depreciation, the PC and DV methods do not consider any estimated residual value on
disposal for the depreciating asset.
The PC and DV methods may not apply where the taxpayer is a small business entity (SBE) that has chosen
to apply the SBE capital allowance rules and therefore has elected to pool eligible assets, or is entitled to an
immediate deduction where the cost of the asset is under the instant asset write off (IAWO) threshold.

Prime cost method

Where the PC method is used, it provides for fixed decline in value deductions on an annual basis (s 40-75).
The formula used in the PC method is:

Days held during income year 100%

Cost × × = Decline in value
365 Asset’s effective life

Key points to note for the PC method are:

• If the effective life is recalculated or there are second element costs, the formula must be adjusted in
later income years.
• Days held during an income year includes both the date of acquisition and disposal.
• The calculated decline in value deduction is reduced by any non-taxable use (s 40-25). However, a
reduction to the decline in value deduction is not reflected in the calculation of adjustable value for the
depreciating asset. Moreover, decline in value deductions are not available for secondhand assets used in
residential properties for the purpose of deriving rental income where the taxpayer is not an excluded
entity (eg an individual, SMSF or discretionary trust).

Diminishing value method

Where the DV method is chosen, the decline in value is based on a percentage of the asset’s adjustable
value (ie its closing written-down value) of the prior year (s 40-70). Where the asset was acquired on or after
10 May 2006, the formula used to calculate the decline in value for a particular income year is (s 40-72):

Days held during income year 200%

Base value × × = Decline in value
365 Asset's effective life

The base value of a depreciating asset in the first income year is its cost. In a subsequent income year, the
base value is calculated as follows:

Cost – Decline in value to date = Opening adjustable value (s 40-85)

Second element costs in later

Opening adjustable value + = Base value
income year

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90 Tax
Key points to note for the DV method are:
• the decline in value of an asset for an income year can never exceed its base value
• days held during income year includes both the date of acquisition and disposal.
It is not required that capital allowance deductions be apportioned when a second element of cost is
incurred during an income year. For example, if an improvement is made to an asset on the last day of the
year, depreciation is available for the full opening adjustable value plus the second element cost (ss 40-70
and 40-72).
The base value is reduced by the total decline in value for the particular income year regardless of whether
a decline in value deduction was claimed. The DV method gives greater tax deductions in earlier years and
smaller tax deductions in later years.
Similar reductions apply under the DV method as the PC method for any non-taxable use of the asset. In
addition, the restrictions for secondhand assets used in residential rental properties also apply.
Note: The PC and DV formulae use 365 days, rather than the number of days in the income year, as this is what is specifically included in
the income tax legislation. Due to this drafting anomaly, leap years are not taken into account in the denominator. For the purposes of
calculations in this subject, the impact of leap years is fully ignored (ie it is assumed that February always has 28 days). In practice, the
impact of leap years may be taken into account in both the numerator and the denominator.

Example 2.17 – Prime cost versus diminishing value

Oner Pty Ltd (Oner) manufactures electrical boxes. At the start of Year 1, it acquires a sanding
machine for $150,000. The sanding machine has an effective life of five years.

If Oner uses the prime cost method of depreciation, the deductions would be as follows:

Year 1: $30,000

Year 2: $30,000

Year 3: $30,000

Year 4: $30,000

Year 5: $30,000

If Oner uses the diminishing value method of depreciation, the deductions would be as follows:

Year 1: $60,000 (150,000 × 200%/5)

Year 2: $36,000 (90,000 × 200%/5)

Year 3: $21,600 ($54,000 × 200%/5)

Year 4: $12,960 ($32,400 × 200%/5)

Year 5: $7,776 ($19,440 × 200%/5)

This example shows that the prime cost method fully depreciates the asset after five years. In
contrast, the diminishing value method keeps depreciating the asset past that time. The choice
between prime cost and diminishing value comes down to:

• simplicity, lower upfront deductions and a finite life (prime cost)

• higher deductions upfront and an infinite life (diminishing value).

From a practical business perspective, a choice may be made depending on matching the asset’s
depreciation profile over its useful life and/or considering the taxpayer’s overall profile to determine
which method would result in a more efficient taxable position.

Immediate deduction – overview

An immediate decline in value deduction for the total cost of a depreciating asset is available for certain
depreciating assets that are used in deriving assessable income and/or certain eligible taxpayers.
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Income tax – general rules 91

Assets used in producing non-business income

Under s 40-80(2), the decline in value of a depreciating asset is the asset’s cost if:
• the cost does not exceed $300 (GST-inclusive) (eg a briefcase for work)
• the asset is used predominantly to produce assessable income that is not income from carrying on a
business (eg salary income, rental property income)
• the asset is not part of a set of assets acquired in an income year where the total cost of the set of assets
is more than $300
• the total cost of the asset and any other identical, or substantially identical, assets acquired in the income
year does not exceed $300.

Example 2.18 – Assets acquired in a set

Sacha owns a fully furnished rental property. During the income year, Sacha purchased four new
kitchen stools at a total cost of $1,000. Sacha may be entitled to an immediate deduction under
s 40-80 as she is deriving non-business income and each stool costs $250. However, because the
stools belong to a set, an immediate deduction is not allowed as the total cost of the set of assets is
more than $300.

Assets used in producing business income

Some businesses can access an immediate deduction for the total cost of a depreciating asset provided
certain requirements are satisfied.
Under Subdivision 40-BB of the Income Tax (Transitional Provisions) Act 1997 (ITTP Act), 100% of the cost of
plant which is located (and principally used in carrying on a business) in Australia which is first held, and
first used or installed read for use for a taxable purpose, can be claimed outright in that use year.
Note: Taxpayers can elect out of the 100% write off on an asset by asset basis.

The cost of improvements to post-6 October 2020 plant and pre-existing plant made during the write off
period (see below) can also be claimed outright. The write off amount is not capped, it applies to any
amount. The write off amount includes software. This 100% write off concession goes from 7 October
2020 to 30 June 2023.
Note: The asset must be used or installed ready for use by 30 June 2023.

Where the aggregated turnover is more than $50 million and less than $5 billion (the aggregated turnover
limit is $5 billion), the write off does not apply where:
• the entity entered into a commitment to hold, construct or use the asset before 7 October 2020 (note
this does not include a call option)
Note 1: Construction of an asset occurs when expenditure in respect of the construction of the asset occurs.
Note 2: There are anti-avoidance rules.

• the asset is second hand.

Note: This rule does not apply to second element costs.

Where the aggregated turnover is less than $50 million, there are no restrictions.
The following assets are excluded from the 100% write off rules:
• Where they are outside of Division 40 (eg building and capital works).
• Where they are allocated to low value and software development pools (Subdivision 40-E).
• Where, at the time that the asset is first used or installed ready for use for a taxable purpose:
– it is not reasonable to conclude that the entity will use the asset principally in Australia for the
principal purpose of carrying on a business
– it is reasonable to conclude that the asset will never be located in Australia.

• Where assets are sold in the same year.

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92 Tax
Companies with an aggregated turnover of more than $5 billion due to the income of an overseas parent or
associate can qualify for temporary full expensing under an alternative test provided they meet the
additional investment requirements. Under this alternative test, companies must have:
• less than $5 billion in total statutory and ordinary income (excluding non-assessable non-exempt income)
in either the 2018–19 or 2019–20 income year
• invested more than $100 million in tangible depreciating assets in the period 2016–17 to 2018–19.
For SBE’s (with an aggregated turnover of less than $10 million) that choose to apply the simplified
depreciation rules, temporary full expensing is contained in modifications to those rules made by
s 328-181 of the ITTP Act. This does mean that SBEs that use the simplified depreciation rules can also use
this instant asset write-off concession to claim 100% deduction for eligible assets. In addition, the SBE can
use this concession to fully deduct the balance of their small business asset pool.
The immediate deduction thresholds that may apply are summarised in the following table.

Immediate deduction thresholds

Date depreciating asset acquired Aggregated turnover threshold

and used (or installed ready for use) Immediate deduction thresh- used to determine if the taxpayer is
in producing business income old amount entitled to write off business assets

7 October 2020 to 30 June 2023 No limit $5 billion

1 July 2023 onwards $100 N/A

As with the PC method and the DV method, the decline in value amount determined above is reduced by
any non-taxable use to arrive at the deduction for the current income year (s 40-25).
Where s 40-82 applies or the instant asset write off rule applies, the depreciating asset’s adjustable value is
reduced to $Nil. If the asset is later disposed of, there will be a balancing adjustment event and the asset’s
terminating value (ie proceeds of sale) will give rise to an assessable balancing adjustment for the taxpayer
(see ‘Balancing adjustments’ below).
Where s 40-82 or the instant asset write off rule does not apply, the ATO will allow items that have a
GST-inclusive cost of $100 and that are expensed for accounting purposes, to be claimed as an outright tax
deduction (PS LA 2003/8). For example, if a company acquires a calculator for $80, it can be assumed, for
tax purposes, to be revenue in nature and deducted immediately under s 8-1.

Accelerated decline in value

Prior to 1 July 2021, the decline in value of an asset could be calculated using the accelerated decline in
value concession under s 40-130 ITTP Act. This concession was only available to certain assets acquired
between 12 March 2020 and 30 June 2021 where the criteria in ss 40-120 to 40-135 of the ITTP Act were
satisfied. Under this concession, the decline in value was calculated as broadly the sum of:
• 50% of the asset’s cost at the end of the year the asset was purchased
• the amount of decline in value calculated under the general rules, if the cost is reduced by the above
50% amount.
In subsequent income years, (ie 30 June 2022 and beyond), the decline in value of an asset to which the
above concession has already applied, is worked out under the general rules in Division 40.
For an eligible SBE, the accelerated depreciation was 57.5% of the cost in the year the asset was added to
the small business asset pool rather than the normal 15%. The normal diminishing value rate of 30% applies
after the first year. As the accelerated depreciation concession was only available where assets were
acquired before 30 June 2021, they are not considered further but their impact should be considered
in practice.
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Decline in value reductions
Section 40-25 allows a deduction for the decline in value of a depreciating asset. However, limitations may
be placed on the amount that can be claimed under this section. These limitations (or reductions) do not
change the decline in value of a depreciating asset for the income year or its adjustable value.

Non-taxable use

A tax deduction for the decline in value is only available when the depreciating asset is used for a taxable
purpose. Therefore, the amount of the decline in value deduction calculated must be reduced to reflect its
use for any purpose other than a taxable purpose from the start time (s 40-25(2)).
For example, assume Ben is a non-business taxpayer who holds a depreciating asset that he uses for
private purposes for 30% of his total use in the income year. If the asset declines in value by $1,000 in the
current income year, Ben would have to reduce the decline in value deduction by $300 (ie 30% of $1,000),
and therefore would only be entitled to an income tax deduction of $700.
Note: A balancing adjustment must also be reduced for non-taxable use (see below under ‘Balancing adjustments’).

Second-hand assets in residential rental properties

A tax deduction for the decline in value of a depreciating asset is not available under s 40-27
(ie depreciating assets in a residential rental property) where either of the following applies:
• The taxpayer was not the holder of the asset when it was first used or installed ready for use (other than
as trading stock) by any entity (eg it is a second-hand asset).
• The asset was used or installed ready for use at any time either in the taxpayer’s residence or for a
non-taxable purpose, and in a way that was not occasional.
However, this reduction provision does not apply where:
• the taxpayer is carrying on a business
• the taxpayer is a company, superannuation fund (excluding a self-managed fund), managed investment
trust or public unit trust
• the asset is supplied to the taxpayer as part of new residential premises (or within six months of the
supply of new residential premises).
For example:
• Where an individual taxpayer acquires an existing rental property that has a dishwasher already installed
(ie it is a second-hand dishwasher), the decline in value deduction on the dishwasher is reduced to
$0 under s 40-27 and the taxpayer cannot claim a decline in value deduction.
• Where an individual taxpayer acquires an existing rental property and then installs a new dishwasher in
the property, there is no reduction in the decline in value deduction and the taxpayer can claim the
decline in value as a deduction.
• Where an individual taxpayer acquires a new rental property (eg off the plan from a developer) that has a
dishwasher already installed in the last 6 months (ie it is a new dishwasher supplied as part of a new
residential premises acquisition), there is no reduction in the decline in value deduction, ie the individual
can claim the decline in value as a deduction.

Balancing adjustment
Application

A balancing adjustment is similar to an accounting profit or loss on the sale of a depreciating asset. A
balancing adjustment is included in a taxpayer’s assessable income in the income year of the balancing
adjustment event. A balancing adjustment event (s 40-295) occurs when a taxpayer either:
• stops holding a depreciating asset
• permanently stops using a depreciating asset for any purpose (whether or not it has ever actually been
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used).

94 Tax
Hold has the meaning given by s 40-40. Therefore, a taxpayer will usually stop holding a depreciating asset
when they are no longer its legal owner.
For example, where a taxpayer sells a rental property, they will stop holding the fixtures and fittings
(ie depreciating assets) in the rental property when the contract of sale settles. However, for CGT purposes,
the taxpayer is considered to have disposed of the land and buildings (under CGT event A1) when the
contract of sale was entered into. The taxpayer needs to take these different timings into account when
apportioning the proceeds of disposal under a contract of sale between the depreciating assets and the
assets subject to CGT.

Calculation method

The balancing adjustment calculation compares the termination value and the adjustable value
(ie written-down value) of the depreciating asset at the time of the balancing adjustment event to
determine whether the asset has been over-depreciated or under-depreciated for tax purposes. This is
because the aim of the capital allowances system is to provide deductions that are equivalent to the overall
cost to a taxpayer of having held an asset.

Assessable balancing adjustment

Under s 40-285(1), an assessable balancing adjustment is calculated as follows:

Termination value – Adjustable value = Assessable balancing adjustment amount

Deductible balancing adjustment

Under s 40-285(2), a deductible balancing adjustment is calculated as follows:

Adjustable value – Termination value = Deductible balancing adjustment amount

A deductible balancing adjustment is available under s 40-285(2) if an asset is sold for a loss, including
situations where the asset has not ever actually been used (refer to ATO ID 2003/185 and item 2 of
s 40-300(2)).

Termination value

Termination value is what is received, or considered to be received (if anything), for the asset when a
balancing adjustment event occurs – typically, the proceeds of selling an asset or where the asset is
scrapped (disposed and discarded for no value).
Under s 40-300, termination value is calculated as the amount received on disposal of the depreciating
asset less any disposal costs. However, where an asset is disposed of at less than its market value (but not
over its market value), market value is substituted under s 40-300 item 6. The market value substitution
rule does not apply if an item is scrapped.

Example 2.20 – Balancing adjustment

Bouyd Pty Ltd manufactures cars. In Year 1, it acquires a compressing machine for $100,000. The
compressing machine has an effective life of 5 years and Bouyd uses the prime cost method of
depreciation.

At the end of Year 3, the machine has an adjustable value of $40,000 ($100,000 – $20,000 –
$20,000 – $20,000).
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 The machine is sold for:

Scenario 1: $15,000

Scenario 2: $40,000

Scenario 3: $45,000

The balancing adjustment is:

Scenario 1: $15,000 – $40,000 = $25,000 loss.

Scenario 2: $40,000 – $40,000 = Nil.

Scenario 3: $45,000 – $40,000 = $5,000 gain.

Special rule for cars

The decline in value deduction for a car is restricted by the car cost limit, which is currently $64,741. As the
decline in value deduction is based on this capped amount, when a car is disposed of, the termination value
of the car is adjusted downwards.
The termination value is adjusted under s 40-325 as follows:

Car limit in year car was first held +

Second elements of the car’s cost
Termination value ×
Total cost of the car (ignoring the car limit)
after applying Subdivision 27 − B (ie excluding GST)

Refer to ss 27-95(1) and (2) regarding applying Subdivision 27-B.

The termination value of a depreciating asset is reduced if the relevant balancing adjustment event is a
taxable supply. The reduction is an amount equal to the GST payable on the supply.
However, subsection (1) does not apply if the termination value of the depreciating asset is modified under
Division 40 to be its market value.
The termination value adjustment needs to take into account the GST credit on the acquisition. Under
s 69-10 GST Act, the GST credit is limited to 1/11 of the car cost limit.

Example 2.21 – Disposal of a car exceeding the cost limit

Best Pty Ltd (Best) acquired an Audi car for $88,000 (inclusive of GST) and sold it approximately two
years later when it had an adjustable value of $29,000. The car limit for the year in which the car was
first held was $64,741. There are no second elements of cost. The car was sold for $66,000 (inclusive
of GST).

To calculate whether there is an assessable or deductible balancing adjustment amount on the

disposal of the car to be included in Best’s assessable income, the adjusted termination value needs
to be calculated.

Step 1 – exclude the GST component from the termination value

$66,000 – [$66000 × (1/11)] = $60,000

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96 Tax
 Step 2 – adjust the termination value downwards to reflect the $64,741 car limit

$60,000 × $64,741 ÷ [$88,000 – ($64,741 × 1/11)]

= $60,000 × $64,741 ÷ $82,114

= $47,305

Step 3 – the balancing adjustment is an assessable balancing adjustment:

$47,305 termination $29,000 adjustable

– = $18,305
value value

Note:

• The total cost of (

the car (excluding
) GST) in the denominator is $82,114, which is calculated by subtracting the GST input tax
1
credit of $5,886 of $64,741 from the $88,000 cost.
11
• If the car in this example was acquired in an income year where the car cost limit is not $64,741, then the car cost limit applied
would be that other limit.

Non-taxable use

Where an asset has been used for a non-taxable purpose, the balancing adjustment amount is reduced in
proportion to the extent of use of the depreciating asset for non-taxable purposes.
The reduction under s 40-290 is the amount of the balancing adjustment multiplied by the sum of the
reductions in the decline in values to date, divided by the total decline in value.
If the balancing adjustment is reduced, CGT event K7 may apply.

Second-hand assets in residential rental properties

The decline in value deduction for second-hand assets in certain residential rental properties is restricted.
Where the deduction has been reduced and the asset is then disposed of, the balancing adjustment is also
reduced. The reduction under s 40-291 is the amount of the balancing adjustment multiplied by the sum of
the reductions in the decline in value to date, divided by the total decline in value.
For example, where no decline in value deduction was available, the balancing adjustment amount will be
reduced by 100%, that is to $0. However, CGT event K7 may allow a capital gain or capital loss on the
disposal.

Involuntary disposals

A taxpayer may choose to exclude some or all of a balancing adjustment amount resulting from an
involuntary disposal of a depreciating asset. Under s 40-365, where a taxpayer ceases to hold a
depreciating asset because it is:
• lost or destroyed
• compulsorily acquired by an Australian Government agency
• disposed of to an Australian Government agency after compulsory negotiations.
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The taxpayer can choose whether or not to include a balancing adjustment in assessable income. Instead,
the taxpayer may choose to include some or all of the amount that would otherwise be a balancing
adjustment as a reduction in the cost, or in the base value, of one or more replacement assets.
Any replacement asset must be:
• acquired no earlier than one year before the involuntary disposal occurred or no later than one year after
the end of the income year in which the involuntary disposal occurred
• used by the taxpayer, or be installed and ready for use, for a wholly taxable purpose by the end of the
income year in which the taxpayer started to hold it.

Change in ownership or interests – partnership or interests of partners

The definition of balancing adjustment event in s 40-295 includes situations in which there is a change in
the interests of persons who own a depreciating asset. This could occur because of:
• the formation or dissolution of a partnership
• a variation in the constitution of a partnership, or in the interests of the partners.
Where such a change occurs, s 40-300 treats the taxpayer as having disposed of their interest at market
value (s 40-300(2) item 5), unless a joint election is made under s 40-340(3). If such an election is made,
s 40-340 provides relief from any balancing adjustment.

Splitting and merging assets

There are special rules that apply when a depreciating asset is split into more than one asset (s 40-115), or
more than one asset is merged into a single asset (s 40-125).
In the case of a split, the taxpayer is treated as if they had stopped holding the first asset (ie the original
asset) at the time of the split and started holding new assets (ie the assets resulting from splitting the first
asset) at the same time.
A similar treatment is applied in the case of a new asset being created from the merging of other assets.
The taxpayer is treated as if they had stopped holding the separate assets (ie the original assets) and
started holding the new asset (ie the asset resulting from merging the separate assets).
Split assets should be allocated a reasonable proportion of the adjustable value of the original asset just
before the split, as well as any costs involved in the split (s 40-205).
A merged asset is considered to cost an amount that is calculated by adding together the adjustable values
of the separate assets immediately before the merger and any costs involved in the merger.
The taxpayer is treated as if they had started holding the new assets at the time the split or merger
occurred. Therefore, the effective life of the new assets needs to be reassessed to calculate the decline in
value. There is no balancing adjustment brought about by a split or merger (s 40-295(3)).

Interaction with CGT and trading stock

Depreciating assets where decline in value is fully deductible

The CGT regime encompasses all CGT assets. This includes types of depreciating assets.
However, to prevent the occurrence of double taxation or double deductions, capital gains or losses are
disregarded where there is a balancing adjustment event relating to depreciating assets where the decline
in value of the asset is fully deductible (s 118-24). For example, where the asset is used solely for taxable
purposes.
This excludes most depreciating assets from the CGT regime and allows them to be dealt with exclusively
under Division 40.
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98 Tax
Depreciating assets where decline in value is partly non-deductible – CGT event K7

CGT event K7 applies where any part of the balancing adjustment for the depreciating asset is reduced
because a proportion of the decline in value was not deductible or where any part of the cost allocated to a
pool is reduced.
CGT event K7 could occur where:
• the asset was wholly or partly used for private purposes or non-income-producing purposes
• the asset is a second-hand asset used in certain residential rental properties.
CGT event K7 can result in either a capital gain or loss. However, due to the operation of s 118-10(3), a
capital gain or loss may be disregarded if it is a personal use asset like a boat used for private purposes and
acquired for less than $10,000.
If the use of a depreciable asset (that is not an asset to which s 40-27 applies) is 100% taxable, CGT event
K7 would not apply. If the use is 100% non-taxable, there will be a capital gain or loss under CGT event K7
based on the difference between the assets terminating value and its cost (s 104-240 and s 104-245).

Depreciating assets becoming or ceasing to be trading stock

It is possible for a depreciable asset to change its tax character – that is, it can change from a depreciable
asset (eg a company car for the managing director of a car retailer) to trading stock (eg a car to be sold to
the public by the car retailer), or vice versa.
The provisions applicable to trading stock are set out in Division 70. The definition of trading stock in
s 70-10 caters for changes in an asset’s use by looking at the asset’s current use, rather than the original
purpose of its acquisition.
Under s 70-30, where a taxpayer starts holding as trading stock an item that it already owns but does not
hold as trading stock (ie held as a depreciable asset), there is a deemed disposal and reacquisition of the
item by the taxpayer at either its cost or market value.
However, under s 70-110, where an item stops being trading stock of a taxpayer but continues to be held by
the taxpayer (ie held as a depreciable asset), there is a deemed disposal and reacquisition of the item at cost.
The income tax treatment of depreciable assets becoming/ceasing to be trading stock is illustrated in the
following examples.

Example 2.22 – Asset changing its tax character from trading stock to
depreciating asset

Before After

Asset Selling and hiring business Bulldozer X hired out to a client

withdraws bulldozer X from sale
Assume bulldozer X’s acquisition
cost is $100,000 and the remaining
effective life is 10 years

Tax character Trading stock Depreciable asset

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Income tax – general rules 99

 Before After

Income tax treatment Division 70 treatment Division 40 treatment

Section 70-110 treats the taxpayer The cost of the depreciable asset
as having both sold the asset at will be the cost of the asset used in
arm’s length for its cost and the s 70-110 calculation
reacquired it for the same amount

Tax consequences Assessable income under s 70-110 Assessable income under s 6-5 for
= $100,000 hiring fee income
Assuming asset was purchased in Assuming the PC method used =
an earlier income year and trading decline in value deduction available
stock is valued at cost = deduction under s 40-25 = $100,000 ÷ 10 =
under s 70-35 for the excess of $10,000
opening stock over closing stock =
$100,000 – $0 = $100,000
However, if the asset was instead
purchased in the current income
year = deduction under s 8-1 for
purchase = $100,000

Example 2.23 – Asset changing its tax character from depreciating asset to
trading stock

Before After

Asset Selling and hiring business takes Bulldozer X held as an item of

bulldozer X from the hiring pool trading stock available for sale
Assume bulldozer X’s acquisition
cost $20,000, current adjustable
value is $12,000 and current
market value is $5,000

Tax character Depreciable asset Trading stock

Income tax treatment Division 40 treatment Division 70 treatment

Taxpayer will have an Section 70-30 considers the
assessable/deductible balancing taxpayer to have sold and
adjustment under s 40-285. reacquired the asset at one of the
following values (chosen by the
The termination value under
taxpayer):
s 40-305 is the value of the asset
chosen under s 70-30. • cost
• market value.
The adjustable value under s 40-85
is the asset’s written-down value at
the time of the change

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100 Tax
 Tax consequences If the taxpayer’s s 70-30 choice is Taxpayer decline in value deduction
to use: is available under s 40-25 up to the
• Cost: Assessable balancing time of the change
adjustment = Termination value – Assuming the asset is still on hand
Adjustable value = $20,000 – at year end, the taxpayer will have:
$12,000 = $8,000.
• assessable income under s 70-35
• Market value: Deductible for the excess of closing stock
balancing adjustment = over opening stock = $5,000 –
Adjustable value – Termination $0 = $5,000
value = $12,000 – $5,000 =
• a deduction under s 8-1 for the
$7,000.
deemed purchase of trading
• Therefore, the taxpayer should stock on hand at the chosen
elect to use market value to market value = $5,000
minimise taxable income

2.2.2 Capital works application and deduction

When a CGT event occurs relating to an asset, a capital gain or loss is calculated by applying the CGT rules
that are applicable to that CGT event.
The Division 43 tax deduction for capital works has an impact on the calculation of the cost base of the
CGT asset. ‘Capital works’ is a broad term covering buildings, or extensions, alternations or improvements
to structures. In general terms, the Division 43 tax deduction is a percentage of the initial cost of
constructing a capital asset (eg a building), so the deductions must be based on the actual costs incurred.
You should be aware that different rates apply (2.5% or 4%) depending on:
• date of construction
• type of capital works
• manner of use.
For example, if the deduction percentage is 2.5% and a building cost $100,000 to build, the annual
Division 43 deduction will be $2,500.
Where the CGT asset was acquired after 13 May 1997, deductible expenditure is excluded from the cost
base. Deductions arising under Division 43 will be excluded from the CGT cost base/reduced cost base.
These exclusions are:
• the capital works deductions the taxpayer has claimed or can claim
• any balancing deduction arising on the destruction of the capital works.
For example, if the cost base of a building is $1 million and Division 43 deductions of $50,000 are claimed,
the cost base of the building would be reduced to $950,000. If the building is then destroyed, giving rise to
a $950,000 balancing deduction, the cost base of the building would be reduced to $0.

Overview of capital works – Division 43

Common tax rules and principles that apply to capital works are used by tax practitioners to determine the
taxable income for a taxpayer.
The following table provides an overview of key guidance and sections related to capital works that might
be used to determine taxable income.

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Income tax – general rules 101

 Section ITAA
1997 unless
Item otherwise stated Guidance

Deduction, amount and 43-10, 43-15, Deduction of 2.5% or 4% of construction costs on a

rate 43-20, 43-25 straight-line basis in respect of:
and 43-30 • Buildings, extensions or alterations
• Structural improvements such as sealed roads, driveways
and car parks.

However, the deduction:

• Cannot exceed the undeducted construction costs
• Rate depends on:
– Date of construction
– Type of capital expenditure
– Manner of use.
• Does not commence until the construction is complete.

Note: The government has announced that the 2023–24 Budget will
increase the depreciation rate from 2.5% to 4% per year for eligible
new build-to-rent projects where construction commences after
9 May 2023, to boost the supply of rental housing.

Calculation 43-210 and Capital works deduction = Construction expenditure × Rate

43-215 of deduction × Days used in that manner / 365 days.

CGT asset: Cost base 110-40 A capital works deduction and a balancing adjustment
exclusion (assets acquired deduction (see below) does not reduce the cost base of a
before 13 May 1997) CGT asset acquired before 13 May 1997. This is because:
• construction expenditure is included in the first element of
a CGT asset’s cost base (s 110-25(2), and
• the exclusion only applies to expenditure that is included
under the second or third element of a CGT asset’s cost
base (s 110-40).

CGT asset: Cost base 110-45 A capital works deduction and a balancing adjustment
exclusion (assets acquired deduction (see below) reduces the cost base of a CGT asset
on or after 13 May 1997) acquired after 13 May 1997. This is because the cost base
reduction applies to any expenditure (ie including first
element of cost base) to the extent the taxpayer has
deducted or could deduct it.

Capital works amount 43-15 When a building or structural improvement is sold, the
entitlement to any future capital works deductions passes
to the acquirer (ie there is no balancing adjustment for
the seller).

The acquirer’s capital works deduction is based on the

amount of undeducted construction expenditure (if any) and
not on the amount paid to acquire the asset.

Destruction 43-40 and A balancing adjustment deduction arises for any undeducted
43-250 construction expenditure when:
• a building or structural improvement is destroyed, and
• at the time of destruction the taxpayer was using (or had
previously used) the building.

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102 Tax
2.2.3 Trading stock
Disposals
Trading stock can be disposed of in a number of ways, resulting in different tax adjustments to the taxable
income calculations. The tax rules associated with common trading stock disposals are described below.

Sale in the ordinary course of business

Where trading stock is sold in the ordinary course of business, the proceeds are considered ordinary
income under s 6-5.

Lost or destroyed

Trading stock that is lost (including through theft) or destroyed will not be included in the closing stock
value – that is, the closing stock value will be nil. The taxpayer obtains a deduction for the lost or destroyed
stock as a result of the operation of the trading stock account, in one of two ways:
• under s 8-1 as purchases, if it was acquired during the year
• under s 70-35(3), if opening stock exceeds closing stock. Remember that if the stock was purchased in
the previous year, it would be recorded in the opening stock but not in the closing stock, as it is not on
hand at year end. Given that opening stock is greater than closing stock, the taxpayer effectively deducts
the value of the items lost or destroyed.
Compensation for any loss of trading stock will be assessable under s 70-115. Broadly, the value of any
compensation received through insurance would be assessable under this specific section.

Market value substitution rules

For transactions that occur in the ordinary course of business, if trading stock is acquired at more than its
market value, s 70-20 treats the purchaser as having paid the arm’s-length price, which will reduce the
deduction under s 8-1 to the market value. Section 70-20 also operates to make the sale at the
arm’s-length value assessable for the seller (ie there is symmetry between the vendor and the purchaser).
The arm’s-length rule does not apply where the amount paid is less than the market value (ie there is no
uplift/increase to market value).
For transactions involving trading stock that is disposed of other than in the ordinary course of business,
the taxpayer is required by s 70-90 to consider as assessable income the market value of the items at the
date of disposal (the actual sale proceeds are made non-assessable non-exempt income). This also applies
to crops or trees that have been planted and tended for sale.
Correspondingly, the purchaser will be considered to have purchased the stock at market value (s 70-95).
There is, therefore, symmetry between the vendor and the purchaser. This section may be triggered when a
business that comprises many assets, including trading stock, is sold (refer Deputy Commissioner of Taxation
v Newman (1921) 29 CLR 484 and Farnsworth v FCT (1949) 78 CLR 504). In Case 2/99, the value of trading
stock sold other than in the ordinary course of business was the market value attributed to the trading
stock by the parties in the sale agreement (and not that determined by reference to the price at which the
stock had been purchased by the vendor). This was because the parties actively bargained for the price to
be paid, which inherently created the requisite market value. On the other hand, where one party passively
agrees to the price allocation, or is indifferent (so that there is no robust bargaining), the price in the sale
agreement will be adjusted under ss 70-90 and 70-95.

Gifts of trading stock

Gifts of trading stock to a deductible gift recipient (broadly, an approved charity) are tax deductible under
s 30-15. The donation may be treated as a disposal of stock that occurs outside the ordinary course of
business. Generally, the deduction available to the taxpayer (s 30-212 deals with valuations) is the same as
the market value of the trading stock gifted and included in the taxpayer’s assessable income, as required
by s 70-90. The section may apply, for example, where a bakery donates its unused bread for the day to a
soup kitchen which is an approved deductible gift recipient.
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Income tax – general rules 103

The net effect would be that the s 70-90 assessable amount would offset the s 30-15 deduction.
Therefore, the taxpayer would end up with a tax deduction under s 8-1 for the cost of buying the stock,
which would be the same as the taxpayer’s economic loss.
It is likely that the donation would be made in the ordinary course of business – that is, in the form of
marketing – if the gifting is part of the taxpayer’s normal business operations. For example, if a bakery
regularly makes donations of excess bread, s 70-90 would not apply. In this instance, a deduction for the
cost of the trading stock donated would be provided under s 8-1, which again will be the same as the
taxpayer’s economic loss.
Where stock is gifted to employees, a tax deduction would be available through the trading stock
movement account (ie as the value of closing stock will be less than the value of opening stock there will be
a deduction under s 70-35). However, the FBT provisions would need to be considered.

Change in ownership or interest in trading stock

Where there is a change in the ownership or interest in trading stock, in circumstances such as the
formation, variation or dissolution of a partnership, s 70-100 applies – resulting in a notional disposal of
trading stock by all the old owners to the new owners. Such a disposal is treated as being made at market
value (s 70-100(2)).
However, where:
• the trading stock becomes an asset of a business carried on by the new owners and the former owners
retain an interest in the trading stock of at least 25% of the market value of the stock, and
• the market value of the trading stock is more than the value of the stock recorded in the books of the
former owners just before the change in ownership.
The old and new owners can elect that s 70-100 does not apply. If this election is made, a deemed disposal
may occur at the value at which the stock is recorded (eg at cost and not market value) (see ss 70-100(4),
(5) and (6)).

Change in purpose
For property to be trading stock it must be held for the purpose of manufacture, sale or exchange in the
ordinary course of a business. Therefore, special tax rules exist to deal with property that becomes or
ceases to be trading stock.

Property that becomes trading stock

Section 70-30 provides that where a taxpayer starts holding an item as trading stock that it already owns
but does not hold as trading stock, there is:
• a deemed disposal of the item by the taxpayer
• a deemed reacquisition of the item by the taxpayer.
This section should be considered where a taxpayer holds an asset on capital account and the purpose of
the asset changes to being held as trading stock (eg shares held on capital account are reclassified as trading
shares), or where an asset is initially held as a depreciable asset and the asset is subsequently held as trading
stock (eg a salesman’s company car is now held for sale as part of the used car fleet for a car retailer).
A taxpayer can elect whether the notional disposal and reacquisition occurs at either cost, or market value:
• Electing to use cost for a capital asset will usually not have any adverse tax consequences as the asset is
simply being sold for its original cost to the taxpayer.
• By electing to use market value for a capital asset, a capital gain may be triggered on the notional
disposal (CGT event K4). The individual circumstances of the taxpayer need to be considered; for
example, the availability of capital losses.
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104 Tax
In addition, using market value will establish a higher deemed reacquisition amount in situations where the
market value is more than the item’s cost.

Property that ceases to be trading stock

Section 70-110 deals with property that stops being trading stock but continues to be held by the taxpayer
(ie there is a change of use or a conversion). In such a case, s 70-110 considers the item of stock to have
been disposed of at cost and immediately reacquired at cost. By deeming a disposal at cost, generally no
taxable income arises, the sale at cost is recognised as assessable income under s 6-5 and the movement in
stock value is recognised as a deduction under s 70-35.
Section 70-110 applies where the taxpayer holds the asset initially as trading stock and the purpose of
holding the asset changes to being held on capital account or being a depreciable asset.

Private use of trading stock

The cost of an item of trading stock appropriated for the private use of the business owner is included as
assessable income as per s 70-110. The following example illustrates the taxation treatment of stock that is
taken for private use.

Example 2.24 – Trading stock: Taken for private use at actual values
A chemist takes home headache tablets from his own business for his personal consumption. The
chemist is considered to have sold the tablets at cost, as per s 70-110. A tax deduction for the cost
of the tablets would have been claimed when purchased. The deemed sale amount is effectively the
same as the cost claimed as a deduction.

Commissioner’s rates

Certain taxpayers, such as sole traders and partners in a partnership, have the option of applying the
Commissioner’s deemed annual values for stock taken as private use, instead of determining the cost of all
stock taken for private use over the income year.
Practically, the Commissioner’s determination (TD 2022/15 for the income year ended 30 June 2023)
simplifies the process of applying s 70-110 for business owners such as butchers, fruit vendors and bakers.
The following example illustrates the options for valuing stock when taken for private use.

Example 2.25 – Trading stock: Taken for private use at deemed values
Malcolm is the sole proprietor of a butchery business that trades under the name of ‘Meaty Morsels’.
Malcolm is married and has two children, aged 8 and 10. Every second night, Malcolm takes home
some meat for his family’s consumption. The cost of the goods taken for private use over the income
year is $2,600.

Malcolm has two options for determining the deemed sale value when applying s 70-110: He can
either include the actual cost as the deemed sale amount (option 1) or apply the Commissioner’s
annual values (option 2). Assume that the Commissioner’s list of values is as follows:

• $850 for an adult or child over the age of 16

• $425 for a child aged 4–16 years.

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Income tax – general rules 105

 Therefore, under s 70-110:

• Option 1 – if the actual cost of the goods is used, $2,600 is included in Malcolm’s assessable income.
• Option 2 – using the Commissioner’s values, an amount of $2,550 (2 × ($850 + $425)) is included
in Malcolm’s assessable income.

As long as Malcolm’s actual private consumption of meat closely reflects the specified values
published by the Commissioner, he can use those values, which will minimise his taxable income.

Change of residence

There are no trading stock rules that deal with a change of residence, unlike the CGT provisions, which
contain CGT event I1. Therefore, if a taxpayer leaves Australia with trading stock, the tax treatment is
unclear.
The ATO’s view in PR No: 1012827324841 is that a non-resident who held shares as trading stock when
they became an Australian resident is considered to have acquired the trading stock at cost or market
value, under s 70-30. Even though the shares were trading stock when the taxpayer was a non-resident,
the ATO’s view is that they were not trading stock for s 70-30 purposes. In other words, the ATO used
common sense to allow the taxpayer to get a fair tax cost for the shares. Otherwise, s 70-40(2) would have
given the non-resident a nil opening value (see above discussion on opening stock values).

Trading stock (Division 70) – overview

To determine the taxable income for a taxpayer, tax practitioners must be able to apply common tax rules
and principles related to trading stock.
The following table provides a summary of guidance and key sections related to trading stock. These
sections may be used to determine taxable income.

Section ITAA
1997 unless
Item otherwise stated Guidance

Sale of trading stock 6-5 Assessable as ordinary income when it is derived.

Purchase of trading 8-1 Deductible as a general deduction when it is incurred

stock (subject to on hand rule below).

Trading stock 70-10 Refer above under Overview.

Trading stock examples include:

• Products available for sale in a store (eg cars held by a car
manufacturer, but not the machines and tools used to
build the cars)
• Raw materials that will be integrated for sale as part of the
products (eg containers and packaging materials)
• Work-in-progress (partially completed) products.

Land or shares held by a dealer or trader (but not if held on

capital account).

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106 Tax
 Deduction 70-15 Purchases are deductible under s 8-1 when:
• Stock is on hand = when taxpayer has dispositive power
(ie has the power to dispose of the goods even if the
taxpayer does not have physical possession – IT 2670 and
All States Frozen Foods Pty Ltd v FCT)
• An amount is included in the taxpayer’s assessable income
in connection with the disposal of the trading stock.

Non-arm’s length 70-20 Where there is a non-arm’s length transaction > market value:
transaction • Purchaser = Deemed acquisition at market value
• Seller = Deemed sale at market value.

Movement in balances 70-35 Trading stock movement:

• Assessable income arises if the value of opening stock is
less than the value of closing stock
• Deductible amount arises if the value of closing stock is
less than the value of opening.

However, an adjustment will only be required when

preparing a reconciliation from accounting profit to taxable
income when the tax and accounting values of the trading
stock differ.
Refer to QRG: Tax reconciliation adjustments.

Opening stock value 70-40 Open value at the start of an income year = Closing value at
the end of the prior income year.

Valuation methods at 70-45 Closing stock can be valued at:

the end of the income • Cost
year • Market selling value
• Replacement value.

Valuation if trading 70-50 Taxpayer can choose a value that is below the values under s
stock obsolete 70-45 provided it is because of obsolescence or any other
special reason and the value is reasonable. For example,
stock may be written down to a lower value if it is:
• Becoming obsolete (ie going out of use, going out of date,
becoming unfashionable or becoming outmoded), or
• Is obsolete (ie out of use, out of date, unfashionable or
outmoded).

Gifts of trading stock 30-15 / 30-212 Deduction = Market value of trading stock gifted. However,
where the gift is outside the ordinary course of business there
will also be a deemed disposal at market value (see below).

Property that becomes 70-30 Where a taxpayer starts holding an item as trading stock that
trading stock they already own:
• Deemed disposal = Market value or Cost
• Deemed acquisition = Same amount.

Where market value is chosen for a CGT asset, a capital gain

under CGT event K4 arise.

Lost or destroyed stock 70-35 The movement in trading stock will effectively provide a
deduction for items of trading stock that are lost or
destroyed.

Disposal outside the 70-90 Disposal outside ordinary course of business

ordinary course of • Sale proceeds = Market value.
business

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Income tax – general rules 107

 Section ITAA
1997 unless
Item otherwise stated Guidance

Purchase outside the 70-95 Purchase outside the ordinary course of business
ordinary course of • Purchase cost = Market value (ie amount included in
business seller’s assessable income).

Notional disposal when 70-100 A disposal of trading stock is treated as being outside the
taxpayer stops holding ordinary course of business where a taxpayer stops holding
an item as trading stock an item as trading stock, but continues to own an interest in
but continues to have the stock (eg variation to partners in a partnership).
an interest in the stock Therefore, under s 70-100:
• Deemed disposal = Market value
• Deemed acquisition = Market value.

However, the old and new owners can elect for s 70-100 not
to apply provided certain conditions are met.

Property that ceases to 70-110 Where a taxpayer stops holding an item as trading stock but
be trading stock continues to own it:
• Deemed disposal = Cost
• Deemed acquisition = Cost.

Compensation for lost 70-115 A taxpayer’s assessable income includes an amount received
trading stock by way of insurance or indemnity for a loss of trading stock.

2.2.4 Capital gains tax (CGT) application

Methodology
The CGT rules are in the ITAA 1997 in Part 3-1 (general rules) and Part 3-2 (special rules).
Division 100 provides a guide to the fundamentals of CGT. The diagram below is taken from s 100-15 and
illustrates what is involved in determining whether a capital gain or a capital loss has been made, and the
amount of the capital gain or capital loss.

No You do not have a capital

Did a CGT event happen in the income year?
gain or loss

Yes

Yes Disregard (or reduce) a

Does an exemption apply? capital gain or loss from
the event
No

Yes The excess is your capital

Do the capital proceeds exceed the cost base?
gain from the event

No

Yes The excess is your capital

Does the reduced cost base exceed the capital proceeds?
loss from the event

No

No capital gain or loss

The CGT rules do not make up a separate taxing Act in their own right.
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108 Tax
While referred to as a capital gains tax, the CGT rules do not actually impose a tax. The income tax
legislation simply includes a net capital gain in the assessable income of a taxpayer under s 102-5. That is, a
net capital gain is statutory income under s 6-10.
Specifically, to calculate an entity’s taxable income, the following formula is used:
A net capital gain under s 102-5 forms part of the assessable income component.

Step 1 Consists of items that are:

• Ordinary income.
Assessable income
• Statutory income.
(Division 6)
Excludes amounts that are exempt income and non-assessable
non-exempt (NANE) income

Step 2
–
Consists of items that are:
Deductions • General deductions (ie losses and outgoings).
(Division 8) • Specific deductions.
Excludes amounts that are not deductible under a specific provision

=
Taxable income Income tax can now be calculated (s 4–10)

A net capital loss arises for the income year if capital losses exceed capital gains, it is quarantined and not
included as a deduction in the calculation of taxable income. However, it is carried forward and may be
used to offset capital gains derived in future income years, subject to loss recoupment tests where the
taxpayer is a company.
The CGT rules are generally a residual taxing mechanism. Where an amount has been included as part of
calculation of assessable income under another provision of the income tax legislation the related capital
gain or capital loss is disregarded.
Australian residents are taxed in Australia on their worldwide income, which includes a net capital gain
(s 6-10(4) and s 102-5).
Foreign residents are taxed in Australia on their Australian-sourced income (s 6-5 and s 6-10). However, a
further restriction applies under the CGT rules. A foreign resident is only taxable in Australia on capital
gains (and losses) where a CGT event happens to a CGT asset that is taxable Australian property.

Overview of CGT application

The following table provides a summary of key guidance and related sections for the application of CGT
general rules.

Section ITAA
1997 unless
Item otherwise stated Guidance

Net capital gain 102-5 A net capital gain is included in assessable income. The calculation
must be completed in the order of the steps as contained in this
section. For example:
• Step 1: Current year capital gains must be reduced by current
year capital losses (Note: Capital gains that are disregarded are
not included in this step).
• Step 2: Carry forward net capital losses must reduce step 1
amount.
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Income tax – general rules 109

 Section ITAA
1997 unless
Item otherwise stated Guidance

• Step 3: Apply CGT general discount to any remaining amount of

discount capital gains (ie capital gains that qualify for the CGT
general discount).
• Step 4: Apply small business entity (SBE) concessions.
• Step 5: Net capital gain is remaining amount (if any).

Net capital loss 102-10 and A net capital loss is not deductible. It can only be used to reduce
102-15 capital gains made in a future income year.

Net capital losses must be used in the order in which they were
made, that is, on a first-in-first-out (FIFO) basis.

CGT cost base 103-30 Cost base is reduced by the GST component of the acquisition
interaction with GST price that the taxpayer is entitled to claim as a GST input tax credit.

CGT events: 104-5 Summary of CGT events. A capital gain or a capital loss made in
summary and respect of a CGT asset acquired before 20 September 1985 (ie a
examples pre-CGT asset) is generally disregarded. For example:
• CGT event A1 – s 104-10(5) disregards the disposal of a
pre-CGT asset.
• CGT event C1 – s 104-20(4) disregards the loss or destruction
of a pre-CGT asset.
• CGT event I1 – s 104-160(5) disregards the deemed disposal of
a pre-CGT asset when an individual taxpayer becomes a foreign
resident for tax purposes.

CGT events: 104-25 The more specific CGT event usually takes priority over the more
ordering general event.

CGT assets: 108-5 A CGT asset is defined as (s 108-5):

definition • Any kind of property, or
• A legal or equitable right that is not property.

Examples of CGT assets included in the definition are:

• Goodwill.
• Land and buildings.
• Shares and options.
• Debts owed to the taxpayer.
• Rights to enforce contractual obligations.
• Foreign currency.
• An interest (or a part interest) in an asset.

However, a capital gain or loss is disregarded to the extent that:

• It is a capital gain that is assessable under another provision
(s 118-20). Where there is a loss, s 110-55(9) reduces the cost
base of the revenue asset to ensure there is no double deduction.
• It relates to a depreciating asset where the decline in value of
the asset is fully tax deductible (s 118-24). Both the capital
allowance rules and CGT event K7 may apply where the decline
in value is only partly tax deductible.
• It relates to the disposal of trading stock (s 118-25).

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110 Tax
 CGT separate assets 108-55 to The CGT rules deem separate assets to exist in a number of
108-85 circumstances. For example, where:
• Pre-CGT land has a post-CGT asset built on it.
• Pre-CGT asset has a post-CGT improvement and the cost base
of the improvement at the time of the later CGT event is for
than the CGT improvement threshold (ie $162,899 for the
income year ended 30 June 2023) and exceeds 5% of the
capital proceeds

CGT assets: 109-5 and The general timing rules mirror the operation of the CGT event
acquisition rules 109-10 rules.

However, there are specific rules where an asset is acquired

without there being a CGT event:
• Taxpayer constructs an asset = When the construction started.
• Shareholder receives shares issued on initial incorporation of a
company
– With contract = When contract is entered into
– No contract = When shares are issued.

CGT cost base 110-25 Cost base = Amount paid to acquire the CGT asset. There are five
(5) elements of cost base:
• Acquisition costs.
• Incidental costs = As defined in s 110-35. For example,
professional advice, stamp duty, advertising, valuation costs,
search fees, conveyancing, borrowing costs (where not
otherwise deductible).
• Cost of owning the asset, if acquired after 20 August 1991 and
not otherwise deductible = For example, interest and other
financing costs, repairs or maintenance costs, rates and land tax.
• Capital costs to increase/preserve asset’s value, or that relate to
installing or moving the asset.
• Capital costs to preserve title = For example, legal fees related
to land boundary dispute.

CGT cost base: 110-38 Expenditure is excluded from cost base to the extent that it is:
exclusion • Entertainment that is not deductible under s 32-5.
• Penalties that are not deductible under s 26-5.
• Travel related to a residential rental property that is not
deductible under s 26-31.

CGT cost base: 110-40 A cost base exclusion applies to:

exclusion (assets • Expenditure included under the second or third element
acquired before (ie incidental costs and costs of owning the asset) to the extent
13 May 1997) the taxpayer has deducted or could deduct it.
• Expenditure that is recouped unless it is included in assessable
income.

Note: Construction expenditure related to a building is included in the first

element of cost base. Therefore, where a building is acquired before
13 May 1997, a capital works deduction and a balancing adjustment
deduction related to the destruction of the building do not reduce the cost
base of the CGT asset.

CGT cost base: 110-45 A cost base exclusion applies to:

exclusion (assets • Any expenditure (ie including first element of cost base) to the
acquired on or after extent the taxpayer has deducted or could deduct it. For
13 May 1997) example, a capital works deduction and a balancing adjustment
deduction related to the destruction of a building.
• Expenditure that is recouped unless it is included in assessable
income.

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Income tax – general rules 111

 Section ITAA
1997 unless
Item otherwise stated Guidance

CGT reduced cost 110-55 Reduced cost base must be used to calculate a capital loss. Cost
base base and reduced cost base are calculated in the same manner,
except for the following:
• Third element of cost base is not included and is replaced with
an adjustment for assessable balancing charge.

CGT cost base: 112-20 to Cost base special rules and modifications include:
modifications 112-36 • Market value substitution rule (s 112-20), applicable when:
– No expenditure incurred to acquire the CGT asset
– Some or all of the expenditure cannot be valued
– A non-arm’s length dealing.
• Split, changed or merged assets (s 112-25)
• Apportionment rule (s 112-30)
• Assumption of liability rule (s 112-35)
• Look through earnout rights (s 112-36).

CGT cost base: 104-135 and Cost base is reduced for certain tax-free distributions, including:
reductions for tax- 104-70 • From a company to a shareholder – The cost base of each share
free distributions will be reduced by the non-assessable part (s 104-135).
However, the shareholder can disregard certain non-assessable
parts. If the cost base is reduced to $nil, further non-assessable
distributions trigger a capital gain under CGT event G1
(s 104-135).
• From a trust to a beneficiary – the cost base of the unit or
interest is reduced by the non-assessable part (s 104-70(6)).
However, the unit holder can disregard certain non-assessable
parts. If the cost base is reduced to $nil, further non-assessable
distributions trigger a capital gain under CGT event E4
(s 104-70).

Refer to the topic on tax structures.

CGT general 115-5, 115-10, To qualify for the CGT general discount a capital gain needs to
discount 115-15, 115-20, satisfy the following requirements:
115-25, and • Made by an individual, complying superannuation fund, or trust.
115-105 However, a non-resident individual is only entitled to apply the
CGT general discount for gains accrued up to 8 May 2012.
• Result from a CGT event happening after 21 September 1999.
• The cost base has not been indexed.
• Result from a CGT event happening in relation to a CGT asset
acquired by the taxpayer at least 12 months before the CGT
event.
• Is not one of the specified ineligible CGT events – for example,
CGT event D1.
The discount percentage is:
• Individual taxpayer and trust = 50%
• Complying superannuation fund = 33 ⅓%.

CGT capital 116-20 Capital proceeds = Sum of any money received, and/or the market
proceeds value of any property received.

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112 Tax
 CGT capital 116-30 to Capital proceeds special rules and modifications include:
proceeds: 116-120 • Market value substitution rule (s 116-30), applicable when:
modifications – No capital proceeds are received.
– Some or all of the capital proceeds cannot be valued.
– A non-arm’s length dealing.
• Apportionment rule (s 116-40).
• Non-receipt rule (s 116-45).
• Repaid rule (s 116-50).
• Assumption of liability rule (s 116-55).
• Misappropriation rule (s 116-60).
• Assets subject to an option (s 116-65).
• Look through earnout rights (s 116-120).

CGT capital 116-20 Capital proceeds are reduced by the GST component of the
proceeds: acquisition price that the taxpayer is required to remit to the
interaction with GST Australian Taxation Office.

CGT exempt assets: 108-10, 108-17, Capital gains and capital losses are disregarded as follows:
cars, personal use 108-20, 108-30, • For cars, motorcycles and decorations for valour or brave
assets and 118-5 and conduct = disregard all capital gains and capital losses (s 118-5).
collectables 118-10, • For collectables:
– Where acquired for $500 or less = Capital gain and capital
loss is disregarded (s 118-10).
– Where acquired for more than $500 = Capital gain and capital
loss is not disregarded. However:
◦ Capital loss can only be used to reduce capital gains on
another collectable (s 108-10).
◦ Third element of cost base does not apply (s 108-17).
• For personal use assets:
– Capital loss is always disregarded (s 108-20).
– Where acquired for $10,000 or less = Capital gain is
disregarded.
– Where acquired for more than $10,000 = Capital gain is not
disregarded. However, the third element of cost base does
not apply (s 108-30).

A personal use asset includes any CGT asset that is used for kept
mainly for the taxpayer’s personal use or enjoyment (s 108-20).
A collectable is specifically defined group of personal use asset
that only includes (s 108-10):
• artwork, jewellery, an antique, or a coin or medallion
• a rare folio, manuscript or book, or
• a postage stamp or first-day cover.

CGT anti-overlap 118-20, A capital gain or capital loss is disregarded to the extent that it
rules 118-24,118-25 relates to:
• A capital gain that is assessable under another provision
(s 118-20). Where there is a loss, s 110-55(9) reduces the cost
base of the revenue asset to ensure there is no double
deduction.
• A depreciating asset where the decline in value of the asset is
fully tax deductible (s 118-24). Both the capital allowance rules
and CGT event K7 may apply where the decline in value is only
partly tax deductible.
• It relates to the disposal of trading stock (s 118-25).

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Income tax – general rules 113

 Section ITAA
1997 unless
Item otherwise stated Guidance

CGT compensation, 118-37 A capital gain or capital loss is disregarded if it relates to:
damages and • Certain types of compensation (eg for any wrong or injury a
windfall gains taxpayer suffers in their occupation)
exemption • Gambling, a game, or a competition with prizes

CGT main residence 118-110 to A capital gain or a capital loss arising from the disposal of an
exemption 118-190 individual taxpayer’s home may be disregarded or reduced under
the main residence exemption.
• The taxpayer must be a resident at the time of the CGT event.
There is no apportionment for any periods when the taxpayer
was a resident.
• The exemption also applies to adjacent land of two hectares
and vacant land for up to four years where the taxpayer builds a
house on the land.
• The taxpayer must physically move into the house. However,
after the exemption is triggered, the taxpayer can move out and
use the house for income-producing purposes for periods of up
to six years.
• The taxpayer can hold two properties as their main residence
for up to six months when a new main residence is acquired.
• The exemption is apportioned where the house only qualifies
as the taxpayer’s main residence for part of the ownership
period.

CGT assets stops 149-30 and A CGT asset stops being a pre-CGT asset if it no longer has the
being pre-CGT 149-35 same majority underlying ownership = Deemed acquisition at
market value.

CGT application: 855-10 and A capital gain or capital loss made by a non-resident taxpayer is
non-resident 855-15 disregarded if the asset is not taxable Australian property (TAP).
taxpayer disposals TAP includes:
• Taxable Australian real property (TARP) = Real property situated
in Australia (eg land and buildings).
• Indirect Australian real property interest = Foreign resident who
owns at least a 10% interest in a company and more than 50%
of the market value of the assets of that company are real
property situated in Australia. There are also tracing rules that
look through interposed entities to the underlying assets.
• An asset used in carrying on a business through a permanent
establishment of a non-resident in Australia.
• An option or right to acquire any of the above.
• A CGT asset that a foreign resident has elected to be TAP when
they ceased to be an Australian resident (s 104-165).

CGT application: 855-45 A CGT asset that is not taxable Australian property (TAP) has a
non-resident deemed cost base of market value at the time a taxpayer becomes
taxpayer becoming an Australian resident.
an Australian Note: A similar rule exists for a person who ceases to be a temporary
resident resident but remains an Australian resident (s 768-950 and s 768-955).

Expenses related to 51AAA ITAA Expenses incurred in relation to a CGT asset are not, for that
net capital gains 1936 reason alone, tax deductible. However, the expenses may be
included in cost base of CGT asset.

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114 Tax
CGT events – overview
CGT events are transactions and events that may result in a capital loss or capital gain. CGT events
generally involve a CGT asset, or they will involve capital receipts. To calculate a taxpayer’s capital gain or
capital loss, tax practitioners will need to know what CGT event applies to the given circumstances.
Therefore, CGT events include a range of categories and consequences.
The following table provides a summary of common CGT events and how they apply, including
descriptions, examples, and consequences.

CGT
Category event Section Description/examples Consequence

Disposal A1 104-10 Disposal (eg sale) of CGT asset. Capital gain

(CG) or capital
loss (CL)

Use and B1 104-15 CG or CL

enjoyment
before title
(B1)

C1 104-20 Loss or destruction of CGT asset when CG or CL

compensation received (eg insurance).

Note: Subdivision 124-B rollovers (outside scope

of subject).

End of C2 104-25 Cancellation (eg of a share in a liquidation where CG or CL

CGT asset pass 18-month rule), surrender (eg of a right) or
(C1 to C3) similar ending (eg end of a fishing licence).

C3 104-30 End of an option to acquire shares (granted by the CG or CL

company issuing the shares).

Bringing D1 104-35 Creating contractual or other rights (eg restrictive CG or CL

into covenant).
existence a
CGT asset D2 104-40 Granting an option. CG or CL
(D1 to D4)

E1 104-55 Creating a trust over a CSG asset. CG or CL

E2 104-60 Assets transferred to a trust. CG or CL

Trusts (E1 E4 104-70 Capital payment for trust interest (eg tax deferred CG only
to E9) distribution to unit holders). (once cost
base reduced
to nil)

E5 104-75 Beneficiary becoming absolutely entitled to a trust CG or CL

asset (eg asset held in trust until a specified age).

E6 / 104-80 / Disposal of trust asset to a beneficiary to end an CG or CL

E7 104-85 income right or capital interest (eg rather than
paying cash a beneficiary is given as asset equal to
the value of the trust distribution to which they
are presently entitled).

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Income tax – general rules 115

 CGT
Category event Section Description/examples Consequence

Leases (F1 F1 104-110 Granting of a lease (Note: Not eligible for CGT CG or CL
to F5) discount).

Special H1 104-150 Forfeiture of a deposit. CG or CL

capital
receipts
(H1 and
H2)

Australian I1 104-160 Individual or company stops being an Australian CG or CL

residency resident = deemed disposal at market value of CGT
ends (I1 assets (other than certain types of TAP).
and I2)
Note:
• Choice to disregard deemed disposal (s 104-165)
(ie to pay tax at the time of actual disposal).
• If taxpayer becomes an Australian resident =
Deemed acquisition (other than certain types of
TAP) at market value (s 855-45).
• Foreign resident only subject to CGT on TAP
(s 855-20).
• Foreign residents not entitled to CGT discount
on gains accruing after 8 May 2012.

K4 104-220 CGT asset starts being trading stock (ie changing CG or CL

the tax character) (eg a farmer starts a new
business by subdividing and selling the land).

Note:
• K4 only applies where the choice under s 70-30
is to use market value.
• If trading stock starts to be CGT asset = Deemed
acquisition at cost (s 70-110).

Other CGT K6 104-230 Pre-CGT shares or trust interest where at least CG only
events (K1 75% of the market value of the entity is comprised
to K12) of post-CGT assets.

Note:
• CGT asset stops being pre-CGT if it no longer
has the same majority underlying ownership =
Deemed acquisition at market value (s 149-30 /
s 149-35).

K7 104-235 If balancing adjustment occurs for a depreciating CG or CL

asset used partly for non-income producing
purposes

Calculation = [(Proceeds – Cost) x Private use %].

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116 Tax
Example 2.26 below provides a series of CGT event examples and the sections that apply.

Example 2.26 – CGT events

Situation CGT event and timing Section

UnluckyCo’s warehouse is damaged by fire CGT event C1 occurs when compensation 104-20
on 1 August 2022. The damage is is first received, not when the damage is
discovered on 2 August 2022. The done.
insurance proceeds are received on
12 December 2022. Note: The taxpayer may choose rollover
relief.

A commercial fishing licence expires. CGT event C2 occurs when the licence 104-25
expires.

Bob Pty Ltd acquired a trade debtor CGT event C2 occurs when the debt is 104-25
balance that it subsequently wrote off as written off / disposed of.
uncollectible.
Note: It is not deductible under s 25-35 as
a bad debt as it has not previously been
brought to account as assessable income.

SmithCo granted an option to a CGT event C3 occurs when the option 104-30
shareholder for $1,000 to purchase ends.
additional shares in SmithCo. The option
lapses unexercised.

Mr Jones enters into a contract with the CGT event D1 occurs when the contract is 104-35
purchaser of his business not to operate a entered into.
similar business in the same town (ie a
restrictive covenant) and was paid
$20,000.

SmithCo granted an option to ChipCo for CGT event D2 occurs when the option is 104-40
$10,000 to purchase an asset owned by granted.
SmithCo. The option has not expired in the
income year. Note: If exercised in a later income year,
CGT event D2 is disregarded and Smith Co
recognises the amount received on
granting the option as part of the asset’s
capital proceeds.

A company makes a capital payment (ie CGT event G1 occurs when the payment is 104-135
non-assessable distribution) to its made.
shareholder (eg return of share capital). The
cost base of the shares is reduced to $nil.

Tim decides to sell his land. Before CGT event H1 occurs when the deposit is 104-150
entering into a contract, the prospective forfeited.
purchaser pays Tim a holding deposit of
$1,000. The negotiations fail and the
deposit is forfeited.

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Income tax – general rules 117

 Situation CGT event and timing Section

An individual taxpayer leaves Australia and CGT event I1 occurs when the individual 104-160
becomes a foreign resident for tax stops being a resident.
purposes.

A farmer starts a new business of CGT event K4 occurs when the land starts 104-220
subdividing and selling land (ie CGT asset being held as trading stock.
becomes trading stock). The farmer
chooses under s 70-30 to use market value.

A taxpayer sells shares it acquired in CGT event K6 occurs when CGT event A1 104-230
SmallCo in 1983. SmallCo’s only asset is occurs, that is at date of contract, or
land acquired in 2006 (ie at least 75% change in ownership if no contract.
post-CGT).

An individual taxpayer disposes of a CGT event K7 occurs when the balancing 104-235
depreciating asset that is predominantly, adjustment event happens.
but not exclusively, used for
income-producing purposes (ie it is not a
personal use asset).

2.2.5 Capital gain/(loss) and discount capital gains

The CGT general discount was introduced to replace cost base indexation. However, it is not available to all
taxpayers. Where applicable, a capital gain that is a discount capital gain may be reduced by a discount
percentage.

Application
Under s 115-5, a discount capital gain is a capital gain that meets the following requirements:
• It is made by an individual, a complying superannuation entity or a trust (s 115-10). However, where
trustees are assessed under provisions such as s 99A ITAA 1936, no discount is generally available (see
s 115-222).
• It results from a CGT event happening after 21 September 1999 (s 115-15).
• The cost base has not been indexed (s 115-20).
• It results from a CGT event relating to a CGT asset acquired by the taxpayer at least 12 months before
the CGT event (s 115-25(1)).
• It is not one of the specified ineligible CGT events in s 115-25(3).
Despite the above, a capital gain is not a discount capital gain where the integrity measures apply
(eg section 115-45, which deals with entities with newly acquired assets (refer below)).
Companies cannot access the discount (s 115-10 ITAA 1997).

Eligible individual taxpayers

All resident individual taxpayers are entitled to apply the CGT general discount.
Non-resident individual taxpayers are only entitled to apply the CGT general discount for gains accrued up
to 8 May 2012 (s 115-105). For example, if a non-resident individual taxpayer disposed of an asset in the
current income year and that asset was acquired before 8 May 2012, the non-resident would be entitled to
a partial CGT general discount (s 115-115).
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118 Tax
Measuring ‘12 months’

The ‘at least 12 months’ holding requirement in s 115-25(1) means that the asset must be held for a clear
period of 12 months between the acquisition of the CGT asset and the time the CGT event.
The ATO’s view is that both the day of acquisition and the day on which the CGT event happens must be
excluded in reckoning the 12-month period (TD 2002/10). For example, if an asset is acquired on the first
day of Year 1, it cannot be sold before the second day of Year 2 if the capital gain is to qualify for
discounting (ie it cannot be sold on the last day of Year 1).

Ineligible CGT events

Ineligible CGT events are listed in s 115-25(3) and are events that generally could not satisfy the 12-month
holding requirement (eg CGT event F1 which relates to the grant of a lease, or CGT event D1 which relates
to the receipt of a restrictive covenant payment).

Discount percentage
Under s 115-100, the discount percentage is:
• 50% for individuals (excluding non-residents) and trusts.
• 33⅓% for complying superannuation funds.
Note: The discount percentage is generally 60% for individuals (excluding non-residents) and trusts, where the capital gain relates to
qualifying affordable housing (subject to specific conditions under s 115-125).

Integrity measures
A capital gain is not a discount capital gain in the following situations:
• Agreement within 12 months – where the CGT event giving rise to the capital gain occurs because of an
agreement made within 12 months of the date the CGT asset was acquired, even though the CGT event
itself occurs after 12 months (s 115-40).
• Entities with newly acquired assets – where the CGT asset is shares or an interest in a trust and the
following three tests are satisfied (s 115-45):
– The taxpayer (together with associates) has at least a 10% stake in the company or trust.
– The cost bases of the assets acquired by the company or trust within the preceding 12 months are
more than 50% of the total cost bases of the CGT assets.
– Assuming the company or trust sold its CGT assets, the net capital gain on the CGT assets acquired by
the company or trust within the preceding 12 months would be more than 50% of the net notional
capital gain on all the CGT assets (this excludes CGT-exempt assets like trading stock, depreciating
assets, etc).

Example 2.27 – CGT discount: Integrity rule for recently acquired assets
Bob Smith sells his 20% shareholding in Family Company Pty Ltd, making a capital gain of $25,000.
Bob has owned the shares for four years. At the time of the sale, Family Company Pty Ltd owns the
following assets:

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Income tax – general rules 119

 Asset Period owned Cost base $ Market value $ Unrealised capital gain $

1 > 12 months 500 1,200 700

2 > 12 months 8,000 13,000 5,000

3 < 12 months 2,000 13,000 11,000

4 < 12 months 30,000 32,000 2,000

40,500 59,200 18,700

Applying the three tests in s 115-45 produces the following results:

• The stakeholder condition is satisfied. Bob owns 20% of the shares in the company.
• The cost base condition is satisfied: $32,000 (cost base of less than 12 months assets) is greater
than 50% of $40,500 (cost base of all assets).
• The capital gain condition (assuming underlying assets are sold) is satisfied: $13,000 (notional
capital gain of less than 12 months assets) is greater than 50% of $18,700 (capital gain on all assets).

Accordingly, Bob is denied the CGT discount on the sale of his shares.

The obvious tax planning strategy to legitimately avoid s 115-45 (subject to Part IVA ITAA 1936)
would be for Bob to delay the sale of his shares until the necessary proportion of the company’s
underlying assets had been held for more than 12 months.

In practice, s 115-45 does not tend to apply very often because it is unusual for assets held for less than 12
months to increase in value materially and also to represent the bulk of the cost base of all assets.

Calculation method
The discount percentage is not applied until the taxpayer calculates their net capital gain for an income
year under s 102-5. Note, in this calculation, current and prior year capital losses are offset before the CGT
general discount is applied. Therefore, the benefit of the CGT general discount may be partially or fully
wasted where the taxpayer has capital losses.

Example 2.28 – Discount method

David Morrow is a tax consultant working for ABC Accountants. One of David’s clients, Henry Ross,
an Australian resident taxpayer, has disposed of an asset and provided David with the following
information relevant to the capital gain calculation.

The asset was acquired on 1 November 1999. The cost of the asset (the first element of cost base
expenditure) was $100,000.

Expenditure incurred on the asset on 6 March 2005 (the fourth element of cost base expenditure)
was $20,000.

The asset was sold in the current year.

The capital proceeds on sale amounted to $350,000.

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120 Tax
 Item $ $

Capital proceeds 350,000

Less:

First element cost base 100,000

Fourth element cost base 20,000 (120,000)

Discount capital gain 230,000

Less: Discount percentage (115,000)

Capital gain 115,000

2.2.6 Net capital gain/(loss)

Calculation method
Once a capital gain or loss has been separately calculated for each CGT event occurring in an income year,
the taxpayer needs to calculate their net capital gain or loss for the income year. Broadly, the outcome of
the net capital gain or loss calculation is as follows:

If capital gains > Capital losses Net capital gain to be included in assessable income

If capital losses > Capital gains Net capital loss to be carried forward

Specifically:
Step 1: The current year capital gains are reduced by current year capital losses. Capital gains or losses that
are disregarded are excluded from Step 1. For example, exclude:
• capital gains that qualify for the 15-year small business exemption
• capital gains or losses on motor vehicles
• capital losses on all personal use assets and capital gains on personal use assets costing less than the
specified threshold
• capital gains on collectables costing less than the specified threshold.
Step 2: If there is an amount remaining after Step 1, apply any carry forward net capital losses to reduce
that amount.
Step 3: If there is an amount remaining after Step 2, that qualifies for the CGT general discount (ie discount
capital gains), apply the discount percentage to reduce that amount. Non-discount capital gains are
not reduced.

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Income tax – general rules 121

Step 4: If there is an amount remaining after Step 3, whether or not it is a discount capital gain that
qualifies for the small business CGT concessions, apply those concessions to reduce that amount. Note, the
small business CGT concessions generally must be applied in a prescribed order.
Step 5: Add up remaining capital gains amounts after Step 4. This amount is the net capital gain for the
income year. It is included in assessable income.
If the current year capital losses exceed the current year capital gains, the amount remaining after they are
offset is the net capital loss for the income year (s 102-10). It is carried forward to potentially offset capital
gains in future income years.

Capital loss utilisation rules

Key capital loss utilisation rules include the following:
• Carry forward net capital losses must be offset against capital gains in the order in which the losses were
made (ie oldest net capital losses must be used first) (s 102-15(1)).
• Capital losses (current year and net carry forward) must be offset against capital gains before the CGT
general discount and the CGT small business entity concessions are applied (ie under Step 1 and Step 2
of the net capital gain calculation method). This same restriction does not apply to tax losses. Tax losses
are included as a deduction under s 8-1. Therefore, a tax loss reduces a net capital gain after it is included
in assessable income (ie it is not included in the calculation of a net capital gain).
• A taxpayer can generally choose which capital gains are reduced by capital losses. To minimise the net
capital gain for an income year, taxpayers should choose to prioritise the reduction of capital gains that
are not eligible for CGT concessions.
• Capital losses on collectables can only be used to reduce capital gains on other collectables.
• Capital losses arising from the disposal of a business (or its active assets) involving an indeterminate (ie
yet to be determined) look-through earnout right may not be considered in determining a taxpayer’s tax
liability (ie a net capital gain to be included in assessable income) until such time as it cannot be reduced
by future financial benefits received (ie all additional capital proceeds under the earnout arrangement
have been received – see above under modifications and special rules for capital proceeds) (s 118-580).
• A net capital loss cannot be offset against other assessable income (s 102-10(2)). That is, a net capital
loss is quarantined and can only be offset against capital gains in a future income year. A net capital loss
may be carried forward indefinitely (s 102-15), although to use a carry forward capital loss a company
must satisfy loss carry forward tests.
The following example illustrates the application of tax losses and the application of capital losses against
capital gains.

Example 2.29 – Net capital gain and tax losses

Simple Pty Ltd provides the following tax data for the current income year:

• Trading income – $100,000.

• Current year deductions – $40,000.
• Carry forward tax loss – $90,000.
• Capital proceeds from sale of asset A – $80,000 (acquired June 2000).
• Cost base of asset A – $20,000.
• Capital proceeds from sale of asset B – $40,000.
• Reduced cost base of asset B – $50,000.

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122 Tax
 Calculate the capital gain

Asset A $

Capital proceeds 80,000

Less: Cost base (20,000)

Capital gain 60,000

Calculate the capital loss

Asset B $

Capital proceeds 40,000

Less: Reduced cost base (50,000)

Capital loss (10,000)

Calculate the net capital gain

Capital gain 60,000

Less: Capital loss (10,000)

Net capital gain 50,000

(Note: A company is not eligible for the CGT general discount.)

Calculate the taxable income

$ $

Assessable income

Trading income 100,000

Net capital gain (see above) 50,000 150,000

Deductions

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Income tax – general rules 123

 $ $

Current year deductions 40,000

Carry forward tax losses 90,000 (130,000)

Taxable income 20,000

The calculation of capital gains and losses may be modified in a number of situations, including those that
involve collectables and personal use assets. A full list of modifications is set out in s 102-30.

Tax implications
Under s 102-5, any net capital gain is included in the taxpayer’s assessable income and taxed at the income
tax rates applicable to the taxpayer who derived the gain.
A capital gain or loss arises in the income year in which the CGT event happens.
Remember, the time that something happens is also critical to the operation of the CGT provisions for a
number of other reasons, including the following:
• In general, the CGT provisions do not apply to assets that were acquired before 20 September 1985.
• Neither indexed cost base nor the CGT general discount is available where a CGT asset has been held for
less than 12 months.
• The timing of the asset’s acquisition and its subsequent disposal determines whether the taxpayer can
choose to use the indexed cost base instead of the CGT general discount in calculating their capital gain.

2.2.7 CGT exemptions and anti-overlap provisions

Overview
The CGT exemptions mean that the capital gains or capital losses that arise from certain CGT events are
either disregarded or reduced for tax purposes. The four categories of general exemptions, which are listed
in s 100-30(2), are:
• exempt assets
• anti-overlap provisions
• exempt or loss-denying transactions
• small business relief.
These general exemptions are dealt with in detail in Subdivision 118-A.
In addition to the above general CGT exemptions, Division 118 contains a number of specific CGT
exemptions for:
• main residence (Subdivision 118-B) – this is the most commonly encountered specific exemption given
the significant number of Australian families that own a family home
• insurance policies including life and general (Subdivision 118-D)
• units in pooled superannuation trusts (Subdivision 118-E)
• look-through earnout rights (Subdivision 118-I).

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124 Tax
Exempt assets
The following types of assets are categorised as exempt CGT assets. However, this categorisation does not
mean that all capital gains or losses on these assets are disregarded. The assets are:
• cars, motorcycles and valour decorations
• collectables
• personal use assets.

Cars, motorcycles and valour decorations

Capital gains or capital losses made from the disposal of cars, motorcycles and valour or brave-conduct
decorations are disregarded in all situations (s 118-5).
With cars, this exemption applies regardless of the age of a car. For example, the sale of a vintage car would
be exempt under s 118-5. The reason for this exemption is that most cars are sold for a loss and the
government does not want to provide taxpayers with a tax benefit in this circumstance.

Collectables

A collectable is specifically defined in ss 108-10(2) and (3). To qualify, a collectable must be:
• artwork, jewellery, an antique, or a coin or medallion
• a rare folio, manuscript or book
• a postage stamp or first-day cover.
that is used or kept mainly for the taxpayer’s (or their associate’s) personal use or enjoyment. An option or a
right to acquire any of the above is also a collectable.
Note: TD 1999/40 describes an antique as ‘an object of artistic and historical significance’ that is more than 100 years old at the time of
the CGT event.

There are three special CGT rules that apply to collectables:

• Capital gains or capital losses made on collectables that were acquired for $500 or less are disregarded
(s 118-10(1)).
• For collectables that comprise an interest in artwork, jewellery, antiques, coins or medallions, rare folios,
manuscripts, books, postage stamps or firstday covers, the exemption only applies if the market value of
the collectable at the time of acquiring the interest (not what the taxpayer paid for it) was $500 or less
(s 118-10(2)). However, where parties are acting at arm’s length (ie acting in their own best interests –
see Granby v FCT), generally the acquisition price would be its market value.
• The third element of the cost base of a CGT asset (the costs of asset ownership) does not apply to a
collectable (s 108-17).
• Any capital loss on a collectable that is acquired for more than $500 is quarantined and can only be
offset against capital gains from collectables (s 108-10(1)).
Note: Capital losses arising from non-collectable assets can be offset against gains arising from collectable assets (ie the quarantining rule
only applies one way).

Personal use assets

A personal use asset is a CGT asset (other than a collectable) that is used or kept mainly for the taxpayer’s
(or their associate’s) personal use or enjoyment (s 108-20(2)); for example, boats, planes, motor vehicles, etc.
Land and buildings are not personal use assets (s 108-20(3)).
Certain interest-free loans can be personal use assets (see s 108-20(2)(d)). For example, it may not be
possible to obtain a capital loss if a loan is forgiven when it is a personal use asset (s 108-20(1)).

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Income tax – general rules 125

There are three special CGT rules that apply to personal use assets:
• Capital gains made on personal use assets are disregarded if the personal use asset was acquired for
$10,000 or less (s 118-10(3)). To prevent manipulation of the $10,000 limit, special rules apply to assets
which would ordinarily be disposed of as a set (s 108-25).
• The third element of the cost base of a CGT asset (the cost of asset ownership) does not apply to a
personal use asset (see above and s 108-30).
• A capital loss cannot be made from the disposal of a personal use asset (s 108-20(1)).

Example 2.30 – Net capital gain

Tom had the following transactions in the current year:

• He sold units in a unit trust for $6,000. The units were originally acquired four years earlier for
$8,500. He has previously received $2,000 in tax deferred distributions from the trust (due to the
difference between the depreciation rates used by the trust for tax purposes and calculating the
trust income).
• He sold his 1970 Mustang in October to a collector for $300,000. There are only two of these in
the world. The motor vehicle was acquired for $170,000 four years earlier.
• In June of the current year, he signed an agreement with his ex-employer whereby Tom agreed not
to compete in the same business as his ex-employer for three years within a 5 km radius. In return,
he received $100,000. He incurred $5,000 in legal fees to review the relevant agreement. The
amount was only received in the following July. (Ignore non-CGT provisions.)
• On 30 April, he granted an option to a third party to acquire 1,000 BHP Billiton Ltd shares from
him for $38 each. The premium received from granting that option was $1,200. The option expired
worthless on 31 May.
• On 1 May, he granted an option to a third party to acquire 2,000 Qantas Ltd shares from him at
$3.50 each. The premium received from granting that option was $600. The options were
exercised in the following year.
• He sold a yacht which he used for private purposes. He acquired it for $7,000 three years ago and
sold it for $40,000.
• He sold a wedding ring for $25,000 which he acquired in 1986 for $300.
• He sold a glider for $50,000 which he used for private purposes. He acquired it two years ago
for $80,000.
• Tom has carry forward capital losses of $15,000.

Tom’s net capital gain is calculated as follows:

Non- Net
Discount discounted capital
Asset Capital loss capital gain capital gain Exempt gain

Units $6,000 Less

(refer ($8,500 —
104-70(6)) $2,000)
= $500

Mustang 118-5

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126 Tax
 Non- Net
Discount discounted capital
Asset Capital loss capital gain capital gain Exempt gain

Restrictive $100,000
Covenant Less $5,000
(refer CGT = $95,000
event D1)

BHP Option 1,200

(refer CGT
event D2)

Qantas 104-40(5)
Option*

Yacht 118-10(3)

Ring 118-10(1)

Glider 0 108-20

$500 $96,200 $95,700

Less: Capital
losses ($15,000)

$80,700

*Section 104-40(5) provides that the proceeds from an option are disregarded if the option is exercised.

Anti-overlap provisions
The diagram below summarises the application of the anti-overlap provisions.

Assets
Trading stock Division 230 financial arrangements
Apply Division 70 Apply Division 230
No CGT: s 118–25 No CGT: s 118–27

Revenue assets (eg Federal Commissioner of Taxation

Depreciating asset
v Whitfords Beach Pty Ltd (1982) 150 CLR 355)
Apply Division 40
Apply s 6–5 CGT
No CGT: s 118–24
No CGT: s 118–20 assets

Gain from Isolated business transaction entered into with

Foreign currency profit-making purpose (eg Federal Commissioner of Taxation
Apply Division 775 v Myer Emporium Ltd (1987) 163 CLR 199)
No CGT: s 118–20 Apply s 6–5
No CGT: s 118–20

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Income tax – general rules 127

Otherwise assessable amounts

A capital gain is reduced if the CGT event that has occurred results in the capital gain, or part of the capital
gain, being assessable under another provision of the income tax law (s 118-20).

Example 2.31 – Otherwise assessable amount

Risk Limited (Risk), a general insurance company, acquires and disposes of shares in Big Australian
Bank Limited. Risk does not carry on a business of trading in shares (so the shares are not trading
stock), but the shares it holds are revenue assets: see Colonial Mutual Life Assurance Society Ltd v FCT
(1946) 73 CLR 604. The $100,000 gain made on the sale of the shares is ordinary income under s 6-5.
CGT event A1 also applies to the transaction, but the capital gain will be reduced under s 118-20(1)
by the $100,000 included in assessable income. The capital gain will be reduced to zero (s 118-20(2)).
Note: If the shares were trading stock, the gain would be reduced under s 118-25.

Section 118-20 does not apply if there is a loss. In that case, s 110-55(9) reduces the cost base of the
revenue asset by the amount of the deductible loss to prevent a double dip. Section 8-1 takes precedence
over the capital loss provisions.

Depreciating assets
Decline in value fully tax deductible

A capital gain or loss made from a depreciating asset where the decline in value of the asset is fully tax
deductible is disregarded under s 118-24. The capital allowance provisions apply to calculate any
assessable gain or deductible loss arising from the disposal of the depreciating asset, or the occurrence of
some other type of balancing adjustment event.

Decline in value wholly or partly non-tax deductible – CGT event K7

A partial CGT liability arises under CGT event K7 in s 104-235 where the decline in value of a depreciating
asset is partly non-deductible. This will arise where:
• a depreciating asset that is used wholly or partly for a non-taxable purpose (eg private use) is denied a
deduction under s 40-25
• a second-hand depreciating asset that is used in a residential rental property is denied a deduction under
s 40-27(2)(a) and (b).
The CGT event K7 capital gain is calculated under s 104-240 as follows:

(Termination value – Cost) × Sum of reductions / Total decline

Where:
• Sum of reductions is equal to the reductions in decline in value deductions for the asset under s 40-25
and s 40-27.
• Total decline is equal to the decline in value of the depreciating asset since it was first held.

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128 Tax
 Example 2.32 – Depreciating asset (CGT event K7)
Bill Brown purchased a digital camera (a depreciating asset) on 1 July 2021 for $5,000 and sold it on
30 June 2023 for $5,500. Bill uses the camera in his business as a wedding photographer, and at the
time of the sale, the camera had declined in value to $4,500. For 10% of the time, the camera was
also used for private purposes. The camera was not a pooled asset.

The sale of the camera triggers a balancing adjustment event under Division 40. In such cases, CGT
event K7 operates to capture the profit or loss on the private use component that is not subject to
the capital allowance provisions in Division 40.

The CGT event K7 capital gain is calculated under s 104-240 as follows:

(Termination value – × Sum of reductions

Cost) Total decline

10% × $500
($5,500 – $5,000) ×
$500

= $500 × 0.1

= $50

Therefore, the capital gain from CGT event K7 is $50 (before applying any discount). The capital gain
would not be disregarded under s 118-10(3). The asset is not a personal use asset because it is not
used or kept mainly for personal use and enjoyment.

There will also be an assessable balancing adjustment of $900 under Division 40, attributed to the
business use included in assessable income under s 40-285(1) and calculated as follows:

Sum of reductions
Balancing adjustment – × Balancing adjustment
Total decline

10% × $500
($5,500 – $4,500) – × Balancing adjustment
$500

= $1,000 – (10% × $1,000)

= $900

This calculation is the sum of:

• A clawback of the capital allowance deductions of $450 (Division 40).

• Taxation on 90% of the profit of $500 ($450) over the original cost of $5,000 attributable to the
business use.

Trading stock

A capital gain or loss made on the disposal of trading stock is disregarded (s 118-25).
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Income tax – general rules 129

The provisions that apply to the disposal of trading stock are set out in Division 70.
It is possible for an asset to change its tax character (ie from trading stock to a CGT asset, or vice versa).
The s 70-10 definition of trading stock caters for this by looking at the asset’s current use, rather than the
original purpose of its acquisition.
The income tax treatment is summarised in the example below.

Example 2.33 – Changing an assets tax character from trading stock to CGT asset

Before After

Asset Land developer selling subdivided land Land developer now holds Block X as
to new home buyers withdraws Block X an investment asset in the hope that
from sale this parcel of land may one day be
rezoned for commercial use

Tax character Trading stock CGT asset

Income tax Division 70 treatment CGT treatment

treatment
Section 70-110 treats the taxpayer as The CGT cost base will be the cost of the
having both sold the asset at arm’s asset used in the s 70-110 calculation
length for its cost and reacquired it for
the same amount

Example 2.34 – Changing an assets tax character from CGT asset to trading stock

Before After

Asset Farmer owning land on the outskirts of Farmer, now operating in his new
town embarks on a new business by business as a land developer, holds the
subdividing and selling the land as parcels of land as trading stock
trading stock to new home buyers
(TD 92/124)

Tax character CGT asset Trading stock

Income tax CGT treatment Division 70 treatment

treatment
If the taxpayer’s s 70-30 choice is to use: Section 70-30 considers the taxpayer
• Cost – the gain or loss is disregarded to have sold and reacquired the asset at
(s 118-25(2)) one of the following values (chosen by
the taxpayer):
• Market value – CGT event K4 applies
(s 104-220) • cost
• market value.

Financial arrangements

A gain or loss from a financial arrangement that is assessable or deductible under Division 230, or dealt
with under the hedging rules in Subdivision 230-E, is disregarded for CGT purposes (s 118-27).

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130 Tax
Exempt or loss-denying transactions
Compensation or damages, and windfall gains

Capital gains or losses arising from certain types of compensation or damages, and from gambling winnings
or losses, or a game or competition with prizes, are CGT-exempt (s 118-37).
Compensation or damages are sometimes treated as revenue, assessable under s 6-5 as ordinary income or
under a statutory income provision outside the realm of CGT. Examples of revenue include compensation
for the loss or destruction of:
• trading stock – which is ordinary income and considered assessable by s 70-115
• a depreciating asset – where the compensation is treated as the termination value of the asset for the
purposes of calculating the balancing adjustment (s 40-300(2) item 8).
A look-through approach is typically used to determine the CGT impact of compensation or damages that
are treated as capital (TR 95/35). This involves ‘looking through’ the transaction to identify the underlying
asset to which the compensation is most directly related. This approach is also commonly called the
underlying asset approach.

Example 2.35 – Compensation and damages

Both example payments provided in the table below give rise to a right to sue the party at fault.
However, applying the look-through approach to finding out their CGT impact means that this right is
not itself treated as a CGT asset. Rather, the underlying asset that the compensation payment relates
to needs to be identified and the payment takes its tax character by reference to that underlying
asset (the right to sue is ignored).

CGT impact of compensation or damages

What does the payment

Example relate to? CGT outcome

A car accident results in an Taxpayer’s car ($20,000) CGT disregards a gain or loss
insurance payout of $20,000 for on a car (s 118-5). There are
the taxpayer’s (written-off) no CGT implications. Nor is
private car the amount ordinary income.
Not assessable

A newspaper wrongly states that Loss of profits ($50,000) The $50,000 takes the
a restaurant has been raided for a character of the thing
Business goodwill
breach of health regulations. The compensated for (profits).
($100,000)
restaurateur, who recently paid This amount is assessable as
$300,000 to acquire the ordinary income (s 6-5)
restaurant and its associated
The $100,000 is treated as
goodwill, threatens to take legal
partial recoupment of the
action. The newspaper’s publisher
amount paid to acquire the
settles the matter by printing an
goodwill. The CGT cost base
apology and paying the
is reduced by the
restaurateur $150,000: $50,000
compensation received and
(for loss of profits) and $100,000
is therefore not taxable in its
(for damage to business goodwill)
own right
(TR95/35)

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Income tax – general rules 131

Main residence exemption
Capital gains or losses from dwellings are disregarded under s 118-110 where:
• the dwelling was owned by an individual,
• the dwelling was that individual’s main residence (eg family home) throughout the ownership period, and
• at the time of the CGT event, the individual was not:
– a foreign resident for a continuous period of more than six years (ie an excluded foreign resident), or
– a foreign resident for a continuous period of six years or less and did not satisfy the life events test,
which includes terminal medical conditions, death and family law matters (ie divorce or separation).

A dwelling is a building that provides mainly residential accommodation, but can include a caravan,
houseboat or other mobile home (s 118-115).
The exemption also applies to adjacent land used primarily for private or domestic purposes, subject to a
total land area of two hectares (s 118-120). Adjacent land can include:
• land acquired after the acquisition of the dwelling and on a separate title (TD 92/171)
• land that is not contiguous (TD 1999/68). The Commissioner gives an example of a block of land bought
two streets away as being adjacent.

Example 2.36 – Dwelling and adjacent land: Main residence exemption

Bill Brown, an Australian resident, purchased a home in 2016 and occupied it as his main residence.
The home has never been used for income-producing purposes. In 2018, Bill purchased the vacant
block of land that is adjacent to the land on which his dwelling is situated. He then constructed a
private swimming pool on the land. The total area of the adjacent land and of the land on which the
home is located is less than two hectares.

In the current year, Bill, an Australian resident, entered into a contract to sell the home and the
adjoining block. A full main residence exemption is available regardless of whether or not Bill merges
the titles.
Adapted from: TD 92/171.

Example 2.37 – Buying unit next door

Adam, his wife and their two children, bought a 2-bedroom unit eight years ago to live in. As their
children have grown, the unit is too small. They really like the apartment complex that they live in.
The unit next door has just come up for sale. If Adam buys it, the family could easily live in both units
and it could become an extended home. The body corporate has advised Adam that he cannot merge
the two titles if he acquires the second unit.

Given that the unit is on a separate title, Adam is reluctant to buy it because he believes that he will
end up paying CGT on the capital gain, whereas if he buys a brand new house, the whole house
would be exempt from CGT.

The Tax Office considers a similar question in TD 1999/69 and concludes that two units of
accommodation can be treated as a single dwelling where the units of accommodation are used
together as one place of residence or abode.

In considering this issue, the Tax Office considers the following factors consistent with TD 1999/69:
1. whether the occupants sleep, eat and live in the units
2. the distance between and the proximity of the units of accommodation
3. whether the units are connected
4. whether the units are capable of being sold separately

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132 Tax
 5. the extent to which the daily activities of the occupants in the units are integrated
6. how the units are shared by the occupants
7. how costs of the units are shared by the occupants.
All of the above facts (apart from point 4) would be satisfied in Adam’s circumstances.

In this instance, Adam may wish to seek a ruling from the Tax Office about whether point 4 would
negate both units from being eligible for the main residence exemption, or if it would only be
available if the titles were merged.

Rules that extend the exemption

The following rules extend the application of the main residence exemption:
• A dwelling is treated as a taxpayer’s main residence if it is moved into at the time it was first practicable
for the taxpayer to do so after its acquisition (s 118-135). In this regard:
– The taxpayer’s intention to move in is not enough. They must physically move in. For example, if a
taxpayer acquires a house to live in, but is relocated before they do so for work reasons, the exemption
will not be available (refer Caller & Anor v FCT [2009] ATC 10 and Chapman v FCT (1989) 20 ATR 438).
– There are no hard and fast rules about when a house becomes a taxpayer’s main residence. It comes
down to facts, such as intention and conduct that shows the intention (eg moving in furniture,
connecting utilities, changing your address on your driver’s licence or on the electoral roll).
• Where a taxpayer acquires a new main residence before disposing of their previous main residence, they
are entitled to claim the main residence exemption on both residences for up to six months (s 118-140).
• If a residence stops being the taxpayer’s main residence, the taxpayer may use it for income-producing
purposes and choose to continue to treat that residence as a main residence for up to six years, provided
that the taxpayer does not treat another residence as the main residence at the same time (s 118-145).
The six-year period starts from the time the property is used for income-producing purposes and is reset
each time the taxpayer moves back into the premises and uses it again as a main residence. This concession
is only available in circumstances where, before being used for income-producing purposes, the dwelling
was used as a main residence.
If the dwelling is not used for income-producing purposes, there is no time limit. A taxpayer therefore could
leave their home for 10 years and take advantage of this concession, provided that no other home
becomes their main residence.

Example 2.38 – Two dwellings: Main residence exemption

Bill Brown, an Australian resident, acquired a dwelling on 1 January 2016. He lived in the home until
he went overseas on 1 January 2017. Bill did not rent out the home during his absence. Bill acquired
a second dwelling on 1 February 2022, which he moved into on his return to Australia on 1 March
2022. Bill disposed of the first dwelling on 1 August 2022. At the time the dwelling was sold, Bill was
an Australian resident.

In line with s 118-145, Bill continued to treat the first dwelling as his main residence from 1 January
2017 until its disposal on 1 August 2022 (ie for five years and seven months).

In addition, under s 118-140, Bill also treated the second dwelling as his main residence from the
time he acquired it on 1 February 2022 up until the time he ceased to have an ownership interest in
the first dwelling (1 August 2022).
Note: The six-year limitation rule for income-producing use and the deemed acquisition rule at the time of first income-producing
use are not relevant for Bill.

Adapted from: TD 1999/43.

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The main residence exemption can be applied to land for up to four years where the taxpayer builds a
dwelling on the land, or repairs, renovates or finishes building a dwelling on the land (s 118-150). However,
the taxpayer can make this choice only if the dwelling:
• becomes their main residence as soon as practicable after the dwelling is built, repaired or renovated
(s 118-150(3)(a)), and
• continues to be their main residence for at least three months (s 118-150(3)(b)).

Example 2.39 – Constructing a dwelling: Main residence exemption

Bill Brown, an Australian resident, purchased land in late 2016 and began building a dwelling on it in
mid-2018. In early 2019, as soon as practicable after construction of the dwelling was completed, Bill
moved in. He lived in it for approximately two and a half months. Due to a lack of local employment
opportunities, Bill moved interstate (within Australia) and, after moving out, rented the dwelling. The
dwelling is still currently rented. Bill now intends to sell the dwelling. He does not own any other
dwellings. When the dwelling was eventually sold, Bill was an Australian resident.

Although the dwelling was Bill’s actual main residence for less than three months after its
construction was completed, this period (ie the construction period) was immediately followed by a
period in which Bill could treat it as his main residence under s 118-145. For the purposes of
s 118-150(3)(b), this extended the time that the dwelling continued to be the taxpayer’s main
residence to the requisite period of at least three months.
Adapted from: ATO Guide to Capital Gains Tax.

Rules that limit the exemption

The following rules limit the main residence exemption:

• The main residence exemption is only available for certain CGT events (s 118-110(2)). For example, the
main residence exemption is not available for CGT event I1 that occurs when a taxpayer ceases to be an
Australian resident (subject to a transitional provision).
• The main residence exemption is not available for adjacent land, which is disposed of separately from the
dwelling (s 118-165). For example, it would not apply if a taxpayer subdivides their backyard and sells
the subdivided portion.
• A full main residence exemption is not available for a residence where a taxpayer and their spouse
nominate different residences as their main residence (s 118-170).
• A partial CGT liability arises where a transferred dwelling (eligible for a Subdivision 126-A marriage or
relationship breakdown rollover relief) did not qualify as the main residence of both the transferee and
transferor spouse (s 118-178).
• A partial exemption is available where the dwelling was the main residence for a part of the ownership
period (s 118-185). This situation could arise where, for example:
– the dwelling was not occupied as a main residence from the time it was first practicable to do so after
acquisition (s 118-135)
– the six-year absence period is exceeded (s 118-145)
– the four-year period for building a dwelling on vacant land is exceeded (s 118-150).
Note: This partial main residence exemption does not apply if the taxpayer is an excluded foreign resident or a foreign resident who does
not satisfy the life events test (subject to a transitional provision).

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134 Tax
 Example 2.40 – Main residence for part of ownership: Main residence exemption
Bill Brown, an Australian resident, purchased a dwelling on 1 July 2019 using borrowed funds and
immediately rented it out on an arm’s-length basis for two years. Bill continued to live at home with
his parents, and claimed negative gearing deductions on the property. On 1 July 2021,
Bill terminated the tenancy arrangement and occupied the dwelling as his main residence. On
1 July 2022, Bill sold the property and made a $100,000 capital gain. Bill was an Australian resident
at the time the dwelling was sold.

Bill’s taxable capital gain (before discounting) is calculated using the formula in s 118-185(2):

Gain/loss on Non-main residence days

× = Taxable capital gain
the transaction Days in ownership period

$100,000 × 730 ÷ 1,095 = $66,667

In the example, the date the contract of sale was entered into (ie the time of CGT event A1) and the
date of settlement under that contract (ie when legal ownership ends) are taken to both occur on 1
July 2022. However, in practice, settlement would occur later, say on 1 October 2022. In that
situation, under s 118-130(3) the total days in the ownership period would continue until legal
ownership ends (ie 1,095 + 92 = 1,187).

Income-producing purposes

Only a partial exemption is available where the dwelling is used fully for income-producing purposes during
the ownership period and the period of such use exceeds the six-year absence concession in s 118-145
(s 118-190).
A partial exemption may only be available where a dwelling is partly used for income-producing purposes
at the same time as being the taxpayer’s main residence (s 118-190). ATO guidance can be found in
IT 2673 and TD 1999/71.

Example 2.41 – Partly income-producing purpose: Main residence partial

exemption
Bill Brown, an Australian resident, takes out a mortgage to buy a two-bedroom unit to live in as his
main residence. He rents out the second bedroom on an arm’s-length basis for his entire ownership
period. Bill claims a deduction for 40% of the interest repayments and other holding costs (council
rates and body corporate fees), based on the floor space shared with the tenant. Bill later sells the unit
and makes a $100,000 capital gain. Bill was an Australian resident at the time the dwelling was sold.

The partial exemption rule in s 118-190 applies. The taxable gain is determined by reference to the
deductible portion of interest that was, or could be, deducted from the money Bill borrowed to
acquire the unit using a reasonable approach. For example:

$100,000 × 40% = $40,000 taxable capital gain (before the CGT general discount)

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Income tax – general rules 135

 Example 2.42 – Partly income-producing purpose: Main residence full exemption
Sue Smith, an Australian resident, takes out a mortgage to buy a two-bedroom unit to live in as her
main residence. She uses the second bedroom as a study, where she does after-hours work for her
employer and studies for her Chartered Accountants Program qualification.

Applying case law (eg Handley v FCT [1981] HCA 16) and TR 93/30, Sue claims a deduction only for
non-ownership costs that have a direct connection to the home study (eg power, heating), on a
floor-area basis. No deductions are claimed for occupancy or ownership expenses (eg interest,
council rates and body corporate fees).

Sue later sells the unit and makes a $100,000 capital gain. Sue was an Australian resident at the time
the dwelling was sold.

The partial exemption rule in s 118-190 does not apply. Sue could not claim a deduction for the
interest on the money she borrowed to acquire the dwelling.

The $100,000 capital gain is fully disregarded under the main residence exemption. Having a home
office will not jeopardise the main residence exemption, unless the home office is a business premises.

Deemed cost base

Section 118-192 provides a deemed CGT cost base rule for working out a capital gain or loss on a dwelling
that has been a main residence and also used for income-producing purposes. The rule applies if:
• only a partial main residence exemption would be available because the dwelling was used to produce
income during the ownership period
• the income-producing use started after 20 August 1996
• the taxpayer would have been entitled to a full main residence exemption if they had entered into a
contract to dispose of the dwelling just before the first time it was used for the income-producing
purpose.
If these three conditions are satisfied, the taxpayer is taken to have acquired the dwelling at its market
value at the time they first started using it for income-producing purposes (s 118-192(2)).
The effect of this provision is that the first element of the dwelling’s cost base and reduced cost base is the
market value of the dwelling on the day it was first used for income-producing purposes (and the
expenditure incurred by the taxpayer before that day is ignored). In a rising property market, s 118-192
provides a useful cost base ‘step up’ opportunity. However, a valuation of the property at that time must be
obtained.

Example 2.43 – Main residence subsequently used for income-producing

purposes: Main residence exemption
Bill Brown, an Australian resident, purchased on 1 July 2012 for $200,000, a dwelling which he lived
in until he moved interstate on 1 July 2014. On 1 July 2014, his dwelling had a market value of
$300,000. Bill rented out his dwelling for the whole time he was absent and did not acquire another
dwelling interstate. On 30 June 2023, Bill sold the dwelling for $1,000,000. Bill was an Australian
resident at the time the dwelling was sold. Assume Bill had no other amounts related to the
calculation of his capital gain.

Under s 118-192, Bill is considered to have acquired the dwelling on 1 July 2014 (ie the day it was
first used for income-producing purposes) for its market value of $300,000. Therefore, Bill made a
capital gain of $1,000,000 – $300,000 = $700,000.

Under s 118-145, Bill continues to treat the dwelling as his main residence from 1 July 2014 to 30 June
2020 (ie for up to six years). Therefore, his non-main residence days are 1,095 (ie from 1 July 2020 to
30 June 2023) and his days in ownership period are 3,285 (ie from 1 July 2014 to 30 June 2023).
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136 Tax
 Bill’s taxable capital gain (before discounting) for the income year ended 30 June 2023 calculated
using the formula in s 118-185(2) is:

Gain/loss on Non-main residence days

× = Taxable capital gain
the transaction Days in ownership period

$700,000 × 1,095 ÷ 3,285 = $233,333

Note: In the above example, the date the contract of sale was entered into (ie the time of CGT event A1) and the date of
settlement under that contract (ie when legal ownership ends) are taken to both occur on 30 June 2023. However, in practice,
settlement would occur later, say on 30 September 2023. In that situation, under s 118-130(3), the total days in the ownership
period would continue until legal ownership ends (ie 3,285 + 92 = 3,377 days).

Main residence exemption for foreign residents

Under section 118-110, the main residence exemption is not available to a taxpayer that is either:
• an excluded foreign resident (being a foreign resident that has been a foreign resident for a continuous
period of more than 6 years); or
• a foreign resident that does not satisfy the life events test (ie where they have been a foreign resident for
less than 6 years and a close family member has a terminal medical condition or has died or if there is
divorce/separation during that period.)
In other words, ’6 year plus’ foreign residents never get the exemption. ’6 year less’ foreign residents only
get the exemption if they are forced to sell their main residence because of family tragedy.
There was a transitional provision which expired on 30 June 2020.

Dwellings acquired from a deceased estate

Sections 118-195 to 118-210 provide either a full or partial exemption on the disposal of a dwelling by a
beneficiary or trustee who acquired it from a deceased estate.

Other exemptions
Life insurance

CGT events relating to life insurance policies or annuity instruments that result in a capital gain or loss are
generally disregarded for CGT purposes (s 118-300). Specifically, such gains and losses are disregarded
where they are made by:
• the original beneficial owner of a policy or instrument. In withdrawn TD 94/31, the Australian Taxation
Office (ATO) accepts that:
- where two or more persons (eg a husband and wife) jointly effect a life assurance policy, each person
may be an original beneficial owner
- the person holding the rights under a life assurance policy may be an individual, a company or a trustee
of a trust estate, if the holder possesses ‘all the normal incidents of beneficial ownership’. The fact that
a trustee, who is not legally a beneficial owner, is included in this list by the ATO shows that the ATO
takes an expansive and purposive interpretation of the law
• an entity that acquired the interest in a policy for no consideration (eg a person nominated by the policy
owner to receive the insurance payout if the policy owner dies)

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Income tax – general rules 137

• the trustee of a complying superannuation fund, approved deposit fund (ADF) or pooled superannuation
trust (PST).
The ATO adopts a practical approach to the meaning of a life insurance policy (TD 2007/4). The life
insurance exemption will apply to:
• a payment under a trauma policy if it is paid because of the death (rather than illness) of the insured
• terminal illness benefits (ie a pre-payment of a death benefit based on medical opinion that the insured’s
death is imminent). Under Australian insurance standards, a terminal illness benefit is one which is
payable within 12 months of death.

Example 2.44 – Trauma and life insurance policy: CGT exemptions

Bill Brown is the beneficial owner of a trauma and life insurance policy. Under the policy, Bill is to be
paid a sum in the event that his wife, Noelene, suffers one of a number of traumas or dies. The CGT
exemption applicable to each scenario is as follows:

Scenario 1: Noelene suffers a heart attack and dies

On receipt of the payment under the policy, CGT event C2 in s 104-25 occurs because Bill’s rights
under the policy end. Any capital gain or loss that Bill makes is disregarded under s 118-300(1) item
3, because the payment under the policy was made for Noelene’s death.

Scenario 2: Noelene suffers a heart attack (a trauma event) and survives

The payment under the policy is not exempt under s 118-300(1) item 3 since it was paid because
Noelene suffered a heart attack and not because of her death. However, the payment is exempt
under s 118-37(1)(b), which exempts compensation received for an illness suffered by a relative.

General insurance

Payments under a general insurance policy are also CGT-exempt under s 118-300 in cases where, should a
CGT event happen relating to the property that is the subject of the policy, any gain or loss would be
disregarded.

Example 2.45 – General insurance policy: CGT exemption

Bill Brown (the insured) receives an insurance payment for the destruction of his pre-CGT investment
property. While the destruction of the property triggers CGT event C1, the insurance payout gives
rise to CGT event C2. However, the insurance payout has no CGT consequences because the
underlying asset is a pre-CGT asset (s 118-300(1) item 2).

CGT rollover that retains pre-CGT status may be available if the investment property is rebuilt
(s 124-85).

Pooled superannuation trusts

A pooled superannuation trust (PST) is a resident unit trust regulated by the Australian Prudential
Regulation Authority (APRA). Assets of superannuation funds, AFDs, other PSTs and certain other specified
entities are invested in PSTs.
Capital gains and losses are disregarded where they are made in relation to units in a PST and the entity is
(s 118-350):
• the trustee of a complying superannuation fund, ADF or PST
• a life insurance entity with additional restrictions.

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138 Tax
Look-through earnout rights

Look-through earnout rights under s 118-565 are indeterminate rights to future payments (ie financial
benefits) that are:
• linked to the performance of a business or active asset after sale
• not reasonably ascertainable at the time the right is created
• not required to be provided more than five years after the end of income year in which the underlying
CGT event occurs.
The capital gain or loss arising on a look-through earnout right acquired on or after 24 April 2015 is
disregarded (s 118-575). The financial benefits are included in the cost base or capital proceeds of the
underlying asset.

2.2.8 Other CGT measures

Pre-CGT asset integrity provisions
The introduction of CGT in 1985 included integrity measures that were designed to ensure that pre-CGT
status could not be claimed indefinitely by:
• entities with pre-CGT assets that had post-CGT improvements over a specified value
• individuals who owned pre-CGT interests in entities that owned predominantly post-CGT assets
• entities with pre-CGT assets whose ultimate owners had acquired their interests after CGT was
introduced.

Separate assets for CGT purposes

At common law, land and any fixtures are considered to be one asset, but this is overridden by the CGT
rules. For example, where a plot of pre-CGT land has a post-CGT asset built on it, the assets are considered
to be separate assets, so that the post-CGT asset does not escape CGT.
In addition, a post-CGT capital improvements to a pre-CGT asset may be a separate asset where the cost
base of the improvement at the time of a later CGT event is more than the set improvement threshold and
exceeds 5% of the capital proceeds.
If the improvement is treated as a separate CGT asset, the capital proceeds from the CGT event must be
apportioned between the original asset and the improvement (s 116-40). The effect is that only the
improvement is subject to CGT.
Subdivision 108-D sets out circumstances where separate assets are considered to exist for CGT purposes.
Note: A building constructed on post-CGT land is treated as a single asset with the land.

Sale of interests in a company or trust – CGT event K6

Application

CGT event K6 (s 104-230) addresses the situation in which a taxpayer disposes of pre-CGT:
• shares in a private company
• interest in a non-discretionary trust (eg a unit trust).
where at least 75% of the market value of the company or trust is comprised of post-CGT assets
(s 104-230(2)).
CGT event K6 is designed to prevent shareholders in private companies (or beneficiaries in
non-discretionary trusts) obtaining CGT-free gains where the entity’s assets are predominantly comprised
of post-CGT assets that carry unrealised gains.
Where it applies, CGT event K6 treats part of the capital proceeds from the sale of pre-CGT shares (or an
interest in a trust) as a capital gain that is subject to CGT (s 104-230(6)).
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Income tax – general rules 139

CGT event K6 can never result in a capital loss (s 104-230(6)).

Calculation method

The income tax legislation does not provide a specific method to determine the part of the capital proceeds
that is treated as a capital gain. However, the ATO applies the following process for calculating the capital
gain (adapted from TR 2004/18):
Step 1 – Determine how much of the capital proceeds actually relates to the post-CGT property using a
proportional market value basis:

Market value of entity’s post-CGT property

Capital proceeds ×
Market value of all the entity’s property

Step 2 – Determine how much of the Step 1 amount relates to the amount by which the market value of
the entity’s post-CGT property exceeds the costs bases of that property:

Market value excess

Step 1 amount ×
Market value of entity’s post-CGT property

Where Market value excess = Market value of post-CGT property – Cost base of post-CGT property.
The capital gain is equal to the lesser of:
• the market value excess
• the Step 2 amount.

Example 2.46 – Sale of pre-CGT shares: CGT event K6

Bob Brown owns 100% of the shares in Brown Pty Ltd, a private company. Bob acquired his shares in
1982 (ie pre-CGT) and has held them continuously. In the current year, Bob disposes of his shares for
$2.5 million. At the time of disposal, Brown Pty Ltd held the following two assets:

• Post-CGT property with a cost base of $1 million and a market value of $2 million.
• Pre-CGT property with a cost base of $100,000 and a market value of $500,000.

CGT event A1 occurs in the current year when Bob disposes of his shares in Brown Pty Ltd. As the
shares are pre-CGT, the CGT event A1 capital gain is disregarded (s 104-10(5)). However, Bob also
needs to consider the application of CGT event K6 (s 104-230).

Brown Pty Ltd’s percentage of post-CGT property is:

Market value of post-CGT property $2 million ÷ Market value of all property $2.5 million = 80%

As this percentage is at least 75%, CGT event K6 applies. Bob must determine the amount of the
capital proceeds that are reasonably attributable to the amount by which the market value of the
post-CGT property exceeds the cost base of that property.

Bob follows the ATO’s approach to determine his capital gain:

Step 1 – the amount of capital proceeds that relate to post-CGT assets is:

Capital proceeds $2.5 million × 80% =$2 million.

Step 2 – the reasonably attributable amount is:

Step 1 amount $2 million × (Market value post-CGT property $2 million – Cost base of post-CGT
property $1 million) ÷ Market value of post-CGT property $2 million = $1 million

Thus, Bob’s capital gain = $1 million.

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140 Tax
 BEFORE AFTER

One Blue Two Red

Brother Sisters
Three Blue Brothers (pre-CGT (post-CGT
(All pre-CGT shareholders) Shareholder) shareholders)

B1 B2 B3 B1 R1 R2

33.3% 33.3%
each each

Division 149 Pty Ltd Division 149 Pty Ltd

CGT cost base =

market value at
Pre-CGT assets date of change of
Pre-CGT assets converted to majority pre-CGT
post-CGT assets ownership

Majority post-CGT ownership of an asset

Application

Division 149 deems a pre-CGT asset held by an entity to cease being a pre-CGT asset when majority
underlying interests in the asset are no longer held by ultimate owners who had majority underlying
interests (more than 50%) in the asset immediately before 20 September 1985 (s 149-30(1)).
Division 149 is designed to prevent an entity selling its assets CGT-free where the majority of the entity’s
ultimate owners acquired their interests after CGT was introduced. The following diagram illustrates how
the pre-CGT assets of a company become post-CGT assets because of a change in majority underlying
interests.
Consequences

The asset is deemed to be acquired by the entity (s 149-30) (applicable to non-public entities) at the
earliest time that the majority underlying interests are not held by the same ultimate shareholders or
beneficiaries that held the interests before CGT was introduced. The asset is also deemed to be acquired at
its market value (s 149-35).
There are further issues to consider when dealing with a public entity. The rules are modified in the case of
public entities; however, these are outside the scope of this subject.
Note that Division 149 does not produce a capital gain. It deems pre-CGT assets to have been acquired
post-CGT at their prevailing market values, so that future CGT events may give rise to capital gains or
capital losses.

Exceptions

Division 149 is not triggered where ownership changes are caused by:
• the rollover of assets because of the breakdown of a marriage or relationship
• a person’s death.
In such cases, s 149-30(3) and (4) treats the new owner in these circumstances as one who ‘stands in the
shoes’ of the former owner.
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2.2.9 Record-keeping requirements
Taxpayers must keep records of every act, transaction, event or circumstance that may be relevant to
working out whether they have made a capital gain or loss from a CGT event (s 121-20).
Of importance is that the record-keeping period for CGT records is five years starting after the relevant
CGT event occurs (s 121-25(2)). This means that CGT records for long-held assets will need to be kept for
many years. The special nature of the CGT record-keeping requirement is often not fully understood by
taxpayers. Some destroy their records after they have kept them for five years under the general income
tax record-keeping provision in s 262A(4) ITAA 1936. Where the necessary CGT records are unavailable,
practitioners are often required to reconstruct the data necessary to perform CGT calculations.
Recently, in practice, this has also come to light when considering document retention policies as part of
the Tax Office’s focus on tax risk management and governance frameworks.

Chapter summary

Income tax
A fundamental feature of Australian income tax law is the framework for calculating an entity’s taxable
income and tax payable (or refundable). The Income Tax Assessment Act requires this calculation each
financial year by each individual and company, and by some other entities.
The first part of this chapter looked at elements of the tax equation, which is the core income tax principle:

Taxable income = Assessable income – Deductions

Ordinary income Statutory income General deductions Specific deductions

Income tax payable = Taxable income × Tax rates – Offsets – Credits

You should now be able to:

• calculate and advise on the items to be included in taxable income and income tax payable in basic and
less complex situations
• explain and apply the provisions regarding specific assessable income items, including reimbursements,
sale of WIP, and gains and losses on profit-making undertakings
• explain and apply the provisions regarding specific deductible items, including lease payments,
entertainment expenses, prepayments, superannuation and mortgage discharge expenses
• explain and apply different types of tax offsets and tax rates
• reconcile accounting profit to taxable income.

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142 Tax
Property and capital transactions
The second part of this chapter looked at four key issues:
1. Decline in value deductions.
2. The interaction of CGT and buildings/structural improvements.
3. Trading stock.
4. CGT.

You should now be able to:

• calculate and advise on the decline in value and balancing adjustments in complex situations; explain the
taxation consequences of a change in ownership or interest in a depreciating asset; and explain the
interactions between the CGT provisions, the trading stock provisions and the capital allowance provisions
• explain and apply the provisions about the interaction between the capital works allowance and CGT
regimes
• explain and calculate the tax outcomes of trading stock on disposal and explain and calculate the
taxation consequences of property either becoming or ceasing to be trading stock
• explain the interaction of CGT with the income tax formula (ie CGT is simply a component of assessable
income), advise on the capital gain or loss and application of discount, calculate and advise a taxpayer’s
capital gain or loss using complex scenarios, understand CGT exemptions and concessions for complex
scenarios, and explain and apply the CGT integrity measure.
These four areas of tax are pivotal in the everyday application of tax principles to most taxpayers in
Australia. The interaction between these areas of tax is also critical because of the fundamental
interconnectedness of the various tax principles.

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Income tax – general rules 143

Pdf_Folio:144
CHAPTER 3

Income tax – taxation of structures

and transactions

Chapter introduction
This chapter focuses on structures and international transactions.
The structures and key issues covered are:
• Companies – tax rates, loans, losses and tax consolidation membership.
• Individuals – assessable amounts and deductions, tax losses and tax rates.
• Partnerships – partnership changes and refinancing.
• Trusts – net income, allocation, present entitlement, streaming and CGT interaction.
• Small business entities – tax rates, base rate entities and SBE concessions.
Before starting a business, it is important to understand the commercial drivers and tax aspects of different
structures. An inappropriate structure can result in additional tax being paid either directly or indirectly.
The international issues explored are:
• Calculating the tax payable for taxpayers in receipt of foreign income. This includes an overview of the
foreign income tax offset (FITO) rules.
• Determining how the withholding tax regime applies to dividends, interest, royalties and capital gains.
In analysing an international issue, it is important to identify the funds flowing into Australia and the funds
flowing out of Australia.

3.1 Tax structures

Whenever a person is contemplating setting up a business or using an alter ego to hold assets, they
generally choose from four main structures:
1. Sole trader. In this situation, the person conducts business in their own right and pays tax on their taxable
income as an individual.

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Income tax – taxation of structures and transactions 145

 Business/Asset

2. Company. In this situation, the person conducts business by interposing a company between themselves
and the business/assets. The person becomes a shareholder in the company, and the company pays tax
on the company’s taxable income at the company tax rate.

Company

Business/Asset

3. Partnership. Under common law, a partnership is two or more persons carrying on business in common
with a view to profit. Under tax law, a partnership is extended to also include two or more persons in
receipt of income jointly.

In this situation, the person conducts business as a partner and each partner pays tax at the tax rate of
the partner on their share of the net taxable income of the partnership.

Partnership

Business/Asset

4. Trust. A trust is a fiduciary relationship between a trustee (the legal owner) and the beneficiaries (the
beneficial owners). The trustee holds assets on behalf of beneficiaries who have fixed interests or
discretionary interests in the trust property. For example, in a unit trust, the beneficiaries have fixed
interests, and, for a discretionary trust, the beneficiaries have discretionary interests.

In this situation, the trustee conducts business on behalf of the person. Each beneficiary pays tax on their
share of the net taxable income of the trust at the tax rate of the beneficiary. If they are not ‘presently

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146 Tax
 entitled’ to any trust income and no other beneficiary is presently entitled, the trustee would pay tax at
the trustee tax rates. The taxation of trusts and beneficiaries is discussed further in Topic 3.1.4.

Trust Trustee

Business/Asset

Tax structures – overview

To determine the taxable income for a taxpayer, tax practitioners need to be able to identify the common
tax rules and principles that apply to particular types of taxpayers (ie tax structures).
The following table provides further details on key sections that relate to types of taxpayers.

Section ITAA
1997 unless
Item otherwise stated Guidance

Entity, you, and 4-5, 960-100 The definitions contained in the income tax legislation can
person and 995-1 significantly alter the meaning of words. The general definition
sections are s 995-1 ITAA 1997 and s 6(1) ITAA 1936. In particular,
when considering different tax structures:
• The expression ‘you’ in a section includes all ‘entities’, unless the
application of the section is expressly limited (s 4-5).
• An ‘entity’ means (but is not limited to) any of the following
(s 960-100):
– an individual
– a body corporate (ie a company)
– a partnership, or
– a trust.
• A ‘person’ includes a company (s 995-1). Or in other words, for
income tax purposes the common meaning of the word person is
extended to also include a company.

Company 4-1, 995-1 and A company means:

103A ITAA 1936 • a body corporate, or
• any other unincorporated association or body of persons,
but does not include a partnership or a non-equity joint venture.

Companies are characterised for income tax purposes as:

• Public = The main test for determining whether a company is a
public company for a year is if its ordinary shares are listed on a
stock exchange on the last day of the income year (subject to
some concentrated ownership exclusions).
• Private = A company that is not a public company for an income
year.

However, the Commissioner has the power to treat a private

company as if it were a public company and vice versa.

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Income tax – taxation of structures and transactions 147

 Section ITAA
1997 unless
Item otherwise stated Guidance

Individual 995-1 An ‘individual’ means a natural person. An individual who is carrying

on business is known as a sole trader.

Partnership 995-1 and A partnership means:

TR 94/8 • an association of persons (other than a company or a limited
partnership) carrying on business as partners (referred to as a
common law partnership),
• an association of persons in receipt of ordinary income or
statutory income jointly (referred to as a tax law partnership), or
• a limited partnership.

Or in other words, for income tax purposes the common law meaning
of a partnership is extended to also include persons who are in
receipt of ordinary income or statutory income jointly. For example,
two taxpayers who own a rental property deriving passive rental
income may satisfy the definition of a tax law partnership (TR 94/8).

Trust 995-1 and A trust is an equitable obligation binding a person (ie the trustee) to
272-75 of administer the trust (ie the trust property) under the terms of the
Schedule 2F trust deed for the benefit of the beneficiaries of the trust.
ITAA 1936
Each income year a trust calculates its trust income in accordance
with the terms of the trust deed, makes a trustee resolution, and
distributes (in cash or in specie) the trust income to the beneficiaries
in accordance with the terms of the trust deed.

For tax purposes a trust is:

• A fixed trust – where entities have fixed entitlements to all of the
income and capital of the trust (eg a unit trust).
• A non-fixed trust – where a trust is not a fixed trust (eg a
discretionary trust).
• A family trust – is a trust (whether fixed or non-fixed) for which a
family trust election has been made.

There are also special types of trusts for tax purposes, including:
• A superannuation fund (see below).
• Managed investment trusts and attribution investment vehicles.

These special types of trust have their own income tax rules that are
outside the scope of this guide and the core tax subject.

Small business 328-110 To be an SBE, a taxpayer must:

entity (SBE) • carry on, or be in the process of winding up, a business, and
• satisfy the less than $10 million aggregated turnover test.

The definition of an SBE uses the word ‘you’. Therefore, an

individual, a company, a partnership, or a trust may be an SBE. Note
a different turnover threshold is applicable for the small business
income tax offset ($5 million) and CGT concessions ($2 million).

Medium sized 40-82 The term medium sized business is often used to generally describe
business a business that is not considered small or large. However, it also has
a specific definition under the income tax legislation in s 40-82.

The specific income tax definition in s 40-82 is only applicable for

the purposes of the concessions contained in capital allowance rules
in Division 40. As defined, a medium sized business specifically
excludes an entity that is an SBE.

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148 Tax
 Superannuation 26-95, 290-60 A superannuation fund is a special type of trust that has its own
fund/ and Division 295 income tax rules. Unlike other trusts, a superannuation fund is a
superannuation taxpayer. There are a number of special rules that apply to
contributions determining the assessable income and deductions of a
superannuation fund.

These special rules for superannuation funds are outside the scope
of this subject but are covered in the Advanced Tax subject.

3.1.1 Company
To determine the taxable income for a company, tax practitioners need to be able to apply the common tax
rules and principle outlined in the following tables.

TABLE: Company – key tax attributes

Section ITAA
1997 unless
otherwise
Item stated Guidance

Taxpayer 4-1 A company is a taxpayer for income tax purposes. Unlike many other
types of taxpayers, it is also a separate legal entity.

Residency 6-5 ITAA 1997, A resident company is taxable in Australia on its worldwide
and 6(1) ITAA assessable income. However, to minimise the double taxation of
1936 foreign income, resident companies may be entitled to exemptions
or foreign income tax offsets (FITOs).

A non-resident company is only taxable in Australia on its Australian

sourced assessable income. However, a further restriction applies
for CGT purposes. A non-resident is only taxable in Australia on a
capital gain (or loss) where the CGT asset is taxable Australian
property (TAP).

There are specific rules for determining the residency status of a

company.

Refer to Topic 2.1.1.

Tax rate 23(2) and 23AA Both a resident and non-resident company generally pay a flat rate
ITRA 1986 of tax:
328-115 and • General = 30%.
328-120 • Base rate entity = 25%.

A base rate entity is an entity where:

• no more than 80% of its assessable income for the income year is
‘base rate entity passive income’ (BREPI), and
• its ‘aggregated turnover’, calculated at the end of the income year,
is less than $50 million.

Aggregated turnover is defined under the SBE rules. It includes the

annual turnover of the company and of its connected entities and
affiliates.

An important difference between the SBE rules and the base rate
entity rule is the timing of when the aggregated turnover calculation
is performed. For a base rate entity the calculation is at the end of
the income year. Whereas under the SBE rules there are three
alternate aggregated turnover tests.

Refer to Topic 3.1.5 for the calculation of aggregated turnover.

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Income tax – taxation of structures and transactions 149

 Section ITAA
1997 unless
otherwise
Item stated Guidance

Tax offsets 36-55, 63-10, A resident company:

207-20 and • Is not entitled to a refund of excess franking offsets. However, it
770-10 can convert the excess into a tax loss (s 36-55).
• Is not entitled to a refund or to carry forward any excess foreign
income tax offsets (FITOs). The company must use the FITO in the
income year to which it relates, or any remaining unused balance
is lost.

When calculating a resident company’s income tax liability, franking

tax offsets must be applied before FITOs.

A non-resident company is not entitled to a franking tax offset (but

may be entitled to a FITO).

Refer to Topic 3.2.2.

Goods and 9-20 GST Act A company that carries on an enterprise (ie a business) can be
services tax (GST) registered for GST.

Refer to QRG: Other taxes and interactions (Part 1) in Topic 4.1 of

your learning materials.

Fringe benefits 136(1) FBTAA A company that is an employer can provide a fringe benefits to an
tax (FBT) 1936 employee (or their associate) and may be subject to FBT.

However, a company cannot be an employee, but s 21A ITAA 1936

may apply to non-cash benefits received.

Refer to QRG: Other taxes and interactions (Part 2) in Topic 4.2 of

your learning materials.

Small business Division 328 A company that carries on a business may be classified as an SBE (or
entity (SBE) an entity that would be an SBE applying an alternate aggregated
concessions turnover threshold) and may choose to apply the available SBE
concessions in the calculation of its taxable income where eligible.

Refer to Topic 3.1.5.

Personal services A company may be classified as a PSE and subject to the personal
entity (PSE) services income (PSI) rules where it is not a personal services
business (PSB). When this occurs certain deductions to which the
company would otherwise be entitled are denied or limited.

The PSI rules are covered in the Advanced Tax subject.

Treatment of 6(1) and 44(1) A company distributes its accounting profits (after tax) to
profits: Dividends ITAA 1936 shareholders through the payment of dividends. Dividends may be
franked (where the company is a resident) or unfranked for tax
purposes (see below).
A dividend is defined in s 6(1) ITAA 1936 to include:
• any distribution made by a company to any of its shareholders,
whether in money or other property; and
• any amount credited by a company to any of its shareholders as
shareholders.

A dividend does not include:

• Distributions from the share capital account (subject to s 6(4)
ITAA 1936 and tainted share capital account rules).
• Certain distributions in relation to the redemption or cancellation
of redeemable preference shares (s 6(1)(d) ITAA 1936).
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150 Tax
 Thus, dividends may include payments of cash, dividends reinvested
in further shares (under a dividend reinvestment plan) and bonus
shares in certain limited circumstances.

Company distributions or payments may also be deemed to be

dividends paid by the company for income tax purposes. Examples
include:
• Distributions from private companies (Division 7A ITAA 1936 –
see below).
• Excessive payments to shareholders (s 109 ITAA 1936).

Franking account Part 3-6 A resident company maintains a franking account and is subject to
and dividend Divisions dividend franking rules. These rules include:
franking rules 200-207 • Definitions of what is a frankable dividend (s 202-40) and an
unfrankable dividend (s 202-45) dividend. For example, an
unfrankable dividend includes:
– A deemed dividend under Division 7A ITAA 1936.
– Dividends debited against share capital accounts.
• A corporate tax rate for imputation purposes (s 995-1) which is
calculated:
– On the assumption that its aggregated turnover, assessable
income, and base rate entity passive income (BREPI) are the
same as the previous income year but apply the tax rates.
– By applying the corporate tax rates of the current income year.
• The maximum franking credit rule (s 202-60), broadly = Amount
of distribution x Corporate tax rate for imputation purposes /
(1 – Corporate tax rate for imputation purposes)
• The benchmark rule (s 203-25) – Under this rule:
– A company must frank all dividends paid during a franking
period at the same benchmark percentage.
A company’s franking period (s 203-40 and 203-45) is:
○ Private company = same as its income year (ie generally from
1 July to 30 June)
○ Public company = two periods of 6 months each (ie generally
1 July to 31 December and 1 January to 30 June)
– An additional debit arises in the company’s franking account
when a dividend is underfranked (s 203-50) – that is, when the
percentage of franking credits that are attached to a dividend is
lower than the company’s benchmark rate.
– Overfranking tax is payable when a dividend is overfranked
(s 203-50) – that is, when the percentage of franking credits
that are attached to a dividend is higher than the company’s
benchmark rate.
• A franking account must record all the franking credits (s 205-15)
and all the franking debits (s 205-30) that happen during a
franking year. Where the franking account is in deficit at the end
of the franking year:
– The company is required to pay franking deficit tax (FDT) (s
205-45). FDT is effectively a prepayment of a company’s income
tax instalment. After paying the FDT the franking account will
have a $0 opening balance at the start of the next income year.
– The company is entitled to an FDT offset equal to the FDT paid,
unless there has been excessive overfranking (s 205-70).
○ Excessive over-franking occurs if a company’s franking deficit
(recalculated to only include certain franking account debits)
is more than 10% of the total franking credits.
○ Where there is excessive overfranking, the amount of the
FDT offset that the company is entitled to is reduced by 30%.
○ Like other tax offsets, the FDT offset reduces the company’s
income tax liability.

Refer to QRG: Company – dividends and franking accounts.

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Income tax – taxation of structures and transactions 151

 Section ITAA
1997 unless
otherwise
Item stated Guidance

Private company 109C, 109CA, Distributions by a private company to a shareholder (but not if the
deemed dividends 109D, 109E, distribution is to another company) that are deemed to be a
109F, 109N, dividend (to the extent the private company has a distributable
and 109Y ITAA surplus (s 109Y)) include:
1936 • Payments – eg paying the private expenses of a shareholder
(s 109C) = Amount of the payment.
• Use of company assets – eg a shareholder uses a holiday house
owned by the private company on the weekend (s 109CA) = Value
of the benefit.
• Loans in the year made, that do not satisfy the minimum interest
rate and maximum terms rules under s 109N – eg an interest free
loan to a shareholder (s 109D) = Amount loaned less repayments
made (including repayments made after year end but prior to the
due date for lodgement of the company’s income tax return, or
the actual lodgement date of the return whichever is the earlier).
• Loans in subsequent years, that satisfied the requirements of
s 109N in the year made, but on which the repayments by the
shareholder during the income year do not equal or exceed the
minimum yearly repayment amount (s 109E) = Amount of the
shortfall.
• Debts forgiven (s 109F) = Amount forgiven
To satisfy the conditions of s 109N:
• There must be a loan agreement.
• The interest rate on the loan must be at least equal to the
benchmark interest rate = 4.77% for the income year ended
30 June 2023.
• The term of the loan must not exceed 7 years, or if there is a
registered mortgage over real property 25 years.

Note: The government has announced that it intends to amend the

Division 7A rules. However, at the time of writing while consultation
papers have been released, the enabling legislation has not yet been
introduced into Parliament.

Return of capital 104-135 Where a company makes a non-assessable distribution to a

(ie non-assessable shareholder:
distribution) • The cost base of each share will be reduced. However, the
shareholder can disregard certain parts of the non-assessable
distribution (for example, where certain types of NANE income
flow to the shareholder under the SBE CGT concessions).
• If the cost base is reduced to $nil, further non-assessable
distributions trigger a capital gain under CGT event G1.

The SBE CGT concessions are covered in the Advanced Tax subject.
Refer to Topic 2.2.4.

Tax consolidated 701-1, 703-5, An Australian resident company and its wholly owned Australian
group 703-10, subsidiaries may choose to form a tax consolidated group for income
703-15 tax purposes. When this occurs:
• A resident company that is a member of a tax consolidated group
(but is not the head company of that group) generally does not
prepare a separate income tax calculation. The assessable income
and deductions of the company are included in the head
company’s income tax calculations (ie the subsidiary members are
treated as though they are parts or divisions of the head company).

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152 Tax
 • A resident company that is the head company of a tax
consolidated group prepares a single income tax calculation for
the group. Intra-group transactions (including dividends) are
excluded from the head company’s taxable income.
• A single franking account is maintained by the head company
(ie dividends between members cannot be franked).
• Losses are transferred to and carried forward by the head company.

The entry and exit rules for tax consolidated groups are covered in
the Advanced Tax subject.

Tax The uniform administrative penalty regime applies to a company in

administration the same way as other taxpayers. However, significant global
entities may be subject to increased amounts.

The time frame for the Commissioner to amend an assessment that

is applicable to a company is generally four years (except where the
company is an SBE or would be an SBE if an alternate aggregated
turnover threshold is used).

Refer to Topics 3.1.5 and 1.1.

TABLE: Company – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

Assessable 6-5, 6-10, 8-1 Like other taxpayers, most of the assessable income and deduction
income and and 8-5 provisions apply to a company.
deduction
A company includes ordinary income in its assessable income when
general rules
it is derived:
• Non-business income is derived on a cash basis. For example,
income from passive investments including rent, interest, dividend
and royalty income are derived when received.
• Business income is generally derived on an accruals basis. For
example, sales and other income that results from carrying on a
business are derived when earned.
A company includes statutory income in its assessable income in
accordance with the timing rules in the statutory income provision.
A company is entitled to a general deduction under s 8-1 for losses
and outgoings it incurs in carrying on its business, subject to the
normal limitations and exclusions.
A company is entitled to specific deductions in accordance with the
timing rules in the specific deduction provision.

Net capital 102-5 and Like most taxpayers:

gains/(losses) 102-10 • A company must follow the method in s 102-5 to determine the
net capital gain included in its assessable income or the net capital
loss carried forward.
• Most CGT events are applicable to companies.
• A company cannot discount a capital gain (ie it is not entitled to
the 50% general CGT discount even if it is a resident taxpayer).
However, if the company is an SBE, there are a number of CGT
and rollover concessions that may apply.

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Income tax – taxation of structures and transactions 153

 Section ITAA
1997 unless
Item otherwise stated Guidance

• A company can index the cost base of certain assets (ie to

September 1999, when indexation ceased) when calculating a
capital gain.
• A capital loss can only be used to reduce a capital gain (ie it is not
a general or specific deduction). To use a capital loss, a company
needs to satisfy additional tests.
Refer to Topic 2.2.4.

Distributions 44(1), 92, and 97 A company can be a shareholder in another company, a partner in a
received (ie in ITAA 1936 partnership, or a beneficiary of a trust. Thus, assessable income and
capacity as a deductions arising from these investments must be considered.
shareholder,
Note: There is an exception from the application of the deemed
partner, or
dividend rules under Division 7A where the shareholder is a company.
beneficiary)
Refer to Topic 3.1.3 and 3.1.4.

Australian 44(1) and 128D A resident company that receives a franked dividend from another
sourced ITAA 1936 and Australian company must include the dividend and a franking credit
dividend, 207-20 gross-up in its assessable income (they are also entitled to a franking
interest and tax offset).
royalty income A non-resident company:
• Is subject to withholding tax on its Australian sourced dividend
(unfranked component), interest and royalty income.
• The Australian sourced dividend (franked and unfranked
components), interest, and royalty income is deemed to be NANE
income.
Refer to Topic 3.2.2.

Foreign income 6-5 and Division An exemption may apply in respect of the foreign income of a
770 resident company (eg the foreign branch exemption or the foreign
equity distribution exemption). Where an exemption applies, the
foreign income is NANE income (ie excluded from the resident
company’s assessable income) and the company is not entitled to a
FITO.

Where an exemption does not apply, a resident company includes

gross foreign dividend, interest and royalty income (ie net income
grossed-up for foreign taxes withheld) in its assessable income and it
may be entitled to a FITO.

A non-resident company is not subject to tax in Australia on its

foreign sourced income. However, the income of a controlled foreign
company (CFC) may be included in the assessable income of an
Australian resident company (or other taxpayer) on an attribution
basis.

Refer to Topic 3.2.1.

The CFC attribution rules are covered in the Advanced Tax subject.

Bad debt 25-35 The specific deductibility rules for bad debts apply to companies.
deduction However, to claim a bad debt deduction a company needs to satisfy
additional tests.

Substantiation The substantiation rules in Division 900 ITAA 1997 do not apply to
of deductions companies in claiming a deduction. However, the substantiation
requirements of the FBTAA 1986 need to be considered.

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154 Tax
 Capital Division 40, A company can claim a decline in value deduction and balancing
allowances, Division 43 and adjustment for a depreciating asset. However, a company that is an
capital works Division 328 as SBE may choose to apply the SBE capital allowance pooling rules.
and blackhole set out in QRG
expenditure A company can claim a capital works deduction for buildings and
deductions structural improvements.

A company can claim a blackhole expenditure deduction for certain

business-related capital expenditure costs.

Refer to Topics 2.2.1 and 2.2.2.

Tax loss 36-17, 165-10, To utilise a tax loss (a capital loss or to claim a bad debt deduction), a
deduction and 165-12, 165-13, company needs to satisfy either:
related tests 165-210, and • Continuity of ownership test = ownership test period from the
165-211 start of the loss year to the end of the income year > 50% of same
shares.
• Business continuity test, which includes:
– Same business test = identical business in the year of
recoupment as carried on immediately before the change in
ownership.
– Similar business test (on or after 1 July 2015 only).

A company can choose the amount of carry forward tax losses it

claims as a deduction (subject to integrity measures that prevent the
‘refreshing’ of tax losses).

Debt–equity The debt–equity rules are applicable to companies and can impact
rules and thin the calculation of taxable income. They can apply to:
capitalisation • Allow a deduction for certain dividends (ie on a non-equity share
that is classified as a debt interest).
• Disallow a deduction for interest payments (ie on a non-share
equity that is classified as an equity interest).

A company may be subject to the thin capitalisation provisions

which may limit the deductibility of debt deductions (eg interest).

The debt–equity and thin capitalisation rules are covered in the

Advanced Tax subject.

Tax rate and offsets

A broad overview of the tax provisions under which a company determines its tax payable is set out below.

Tax issue How the issue relates to companies Refer to

Tax payable

Tax rate Companies generally pay a flat tax rate. The tax rate See below
does not alter even if the company is a non-resident.
Companies are not liable to pay the Medicare levy

Franking tax offset A company may be entitled to a franking tax offset Assumed
knowledge
Excess franking tax offsets cannot be refunded.
However, they can be converted into tax losses

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Income tax – taxation of structures and transactions 155

 Tax issue How the issue relates to companies Refer to

Tax payable

Foreign income tax offset A company may be entitled to a FITO Topic 3.2.1
(FITO)
Like other taxpayers, excess FITOs cannot be refunded
or converted into tax losses (ie use it or lose it)

Other incentives and Companies may have different incentives or offset See below
offsets entitlements to other taxpayers

Payment of tax Companies pay tax instalments under the PAYG regime Topic 1.1.4

Tax rate

Under s 23(2) ITRA 1986, the tax rate of a company on its taxable income is:
• 25% for a company that is a base rate entity
• 30% for all other companies.
Base rate entity (s 23AA ITRA 1986) is an entity where:
• no more than 80% of its assessable income for the income year is base rate entity passive income (BREPI)
• its aggregated turnover, calculated at the end of the income year, is less than $50 million.
Base rate entity passive income is assessable income that is any of the following:
• Dividends and franking credits: As defined under s 960-120 and s 205-15. However, it excludes amounts
for a non-portfolio investment as defined under s 317 ITAA 1936 (ie ownership interest of 10% or more).
• Interest and amounts in the nature of interest: However, it excludes amounts where the taxpayer is a
financial institution (ie where the interest is business income).
• Royalties: As defined under s 6(1) ITAA 1936 (including lease fees on plant and equipment).
• Rent: There is no specific definition included in the legislation. Therefore, rent means the consideration
payable by a tenant to a landlord. There are no exclusions. Thus, even if rent is business income, it will be
included.
• Net capital gains: As defined under s 102-5 (see Topic 2.2.4).
• A partnership or trust distribution of base rate entity passive income: The taxpayer’s share of BREPI that
flows via a partnership or trust. However, dividends and franking credits for non-portfolio investments
are also treated as BREPI.
For ATO guidance on base rate entities and base rate entity passive income see LCR 2019/5.
Aggregated turnover has the meaning given by s 328-115 ITAA 1997. Under subsection 328-120(1), an
entity’s annual turnover is the total GST-exclusive ordinary income that the entity (and its connected
entities and affiliates) derives in the income year in the ordinary course of carrying on a business.
There is no requirement that the ordinary income be assessable income. Therefore, it would include
exempt income and offshore income.
The ordinary income must be derived in the ordinary course of carrying on a business. These words bear
their ordinary meaning and would include amounts which are part of the ordinary and common flow of
transactions of the particular business (refer Doutch v Commissioner of Taxation (2016) 248 FCR 211), both
direct and indirect, such as interest on surplus working capital.
However, statutory income (eg a capital gain under s 102-5, a share of partnership net income under s 92, a
share of trust net income under s 97 etc), which is not otherwise ordinary income (eg dividends), would not
be taken into account.
This example determines the company tax rate for an Australian resident company.
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156 Tax
 Example 3.12 – Company tax rate
Goober Pty Limited (Goober) is an Australian resident company. Assume Goober has no connected or
affiliated entities. Goober has provided the following information in respect of its operations for the
current income year:

• sales income $40 million

• interest and rental (ordinary course of business) income of $3 million.

On the basis of the above information, for the current year:

• Goober has aggregated turnover of $43 million (ie total ordinary course of business income)
• Goober has base rate entity passive income of $3 million (ie the interest and rental income) and
assessable income of $43 million.

Applying the base rate entity definition:

• Goober satisfies the first condition, as its percentage of base rate passive income to assessable
income is $3 million ÷ $43 million = 7% (which is less than 80%).
• Goober satisfies the second condition, as its aggregated turnover is $43 million (which is less than
$50 million).

Therefore, Goober is a base rate entity for the current year and has a lower tax rate.

This next example determines the company tax payable for an Australian resident company that is not a
base rate entity.

Example 3.13 – Company tax payable

Doner Pty Limited (Doner) is an Australian resident company that is not a base rate entity. Doner
derived a taxable income of $100 million for the current year. This amount includes some foreign
income for which Doner is entitled to claim a foreign income tax offset (FITO) of $2 million. Note
that in order to work out the FITO, you would need to work their way through the FITO offset
calculation – this is not relevant for present purposes. During the year, the company paid PAYG
instalments of $10 million.

The balance of Doner’s company tax payable for the current year is:

Item Calculation $ million

Tax on taxable income $100 million × 30% 30

Less: Foreign income tax offset (2)

Less: PAYG instalments paid (10)

Company tax payable 18

Private company loans and other payments (Division 7A ITAA 1936)

Division 7A (ss 109B-109ZE) ITAA 1936 aims to prevent private companies from making tax-free
distributions of profits to shareholders or their associates. Payments, loans and debts forgiven to
shareholders or their associates on or after 4 December 1997 are deemed to be dividends to the extent
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Income tax – taxation of structures and transactions 157

the private company has a distributable surplus, unless they are specifically excluded. If deemed to be a
dividend, the amount will be assessable to the shareholder or their associate.
The definition of associate is important. It includes shareholders, certain trusts, individuals etc. For an
individual, it includes a relative. But relative is a defined term and certain people may be excluded
(eg cousins).

Required reading
Section 109B ITAA 1936.

Application
Payments and use of company assets

Section 109C ITAA 1936 treats payments to shareholders (and associates) as deemed dividends to the
extent the private company has a distributable surplus. Payments include any amount given, excluding a
loan. For example:
• Payment of the private shareholder expenses such as travel expenses for a family holiday or private health
insurance premiums (subject to the application of the FBT rules for shareholders that are also employees).
• Transfers of property for less than the amount that would have been paid in an arm’s-length dealing.
TR 2014/5 states that transfers of property by a company under a family law settlement will trigger
Division 7A if distributed to an associate. In this context, former spouses are treated as associates
because of their past association.
Section 109CA(1) ITAA 1936 treats the use of company assets (eg cars, holiday homes, boats) by
shareholders (and associates) as deemed dividends to the extent the company has a distributable surplus.
For example, if a shareholder uses a company holiday house each weekend, the value of the benefit would
be a deemed dividend. In working out the value of the benefit, the whole week’s rental value (not just the
weekend) would be used if the holiday house stores the shareholder’s possessions and it is not available for
rent to third parties during the non-use periods. This is because the asset is available for use by the
shareholder. There are a limited number of exceptions to these provisions, a common one being where the
use of the asset is considered minor and infrequent. The same rules apply as the minor benefit exemption
in FBT. There are also exceptions for the provision of certain kinds of dwellings, and otherwise
deductible circumstances.

Exclusions

Payments not treated as dividends include:

• payments of genuine debts by the private company (s 109J) – for example, where a company pays an
arm’s-length amount to a shareholder for an asset
• payments to other companies (s 109K) – for example, where a company pays an expense on behalf of a
shareholder that is a company
• payments that are otherwise assessable to the shareholder (s 109L)
• certain liquidator’s distributions in respect of the private company (s 109NA).

Loans

Under s 109D ITAA 1936, loans that are not fully repaid by the earlier of lodgement or the due date for the
lodgement of the company’s income tax return for the income year in which the loan was made can be
treated as dividends to the extent the private company has a distributable surplus where a complying loan
agreement is not entered into.
Under s 109E, in subsequent years, if the minimum yearly repayment on complying s 109N loans are not
made, the shortfall is treated as a dividend to the extent the private company has a distributable surplus.
See below for a discussion of s 109N ITAA 1936.
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158 Tax
Exclusions

Loans not treated as dividends include:

• loans to other companies (s 109K) – for example, where a company makes a loan to a shareholder that is
a company
• loans that are otherwise assessable to the shareholder (s 109L)
• loans made by the private company in the ordinary course of business on commercial terms (s 109M).
For example, where a company that operates a banking business makes a loan to a shareholder under the
same terms and conditions as the loans it makes to the public
• loans that meet the criteria for minimum interest rate and maximum term in the year they are made
(s 109N)
• certain liquidator’s distributions in respect of the private company (s 109NA)
• loans to purchase qualifying shares or rights under an employee share scheme (s 109NB)
• amalgamated loans in the year they are made (s 109P)
• where undue hardship is caused (s 109Q).
Refer below for detailed analysis of the application of Division 7A to loans.

Debts forgiven

Section 109F ITAA 1936 deals with debts forgiven on or after 4 December 1997, regardless of the date
that the debt was incurred. Under s 109F(6), a debt is taken to be forgiven for the purposes of Division 7A
if a reasonable person would conclude that the private company would not insist on the entity paying the
amount, or rely on the entity’s obligation to repay that amount.
Section 109F describes what types of forgiven debts are treated as dividends. For example, a debt
forgiveness to a shareholder that is a superannuation fund or individual (ie a company to superfund or
individual debt forgiveness) is specifically included under s 109F, and therefore gives rise to a deemed
dividend.
Section 109G ITAA 1936 describes what types of debt forgiveness are not caught by these rules. For
example, a debt forgiveness to a shareholder that is a company (ie a company-to-company debt
forgiveness) is specifically excluded under s 109G, and therefore does not give rise to a deemed dividend.

Commissioner’s discretion

The Commissioner has the discretion to disregard the application of Division 7A, or allow a Division 7A
dividend to be franked where a taxpayer has triggered the operation of the provisions through an honest
mistake or inadvertent omission (s 109RB ITAA 1936).

Summary

The following flow chart helps to determine whether Division 7A applies.

Consequences
Deemed dividends

Where Division 7A applies, amounts taken to be dividends are:

• not deductible to the company under s 8-1
• included in the assessable income of the shareholder or their associate as an unfranked dividend under
s 44(1) ITAA 1936. However, dividends arising due to a family law obligation may be franked (s 109RC
ITAA 1936) and the Commissioner can allow a dividend to be franked in special circumstances (s 109RB
ITAA 1936). Refer to para (g) of the definition of unfrankable distribution in s 202-45 ITAA 1997

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Income tax – taxation of structures and transactions 159

• not subject to withholding tax if deemed to be paid to a non-resident (s 109ZA ITAA 1936). The
exclusion from withholding tax means the deemed dividend is subject to ordinary income tax (ie the
exception to withholding tax in s 128D ITAA 1936 does not apply).

Subsequent dividends

To prevent double taxation, if a subsequent dividend is actually distributed (ie a dividend is declared by a
private company under the Corporations Act) and some or all of that dividend is offset against the loan
amount which was a deemed dividend under Division 7A, the amount offset is (to the extent that it is
unfranked) not taken to be a dividend (s 109ZC ITAA 1936).
For example, in Year 1, a shareholder borrows $100,000 from a private company and the loan is deemed to
be a dividend under Division 7A in that income year. In Year 1, the shareholder includes the deemed
dividend in their assessable income under s 44(1) ITAA 1936. In Year 2, the private company declares an
unfranked dividend of $100,000 and reduces the loan owed by the shareholder. In Year 2, the shareholder
does not include any amount in their assessable income under s 44(1) ITAA 1936.

Did one of the following transactions

occur on or after 4 December 1997?
• The company paid an amount to a shareholder
(or associate) (s 109C) No
• An existing loan was significantly altered Has one of these transactions occurred
(s 109D(5)) through an interposed entity?
• The company lent an amount to a shareholder
or associate which was not fully repaid by the
earlier of the tax return lodgement day and the
due date for lodgement (ss 109D-109E)
• A debt owed by a shareholder or associate to
the company was forgiven by the company
(s 109F)

Yes No
Yes

Is the transaction excluded by

Subdivisions C and D?
The following are excluded:
• Payments of genuine debt (s 109J)
• Payments or loans to other companies (s 109K)
• Payments or loans that are otherwise
assessable (s 109L)
• Loans made in the ordinary course of business
(s 109M)
Yes
• Loans that meet the criteria for minimum Rules do not apply
interest rate and maximum term (s 109N)

No

Is the amount greater than the company’s Yes Section 109Y: Only that part of the total
distributable surplus? equal to the distributable surplus is
treated as dividends

No

A deemed dividend arises and Division 7A

consequences apply without modification
(see following)

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160 Tax
Interaction with FBT
Loans and debts forgiven

Division 7A can apply to a loan or debt forgiven even if it is made to or accepted by a shareholder in their
capacity as an employee or in respect of their employment (ss 109ZB(1) and (2) ITAA 1936).
The FBT rules do not apply to a loan or debt forgiven (which are otherwise in respect of employment)
which are deemed to be a dividend under Division 7A or meet the excluded loan criteria of s 109N
ITAA 1936 (see the definition of fringe benefit in s 136(1) FBTAA 1986).

Payments

Division 7A does not apply to a payment made to a shareholder in their capacity as an employee
(s 109ZB(3) ITAA 1936). These payments would be subject to the FBT or ordinary income tax rules.
A director will be an employee of a company if they receive salary or wages, directors’ fees or other
non-cash benefits provided as remuneration for services. Non-cash benefits provided in connection with
the performance of their duties as an employee (eg a restaurant meal with clients of the company) will be
subject to the FBT rules. However, for benefits not expressly linked to the carrying out of the employee’s
duties, all facts and circumstances should be examined to determine whether it was provided as
remuneration for services or in the capacity of a shareholder (MT 2019). An investment company does not
have employees. Thus, Division 7A will apply and FBT cannot apply to payments even where the
shareholder does work for the company (MT 2016).

Distributable surplus

The amount that is deemed to be a dividend cannot exceed the company’s distributable surplus (s 109Y
ITAA 1936).

Calculation method

A company’s distributable surplus is calculated under s 109Y(2) ITAA 1936. It is broadly equal to its net
assets reduced by its share capital, and adjusted for certain excluded amounts.
The exclusions relate to:
• anti-avoidance measures, which are designed to prevent the company manipulating its profits by paying
shareholder expenses, transferring property or forgiving debts
• tainted share capital accounts, which are deemed not be a share capital account under s 975-300
• amounts under the former private company distribution rules.
Assets and liabilities included in the calculation of net assets are brought to account at their book value.
Book value is the amount shown in the company’s accounting records, unless the Commissioner considers
that the company’s accounting records significantly undervalue or overvalue its assets or provisions (see
the final paragraph of the definition of net assets in s 109Y(2)).
The following are key points to note:
• The Commissioner is not empowered to alter the value of a present legal obligation (eg a loan), even if it
is likely to be released.
• In TD 2009/5, the Commissioner states that the ATO will not generally take into account internally
generated goodwill in the distributable surplus calculation if it is not required to be disclosed for
Accounting Standards purposes. Only if there are intentions to circumvent the operation of Division 7A
will the Commissioner impute a value for internally generated goodwill.
• In FCT v H, the Full Federal Court held that the accrued year-end tax liability and the accrued general
interest charge were present legal obligations even though the tax return had not yet been lodged and
the assessment was not yet issued. The ATO has now accepted that the obligation to pay income tax is a
present legal obligation of the company at the end of that year of income and that these values can be
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taken into account in the distributable surplus calculation (TD 2012/10).

Income tax – taxation of structures and transactions 161

Relevance of accounting policies

An interesting outcome of the definitions in s 109Y(2) relate to the distributable surplus calculation is that
it is tied back to the company’s accounting records. However, it is silent on whether those accounting
records must be prepared in accordance with the Accounting Standards.
In deciding whether there is a deemed dividend, policies on asset recognition and valuation will have a
material influence on the outcome. Therefore, the Commissioner can substitute a different value if the
assets or provisions are significantly understated or overstated (see TD 2009/5 above).

Required reading
Section 109Y ITAA 1936.

Loans in an income year (s 109D ITAA 1936)

Application

For the income year in which a loan was made:

• If the loan is fully repaid by the earlier of the relevant time (ie the actual lodgement or the due date for
the lodgement of the company’s income tax return), Division 7A does not apply (s 109D ITAA 1936).
• If the loan is partly repaid by then, the unpaid year-end balance, subject to there being available a
distributable surplus (see above), is treated as the amount of the deemed dividend unless one of the
exceptions noted below is satisfied (eg the minimum interest rate and maximum term conditions in
s 109N ITAA 1936 are satisfied).
• If a loan is repaid after the relevant date (even if by one day), the full amount of the loan will be deemed
a dividend.
• If a loan satisfies the conditions in s 109N ITAA 1997, no amount is deemed to be a dividend in the year
it was made. However, in subsequent years, a deemed dividend may arise to the extent a minimum
payment is not made (s 109E ITAA 1936 – see below).
There is also an integrity measure that prevents arrangements involving:
• private company loans being repaid with borrowings from a third party so that the balance at the
relevant time is reduced to $nil
• immediately after the relevant time, borrowing back from the private company and using the funds to
repay the third-party loan.
If the Commissioner is satisfied that these arrangements are in place, the repayment made before the
relevant time will not be taken into account (s 109R(2) ITAA 1936).
However, repayments of private company loans would be effective where they are achieved by way of:
• payment of additional salary to shareholders (subject to s 109 ITAA 1936)
• payment of dividends
• transfer by the shareholder (or their associates) of assets to the company in satisfaction of the loan (although
this may give rise to a CGT issue for the company and transferee and stamp duty for the transferee).
If the loan was made before 4 December 1997, Division 7A does not apply. If the terms of a
pre-4 December 1997 loan are varied on or after 4 December 1997 by either extending the term of the
loan or increasing the amount, Division 7A applies to the loan as if it was made on new terms when the
variation occurred (s 109D(5) ITAA 1936).
The ATO has released TD 2022/11 and represents a departure from the ATO’s previous guidance in
TR 2010/3. TD 2022/11 stipulates that a private company provides a loan where it is made presently
entitled to income of a trust and either the private company’s entitlement remains unpaid at year end or
the trustee sets aside an amount from the main trust fund and holds it on a new separate trust for the
exclusive benefit of the private company beneficiary. The view in TD 2022/11 applies from 1 July 2022.
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162 Tax
If a loan is deemed to be a dividend in the year it is made, it cannot be deemed to be a dividend in a
subsequent year, even if there is no distributable surplus in the year the loan was made (and thus, the
actual amount deemed to be a dividend was $nil).

Exception under s 109N

Section 109N allows an exception to Division 7A for loans that meet minimum interest rate and maximum
term criteria. For loans to fall under s 109N, they must satisfy the following criteria before the earlier of the
lodgement date and the due date for lodgement of the company’s income tax return:
• The loan agreement must be in writing. TD 2008/8 outlines the requirements for a loan agreement to be
valid. The loan agreement can be a formal agreement or an exchange of letters, emails etc provided that
they show the name of the parties, the loan terms, that the parties have agreed the terms, the date of the
agreement etc.
• The rate of interest payable on the loan for the years of income after the year in which the loan was
made must equal or exceed the yearly benchmark interest rate published annually by the ATO.
• The term of the loan must not exceed the maximum term, being 25 years where there is a registered
mortgage over real property of not more than 91% of the value of the property. Otherwise, the maximum
term is seven years. Section 109N(3A) allows a seven-year loan to be extended into a 25-year loan.

Amalgamated loans

Loans that have the same maximum term (for the purposes of s 109N) and are not treated as dividends
under s 109D (in the year of making) are brought together to form a single amalgamated loan at the end of
that income year under s 109E ITAA 1936. A single loan may also constitute an amalgamated loan if one
loan only was made by the company to a shareholder (or associate) in an income year.
Under s 109P ITAA 1936, amalgamated loans made by a private company to a shareholder (or associate)
are not taken to be a dividend under Division 7A in the year in which amalgamation occurs.

Required reading
Section 109D and 109N ITAA 1936.

Loans in subsequent years (s 109E ITAA 1936)

Application

Amalgamated loans that are not deemed to be dividends in the year they are made must satisfy the minimum
interest rate and maximum term criteria in subsequent income years. In other words, shareholders actually
need to make minimum yearly repayments in subsequent years (ie not in the year the loan was made).
If the minimum yearly repayment is not made (ie there is a shortfall and the loan is not fully repaid), the
shortfall is treated as a dividend in that income year to the extent that the company has a
distributable surplus.
When determining the minimum yearly repayment:
• ATO ID 2010/82 states that, where a repayment is made after the income year in which the loan is made
but before the company’s income tax return lodgement date, the repayment is taken into account in
working out if the shareholder has made the minimum yearly repayment under s 109E.
• ATO ID 2013/36 states that, if there is a shortfall in the minimum yearly repayment in Year 1 which gives
rise to a deemed dividend at the end of Year 1, the capital component of the shortfall does not reduce
the closing balance of the loan for the purpose of working out the minimum yearly repayment in Year 2.

Exception (s 109Q ITAA 1936)

The deemed dividend rules do not apply if a shareholder or an associate pays less than the minimum yearly
repayment on an amalgamated loan and can satisfy the Commissioner that the amount paid was less
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Income tax – taxation of structures and transactions 163

because of circumstances beyond the shareholder’s or associate’s control, and that undue hardship would
be suffered if the private company was taken under s 109E to pay a dividend (refer s 109Q).

Minimum yearly repayment

Section 109E(6) ITAA 1936 sets out the formula for determining minimum yearly repayments.

Amount of
Current
the loan not
years )remaining term
repaid by the 1
(
× benchmark ÷ 1−
end of the 1 + Current year s benchmark interest rate
′
interest
previous year
rate
of income

Where:
• the benchmark interest rate is for the current income year
• the remaining term (rounded up to a whole year) is the difference between the number of years in the
longest term of any of the loans that the amalgamated loan takes account of
• the number of years between the end of the private company’s year of income in which the loan was
made and the end of the private company’s year of income before the year of income for which the
minimum yearly repayment is being worked out.
Note: In the year the loan is first made, repayments up to the lodgement date reduce the amounts which are subject to the above formula.

Payments and loans through interposed entities

Anti-avoidance rules apply to arrangements such as back-to-back loans, where a private company pays or
lends an amount to an interposed entity and that entity (or another interposed entity) pays or lends an
amount to a shareholder or an associate of the private company or shareholder. These rules are contained
in ss 109T and 109U ITAA 1936. The effect of these provisions is to treat the private company (and not the
interposed entity) as having paid or lent the amount to the shareholder. This may in turn cause the private
company to be deemed to have paid a dividend to the shareholder under Division 7A ITAA 1936, under the
rules discussed earlier. For further ATO guidance on the application of s 109T see TD 2018/13.
For loans that are deemed to arise under the interposed entity rules, s 109X ITAA 1936 does not preclude
the effective operation of s 109K ITAA 1936. That is, s 109K still applies, but this provision cannot be used
to exclude the operation of Division 7A ITAA 1936 just because the interposed entity is a company.
Another variation is if:
• a private company is a beneficiary of a trust
• there is an existing unpaid trust distribution to the private company
• the trustee pays or lends an amount to, or forgives a debt owed by, a shareholder (or associate) of the
corporate beneficiary.
In these circumstances, Subdivision EA ITAA 1936 applies (s 109XA ITAA 1936).
The broad scheme of the provisions is to treat the trust as a private company for the purposes of
determining whether a deemed dividend arises in circumstances where the trustee has made a payment or
loan, or forgiven a debt, of the kind covered by ss 109XA(1), (2) or (3) ITAA 1936. For example, the
provisions could operate to treat the loan from a trust to an individual beneficiary as being subject to
Division 7A. This is achieved through the hypothesis contained in s 109XB ITAA 1936. That section
provides that an amount is included (as a dividend) in the assessable income of the shareholder or associate
if that amount, referred to as the Division 7A amount, would have been so included had:
• the actual transaction (ie payment, loan or forgiven debt provided by the trustee) been made by a private
company
•
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the shareholder or associate been a shareholder of that company at the time of the actual transaction.

164 Tax
The effect of the hypothetical approach is to allow loans provided by a trustee to a shareholder to be
repaid or put on a commercial footing (ie have minimum repayments made and written loan agreements
put in place), and therefore avoid the operation of the deemed dividend rules.
The following two examples examine cases where Division 7A applies.

Example 3.14 – Private company loan

Consider the following loan structure.

Shareholder Employee
Spouse

Son

Aust
Company A Company B
Trust

Assume that Company A has a distributable surplus at year end and lends funds to each of the above
entities. Which loans would be caught by Division 7A?

Shareholder: Yes Spouse: Yes (associate)

Son: Yes (associate) Trust: Yes (associate)

Company B: No (s 109K) Employee: No (not a shareholder or associate, but FBT may apply).

Example 3.15 – Private company loan repayment

On 1 July 2022, Company A lends funds to its shareholder with a complying Division 7A loan
agreement:

This loan is repaid on:

Scenario 1: 31 May 2023

Shareholder
Scenario 2: 30 June 2023

Scenario 3: 1 July 2023

Scenario 4: 15 March 2024 (the day before Company

A’s tax return is lodged or due to be lodged)

Scenario 5: 30 March 2024

Company A
In which scenarios (if any) would a minimum repayment
apply?

Answer

Only scenario 5. In all other cases, the loan has been repaid
before the date that Company A’s tax return is lodged or due
to be lodged.
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Income tax – taxation of structures and transactions 165

Company losses and bad debts
There are additional rules that apply when a company incurs a loss or a bad debt under s 25-35. This is
largely because a company is a separate taxpayer from its owners and, therefore, the rules are designed to
prevent trading in losses or bad debts. The additional rules that affect the ability of companies to claim tax
losses, capital losses and bad debts include:
• carry forward loss provisions
• current year loss provisions
• bad debt provisions
• unrealised loss provisions
• loss anti-avoidance arrangements
• loss carry back provisions.

Carry forward loss provisions

Under Subdivision 165-A, a company cannot utilise a carry forward tax loss in its calculation of taxable
income unless it satisfies one of the following:
• the continuity of ownership test (COT) – the company has the same owners and the same control
throughout the period from the start of the loss year to the end of the income year
• the business continuity test (BCT) – the same business test or similar business test.
Under Subdivision 165-CA, a company cannot utilise a carry forward net capital loss if Subdivision 165-A
would prevent it if it was a tax loss. See below for further discussion on the operation of Subdivision 165-A.

Current year loss provisions

Subdivision 165-B deals with the calculation of taxable income and tax losses in a year when the company
has had a change of ownership (or control) in that year, unless it satisfies the COT.
Subdivision 165-CB deals with the calculation of a net capital gain or net capital loss in a year when the
company has had a change of ownership (or control) in that year, unless it satisfies the BCT. This
subdivision broadly operates in a similar manner to Subdivision 165-B for current year tax losses.

Bad debt provisions

Under Subdivision 165-C, a company cannot deduct a bad debt under s 25-35, unless:
• for debt incurred in an earlier income year, the company had the same owners and the same control
throughout the period from the day on which the debt was incurred to the end of the income year in
which it writes off the debt as bad
• for debt incurred in the current year, the company had the same owners and the same control during the
income year both before and after the debt was incurred.
Alternatively, if there has been a change in ownership or control, the company must satisfy the BCT to
deduct a bad debt.

Unrealised loss provisions

Subdivision 165-CC contains rules relating to the treatment of unrealised losses in companies. See below
for further discussion on the operation of Subdivision 165-CC.

Loss anti-avoidance arrangements

Division 175 provides that, even if a company passes the continuity of ownership and control type tests,
losses may still be denied if:
• income is injected into the company
•
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166 Tax
• a deduction is injected into the company
• a tax benefit is obtained because of available income.

Loss carry back rules

Under s 67-23 item 14 (refundable tax offset) and Division 160 (loss carry back rules), losses can be carried
back in certain circumstances. This is discussed below.

Carry forward tax losses

Under Subdivision 165-A a company cannot utilise a carry forward prior year tax loss against a future
year’s income unless (s 165-10) it satisfies one of the following tests:
• The continuity of ownership test in s 165-12. However, this test may be modified by the rules in:
– Subdivision 166-A for widely held and eligible Division 166 companies
– Subdivision 167-A for companies whose shares do not all carry the same rights to dividends or do not
all carry the same rights to capital distributions
– Subdivision 167-B for companies whose shares do not all carry the same voting rights, or do not carry
all the voting rights in the company.
• The business continuity test in s 165-13, which comprises the same business test for all losses and the
similar business test for losses incurred on or after 1 July 2015.
The tests are applied in this order. The BCT is only considered if the COT is failed (ie the business
continuity test is a saving provision).
Where one of the applicable tests is satisfied, the company can choose whether or not to claim a tax
deduction for the carry forward tax loss in the income year (s 36-17).

Required reading
Section 36-17.

Continuity of ownership test (COT)

The first test a company must pass in order to carry forward prior year losses is the COT (s 165-12). This
test requires that:
• there is no substantial change in proportionate shareholding within a group of continuing owners
• majority ownership by individuals is maintained throughout the ownership test period time (ie the period
from the start of the loss year to the end of the income year).
The COT will only be satisfied where, during the whole of the ownership test period, the same persons
beneficially owned the same shares that, when taken together, carried:
• more than 50% of the voting power in the company
• the rights to more than 50% of the company’s dividends
• the rights to more than 50% of any capital distributions made by the company.
To pass the COT, the company must demonstrate that the same shareholders who owned more than 50%
of the voting power, dividend and capital rights in the company at the start of the loss year (ie the start of
the income year in which the loss was incurred) continue to own more than 50% in the company at all
times until the end of the income year in which the brought forward loss is to be used.
Note: On the death of a shareholder, provided that shares are transferred to someone who receives them as a beneficiary of a deceased
estate, the COT continues to be satisfied (s 165-250). There is no such concession on a marriage breakdown.

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Income tax – taxation of structures and transactions 167

The following example illustrates the COT.

Example 3.16 – Continuity of ownership test

Charming Pty Ltd (Charming):

• incurred tax losses of $10,000 and $20,000 in Year 1 and Year 2, respectively
• has $100,000 of taxable income for Year 3
• is owned by Jon (34%), Sonika (17%) and Bryn (49%).

To determine whether Charming can deduct the Year 1 and Year 2 tax losses against the Year 3
taxable income, two terms need to be understood:

• Loss year – the income year in which the relevant loss was incurred
• Income year – the income year in which the loss was purported to be used.

Year 1 losses
If Charming wishes to use the $10,000 loss from Year 1 in Year 3, it will satisfy the COT if the same
shareholders who owned more than 50% of the company at the beginning of the loss year continue
to own more than 50% of the company at all times until the end of the income year. This means that
Jon, Sonika and Bryn must own more than 50% of the company from 1 July in Year 1 (the beginning
of the loss year) until 30 June Year 3 (the end of the income year).

Assume for the moment that Bryn sold all of his shares to Sonika on 30 June Year 1. Charming would
still satisfy the COT. This is because Jon and Sonika together still own more than 50% of the company.

On the other hand, if Jon and Sonika rather than Bryn sold all of their shares on 30 June Year 1, the
COT would not be satisfied in relation to the Year 1 losses.

Year 2 losses
The $20,000 loss from the Year 2 must be tested separately from the Year 1 losses. Assume that Jon
and Sonika sold all of their shares to Lisa on 30 June Year 1. Based on this information, we know that
Charming will fail the COT in relation to the Year 1 losses (as discussed above).

However, the company will satisfy the COT in relation to the Year 2 losses. This is because Lisa and
Bryn together own more than 50% of the company from 1 July Year 2 (beginning of the loss year)
until 30 June Year 3 (the end of the income year).

Tracing rules

Under Subdivision 165-D, where one company owns shares in another company, ss 165-150, 165-155 and
165-160 provide for tracing of interests back to persons who have indirect interests in the company. In
other words, when applying the COT, it is always necessary to trace the shareholding back to natural
person shareholders unless the legislation specifically provides otherwise.
However, it is not possible to trace through a discretionary trust, as the beneficiaries of the trust do not
have fixed interests in the income or capital of the loss company or interposed entity. To overcome this
problem, there are two special tracing rules:
• Family trust concession rule – applies where relevant interests in a company are held, directly or
indirectly, by a family trust (a trust that has made a Family Trust Election (FTE) in accordance with
Schedule 2F of ITAA 1936 in the year the loss was incurred). In this situation, the trustee of the family
trust will be treated as an individual holding the interests for its own benefit (s 165-207). Therefore,
there is no need to trace through the family trust to identify the individual beneficiaries.

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168 Tax
• Alternative condition rule – applies more generally in testing for continuity of majority beneficial
ownership of a company. Under Subdivision 165-F, if the company is held by non-fixed trusts such that it
cannot pass the COT, the company can still deduct its losses or debts if:
– there has been no change in the trust’s holding (directly or indirectly) of fixed entitlements to shares of
the income or capital of the company, or in the percentage of their shares
– every non-fixed trust (other than a family trust or other excepted trust) that holds fixed entitlements in
the company (directly or indirectly) satisfies the relevant tests that apply to non-fixed trusts (the 50%
stake test, the control test and the pattern of distributions test) if the losses of the company were
taken to be the losses of the trust.

Percentage of rights

Under Subdivisions 167-A and 167-B, there are special rules that apply for working out a shareholder’s
percentage of ownership where the shares in a company do not carry all the same rights to voting power,
dividends and capital distributions. Without these special rules, a company that has shares with unequal
rights to dividends, capital distributions or voting may technically fail the COT even though there is no
significant change in underlying beneficial ownership during the ownership test period.
Under these special rules, where the COT is not satisfied because a company has unequal rights to dividends
or capital distributions, the company may choose to reconsider the COT in up to three ways, by disregarding:
• debt interests
• debt interests and certain secondary share classes
• debt interests and certain secondary share classes, and treat the remaining shares as having certain
relative rights (fixed percentage) to receive dividends and capital distributions.
Also under these special rules, if the shares of a company have different voting rights, or do not carry all of
the voting rights in the company, a choice can be made to test voting power solely by reference to the
maximum number of votes that could be cast on a poll on:
• the election of the company’s directors
• an amendment to the company’s constitution (subject to some restrictions).

Business continuity test (BCT)

Where the COT is not satisfied, the company must rely on the BCT under s 165-13. This test can be passed
by satisfying either the:
• same business test (ie the core test under s 165-210 applicable to all losses), or
• similar business test (ie the alternative test under s 165-211 applicable to losses incurred on or after
1 July 2015, subject to specific integrity rules).
The BCT must be applied in the year of loss recoupment and tested against the business carried on
immediately before the COT was failed.

Same business test

Under s 165-210(1), a company satisfies the same business test if it carries on the same business
throughout a year of recoupment as it carried on immediately before the change in ownership.
The same business test is generally a look forward test. That is, compare the business in the year of
recoupment (say Year 3) to the business immediately before the change of ownership (say Year 1).
However, when the year of recoupment occurs in the same year as the change in ownership, the test is a
look back test because it is necessary to have regard to the business from the start of the recoupment year
(refer s 165-13(2)). For example, if a change in ownership occurs on 1 October 2022 and carry forward
losses are recouped in the year ended 30 June 2023, it would be necessary to compare the business at
30 September 2022 to the business from 1 July 2022 to 30 June 2023.
ITAA 1997 contains measures to provide a default test time at which the same business test can be applied
if a company cannot determine precisely when it has failed the COT. In the case of tax losses, the test time
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Income tax – taxation of structures and transactions 169

is the latest time that the company can show it has satisfied the COT. However, if it is not practicable for
the company to show that it has maintained the same owners for any period since incurring the loss, the
default test time is the start of the loss year. Alternatively, if the company came into being during the loss
year, the default test time is the end of the loss year.
A company does not satisfy the same business test if it derives assessable income from:
• a business of a kind that it did not carry on before the change in ownership or control
• a transaction of a kind that it had not entered into in the course of its business operations before the
ownership or control change.
Section 165-210(3) provides an anti-avoidance measure so that the same business test will not be satisfied
if a company:
• started to carry on a business it had not previously carried on, or
• in the course of its business operations, entered into a transaction of a kind that it had not previously
entered into, and
• did so before the change in ownership or control, for the purpose of otherwise satisfying the same
business test.
TR 1999/9 sets out the Commissioner’s views on the operation of the same business test. In short, organic
growth or evolution is permissible, but not sudden or dramatic changes.
In Lilyvale Hotel Pty Ltd v FCT (2009) 75 ATR 253, the court stated that a mere change in the way a business
is operated or managed does not amount to a different business. Therefore, provided that the output and
external characteristics of a business remain the same, changes in the internal processes do not cause the
same business test to be failed.
The ATO applies a ‘de minimis’ (i.e. small value) test when applying the same business test (refer
TR 1999/9). In other words, minor transactions can be ignored.
If a company is not carrying on a business (eg if it is a passive investor), it cannot, by definition, pass the
same business test because it is not actually carrying on a business in the first place.
The next example illustrates the application of the same business test.

Example 3.17 – Same business test

Donkey Pty Ltd (Donkey) incurred losses of $10,000 and $20,000 in Year 1 and Year 2, respectively.
Its shareholders on 1 July Year 1 are:

• Fiona – 40%.
• Shrek – 60%.

Shrek sold all of his shares to Prince Charming on 22 July Year 2. Donkey has $100,000 of taxable
income for the Year 4. Donkey’s business remains unchanged since before Year 1.

COT
Because Shrek sold all of his shares to Prince Charming, Donkey will fail the COT in relation to the
Year 1 and Year 2 losses (ie the same beneficial owners did not own the same shares for the period
from the start of the loss year to the end of the income year).

Same business test

To be able to utilise the Year 1 and Year 2 losses in Year 4, the same business test or similar business
test must be satisfied. To satisfy the same business test, Donkey must show:

• that it carried on the same business during the whole of the income year (Year 4)
• that the same business was also carried on immediately prior to it failing the COT (ie just before
22 July Year 2).
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170 Tax
 As Donkey’s business throughout the income year is the same as it was just before 22 July Year 2,
the company satisfies the same business test (and the company does not need to consider the similar
business test).

Donkey can claim a tax deduction in Year 4 for the Year 1 and Year 2 tax losses, reducing its taxable
income to $70,000.

Similar business test

Under the similar business test, companies may be able to deduct tax losses, net capital losses and bad
debts where their business, while not the same, uses similar assets and generates income from similar
sources. The test operates in a way that is comparable to the same business test but removes the negative
limbs which can deny a deduction merely because transactions or activities are new or a different kind to
those entered into or carried on before a change in ownership or control.
Under s 165-211(1), a company satisfies the similar business test if throughout the business continuity test
period (ie the income year) it carries on a business (ie its current business) that is similar to the business it
carried on immediately before the ownership change (ie its former business).
In determining whether the current business is similar to the former business, any relevant factor can be
taken into account. But in accordance with s 165-211(2), the following factors must be considered:
• the extent to which the income-generating assets used in the current business were also used in the
former business
• the extent to which activities and operations from which the current business generates assessable
income were also activities and operations of the former business
• the identity of the current business and the former business
• the extent to which any changes to the former business result from development or commercialisation of
assets, products, processes, sources or marketing or organisational methods of the former business.
Whether or not the similar business test is passed is a question of fact, involving a weighing up of all
relevant factors. These factors are intended to allow for changes resulting from attempts to grow or
rehabilitate a business.
Consistent with the same business test, s 165-211(3) provides an anti-avoidance measure so that the
similar business test will not be satisfied if a company:
• started to carry on a business it had not previously carried on, or
• in the course of its business operations, entered into a transaction of a kind that it had not previously
entered into, and
• did so before the change in ownership or control, for the purpose of otherwise satisfying the similar
business test.
LCR 2019/1 sets out the Commissioner’s views on carrying on a similar business. The following are two key
points to note:
1. It is not sufficient for the current business to be of a similar kind or type to the former business. For
example, it is not enough to say that the former business was in the hospitality industry and the current
business is in the hospitality industry.
2. It will be more difficult to satisfy the similar business test if substantial new business activities and
transactions do not evolve from, and complement, the business carried on before the test time.

Control test

Even if a company passes the COT or the BCT, a deduction will not be allowed if the control test in s 165-15
applies and is not satisfied. The control test is an integrity measure that only operates when control of the
voting power of a company has been manipulated for the purpose of obtaining a benefit under the rules.
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Income tax – taxation of structures and transactions 171

Where the control test applies, it is only passed if the voting power in a company is maintained by the same
persons throughout the ownership test period.
If the control test is not passed, a company cannot claim a tax loss unless it satisfies a modified business
continuity test. Under the modified business continuity test, the company must carry on the same business
(or a similar business where applicable) throughout the income year as it did immediately before the time
when the person began, or became able to control the relevant voting power (s 165-15(3)). This is
potentially a different testing time to the normal business continuity test.
For example, if 60% of the voting interests (but not ownership interests) in a company are disposed of on
1 July 2021 for the purpose of obtaining a benefit under the carry forward loss rules (ie of not failing COT),
the company will fail the control test. To utilise tax losses from prior income years in the year ended
30 June 2023, the company must carry on the same business or similar business where applicable
throughout the income year as it did on 30 June 2021 (ie immediately before the voting power was
manipulated).

Modified COT – widely held company or an eligible Division 166 company

Division 166 modifies the way in which the rules in Division 165, regarding ownership and control of a
company, apply to certain companies. However, these companies may choose not to have Division 166
apply (see s 166-15).
Division 166 is only available to a company if, in the year in which it wishes to use the carried forward
losses, it is:
• a widely held company or an eligible Division 166 company for that whole income year
• a widely held company for part of that income year and an eligible Division 166 company for the rest of
that income year.
See ss 166-5(1), 166-20(1), 166-40(1), 166-80(1) and 166-220.

Defining a widely held company

A company is a widely held company if it is listed on an approved stock exchange. A company is also widely
held if it has more than 50 members, unless:
• at any time in the income year, 20 or fewer people hold or have the right to acquire or become the
holder of shares representing 75% or more of the value of shares in the company, other than shares
entitled to a fixed rate of dividend only
• at any time during the income year, 20 or fewer people are capable of exercising 75% or more of the
voting power in the company
• in that year, 20 or fewer people receive 75% or more of any dividend paid by the company, or the
company did not pay a dividend in that year, but the Commissioner is of the opinion that, if a dividend
had been paid by the company at any time during the income year, 20 or fewer people would have
received 75% or more of that dividend.

Defining an eligible Division 166 company

A company is an eligible Division 166 company if more than 50% of the voting power, rights to dividends
or rights to capital distributions are held by one or more:
• widely held companies
• superannuation funds
• approved deposit funds
• special companies
• managed investment schemes
• entities that are prescribed under the tracing rule that deems entities to be beneficial owners
• non-profit companies
•
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charitable institutions, charitable funds or any other kind of charitable bodies.

172 Tax
Applying the concessions applicable to these companies

Widely held and eligible Division 166 companies face less stringent tests under Division 166 than other
companies under Division 165.
Recall that the normal rules require that the same shareholders own more than 50% of the company at all
times, starting from the beginning of the loss year until the end of the income year. The effect of
Division 166 applying is to make it less onerous to demonstrate that the COT is satisfied.
The main concessions that are available include the following:
• Maintenance of the same owners between certain points of time is required, rather than proof of
maintenance of the same owners throughout the periods in between. In the case of past year losses, the
relevant points of time are:
– the start of the loss year
– the end of each corporate change
– the end of the loss year, the end of the claim year and the end of any intervening income years (refer
Subdivision 166-A).
• In the case of current year losses, the company is taken to have satisfied the COT if there were no
corporate changes during the income year. If there was a corporate change, the widely held company
must show that it had substantial same ownership between the start of the income year and the time
immediately after the corporate change occurs (see Subdivision 166-B).
• Direct shareholdings of less than 10% in the company are treated as if they were held by a single
notional entity, so that it is unnecessary to trace through to the persons who beneficially own those
shareholdings (refer to Subdivision 166-E). There are also concessions available in relation to indirect
shareholdings of less than 10%. Without this concession under Division 166, it would be necessary to
trace through all entities until the ultimate beneficial owner that is a natural person is found.
• Where a new holding company is interposed between the tested company and a less than 10% direct
shareholder, this does not cause a failure of COT because the new holding company is taken to hold the
stakes formerly held by the single notional entity.
• If all of a listed company’s shares are held by shareholders who each hold less than 10%, it will be
deemed to have a single 100% shareholder.
• Direct and indirect shareholdings of between 10% and 50% in the company held by a widely held
company are treated as having been held by that widely held company, so that it is not necessary to trace
beyond those companies.
• There is also no need to trace through complying superannuation funds (or superannuation funds that
are established in a foreign country and regulated under a foreign law), complying approved deposit
funds, special companies or managed investment schemes (see Subdivision 166-E).
As the COT is applied each time there is a corporate change, it is critical to define corporate change. The
factors used to determine whether corporate change has occurred are listed in s 166-175.

Current year losses

The current year loss rules in Subdivision 165-B are designed to stop losses incurred by a company in one
part of an income year from being offset against income earned by the company during another part of the
income year (ie the losses are quarantined). That is, unless the shareholders who benefit from the
recoupment of the losses are substantially the same as those who bore the burden of those losses.
The current year loss rules are applied if one of the following events is triggered:
• The company does not pass the COT and the business continuity test for the whole income year
(s 165-35).
• A person begins to control, or becomes able to control, the voting power in the company where one
purpose of obtaining that control is to get a tax benefit or advantage for any person (s 165-40).

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Income tax – taxation of structures and transactions 173

Where a company makes a loss during one part of the current income year and is profitable for the other
part of the current income year, the income year is artificially broken up into two periods: the loss-making
period and the profitable period. These periods are notionally treated as two separate income years. Losses
from one part can only be offset against income from the profitable period if the COT (or failing that, the
BCT) is satisfied, as per the discussion on prior year losses earlier.

Partitioning the income year

If one of those trigger events occurs, the income year is then divided into separate periods (s 165-45).
The first period starts at the beginning of the income year and ends at the time of the first relevant change
of ownership or control.
The next period begins at the end of the first period and continues until the earlier of the end of the
income year or the time of any further change of ownership or control. If there is more than one change in
ownership or control, successive periods are calculated until the end of the year of income.
If there is more than one change of ownership or control during the year, successive periods can be merged
if the company satisfies the business continuity test in relation to them (s 165-40).

Notional loss or notional taxable income for each period

A notional loss exists for a period if the deductions attributed to the period exceed the assessable income
attributed to the period. Conversely, a notional taxable income for a period exists if the assessable income
attributed to the period exceeds the deductions attributed to the period.
Section 165-55 explains how deductions are attributed to a particular period. Certain deductions, such as
depreciation, are attributed to periods on a time basis. Others, such as bad debts, are full year deductions
and are not attributed to any periods. Full year deductions are taken into account in the final calculation of
the company’s taxable income. All other deductions are attributed to periods as if each period was an
income year.
Section 165-60 explains how income is attributed to a period. Items of assessable income are attributed to
periods as if each period was an income year. There are, however, some special rules:
• A company’s share of any trust income is attributed to a period if it is reasonably attributable to that
period (s 165-60(2)).
• Certain types of insurance recoveries and recoupments are attributed to periods on a time basis
(s 165-60(3)).
• Deemed dividends are attributed to the period when the amount was paid or credited, whichever
occurred first (s 165-60(5)).

Taxable income and tax loss for the year

To calculate a company’s taxable income for the year (s 165-65):

• add up the notional taxable incomes for each income period
• add any full year income amounts
• subtract any full year deductions in the order specified in s 165-65(4). (Notional losses are not taken into
account).
To calculate the tax loss for the year (s 165-70):
• add up the notional losses for each loss period
• add any full year deductions that have not been fully utilised in calculating the taxable income
• subtract any net exempt income.

Loss carry back rules

The loss carry back rules are contained in s 67-23 item 14 (refundable tax offset) and Division 160 (loss
carry back rules).
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174 Tax
Relevant years

Tax losses incurred in the 2020, 2021, 2022 and 2023 income years can be carried back and applied
against income in the 2019, 2020, 2021 and 2022 income years. Corporate tax entities that apply the loss
carry back rules will claim a refundable tax offset in the income year that they elect to carry back the loss
rather than amending their prior year tax returns.
This is a choice, otherwise the losses get carried forward as normal. The choice can be made in respect of
all or some of the losses in a relevant year. The choice is made in the relevant tax return unless the
Commissioner allows a further time (eg an amendment to an assessment is made).
Note 1: Capital losses cannot be carried back.

Note 2: Losses can be generated by the 100% instant asset write off rules.

Relevant offset year

The loss carry back and the tax offsets can only be claimed in the 2021, 2022 and 2023 income years. The
choice will be made when tax returns are lodged for those years.
Note: A loss in the year ended 30 June 2020 can only be claimed in 30 June 2021.

Limitations

The maximum amount of the loss that can be carried back is the tax equivalent amount (ie the tax effected
amount of the loss) equal to the tax payable in the prior year. Moreover, the amount of any refund due to
the company is capped at the franking account balance of the company in the income year that the loss
carry back election is made. This prevents the franking account of the company from going into deficit.
Note: The tax loss must first be offset against any net exempt income in the loss year.

In addition, in order to access the loss carry back concession, a tax return must have been lodged for the
current year and the five preceding years (where the company was in existence).

Losses caused by excess franking offsets

The part of a tax loss that is deemed to exist when a company has excess franking offsets for an income
year (s 36-55) is not eligible for carry back because it does not represent an economic loss.

Turnover threshold

The loss carry back rules can generally only be applied by corporate tax entities who are carrying on a
business with turnover less than $5 billion.
Steps
1. Determine the loss to be carried back (either in whole or in part).
2. Reduce the amount at step 1 by any net exempt income.
3. Multiply the amount at step 2 by the company tax rate that applied for the year that the loss was
incurred (ie if the company is a BRE, the tax rate for 2022–2023 would be 25%). This is the tax
equivalent amount of the loss.

This means that as the company tax rate falls, the offset reduces.

Example 3.18 – Tax liability

Tax liability in 2021 = $100 x 26% (note the tax rate for a BRE in the 2021 income year was 26%)

Tax loss in 2023 = $100.

The offset in 2023 is $25 ($100 x 25%), leaving $1 from 2021.

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Income tax – taxation of structures and transactions 175

Tax consolidation

For the purposes of working out the available tax liability for an earlier income year, the head company of a
consolidated group must disregard an income tax liability of a subsidiary member of the group that relates
to a period before it joined the group and which is taken to be an income tax liability of the head company
because of the entry history rule.

Example 3.19 – Tax consolidation

There is a tax loss in a tax consolidated group of $100 in 2023. If the group is a 30% taxpayer, the
equivalent tax is $30. In the 2021 year, the group had a tax payable of $10. A subsidiary joined the
group in the 2023 tax year and it had a stand-alone tax payable of $50 in the prior year. The offset is
only $10. The remaining $20 is disregarded in working out the amount of the offset because even
though the subsidiary had tax payable of more than $20 (ie $50), its tax payable is disregarded.

Losses transferred from a subsidiary to the head company cannot be carried back.

Integrity rules

A specific integrity rule for loss carry back denies a company a loss carry back tax offset it would otherwise
be entitled to where there has been a change in the control of the voting power of the company arising
from a disposition of membership interests and, considering all of the relevant circumstances, one or more
parties entered into a scheme to obtain the tax offset.
The scheme must have been entered into or carried out between the start of the year the entity seeks to
carry the loss back to, and the end of the year it claims the loss carry back tax offset.
Broadly, the policy intent is to prevent a company with prior year profits (ie tax payable) and a pending loss
having a change in ownership which could otherwise be carried back, thereby creating a tax refund.
Losses that cannot be carried back as a result of the integrity measure can still be carried forward and
claimed as a deduction against the income of future years provided the requirements for doing so are met.
Where the integrity rules do not apply, Part IVA could apply. (Part IVA includes schemes to obtain a loss
carry back tax offset.)

Franking account

A franking debit will arise in the franking account when the company receives the refund (ie where the
company is in loss in the current year and chooses to carry back a loss, the refundable tax offset will result
in the company being eligible for a tax refund).

Consolidated group tax principles

Membership rules

The tax consolidation regime applies where the head company of a consolidatable group makes a choice to
form a consolidated group. Once made, the choice is irrevocable (s 703-50(2)).
A choice to consolidate must be in writing (eg approved in board minutes). In addition, an approved
consolidation form must be lodged with the ATO (refer s 703-50).
A one in, all in principle applies when entering the consolidation regime (s 703-5(3)). This means that once a
head company chooses to consolidate, all eligible subsidiary members automatically become part of the
consolidated group. An eligible subsidiary cannot choose to be excluded from the consolidated group.

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176 Tax
Consolidatable group

A tax consolidatable group must consist of:

• an Australian resident head company (although a head company can also be a corporate unit trust or a
public trading trust that is taxed like a company)
• at least one eligible, wholly owned resident subsidiary, which may be a company, trust or partnership.
In other words, a single entity cannot form a consolidated group. There must be at least two entities: a
head company and a subsidiary member (s 703-10). However, once a consolidated group is formed, it will
continue even if the head company has no subsidiaries (ie if all subsidiaries are subsequently sold), as
explained in the note under s 703-5(3).

Head company

Under s 703-15(2)(a), the head company must:

• be an Australian resident (but not a prescribed dual resident) company
• not be a subsidiary member of a consolidatable or consolidated group (ie the head company must be the
top resident company in the domestic group structure)
• have at least some of its taxable income taxed at the general company tax rate.
Once established, a consolidated group continues to exist until the head company ceases to meet the
definition of head company (s 703-5(2)). This could occur, for example, where a consolidated group is taken
over by a stand-alone Australian company.

Subsidiary member

Under s 703-15(2)(b), a subsidiary member must:

• be a company, trust or partnership
• be wholly owned by the head company (except for shares acquired under an employee share scheme
where the total of those shares does not exceed 1% of the number of ordinary shares in the company)
• if there are interposed entities, include each interposed entity as a member of the tax consolidated group
• if it is a company, be an Australian resident (but not a prescribed dual resident)
• have at least some of its taxable income (if any) taxed at the general company tax rate (if a company).
The following are key points for subsidiary members:
• An entity is a wholly owned subsidiary of the head company if all of the membership interests (ie shares)
in it are beneficially owned by the head company or other wholly owned Australian subsidiaries of the
head company (s 703-30).
• Shares that are classified as debt interests for income tax purposes under the Division 974 debt and
equity rules do not constitute membership interests (ss 960-130 and 960-135). For example, a
preference share that is redeemable for cash with an eight-year life would be a debt interest and would
not count as a membership interest.
• For a partnership to satisfy the requirements of a subsidiary member, all partners must be members of
the consolidated group. For example, if any of the partners are individuals, the partnership cannot be a
member of a consolidated group. However, if all the partners are wholly owned directly or indirectly by
the head company, the partnership would be a member of the consolidated group.
• For a unit trust to satisfy the requirements of a subsidiary member, all units must be held by members of
the consolidated group.
• With non-fixed trusts (ie family or discretionary trusts), all of the trust’s objects are taken to be
beneficiaries and all the trust’s beneficiaries must be members of the consolidated group. If any of the
trust’s beneficiaries are individuals, the trust cannot be wholly owned directly or indirectly by a head
company, and therefore cannot be a member of a consolidated group. In practice, it is extremely rare to
see a non-fixed trust as a member of a consolidated group.
Note: A consolidated group can exist even where a subsidiary member holds some shares in the head company (refer ATO ID 2008/32).
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Income tax – taxation of structures and transactions 177

The following example illustrates the tax consolidated group for an Australian company.

Example 3.20 – Tax consolidated group

Consider the following group structure where all entities are residents apart from UK public limited
companies (plc):

100% ABC Ltd

100%

1 Pty Ltd 100%

40%
100%

UK plc
2 Pty Ltd
Aust Trust

60% 100%

3 Pty Ltd
5 Pty Ltd

90%

4 Pty Ltd

All entities form part of the tax consolidated group except 4 Pty Ltd, UK plc and 5 Pty Ltd. 4 Pty Ltd
is not 100% ultimately owned by ABC Ltd and UK plc is a non-resident. 5 Pty Ltd is not owned by an
Australian resident.

Multiple entry consolidated group

Consolidation is also permissible between resident subsidiaries of a foreign parent, notwithstanding the
absence of a single head company resident in Australia. This is done by way of a multiple entry
consolidated (MEC) group (see Division 719).

Accounting consolidation

Consolidated financial statements must be prepared by a parent entity if it controls another entity. Control
looks to more than shareholding and can be achieved without 100% share ownership.
For tax consolidation purposes, control is irrelevant and 100% shareholding is required provided that the
shares are equity interests (not debt interests) under the debt–equity rules (there is a 1% exception for
employee share schemes). Furthermore, certain entities that form part of the accounting consolidated group
(eg non-resident entities) are excluded from being a member of the tax consolidated group. Therefore, a
consolidated group for accounting purposes is very different from a consolidated group for tax purposes.

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178 Tax
GST groups

The tax consolidation regime applies to consolidated groups and MEC groups. The GST law allows the
formation of GST groups, but the eligibility criteria for forming a GST group is different from those for
forming a consolidated group.

Key features and tax attributes

A broad overview of the key features and tax attributes for a consolidated group are set out in the
following table.

Tax issue How the issue relates to a consolidated group

Taxpayer Under the single entity rule, subsidiary members are ignored for income tax
liability purposes.

Residency The head company and all subsidiary members must be Australian resident
entities. A head company is therefore taxable in Australia on its worldwide income
unless an exemption for foreign income applies.

Goods and services tax A head company and/or a subsidiary member can be registered for GST. The single
(GST) entity rule does not apply for GST purposes.

Fringe benefits tax (FBT) A head company and/or a subsidiary member can provide a benefit to an employee
or an associate of an employee. The single entity rule does not apply for
FBT purposes.

Small business entity Like any other company, a head company may be classified as an SBE and choose
(SBE) concessions to apply the available concessions.

Taxable income, Like any other company, a head company calculates its taxable income under the
assessable income and income tax framework. In doing this it applies the general and specific provisions
deductions applicable for a company. However, when calculating its assessable income and
deductions:
• the impact of intra-group assets and transactions are eliminated under the single
entity rule
• the head company is assessable on and entitled to the deductions of a subsidiary
member at the time of formation or joining the group under the entry history rule.

Tax loss and bad debt Like other companies, to utilise a consolidated group tax loss or bad debt a head
deductions company needs to satisfy either COT or BCT. However, additional specific rules
exist to limit the transfer and utilisation of carry forward tax losses of members of
a tax consolidated group at the time of formation or joining the group.

Treatment of profits Like any other company, a head company and subsidiary member company
distributes its profits to shareholders through the payment of dividends. However,
under the single entity rule, subsidiary member dividend payments are eliminated
from the head company’s calculation of taxable income and have no impact on the
franking account and cannot be franked.

Franking account Like any other company, a head company maintains a franking account. However, a
subsidiary member’s franking account is inactive while it is a member. Credit
balances in a subsidiary member’s franking account transfer to the head company
on formation or joining the group. However, no balance is transferred back on exit.

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Income tax – taxation of structures and transactions 179

Single entity rule

Under the single entity rule in s 701-1 only the head company of a consolidated group is recognised. The
subsidiary members are treated as though they are parts or divisions (ie branches) of the head company,
rather than separate entities. Therefore, the assets and liabilities of the subsidiary members are taken to be
that of the head company and the membership interests in the subsidiary (ie shares) are taken not to exist.

Core application – income tax liability or loss

The single entity rule in s 701-1 only applies for the following core purposes:
• For the head company – working out its income tax liability or loss for any period during which it is the
head company of a consolidated group, or any later income year.
• For a subsidiary member – working out its income tax liability or loss for any period during which it is a
subsidiary member of a consolidated group, or any later income year.
For all other purposes, subsidiary members are not treated as part of the head company (eg the tax
consolidation regime is not applicable for withholding tax, FBT or GST purposes). However, there are some
specific rules within the income tax legislation that extend the scope of the single entity rule, as illustrated
in the next example.

Example 3.21 –Single entity rule for commercial debt forgiveness and Division 7A
Core purpose
An example of a core purpose is where a commercial debt owed by a subsidiary member
of a consolidated group is forgiven by another member of the same consolidated group. The single
entity rule prevents the commercial debt forgiveness rules in Division 245 from applying to the head
company because only one entity (ie the head company) is recognised. The existence of the
subsidiary member and the debt forgiveness transaction are both ignored.

Non-core purpose
An example of a non-core purpose is a transaction that involves an entity outside the consolidated
group. For example, if a subsidiary member which is a private company makes a loan to an individual
shareholder in the head company, Division 7A ITAA 1936 applies to the subsidiary member in
determining whether there is a distributable surplus, rather than to the head company (TD 2004/68).
Therefore, if the subsidiary has no distributable surplus, Division 7A will not apply even if the group
has a distributable surplus overall.

Extended application – franking, PAYG and value-shifting

There are specific rules in the income tax legislation that extend the scope of the single entity rule. Some of
those specific rules are summarised in the following table.

Extension of the single entity rule

Extended rule Description

Franking Subdivisions 709-A to 709-C consolidate the subsidiary member’s franking account into
accounts and the head company’s franking account. While the subsidiary members are part of the
imputation consolidated group, their own franking accounts are inoperative. Any franking debit or
credit that occurs for a subsidiary member is taken to be a franking debit or credit for the
head company.

For example, a subsidiary member distributes its profits to the head company by paying a
dividend under the Corporations Act. Under the single entity rule, the dividend cannot be
franked and it has no impact on the head company’s franking account.
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180 Tax
 PAYG Section 45-710 TAA 1953 contains a single entity rule similar to that in s 701-1
instalments ITAA 1997. For the purpose of working out the PAYG instalments of the tax consolidated
group, subsidiary members are treated as part of the head company.

Consequences

The application of the single entity rule has four broad consequences. These consequences are outlined in
detail in TR 2004/11 and are summarised in the table below.

Consequences of the single entity rule

Impact on Consequence

Assets of subsidiary The assets that subsidiary members of the group legally own (except intra-group
members assets such as shares in other group members) are taken to be owned by the head
company while the subsidiary remains a member of the tax consolidated group.
Therefore, a subsidiary member’s assets (such as CGT assets, depreciating assets and
trading stock) can be moved within a tax consolidated group without triggering any
income tax consequences.

Intra-group assets Intra-group assets and liabilities are not recognised for income tax purposes during
and liabilities the period they are held within the group. This is regardless of whether the assets or
liabilities were created before or during the period of consolidation.
For example, an option granted by one member to another member of the same tax
consolidated group is not recognised. Therefore, they can be moved within a tax
consolidated group without triggering any income tax consequences.

Intra-group Dealings that are solely between members of the same tax consolidated group are
transactions not recognised for income tax purposes. Accordingly, these transactions will not give
rise to ordinary income, statutory income or a deduction.
For example:
• A dividend paid by a subsidiary member to the head company, or a dividend paid
between two subsidiary members, is not recognised.
• Trading between members and/or with the head company is not recognised.
• Debt forgiveness between members and/or with the head company is not
recognised (ATO ID 2005/344).

Actions of subsidiary The actions and transactions of a subsidiary member are treated as having been
members undertaken by the head company.
For example, a sale made by a subsidiary member to an external party is treated as
having been made by the head company, rather than by the subsidiary member.

Note: A general anti-avoidance notice under Part IVA ITAA 1936 can still be issued to a member of a tax consolidated group as the entry
into a tax consolidated group could be a step in a scheme (see Channel Pastoral Holdings Pty Ltd v FCT).

The next example illustrates the application of the single entity rule to intra-group transactions.

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Income tax – taxation of structures and transactions 181

 Example 3.22 – Single entity rule for intra-group assets
Intra-group assets are ignored while held within a consolidated group but are recognised when they
are transferred out of the group.

Third
Party Head
Company

3. Subsidiary
Company A
assigns 100% 100%
option for
1. Pays $1 million
$2 million Subsidiary Subsidiary
Company A 2. Grants option over land Company B

Head Company is the head company of a consolidated group, with Subsidiary Company A and
Subsidiary Company B as subsidiary members. The following transactions are entered into:

• Subsidiary Company A pays $1 million to Subsidiary Company B:

– in return, Subsidiary Company B grants Subsidiary Company A an option over land it owns

– subsequently, Subsidiary Company A assigns the option to a non-group entity for $2 million.
• The incidental costs associated with the assignment are $10,000.

Under the single entity rule, transactions 1 and 2 are ignored for income tax purposes because they
occur wholly within the consolidated group. However, transaction 3 is treated as if Head Company
had assigned the option to the non-group entity. Head Company is considered to have:

• received capital proceeds of $2 million for the assignment of an option

• incurred incidental costs of $10,000 relating to the assignment.

Head Company makes a capital gain of $1,990,000.

Consolidated income tax return

A head company prepares and lodges a single company income tax return for the consolidated group. In
practice, many head companies require subsidiary members to prepare their own income tax calculations.
The head company aggregates this tax data and eliminates the impacts of intra-group transactions. It uses a
bottom-up approach to preparing the income tax return for the consolidated group.
A part year (stub) tax calculation and income tax return must be prepared by a subsidiary member for any
period during an income year that it is not a member of a consolidated group. This includes the period
before it becomes a member and/or for the period after it ceases to be a member.

Tax sharing agreement

Despite the single entity rule, the Commissioner is entitled to recover any outstanding income tax debts
from subsidiary members because they are jointly and severally liable with the head company for tax
liabilities (s 721-15).
This joint and several liability exposures can be mitigated by a valid tax sharing agreement (TSA). A TSA is
an agreement that provides for the allocation of liability on default. It also establishes the amount that each
entity is liable to directly pay the Commissioner in the event of default. It is not an agreement that provides
for the funding of the head company to make its regular payments, which is typically referred to as the tax
funding agreement (TFA).
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182 Tax
A group that has a valid TSA in place can avoid a situation in which all of the members of the group become
jointly and severally liable for each group liability.

3.1.2 Individual
When an individual operates a business under their own name or with a registered business name, they are
known as a sole trader. A sole trader is the simplest business structure. Often, an individual may commence
a business as a sole trader but later transition to a more complex structure, such as a company, as the
business expands.
From an asset protection and legal liability perspective, individuals operating as sole traders do not have
their liability limited. This is a feature of most companies and trusts. While asset protection and succession
planning are important issues to consider when providing advice to clients on appropriate tax structures,
the focus of this topic is the tax issues.
To determine the taxable income for an individual taxpayer, tax practitioners need to be able to apply the
following common tax rules and principles outlined in the below tables.

TABLE: Individual – key tax attributes

Section
ITAA 1997
unless
otherwise
Item stated Guidance

Taxpayer 4-1 An individual is a taxpayer for income tax purposes. A sole trader business
structure is not a separate taxpayer, its income tax consequences are simply
part of the individual’s tax affairs.

Residency 6-5, A resident individual is taxable in Australia on their worldwide assessable

855-10, income. However, to minimise the double taxation of foreign income,
855-15 resident individuals may be entitled to exemptions or tax credits.
and 6(1)
ITAA 1936 A non-resident individual is only taxable in Australia on their Australian
sourced assessable income. However, a further restriction applies for CGT
purposes. A non-resident is only taxable in Australia on a capital gain (or
loss) where the CGT asset is taxable Australian property (TAP).

There are specific rules for determining the residency of an individual and
the source of income.

Refer to Topic 2.1.1.

Tax rate Schedule 7 Individuals pay tax at marginal tax rates. There are different rates applicable
ITRA 1986 for:
• Resident taxpayers (eg entitled to a tax-free threshold and generally
subject to Medicare levy at 2% (or a higher percentage where the
taxpayer does not have private health insurance)
• Non-resident taxpayers (eg no entitlement to the tax-free threshold and
not subject to Medicare levy).
• Working holiday makers (eg tax rate of 15% for up to $45,000 of income)
• Special income of minors, that is taxpayers who are under the age of
18 years on the last day of the income year (eg highest marginal tax rate
applied to many types of income).

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Income tax – taxation of structures and transactions 183

 Section
ITAA 1997
unless
otherwise
Item stated Guidance

Tax offsets 63-10, A tax offset reduces the amount of income tax payable. A resident individual:
67-25, • Who receives a franked dividend is entitled to a franking tax offset
207-20, (s 207-20) and to a refund of any excess franking tax offsets
and (s 67-25).
770-10 • Who receives a foreign income may be entitled to a foreign income tax
offset (FITO) (s 770-10) but is not entitled to a refund or to carry forward
any excess FITOs. The individual must use the FITO in the income year to
which it relates, or any remaining unused balance is lost.

When calculating a resident individual’s income tax payable, FITOs are

applied before franking tax offsets (ie non-refundable before refundable)
(s 63-10).

A non-resident individual is not entitled to a franking tax offset (but may be

entitled to FITO).

Refer to Topic 3.2.1.

Dividend, 128B and A non-resident individual:

interest, and 128D • Is subject to DIR WHT on their Australian sourced dividend (unfranked
royalty (DIR) component), interest, and royalty income. DIR WHT is a final tax.
withholding • The Australian sourced dividend (franked and unfranked components),
tax (WHT) interest and royalty income are deemed to be NANE income.

Refer to Topic 3.2.1.

Goods and 9-20 GST An individual that carries on an enterprise (ie as a sole trader) can be
services tax Act registered for GST.
(GST)
Refer to QRG: Other taxes and interactions (Part 1) in Topic 4.1 of your
learning materials.

Fringe benefits 136(1) An individual that is an employer can provide a fringe benefit to an
tax (FBT) FBTAA employee (or their associate) and may be subject to FBT. However, an
1986 individual cannot be an employee of their own sole trader business.

Refer QRG: Other taxes and interactions (Part 2) in Topic 4.2 of your
learning materials.

Small business Division An individual that is a sole trader may be classified as an SBE (or an entity
entity (SBE) 328 that would be an SBE applying an alternate aggregated turnover threshold)
concessions and may choose to apply the SBE concessions, where eligible.

Refer to Topic 3.1.5.

Tax 170(1) The uniform administrative penalty regime applies to individuals in the
administration ITAA same way as other taxpayers.
1936 and The time frame for the Commissioner to amend an assessment that is
Schedule 1 applicable to an individual is generally two years.
Divisions
284-288 Refer to Topic 1.1.
TAA 1953

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184 Tax
 TABLE: Individual assessable income – key sections

Section
ITAA 1997
unless
otherwise
Item stated Guidance

Ordinary and 6-5 and An individual’s assessable income includes ordinary income and statutory
statutory 6-10 income. However, it excludes exempt income and non-assessable
income non-exempt (NANE) income.
• An individual’s ordinary income includes income from personal exertion
(eg salary or wages income), property (eg rent, interest, dividends, and
royalties), and business (eg operating as a sole trader).
• The most common types of statutory income for an individual are a net
capital gain, a share of the net income or loss of a partnership, and a
trust distribution.

Timing of 6-5 and An individual includes ordinary income in their assessable income when it
inclusion in 6-10 is derived.
assessable • Non-business ordinary income is derived on a cash basis (ie on receipt).
income • Business income is derived on a cash basis where it is all from the
individual’s own personal exertion. However, where they employ other
individuals or have trading stock, an accruals basis is more appropriate.
An individual includes statutory income in their assessable income in
accordance with the timing rules in the statutory income provision.

Employment 6-5, 15-2, An individual includes in their assessable income:

income and 15-70 • Gross salary and wages income (ie net income grossed-up for PAYG
withheld) (s 6-5).
• Allowances and other amounts provided in respect of employment that
are not included under another section (s 15-2).
• Car expenses reimbursed on a cents per kilometre basis (s 15-70).
• Certain payments on termination of employment.

The employment termination payment (ETP) rules are covered in the

Advanced Tax subject.

Rental income 6-5 An individual includes rental income in their assessable income:
and interaction • Where a residential property is held as a passive investment (ie not as
with GST part of carrying on a business), when it is received (ie not when it is due).
• Where a commercial property is held as part of carrying on a business,
when it is earned (ie on an accruals basis).
Residential rent in an input taxed supply for GST purposes. Therefore, GST
is not payable in respect of residential rent and the owner of the rental
property is not entitled to claim GST input tax credits in respect of
expenditure incurred.
Refer to QRG: Other taxes and interactions (Part 1) in Topic 4.1 of your
learning materials.

Dividend, 6-5, 15-20, A resident individual includes in their assessable income:

interest and 207-20, • A franked dividend from an Australian company and a franking credit
royalty income 770-10, and gross-up. They are also entitled to a franking tax offset.
(ie passive 44(1) ITAA • Gross foreign dividend, interest and royalty income (ie net income
income) 1936 grossed-up for foreign taxes withheld). They may also be entitled to a
128B and foreign income tax offset (FITO).
128D ITAA
A non-resident individual does not include Australian sourced dividend,
1936
interest or royalty income in their assessable income as it is subject to DIR
WHT and deemed to be NANE income.
Refer to Topics 3.1.1 and 3.2.1.

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Income tax – taxation of structures and transactions 185

 Section
ITAA 1997
unless
otherwise
Item stated Guidance

Net capital 102-5, A resident individual includes a net capital gain in their assessable income
gains 102-10, and can carry forward a net capital loss to a future income tax year.
115-5, and A resident individual may be eligible for various CGT concessions,
118-110 including:
855-10, and • CGT 50% general discount (Division 115).
855-15 • CGT main residence exemption (Subdivision 118-B).

A non-resident individual:
• Includes a net capital gain in their assessable income and can carry
forward a net capital loss to a future income tax year where the asset is
taxable Australian property (TAP). The non-resident individual:
– May also be subject to foreign resident WHT.
– May be eligible for the CGT 50% general discount, but only for gains
accrued up to 8 May 2012.
– Is generally not entitled to the CGT main residence exemption.
• Disregards a capital gain/(loss) on non-TAP assets.

The sale of residential premises is generally an input taxed supply for GST
purposes, unless it is either commercial residential premises or new
residential premises (Subdivision 40-C GST Act). Therefore, GST is not
payable in respect of the sale proceeds and the owner of the property is not
entitled to claim GST input tax credits in respect of expenditure incurred.

Refer to the capital gains tax content in Topic 2.2, and QRG: Other taxes
and interactions (Part 1) in Topic 4.1 of your learning materials.

Fringe benefits 23L(1) and In the hands of the individual employee:

(ie generally 23L(1A) • A fringe benefit is deemed to be NANE income.
non-cash ITAA 1936 • An exempt benefit for FBT purposes is deemed to be exempt income,
benefits with the exception of car expenses reimbursed by an employer on a cents
provided to an per kilometre basis that are included in assessable income (see above).
employee in
respect of their Refer to QRG: Other taxes and interactions (Part 2) in Topic 4.2 and
employment) (Part 3) in Topic 4.3 of your learning materials.

Partnership net 92 ITAA An individual that is a partner in a partnership must include their share of
income or loss 1936 and a partnership’s net income or loss in their assessable income (subject to
106-5 exceptions where the partner is a non-resident).

Note: Any capital gain or loss in relation to a partnership or one of its CGT
assets is made by each partner individually on a fractional interest basis
(s 106-5) (ie each partner must separately calculate their net capital gain
or loss).

Refer to Topic 3.1.3.

Trust 97 ITAA An individual that is a beneficiary of a trust must include the assessable
distribution 1936 component of a trust distribution in their assessable income (subject to
exceptions where the beneficiary is a non-resident).

Note: The non-assessable component of a trust distribution from a unit

trust (ie a fixed trust) may result in a reduction to the cost base of the
units or give rise to a capital gain for the beneficiary.

Refer to Topic 3.1.4.

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186 Tax
 Private 109C, An individual shareholder in a private company may have to include
company 109CA, deemed dividends under Division 7A in their assessable income.
deemed 109D, 109E,
dividends or 109F Refer to Topic 3.1.1.
ITAA 1936

Deemed An individual that attempts to alienate their PSI may be subject to the PSI
personal rules in Divisions 84–87. These rules can deem amounts that are not
services promptly paid as salary and wages to be included in the individual’s
income (PSI) assessable income.

The PSI rules are covered in the Advanced Tax subject.

TABLE: Individual deductions – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

General and 8-1 and 8-5 An individual’s deductions include general deductions and specific
specific deductions. An individual is entitled to a general deduction under s
deductions 8-1 for losses and outgoings:
• Incurred in gaining or producing their assessable income
(ie expenditure that has a direct nexus to the individual’s
assessable income) – for example, income protection insurance
(as any compensation received is assessable income) and
membership fees of a professional or trade organisation related to
the industry in which the individual is currently employed.
• Incurred in carrying on a business (ie expenditure that simply
relates to the business carried on by the individual as a sole trader).

However, under s 8-1, a general deduction is not available to the

extent that:
• It is of capital or a capital nature – for example, where an
individual taxpayer purchases a new computer, the cost of
acquisition is capital in nature; however, a decline in value
deduction may be available under the capital allowance rules.
• It is of a private or domestic nature – for example, home to work
travel of an employee (subject to limited exceptions), work
clothing that is not a registered uniform or occupation-specific,
and childcare costs while an employee is at work.

Timing of 8-1 and 8-5 An individual is entitled to a deduction for:

inclusion as a • A general deduction when it is incurred. Expenditure is incurred
deduction when there is a definitely committed obligation or a liability is
enforceable at law (eg the invoice is received or paid). However, it
does not have to be paid. This might broadly be thought of as an
accruals basis; however, there is no income tax concept of a cash
or accruals basis for expenditure.
• A specific deduction as determined by the timing rules in each
specific deduction section.

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Income tax – taxation of structures and transactions 187

 Section ITAA
1997 unless
Item otherwise stated Guidance

Reduction for 8-1 and 40-25 An individual (or a partnership with individual partners) can incur
private use expenditure partly for private purposes. Where this applies:
• General deductions under s 8-1 are reduced to the extent that a
loss or outgoing is of a private or domestic nature.
• Decline in value deductions under s 40-25 are reduced to the
extent that a depreciating asset is used for non-taxable purposes.
This reduction may also result in a capital gain or loss under CGT
event K7 on disposal of the asset.

Refer to Topics 2.1 and 2.2.

Prepayments 82KZM ITAA An individual is entitled to an exclusion from the prepayment rules
1936 (which only apply to expenditure that is otherwise deductible under
s 8-1) provided:
• the period covered by the expenditure is 12 months or less, and
• the individual:
◦ is not carrying on a business, or
◦ is carrying on a business that is an SBE or would be an SBE if
the aggregated turnover threshold used to determine eligibility
was $50 million rather than $10 million.

Where the expenditure is excluded from the prepayment rules, it is

deductible to the individual when incurred (ie at the time of the
prepayment) and does not have to be spread over the eligible
service period.

Refer to Topic 2.1.4 and QRG: Tax reconciliation adjustments in

Topic 2.1 of your learning materials.

Interactions 27-5, Where an individual is not entitled to claim an input tax credit for
with goods and 27-80, the GST component of an acquisition (eg because the individual is
services tax 27-100, and not registered or required to be registered for GST, or is making
(GST) 103-30 input-taxed supplies), the GST component is included in:
• The amount incurred under s 8-1.
• The cost of a depreciating asset under s 40-175.
• The cost base of a CGT asset under s 110-25.

For example, the owner of the residential rental property pays $110
(GST-inclusive) to repair a kitchen stove. The supply of a residential
rental property is an input-taxed supply for GST purposes and thus,
the GST component of any expenditure incurred in the making of
that supply cannot be claimed as an input tax credit. The owner can
claim an income tax deduction for the repair under s 25-10 for the
GST-inclusive cost of $110.

Refer to QRG: Other taxes and interactions (Part 1) in Topic 4.1 of

your learning materials.

Residential 26-31, 40-27, Where an individual (or partnership) is not carrying on a business:
rental property 110-38, • Travel expenses related to a residential rental property are denied
expenses a deduction under s 26-31 – for example, travel to inspect the
property or collect rent. The travel expenses are also specifically
excluded from the property’s cost base under s 110-38.
• Second-hand assets used in a residential rental property
(excluding those provided as part of new residential premises) are
denied a decline in value deduction under s 40-27. This reduction
may result in a capital gain or loss under CGT event K7.

Refer to Topics 2.1 and 2.2 of your learning materials.

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188 Tax
 Capital 40-25, 43-10 An individual is entitled to a deduction for the decline in value of
allowances and and 43-15 depreciating assets to the extent they are used for a taxable purpose
capital works (see above reduction for private use). Special capital allowance rules
may apply for:
• An individual who is carrying on a business and qualifies for the
SBE concessions in Subdivision 328-D or the general concessions
for small, medium and large taxpayers in Division 40.
• Second-hand assets in a residential rental property (see above).

An individual is entitled to a capital works deduction for a building

(or structural improvement) to the extent it is used to produce
assessable income (eg an individual that owns a residential rental
property may be entitled to a capital works deduction).

Refer to Topics 2.2.1 and 2.2.2.

Car and business 28-12, 28-25, A car expense deduction can be calculated using either:
travel expenses and 28-90 • The cents per kilometre method – allows a fixed rate per
kilometre for up to a maximum of 5,000 kilometres per car per
income year. The rate per kilometre for the income year ended
30 June 2023 is 78 cents.
• Logbook method – allows a deduction for a percentage of total
car expenses. The percentage is determined on the basis of a
12-week logbook.

Self-education 8-1 Self-education expenses that have a direct nexus to an individual

expenses taxpayer’s income earning activities are deductible under s 8-1. The
first $250 of self-education expenses were previously disallowed
under s 82A ITAA 1936.

Substantiation Subdivision All individuals, including sole traders, need to ensure that they have
of deductions 900-B, 900-C, complied with the substantiation provisions in order to claim their
and 900-D expenses as a tax deduction.
There are specific substantiation rules for:
• Work expenses (ie expenses incurred in producing salary or
wages, excluding car expenses (s 900-30)). Examples of work
expenses include (but are not limited to):
– Compulsory union fees, subscriptions to trade and professional
magazines, membership fees of a professional body, etc.
– Expenses related to allowances included in the individual’s
assessable income under s 6-5 or s 15-2 (see above). For
example, actual travel, accommodation and meal costs incurred
while an employee is required to work away from their usual
place of residence (TR 2021/4).
– Registered uniforms, occupation specific and protective clothing
(including associated laundry costs and dry-cleaning costs).
– Decline in value deduction for depreciating assets used to
produce salary and wage income (see above).
– Travel between workplaces (s 25-100).
– Home study/office expenses (TR 93/30 and PCG 2020/3).

Substantiation = generally invoices and receipts are required,

subject to exceptions / reduced requirements for (but not
limited to):
– Reasonable claims against for overtime meal and travel
allowances (ATO determination released each year with
thresholds of what is reasonable).
– Laundry expense up to $150.

– Where total of all work-related expenses, including laundry but

excluding reasonable overtime meal and travel allowances, is
$300 or less.
– Minor expenses of less than $10 each and $200 for the year can
be evidenced by personal records, such as diary entries.

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Income tax – taxation of structures and transactions 189

 Section ITAA
1997 unless
Item otherwise stated Guidance

• Car expenses – Substantiation = Maintaining a logbook and/or

odometer records (see above).
• Business-related travel (ie travel costs incurred by an individual
taxpayer in producing their assessable income, other than salary
or wages, where the individual is away from their usual place of
residence for at least one night (s 900-95)).

Substantiation:
– Where travel is less than six nights = Written evidence of
expenditure.
– Where travel is six nights or more = Written evidence and a
travel diary.

Personal 290-60 An individual is entitled to claim a deduction for personal

superannuation superannuation contributions when they are paid, subject to
contributions satisfying the deduction eligibility requirements.

Refer to Topic 2.1.4.

Employee 51AJ ITAA 1936 An employee contribution to reduce the taxable value of a fringe
contributions benefit provided by their employer (or an associate of their
related to fringe employer) is not deductible to the individual.
benefits
Refer to QRG: Other taxes and interactions (Part 2) in Topic 4.2 of
your learning materials.

Tax loss 36-10, 36-15, An individual is entitled to a general deduction for tax losses, subject
and 36-20 to the general carry forward tax loss rules that are applicable to all
taxpayers.

However, the amount of a tax loss made by an individual taxpayer

may be impacted by their residency as:
• For a resident, net exempt income = from all sources.
• For a non-resident, net exempt income = from Australian sources
only.

The current and prior period tax losses incurred by an individual in

carrying on a business are also subject to the non-commercial loss
rules in Division 35.

The non-commercial loss rules are covered in the Advanced Tax

subject.

Specific The specific deduction provisions that are applicable to all taxpayers,
deductions: including individuals, are analysed in various locations in your
Various other learning materials. The above table does not provide a summary of
amounts all deductions available to an individual.

Refer to Topic 2.1.4.

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190 Tax
Taxable income
An individual’s taxable income is equal to their assessable income reduced by the deductions they incurred
in deriving that income.
The concepts of assessable income and deductions are covered in Topic 2.1 and are therefore not covered
further in this chapter.

Substantiation

All individuals, including sole traders, need to ensure that they have complied with the substantiation
provisions in order to claim their expenses as a tax deduction. There are specific substantiation rules for:
• work expenses – for example, invoices (subject to exclusions)
• car expenses – for example, maintaining a logbook
• business-related travel – for example, maintaining a travel diary.
The ATO has outlined a new method for taxpayers to calculate their deduction for certain additional
running expenses while working from home from 1 July 2022. Practical Compliance Guideline PCG 2023/1
allows taxpayers to claim at a rate of 67 cents per hour for the following additional running expenses for
working from home from 1 July 2022:
• energy expenses (electricity and gas) for lighting, heating, cooling and electronic items used while
working from home
• internet expenses
• mobile and home phone expenses, and
• stationery and computer consumables.
Meanwhile, deductions for the decline in value of depreciating assets used when working from home, such
as office furniture and laptop computers, are calculated separately.
For example, Bob works 1,000 hours from home in the year ended 30 June 2023. He can claim a tax
deduction for $670 provided that he can substantiate his work from home hours. He also can claim decline
in value deductions on his desk at home which he used for work.

Tax losses

An individual is entitled to a general deduction for tax losses, subject to the general carry forward tax loss
rules in Division 36 that are applicable to all taxpayers. The current and prior period tax losses incurred by
an individual in carrying on a business are also subject to the non-commercial loss rules in Division 35.
These rules are discussed in Advanced Tax. The below examples cover a number of specific cases.

Example 3.1 – Prepaid interest for sole trader

Suzie is a landscape gardener. She buys some equipment using borrowings from a bank in June 2023.
She prepays interest for 11 months on 30 June amounting to $20,000. Her other business income
(less deductions) is $80,000.

The prepayment rules do not apply to Suzy. She can therefore deduct the interest in full against her
other business income. Suzie’s taxable income is $60,000.

Example 3.2 – Prepaid interest

Tom buys a rental property using borrowings from a bank in June 2023. He prepays interest for
11 months on 30 June amounting to $30,000. Tom has salary of $70,000.

The prepayment rules do not apply to Tom. He is therefore able to deduct the interest in full against
his salary income. Tom’s taxable income is $40,000.

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Income tax – taxation of structures and transactions 191

 Example 3.3 – Rental property
Jenny lives in Melbourne. Jenny bought a rental property in Queensland. Her plan is to travel to the
property once a year, do an inspection and then have a 2-week holiday in the house. She wants to
claim a tax deduction for her airfares to do the inspection.

Jenny is not allowed to claim her airfares (refer s 26-31).

Example 3.4 – Dishwasher in rental property

Jack buys a second-hand dishwasher for his rental property. He wants to claim a depreciation
deduction for the dishwasher.

Jack is not allowed to claim a depreciation deduction (refer s 40-27).

Example 3.5 – Substantiation

Isabel incurs $5,000 in tax deductible expenses against her salary income. On the way home, she
leaves her briefcase in the train, and loses all of the supporting invoices and documentation which
substantiates the expenses.

Isabel needs to ask for replacement receipts. If she cannot substantiate the expenses, they are not
deductible (subject to certain exclusions).

Example 3.6 – Taxable income from a rental property

Carolyn Anderson, an Australian resident individual taxpayer, owns a two-bedroom apartment
located in Australia that she holds as an investment property (ie a residential rental property).
The apartment is rented (or available for rent) on an arm’s-length basis at all times (ie the property is
used solely for producing assessable income and there is no private use).

During the income year ended 30 June 2023, Carolyn received rent of $30,000 and has the following
expenses:

• interest on a loan used to acquire the property of $10,000. The 10-year loan was entered into
when the property was purchased two years ago (on the first day of that income year). At that
time, Carolyn also paid borrowing costs of $1,000 and stamp duty in respect to the property
purchase of $7,000
• travel costs of $2,000 to inspect the condition of the property
• repair costs of $100 to stop a water leak for the apartment’s dishwasher
• costs of $900 to purchase a replacement fridge for the apartment. She purchased the replacement
fridge online from a seller who had previously used it in their home
• other expenses for the property included council rates of $2,000, building insurance of $1,200 and
land tax of $1,500.

At the time Carolyn acquired the apartment for $400,000, the seller provided documentation to
Carolyn showing that the apartment had a construction cost of $300,000 (fully undeducted).

Carolyn calculated her taxable income in respect of her rental property as follows:

Details Explanation $ $

Assessable income

Rent Assessable under s 6-5 as ordinary income 30,000

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192 Tax
 Deductions

Interest Deductible under s 8-1 (as it has a direct nexus to a 10,000

property used solely for income-producing purposes)

Borrowing costs Deductible over 5 years under s 25-25 (as this is less 200
than the loan term). $1,000 ÷ 5 = $200
Note: The borrowing costs are not included in the cost base
of the property under s 110-25 as they are otherwise
deductible (ie the specific deduction provision applies)

Stamp duty Stamp duty is capital in nature and included in the 0

cost base of the property under s 110-25

Travel costs Travel costs (despite having a direct nexus to a 0

property used solely for income-producing
purposes) are specifically non-deductible under
s 26-31 as Carolyn is an individual taxpayer and is
not carrying on a business
Note: The travel costs are also specifically excluded from
the cost base of the property under s 110-38

Dishwasher cost Repairs are specifically deductible under s 25-10 100

Fridge cost The fridge is a depreciating asset, but it is specifically 0

denied a decline in value deduction under s 40-27 as
Carolyn is an individual taxpayer and it is a second-
hand asset used in a residential rental property

Other expenses Deductible under s 8-1 (as they have a direct nexus 4,700
to a property used solely for income-producing
purposes)

Building cost Capital works deduction for undeducted 7,500 22,500

construction costs under s 43-10. $300,000 × 2.5%
= $7,500

Taxable income 7,500

Tax rates
General income tax rates for residents

The general marginal tax rates that are applicable for resident individuals for the year ended 30 June 2023
are set out in the table below (see Schedule 7 ITRA 1986):

Taxable income Tax on this income

0 – $18,200 Nil

$18,201 – $45,000 19 cents for each $1 over $18,200

$45,001 – $120,000 $5,092 plus 32.5 cents for each $1 over $45,000

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Income tax – taxation of structures and transactions 193

 Taxable income Tax on this income

$120,001 – $180,000 $29,467 plus 37 cents for each $1 over $120,000

$180,001 and over $51,667 plus 45 cents for each $1 over $180,000

Source: Australian Taxation Office, ‘Individual income tax rates’, www.ato.gov.au/Rates/Individual-income-tax-rates

General income tax rates for non-residents

The general marginal tax rates that are applicable for non-resident individuals for the year ended 30 June
2023 are set out in the table below (see Schedule 7 ITRA 1986):

Taxable income Tax on this income

0 – $120,000 32.5 cents for each $1

$120,001 – $180,000 $39,000 plus 37 cents for each $1 over $120,000

$180,001 and over $61,200 plus 45 cents for each $1 over $180,000

Source: Australian Taxation Office, ‘Individual income tax rates’, www.ato.gov.au/Rates/Individual-income-tax-rates

Special income tax rate for non-resident working holiday-makers

An income tax rate of 15% applies to taxable income of up to $45,000 of working holiday-makers in a year
of income, regardless of whether they are a resident or a non-resident. Taxable income above this amount
in a year of income is subject to the general marginal income tax rates for non-resident taxpayers:

Taxable income Tax on this income

0 – $45,000 15%

$45,001 – $120,000 $6,750 plus 32.5 cents for each $1 over $45,000

$120,001 – $180,000 $31,125 plus 37 cents for each $1 over $120,000

$180,001 and over $53,325 plus 45 cents for each $1 over $180,000

Source: Australian Taxation Office, ‘Individual income tax rates’, www.ato.gov.au/Rates/Individual-income-tax-rates

Broadly, under these rules:

• An individual is a working holiday-maker at a particular time if the individual holds at that time a working
holiday visa (Subclass 417), a work and holiday visa (Subclass 462) or certain bridging visas.
• An individual’s working holiday taxable income for a year of income is the individual’s assessable income
for the year of income derived from sources in Australia and while the individual is a working
holiday-maker, less so much of any amount the individual can deduct for the year of income as relates to
that assessable income.
• If the non-resident taxpayer is a working holiday-maker at any time during the year of income, count the
taxpayer’s working holiday taxable income for the year of income as the first part (starting from $0) of
the taxpayer’s ordinary taxable income for the purposes of calculating their income tax payable.
Note that in the High Court decision in Addy v FC of T 2021, the High Court held that a UK working holiday
visa holder who was an Australian tax resident was entitled to be taxed consistently with Australian
resident nationals, thereby allowing access to the $18,200 tax-free threshold. The High Court essentially
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194 Tax
stipulated that the tax rates applicable to working holiday makers irrespective of tax residency status
contravened the non-discrimination clause of the Australia and UK double tax agreement.
The implication from the High Court case is that some working holiday visa holders may be eligible to be
taxed on the same basis as a resident Australian. To be eligible, the individual must be considered an
Australian resident for tax purposes and from a non-discrimination article country.

Special income tax rates for minors

There are special rates that apply to the eligible taxable income of resident and non-resident minors
(ie individuals less than 18 years of age on the last day of the year of income – see ss 102AA–102AGA,
Division 6AA ITAA 1936 and Schedule 11 ITRA 1986). Broadly, under these rules, the eligible taxable
income of minors is taxed at the highest marginal tax rate.
Eligible taxable income includes all types of assessable income except for employment income, business
income, lottery winnings, and testamentary trust distributions where the distribution is sourced from assets
that are transferred from a deceased estate, or the proceeds of the disposal or investment of those assets.
Therefore, eligible taxable income commonly includes dividends, interest, rent, royalties and capital gains
received by a minor. A minor could derive these types of income either directly or via a trust distribution.
Any taxable income of a minor that is not eligible taxable income is taxed at the general tax rates (ie
resident and non-resident rates, as applicable) with access to the full tax-free threshold where the minor is
a resident for the full income year.
Where the eligible taxable income of a resident minor exceeds $416, special penalty rates of tax apply.
Amounts up to $416 are generally not subject to tax.
The special rates do not apply to a minor who is engaged in a full-time occupation.

Tax offsets
Tax offsets reduce the amount of income tax payable by a taxpayer.
Some of the key tax principles that apply to the calculation of tax offsets for an individual taxpayer are as
follows:
• Certain tax offsets are only available to individual taxpayers, for example, the low-income tax offset
(LITO) and the low and middle income tax offset (LMITO).
• Franking tax offset – resident individuals can claim a refund for excess franking tax offsets.
• Foreign income tax offset – resident individuals are not able to claim a refund for excess foreign income
tax offsets. They either use it or lose it.
• SBE tax offset – where the business operations of an individual satisfy the requirements of being an SBE,
the individual may be entitled to an additional offset.
The next example considers the effect of Australian residence on assessable income. The example ignores
double taxation agreements and CGT.

Example 3.7 – Rental property losses and a change of residence

Carolyn Anderson has a negatively geared rental property in Australia. She is about to leave Australia
for three years to work in the United States (US) for a multinational company, after which time she
will return to Australia.

If Carolyn remains an Australian resident for taxation purposes while working in the US, the US salary
income and the Australian rental property income will be assessable under s 6-5(2), while the rental
property expenses will be deductible under s 8-1(1).

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Income tax – taxation of structures and transactions 195

 Alternatively, if Carolyn becomes a non-resident of Australia for taxation purposes while in the US,
the US salary will not be assessable in Australia if it is not sourced in Australia (s 6-5(3)).

A tax loss only arises when deductions exceed both assessable income (rental property income in this
case, where Carolyn is a non-resident) and net exempt income.

Net exempt income is defined as follows:

• For a resident, under s 36-20(1) – exempt income derived from all sources, less losses and outgoings
incurred in deriving that income and taxes payable in respect of that income outside Australia.
• For a non-resident, under s 36-20(2) – exempt income derived from sources in Australia, less
expenses incurred in deriving that income.

Therefore, if Carolyn remains an Australian resident while in the US, her negative gearing losses will
be offset against her US salary when working out her Australian taxable income. The provisions for
calculating a tax loss would not apply (unless her negative gearing losses exceed her US salary).

However, if Carolyn becomes a non-resident, her US salary will not be classified as net exempt
income under s 36-20 (because exempt income only arises under s 6-20 where a provision of the Tax
Act makes it specifically exempt and ss 11-5 and 11-15 do not list foreign income of a non-resident
as exempt income), and her accumulated Australian negative gearing losses will be tax losses under
s 36-10. The tax losses can be carried forward to future income tax years under s 36-15.
The tax losses can be used as a deduction against future assessable income when her rental property
ceases to be negatively geared or she returns to Australia.

3.1.3 Partnership
Partnerships are generally governed by a contractual relationship (a partnership agreement) that outlines
the terms and conditions of the arrangement. The agreement should be read carefully prior to providing
any advice about ongoing tax matters or dissolution of a partnership.
Similar to companies, tax law partnerships require a tax return to be lodged with the ATO although the tax
is paid on each share of the partner’s interest in the partnership.
To determine the net partnership income/(loss), tax practitioners need to be able to apply the following
common tax rules and principles outlined in the following tables.

TABLE: Partnership – key tax attributes

Section ITAA
1997 unless
Item otherwise stated Guidance

Taxpayer and 91 and 92 ITAA A partnership is not a separate legal entity and is not a separate
tax rate 1936 taxpayer for income tax purposes.

A partner may be an individual, trust, company or another

partnership. It is the partners of the partnership (or the ultimate
individuals and companies where one or more of the partners is a
partnership or trust) who are the taxpayers.

However, a partnership is required to prepare and lodge an income

tax return that discloses the net partnership income/(loss) and the
allocation of that net partnership income/(loss) to each of the
partners (ie each partner’s share of the net partnership income/(loss).

A tax rate is not relevant at the partnership level. Partners pay tax at
the partner’s applicable rate of tax (for example, a partner that is a
company pays tax at a flat rate, and a partner that is a resident
individual pays tax at resident marginal tax rates).
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196 Tax
 Allocation of net 92 ITAA 1936 Where a partnership:
partnership • Is carrying on a business (ie is a common law partnership), the
income/(loss) partners can determine the allocation of the net partnership
income/(loss) under the partnership agreement.
• Is not carrying on a business (ie is only a tax law partnership), the
net partnership income/(loss) must be allocated in proportion to
the underlying ownership of the assets.

The partners are allocated a share of the net income of the

partnership or a share of the net loss of the partnership. Each
partner is also entitled to the same share of:
• Franking tax offsets and FITOs.
• Exempt income and non-assessable non-exempt (NANE) income.

A partnership cannot distribute net income to some partners and

losses to other partners in the same income year (TR 2005/7).

Residency: 90 ITAA 1936 Residence is not directly relevant at the partnership level.
Partnership
However, the net partnership income/(loss) must be calculated as if
the partnership is a resident taxpayer. Or in other words, it must
include the worldwide assessable income of the partnership.

Residency: 92, 128B and A resident partner:

Partner 128D ITAA 1936 • Includes in assessable income their share of the partnership’s net
36-55, 63-10, income and is allowed a deduction for their share of the
63-25, 207-35 partnership’s net loss.
and 770-10 • To minimise the double taxation of foreign sourced income each
partner may be entitled to:
– Where the partner is an individual = FITOs.
– Where the partner is a company = Exemptions or FITOs.
• A franked distribution paid to a partnership is treated as flowing
indirectly to the partners. Each partner is entitled to a share of the
franking credit offsets.
– Where the partner is an individual = any excess franking tax
offsets are refundable (s 63-10 / s 63-25).
– Where the partner is a company = any excess franking offsets
are non-refundable, but instead convert into a tax loss (s 36-55).

A non-resident partner is only taxable in Australia on their share of

the partnership’s Australian sourced net income.

However, a non-resident:
• Is subject to DIR WHT on their Australian sourced dividend
(unfranked component), interest, and royalty income (s 128B). DIR
WHT is a final tax.
• The Australian sourced dividend (franked and unfranked
components), interest and royalty income are deemed to be NANE
income (s 128D).

Therefore, when allocating the net partnership income/(loss) to a

non-resident partner, you must remove:
• The partner’s share of the foreign sourced income and related
expenses.
• Australian sourced dividend, interest and royalty income.

Refer to Topics 3.1.1, 3.1.2, 3.2.1 and 3.2.2.

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Income tax – taxation of structures and transactions 197

 Section ITAA
1997 unless
Item otherwise stated Guidance

Net capital 106-5 and 108-5 Net capital gains/(losses) are not applicable at the partnership level.
gains/(losses) Partners own an interest in each CGT asset of the partnership.
The application of the CGT rules depends on each partner’s tax
profile. For example:
• The capital gain/(loss) may be disregarded for non-TAP assets
where a partner is a non-resident.
• The CGT general 50% discount may apply to a partner who is a
resident individual.
• The SBE CGT concessions may apply to a partner in a partnership.
• The CGT rollover relief under Subdivision 122-B may be available
where the tax structure is changed from a partnership to a wholly
owned company.

The SBE CGT concessions are covered in the Advanced Tax subject.

Refer to the content on capital gains tax in Topic 2.2 of your

learning materials.

Goods and 184-5 GST Act A partnership that carries on an enterprise can be registered for
services tax GST. A supply made by a partner, in their capacity as a partner, is
(GST) taken to be made by the partnership.

Refer to QRG: Other taxes and transactions (Part 1) in Topic 4.1 of

your learning materials.

Fringe benefits 136(1) FBTAA A partnership that is an employer can provide a fringe benefits to an
tax (FBT) 1986 employee (or their associate) and may be subject to FBT. However, a
partner cannot be an employee of a partnership.

Refer to QRG: Other taxes and transactions (Part 2) in Topic 4.2 of

your learning materials.

Small business Division 328 A partnership that carries on a business may be classified as an SBE
entity (or an entity that would be an SBE applying an alternate aggregated
concessions turnover threshold) and may choose to apply the SBE concessions,
where eligible.

Refer to Topic 3.1.5.

Personal A partnership may be classified as a PSE and subject to the personal

services entity services income (PSI) rules where it is not a personal services
(PSE) business (PSB). When this occurs certain deductions to which the
partnership would otherwise be entitled are denied or limited.

The PSI rules are covered in the Advanced Tax subject.

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198 Tax
 TABLE: Partnership assessable income – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

Change in 15-50, 40-295, Each time a partner joins or leaves a partnership, the original
partnership 40-300, 40-340, partnership is dissolved, and a new partnership is formed. This is the
composition: 70-90, and reason why existing partners often retire on the last day of the
Sale of work-in- 70-100 income year and new partners are often admitted on the first day of
progress (WIP), the income year.
trading stock,
and depreciating When a partnership is dissolved the assets of that partnership are
assets disposed of and those same assets are then re-acquired by the new
partnership. The income tax consequences therefore include:
• Proceeds from the sale of WIP are assessable when received
(s 15-50).
• A disposal of trading stock is treated as being outside the ordinary
course of business where a taxpayer stops holding an item as
trading stock but continues to own an interest in the stock.
Therefore, under s 70-90:
– Deemed disposal = Market value
– Deemed re-acquisition = Market value.

However, the old and new partners can make an election to deem
the disposal to be at the relevant tax value of the trading stock
(ie cost, market selling, or replacement value) provided certain
conditions are satisfied (s 70-100).
• A balancing adjustment event occurs for depreciating assets
(s 40-295). Therefore, under s 40-300:
– Deemed disposal = Market value
– Deemed re-acquisition = Market value.

However, the old and new partners can make an election to obtain
rollover relief (ie the assessable balancing adjustment can be
disregarded).

There may also be consequences for the partners (but not the
partnership) in respect of CGT assets – see above (s 106-5).

Interest income 6-5 If a partner borrows money from the partnership under a genuine
received from a loan arrangement:
partner: Loan • The interest received by the partnership from that partner is
and Capital included in assessable income of the partnership.
account • The partner’s entitlement to a deduction for the interest paid to
the partnership depends on how the partner used the money. For
example, if it were used by the partner to go on a holiday it would
be a private expense and therefore not deductible under s 8-1.

If a partner has an overdrawn partner capital account (ie a partner

has made drawings from the partnership of more than what they
contributed) then:
• The interest received by the partnership would not be assessable
income of the partnership. However, it may form part of the
allocation of net partnership income to each partner under the
terms of the partnership agreement.
• The partner would not be entitled to a deduction for the interest
paid.

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Income tax – taxation of structures and transactions 199

 Section ITAA
1997 unless
Item otherwise stated Guidance

Dividend 44(1) ITAA 1936 The partnership includes in its assessable income the franked
income: and 207-35 dividend (s 44(1) ITAA 1936) and the franking credit gross-up
Australian (s 207-35).
sourced
Franking tax offsets are not applicable at the partnership level.

Ordinary and 6-5 and 6-10 The general rules for assessable income that are applicable to all
statutory taxpayers, including partnerships, are analysed in various locations in
income: Various your learning materials. The above table does not provide a
other amounts summary of all amounts that are assessable income to a partnership.

Refer to Topic 3.1.2 for guidance in respect of rental properties and

Topic 2.1.3 on assessable income.

TABLE: Partnership deductions – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

Salary and 8-1 Not deductible to the partnership. However, they may form part of
wages paid to how the allocation of the net partnership income/(loss) to each
partners partner is calculated.

For example, it is common for the partners in a partnership to

agree to:
• allocate partner salary amounts in priority to all other
distributions, and
• then allocate the remainder of the net partnership income (ie total
net partnership income reduced by partner salary) based on fixed
percentages.

Drawings paid 8-1 Not deductible to the partnership. They simply reduce the balance
to partners of a partner’s capital account.

Personal 290-150 Not deductible to the partnership. However, each partner may be
superannuation able to claim a personal deduction for the contributions when paid
contributions (subject to satisfying the deductibility conditions)
made on behalf
of partners Refer to Topic 2.1.4 for superannuation contributions.

Change in 25-95 See above for the impacts on assessable income when a partner
partnership leave or joins a partnership. In addition, the cost of acquisition of
composition: WIP by the new partnership is:
Acquisition of • Deductible in the income year it is paid where:
WIP – a recoverable debt has arisen, or
– reasonable to expect a recoverable debt to arise within
12 months from when paid.
• Deductible in the next income year, for any remaining amount
(ie that was not deductible in the year paid).

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200 Tax
 Interest paid to 8-1 If a partner loans money to the partnership under a genuine loan
a partner: Loan arrangement:
and capital • The interest paid by the partnership to that partner is deductible
account to the partnership (Leonard v FCT).
• The interest would be included in the assessable income of the
partner.

However, if the interest relates to a partner capital account then:

• The interest paid is not deductible to the partnership. However, it
may form part of the allocation of net partnership income to each
partner.
• The interest would not be included in the assessable income of
the partner.

Interest paid: 8-1 and Interest paid by a partnership on borrowings to fund working capital
Refinanced TR 95/25 or to buy income producing assets is deductible.
amounts
Under the refinancing principle (FCT v Roberts and Smith), interest
paid on borrowing used to fund a repayment of monies originally
invested by the partners in the business (or subsequently
invested – eg where a partner’s share of the net income of the
partnership is more than the amounts withdrawn by that partner) is
also deductible.

Tax losses 36-10, and As a partnership allocates a net partnership income loss to
36-20 each of the partners, the partnership does not carry forward
tax losses.

A partner may carry forward a tax loss, subject to the usual rules.
For example:
• An individual partner is subject to the non-commercial loss rules
(these rules are discussed in Advanced Tax).
• A company that is a partner is subject to the continuity of
ownership or continuity of business rules (refer to
Topic 3.1.1).

Specific The specific deduction provisions that are applicable to all taxpayers,
deductions: including partnerships, are analysed in various locations in your
Various other learning materials. The above table does not provide a summary of
amounts all deductions available to a partnership.

Refer to Topic 3.1.2 for guidance in respect of rental properties and

Topic 2.1.4.

Change in partnership composition

When a new partner is admitted to a partnership, the old partnership is dissolved and a new partnership is
created, unless there is an express clause (or some other express agreement) in the partnership agreement
that the original partnership is to continue.
Changes to the composition or existence of a partnership may have taxation consequences.
At the partnership level:
Where the election is made, its effect is to allow the partnership to defer the income otherwise assessable
in respect of the notional disposal.
• Depreciation – A balancing adjustment event arises in situations where there is a change in the interests
of persons (eg via formation or dissolution of a partnership or in the interests of partners) who own a
depreciating asset under s 40-295 ITAA 1997. Where such a change occurs, s 40-300 ITAA 1997 treats
the partnership as having disposed of its interest at market value (s 40-300(2) item 5). Where the market
value exceeds the adjustable value (ie the tax WDV), an assessable balancing adjustment amount equal to
the difference arises. This is unless a joint election by all partners (old and new) is made under s 40-340(3)
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Income tax – taxation of structures and transactions 201

 ITAA 1997. If such an election is made, the partnership can obtain rollover relief. Section 40-340
ITAA 1997 allows the partnership to defer the tax consequences arising from a balancing adjustment.
• Trading stock – Where there is a change in the ownership or interest in trading stock (eg via formation or
dissolution of a partnership or in the interests of partners), s 70-100 ITAA 1997 applies, so that there is a
notional disposal of trading stock by all of the old owners to the new owners. Such a disposal is treated
as being disposed of at market value by the partnership (s 70-100(2) ITAA 1997). However, the old and
new owners can elect that s 70-100 ITAA 1997 does not apply and a deemed disposal may occur at the
value at which the trading stock is recorded (eg at cost, and not at market value). Refer to ss 70-100(4),
(5) and (6) ITAA 1997. This election can only be made where:
– the trading stock becomes an asset of a business carried on by the new owners
– the former owners retain an interest in the trading stock of at least 25% of the stock’s market value
– the market value of the trading stock is more than the value of the stock as recorded in the books of
the former owners just before the change in ownership.
• Work in progress adjustments – Where there is a sale of WIP, a WIP amount that is received (by the old
partnership on the sale of the WIP asset to the new partnership) is specifically included in assessable
income (of the old partnership) in the income year in which it is received under s 15-50 ITAA 1997.
Under s 25-95 ITAA 1997, the new partnership can deduct the payment made to purchase the WIP
amount in the income year in which it was paid, to the extent that, as at the end of that income year:
– a recoverable debt has arisen in respect of the completion or partial completion of the work to which
the amount related
– the taxpayer reasonably expects a recoverable debt to arise in respect of the completion or partial
completion of that work within 12 months after the amount was paid (the balance is deductible in the
following year even if no recoverable debt is expected to arise in the future).
Note: WIP is the value of services performed by a professional practice where circumstances do not yet allow demand for payment
(ie unbilled services income). The legislation does not provide a method for valuing WIP. This is a commercial decision between the
parties.

At the partner level:

• Capital gains tax – For CGT purposes, the partnership is essentially ignored and a fractional interest
approach is taken. Each partner has a fractional interest in each and every CGT asset of the partnership
(ss 106-5 and 108-5(2)(c) ITAA 1997). Each partner will need to calculate their individual capital
gain/capital loss on the disposal of their interest in the partnership and each individual asset.
Capital gains are adjusted (ie reversed) out of the partnership’s net income calculation and are accounted
for on a partner-by-partner basis.
The example below illustrates the taxation consequences of changes to the composition of a partnership.

Example 3.8 – Trading stock and depreciable plant

Assume the following facts:

• Tom and Jerry are equal partners

• They own trading stock with a cost of $100,000 and a market value of $150,000.
• They also own plant with a tax written down value of $30,000 with a market value of $50,000.
• On 30 June 2023, Tom and Jerry admit Taya and Jocelyn to the partnership.

If no elections are made, the Tom and Jerry partnership will have an assessable gain on the trading
stock of $50,000 and an assessable gain on the plant of $20,000. Alternatively, the Tom and Jerry
partnership and the Tom, Jerry, Taya and Jocelyn partnership can elect that these assets be rolled
over at their prevailing tax cost.

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202 Tax
 Example 3.9 – WIP deduction relating to a change in partnership interests
Assume the following facts:

• The P & C Partnership is an accounting practice that was originally operated by two equal partners,
Paul and Chris.
• On 1 April 2023, Paul and Chris accepted an offer from Deb and John to buy the accounting
practice. As part of the agreement, Deb and John paid Paul and Chris $22,500 for the WIP of the
practice.
• Deb and John now carry on the accounting practice as a partnership in which they are
equal partners.
• On 30 June 2023, $12,000 of the WIP at 1 April 2023 had been billed. Of the remaining work
related to the payment made to Paul and Chris, $6,000 could reasonably be expected to be
completed and billed by 31 March 2024.

Under s 25-95 ITAA 1997, a deduction for $12,000 + $6,000 ($18,000) will be available. The amount
deductible to Deb and John for the following income year is the remaining $4,500.
Note: Where partners come and go into a partnership and no amounts are actually paid/received for WIP, there would generally
be no implications for WIP. In other words, the WIP would simply roll from the old partnership to the new partnership and would
be derived for tax purposes when it is billed. Sections 15-50 and 25-95 ITAA 1997 would not apply in this circumstance because
no amount is paid or received for the WIP.

Required reading
Section 108-5(2)(c) ITAA 1997.

Sections 15-50 and 25-95 ITAA 1997.

Change in partnership structure – CGT rollover

Subdivision 122-B ITAA 1997 provides CGT rollover relief to partners in a partnership:
• who roll over assets of the partnership to a wholly owned company
• where an asset is created by the partners in a wholly owned company.
The partners can transfer to a company either:
• a specific CGT asset
• all of the partnership’s business assets.
It is the partners who own a fractional interest in each and every partnership asset, the partnership itself
does not own the asset.
The rollover applies to both common law and tax law partnerships.
This means, for example, that the joint owners of a rental property are eligible to roll over assets even
though they are not conducting a business and are not partners at general law (TR 93/32 and ATO
ID 2004/874W). They are partners of a ‘tax law’ partnership and the jointly owned property is a CGT asset
of that partnership. However, if the property was not income producing, they could not take advantage of
this rollover concession because they would not be a tax law partnership.

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Income tax – taxation of structures and transactions 203

The disposal or creation of assets by partners to a wholly owned company is illustrated by the following
diagram:

BEFORE AFTER

P1 P2 P3 S1 S2 S3

33.3% 33.3%
each each

Look-through Separate legal

entity Partnership entity Company

CGT assets held in

CGT assets
partnership

It is also relevant to note that the disposal of some assets may give rise to income gains for the partnership
which cannot be rolled over. For example, if an accounting firm rolls over work in progress to a company in
exchange for shares in that company, the partnership would be assessable under s 15-50 or s 6-5 on the
market value of the shares received (being equal to the market value of the work in progress transferred to
the company). In this context, any CGT rollover relief is academic because the income tax provisions apply
regardless to tax the gain on sale of the WIP.

Eligibility conditions

Sections 122-125 to 122-145 outline the conditions that must be met for rollover relief to be available
where partners dispose of an asset to, or create an asset in, a wholly owned company. These conditions are
summarised in the following table:

Conditions for Subdivision 122-B rollover relief

Condition ITAA 1997 section reference

CGT event A1, D1, D2, D3 or F1 has occurred as a result of the partners s 122-125
disposing of their interests in an asset or assets of, or creating an asset in,
the company.

All the partners in the partnership must choose to obtain rollover relief. s 122-125

The company may issue only non-redeemable shares as consideration for the ss 122-130(1) and (2)
acquisition, although it may assume liabilities relating to the asset or business. ss 122-140 and 122-145

The market value of the shares each partner receives must be substantially the ss 122-130(3) and (4)
same as the market value of the partner’s interest in the transferred asset(s), ss 122-140 and 122-145
and adjusted if the company assumes liabilities relating to the asset or business.

The partners must own all the shares in the company just after the CGT event. s 122-135(1)

Each partner must own the shares received in the same capacity as they s 122-135(2)
owned their previous interests (eg if the partner’s interests were owned in the
capacity of a trustee, they must receive the shares in the capacity of a trustee).

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204 Tax
 Rollover is not available for an asset that: s 122-135(3)
• is a collectable or personal use asset
• is a decoration awarded for valour or brave conduct (except if the
decoration was purchased)
• is a precluded asset (defined in s 122-25(3) to include a depreciating asset
and trading stock). Note that these assets can be transferred as part of
transferring a business. Because transferring stock and depreciating assets
have their own taxing codes outside of CGT (eg s 6-5 and the balancing
charge provisions), transferring a business to a company is outside the scope
of this topic
• becomes trading stock of the company on its disposal.

The company cannot be exempt from income tax because it is an exempt entity. s 122-135(5)

The asset transfer must be either: s 122-135(6)

• from a resident partner to a resident company
• of an asset that is taxable Australian property (s 855-15) – the shares in the
resident company must also be taxable Australian property.

Consequences for the partners

The following table summarises the consequences for the partners of a Subdivision 122-B rollover:

Consequences for the partners of a Subdivision 122-B rollover

ITAA 1997 section

Condition Consequence reference

Where the partners choose a rollover to The capital gain or loss in relation to the s 122-150
dispose of their interest in a CGT asset to CGT event is disregarded.
a company.

Where a partner’s interest in the asset transferred is:

Pre-CGT The shares are deemed to be pre-CGT. s 122-155(2)

Post-CGT The shares are deemed to have been s 122-155(1) and

acquired for a consideration equal to the s 115-30(1) Item 1
relevant cost base of the partner’s interest
in the transferred asset. The partner is also
deemed to have acquired the shares on
the date the partner acquired their interest
in the transferred asset.

Both pre- and post-CGT The shares will be deemed to be a mixture s 122-160
of both post-CGT and pre-CGT assets
determined using an allocation formula.
The shares are deemed to have been
acquired for a consideration equal to the
relevant cost base of the partner’s
interest in the transferred asset. The
shares will also be deemed to be held for
more than 12 months if the asset rolled
over has been held for more than
12 months.

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Income tax – taxation of structures and transactions 205

Consequences for the company

The following table summarises the consequences for the company of a Subdivision 122-B rollover:

Consequences for the company of a Subdivision 122-B rollover

Where the partner’s interests in the ITAA 1997 section

asset transferred are: Consequences reference

Pre-CGT The company is treated as having s 122-200(3)

acquired a pre-CGT asset.

Post-CGT The company inherits the sum of the cost s 122-200(2)

bases of the partners’ interests
in the asset.

Partly pre-CGT and partly post-CGT The company is deemed to acquire two ss 122-200(4), (5)
separate assets (ie a pre-CGT and a
post-CGT asset), with the cost base of the
post-CGT asset determined by reference
to the sum of the partners’ cost bases of
their interests in the relevant asset.

The following example looks at the CGT rollover relief under Subdivision 122-B.

Example 3.10 – CGT Rollover Relief

John and Janet are 50/50 Australian partners in a post-CGT rental property:

For various commercial reasons, they would like to transfer their partnership interests in consideration
for non-redeemable shares in a 100% owned Australian company and minimise their tax:

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206 Tax
 Company

CGT rollover relief under Subdivision 122-B would be available because the rollover conditions
summarised above are met, bearing in mind that each partner would be disposing of a fractional
interest in their tax partnership asset (being 50% of the rental property). Further, the company would
inherit the cost base of the partners’ interests in the property.

Note, in practice, rolling assets from a partner to a company may cause other complications (eg
possible loss of CGT discount provisions, inability to negatively gear etc). Therefore, assets should
not be transferred to a company without thinking through all of the issues.

Partnership refinancing – interest payments on refinanced amounts

Interest payable on borrowings by a partnership to fund working capital or to buy income-producing assets
is deductible.
Under what is known as the ‘refinancing principle’, interest payable on borrowings used to fund a
repayment of monies originally invested by the partners in the business is also deductible.
However, the interest will not be deductible to the extent that the payment to the partners does not
replace capital primarily invested by the partner but is for an internally generated revaluation of assets not
yet realised (eg land or goodwill).
In FCT v Roberts and Smith, the partnership claimed interest deductions for $125,000 borrowed. The issue
was whether interest was deductible on partnership borrowings used to pay out partners’ capital
contributions. The partners used their payouts for private purposes. The Commissioner originally
disallowed the interest deductions on the basis that the borrowing replaced capital was used for private
purposes and thus the $125,000 borrowed was not used to produce assessable income.
The Full Federal Court held that the purpose for which the money was borrowed (ie to fund the working
capital and ongoing operations of the partnership) was of primary importance, rather than the use to which
the funds were put. In other words, if the partnership had initially borrowed the funds from a bank –
instead of having each partner contribute a large amount of capital – then the interest on such borrowings
would have been deductible. In this case, the funds were subsequently borrowed from a bank to refinance
earlier borrowings and, in such a case, interest on these funds used to produce assessable income should
also be deductible. This is known as the refinancing principle.
The court said that a deduction for interest on such financing would be limited to the capital of the
partnership. This would include capital contributed and profits not drawn on by the partners but left in the
business. A deduction would not be allowed for borrowings to replace capital generated from a revaluation
of assets, such as the recognition of internally generated goodwill.
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Income tax – taxation of structures and transactions 207

The views of the ATO on the application of the decision in Federal Commissioner of Taxation v Roberts &
Smith (1992) 37 FCR 246 are found in TR 95/25. The Commissioner accepts the decision in FCT v Roberts &
Smith and expands the application of that decision beyond common law partnerships to companies
(see paras 12–17 of TR 95/25).
The next example looks at partnership borrowings and which interest payments are deductible.

Example 3.11 – Refinancing

Andrew and Anna conduct a partnership. The partnership borrows to:
1. Return current year profits to the partners.
2. Return partner capital to the partners.
3. Recognise internally generated goodwill.
The accounting entries are as follows:

Dr Bank

Cr Bank Loan

Dr Partner Drawings

Cr Bank

Dr Partner Capital

Cr Bank

Dr Goodwill

Cr Bank

The interest in respect of entries 1 and 2 would be deductible but not the interest in respect of entry 3.

Required reading
Sections 90 and 91 ITAA 1936.

TR 95/25.

3.1.4 Trust
To determine the net income/(loss) of a trust, tax practitioners need to be able to apply the following
common tax rules and principles outlined in the below tables.

TABLE: Trust – key tax attributes

Section ITAA
1997 unless
Item otherwise stated Guidance

Taxpayer and tax 95, 97, 98, 99, A trust is not a separate legal entity and therefore is not usually a
rate and 99A ITAA taxpayer for income tax purposes.
1936
However, a trustee is required to prepare and lodge an income tax
return that discloses the net trust income and the allocation of that
net trust income to the beneficiaries.

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208 Tax
 Once a net trust income has been determined, it may be taxable to:
• The beneficiary – where the beneficiary is a resident, is presently
entitled to the income, and is not under a legal disability (s 97(1)).
• The trustee on behalf of the beneficiary, where the beneficiary:
– Is presently entitled to the income but is under a legal disability
(eg is under 18 years of age) (s 98(1)).
– Is a non-resident taxpayer (s 98(2A), (3) and (4)). However: the
non-resident may also be taxable of this income and entitled to
reduce their income tax payable by the tax already paid by the
trustee.
– Has a vested and indefeasible right (s 98(2)).
• The trustee – where the net income is not allocated to a
beneficiary (ie no beneficiary is presently entitled to the income):
– General rule (s 99A).
– Special rule – deceased estate (s 99).

The tax rate depends on whether the trustee or beneficiary is being

taxed and under which section of the tax law they are being assessed.

Residency 95 ITAA 1936 The residency of a trust depends on the residence of the trustee or
the central management and control of the trust (s 95(2) and
(3) ITAA 1936).

Net trust income (ie as determined under the income tax law and
therefore commonly referred to as the trust’s taxable income) is
calculated as if the trustee is a taxpayer that is a resident (s 95(1)
ITAA 1936).

Note: The focus of the core tax subject is resident trusts. The
implications for non-resident trusts are therefore not considered in
this guide.

Allocation of Trust income (ie accounting income as determined by the trust deed)
trust may be distributed to the beneficiaries.
income/(loss)
If there is a trust loss (ie accounting loss as determined by the trust
deed) then there is no distribution to the beneficiaries.

Allocation of net The net trust income (ie taxable income) is allocated to each
trust beneficiary using a proportionate approach. In a very simple
income/(loss) scenario, what this means is that, if Beneficiary A received 40% of
the trust income (ie accounting income) then Beneficiary A’s share of
the net trust income (ie taxable income) will be 40% (FCT v Bamford
and TD 2012/22).

A net trust loss (ie the trust’s taxable loss) is not allocated to the
beneficiaries. Instead it is carried forward by the trust and can be
used to reduce future assessable income of the trust. To utilise a
carry forward net trust loss, a trust needs to satisfy additional rules.

The trust loss rules are covered in the Advanced Tax subject.

Goods and 9-20 GST Act A trust that carries on an enterprise can be registered for GST.
services tax
(GST) Refer to QRG: Other taxes and transactions (Part 1) in Topic 4.1 of
your learning materials.

Fringe benefits 136(1) FBTAA A trust that is an employer can provide a fringe benefits to an
tax (FBT) 1986 employee (or their associate) and may be subject to FBT.

Refer to QRG: Other taxes and transactions (Part 2) in Topic 4.2 of

your learning materials.

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Income tax – taxation of structures and transactions 209

 Section ITAA
1997 unless
Item otherwise stated Guidance

Small business A trust that carries on a business may be classified as an SBE (or an
entity (SBE) entity that would be an SBE applying an alternate aggregated
concessions turnover threshold) and choose to apply the available SBE
concessions where eligible.

Refer to Topic 3.1.5.

Personal services A trust may be classified as a PSE and subject to the personal services
entity (PSE) income (PSI) rules where it is not a personal services business (PSB).

The PSI rules are covered in the Advanced Tax subject.

Family trusts and There are trust anti-avoidance rules that apply to both family trusts
closely held and closely held trusts.
trusts
The trust anti-avoidance rules are covered in the Advanced Tax
subject.

TABLE: Trust – key sections

Section ITAA
Key 1997 unless
requirements otherwise stated Guidance

Dividends, 44(1), 128A(3) A trust that receives a franked dividend from an Australian company
interest and and 128D ITAA must include the dividend and a franking credit gross-up in its net
royalty income 1936 trust income.

207-35 and Special rules apply to allow a trust to allocate franked dividends and
207-45 the attaching franking credit to particular beneficiaries (ie the
streaming rules for franked dividends). The special rules are not
covered in this guide.

A distribution of dividend, interest, and royalty income to a

non-resident beneficiary retains its tax character (s 128A(3)).
A non-resident beneficiary:
• Is not entitled to a franking tax offset.
• Is subject to withholding tax on interest, dividend (unfranked
portion), and royalty income that is allocated to them.
• The interest, dividend (unfranked and franked portion), and royalty
income is deemed to be NANE income (s 128D).

Refer to Topic 3.2.2.

Foreign income 6-5 and 97 A trust includes gross foreign income (ie net income grossed-up for
ITAA 1936 foreign taxes withheld) in its net income, unless an exemption applies.

There are no special rules that allow a trust to allocate foreign income
and attaching foreign income tax offsets (FITOs) to particular
beneficiaries (ie there are no streaming rules for foreign income).
Therefore, each beneficiary is allocated a share of the trust’s foreign
income.

Note: A non-resident’s assessable income only includes a share of

the net income that is attributable to sources in Australia (s 97(1)
ITAA 1936). Therefore, foreign income allocated to a non-resident is
not taxed.

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210 Tax
 Net capital 102-5 A trust must follow the method statement in s 102-5 to determine
gains/(losses) the net capital gain included in the net trust income or the net
capital loss carried forward. A trust can generally apply:
• The CGT general 50% discount.
• The SBE CGT concessions (where relevant).
Special rules apply to allow a trust to allocate net capital gains to
particular beneficiaries (ie the streaming rules for capital gains). The
special rules are not covered in this guide.

A net capital gain allocated to a beneficiary generally retains its

nature as a capital gain in the hands of the beneficiary. However, to
determine a beneficiary’s net capital gain:
• The CGT concessions applied by the trust must be reversed.
• The beneficiary must then determine their entitlement to the CGT
general 50% discount and the SBE CGT concessions (where
relevant) based on their own tax profile.

Note: Despite the above proposition that a capital gain retains its
nature, where a capital gain arises from non-Taxable Australian
Property (TAP) and is distributed by a discretionary trust to a
non-resident beneficiary, the beneficiary is not able to disregard the
capital gain under Division 855. Its application is outside the scope
of the core tax subject but should be considered in practice.

Difference 104-70 and The trust income (ie accounting income) and the net trust income
between 104-71 (ie taxable income) are usually different amounts. Therefore, the
accounting and amount a beneficiary receives as a trust distribution (in cash or in
tax allocations: specie) each year is usually different to the amount that same
CGT event E4 beneficiary in required to include in their assessable income.
and cost base
reduction

Where there is a non-assessable distribution (ie a difference

between the accounting and taxable income allocation) to a
beneficiary of a unit trust:
• The cost base of the unit or interest is reduced. However, the unit
holder can disregard parts of the payment that result from:
– CGT general 50% discount.
– Certain types of NANE income flow to the unitholder under the
SBE CGT concessions.
• If the cost base is reduced to $nil, further non-assessable
distributions trigger a capital gain under CGT event E4 (s 104-70).

Other CGT 104-10, 104-60, There are a number of other CGT events relating to trusts including:
events 104-75, 104-80, • CGT event E1 – when a trust is created over a CGT asset
and 104-85 (s 104-10).
• CGT event E2 – when an asset is transferred to a trust (s 104-60).
• CGT event E5 – absolute entitlement to trust assets (s 104-75).
• CGT event E6 – disposal of CGT asset to a beneficiary to satisfy
beneficiaries right to receive ordinary or statutory income
(s 104-80).
• CGT event E7 – disposal of CGT asset to a beneficiary to satisfy
beneficiaries interest in trust capital (s 104-85).

Refer to Topic 2.2.4.

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Income tax – taxation of structures and transactions 211

Trust net income or loss
Divisions 6 (ss 95 to 102) and 6E (ss 102UW to 102UY) of the ITAA 1936 contain the primary provisions
for the taxation of trusts and beneficiaries, as follows:

Determine both the accounting income

and the net income (effectively taxable
Step 1:
income) of the trust. ‘Net income’ is defined
in s 95 ITAA 1936 and is dicussed below

Identify the beneficiaries of the trust. The

nature of each beneficiary will determine:
Step 2:
• who is assessable on the trust’s net income
• how much tax is to be paid

This topic considers Step 1.

Net taxable income

Net income, defined in s 95(1) ITAA 1936, is the excess of assessable income over deductions (in effect a
taxable income calculation), calculated on the assumption that the trustee is a resident individual taxpayer.
The calculation is focused on the trustee as, by law, the trustee owns the trust property, earns any income
and incurs any liabilities.
If the trust makes a loss, that loss is trapped in the trust and must be carried forward to be offset against
income in a future year – it cannot be distributed to a beneficiary (Doherty v FCT). When the loss is claimed
as a deduction in that future year, it should be remembered that it cannot be offset against income due to a
beneficiary if the:
• loss is required to be met out of corpus (capital)
• beneficiary has no interest in the capital of the trust.

Deductions for interest

Careful consideration is needed before claiming a deduction in the net income calculation for interest on
funds borrowed by the trustee to pay a monetary distribution to a beneficiary. The refinancing principle
expressed in FCT v Roberts and Smith is not, in the ATO’s view, as applicable to trusts as it is to partnerships
and companies. The ATO does not accept that the interest is deductible simply because the borrowing
of funds by the trustee allows income-producing assets to remain part of the trust estate. The decision in
Hayden v FCT (see example below) supports the ATO’s view.
However, in TR 2005/12, the ATO accepts that the interest expenses are deductible if the objective of the
trustee in borrowing funds is to refinance a returnable amount.
The ruling provides the following examples when money or property is a returnable amount:
• An individual has subscribed money for units in a unit trust and has a right of redemption in relation to
the units, and the money is used by the trustee to purchase income-producing assets.
• A beneficiary has an unpaid present entitlement to some or all of the capital of a trust estate, or some or
all of the net income of the trust estate, and the entitlement amount has been retained by the trustee
and used in the gaining or producing of assessable income of the trust.
• A beneficiary lends an amount to the trustee who uses the money for income-producing purposes (eg by
depositing it in a bank to receive interest).
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212 Tax
In TD 2018/9, the ATO stated that a beneficiary of a discretionary trust who borrows money, and on-lends
all or part of that money to the trustee of the discretionary trust interest-free, is usually not entitled to a
deduction for any interest expenditure. This is because there is no nexus between the expense and income
as any future distribution from the trust depends on the discretion of the trustee.
In the following example, interest claimed by a trust executor was ruled to be non-deductible.

Example 3.23 – Funds borrowed to make trust distributions

In Hayden v FCT, a son commenced proceedings in the Supreme Court of Queensland claiming that
his deceased father had failed to make adequate provision from his estate for the proper
maintenance and support of his son. The court ordered that the estate pay the son $150,000. In
order to pay this amount, the executor borrowed $150,000 rather than sell the income-producing
assets of the estate. The interest incurred was claimed as a deduction. The court held that the
interest was not deductible. In his decision, Justice Spender stated:

Here, the borrowed funds were used to discharge an obligation by the estate [to pay an amount ordered
by a court under family maintenance provisions]. I can see no difference in the present case from a case
where an individual taxpayer, in order to discharge an obligation such as school fees, borrows funds on
which interest is paid rather than sell income-producing assets and from the proceeds discharge the
obligation. The paying of school fees requires funds, on which interest might be otherwise earned; that
fact does not make interest on funds borrowed for the purpose of paying school fees deductible.
The discharge of the obligation is a purpose quite independent of the property.

Net income retains its tax character

Specific provisions allow:

• a franked dividend derived by a trust to retain its tax character as a dividend and the associated franking
credits to pass through the trust when a trust distribution is made
• capital gains derived by a trust to retain their tax character as capital gains in the hands of beneficiaries
• trust distributions of interest, dividends and royalties to a non-resident beneficiary to retain their tax
character (s 128A(3) ITAA 1936). This means that trustees distributing such amounts to non-residents
must comply with the withholding tax obligations.
However, the High Court decision in Federal Commissioner of Taxation v Bamford (2010) 240 CLR 481 put into
doubt the proposition that all types of income and gains derived by a trust generally retain their tax character
in the hands of the beneficiary (also see Baker v Archer-Shee [1927] All ER Rep Ext 755 and Charles v FCT
(1954) 90 CLR 598). A Treasury policy paper (released in October 2012) contained proposals to provide
legislative certainty that all amounts that flow through a trust would retain the character that they had in
the hands of the trustee when assessed to the beneficiaries, unless another part of the tax law requires
that the amount be treated otherwise. Legislation to give effect to these proposals has yet to be released.
However, the ATO expressed views on the taxing of non-resident beneficiary capital gains in TD 2022/13
and TD 2022/12. These views have been endorsed in Peter Greensill Family Co Pty Ltd (trustee) v
Commissioner of Taxation [2021] FCAFC 99.

Income of the trust (ie accounting income)

The income of the trust is its distributable income (ie a net concept), which is determined by the trustee
based on accounting principles and the terms of the trust deed (Federal Commissioner of Taxation v Totledge
Pty Ltd (1982) 40 ALR 385). It is the income of the trust as defined by the trust deed that may be
distributed in cash to the beneficiaries of a trust. It is important for taxpayers to understand what the
income of the trust is because s 97 ITAA 1936 provides that a beneficiary is generally only subject to tax

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Income tax – taxation of structures and transactions 213

on the trust’s net taxable income if they are first presently entitled to the income of the trust. See below
for a discussion of present entitlement.
The income of the trust and the trust’s net taxable income are sometimes different. However, the trust
deed may be drafted in a way that aligns the two. Differences between the income of the trust and its net
income can arise because of tax adjustments. For example, tax depreciation rates may differ from the rates
used for trust accounting purposes, or trust expenses may not be deductible for income tax purposes.
In FCT v Bamford, the High Court held that the income of the trust is to be determined in accordance with
trust law principles and that the trust deed may influence what is trust income. For example, if a trust deed
defines trust income to include a net capital gain under ITAA 1997, it would generally include that amount.
Depending on the trust deed, there can be a mismatch between the income of the trust and its net
taxable income.
In the worst case, an income beneficiary may be assessable under s 97 ITAA 1936 on the accounting-tax
difference represented by a capital gain, but may not be entitled to actually receive the capital profit as a
trust distribution under the terms of the trust deed. This is why the specific entitlement rules (discussed later
in this topic under streaming of trust distributions) were introduced for capital gains and franked dividends.
Where the income of the trust exceeds the trust’s net taxable income there is a portion of a trust
distribution that may be non-assessable to a beneficiary. The non-assessable portion may have CGT
consequences for a beneficiary (see later in this topic, under ‘CGT events relating to trusts’).

Proportionate allocation approach

The trust’s taxable net income is taxed in the hands of the beneficiaries (or the trustee on their behalf)
based on their share of the income of the trust estate. For example, if the beneficiary has a 50% share of
the trust’s income, they have a 50% share of the trust’s net income. This is referred to as the proportionate
approach and is the methodology approved by the courts (FCT v Bamford; TD 2012/22).
The operation of the proportionate approach is best illustrated by an example. In both of the example
scenarios the income of the trust consists solely of interest and net rental income. There are no capital
gains or franked dividends, which would otherwise create streaming complications.

Example 3.24 – Proportionate approach

Scenario A: The trust’s income is the same as its net income
Under the trust deed for the Riverdale Family Trust, income is defined to be the same as the net
income calculated for tax purposes. The deed does not contain any provision enabling the trustee to
determine a different amount to be the income of the trust. Prior to 30 June, the trustee calculated
the net income for the year as $120,000.

The trustee resolves to distribute $40,000 to each of beneficiaries Ann, Ben and Cy and they were
each assessed on that amount. This distribution was not done by formula (eg 13 to each beneficiary), it
was a monetary distribution of a fixed amount per beneficiary.

Subsequently, the Commissioner determined on audit that the trustee had omitted $9,000 interest
income in calculating the net income. The net income and consequently the trust income was
therefore $129,000.

The deed contained no provisions dealing with the situation where the trustee failed to appoint
some or all of the income of the trust estate by a particular time. As the trustee had distributed only
$120,000, there is $9,000 trust income to which no beneficiary was presently entitled.

The corresponding share of net income ($9,000) is therefore assessed to the trustee.

If the distribution had been done by way of formula instead of a monetary distribution, Ann, Ben and
Cy would each be assessable on an additional $3,000 each.

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214 Tax
 Scenario B: Trust income determined and differs from net income
Under the trust deed for the Farmer Trust, income is defined to be the amount determined by the
trustee or, if no determination is made, it is the same as the net income calculated for tax purposes.
Prior to 30 June, the trustee determined, pursuant to the trust deed, that the income of the trust for
the year was $120,000.

The trustee resolved to distribute $40,000 to each of beneficiaries Ed, Fred and Greg.

The trustee’s determination that the income of the trust was $120,000 had the effect of fixing the
income of the trust at $120,000.

Although the trustee believed at the time of the determination that the net income would also be
$120,000, the net income was actually $129,000 – the trustee had mistakenly believed that $9,000
related to a later income year.

Unlike the result in Scenario A, each beneficiary in this example was presently entitled to one-third of
the trust’s income and each is assessed on $43,000, being one-third of the net income of the trust.
No amount of the trust’s net income was assessed to the trustee.

Impact of streaming

It may be possible to stream capital gains and franked dividends to beneficiaries who have been made
specifically entitled to distributions of such amounts in accordance with the terms of the trust deed. The
distribution of such amounts to beneficiaries is dealt with under specific rules contained in the CGT and
dividend provisions. See below for a detailed discussion of streaming.
It is important to note, however, that the net taxable income calculation at the trust level is not impacted by
the special rules dealing with the distribution of capital gains and franked dividends, see note in s 102UX(1)
ITAA 1936. This means, for example, that the following items form part of the trust’s net income calculation:
• net capital gains, and the trust is entitled to the 50% CGT discount (ss 102-5(1) and 115-10 ITAA 1997)
• franked dividends and the gross-up amount for franking credits (s 44(1) ITAA 1936 and s 207-20(1) or, if
not a corporate trustee, s 207-35(1) ITAA 1997).

Trust income tax returns

Each year the Commissioner requires taxpayers, including trusts, to lodge an income tax return which
explains how the net income of the trust has been calculated.

Taxation of net income – relevant taxpayer

Once a trust’s net income has been determined, that income may be taxable in the hands of the:
• trustee
• beneficiary
• trustee, on behalf of the beneficiary.
Determining the relevant taxpayer depends on whether any beneficiary has a present entitlement to that
trust income and/or whether or not the beneficiary is under a legal disability.

Flow chart approach

The following flow chart can be used to determine who is assessed on the net income of a resident trust
estate. The flow chart uses the following assumptions:
• no beneficiary is specifically entitled to franked dividends and capital gains (ie there is no streaming of
distributions)
•
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the trust only derives Australian-sourced income.

Income tax – taxation of structures and transactions 215

 Is the beneficiary presently entitled to a share of trust income?

Yes No

If a discretionary trust, was income

Is the beneficiary under a legal disability?
applied for s 101 purpose? No

Yes No Yes

Is the beneficiary a resident natural

No person and not a trustee?

Yes

Does the beneficiary have a

Is the beneficiary Is the beneficiary under
‘vested and indefeasible’
a resident? a legal disability?
interest? s 95A(2)

Yes No Yes No No Yes

Tax Tax trustee Tax Tax trustee

Tax trustee Tax trustee Tax trustee
beneficiary ss 98(2A), beneficiary ss 99 and
s 98(1) s 98(1) s 98(2)
s 97(1) (3), (4) s 97(1) 99A

Note: Legislative references relate to ITAA 1936.

Present entitlement

In practice, present entitlement can only be determined by a careful reading of the trust deed, a clear
understanding of how the trust was managed by the trustee and the details of all trustee resolutions
and distributions.
The concept of present entitlement was considered in Federal Commissioner of Taxation v Whiting (1943) 68
CLR 199 and in Taylor v FCT (1970) 119 CLR 444. The expression embraces a vested interest in possession
of trust property or income, as opposed to an expected or contingent future interest. The beneficiary must
be entitled to immediate payment, whether or not payment is made. The beneficiary’s legal capacity to
demand payment is irrelevant. That is, a person can still be presently entitled to trust income even if they
are under a legal disability and this is also reflected in the drafting of s 98(1) ITAA 1936.
In Harmer & Ors v FCT (1991) 173 CLR 264, present entitlement was defined as a situation where the
beneficiary has:
• an interest in trust income that is both vested in interest and vested in possession
• a legal right to demand and receive payment, whether or not the:
– precise amount can be determined before year end (eg accounts may not be completed until some
months after year end, yet the trustee resolves to distribute income at 30 June)
– trustee has funds available for immediate payment (a beneficiary may still be presently entitled to trust
income even though an amount has not been paid; it is only a right to demand that must exist)
– beneficiary is under a legal disability and does not have the legal capacity to demand payment
(eg children under the age of 18, bankrupts and those who are mentally incapable).

The beneficiaries of a discretionary trust do not have any interest in the property or income of a trust
estate. It is for the trustee to determine whether such beneficiaries will benefit at all under the terms of the

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216 Tax
trust and to what extent they will benefit. Such beneficiaries have no more than a right to have the trust
property administered (Gartside v Inland Revenue Commissioners [1968] 1 All ER 121).

Timing

Unless the trust deed provides otherwise, present entitlement arises when the trustee makes a resolution
to appoint the income to the beneficiaries or discretionary objects of the trust. The trustee must determine
present entitlement by the end of the income year (or earlier, if stipulated in the trust deed) (Colonial First
State Investments Ltd v FCT [2011] FCA 16). Note that, if the trustee does not appoint the income of the
trust for the year and there is a default clause in the trust deed, the default beneficiary nominated in the
default clause of the trust deed will be presently entitled to the income.
If there is a change of beneficiaries in a fixed trust during the income year, it is the beneficiary at the end of
the year who is entitled to the income for the whole year, unless the trust deed provides otherwise. For
example, listed unit trusts typically have a trust deed that treats beneficiaries (unit-holders) as entitled to
quarterly or biannual distributions, regardless of whether they sold their units after receiving the
distribution and before year end.
Section 95A(1) ITAA 1936 provides a type of constructive payment rule. It states that where a beneficiary
is presently entitled, the beneficiary is taken to continue to be presently entitled, notwithstanding that the
income is applied for the benefit of the beneficiary (ie actual payment to the beneficiary is not required).

Deeming rules

Present entitlement can arise in other ways. For example:

• In the case of a discretionary trust, a beneficiary in whose favour the trustee’s discretion is exercised is
deemed, by s 101 ITAA 1936, to be presently entitled to the amount paid to them or applied for
their benefit.
• In the case of a fixed or unit trust, present entitlement typically arises because the terms of the trust deed
provide that the beneficiaries (or unit holders) have a vested interest in the income or capital of the trust.
• Aside from s 101 ITAA 1936, a beneficiary may be deemed to be presently entitled by the operation of
s 95A(2) ITAA 1936 in circumstances where there is not otherwise a present entitlement but there is a
vested and indefeasible interest in the trust’s income.

Anti-avoidance rules

Two specific anti-avoidance rules apply to address arrangements whereby exempt entities are made
presently entitled to shelter the taxable income of a trust:
• The pay or notify rule (s 100AA ITAA 1936) applies if an exempt beneficiary (eg a charity) has not been
notified of, or paid their present entitlement to, income of the trust estate within two months of the end
of the income year. In this circumstance, and subject to the Commissioner’s discretion, the exempt
beneficiary is treated as not being presently entitled to that income and the trustee will be assessed
under s 99A ITAA 1936.
• The benchmark percentage rule (s 100AB ITAA 1936) applies if the entitlement of an exempt entity (eg a
charity) to the income of the trust estate (ignoring any franked distributions and capital gains that any
entity is specifically entitled to), expressed as a percentage, exceeds a benchmark percentage. This rule
aims to prevent an exempt entity from receiving a disproportionate share of the trust’s net income,
relative to the exempt entity’s trust entitlements. If the exempt beneficiary’s entitlement exceeds the
benchmark percentage, the beneficiary is treated as not being presently entitled to the percentage share
of the income of the trust estate that exceeds the benchmark percentage.
Under both rules, the trustee is assessed on the share of the trust’s taxable income to which the exempt
beneficiary has been disentitled. These rules do not apply to tax loss entities.
The Commissioner has a discretion not to apply the anti-avoidance rules if, in the circumstances, it would
be unreasonable to do so.
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Income tax – taxation of structures and transactions 217

The following examples illustrate these rules.

Example 3.25 – Accounting loss (trust income) and net income

Big Trust is an Australian unit trust. It distributes all of its accounting profits each year to unitholders.
In the current income year, the trust made an accounting loss of $5,000 and no corpus/capital
distributions were made. The trust has net taxable income of $20,000 for the current income year.
Because the trust made an accounting loss there is no beneficiary who is presently entitled to a share
of the trust’s income. Therefore, the trustee will be assessed on the $20,000 net income.

Example 3.26 – Accounting profit (trust income) and net loss

Large Trust is an Australian discretionary trust. In the current income year, the trust made an
accounting profit of $100,000 and distributed $10,000 to one of its beneficiaries. The trust made a
net tax loss of $50,000 because of a deductible prepayment which was capitalised for accounting
purposes. A beneficiary is only assessable on their share of a trust’s net income; trust net losses are
retained in the trust. Therefore, the beneficiary has no amount to include in their assessable income
in the current income year.

Example 3.27 – Distribution of accounting profit (trust income) and lower net
income
Funny Trust is an Australian discretionary trust. In the current income year, the trust made an
accounting profit of $100,000 and distributed $50,000 to one of its beneficiaries. The trust had net
taxable income of $60,000. Because the beneficiary is entitled to 50% of the accounting income,
they are assessable on 50% of the net income (ie $30,000). The trustee is assessed on the remaining
$30,000 to which no beneficiary is presently entitled.

Example 3.28 – Distribution of accounting profit (trust income) and higher net
income
Pebble Trust is an Australian discretionary trust. In the current income year, the trust made an
accounting profit of $100,000 and distributed $50,000 to one of its beneficiaries. The trust had net
taxable income of $140,000. Because the beneficiary is entitled to 50% of the accounting income,
they are assessable on 50% of the net income (ie $70,000). The trustee is assessed on the remaining
$70,000 to which no beneficiary is presently entitled.

No present entitlement

The trustee is assessed on so much, if any, of what may conveniently be referred to as the net income of
the trust estate to which no beneficiary is presently entitled (ss 99 and 99A ITAA 1936). The trustee pays
the tax and the income is not taxed again when distributed to a beneficiary, nor does the beneficiary get a
credit for the tax paid by the trustee.

General rule

Section 99A ITAA 1936 applies in relation to all trust estates unless the:
• trust estate is of a kind identified in s 99A(2) as a deceased estate, bankrupt estate, or family
maintenance trust
• Commissioner forms the opinion that it would be unreasonable for s 99A ITAA 1936 to apply to the trust
estate in relation to the year of income (eg trusts for injured persons or those in difficult circumstances,
family breakdown situations, etc).
Where s 99A ITAA 1936 applies, the trustee is taxed at a flat rate of 45% plus the 2% Medicare levy (ie 47%).
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218 Tax
Where the Commissioner determines that it would be unreasonable for s 99A ITAA 1936 to apply, the net
income of the trust estate is assessed under s 99 ITAA 1936, generally at individual rates, rather than at the
47% penalty rate.

Special rule – deceased estate

The most common situation in which s 99 ITAA 1936 will apply is in the context of the administration of a
deceased estate.
Beneficiaries usually cannot be presently entitled to income and gains derived by a deceased estate during
the administration of the estate and it is the trustee who will be liable for tax during this period at
concessional tax rates (FCT v Whiting). This concession generally only lasts for 3 years, after which different
penalty rates and thresholds apply. However, where it becomes apparent during the period of
administration that part of the net income of the estate will not be required to pay for the deceased’s
debts, the executor may exercise a discretion to pay some of the income to beneficiaries. The fact that the
estate has not been fully administered does not prevent the beneficiaries in this situation from being
presently entitled to the income actually paid to, or on behalf of, the beneficiaries (IT 2622).
The ATO’s practice in IT 2622 is to adopt an apportionment approach in the income year in which the
estate is fully administered.
• Income derived in the period between the beginning of the income year and the day administration was
completed – assessed in the hands of the executor under s 99 ITAA 1936.
• Income derived in the period between the day administration was completed and the end of the income
year – assessed to the adult beneficiaries presently entitled to the income under s 97 ITAA 1936 (the
trustee will be liable to pay tax at normal rates if a child is presently entitled under ss 98 and 102AG
ITAA 1936).

Legal disability

A person who is under a legal disability is a person who is unable to give the trustee an immediate and valid
discharge in respect of a distribution of income from a trust.
In practice, three classes of persons are under a legal disability for trust and tax law purposes:
• a minor who was under the age of 18 on the last day of the income year
• a bankrupt
• an insane or mentally incapable person.
Section 98(1) ITAA 1936 provides that, where a beneficiary who is under a legal disability is presently
entitled to a share of trust income, the trustee is liable to pay tax on that share. A credit for the tax payable
by the trustee is allowed to the beneficiary under s 100(2) ITAA 1936. This circumstance is illustrated by
the following example.

Example 3.29 – Beneficiary under a legal disability

Peter Brown suffered severe head and spinal injuries in a motorcycle accident in 2018 and now
resides in the special care unit of a nursing home. He is 25 years old.

The state guardianship tribunal accepted medical evidence that Peter was incapable of managing his
own affairs and has appointed a guardian and a financial manager.

The Brown family has established a discretionary trust for Peter. The trust invests in government
bonds and the trustees apply the income of the trust estate for Peter’s benefit (eg by paying for
various medical expenses). In the current year, the income of the trust and the net income is $30,000.

Section 101 ITAA 1936 deems a beneficiary to be presently entitled to the amount paid to them or
applied for their benefit. For the current income year, Peter is deemed presently entitled to $30,000,
being the amount of income applied for his benefit.
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Income tax – taxation of structures and transactions 219

 As Peter is under a legal disability in the relevant year of income, the trustee is liable to be assessed
and to pay tax pursuant to s 98 ITAA 1936. The tax will be calculated at adult resident individual
rates and Peter will be credited for the tax paid on his behalf by the trustee when his financial
manager lodges his personal tax return (s 100(2) ITAA 1936).

Minors

There are special rates that apply to the eligible taxable income of resident and non-resident minors
(ie individuals less than 18 years of age on the last day of the year of income – see ss 102AA–102AGA,
Division 6AA ITAA 1936 and Schedule 11 ITRA 1986).
Broadly, under these rules, the eligible taxable income of minors is taxed at the highest marginal tax rate.
Eligible taxable income includes all types of assessable income except for employment income, business
income, lottery winnings, and testamentary trust distributions where the income is generated from assets
that are transferred from a deceased estate, or the proceeds of the disposal or investment of those assets.
Therefore, eligible taxable income commonly includes dividends, interest, rent, royalties and capital gains.
An individual can derive these types of income either directly or via a trust distribution.
Any taxable income of a minor that is not eligible taxable income is taxed at the general tax rates
(ie resident and non-resident rates, as applicable).
Where an amount is eligible taxable income of a resident minor, the income is taxed as follows:

Income Tax rates for 2022–2023 income year

$0 – $416 Nil

$417 – $1,307 Nil plus 66% of the excess over $416

Over $1,307 45% of the total amount of income that is not excepted income

Source: www.ato.gov.au/individuals/investing/in-detail/children-and-under-18s/your-income-if-you-are-under-18-years-old/?page=4

Most family discretionary trusts would limit trust distributions to minors to $416 or less. Where the
distribution exceeds this amount, the income is taxed to the trustee on behalf of the minor. The following
example illustrates the rules for trust distributions to minors.

Example 3.30 – Minors

The XYZ Trust has accounting income of $100,000 and net taxable income of $120,000. This
comprises rent. The trustee resolves to distribute $400 to five beneficiaries who are under 18 with
the balance to a corporate beneficiary. The trustee’s aim is to cap the minor’s assessable income to
less than $416.

Because the minors are each entitled to 0.4% of the accounting income, they are assessable on 0.4%
of the taxable income (ie $480).

Because this exceeds the $416 tax-free threshold, the beneficiaries will be assessable on the balance
as follows:

$64 × 66% = $42.

This will mean that each of the minors will need to have a tax file number and lodge a tax return.

The trustee has forgotten that the minors are assessable on their proportionate share of the taxable
income – not the accounting income.

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220 Tax
Streaming of trust distributions
As an interim response to the High Court decision in FCT v Bamford (pending the outcome of a broader
review of the taxation of trusts), the government enacted measures in 2011 to allow a trustee to appoint or
stream capital gains and franked dividends, including any attached franking credits, to specific beneficiaries.
This is subject to anti-avoidance rules and where permitted by the trust deed. Other types of income like
interest, rent, etc cannot be streamed.
This means that, where permitted by the trust deed, capital gains and franked dividends can be effectively
streamed to beneficiaries for tax purposes by the trustee making the beneficiaries specifically entitled to
those amounts. In practice, such streaming opportunities are relevant mainly to discretionary trusts.
The tax planning benefits of streaming can be best illustrated by an example.

Example 3.31 – Streaming capital gains and franked dividends

The Jones Discretionary Trust holds shares listed on the Australian Securities Exchange (ASX) and
generates franked dividend income and the occasional capital gain. The trust has made the family
trust election (FTE) – discussed later in this topic – and the trust deed empowers the trustee to make
beneficiaries specifically entitled to capital gains and franked dividends.

For the current income year, the trustee makes the following resolutions on 30 June:

• Bill Jones is specifically entitled to the net capital gain ($150,000).

• Betty Jones is specifically entitled to the franked dividends ($70,000 with accompanying franking
credits of $30,000).

This allocation is advantageous to both beneficiaries because:

• Bill Jones has personal carry forward capital losses that can be utilised against the net capital gain
flowing to him through the trust.
• Betty Jones is currently studying full time at a university and is on a low personal tax rate bracket.
The franking credits attached to the franked dividends flowing to her through the trust will more
than offset the income tax on the dividends and she will receive a refund of the excess franking tax
offset when she lodges her income tax return.

Streaming requirements

For streaming to be effective:

• the trust deed must be suitably worded to permit the creation of a specific entitlement of capital gains
and franked distributions
• the trustee makes the necessary resolutions within the required deadlines to make beneficiaries
specifically entitled (see below)
• discretionary trusts should make a family trust election (FTE) (see the sections on family trusts later in
this topic).

Trustee resolutions

To ensure that a beneficiary is presently entitled to trust income for the income year just ended, trustee
distribution resolutions relating to beneficiary-specific entitlements (ie streamed amounts) must be made by:
• 30 June – for franked dividends
• 31 August – for capital gains (unless the trust deed requires resolutions to be made by 30 June, or
unless the capital gains form part of the income of the trust).
To avoid any unintended consequences, best practice is to ensure that all trustee resolutions are made by
30 June to ensure that a present entitlement to trust income has been created.
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Income tax – taxation of structures and transactions 221

The resolution does not need to specify an actual dollar amount to be effective, unless the trust deed
specifically requires it. A resolution is effective if it prescribes a clear methodology for calculating the
entitlement (eg ‘beneficiary A is entitled to 50% of trust income’).
In addition, provided that the distribution meeting is actually held by 30 June, the minutes do not have to
be written by then. The minutes are merely evidence of earlier meetings. They can be signed and dated at a
later date, provided the meeting to make the resolution was actually held by 30 June.

Distribution components

Irrespective of whether a beneficiary is specifically entitled to a capital gain or franked dividend, provided
the trust has a net income and the net income calculation at the trustee level includes a net capital gain or
franked dividend, the trust distribution is split into the following three components:
• Division 6 ITAA 1936 component – calculated by applying the assumptions in Division 6E ITAA 1936:
– This component is the proportionate share of the trust’s income, exclusive of capital gains and franked
dividends (and franking credits (TR 2012/D1)). The proportion is referred to as the beneficiary’s
adjusted Division 6 percentage.
– These adjustments result in what is termed Division 6E net income and Division 6E income.

• Capital gains component – calculated under Subdivision 115-C ITAA 1997 for:
– beneficiaries with a specific entitlement (s 115-227(a))
– other beneficiaries (s 115-227(b)).
• Franked dividend component – calculated under Subdivision 207-B ITAA 1997 for:
– beneficiaries with a specific entitlement (s 207-55(4)(a))
– other beneficiaries (s 207-55(4)(b)).

Trust capital gains

Trustee level

The starting point in the calculation of capital gains relating to trusts is at the trustee level, prior to the
allocation of the trust net income.
Where a capital gain or capital loss made on a CGT asset held by a trust is taken into account in the trust’s
net income calculation, the CGT calculation at the trustee level is undertaken in the normal way using the
method statement in s 102-5 ITAA 1997. This means that:
• any net capital gain forms part of the trust’s net income and the trust is eligible for the 50% CGT
discount (ss 115-10 and 115-100(a)(ii) ITAA 1997)
• a net capital loss is carried forward by the trust to a future year, subject to the loss carry forward rules
(discussed below).

Beneficiary level

Special rules apply to the capital gains component when a net capital gain is distributed and taxed in the
hands of the beneficiary or trustee, if no beneficiary is presently entitled.
Using a presently entitled beneficiary who is not under a legal disability as an example, these special rules
are the result of the combined operation of:
• Division 6E ITAA 1936, which applies s 97(1) ITAA 1936 on the assumption that the trust has no capital
gains or franked dividends (ss 102UX(2)–(3) and 102UY ITAA 1936)
• Subdivision 115-C ITAA 1997, which determines how much of the capital gain flowing through the trust
is assessable in the hands of the beneficiary. Where Subdivision 115-C ITAA 1997 applies, s 95AAB(3)
ITAA 1936 excludes the capital gain from being assessable again under s 97 ITAA 1936 (see also
s 95AAC ITAA 1936 for exclusions for ss 98, 99 and 99A ITAA 1936 amounts).

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222 Tax
As noted previously, these provisions also enable a beneficiary to be made specifically entitled to a capital
gain flowing through a trust.

Calculation method

To determine the amount a beneficiary includes in their assessable income, the beneficiary must first
gross-up their share of the capital gain of the trust for any CGT concessions applied at the trustee level
(ie calculate their extra capital gain). They then calculate their net capital gain by reducing the extra capital
gain by any CGT losses and CGT concessions to which they are entitled.
There are four steps to calculating a beneficiary’s extra capital gain under Subdivision 115-C ITAA 1997.
Step 1: Determine the beneficiary’s share of the capital gain of the trust (s 115-227 ITAA 1997). The
beneficiary’s share of the capital gain is the amount to which:
• the beneficiary is specifically entitled (ss 115-227(a) and 115-228 ITAA 1977)
• no beneficiary is specifically entitled, multiplied by the beneficiary’s share of the Division 6E income
(s 115-227(b) ITAA 1997).
Step 2: Divide that amount by the total capital gain – this gives the beneficiary’s fraction of the capital gain
(s 115-225(1)(b) ITAA 1997).
Step 3: Multiply the resulting fraction by the net income of the trust that relates to the capital gain (the
attributable gain) (s 115-225(1) ITAA 1997).
Step 4: Gross up the result in Step 3 as appropriate for any CGT concessions (eg the general CGT discount
and the small business 50% reduction) applied by the trustee to that capital gain (s 115-215(3) ITAA 1997).
These steps are illustrated in the following example.

Example 3.32 – Net capital gain made by trust

Assume the following:
• All beneficiaries are presently entitled, resident individuals who are not under a legal disability.
• The trust deed authorises the streaming of capital gains to specifically entitled beneficiaries.

The Little Trust generates $100 of rent and a $600 capital gain on an asset held for at least 12 months.

The trust deed does not define income and therefore capital gains do not form part of the trust’s
income. As a result, the trust’s:

• income is $100
• net income is $400 ($100 + ($600 × 50%)).

The trustee resolves to:

• make Catherine specifically entitled to $360 of the capital gain (undiscounted) and nothing else
• distribute $100 (ie 100%) of the trust’s income to Aaron.

Upon distribution, the calculation is now split into two components:

• Division 6 ITAA 1936 component

• capital gain component.

Division 6 ITAA 1936 component (calculated by applying the assumptions in Division 6E ITAA 1936)
The Division 6 ITAA 1936 component is calculated by excluding the capital gain and therefore,
the trust’s:

• Division 6E income is $100

• Division 6E net income is $100.
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Income tax – taxation of structures and transactions 223

 Aaron is the only presently entitled beneficiary in respect of the Division 6 component and his
assessable income will include all of the Division 6E net income of $100 (s 97(1) ITAA 1936).

Capital gain component (calculated under Subdivision 115-C ITAA 1997)

The capital gain component is $600 and is dealt with under Subdivision 115-C ITAA 1997.

Calculating the extra capital gain for each beneficiary (using the four-step process):

Step 1: Determine the beneficiary’s share of the capital gain.

Catherine’s share of the capital gain is $360 because she is specifically entitled to 60% of the $600
capital gain (ss 115-227(a) and 115-228 ITAA 1997).

Aaron is not specifically entitled to the capital gain, but he is presently entitled to 100% of the trust’s
Division 6E income. His share of the trust’s capital gain is 100% of the capital gain to which
no beneficiary is specifically entitled: $240 (100% × ($600 – $360)) (s 115-227(b)).

Step 2: Divide by the total capital gain.

Catherine divides her share of the capital gain ($360) by the total capital gain ($600) and therefore
has a 0.6 share of the capital gain (s 115-225(1)(b)).

Aaron divides his share of the capital gain ($240) by the total capital gain ($600) and therefore has a
0.4 share of the capital gain (s 115-225(1)(b)).

Step 3: Multiply the beneficiary’s fraction of the capital gain by the trust’s net income relating to the
capital gain.
The net income relating to the capital gain calculated under s 115-225(1)(a) is $300 ($600 × 50%).

Catherine’s attributable gain calculated under s 115-225(1) is $180 ($300 × 0.6).

Aaron’s attributable gain calculated under s 115-225(1) is $120 ($300 × 0.4).

Step 4: Gross up the amount for CGT discounts applied by the trustee.
Catherine must double her attributable gain from $180 to $360 because the trustee has applied the
50% CGT discount (s 115-215(3)(b)).

Aaron similarly doubles his attributable gain from $120 to $240.

Catherine and Aaron can now apply any capital losses they have to reduce the capital gain. Because
they are both resident individuals, they can then apply the 50% CGT discount to any net capital gain
amounts remaining.

Note the harsh outcome for Aaron in this example. He received only $100 as a cash distribution from
the trust. However, his assessable income from the trust is $340 ($100 + $240), although he can
claim the 50% CGT discount on the $240 capital gain component in his own tax return. It is for this
reason that Subdivision 115-C ITAA 1997 contains a facility whereby the trustee may choose to pay
the tax on the $240 capital gain (see below).
Note: This example was adapted from the Explanatory Memorandum relating to the amendments made in 2011 to
Subdivision 115-C.

Summary of consequences

The following table summarises the consequences for assets acquired before and after the introduction of
CGT on 19 September 1985.

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224 Tax
 Treatment of net capital gain made by a trust

CGT treatment (beneficiary level,

Situation CGT treatment (trustee level) assuming trustee is not assessed)

Asset acquired before If asset is held for at least 12 months, Beneficiaries include an extra
21 September 1999 the trustee can choose either of the capital gain (commonly called a
following: ‘gross-up’) in their assessable
• 50% CGT discount (s 115-10 income to reflect the net gain
ITAA 1997) made at the trustee level, using
• Indexation method (s 114-5 the four-step process.
ITAA 1997) (indexation calculated
only up to the September 1999 They then apply any CGT losses
quarter). and the CGT discount to which
they are entitled (ss 102-30 item
No discount is allowed where the 2AA and 115-210 to 115-225
trustee is assessed under s 99A ITAA 1997).
ITAA 1936 (ss 115-222(3) and (4)
ITAA 1997). Note that a corporate beneficiary
is not entitled to a CGT discount.

Asset acquired after The 50% CGT discount is applied

21 September 1999 if asset is held for 12 months (s 115-10
ITAA 1997).

No discount is allowed where the

trustee is assessed under ss 98(3), 98(4)
or 99A ITAA 1936 (s 115-220 and
ss 115-222(3) and (4) ITAA 1997).

Trustee election

To alleviate the unfairness that can result where a beneficiary is taxed on a trust capital gain to which they
are not specifically entitled, s 115-230 ITAA 1997 authorises the trustee of a resident trust to choose to be
assessed on a capital gain, provided the:
• capital gain was taken into account in working out the net capital gain of the trust
• trust property representing all or part of that capital gain has not been paid to or applied for the benefit
of a beneficiary by the end of two months after the end of the income year
• trustee makes this choice within two months after the last day of the income (or later day as allowed by
the Commissioner) (s 115-230(5) ITAA 1997).
Where the choice is made, the trustee is treated as specifically entitled to the capital gain and is assessed
at penalty rates under s 99A or, at the Commissioner’s discretion, s 99 ITAA 1936.

Trust franked dividends

Franked dividends flowing through a trust are taxed in the hands of the beneficiary or trustee if no
beneficiary is presently entitled, in accordance with the rules in Subdivision 207-B ITAA 1997.

Trustee level

Similar to calculating the CGT, the starting point in calculating a trust’s dividends is at the trustee level,
prior to the allocation of the trust net income.
Where a franked dividend or franking credit is taken into account in the trust’s net income calculation, the
net income calculation at the trustee level is undertaken in the normal way. This means that:
• the franked dividend is assessable income of the trust (s 44(1) ITAA 1936)
•
Pdf_Folio:225

the franking credit gross-up is also included in the trust’s net income (ss 207-20 or 207-35 ITAA 1997).

Income tax – taxation of structures and transactions 225

Beneficiary level

Special rules apply to the franked dividend component when the dividend is distributed and taxed in the
hands of the beneficiary or trustee.
Using a presently entitled beneficiary who is not under a legal disability as an example, these special rules
are the result of the combined operation of:
• Division 6E ITAA 1936, which applies s 97(1) ITAA 1936 on the assumption that the trust had no capital
gains or franked dividends (ss 102UX(2)–(3) and 102UY ITAA 1936)
• Subdivision 207-B ITAA 1997, which determines how much of the franked dividend and associated
franking credit flowing through the trust is assessable in the hands of the beneficiary (or trustee).
As noted previously, these provisions also enable a beneficiary to be made specifically entitled to a franked
dividend flowing through a trust.

Calculation method

There are three steps in calculating a beneficiary’s share of a franked dividend flowing through a trust:
Step 1: Determine the beneficiary’s share of a franked distribution (s 207-55 ITAA 1997).
The beneficiary’s share of the franked distribution is the amount to which:
• the beneficiary is specifically entitled (s 207-55(4)(a))
• no beneficiary is specifically entitled, multiplied by the beneficiary’s share of the Division 6E income
(s 207-55(4)(b)).
Step 2: Calculate the beneficiary’s share of the franked distribution as a percentage of the amount of the
franked dividend (s 207-37(1)(b) ITAA 1997).
Step 3: Multiply that fraction by the amount of the franked dividend included in the net income of the trust
to determine the attributable franked dividend and share of franking credit (ss 207-37(1) and 207-57
ITAA 1997)
The steps are best explained through the following examples.

Example 3.33 – Franked dividends paid to a trust

Assume the following:
• All beneficiaries are presently entitled, resident individuals who are not under a legal disability.
• The trust deed enables streaming of franked dividends to specifically entitled beneficiaries and an
FTE is in place.

In the current income year, the Fisher Family Trust received $100,000 in rental income and a $70,000
fully franked dividend with $30,000 of franking credits attached. The trust incurred $20,000 in
expenses relating to the rental income.
The trust deed does not define income and therefore franking credits do not form part of the trust
income. As a result, the trust’s:

• income is $150,000 ($100,000 – $20,000 + $70,000)

• net income is $180,000 ($100,000 – $20,000 + $70,000 + $30,000).
The trust has two beneficiaries, Ethan and Amelia. The trustee makes the following resolutions:

• Amelia is presently entitled to 60% of the income of the trust excluding dividends ($48,000).
• Ethan is specifically entitled to franked dividends of $70,000, and nothing else.
Upon distribution, the calculation is now split into the Division 6 ITAA 1936 component and the
franked dividend component.

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226 Tax
 Division 6 ITAA 1936 component (calculated by applying the assumptions in Division 6E ITAA 1936)

The Division 6 component is calculated by excluding the franked dividend and attached franking
credits; therefore, the trust’s:

• Division 6E income is $80,000 ($100,000 − $20,000)

• Division 6E net income is also $80,000.

The only presently entitled beneficiary in respect of the Division 6 component is Amelia. She will
include $48,000 (60% of $80,000) in her assessable income under s 97(1) ITAA 1936.

No beneficiary is presently entitled to the remaining $32,000 of the Division 6 component, and this
will be assessed to the trustee under s 99A or, if the Commissioner determines, s 99 ITAA 1936.

The franked dividend component (calculated under Subdivision 207-B ITAA 1997)

The franked dividend component is $70,000 and is dealt with under Subdivision 207-B ITAA 1997.

Calculating the franked dividend (and attached franking credits) flowing to each beneficiary

Step 1: Determine Ethan’s share of the franked distribution:

Ethan is specifically entitled to franked dividends of $70,000 (s 207-55(4)(a) ITAA 1997).

Step 2: Calculate Ethan’s share as a percentage of the franked dividend:

Ethan’s share as a percentage of the franked dividend is 100% (s 207-37(1)(b) ITAA 1997).

Step 3: Determine the attributable franked dividend and share of franking credit:

Multiply the amount of the trust’s franked dividend, net of directly relevant expenses, by the
percentage worked out in Step 2 (s 207-37(1) ITAA 1997). As there are no expenses directly related
to the franked dividend, the attributable franked distribution amount will be the same as each
beneficiary’s share of the franked distribution (calculated in Step 2). Ethan’s attributable franked
dividend is $70,000 × 100% = $70,000.

Separately, multiply the amount of the franking credit attached to the dividend ($30,000) by the
percentage worked out in Step 2 (s 207-57 ITAA 1997). Ethan’s share of the franking credit
is $30,000 × 100% = $30,000.

Ethan’s assessable income from the trust’s franked dividend under Subdivision 207-B ITAA 1997 is
$70,000 (attributable franked dividend) plus $30,000 (share of franking credit) (s 207-35(4)(b)
ITAA 1997).

CGT events relating to trusts

Non-assessable trust distributions – CGT event E4

Distributions from the corpus or capital of a trust estate are generally not assessable unless they represent
amounts that would have been assessable to a resident taxpayer if they had been derived by a resident
taxpayer (s 99B(2)(a) ITAA 1936).
However, non-assessable distributions from fixed or unit trusts where the unit or interest was acquired
after 19 September 1985 may lead to either a cost base erosion or crystallisation of a capital gain to the
beneficiary or unit holder under CGT event E4 (s 104-70 ITAA 1997).
CGT event E4 erodes the beneficiary’s or unit-holder’s cost base and reduced cost base of the interest or
unit by an amount equal to the non-assessable component of a distribution. If the cost base is eroded to
zero, CGT event E4 treats the excess non-assessable component as a capital gain.
For example, a beneficiary receives a distribution in cash from the ABC unit trust equal to their share of the
trust’s accounting income. Assume that the amount is $100. However, the beneficiary includes in their
taxable income their share of the taxable net income of the trust. Assume that amount is $80. The
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Income tax – taxation of structures and transactions 227

beneficiary’s non-assessable component is therefore $100 – $80 = $20. The cost base of the beneficiary’s
units in the ABC unit trust will be reduced by $20 (subject to the exceptions discussed below).
Cost base erosion is most commonly encountered by investors in property unit trusts whose distributions
include a tax-deferred component. An example of this is an excess of accounting income over taxable
income resulting from differences in the timing of when amounts are expensed for accounting purposes
and are deductible for tax purposes.
Fortunately, not all types of non-assessable distributions erode cost base. Section 104-71 ITAA 1997
disregards any part of the payment that results from the distribution of:
• CGT 50% general discount
• small business 15-year exemption amount in accordance with s 152-125 ITAA 1997
• NANE income (eg payments to CGT concession stakeholders of the CGT small business retirement
exemption amount under s 152-310 ITAA 1997)
• early stage investor exemption amount in accordance with s 360-50(4) ITAA 1997.
However, cost base is eroded where the non-assessable distribution results from the CGT small business
50% reduction amount under s 152-205 ITAA 1997.
The ATO accepts that the cost base reductions do not apply to discretionary trusts because a beneficiary is
not considered to have the requisite interest in a discretionary trust (TD 2003/28).
Tax practitioners can help their clients plan around CGT event E4 by taking tax timing adjustments into
account when making distributions, as illustrated in the next example.

Example 3.34 – Trading trusts distribution policy

Where a fixed trust carries on a trading business, tax timing adjustments could arise in Year 1, which
reverse in Year 2. For example, the provision for annual leave could reduce in Year 1, but increase in
Year 2.

Alternatively, in Year 1, land could be revalued which creates accounting profit (which is trust income
under the trust deed). In Year 2, the land is sold and the unrealised asset reserve becomes realised,
thereby creating assessable income in Year 2, but no accounting income.

CGT event E4 will apply on the Year 1 distribution because trust income exceeds net income for tax
purposes and there is no corresponding reversal of CGT event E4 for the distribution in Year 2 when
trust income is less than net income.

In these circumstances, and provided the trust deed allows it, the trustee may decide to set the
Year 1 and Year 2 distributions at an amount equal to the net income for tax purposes (ie the trustee
could hold back amounts), thus ensuring the beneficiaries do not suffer cost base erosion simply
because of tax timing issues.

In other words, the trustee could smooth the distributions so that the accounting and tax
distributions match. In this regard, CGT event E4 applies to payments, not present entitlement.

Anomalous outcomes

The application of CGT event E4 can cause double taxation. The following example is an advanced
application of CGT event E4, which may benefit those working in taxation. It is provided only to illustrate
the anomalies in the taxation law.

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228 Tax
 Example 3.35 – CGT event E4: Double taxation issues
Investor A buys $100 worth of units in Big Unit Trust. The trust buys a building for $100.

Trust distribution Investor A

$10 Cash
$0 Taxable
($10 is tax deferred)
100 units at $1 each

Big Unit
Trust

$100 purchase

The trust’s income is $10, but its net income for tax purposes is $0 because of tax accounting
differences relating to the Division 43 ITAA 1997 capital works deduction for buildings.

Income and expenses Accounts $ Tax $

Rent 10 10

Capital works deduction – (10)

10 0

Accordingly, a tax-free distribution (typically called a tax-deferred distribution in the distribution

statement) of $10 is made by the trust to Investor A. CGT event E4 reduces Investor A’s total cost
base by the $10 tax-free amount (from $100 to $90).

The building is sold for $101 and there is a book profit of $1. The trust’s capital gain is $11 because
the $10 capital works deduction reduces the cost base of the building from $100 to $90 (s 110-45(4)
ITAA 1997).

Because Investor A is presently entitled to the $1 book profit under the trust deed (see FCT v
Bamford), Investor A is assessable on the $11 capital gain (the first tax impost). After distributing the
$1 book profit to Investor A, the trust is left with cash of $100, being the original subscription
monies ($100 – $100 + $10 – $10 + $101 – $1 = $100).

Investor A winds up the trust and receives $100 back. Because Investor A’s cost base of the units is
only $90 (due to the cost base erosion under CGT event E4), Investor A has a capital gain of $10 (the
second tax impost).

Therefore, tax has been imposed on total gains of $21, even though Investor A has only made an
economic profit of $11 (being the $10 rent plus the $1 profit from the sale of the building).

This example shows how poorly constructed legislation can lead to anomalous results.

However, there is a possible solution to this problem. In the year the capital gain is made, the trust
could distribute $11 (rather than $1). This would reduce the trust’s net assets from $100 to $90. CGT
event E4 would not apply to this distribution because the amount assessed to the unit holder would

Pdf_Folio:229

Income tax – taxation of structures and transactions 229

 be equal to the accounting distribution. Investor A would not have a capital gain on winding up the
trust because the capital proceeds of $90 (being the net assets of the trust) would equal the reduced
cost base of the units of $90.

Establishment of trusts – CGT events A1, E1 and E2

Inter vivos trusts

An inter vivos trust is one created during the life of the creator or settlor. It may also continue to operate
after their death. Such a trust is created by the transfer of title of intended trust property to a trustee to be
held for the benefit of the beneficiaries of the trust.
The transfer of property to the trustee of an existing trust could attract two CGT events: CGT event A1
(s 104-10 ITAA 1997) and CGT event E2 (s 104-60 ITAA 1997). In Healey v Commissioner of Taxation (2012)
208 FCR 300, the court held that when a CGT asset is transferred to a trust, CGT event E2 applies
(s 104-60 ITAA 1997) and not a CGT event A1. The issue is important because of the timing of the CGT
event. CGT event E2 happens at the date of the transfer of an asset, whereas CGT event A1 happens at the
date of the contract. The date of the transfer will usually be after the date of the contract (ie the date of
settlement). This may affect access to concessions, such as the CGT discount provisions and the small
business CGT concessions.
The principle in Healey v FCT would also appear to apply to any purchase of an asset by a trust. However,
the ATO has stated that arm’s-length purchases by trusts would normally be assessable to the vendor
under CGT event A1, not E2. In other words, Healey’s principle will be confined to transfers of assets to
related trusts, rather than sales to trusts by third parties.
Alternatively, if a new trust is created for a particular asset by a declaration of the asset owner that, from
that time on, the asset is held on trust, CGT event E1 will apply (s 104-55 ITAA 1997). CGT event E1 is also
relevant where a new trust is created by settlement. For the ATO’s views on split trust arrangements
see TD 2019/14.
There are no general CGT rollovers enabling CGT assets owned by individuals to be moved into a trust
without attracting CGT consequences. However, a gain or loss on an asset transferred to a special
disability trust (SDT) is disregarded (s 118-85 ITAA 1997). An SDT is a trust established for persons in
necessitous circumstances, in accordance with the Social Security Act 1991 or the Veterans’ Entitlements
Act 1986. Also, a taxpayer that operates a small business may be able to rollover their active business
assets to a trust.

Testamentary trusts

When a person dies, title to the assets owned by that person passes to that person’s legal representative or
executor. The executor is responsible for settling debts and distributing the residue of the estate in
accordance with the deceased’s will. Division 128 ITAA 1997 explains the CGT implications for the
deceased, the executor and the ultimate beneficiaries.
It is important to note that trusts are often created by the operation of the deceased’s will. These
testamentary trusts typically provide for the care and maintenance of the deceased’s spouse and children.
In some cases, the will creates a trust under which a life tenant (eg the deceased’s widow) enjoys all the
income of the trust, with the capital of the trust passing to the deceased’s children or other beneficiaries
once the life tenant dies. A life tenant presently entitled to all of the income of the trust should be assessed
under s 97 ITAA 1936 on the entire net income of the trust, including the capital gains. This is the case
even though the life tenant cannot benefit from those capital gains.
However, s 115-230 ITAA 1997 avoids this unfair outcome by allowing the trustee to choose to be
assessed on the share of the trust’s net income attributable to capital gains. This choice can be made if a
beneficiary, who would otherwise be assessed under s 97 ITAA 1936 on that share of the net income, does
not have an interest in the trust property representing that share, nor has had such property paid or applied
for their benefit. The trustee must choose to be assessed no later than two months after the last day of the
relevant income year or such later day as the Commissioner allows.
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230 Tax
Absolute entitlement to trust assets – CGT event E5

Where a beneficiary becomes absolutely entitled to a CGT asset of a trust, CGT event E5 occurs (s 104-75
ITAA 1997). A beneficiary is absolutely entitled if they have a vested and indefeasible interest in the entire
trust asset The beneficiary can direct the trustee to transfer the asset to them or to someone else.
When CGT event E5 happens:
• The trustee makes a capital gain if the market value of the asset at the time exceeds its cost base
(s 104-75(3) ITAA 1997). Conversely, a capital loss arises if the market value is less than the asset’s
reduced cost base.
• The beneficiary makes a capital gain if the market value of the asset at the time exceeds the cost base of
the beneficiary’s interest in the trust capital to the extent it relates to the asset (s 104-75(5) ITAA 1997).
Conversely, a capital loss arises if the market value is less than the reduced cost base of that interest.
Note that CGT event E5 is disregarded where the beneficiary acquired the interest in the trust capital
(other than by way of assignment from another entity) for no consideration (s 104-75(6)(a) ITAA 1997).
This means that CGT event E5 would generally not apply to:
– an object (ie potential beneficiary) in a discretionary trust
– a beneficiary who becomes absolutely entitled to an asset that a deceased person owned at the time
of their death (TD 2004/3).

Once absolutely entitled, the beneficiary is taken to own the asset directly. Any actions taken by the
trustee in relation to the asset are taken to have been done by the beneficiary directly (s 106-50
ITAA 1997). This means that, if a CGT event happens in relation to the asset, the beneficiary is responsible
for any resulting capital gain or loss, and the gain or loss will go directly to the beneficiary, rather than
forming part of the trust’s net income. This is illustrated in the next example.

Example 3.36 – CGT event E5: Beneficiary becomes absolutely entitled

Paul has established a fixed trust for his sole grandchild, Tabitha, who is currently six years old. The
trust has invested in blue chip shares listed on the ASX. Under the terms of the trust deed, Tabitha
will have a vested and indefeasible interest in the trust’s assets when she turns 21 years of age.
The default beneficiary in the event that Tabitha dies prematurely is the St Vincent de
Paul Society.

Until the trust vests, dividend income generated from the trust’s share portfolio is applied for Tabitha’s
benefit and the trustee pays tax on the trust’s net income under s 98(1) until Tabitha turns 18.

On her 21st birthday, Tabitha will become absolutely entitled to the trust’s assets and Tabitha will be
the relevant taxpayer if the shares are sold, even if Tabitha never obtains legal title to the shares
(s 106-50 ITAA 1997).

CGT event E5 will trigger a capital gain or loss for the trustee when Tabitha becomes absolutely
entitled (ss 104-75(1) and (2) ITAA 1997). There will be no CGT event E5 ramifications for Tabitha
regarding her interest in the trust because she acquired her interest for no consideration
(ss 104-75(5) and (6)(a) ITAA 1997).

Disposal of CGT asset to a beneficiary – CGT event E6

CGT events also occur where a trustee disposes of CGT assets held by the trust (other than a testamentary
trust) to a beneficiary in satisfaction of the beneficiary’s:
• right to receive ordinary or statutory income from a trust – CGT event E6, s 104-80 ITAA 1997
• interest in trust capital – CGT event E7, s 104-85 ITAA 1997.
For both events, a gain or loss can also arise for the beneficiary’s disposal of the right to income or capital
in the trust.
Pdf_Folio:231

Income tax – taxation of structures and transactions 231

Section 100A

The ATO has released TR 2022/4 and accompanying guidance (PCG 2022/2) on how it will tax distributions
by trusts where they perceive a tax benefit arises under a reimbursement arrangement. The potential issue
with Section 100A applying is that the income distribution to the beneficiary is disregarded, and the
trustee is taxed at the top marginal rate. Furthermore, there is technically no time limit for the ATO to apply
this section, albeit arrangements entered into before 1 July 2014 generally should not be targeted for
ATO review.
Examples of arrangements which could trigger the adverse tax rules include: (a) distributions to adult
children on lower taxable income, where the child does not receive the benefit of the funds because the
funds are transferred to the parents and (b) distributions to corporate beneficiaries that go back to the trust
as dividends and then back to the company. If the Section 100A rule applies, essentially the trustee will be
liable to pay income tax on the distribution income. Significant care is required going forward for trustees
to correctly distribute the trust income and ensuring the Section 100A rule is not triggered.

3.1.5 Small business entity

An SBE can be a company, a partnership, an individual or a trust. Candidates should be familiar with the
SBE rules.
To determine the taxable income of an SBE, tax practitioners need to be able to apply the common tax
rules and principles outlined in the following tables.

TABLE: SBE – key tax attributes

Section ITAA
1997 unless
Item otherwise stated Guidance

Taxpayer, tax As above for the An SBE is not a separate legal entity or a taxpayer.
rate, assessable applicable tax An individual, a partnership, a company, or a trust may qualify as an
income, structure SBE.
deductions, and
tax offsets The tax rates, assessable income, deductions, and tax offsets that
apply will depend on tax affairs of the tax structure. However, the
general rules may be altered as set out below in this guide.

Where a company is an SBE, the company may also satisfy the

requirements for being a base rate entity. But that is not always the
outcome.

TABLE: SBE eligibility – key sections

Section ITAA
Key 1997 unless
requirements otherwise stated Guidance

Small business 328-110 To be an SBE as defined, a taxpayer must:

entity (SBE): • Carry on, or be in the process of winding up, a business.
Definition • Satisfy the less than $10 million aggregated turnover test.

SBE: Despite the definition of an SBE, the aggregated turnover threshold

Concessions amount that is used to determine eligibility for a number of the SBE
extended to general concessions and for the SBE CGT concessions is replaced
other entities with an alternate amount (ie rather than $10 million an alternate
amount is deemed to apply for the purpose of the definition).

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232 Tax
 However, there are no changes to the operation of the aggregated
turnover tests, or to the calculation of aggregated turnover.

Refer below for a table containing the aggregated turnover

thresholds that are applicable to different types of concessions.

SBE: Aggregated 328-110 The aggregated turnover test will be satisfied any of the following
turnover test tests are satisfied (s 328-115):
• Prior year test = Aggregated turnover for the prior year is < $10
million, as determined on the first day of the current income year.
• Current year test – two requirements:
– Aggregated turnover for the current year is likely to be < $10
million, as determined on the first day of the current income year.
– Aggregated turnover for at least one of the two prior years was
< $10 million.
• Additional test = Actual aggregated turnover, calculated at the end
of the current income year, is < $10 million.

SBE: Aggregated 328-115 and Aggregated turnover includes the annual turnover of the entity and
turnover 328-120 the annual turnover of any connected entities and affiliates.

Annual turnover is the total GST-exclusive ordinary income that the

entity derives in the income year in the ordinary course of carrying
on a business.

There is no requirement that the ordinary income be assessable.

Therefore, it would include ordinary income that is exempt or NANE
income.

For example, aggregated turnover:

• Includes:
– Sales from trading stock, fees for professional services provided,
etc.
– Foreign branch income that is NANE income under s 23AH
ITAA 1936.
– Interest income derived on excess working capital or on trade
debtor balances.
• Excludes:
– Statutory income such as net capital gains under s 102-5, a
share of partnership net income under s 92 ITAA 1936, and a
share of net trust income under s 97 ITAA 1936.
– Passive investment income such as rent or dividends. However,
rent derived in the ordinary course of business would be
included (eg boarding house business).
– Amounts derived from dealings between the entity and
connected entities or affiliates (ie to ensure annual turnover is
not double counted).

SBE: Connected 328-125 An entity is connected with another entity if:

entities • Either one controls the other.
• Both are controlled by the same third party.

The concept of control means, the taxpayer, the affiliates, or both

the taxpayer and the affiliates:
• Company:
– Own or have the right to acquire interests in the company that
give it at least 40% voting power in the company.

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Income tax – taxation of structures and transactions 233

 Section ITAA
Key 1997 unless
requirements otherwise stated Guidance

• Discretionary trust:
– Direct the trustee of the trust (or could reasonably expect the
trustee) to act in accordance with their directions or wishes, or
– Have received at least a distribution of capital or income from
the trust in any of the previous four income years and that
capital or income (as the case may be) constitutes at least 40%
of the total capital or income (as the case may be) distributed in
that relevant year.

The trustee may nominate in writing no more than four beneficiaries

as controllers of the trust for an income year in which the trustee did
not make a distribution of income or capital because the trust had a
tax loss, or no net income, for that year (s 152-78(2)).

• Other entity type (eg partnership or fixed trust)

– Own or have the right to acquire interests in the entity that
gives it the right to receive at least 40% of any distribution of
income or capital by the entity.

The rules above relate to direct control of a company or

discretionary trust. There are also indirect rules that are outside the
scope of the core tax subject.

If the control percentage is at least 40% but less than 50%, the
Commissioner may determine that control does not exist if satisfied
that another entity (not being the taxpayer of any of its affiliates
controls the entity.

SBE: Affiliates 328-130 An affiliate is as an individual or company that acts (or could
reasonably be expected to act) in accordance with the taxpayer’s
directions, or in concert with the taxpayer, in relation to the business
of the individual or company.

However, a business relationship between the taxpayer and the

individual or company is not, of itself, sufficient to give rise to
affiliate status. For example:
• A spouse would only be an affiliate if they so act.
• A partner in a partnership would not be an affiliate of another
partner merely because they act in concert in connection with the
affairs of the partnership.
• A director of a company would not be an affiliate of another
director merely because they act in concert in connection with the
affairs of the company.
• A trust or superannuation fund cannot be an affiliate of the
taxpayer.

TABLE: Aggregated turnover thresholds used to determine SBE eligibility for concessions

Concession Threshold

General concessions – unless otherwise stated $10 million

Small business tax offset $5 million

Trading stock $50 million

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234 Tax
 Prepayments $50 million

Blackhole expenditure – start-up expenses $50 million

Capital allowances – decline in value $10 million

Fringe benefit tax (FBT) car parking exemption and work-related devices exemption $50 million
Refer to the FBT topic (Topic 4.2) in your learning materials.

Goods and services tax (GST) simpler BAS, cash basis and instalment concessions $10 million
Refer to the GST topic (Topic 4.1) in your learning materials.

Pay-as-you-go (PAYG) instalment concession $50 million

Refer to the tax administration topic (Topic 1.1) in your learning materials.

Two-year amendment period $50 million

CGT concessions $2 million

Small business restructure rollover $10 million

TABLE: SBE concessions – key sections

Section ITAA
Key 1997 unless
requirements otherwise stated Guidance

Trading stock 328-285 Can elect not to account for the movement in trading stock under
s 70-35 for an income year, if a reasonable estimate of the closing
stock shows an increase or decrease of no more than $5,000 from
the opening stock figure.

Prepayments 82KZM Is entitled to an additional exclusion from the prepayment rules

(which only apply to expenditure that is otherwise deductible under
s 8-1) provided the period covered by the expenditure is 12 months
or less.

Where the expenditure is excluded from the prepayment rules, it is

deductible to the SBE when incurred (ie at the time of the
prepayment) and does not have to be spread over the eligible
service period.

Refer to Topic 2.1.4.

Blackhole 40-880 (2) and Is entitled to an immediate deduction for cost certain start-up costs.
expenditure – (2A)
start-up Refer to Topic 2.2.1.
expenses

Capital Division 328 Can choose to allocate depreciating assets to a general small
allowances – business pool.
decline in value
These rules are covered in detail in Topic 2.2.1.

Pdf_Folio:235

Income tax – taxation of structures and transactions 235

 Section ITAA
Key 1997 unless
requirements otherwise stated Guidance

CGT and small The concessions include:

business • The 15-year CGT asset exemption.
restructure • Small business CGT 50% reduction.
rollover • Small business CGT retirement exemption.
• Small business CGT rollover.
• Small business restructure rollover (applicable to CGT and other
types of assets).

The SBE CGT rules and the small business restructure rollover are
covered in the Advanced Tax subject.

The government has proposed a number of new incentives for small and medium businesses (ie businesses
with an aggregated annual turnover less than $50 million) which include the following:
• A bonus 20% deduction on eligible external training expenditure for employees (ie it does not apply for
the training of non-employee business owners, such as sole traders or independent contractors). The
expenditure must also meet certain criteria to be eligible for the bonus deduction. Broadly, it must be
already deductible under tax law and it must be charged by a registered training provider and be within
that provider’s registration (if applicable). The additional deduction will only apply to expenditure incurred
between 7:30pm (AEDT) on 29 March 2022 and 30 June 2024. The expenditure must be for the provision
of training where the enrolment or arrangement occurs at or after 7:30pm (AEDT) on 29 March 2022.
• A bonus 20% deduction on eligible expenditure supporting digital adoption that has a direct link to an
entity’s digital operations for its business. Eligible expenditure may include digital enabling items (such as
on hardware, software, systems or services that form and facilitate the use of computer networks), digital
media and e-commerce. The bonus deduction is capped at $20,000 per year. The additional deduction
will only apply to expenditure incurred from 7:30pm (AEDT) on 29 March 2022 until 30 June 2023.
• An additional 20% deduction for expenditure that supports electrification and more efficient use of
energy. The additional deduction will be available for eligible expenditure of up to $100,000 and is
therefore capped at $20,000 for each business. The temporary measure will apply to eligible assets or
upgrades first used or installed ready for use between 1 July 2023 and 30 June 2024.
For example, ABC Co is a small business entity and incurs the following expenditure:
• $100,000 in eligible training on 30 June 2023. ABC can claim a tax deduction of $120,000 in the income
year ended 30 June 2023
• $200,000 in digital adoption on 30 June 2023. ABC can claim a tax deduction of $220,000 in the income
year ended 30 June 2023
• $200,000 in eligible electrification on 30 June 2024. ABC can claim a tax deduction of $220,000 in the
income year ended 30 June 2024.

Tax rate and offset

Company tax rate

The rate of income tax for a company that is a base rate entity is 25%.
The rate of income tax for a company that is not a base rate entity is 30%.
An SBE will only be a base rate entity where it satisfies the additional requirements contained in the
definition of that type of entity. A base rate entity (s 23AA ITRA 1986) is an entity where both of the
following requirements are satisfied:
• no more than 80% of its assessable income for the income year is base rate entity passive income (BREPI)
• its aggregated turnover, at the end of the income year, is less than the relevant threshold amount, which
is currently $50 million.
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236 Tax
It should be noted that, under the definition of a base rate entity, aggregated turnover is only tested at
the end of the income year. This is despite aggregated turnover being defined under the SBE rules. The
three aggregated turnover tests under the SBE rules are not applicable for a base rate entity. It should also
be noted that, unlike under the SBE rules, there is no requirement for a base rate entity to be carrying on a
business. In other words, a company that is an SBE can be a base rate entity if it satisfies the tests but is not
automatically a base rate entity.
A company that is an SBE maintains a franking account and may pay franked dividends to its shareholders
just like any other company. The maximum franking credit that can be attached to a dividend is determined
based on the SBE’s corporate tax rate for imputation purposes. These rules apply to all companies not just
SBEs or BREs. This rate is:
• the company’s corporate tax rate for the income year, calculated on the assumption that its aggregated
turnover, assessable income and base rate entity passive income are the same as the prior income year,
and applying the corporate tax rates of the current income year
• if the company did not exist in the prior income year, it is the lower corporate tax rate for the current year.

Concession rules available

Eligible taxpayer entities with an aggregated turnover of $10 million or more and less than $50 million can
access the following small business entity tax concessions.
Eligible entities will be able to access the following concessions from 1 July 2020:
• an immediate deduction for certain prepaid expenses, and
• an immediate deduction for certain start-up expenses.
Eligible entities will be able to access the following concessions from 1 April 2021:
• a fringe benefits tax exemption in relation to small business car parking
• a fringe benefits tax exemption in relation to the provision of multiple work-related portable
electronic devices.
Eligible entities will be able to access the following concessions from 1 July 2021:
• a simplified accounting method for the purposes of GST, if determined by the Commissioner
• the ability to defer excise-equivalent customs duty to a monthly reporting cycle
• the ability to defer excise duty to a monthly reporting cycle
• a two-year amendment period in respect of amendments to income tax assessments
• the simplified trading stock rules
• the ability to pay PAYG instalments based on GDP-adjusted notional tax.
It should be noted that the turnover requirements for the small business CGT concessions, the small
business tax offset, the small business restructure rollover and small business depreciation and pooling
remain unchanged.

Small business tax offset

An individual taxpayer pays tax on their taxable income at marginal tax rates, irrespective of the type of
income derived. However, an individual is entitled to a small business income tax offset when calculating
their net tax payable where:
• the individual is a SBE (ie as a sole trader)
• the individual’s assessable income includes a share of the net income of a SBE (eg a partner distribution
from a partnership that is a SBE or a trust distribution from a trust that is a SBE).

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Income tax – taxation of structures and transactions 237

This offset corresponds to the reduced tax rate that may be available for SBEs that are incorporated.
For the purposes of this offset, the SBE aggregated turnover threshold is $5 million (ie in the aggregated
turnover provisions replace all references to $10 million with $5 million).
The tax offset rate is 16% in the 2022–2023 income year and future years. However, the maximum value
of the offset is capped at $1,000, thereby limiting the real benefit of the increased rate. This is illustrated in
the next example.

Example 3.37 – Small business offset

An individual taxpayer with $5,000 of tax payable on SBE income is entitled to a tax offset of
$5,000 × 16% = $800.

An individual taxpayer with $50,000 of tax payable on SBE income is entitled to a tax offset of
$1,000 (ie the maximum amount, as $50,000 × 16% exceeds $1,000).

Given that this benefit is capped at $1,000, it is not particularly beneficial.

Trading stock
There are some concessions for SBEs and eligible small and medium enterprises (SMEs) as noted below.
Section 70-35 requires a taxpayer to compare its opening stock value with its closing stock value and make
the appropriate adjustment to the entity’s taxable income.
An SBE or eligible SME can elect not to account for this adjustment for an income year if a reasonable
estimate of the closing stock shows an increase or decrease of no more than $5,000 from the opening
stock figure (s 328-285).
The effect of s 328-285 is that the value of closing stock will be the same as the opening stock.
A reasonable estimate requires attention to both the quantity and value of stock on hand.
In the ATO’s view (see PS LA 2008/4), an estimate will be reasonable where it:
• takes into account all relevant factors and considerations likely to affect the number and value of the
particular entity’s items of trading stock on hand
• has been undertaken in good faith
• results from a rational and reasoned process of estimation
• is capable of explanation to, and verification by, a third party.
Given the small margin (ie $5,000), this concession is not used often in practice. It would also not be used
in practice where the opening stock value exceeds the closing stock value because, under s 70-35, the
taxpayer is entitled to a deduction which would minimise taxable income. The next two examples consider
this concession for a trading stock increase and decrease.

Example 3.38 – Trading stock increase

Apple Pty Ltd sells apples. At 30 June 2022, its trading stock value is $30,000. At 30 June 2023, its
trading stock value is $33,000.

Under s 70-35, Apple would normally include $3,000 in its assessable income, being the excess of
the closing value of its trading stock over the opening value of its trading stock. Apple, as the
increase in trading stock over the opening stock figure is below $5,000, could alternatively elect to
value its trading stock at 30 June 2023 at $30,000, in which case it would not need to include
$3,000 in its assessable income.
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238 Tax
 Example 3.39 – Trading stock decrease
Orange Pty Ltd sells oranges. At 30 June 2022, its trading stock value is $30,000. At 30 June 2023,
its trading stock value is $28,000.

Under s 70-35, Orange would normally claim a tax deduction of $2,000, being the excess of the
opening value of its trading stock over the closing value of its trading stock. As the decrease in
trading stock over the opening stock figure is below $5,000, Orange could alternatively elect to value
its trading stock at 30 June 2023 at $30,000, in which case it would not claim a tax deduction for
$2,000. However, as this would inflate Orange’s taxable income, Orange would not normally make
such an election in practice. In this case, the company would elect to not apply the SBE/SME rule
regarding trading stock in s 328-285.

Prepayments
The following prepayments are excluded from the prepayment rules regardless of the type of taxpayer:
• prepayments which are excluded expenditure (refer s 82KZL ITAA 1936). Excluded expenditure is
deductible in full under s 8-1
• prepayments which are deductible under specific provisions outside of s 8-1 (eg tax related expenses,
repairs, superannuation contributions, etc). The timing of the deduction is determined under the specific
provision.
For all other prepayments, an SBE or eligible SME taxpayer needs to consider the prepayment rules
contained in s 82KZM ITAA 1936. The application of the prepayment rules for an SBE or eligible SME
taxpayer is as follows:
• If the prepayment relates to a period of no longer than 12 months, ending in the next income year, the
SBE or eligible SME taxpayer can claim a deduction for the full amount when incurred under s 8-1.
• Otherwise, the expenditure must be apportioned over the period to which the expenditure relates, to a
maximum of 10 years (the eligible service period).
The example considers the prepayment rules for an SBE taxpayer.

Example 3.40 – Prepayments

On 30 June 2023, Petty Pty Ltd (Petty), an SBE, paid the following amounts:

• $10,000 for rent for July to September 2023

• $20,000 for tax fees paid for the period 1 July 2023 to 30 June 2025 (ie for 2 years)
• $30,000 for salaries paid for the period 1 July 2023 to 30 June 2025 (ie for 2 years)
• $40,000 for trading stock to be delivered on 30 September 2023
• $50,000 for insurance for the period from 1 July 2023 to 30 September 2024 (ie 15 months)
• $60,000 for a new computer to be installed in August 2023
• $70,000 for legal fees for a capital raising to be done in July 2023.

Petty is entitled to the following upfront deductions:

• $10,000 because the rental period is less than 12 months

• $20,000 because tax fees are deductible under s 25-5 and are therefore not subject to the
prepayment rules
• $30,000 because salaries are excluded expenditure under s 82KZL and are therefore excluded
from the prepayment rules.

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Income tax – taxation of structures and transactions 239

 The $40,000 trading stock payment is not deductible, despite it being for less than 12 months,
because s 70-15 delays the deduction until the stock is on hand.

The $50,000 insurance payment is not deductible because it is for a coverage period of more than
12 months.

The $60,000 computer is an item of plant which is subject the capital allowance rules (refer below).

The $70,000 legal fee payment is a capital payment which is deductible over 5 years as blackhole
expenditure under s 40-880.

Depreciating assets (capital allowances)

The SBE capital allowance rules allow an SBE taxpayer to choose to allocate depreciating assets to a
general small business pool. This avoids the need to calculate decline in value on a daily basis for individual
depreciating assets and brings forward the timing of the deductions.

Application

SBE taxpayers can choose to apply the SBE capital allowance rules for an income year, instead of applying
the rules in Division 40, to all of the depreciating assets it holds, uses or has installed ready for use, for a
taxable purpose (s 328-175).
The temporary full expensing rules which were introduced in the 2020–21 Federal Budget and which apply
until 30 June 2023 are discussed in Topic 2.2. Entities who are SBEs can only access the asset write-offs
where they have elected to apply small business depreciation and pooling in Subdivision 328-D ITAA 1997.

Exclusions

The following assets (among others) are not eligible for pooling under the SBE capital allowances rules
(s 328-175):
• buildings and structural improvements (as they qualify for deductions under Division 43)
• assets under certain leases (eg a leasing company or a passive investment company that holds depreciating
assets in a residential rental property cannot take advantage of the SBE capital allowance rules)
• assets allocated to a low-value pool under Division 40 (as distinct from a small business pool mentioned
below) before the taxpayer chose to use the SBE capital allowance rules
• in-house software where expenditure on the asset is allocated to a software development pool under
Division 40. Therefore, this expenditure does not qualify for immediate deduction under s 328-180
(see below).

Opening pool balance – existing assets

When a taxpayer first applies the SBE capital allowance rules, any eligible depreciating assets that the
taxpayer holds at the start of that income year, must be allocated to the small business pool (s 328-185(3)).
For the first year a taxpayer chooses to apply the SBE capital allowance rules, the opening pool balance is
the sum of the taxable purpose portions of the adjustable values (ie the closing written down value as
determined under Division 40) of eligible depreciating assets (s 328-195).
Unlike Division 40 where the entire cost is used to calculate the decline in value of an asset and the
deduction amount is reduced for non-taxable use, only the taxable purpose portion of the cost is allocated
to the small business pool (similar to the low-value pool).
For income years after the taxpayer’s first year applying the SBE capital allowance rules, the opening pool
balance is equal to the closing pool balance from the prior income year, adjusted for changes in taxable
purpose if required under s 328-225.

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240 Tax
Asset additions – immediate deduction

Section 328-180 ITAA 1997 provides an immediate deduction for new and second-hand plant for SBE
taxpayers. The plant has to cost less than the applicable immediate deduction threshold. For the income
year ended 30 June 2023, the immediate deduction threshold is unlimited. This is because s 328-181
(about temporary full expensing) of the Income Tax (Transitional Provisions) Act 1997, essentially allows SBEs
to fully write off their plant up to 30 June 2023.
Note that the threshold is normally $1,000 but it has been constantly been amended to different amounts
for specific time periods (eg it was $150,000 for the period 12 March to 31 December 2020). For the 2024
income year only, the government is proposing to set the threshold to $20,000.
The immediate deduction concession applies on an asset by asset basis. The ATO has provided draft
guidance in TR 2017/D1 on whether composite assets are a single asset or multiple assets, for example,
whether a chair is a separate asset from a table.
The write-off applies on a per asset basis. There are no aggregation rules or set of asset rules or identical,
or substantially identical rules as there are with the $300 write-off rule in ss 40-80(2). Therefore, if two
identical assets are acquired for a price below the threshold, they can both be written off in full.
The assets are written off in the year they are first used, or installed ready for use. The entire cost of the
asset must be less than the instant asset write-off threshold, irrespective of any trade-in amount.
The cost of an asset includes both the amount paid for it and any additional amounts spent on transporting
and installing it ready for use (refer s 40-185(1) example 2). The cost also includes amounts spent on
improving the asset.
Creditable GST is excluded from the cost, the instant asset write-off threshold is exclusive of any
creditable GST.
If an asset is acquired for a cost below the threshold and then, in a later year, costs are incurred in
improving or relocating the asset and the improvement/relocation cost is below the threshold, the
improvement/relocation can also be written off (ss 328-180(2) and 40-190(2)).
The write off is limited to the taxable purpose. For example, if a machine costing $900 is acquired in the
income year and is used 70% for business, only $630 will be allowed as an immediate deduction and the
balance is not deductible. However, if a machine costing above the threshold is acquired and is used 60%
for business, there is no immediate deduction as the total cost exceeds the applicable threshold. The
taxable purpose portion of the asset must be allocated to the small business pool.
If the asset is later sold, the taxable purpose proportion of the amount received for the asset is included in
assessable income as a balancing charge.
Assets eligible for the write off include in-house software, but not where it is part of a software pool
(s 328-175(7)).
Where an immediate deduction is claimed, no amount is allocated to the small business pool.

Asset additions – allocated to pool

Depreciating assets with a total cost equal to or exceeding the applicable immediate deduction threshold
are allocated to the small business pool at the end of that income year even if the taxpayer no longer holds
the asset (s 328-185(4)). However, unlike the Division 40 rules for diminishing value and prime cost
calculations:
• only the taxable purpose portion of the depreciating asset is allocated to the pool. Thus, an SBE taxpayer
must make a reasonable estimate of taxable use (s 328-205)
• there is no apportionment on a per day basis, instead the depreciating asset is allocated on the last day
of the income year.
Note: An SBE taxpayer must make an adjustment to the amount allocated to the pool in a later income year where the reasonable
estimate of taxable use for that later income year is more than 10% different to the original estimate (s 328-225).

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Income tax – taxation of structures and transactions 241

Decline in value – general rule

Under s 328-190, the decline in value deduction is the total of the following amounts:
• opening pool balance – apply a rate of 30%
• assets acquired:
– apply a rate of 15%
– asset enhancements, cost additions to existing pooled assets – apply a rate of 15%.

Low pool balance rule

A taxpayer calculates the annual decline in value deduction using the above general rule until the notional
closing pool balance is less than the immediate deduction threshold that applies at the end of the
income year.
The notional closing pool balance is the closing balance before calculating the current year decline in value
deduction, but after including in additions and reducing for disposals during the income year.
In the year that the notional closing pool balance falls below the immediate deduction threshold, it can be
written off as a low pool value (s 328-210), as illustrated in the next example.

Example 3.41 – Low pool balance below immediate deduction threshold

The opening SBE pool balance on 1 July 2022 is $38,500. On 1 December 2022, a new asset costing
$32,600 was acquired and, on 1 March 2023, an asset that was previously allocated to the SBE pool
was sold for $70,600. Ignoring GST, the immediate deduction threshold is unlimited for the 2023
income year.

Under s 328-210, the notional closing pool balance is $38,500 + $32,600 – $70,600 = $500.
Because this is less than the immediate deduction threshold, the balance can be claimed immediately.

Asset disposals

For disposal of an asset that was allocated to the SBE pool, the taxable purpose proportion of the asset’s
termination value is subtracted from the pool balance (s 328-200). If, as a result, the closing pool balance is
less than zero or the amount calculated under s 328-210 is less than zero, the amount by which it is less
than zero is included in the taxpayer’s assessable income (s 328-215(2)).

Closing pool balance

The closing pool balance is calculated under s 328-200. Broadly, it is equal to the following:
Add: Opening pool balance
Add: Taxable purpose portion of the cost of depreciating assets allocated to the pool (ie cost of additions
and enhancements that are not immediately deductible)
Less: Taxable purpose portion of termination value of depreciating assets allocated to the pool. Sale
proceeds on disposals are not included in assessable income.
Sub-total
If less than zero: Amount by which pool is less than zero is included in taxpayer’s assessable income as a
balancing adjustment and the closing pool balance is zero.

If less than applicable immediate deduction threshold: Amount is the low pool balance deduction for the
income year and the closing pool balance is zero (s 328-210).
Less: Decline in value or low pool balance deduction for the income year
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242 Tax
Total
If less than zero: Amount by which pool is less than zero is included in taxpayer’s assessable income as a
balancing adjustment and the closing pool balance is zero.

If equal to or more than zero: Amount is the closing pool balance.

The next example calculates a closing pool balance above the immediate deduction threshold.

Example 3.42 – Low pool balance above immediate deduction threshold

The opening SBE pool balance on 1 July 2013 is $38,500. On 1 December 2013, a new asset
costing $32,600 was acquired and, on 1 March 2014, an asset that was previously allocated to the
SBE pool was sold for $51,600. Ignoring GST, under s 328-200, the closing pool balance is
$38,500 + $32,600 – ($38,500 × 30%) – ($32,600 × 15%) – $51,600 = $3,060.

Note, for the purposes of this example, the relevant income year is 30 June 2014 when the immediate
deduction threshold was $1,000. For the income year ended 30 June 2023, the immediate deduction
threshold is unlimited and the notional closing pool balance of $38,500 + $32,600 - $51,600 =
$19,500 would be deductible under s 328-210 and the closing pool balance would be zero.

Change in taxpayer choice or status

If a taxpayer chooses to apply the SBE capital allowance rules for an income year and opts out of the rules
for a later income year, the taxpayer generally cannot opt back into the SBE capital allowance rules for at
least five years. However, from 7.30 pm (AEST) 12 May 2015 to 30 June 2023 the ‘lock out’ rules are
temporarily suspended to allow small businesses that have chosen to stop using the simplified depreciation
rules to take advantage of temporary full expensing and the instant asset write-off.
Previously, the ‘lock out’ rules prevented small businesses from re-entering the simplified depreciation
system for five years if they had opted out.
Once a depreciating asset is allocated to a small business pool, it must remain in that pool until it is fully
deducted. This applies even where the taxpayer is not an SBE in a later income year or the taxpayer
chooses not to use the SBE capital allowance rules for assets acquired in a later income year (s 328-220).
The taxpayer will continue to calculate the annual decline in value deduction at a rate of 30% of the
opening pool balance, until the closing pool balance before calculating the current year decline in value
deduction is less than the immediate deduction threshold. In the income year the balance is below the
immediate deduction threshold, it can be fully written-off as a low pool value (s 328-210).
Taxpayers who stop using the SBE capital allowance rules must deal with subsequently acquired
depreciating assets under Division 40, the general capital allowance rules.

Primary producers

Primary producers, tax entities carrying on a primary production business as defined in s 995-1(1)) that are
SBEs, can choose whether to claim deductions under the primary production provisions in s 40-F or
s 40-G, or use the SBE provisions under s 328-D.

Blackhole expenditure – start-up expenses

SBE and eligible SME taxpayers, including individuals not in business, are entitled to an immediate
deduction under s 40-880(2A) for costs incurred in relation to start-up expenses, including:
• expenditure in obtaining advice or services related to the proposed structure, or proposed operation of
the business (eg professional, accounting or legal advice)
• government fees, taxes or charges relating to establishing the business or its operating structure
Pdf_Folio:243

(eg costs associated with raising capital).

Income tax – taxation of structures and transactions 243

For other types of taxpayers and for non-qualifying expenses of an SBE, blackhole expenses are deductible
over five years under s 40-880(2). The following examples illustrate these deductions.

Example 3.43 – Blackhole write off

Peach Pty Ltd is a small business entity which distributes peaches. Peach was established during the
current year and incurred $10,000 obtaining legal advice on the proposed structure of the business.
This advice is not deductible under s 8-1 because it relates to the capital structure of the business.
However, it would be eligible for a 100% write off under s 40-880(2A).

Example 3.44 – Ineligible blackhole write off

In the following year, after the business was up and running, Peach incurred $20,000 in professional
fees raising some share capital for the business. This advice is not deductible under s 8-1 because it
relates to the capital of the business. It is also not eligible for a 100% write off under s 40-880(2A)
because the business is already in existence. Subsection 40-880(2A) only applies to a business that is
proposed to be carried on. However, the $20,000 would be deductible over five years (including 20%
in Year 1) under s 40-880(2).

3.2 International and other structures

The basic study of international tax involves a consideration of the tax issues associated with funds:
• flowing into Australia
• flowing out of Australia.

Issues Australian tax residents need to consider

when dealing with international transactions

Funds flow to Funds flow from

a non-resident a non-resident

RESIDENT

1. Withholding tax liability and 1. Assessability

deductibility (including exemptions)
2. Transfer pricing 2. Deductibility
3. Thin capitalisation 3. Foreign income tax offsets

Inbound flows
These transactions include loans into Australia, investments into Australia and income paid to Australian
entities (eg dividends, interest, royalties etc).
Outbound flows
These transactions include loans from Australia, investments out of Australia and income paid by Australian
entities (eg dividends, interest, royalties etc).
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244 Tax
3.2.1 Taxation of foreign income of residents, and foreign
income tax offsets
Taxation of foreign income of residents
The following table provides a high-level snapshot of the taxation implications to be considered for an
Australian resident on the receipt of foreign income from an offshore investment. There are a number of
elements that determine the taxation sections that may be applicable, including the type of taxpayer,
investment structure, investment level and the type of income.

TABLE: Foreign income – application overview

Type of
taxpayer Type of investment Type of income Taxation implications to be considered

Australian Foreign branch – Foreign profits – Non-assessable non-exempt (NANE)

resident permanent active income income under s 23AH ITAA 1936.
company establishment (PE) test passed
Not entitled to s 25-90 debt deductions.
FITO not available.

Foreign profits – ‘Adjusted tainted income’ under s 23AH

active income ITAA 1936 (concessionally taxed portion
test failed thereof for a listed country branch) is
included as assessable foreign income.
FITO available.

Capital gain on NANE income under s 23AH ITAA 1936

closing foreign (subject to tainted asset considerations).
branch/selling assets
Not entitled to s 25-90 debt deductions.
– active and not
taxable Australian FITO not available.
property (TAP)

Capital gain on Assessable foreign income under s 102-5.

closing foreign
FITO available.
branch/selling assets
– not active or is TAP

Australian Foreign company Foreign interest Assessable foreign income under s 6-5.
resident income (financial
Entitled to s 8-1 general deductions.
company instrument classified
as debt under FITO available.
commercial and tax
law)

Foreign royalty Assessable foreign income under:

• s 6-5 ordinary income/extended
definition of ordinary income, or
• s 15-20 statutory income.

Entitled to s 8-1 general deductions.

FITO available.

Foreign profits Not applicable (ie not taxable in Australia)

unless subject to attribution as a Controlled
Foreign Company (CFC). Profits taxable in
foreign jurisdiction.
Note: The CFC rules are covered in the
Advanced Tax subject.
Pdf_Folio:245

Income tax – taxation of structures and transactions 245

 Type of
taxpayer Type of investment Type of income Taxation implications to be considered

Capital gain on sale CGT participation exemption under

of shares in foreign Subdivision 768-G (subject to active
company foreign business asset percentage).

Not entitled to deductions under s 51AAA

ITAA 1936 if the capital gain is the only
expected assessable income.

Foreign dividends – NANE income under s 23AI ITAA 1936.

previously attributed
income (from a CFC) Entitled to s 8-1 general deductions or s
25-90 debt deductions.

FITO is available for foreign dividend

withholding tax (as income previously taxed
in Australia).

Foreign distribution NANE income under s 768-5.

– other: at least 10%
participation interest Entitled to s 25-90 debt deductions.
in subsidiary and
FITO not available.
classified as equity
Note that the government is proposing to
stop such deductions from 1 July 2023.

Foreign distributions Assessable as dividend income under

– other: less than s 44(1) ITAA 1936.
10% participation
interest or classified Entitled to s 8-1 general deductions.
as debt
FITO available.

Any Australian resident Australian ‘conduit NANE income under Division 802.
foreign company foreign income’ – to
investment be distributed to
structure non-residents

Any Foreign rental Foreign rental income Assessable income under s 6-5 or s 102-5.
Australian property asset and capital gain on
resident (passive investment) disposal of foreign Entitled to s 8-1 general deductions.
taxpayer asset
FITO available.

Note: Certain taxpayers are entitled to CGT

concessions – refer to Topic 2.2.4.

Australian Foreign company Foreign dividends – As per Australian resident company

resident previously attributed investment in foreign company above.
individual income

Foreign dividends – Assessable income under s 44 ITAA 1936.

other: portfolio and
non-portfolio FITO available.
interests

Foreign interest As per Australian resident company

investment in foreign company above.

Foreign royalty As per Australian resident company

investment in foreign company above.
Pdf_Folio:246

246 Tax
 Capital gain on sale CGT participation exemption under
of shares in foreign Subdivision 768-G not available for
company individuals.

Not entitled to deductions under s 51AAA

ITAA 1936 if the capital gain is the only
expected assessable income.

Note: Certain taxpayers are entitled to CGT

concessions – refer to Topic 2.2.4.

Australian Foreign debt, Foreign interest As per Australian resident company

resident investment or licence investment in foreign company above.
company agreement with any
or foreign entity
individual

Foreign royalty As per Australian resident company

investment in foreign company above.

Further to the above table, note that:

1. Additional NANE income exemptions are available for temporary residents (see below).
2. Taxation implications may be subject to the operation of double tax agreements (DTAs). The DTA rules
are covered in the Advanced Tax subject.

Calculation of taxable income for foreign sourced income

Following on from the framework for calculating taxable income and tax payable in Chapter 2, the below
formula applies that calculation framework to a resident taxpayer who has only foreign income:

Exempt income
and
Foreign income Foreign tax paid Assessable
+ – non-assessable =
derived (net) on income foreign income
non-exempt
(NANE) income

Assessable Taxable net

– Deductions against assessable foreign income = foreign income
foreign income

Taxable net Foreign income Tax payable on

× Tax rate – =
foreign income tax offsets foreign income

Key concepts

The calculation of tax payable on foreign income links the following three concepts together:
• assessability of income (including exemptions)
• deductibility of expenses
• tax offsets.
These concepts are discussed below.

Pdf_Folio:247

Income tax – taxation of structures and transactions 247

Assessability of income (including exemptions)

When a resident derives foreign income, it is assessable income under s 6-5 or a specific provision
(eg dividends under s 44(1) ITAA 1936) unless a specific exclusion applies. It is the gross pre-tax amount of
foreign income that is included in assessable income.
Assessable income specifically excludes exempt income and NANE income under s 6-15. The particular
kinds of NANE in respect of international transactions are listed in s 11-55.

Deductibility of expenses

A resident taxpayer is entitled to a deduction under s 8-1 for expenditure incurred in gaining or producing
assessable foreign income. Expenses incurred in deriving exempt income and NANE income are specifically
non-deductible, in accordance with s 8-1(2)(c). However, a specific deduction provision can allow a
deduction, notwithstanding that the expenditure relates to income which is not assessable. For example,
debt deductions may be allowable under s 25-90 when there is a nexus with certain NANE dividends
(see below).
When a resident taxpayer has a carried forward or current year tax loss, exempt income wastes the amount
of the tax loss. However, NANE income does not waste tax losses.

Tax offsets

A resident taxpayer may be entitled to a tax offset under the foreign income tax offset (FITO) system for
the foreign taxes paid. Foreign income, foreign expenditure and foreign taxes paid are converted to
Australian dollars, in accordance with Subdivision 960-C. Under this subdivision, each transaction that
forms part of the calculation of tax payable on foreign income is separately converted to Australian dollars.

Key factors impacting taxation consequences

Just as there are specific taxation provisions applicable to different taxpayer types, there are specific
taxation provisions that are applicable to different types of offshore investment. For this reason, offshore
investments are commonly grouped as follows.

Foreign subsidiary – controlled foreign company (CFC)

A CFC is an offshore company that is controlled by the taxpayer. Where this type of investment structure
exists, certain foreign income may be taxed in Australia before it is actually received. The income is
attributed or included in assessable income on an unearned basis.

Foreign investment – at least 10% interest.

This is an offshore company in which the taxpayer:

• for the operation of the foreign equity distribution exemption under s 768-5 – holds a participation
interest in the foreign company of at least 10% (refer below)
• for the operation of other rules – holds a non-portfolio interest as defined in s 317 ITAA 1936. This is the
case where the taxpayer holds a voting interest in the foreign company of at least 10%.

Foreign investment – less than 10% interest

This is an offshore company in which the taxpayer holds a participation interest in the foreign company of
less than 10% (ie does not hold a non-portfolio interest), as defined under s 317 ITAA 1936. This is
commonly called a portfolio interest.

Foreign branch

A branch is a permanent establishment (PE) as defined under s 6(1) ITAA 1936, or a double taxation
agreement (where applicable) of an entity at or through which it carries on business. A branch is not a
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248 Tax
separate legal entity. A branch arises, for example, when a company carries on a business activity at a
separate location without the use of another entity.
Income paid by a branch to the taxpayer retains its character. This is because the profits of a branch are
simply part of the overall profits of the taxpayer (ie an internal transaction).

Foreign rental property asset

In this circumstance, the taxpayer merely holds property in a foreign country from which it earns rental
income and does not carry on a business. The taxpayer does not have a branch at which, or through which,
it carries on business in that foreign country.

Foreign hybrid

A foreign hybrid is a foreign entity that is prima facie a company for Australian income tax purposes but is
treated as a partnership for foreign income tax purposes. Under Division 830, such an entity is deemed to
be a partnership for Australian income tax purposes. A detailed understanding of these rules is outside the
scope of this subject.
The type of offshore investment influences the type of foreign income received. For example, a foreign
subsidiary company can repatriate its profits to Australia as dividend income, whereas a foreign branch
cannot because a branch does not have its own separate legal capacity.
The most common types of foreign income from offshore investments and transactions include dividends,
interest, royalties, business profits and/or capital gains. As outlined in Chapter 2, the type of income
received determines the basis and timing of its inclusion in assessable income.
The application of the taxation provisions can also differ based on the location of the foreign investment.
Australia divides foreign countries into one of two categories, namely: as a listed country or an unlisted
country, in accordance with s 320 ITAA 1936. In principle, there are more exemptions that apply to exclude
foreign income from taxation in Australia for investments in listed countries than in unlisted countries.
This is because listed countries have comprehensive taxation systems like in Australia; they are comparably
taxed and the assumption is made that the investment is for genuine business and commercial reasons, and
not tax-driven.

Regimes to minimise double taxation

When a taxpayer derives direct or indirect foreign income, it may be taxed both in the foreign country and
in Australia. This is known as double taxation. Double taxation can be minimised by:
• excluding the income from being taxed in Australia through exemptions. The key exemptions include:
– foreign branch income and capital gains exemption under s 23AH ITAA 1936
– foreign equity distribution exemption under s 768-5 ITAA 1997 (Subdivision 768-A)
– previously attributed income exemption under s 23AI ITAA 1936
– CGT participation exemption under s 768-505 ITAA 1997 (Subdivision 768-G)
– conduit foreign income (CFI) exemption under Division 802 ITAA 1997
– giving tax offsets for the foreign taxes paid through the FITO rules in Division 770
– allowing special tax treatment to foreign employees who come to Australia temporarily to work but
who satisfy the technical requirements of being an Australian tax resident (ie the temporary resident
provisions).
• Australia’s double taxation treaties with other countries. A double taxation treaty is a reciprocal agreement
between two countries in respect of taxing rights. Taxing rights are usually determined on the basis of
residency and source. Thus, where a double taxation treaty exists between Australia and another country:
– it will usually contain tie breaker rules which overcome scenarios where a taxpayer might otherwise be
resident in both jurisdictions (ie under each jurisdiction’s domestic legislation)
– it may allocate the source of particular types of income or gains to Australia or the treaty partner
Pdf_Folio:249

country using the tie breaker definition of resident.

Income tax – taxation of structures and transactions 249

Exemption provisions have the effect of removing an item of income from the Australian tax net. Some
provisions make these amounts exempt while others make them NANE. It is important to understand the
difference between these two terms because this has an effect on the availability of tax offsets,
deductions, tax losses and applicable tax rates.
When applying the framework for the calculation of tax payable on foreign income, an Australian resident
taxpayer must consider both the implications under Australian domestic law and any impact of the
applicable double taxation treaty.
The regimes that minimise double taxation are subject to the application of integrity measures. These
measures include transfer pricing and hybrid mismatch arrangements, which are analysed in the Advanced
Tax subject.
Australia, along with 136 OECD members of the OECD BEPS, in October 2021 agreed to a new tax system
to ultimately help ensure that global companies pay their fair share of tax. The basic principle is for
countries to legislate a global minimum tax rate of at least 15% which ultimately means these tax havens
will not be tax effective anymore for large global companies.

Exemptions
To determine the taxable income for an Australian resident taxpayer with foreign income or capital gains,
tax practitioners need to be able to apply the following common tax rules and principles related to
exemptions described in the following table.

TABLE: Exemptions – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

Assessable 6-5 and 6-10 Foreign income is included in the assessable income of an Australian
income resident taxpayer, unless a specific exemption applies.

Deductions 8-1 Expenditure incurred in deriving foreign assessable income is

generally deductible. However, where the expenditure relates to
deriving exempt or non-assessable non-exempt (NANE) income it is
not tax deductible, unless a specific section applies to allow the
deduction.

Debt deductions 25-90 and Debt deductions incurred in deriving the following types of income
relating to 820-40 is deductible:
foreign NANE • NANE income under s 768-5, the foreign equity distribution
income exemption. Note that the government is proposing to stop such
deductions from 1 July 2023.
• NANE income under s 23AI ITAA 1936, previously attributed
controlled foreign company (CFC) income exemption.

Debt deductions include (but are not limited to) interest, an amount
in the nature of interest, or any other amount that is calculated by
reference to the time value of money.

Note: There are debt–equity rules that may change the debt to
equity and equity to debt for income tax purposes. The debt–equity
rules are covered in the Advanced Tax subject.

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250 Tax
 Foreign branch 23AH ITAA 1936 Foreign branch income is NANE income of an Australian resident
income and company, with the exception of the following types:
capital gains • Where branch is located in a listed country:
exemption – Branch fails the active income test (ie has 5% or more passive
income), and
– Income is passive income, and
– Income is eligible designated concessional income (EDCI)
(ie concessionally taxed income in the foreign country).
• Where branch is located in an unlisted country:
– Branch fails the active income test (ie has 5% or more passive
income), and
– Income is passive income.

Foreign branch capital gains are NANE income of an Australian

resident company, with the exception of the following types:
• Where branch is located in a listed country:
– Capital gain or loss is from a tainted asset (ie a passive asset), and
– Capital gain or loss is eligible designated concessional income
(EDCI) (ie concessionally taxed income in the foreign country).
• Where branch is located in an unlisted country:
– Capital gain or loss is from a tainted asset (ie a passive asset).

Listed countries include Canada, France, Germany, Japan,

New Zealand, the United Kingdom and the United States (Regulation
19 ITAR 2015).

EDCI only includes items that are not taxable in the source country
and that are specifically listed in the tax legislation. The one type of
EDCI that may be relevant for the Core tax subject is a capital gain
or loss made on the disposal of an asset in New Zealand (NZ). This is
because NZ does not have a comprehensive capital gains tax (CGT)
regime.

However, NZ does have a property tax regime (that may apply to

land and buildings held for less than 10 years) that would need to be
considered when determining the Australian tax consequences of
NZ property disposals. For the purposes of the assessments in the
Core tax subject, the facts of the scenario will state whether the
capital gain or loss was or was not subject to tax in NZ.

Foreign equity 768-5 and A foreign equity distribution (ie a foreign dividend) is NANE income
distribution 768-10 of an Australian resident company where it holds a participation
exemption interest (eg an ownership interest) of 10% or more.

CGT 768-505 A foreign capital gain or loss on the disposal of shares in a foreign
participation company is reduced where an Australian resident company holds a
exemption direct voting percentage (ie an ownership interest) of 10% or more
for a continuous period of at least 12 months in the two years
before the CGT event.

To determine the amount of the reduction:

• Step 1: Calculate the active foreign business asset percentage
(using either market values or book values) = Value of active foreign
business assets / Value of total assets of the foreign company. The
percentage is rounded to the nearest whole percentage.
• Step 2: Reduce the capital gain or loss by, if the calculated
percentage is:
– Less than 10% = 0%.
– 10% to less than 90% = The actual percentage as calculated.
– 90% or more = 100%.

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Income tax – taxation of structures and transactions 251

 Section ITAA
1997 unless
Item otherwise stated Guidance

Previously 23AI ITAA 1936 Under the controlled foreign company (CFC) rules income that is
attributed CFC accumulated in a foreign company may be deemed to be assessable
income income of a person (ie an Australian resident shareholder) before it is
exemption actually received from the foreign company as a distribution (eg as a
foreign dividend).

A foreign distribution (eg a foreign dividend) is NANE income of an

Australian resident shareholder (ie individual, company, partnership,
or trust) where it is paid out of previously attributed CFC income.

This exemption (ie the previously attributed CFC income exemption)

takes priority, where both it and the foreign equity distribution
exemption apply.

The CFC rules are covered in the Advanced Tax subject.

Conduit foreign Division 802 Unfranked dividends paid by an Australian resident company to a
income (CFI) non-resident are NANE income if the dividend is declared to be paid
exemption from CFI (s 802-15).

Broadly, CFI is foreign income derived by an Australian company

(net of related expenses) that is not subject to tax in the Australian
company. CFI includes (but is not limited to) (s 802-25):
• Foreign branch income and capital gains that are NANE income
under the foreign branch exemption.
• Foreign equity distributions (ie foreign dividends) that are NANE
income under the foreign equity distribution exemption.
• Foreign capital gains that are disregarded under the CGT
participation exemption.
• Foreign distributions (eg foreign dividends) that are NANE income
under the previously attributed CFC income exemption.
• Foreign income that is effectively not subject to Australian tax
because of the FITO system.

Note: A detailed understanding of the conduit foreign income rules

is outside the scope of the Core tax subject.

Temporary 768-910, Broadly, a temporary resident is generally an individual taxpayer

resident 768-915, who is an employee and who has come to Australia temporarily for
exemptions 768-950, and work but has satisfied the technical requirements of being an
768-955 Australian resident for tax purposes (but not for the purposes of the
Social Security Act 1991).

For a temporary resident:

• Foreign sourced income is NANE income.
• A capital gain or capital loss is disregarded unless the CGT asset is
taxable Australian property (TAP) (s 855-15).

For CGT purposes:

• Where a non-resident individual becomes a temporary resident,
the general CGT rule that deems a cost base for non-TAP assets
does not apply.
• Where an individual taxpayer ceases to be a temporary resident
but remains an Australian resident, a CGT asset that is not TAP
will be deemed to have a cost base equal to its market value at the
time the taxpayer ceased to be a temporary resident.

Refer to Topics 2.1.1 and 2.2.4.

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252 Tax
Foreign branch income and capital gains exemption (s 23AH ITAA 1936)
Section 23AH ITAA 1936 excludes income and capital gains earned by foreign branches of Australian
companies from being taxed in Australia if certain conditions are met.

Application

The key elements of s 23AH ITAA 1936 are set out below.

Only available to an Australian company operating a foreign branch

The exemption only applies to foreign income, including capital gains, earned by an Australian company
through its permanent establishment (ie branch) in another country. It does not apply if the foreign entity is
a company (s 23AH(2) and (3) ITAA 1936).
Permanent establishment (PE) is defined in s 23AH(15) ITAA 1936. It adopts the meaning in the double
taxation treaty if one is applicable, or the definition in s 6(1) ITAA 1936 if no treaty applies. TR 2002/5
explains the general concept of a PE under s 6(1) ITAA 1936.

Does not apply to branch hybrid mismatch income

Under s 23AH(4A) ITAA 1936, the exemption does not apply if the foreign income derived by the
Australian company is branch hybrid mismatch income (this is covered in the Advanced Tax subject).

Both income and capital gains exempt

Section 23AH(2) ITAA 1936 exempts foreign income, while s 23AH(3) ITAA 1936 exempts foreign capital
gains on assets used in the branch’s business. Section 23AH(4) ITAA 1936 mirrors s 23AH(3) ITAA 1936 by
disregarding foreign capital losses.
Capital gains derived by an Australian resident company’s foreign branch are disregarded provided the
asset is not taxable Australian property (eg land) and is used for the purpose of producing foreign income in
carrying on a business at or through a PE.
Section 23AH(9) deems amounts derived in disposing of the branch’s business as being derived in carrying
on that business.

Applicable if there is an interposed trust or partnership

Section 23AH ITAA 1936 can also apply if there are one or more interposed partnerships or trusts that
exist between the Australian company and its foreign PE (ss 23AH(10) and (11) ITAA 1936). The Australian
company is deemed to derive the amount made by the interposed trust or partnership through the
company’s foreign branch. For example, if 20 companies equally own units in a unit trust which carries on
business in New Zealand, each company would potentially get the s 23AH exemption. The fact that each
company only has an indirect stake of 5% is not relevant.

Exceptions exist

Exceptions to s 23AH ITAA 1936 are contained in ss 23AH(5), (6), (7) and (8). The following table
summarises these:

Exceptions

Item PE in listed country PE in unlisted country

Income Exemption does not apply if the: Exemption does not apply if the:
• PE fails the active income test, and • PE fails the active income test, and
• foreign income is both adjusted tainted • foreign income is adjusted tainted
income and eligible designated income (s 23AH(7)).
concession income (EDCI) (s 23AH(5)).

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Income tax – taxation of structures and transactions 253

 Exceptions

Item PE in listed country PE in unlisted country

Capital gain Exemption does not apply if the: Exemption does not apply if the capital
or loss • capital gain or loss is from the disposal gain or loss is from the disposal of a
of a tainted asset, and tainted asset (s 23AH(8)).
• capital gain is EDCI (or the capital loss
would be EDCI had it been a capital
gain) (s 23AH(6)).

The definitions applicable to these exceptions are explained below.

Listed and unlisted countries

Listed countries and unlisted countries are defined in s 23AH(15) ITAA 1936 by reference to the meaning
in the CFC rules (Part X ITAA 1936).
Listed countries are currently Canada, France, Germany, Japan, New Zealand, the United Kingdom and the
United States (see Regulation 19 ITAR 2015). All other countries are unlisted countries.
As noted earlier, there are more exemptions that apply to exclude foreign investment income from taxation
in Australia in listed countries than unlisted countries.

Active income test

The active income test is defined in s 23AH(12) ITAA 1936, which refers to s 432 ITAA 1936. This is the
active income test that is used in the CFC rules.
The purpose of this test is to see whether the taxpayer is carrying on an active business (as opposed to
passive investment) in the foreign country. If the answer is ‘yes’, the income will not be taxed. If the answer
is ‘no’, the assumption is that the taxpayer has shifted income offshore and the branch’s income may
be taxed in Australia.
The active income test is passed if the branch’s income from ineligible activities (ie gross tainted turnover)
is less than 5% of its gross turnover. The tainted income ratio (s 433 ITAA 1936) is calculated as follows:

Gross tainted turnover ÷ Gross turnover = Tainted income ratio

Gross tainted turnover (s 435 ITAA 1936) is passive income including dividends, interest, royalties, rent and
capital gains on tainted assets, and certain income from dealings with related parties (ie tainted sales, s 447
ITAA 1936 and tainted services, s 448 ITAA 1936).
Gross turnover (s 433 ITAA 1936) is the total revenue including capital gains that is disclosed in a set of
statutory accounts for the foreign branch.

Adjusted tainted income

Adjusted tainted income is defined in s 23AH(13) ITAA 1936, which refers to the meaning in the CFC rules.
Adjusted tainted income for CFC purposes is defined in s 386 ITAA 1936. It refers to passive income,
tainted sales income and tainted services income that is adjusted for certain items. The adjustments are
outside the scope of this chapter.

Eligible designated concession income

Eligible designated concession income (EDCI) is defined in s 23AH(15) ITAA 1936, which refers to the
meaning in the CFC rules. It is specified income that is either taxed concessionally or is untaxed by the
listed country (s 317 ITAA 1936 and Regulations 16 and 17 ITAR 2015).
The most common example of EDCI is the tax-free gain on disposal of a tainted asset (eg a rental property
or shares) in New Zealand, as New Zealand does not have a CGT regime.
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254 Tax
Tainted assets

Tainted assets are defined in s 23AH(15) ITAA 1936, which refers to the meaning in the CFC rules. Tainted
assets, for the purpose of the CFC rules, are defined in s 317 ITAA 1936. They include financial
instruments or contracts but exclude trading stock and assets used solely in carrying on a business
(eg factories and goodwill). Tainted assets are the PE’s assets from which tainted income is earned.
Note: The CFC rules are dealt with in the Advanced Tax subject.

The application of s 23AH ITAA 1936 to the income of a foreign branch can be summarised as follows:
• active income – exemption always applies
• passive income where the branch passes the active income test – exemption always applies
• passive income where the branch fails the active income test:
– unlisted country – exemption never applies
– listed country and EDCI – exemption does not apply
– listed country and non-EDCI – exemption does apply
– capital gains or losses on active assets – exemption always applies.
• capital gains or losses on tainted assets:
– unlisted country – exemption never applies
– listed country and EDCI – exemption does not apply
– listed country and non-EDCI – exemption does apply.

Consequences

The effect where s 23AH ITAA 1936 applies is to make the foreign branch income NANE income. This
raises the following issues:

Issue Explanation

Expenses Section 8-1 ITAA 1997 only allows a deduction to the extent expenditure is incurred in
incurred gaining or producing assessable income. Further, s 8-1(2)(c) specifically denies deductions for
in earning expenses incurred in deriving NANE income. No deductions will be allowed for expenses
s 23AH incurred to earn s 23AH ITAA 1936 NANE income
ITAA 1936
There is no specific provision which provides a tax deduction for expenses which relate to
income
s 23AH ITAA 1936 NANE income. Contrast this to s 25-90 ITAA 1997 which allows a tax
deduction for debt deductions incurred in deriving s 768-5 ITAA 1997 or s 23AI ITAA 1936
NANE income (see below)

FITO One of the requirements to get relief for foreign taxes paid is that the foreign tax is paid in
respect of an amount that is included in assessable income. To the extent the foreign branch
income is NANE income under s 23AH ITAA 1936, there is no amount included in assessable
income and no FITO is available

Losses NANE income does not waste tax losses

Required reading
Section 23AH ITAA 1936

Section 6(1) ITAA 1936 – definition of ‘permanent establishment’.

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Income tax – taxation of structures and transactions 255

Foreign equity distribution exemption (s 768-5)
In broad terms, s 768-5 exempts from taxation in Australia the distributions (eg dividends) received by an
Australian corporate tax entity (eg company) from an equity interest in a foreign company if its participation
interest in the foreign company is at least 10%. Where the exemption applies, the distribution is NANE
income.

Application

The key elements of s 768-5 are set out below.

Only applies where participation interest is at least 10%

The exemption only applies to distributions received where the recipient company has a participation
interest of at least 10% in the payer company. Participation interests include both direct and indirect
interests in share capital, voting rights and distribution rights (disregarding rights on winding up). However,
in simple terms, this often means holding at least 10% of the ordinary shares.
The intent is to exempt distribution income arising from business activities done through a foreign
company, and not distributions derived from passive investments.

Does not apply to distributions entitled to foreign income tax deduction

The exemption is generally denied where all or part of the distribution gives rise to a foreign income tax
deduction (s 768-7). However, the exemption will not be denied where the foreign entity is a collective
investment entity, and foreign income tax or a withholding-type tax was payable in respect of the
distribution.
The exemption only applies to a foreign equity distribution. Foreign equity distribution is defined in
s 768-10 to include a dividend or a non-share dividend made by a company that is not a Part X Australian
resident (eg is a foreign resident) in respect of an equity interest in the company. An equity interest is
defined in s 974-70 of the debt–equity rules. Therefore, the exemption can apply to a return on a
non-share equity interest (eg a convertible note issued by a foreign subsidiary to an Australian company
that is classified as an equity interest).
The exemption does not apply to distributions on debt interests like redeemable preference shares issued
by a foreign subsidiary to an Australian company that are classified as debt interests because they have a
life of less than 10 years. Distributions on debt interests would be included in assessable income as interest
income (under s 6-5) or as dividend income (under s 44(1) ITAA 1936) and therefore, expenditure incurred
in deriving the assessable income including debt deductions would be deductible (under s 8-1).

Only available to corporate tax entities

The exemption is only available to Australian resident corporate tax entities. Corporate tax entity is defined
to include a company, corporate limited partnership, corporate unit trust or public trading trust (s 960-115).
The exemption does not apply to individuals or other types of trusts or partnerships receiving distributions
from a foreign company.

Payer is either a foreign company, interposed trust or interposed partnership

Section 768-5(2) allows the exemption where distributions flow through an interposed trust or partnership
other than one that is a corporate tax entity. This is consistent with the foreign branch exemption in
s 23AH ITAA 1936. For ATO guidance refer TD 2017/21 and TD 2017/22.

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256 Tax
Consequences

The effect where s 768-5 applies is to make the foreign equity distribution NANE income. This raises the
following issues:

Issue Explanation

Expenses incurred in No deductions are allowed for expenses to the extent incurred to earn s 768-5
earning s 768-5 income income under s 8-1(2)(c)

However, s 25-90 ITAA 1997 allows the taxpayer to deduct debt deductions
(interest or amounts in the nature of interest) to the extent incurred in gaining
s 768-5 income, provided that offsetting distributions are expected. Debt
deductions are defined in s 820-40.

In TD 2009/21, the ATO states that s 25-90 only applies where there is a
reasonable expectation, having regard to the objective circumstances, that a
dividend will be paid in the future (eg directors’ minutes, cash flow statements).
This can be contrasted to s 23AH ITAA 1936 above, where there are no specific
provisions to allow deductions against the NANE income derived.

Note that the government is proposing to stop such deductions from 1 July 2023.

FITO As with s 23AH ITAA 1936, where the distribution is NANE income under
s 768-5, there are no amounts included in assessable income and, therefore,
no FITO will be available.

Where both ss 768-5 and 23AI ITAA 1936 (discussed below) apply, s 23AI
ITAA 1936 has priority and a foreign income tax offset may be available for
foreign income taxes paid on the dividend (TD 2006/51).

Losses NANE income does not waste tax losses.

Required reading
Sections 25-90, 768-5, 768-10 and 768-15 ITAA 1997.

Foreign income tax offsets

To determine the taxable income for an Australian resident taxpayer with foreign income or capital gains,
tax practitioners need to be able to apply the following common tax rules and principles related to foreign
income tax offsets (FITOs) outlined in the following table.

TABLE: FITOs – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

FITO: 770-10 Foreign income tax must have been paid by an Australian resident
Entitlement taxpayer in respect of assessable income.
• A common FITO example is foreign withholding tax that is imposed by
a foreign country at the time of payment of dividend, interest and
royalty income to an Australian resident.
• No FITO is available where the:
– Income or capital gain is NANE income under the foreign branch
exemption.
– Dividend is NANE income under the foreign equity distribution
exemption.
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Income tax – taxation of structures and transactions 257

 Section ITAA
1997 unless
Item otherwise stated Guidance

• A FITO is available for foreign income tax that has been paid to the
extent it relates to a dividend that is NANE income under the
previously attributed CFC income exemption. This is because tax has
previously been paid in Australia on that income and rather than
requiring the Australian resident shareholder to amend the income tax
return for the income year in which the income was attributed (ie
deemed to be assessable income of the shareholder), the FITO is
allowed in the income year the subsequent dividend is paid.
• A FITO is generally not relevant for a non-resident taxpayer as they are
generally only taxable in Australia on their Australian sourced income.

FITO: 770-70 FITO eligible amount = Amount of foreign income tax paid that counts
Eligible towards the offset.
amount

FITO: Limit 770-75 FITO limit, greater of:

• $1,000 (or eligible FITOs if less than $1,000).
• FITO cap amount = Income tax payable on taxable income – Income
tax payable on modified taxable income.

Note: The FITO cap calculation is effectively limiting the FITO that can
be claimed to the amount of Australian income tax that is actually
payable in respect of the foreign income or capital gain.

Broadly, modified taxable income is equal to the taxpayer’s Australian

sourced income with some modifications. Applying basic math’s
principles:
• Total income tax payable = Income tax payable on Australian sourced
income + Income tax payable on foreign sourced income.
• Thus, Total income tax payable – Income tax payable on Australian
sourced income = Income tax payable of foreign sourced income.
In practice, this shortcut method is used to give an indication of the FITO
limit but any final calculations follow the legislative formula in s 770-75
(see below).

FITO: Excess 63-10 Excess FITOs cannot be refunded and cannot be carried forward.
amounts and
interactions When calculating income tax payable:
• For a resident individual = FITOs are applied before franking tax
offsets (ie non-refundable before refundable).
• For a resident company = Franking tax offsets are applied before FITOs.

There are two ways to prevent double taxation:

• exempting foreign income from Australian tax
• giving a tax offset for foreign taxes paid on that foreign income.
Division 770 deals with foreign income tax offsets (FITOs). Sections 770-1 and 770-5 set out the basic
principles of the Division. In addition, the ATO’s Guide to foreign income tax offset rules provides a useful
summary.
A FITO effectively reduces the Australian tax that would be payable on foreign income by an amount up to
the foreign income tax paid.

Application

Section 770-10(1) describes when an entity is eligible for a FITO. The key requirements are as follows:
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258 Tax
 Entitlement to FITO

Requirements Explanation

Foreign income tax Foreign income tax is defined in s 770-15(1) to mean foreign taxes on income,
gains and profits, as well as any taxes covered under the tax treaties.

The payment of a credit absorption tax or a unitary tax (both defined in

s 770-15) does not qualify for a FITO (s 770-10(5)).

The note under s 770-15(1) makes it clear that where a foreign tax authority is
not authorised to impose the tax in the first place, for example, because of a
double tax agreement, the tax will not qualify as a foreign tax.

Foreign income tax must Any resident or non-resident taxpayer who has paid foreign income tax may be
have been paid eligible for a FITO. For example, an Australian resident who is deriving foreign
sourced income may be eligible. In addition, the Australian branch of a UK
resident earning assessable income and which paid tax in the United States on
that income, may get a FITO for the US tax paid.

No FITO for residence-based tax – If a taxpayer paid foreign income tax because
they were a resident of a foreign country, they will not get a FITO (s 770-10(3)).
For example, the Australian branch of a UK resident earning assessable income
and which paid UK tax as a UK resident, will not get a FITO for the UK tax paid.

Paid – Generally, foreign income tax can be paid by the taxpayer or by someone
else on their behalf (s 770-130). For example, a FITO may be available in
situations where foreign income tax has been paid by:
• deduction at source or withholding
• the trustee of a trust of which the taxpayer is a beneficiary
• a partnership in which the taxpayer is a partner
• the taxpayer’s spouse.

Generally, a shareholder is not taken to pay the underlying tax paid by the
company. However, if a company (but not an individual) has a 10% or more
direct or indirect interest in a controlled foreign company (CFC) and there is
attribution of income, the company is taken to have paid its share of the foreign
income taxes paid by the CFC on that income (s 770-135).

By contrast, s 770-140 describes when a taxpayer is not considered to have paid

foreign income tax. For example, a taxpayer is not considered to have paid
foreign tax when the taxpayer is entitled to a refund of that foreign tax.

Note 1 to s 770-10(1) provides that the foreign income tax need not be paid in
the current income year. In other words, it does not have to be paid in the same
income year the amount is included in assessable income, so long as the foreign
income tax is paid by the time the FITO is claimed. For example, assume that
foreign interest income is assessable on an accruals basis in Year 1. Foreign tax
is paid in Year 2. When the foreign tax is paid, a FITO can be claimed in Year 1.
This may require an amended assessment if the income tax return for Year 1
is lodged before the foreign tax is paid. Having said that, if it is clear that the
foreign tax will be paid, in practice, many taxpayers claim the FITO upfront,
rather than going down the amendment route.

Foreign income tax must Foreign income tax paid on exempt or NANE amounts does not qualify for a FITO.
have been paid on an
assessable amount Note 2 to s 770-10(1) provides that if only part of the income was assessable
to the taxpayer, then the taxpayer will only get a portion of the FITO.

In Burton v FCT, the taxpayer was entitled to the 50% CGT general discount and
it was held that the taxpayer was only entitled to 50% of the foreign income
taxes paid as a FITO.
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Income tax – taxation of structures and transactions 259

 Entitlement to FITO

Requirements Explanation

Section 770-10(2) provides an exception to the general rule. A distribution by

a CFC that was previously subject to attribution under Part X ITAA 1936
(CFC rules) will be eligible for a FITO if any taxes were paid on repatriation
(eg withholding tax). Even though the distribution paid out of previously
attributed amounts is NANE income under s 23AI ITAA 1936, the CFC income
would have already been subject to tax in Australia at the time of attribution.
Allowing the FITO ensures the same income is not taxed twice.

FITO is available in the year This requirement describes the timing of the FITO. The FITO is not available in
the amount was included in the year the taxpayer paid foreign income taxes but in the year the income was
assessable income assessed in Australia, assuming foreign income taxes have been paid.

If an amount was assessed in one year and foreign income tax was paid in a later
year, the taxpayer will have to amend their assessment to claim a FITO. The
usual amendment time period will not apply. For FITO purposes, the taxpayer
has up to four years from the time they paid foreign income tax to amend their
assessment (s 770-190).

The operation of the FITO rules in a consolidated group is covered by Subdivision 717-A.
The following examples discuss the availability of FITO under different circumstances.

Example 3.50 –Timing of income

David derives foreign dividend income in Year 1. Foreign tax is paid on this income in Year 2. Even
though the tax is paid in a later year, the FITO is married to the income derivation point. Therefore,
the FITO is available in Year 1.

Example 3.51 – Refund of foreign tax

David derives foreign dividend income in Year 1. Foreign tax is paid on this income in Year 2. Shortly
thereafter, the tax is refunded because of the application of a double tax agreement.

David is not entitled to a FITO. This is because there is no net foreign tax ultimately paid.

Example 3.52 – Assessable dividend

David derives a $3,000 dividend from a minority shareholding in a company based in an offshore
country. The dividend is assessable under s 44 ITAA 1936. Dividend withholding tax of $1,000 is
deducted at source by the offshore company.

David is entitled to a FITO. This is because the dividend is assessable and David is deemed to have
paid the foreign tax himself. A FITO is available on this sort of income.

Example 3.53 – Exempt dividend from previously attributed income

David derives a $20,000 dividend from a wholly owned company based in an offshore country which
is paid out of previously attributed income. The dividend is NANE income under s 23AI ITAA 1936.
Dividend withholding tax of $5,000 is deducted at source by the offshore company.

David is entitled to a FITO. This is because the dividend is paid out of previously attributed income
and David is deemed to have paid the foreign tax himself. A FITO is available on this sort of income.

Example 3.54 – Exempt dividend

Posh Pty Ltd (an Australian resident company) derives a $100,000 dividend from a wholly owned
company which is based in an offshore country. The dividend is NANE income under s 768-5
Pdf_Folio:260
ITAA 1997. Dividend withholding tax of $10,000 is deducted at source by the offshore company.

260 Tax
 Posh is not entitled to a FITO. This is because the dividend is non-assessable non-exempt income.
A FITO is not available on this sort of income.

Example 3.55 – Exempt branch profit

Posh Pty Ltd (an Australian resident) derives a $100,000 profit via its offshore branch. The profit is
non-assessable non-exempt income under s 23AH ITAA 1936. Foreign tax of $20,000 is payable by
the offshore branch.

Posh is not entitled to a FITO. This is because the branch profit is non-assessable non-exempt
income. A FITO is not available on this sort of income.

Example 3.56 – Assessable branch profit

Beck Pty Ltd (an Australian resident) derives $100,000 in income via its offshore branch. The income
is assessable under s 6-5 (ITAA 1997). Section 23AH ITAA 1936 is not applicable because Beck fails
the active asset test and it is based in an unlisted country. Foreign tax of $20,000 is payable by the
offshore branch.

Beck is entitled to a FITO. This is because the branch profit is assessable income. A FITO is available
on this sort of income.

The amount of the FITO is discussed below.

Calculation method

The amount of a FITO is the amount of foreign income tax paid (s 770-70). However, s 770-75 places a
limit on the amount of FITO, which is the greater of:
• $1,000
• the FITO cap amount.
Taxpayers do not have to perform the FITO cap calculation if they do not intend to claim more than $1,000
in FITOs, even if they paid more than $1,000 in foreign income tax.
For taxpayers who have paid more than $1,000 of foreign income tax and wish to claim more than $1,000
of FITOs, the FITO cap amount is calculated in accordance with ss 770-75(2), (3) and (4).
The FITO cap calculation is illustrated in the following diagram:

Income tax payable Income tax payable

FITO limit
on taxable income on modified taxable income

Include Medicare levy Include Medicare levy but ignore other

but ignore other tax offsets tax offsets.
Based on the assumptions in s 770–75(4),
including:
• Exclude from assessable income
– any amount on which eligible foreign
income tax was paid, and
– any amount of assessable income that
is foreign-sourced
• Exclude from deductions
– debt deductions attributable to
overseas PEs (eg branches), and
– any deductions (other than debt
deductions) reasonably attributed to
income items excluded above

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Income tax – taxation of structures and transactions 261

Section 770-80 increases the FITO limit (whether $1,000 or a calculated amount) for any amounts of
foreign income tax paid on amounts previously attributed under the CFC regime. In other words, there is
no limit on the amount of a FITO a taxpayer can get for eligible foreign income taxes paid on s 23AI ITAA
1936 amounts.

Excess amounts

Section 63-10 makes it clear that:

• foreign income taxes paid that are not claimed as a FITO cannot be carried forward for use in later years
• excess FITOs cannot be transferred to another entity
• the income does not need to be from a foreign source in order to be eligible for a FITO, foreign tax has to
have been paid.
It is also generally considered that excess FITOs are not deductible because the imposition of tax is a below
the line issue.
Where a company has both a prior year loss and a FITO entitlement, the loss utilisation should be reduced
under s 36-17(2), so that FITOs are not wasted, excess FITOs cannot be carried forward. That is, if a FITO is
allowed, a deduction for prior year losses should not be taken if it results in taxable income for which
Australian tax is payable. This will utilise the FITO that would otherwise be lost and will preserve prior year
losses for potential use in a later income year. The next example illustrates this point.
In the Burton case (Burton v FC of T [2019] FCAFC 141), the Federal Court concurred with the ATO’s
approach of denying the taxpayer a FITO against his tax liability in Australia on the gains to the extent of
half of the US tax paid, due to the availability of concessional CGT rules available in Australia (CGT discount
rule). The Court’s judgment is consistent with ATO ID 2010/175.

Example 3.57 – Individual with FITOs

In this example, it is assumed that the individual tax rate is 35% (including the Medicare levy). Whilst
the tax rates have different scales for individuals, this example focuses on the principles, rather than
on the calculations.

Jughead Otway is an Australian resident individual taxpayer. Jughead has taxable income of $90,000
which comprises:

• $70,000 of Australian-sourced income

• $20,000 net foreign sourced income with $8,000 tax deducted at source, resulting in a net receipt
of $12,000.

Jughead also had $30,000 of net foreign dividend income that was paid out of previously attributed
CFC income. Jughead paid foreign withholding tax of $3,000 on this dividend. The foreign dividend
of $27,000 is NANE income under s 23AI ITAA 1936.

Jughead’s FITO cap under s 770-75 is calculated as follows:

Tax on taxable income of $90,000 at 35% = $31,500

Less: Tax on modified taxable income of $70,000 at 35% ($24,500)

= $7,000

However, in accordance with s 770-80, Jughead increases the FITO cap by the foreign tax paid on
foreign dividend that is paid from income previously attributed under the CFC regime. Therefore, his
total FITO cap is:

$7,000 + $3,000 = $10,000

As Jughead’s FITO cap is less than the total FITOs (ie $8,000 + $3,000 = $11,000), Jughead’s FITO
entitlement is limited to the cap.
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262 Tax
 Therefore, Jughead’s tax payable for the income year is:

$31,500 − $10,000 = $21,500

The remaining $1,000 is lost.

Temporary residents

The temporary residents regime was introduced to give special tax treatment to foreign employees who
come to Australia temporarily to work but have satisfied the technical requirements of being an Australian
tax-resident. It was considered inappropriate that the worldwide income of these workers be taxed in
Australia, so Subdivision 768-R was introduced. The Subdivision provides as follows:
• The ordinary income and statutory income of a temporary resident which has a foreign source is NANE
income if it was derived when the person was a temporary resident (s 768-910).
• The exclusion does not apply to capital gains from assets that are taxable Australian property
(ss 768-910(1) and 768-915). Such gains continue to be taxable under the CGT provisions.
• Other exceptions to Subdivision 768-R are listed in s 768-910(3).

3.2.2 Taxation of Australian-sourced income of

non-residents
In addition, when a non-resident carries on a business in Australia at or through a permanent
establishment, the non-resident is taxable in Australia on:
• business profits, to the extent they are attributable to the permanent establishment (see later in this
topic under double tax treaties, transfer pricing and TR 2001/11)
• dividends it receives from an Australian resident company that are attributable to the permanent
establishment, irrespective of the source of profits from which those dividends are paid (s 44(1)(b) and (c)
ITAA 1936).
The following tables provide a high-level snapshot of the taxation implications to be considered for a
non-resident on the receipt of Australian sourced income. There are a number of elements that determine
the taxation provisions that may be applicable, including the type of taxpayer, investment structure and the
type of income.

TABLE: Foreign residents – application overview

Type of Type of
Type of Australian Australian
taxpayer investment income Taxation implications to be considered

Non- Australian Profits – trading Branch taxable in Australia under s 6-5.

resident branch –
company permanent No tax on repatriation of profits (eg payment / transfer) to
establish- non-resident.
ment

Interest or Branch generally taxable in Australia under s 6-5 (ie DIR

royalty withholding tax does not apply, therefore not NANE income).

No tax on repatriation of amount (eg payment/transfer) to

non-resident.

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Income tax – taxation of structures and transactions 263

 Type of Type of
Type of Australian Australian
taxpayer investment income Taxation implications to be considered

Dividend Branch generally taxable in Australia under s 44(1)(b) and (c)

(attributable to ITAA 1936 (ie DIR withholding tax does not apply, therefore
branch and not not NANE income).
non-resident
company No tax on repatriation of amount (eg payment/transfer) to
offshore non-resident.
operations)

Profits – on sale Subject to CGT (ie branch assets are taxable Australian
of assets used in property (TAP)).
business

No tax on repatriation of profits (eg payment/transfer) to

non-resident.

Refer to Topic 2.2.4.

Australian Dividends, DIR withholding under s 128B ITAA 1936 and NANE income
company interest or of non-resident under s 128D ITAA 1936 (subject to CFI
royalty exemption in s 802-15).

Refer to Topic 3.2.1.

Sale of shares in Subject to CGT and foreign resident CGT withholding tax
Australian (non-final tax) (refer below).
company –
taxable
Australian
property (TAP)

Sale of shares in Not subject to CGT.

Australian
company – Refer to Topic 2.2.4.
non-TAP

Any non- Australian Dividends, DIR withholding under s 128B ITAA 1936 and NANE income
resident trust interest and of non-resident under s 128D ITAA 1936 (subject to CFI
(general) royalties exemption in s 802-17).

Refer to Topic 3.2.1.

Distributions – Trust provisions apply.

other Refer to Topics 3.1.4 and 2.2.4.

Direct Sale of asset that Subject to CGT and foreign resident CGT withholding tax (non-
ownership is TAP final tax).
of asset in
Australia Refer to Topic 2.2.4.

Sale of asset that Not subject to CGT.

is not TAP
Refer to Topic 2.2.4.

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264 Tax
 Dividends, DIR withholding under s 128B ITAA 1936 and NANE income
interest and of non-resident under s 128D ITAA 1936
royalties
(Australian
sourced)

Other (Australian Taxable in Australia under s 6-5.

sourced)

TABLE: Foreign residents – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

Assessable 6-5 and 6-10 Australian sourced income is generally included in the assessable
income: General income of a non-resident taxpayer.

CGT: Capital 855-10, For CGT assets:

gain or loss 855-15, • A capital gain or capital loss made by a non-resident taxpayer, who
855-20, holds a direct ownership interest in a CGT asset, is disregarded
855-25, and unless the asset is taxable Australian property (TAP) (s 855-10).
855-40 • A net capital gain made by a non-resident taxpayer, who holds an
indirect direct ownership interest in a CGT asset via a unit trust, is
disregarded unless the asset is TAP (s 855-40).
• A net capital gain made by a non-resident taxpayer, who is a
beneficiary of a discretionary trust, is not disregarded. This is due
to technical anomalies in the drafting of Division 855 such that
the above limitation for a fixed trust does not apply.

TAP includes:
• Taxable Australian real property (TARP) = Real property situated in
Australia (eg land and buildings).
• Indirect Australian real property interest = Foreign resident who
owns at least a 10% interest in a company and more than 50% of
the market value of the assets of that company are real property
situated in Australia. There are also tracing rules that look through
interposed entities to the underlying assets.
• An asset used in carrying on a business through a permanent
establishment (ie branch) of a non-resident in Australia.
• An option or right to acquire any of the above.
• A CGT asset that a foreign resident has elected to be TAP when
they ceased to be an Australian resident (s 104-165).

Refer to Topics 2.2.4 and 3.1.4.

CGT: Cost base 855-45 When a non-resident taxpayer becomes an Australian resident, a
of assets on CGT asset that is not TAP is deemed to have a cost base equal to its
becoming an market value at that time.
Australian
resident A similar rule exists for a person who ceases to be a temporary
resident but remains an Australian resident (s 768-950 and s
768-955).

Refer to Topics 2.2.4 and 3.2.1.

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Income tax – taxation of structures and transactions 265

 Section ITAA
1997 unless
Item otherwise stated Guidance

CGT: Deemed 104-160 and When an individual or company stops being an Australian resident,
CGT event I1 104-165 (just before that time) there is a deemed disposal at market value of
when individual CGT assets, other than:
or company • Taxable Australian real property (TARP),
ceases to be an • A CGT asset that is used in a permanent establishment (ie branch)
Australian in Australia, or
resident • Non-TAP assets that an individual taxpayer has chosen to treat as
TAP.

Therefore, for post-CGT assets the outcome of the application of

the CGT rules at the time the taxpayer ceases to be a resident is:
• There are no tax implications for TARP, assets of an Australian
permanent establishment, or where an individual has made a valid
choice. These assets will be subject to CGT at the time of actual
disposal.
• Indirect Australian real property interests are deemed to be
disposed of and immediately required at market value. These
assets are subject to CGT at the time the taxpayer becomes a
non-resident and at the time of actual disposal, but only on any
subsequent increase in market value.
• All other CGT assets are subject to CGT at the time the taxpayer
ceases to be a resident. These assets will not be subject to CGT at
the time of actual disposal if the taxpayer remains a non-resident.

Refer to Topic 2.2.4.

Deductions 8-1 Expenditure incurred in deriving the assessable income of a

non-resident taxpayer is generally deductible. However, where the
expenditure relates to deriving exempt or non-assessable
non-exempt (NANE) income it is not tax deductible.

Amounts subject 128D ITAA 1936 Australian sourced dividend (franked and unfranked components),
to withholding interest, and royalty income that is subject to withholding tax are
tax deemed to be NANE income of the non-resident.
• If Australian sourced dividend, interest and royalty income that is
subject to withholding tax is the only type of Australian sourced
income received, the non-resident will not be required to
complete an Australian income tax return.
• If the non-resident has received other types of Australian sourced
income, an income tax return will need to be completed.

For example:
• Where the non-resident is a partner in a partnership = The
partner’s share of the net income or loss of the partnership will
need to be adjusted to remove net foreign sourced income (as this
is not assessable income of a non-resident) and Australian sourced
dividend, interest and royalty income.
• Where the non-resident is a beneficiary of a trust = The
beneficiary’s share of the net income of the trust will need to be
adjusted to remove net foreign sourced income (as this is not
assessable income of a non-resident) and Australian sourced
dividend, interest and royalty income. It may also need to be
adjusted to remove net capital gains (see above).
• Where the non-resident is carrying on business in Australia
through a permanent establishment = No adjustment is required
for dividend, interest and royalty income that is attributed to the
permanent establishment as it is not subject to DIR withholding
tax.

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266 Tax
To determine the taxable income for a non-resident taxpayer with Australian sourced income or capital
gains on the disposal of taxable Australian property (TAP), tax practitioners need to be able to apply the
following common tax rules and principles related to DIR withholding outlined in the following table.

TABLE: DIR withholding – key sections

Section ITAA
1997 unless
Item otherwise stated Guidance

Dividend 128B(1) ITAA The payer is required to withhold tax at a rate of 30% prior to the
1936 payment or distribution of an Australian sourced dividend to a
non-resident recipient.

However, withholding tax is not payable when:

• The dividend is fully franked (s 128B(3)(ga) ITAA 1936).
• The dividend is derived via an Australian permanent establishment
(ie branch).
• An Australian company has declared an unfranked dividend to be
conduit foreign income (CFI).

The rate of withholding tax may be altered under a double tax

agreement (DTA). The DTA rules are covered in the Advanced Tax
subject.

Refer to Topic 3.2.1.

Interest 128B(2) ITAA The payer is required to withhold tax at a rate of 10% prior to the
1936 payment or distribution of Australian sourced interest income to a
non-resident recipient or Australian resident earning the interest
income through a permanent establishment overseas.

However, withholding tax is not payable when:

• The interest is derived via an Australian permanent establishment
(ie branch) of a non-resident.

The rate of withholding tax may be altered under a double tax

agreement (DTA). The DTA rules are covered in the Advanced Tax
subject.

Royalty 128B(2A) ITAA The payer is required to withhold tax at a rate of 30% prior to the
1936 payment or distribution of Australian sourced royalty income to a
non-resident recipient or Australian resident earning the royalty
income through a permanent establishment overseas.

However, withholding tax is not payable when:

• The royalty is derived via an Australian permanent establishment
(ie branch) of a non-resident of a country with whom Australia has
a double tax agreement.

The rate of withholding tax may be altered under a double tax

agreement (DTA). The DTA rules are covered in the Advanced Tax
subject.

Interpretation 128A(2) ITAA Interest or royalty income is deemed to be paid to another person
1936 when it is reinvested, accumulated, capitalised, or otherwise dealt
with on behalf of the other person or as the other person directs.

Deduction 26-25 A deduction is not available to the payer of Australian sourced

limitation for dividend, interest or royalty income until the DIR withholding tax (if
payer any) is paid.

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Income tax – taxation of structures and transactions 267

Withholding tax
It is often impractical for Australia (through the ATO) to enforce the collection of tax from non-residents.
Therefore, provisions exist that require tax to be withheld from certain types of income of a non-resident
taxpayer. Australia’s withholding tax regimes include:
• dividend, interest and royalty (DIR) withholding (Division 11A ITAA 1936)
• managed investment trust (MIT) withholding (Division 840):
– MIT withholding tax applies to fund payments made by a MIT to a non-resident beneficiary where
there is no permanent establishment in Australia. Fund payments are the distributions of income by a
MIT excluding capital gains and losses in relation to a CGT asset that is not taxable Australian property,
amounts that are subject to DIR withholding tax and amounts that are foreign sourced income
(Schedule 1 s 12-405 TAA 1953). Therefore, fund payments generally consist of rental income and
capital gains from taxable Australian property (TAP). The non-resident beneficiary is liable for the MIT
withholding tax, while the collection obligation rests with the payer (Schedule 1 s 12-385 TAA 1953).
Income that is subject to MIT withholding tax is NANE income of the non-resident beneficiary under
s 840-815. Therefore, the usual trust provisions do not apply.
– The rate of MIT withholding tax where the recipient is in a country with which Australia has an
exchange of information (EOI) agreement or double taxation agreement is 15% (except to the extent it
is non-concessional MIT income) and 30% in other cases (Schedule 1 s 12-385 and 12-390 TAA 1953).
EOI countries are listed in Regulation 34 TAR 2017 and are not the same as a country with which
Australia has a double taxation agreement.
– The government has announced that the 2023–24 Budget will reduce the withholding tax rate for
eligible fund payments from managed investment trusts to foreign residents on income from newly
constructed residential build-to-rent properties after 1 July 2024 from 30% to 15%, subject to further
consultation on eligibility criteria.
• Non-resident withholding – certain activities (Schedule 1 s 12-315 TAA 1953):
– Non-resident withholding tax applies to payments made for promoting or operating a gaming junket,
for sports and entertainment activities, and for construction and related activities (Regulation 31, 32
and 33 TAR 2017).
• Non-resident withholding – taxable Australian property (Schedule 1 s 14-200 TAA 1953):
– A 12.5% non-final withholding tax applies on the disposal by non-residents of taxable Australian
property. Like the other withholding regimes, it is the payer (ie purchaser) who is required to pay
12.5% of the purchase price to the ATO as withholding tax.
– The main exceptions from the requirement to withhold includes where the vendor is an Australian tax
resident and has provided the purchaser with a clearance certificate, where the sale of taxable
Australian real property (eg residential property) is valued at less than $750,000, and for transactions
on a stock exchange (eg listed shares) (Schedule 1 ss 14-210 and 14-215 TAA 1953). In addition, assets
used in carrying on a business through an Australian permanent establishment are not subject to
non-resident withholding.
– The non-final withholding tax is collected as an estimate of the non-resident vendor’s final income tax
liability. The non-resident is still required to lodge an income tax return, claim a credit (ie tax offset) for
the amount withheld (Schedule 1 ss 18-15, 18-20 and 18-25 TAA 1953), and pay any outstanding
liability.

The examples below illustrate the effects of withholding tax from income of a non-resident taxpayer.

Example 3.58 – Consequences for Australian resident payer

AC Toys (an Australian resident company) has entered into an agreement with HKCo (a company
resident in Hong Kong) that makes Magic Fairytale Castle toys. Under the agreement, AC Toys will

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268 Tax
 have rights to sell the Magic Fairytale Castle toys in Australia, but will have to pay a royalty of 5% to
HKCo for each sale.

As a non-resident, HKCo is liable for tax in Australia in respect of any Australian-sourced royalty
payments from AC Toys (s 6-5). Withholding tax at a rate of 30% applies to the royalty payments
from AC Toys (s 128B(2B) ITAA 1936 and Income Tax (Dividends, Interest and Royalties Withholding
Tax) Act 1974). This rate is subject to the operation of double taxation treaties. However, Australia
does not have a double taxation treaty with Hong Kong.

As the royalty payment is to a location outside Australia, AC Toys is required to withhold and remit
the withholding tax to the ATO on behalf of HKCo (s 12-280 TAA 1953).

AC Toys is not entitled to a deduction for the royalty payments until the withholding tax is actually
paid (s 26-25). Once paid, the royalty is retrospectively deductible in the year in which it was incurred.
Therefore, AC Toys may need to lodge an amended income tax return to claim the deduction.

The royalty income received by HKCo will be NANE income under s 128D ITAA 1936.

Example 3.59 – Income received by non-resident company

Hong Kong Pty Ltd is a Hong Kong, non-resident company which only earns passive income. Hong
Kong Pty Ltd receives the following income during the year from Australian payers:

• Unfranked dividend from A Ltd: $100,000

• Fully franked dividend from B Ltd: $70,000
• Interest from Aust Bank: $40,000
• Royalty from Royal Aust Pty Ltd: $30,000
• Proceeds on sale of land $2,000,000 (cost base $500,000, acquired 5 years ago for investment
purposes).

The withholding tax required to be deducted by the Australian payers are as follows:

• Unfranked dividend from A Ltd: $100,000 × 30% = $30,000

• Fully franked dividend from B Ltd: $70,000 × 0% = $0 (para 128B(3)(ga) ITAA 1936))
• Interest from Aust Bank: $40,000 × 10% = $4,000
• Royalty from Royal Aust Pty Ltd: $30,000 × 30% = $9,000
• Property sale: $2,000,000 × 12.5% = $250,000.

The amounts which Hong Kong Pty Ltd would be assessable on in Australia are as follows:

• Unfranked dividend from A Ltd: $0 (s 128D ITAA 1936)

• Fully franked dividend from B Ltd: $0 (s 128D ITAA 1936)
• Interest from Aust Bank: $0 (s 128D ITAA 1936)
• Royalty from Royal Aust Pty Ltd: $0 (s 128D ITAA 1936)
• Property sale: $2,000,000 - $500,000 = $1,500,000 (s 102-5 ITAA 1997).

The net tax payable after the credit for the withholding tax would be $1,500,000 × 30% = $450,000
- $250,000 = $200,000.
Note: Australia does not have a double tax agreement (DTA) with Hong Kong. However, both countries have agreed to begin
negotiations for an income tax treaty. The treaty with the People’s Republic of China excludes Hong Kong and Macau. Therefore,
the non-treaty rates are used in this example.

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Income tax – taxation of structures and transactions 269

3.2.3 Other international measures to be dealt with in
Advanced Tax
Double tax treaties
Double taxation can be eliminated either by excluding income from being taxed in Australia or by granting
offsets for the foreign taxes paid against domestic tax. Australia’s double tax treaties (or double tax
agreements) also deal with double taxation by allocating or introducing the rights to tax and the obligations
to grant a tax offset.

Attribution regimes
The international attribution system refers to the regimes that include certain foreign income of a
non-resident in the taxable income of an Australian resident. They do this by attributing or imputing foreign
income of the non-resident to the Australian resident. In other words, the foreign income is deemed to
have been derived by the Australian resident and is included in the Australian resident’s assessable income
for taxing in Australia. The most important regimes are the controlled foreign companies (CFC) rules (Part X
ITAA 1936) and transferor trust (TT) rules (Division 6AAA ITAA 1936).

Thin capitalisation
Thin capitalisation occurs when a multinational entity finances its Australian operation with a large amount
of debt compared to its equity. Consequently, the multinational entity’s equity capitalisation in Australia is
said to be thin or inadequate. The high debt-equity ratio of thin capitalisation is attractive to multinational
entities because debt generates 30% interest deductions, whereas dividends paid on equity investments are
not deductible. There is a threshold test where the thin capitalisation rules don’t apply if debt deductions
(together with any associate entities) are less than $2 million for the income year. The rules apply where debt
is used to fund Australian operations by an offshore controller and when Australian entities invest offshore.
Note: The government is proposing to amend the thin capitalisation provisions from 1 July 2023.

Transfer pricing
The transfer pricing rules aim to ensure that transactions between Australian taxpayers and overseas
parties are conducted on an arm’s-length pricing basis. Specifically, pricing of international dealings
between two parties (whether related or not) should reflect a fair return for the activities performed, the
assets used, and the risks assumed in performing the activities. Pricing that is not in accordance with the
transfer pricing rules contained in the tax legislation may be termed international profit shifting. Transfer
pricing rules designed to counter this are contained in Subdivisions 815-B and 815-C. These rules apply
sanctions where transactions are not at arm’s length.

Hybrid mismatch arrangements

Some entities have been able to exploit the differences between the tax treatment of an arrangement in
different countries (ie double non-taxation, double tax benefits or the long-term deferral of taxation). For
example, an entity may be able to claim a tax deduction in respect of one payment in two or more different
jurisdictions. The hybrid mismatch provisions are designed to impose sanctions where there is a mismatch
between the tax treatment of an amount in Australia and in an overseas country. These rules are complex
and do not have a materiality threshold. The aim is to neutralise the mismatch by denying the deduction or
including amounts in assessable income.

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270 Tax
Chapter summary

Tax structures
When considering a tax issue, the starting point is generally to determine what structure is being
considered. The main ones are:
• individuals
• partnerships
• companies
• trusts
• small business entities
The efficacy of each structure needs to be carefully considered and understood before a business is
established. An inappropriate structure could result in additional tax being paid either directly or indirectly.

International and other structures

The foundations of studying international tax involves a consideration of the tax issues associated with:
• Funds flowing into Australia. Tax issues include:
– the tax treatment of foreign income amounts including exemptions, foreign income tax offsets and
rules to prevent double tax and double tax agreements
– the tax treatment of interest incurred in connection with foreign income amounts
– the arm’s-length rules and transfer pricing
– the hybrid mismatch rules to prevent double non-taxation or long-term deferral of taxation.
• Funds flowing out of Australia. Tax issues include:
– the withholding tax treatment of payments like dividends, interest and royalties, managed investment
trust (MIT) withholding tax and foreign resident withholding tax, and rules to prevent double tax and
double tax agreements
– the attribution of income back to Australia from certain entities like controlled foreign companies and
transferor trusts
– the tax treatment of debt deductions (ie interest) incurred and the thin capitalisation rules
– the arm’s-length rules and transfer pricing
– the hybrid mismatch rules to prevent double non-taxation or long-term deferral of taxation.

By the time you have finished this topic, you should be able to:
• Calculate the tax payable of taxpayers in receipt of foreign income in a complex scenario. This requires a
FITO to be identified and calculated. This also requires an appreciation that FITO’s generally require
there to be assessable income before a FITO can be claimed (s 23AI ITAA 1936 is the main exception to
this rule). This means that where, for example, a taxpayer derives exempt dividend income under s 768-5
ITAA 1997, no FITO is available.
• Determine how the withholding tax regime applies to dividends, interest, royalties and capital gains. This
requires a knowledge of the different rules which apply and the rates applicable, but also how the
non-resident is taxed on these types of income.
The key is to always go back and follow the flow of funds into Australia and out of Australia.
The next step, for those wishing to study Advanced Tax, is to understand double tax treaties, attribution
regimes, thin capitalisation, transfer pricing and the hybrid mismatch rules.

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Income tax – taxation of structures and transactions 271

Pdf_Folio:272
CHAPTER 4

Other taxes and interactions

Chapter introduction
The Australian tax system currently imposes a tax liability on various other transactions. For example,
fringe benefits tax (FBT) applies to tax employers on non-cash benefits provided to employees. Goods and
services tax (GST) is a transaction tax that applies to tax consumption. While income tax is the primary
source of the Australian government’s revenue, the Australian government also relies on these non-income
taxes to be able to provide public services such as education and infrastructure. This chapter covers
non-income related taxes. A brief outline of each key topic which will be examined in this chapter has been
summarised below.

Goods and services tax (GST)

GST was introduced on 1 July 2000 and applies to consumption transactions. GST is a transaction-based
tax levied by the Australian federal government at a rate of 10% on the supply of most goods and services
by entities that are registered, or required to be registered, for GST. The Australian GST rules are complex
because there are supplies which do not attract a GST liability and many exemptions to consider.

Employment remuneration and fringe benefits tax (FBT)

Employers are subject to many employment tax rules and obligations. This chapter will cover non-cash
remuneration transactions such as the payment of superannuation and the provision of other benefits and
will examine tax rules for both employers and employees.
FBT was implemented in 1986 and targets employers who provide non-cash benefits to employees and
associates of the employees. FBT rules capture non-cash benefits but there are also exemptions and
concessions available for employers.

Interactions between taxes and transactions

The Australian tax rules have been designed to prevent double taxation. There are special tax rules to
ensure a taxpayer is not disadvantaged. The interactions between GST, FBT and income tax rules will be
covered in this chapter.

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Other taxes and interactions 273

4.1 Goods and services tax (GST)
The goods and services tax (GST) is a transaction-based tax that applies to transactions rather than taxable
income. GST has an immediate impact on costs and pricing of transactions, and can have a significant
impact on a business’s profits.
GST is a broad-based consumption tax that aims to tax private final consumption expenditure in Australia.
The GST rules have been designed to ensure GST registered businesses, which satisfy key conditions, can
achieve a GST-neutral position as these businesses can claim the GST liability back from the ATO.
GST is not relevant for personal and hobby activities. GST also does not apply to payment of wages and
superannuation benefit to employees.
GST is calculated and collected on the value that is added by each participant in the production chain. To
ensure that the end user of the goods or services is the one who actually bears the cost of the tax, the GST
features a credit (ie refund) mechanism.
This topic covers the fundamentals of GST, including the concepts of taxable supplies, taxable importations,
creditable acquisitions and creditable importations. It also considers the main exceptions to GST (ie GST-free
supplies and input-taxed supplies) and provides an overview of certain special rules. A clear understanding
of these concepts is required when determining GST liabilities and entitlements to input tax credits.

4.1.1 Describe the administration and compliance of GST

Registration
A central tenet of making taxable supplies is that the entity making the supply is registered or required to
be registered. An entity that is not registered or not required to be registered for GST is not subject to the
GST Act.

General requirements

The registration requirements are covered in Division 23 of the GST Act and GST Regulations. The
following flow chart illustrates how to determine whether an entity is required to register.

No
Are you carrying on an enterprise? You cannot be registered

Yes

Does your annual turnover meet

the registration threshold?
• $75,000 for most taxpayers
You may be registered
(s 23–15 and r 5)
No
• $150,000 for non-profit bodies
(s 23–15 and r 10)

Yes

You are required to be registered

Note: Entities that supply taxi travel are required to register regardless of their turnover (Division 144). Ride-sharing services (eg Uber) are
taxi travel services (see Uber v CoT).

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274 Tax
GST turnover is defined in s 188-10. Applying this definition and the registration turnover threshold, most
entities are required to register if either:
• their current annual turnover (CAT) is $75,000 or more, unless the ATO is satisfied that the projected
annual turnover (PAT) is below $75,000, or
• their PAT is $75,000 or more.

Current annual turnover

An entity’s CAT is calculated, under s 188-15, by adding the value of all the supplies made during a
12-month period ending at the end of the current month. However, the value of supplies excludes various
supplies, including transactions which are input taxed and are not connected with the indirect tax zone.
There is no exclusion from annual turnover for the offshore supplies of low-value goods made by a
non-resident to a consumer. These supplies are connected with the indirect tax zone. Therefore, unless
the supply is GST-free or input taxed, it will be a taxable supply and included in the calculation of
annual turnover.
Non-resident sellers, who do not carry on an enterprise in Australia, and have annual turnover of $75,000
or more, from offshore supplies of low-value goods to consumers and intangible supplies to Australian
consumers, are required to register for, collect and remit GST. For example, the supply of digital
entertainment streaming services to an Australian consumer by an overseas provider would generally be a
taxable supply and attract GST.
However, where an offshore supply of low-value goods or intangible supply to an Australian consumer is
treated as being made by an electronic distribution platform (EDP) operator or re-deliverer, instead of the
non-resident seller, these supplies will count towards the EDP operator’s or re-deliverer’s annual turnover
and not the non-resident seller’s annual turnover.

Projected annual turnover

Under s 188-20, an entity’s PAT is calculated by adding the value of all supplies made or likely to be made
during the 12-month period, starting at the beginning of the current month.
The value of supplies excludes the same supplies as detailed for the CAT. However, for the PAT calculation,
the following are also excluded under s 188-25:
• Transfer of capital assets.
• Supplies made solely as a consequence of ceasing to carry on an enterprise or substantially and
permanently reducing its size or scale.

Voluntary registration

Registration below the required threshold is optional, provided the entity is carrying on an enterprise
(s 23-10). This option is attractive because registration enables an entity to claim an input tax credit,
reducing the cost of their good/service. This is particularly desirable for an entity making GST-free supplies.
However, there is a compliance cost that the entity should consider before making this decision.

Example 4.1 – Registration for GST: Resident

SmithCo is an Australian resident company that carries on an enterprise of selling toothbrushes. It
makes $100,000 in supplies to both Australian resident and non-resident customers during the
current year.

SmithCo is required to be registered for GST as its current annual turnover is more than $75,000.
The fact that some of its supplies are to non-residents and may be GST-free is not relevant as the
supplies are connected with the indirect tax zone (ie Australia).

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 Example 4.2 – Registration for GST: Voluntary registration
AdamCo is a newly established business that carries on an enterprise of selling pastries. AdamCo’s
projected annual turnover and creditable purchases for the 2023 financial year are $25,000 and
$100,000, respectively.

AdamCo is not required to be registered for GST purposes however, if AdamCo registers for GST
purposes, it can claim input tax credits.

Tax periods and attribution

Central to the GST regime is the concept of attribution – that is, the timing rules specifying when GST is
payable by an entity. When considering GST, input tax credits, adjustments and net amounts, there is an
underlying premise that these will be attributable to a period or, more specifically, a tax period.

Tax periods

Division 27 specifies the tax periods that apply to an entity. The table below illustrates which GST
reporting cycle (monthly, quarterly and yearly) must be adopted by GST registered entities.

Section Reporting cycle Comment

27-15 Monthly A GST entity’s reporting cycle is monthly if its turnover exceeds the tax
period turnover threshold of $20 million.

27-5 Quarterly A GST entity’s default reporting cycle.

151-5 Yearly An entity may elect to pay and report GST on a yearly basis if it
voluntarily registers itself into the GST regime.

Attribution

Section 29-5 specifies when GST on taxable supplies is attributed. Entities that do not account for GST on
a cash basis are commonly referred to as accounting for GST on an accruals or non-cash basis. Such entities
attribute GST on a taxable supply to:
• the period in which they receive any of the consideration for the supply, or
• before any consideration is received, the period in which an invoice is issued for the supply.
Entities that account for GST on a cash basis attribute GST to the period in which consideration is received,
but only to the extent that the consideration is received in that period.
Similar rules apply to acquisitions (see s 29-10). Accruals taxpayers attribute the input tax credit to:
• the tax period in which they provide any consideration, or
• before any consideration is provided, the tax period in which an invoice is received.
For a taxpayer using a cash basis, the input tax credit is attributable to the tax period in which
consideration is paid.
It is important to note that s 29-10(3) requires an entity attributing an input tax credit to a tax period to
hold a tax invoice. If the entity does not hold a tax invoice, the input tax credit is attributable to the first tax
period in which the entity does hold the tax invoice.

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276 Tax
The exception to s 29-10(3) is if the entity cannot collect a tax invoice within a four-year time limit. The
GST Act mandates that an entity claim its eligible input tax credit within four years from the due date of
the earliest activity statement in which it could have claimed it. Practically, entities wanting to claim input
tax credit must proactively follow up with their suppliers and collect valid tax invoices.

Example 4.3 – Four-year time limit

Company ABC (ABC) reports GST quarterly and accounts for GST on a cash basis. In May 2023, ABC
pays in full for some computer services. The earliest tax period in which ABC can claim the GST
credit for this purchase is the quarterly period ending 30 June 2023 and the activity statement due
date is 28 July 2023. The four-year time limit for claiming the GST credit ends four years from this
date (28 July 2027).

ABC needs to obtain a valid tax invoice and claim the GST credit in an activity statement that it
lodges by 28 July 2027. If it does not claim the credit by this time, ABC will cease to be entitled to
the input tax credit.

Cash versus accruals

As noted above, the GST Act allows for GST to be accounted for in either of two ways: the cash method, or
the non-cash (accruals) method. An entity must use the non-cash method unless it satisfies the criteria for
using the cash method. Subdivision 29-B specifies that an entity may choose to account for GST on a cash
basis if any of the following conditions are satisfied:
• The entity is a small business entity as defined in the income tax legislation – that is, it has an annual
turnover of less than $50 million (see Topic 3.1.5). Entities with turnover between $10 million to less
than $50 million are eligible for the simplified GST accounting rule.
• The entity accounts for income tax using the receipts method.
• The enterprise is of a type that the Commissioner has determined in writing may use cash accounting.
• The entity applies to the Commissioner and receives permission to account for GST on a cash basis.
Under Division 157, certain charitable institutions, gift deductible entities and government schools may
also choose to account for GST on a cash basis.

Tax invoices

The recipient is required to hold a tax invoice before they can attribute an input tax credit to a particular
tax period. Subdivision 29-C specifies what is required for an invoice to be a valid tax invoice.
Section 29-70 stipulates that a tax invoice must report various information, including the Australian
Business Number (ABN) of the supplier and GST liability amount.

Returns, payments and refunds

GST returns

Division 31 specifies an entity’s obligations in relation to GST returns. The business activity statement
(BAS) includes the GST return.
Section 31-8 contains a table showing when entities with quarterly tax periods should lodge a GST return
to the Commissioner. This table is reproduced below.

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 When quarterly GST returns must be given

If this day falls within the quarterly tax Lodge the GST return to the Commissioner on
Item period … or before this day

1 1 September The following 28 October

2 1 December The following 28 February

3 1 March The following 28 April

4 1 June The following 28 July

For entities that are not on quarterly tax periods, s 31-10 requires the GST return to be lodged on the 21st
day of the month following the end of a tax period.
The GST Act gives taxpayers the option of lodging their GST return electronically. However, entities with
an annual turnover that exceeds $20 million must lodge their GST returns electronically.
Note: Small businesses can complete a simpler BAS.

Taxpayers can further extend the lodgement and payment due dates if they report GST on a quarterly
basis, and engage a BAS or Tax agent and satisfy certain conditions. This can be particularly useful for
entities that take a long time to complete the GST reporting process and collect tax invoices.

Quarterly lodgement BAS / Tax agent concession for lodgement

obligation Original due date and payment

Quarter 1 28 October 25 November

Quarter 2 28 February Not applicable

Quarter 3 28 April 26 May

Quarter 4 28 July 25 August

GST payments

A GST payment is required under ss 33-3 and 33-5 where the net amount for a tax period is greater than
zero. The payment is made at the same time the GST return is due.
Division 162 contains special rules that allow certain entities to pay quarterly GST instalments, followed by
an annual reconciliation and balancing amount.

GST refunds

GST refunds arise where the net amount for a tax period is less than zero (s 35-5), with an entitlement to a
refund arising on lodging a GST return with the Commissioner (s 35-10).
There are instances when the ATO can delay processing GST refunds. This typically arises if the balances
reported on the BAS trigger an ATO review process. Before releasing the GST refund, the ATO will check
certain details with the entity. For instance, the ATO may request further information such as tax invoices if
the GST refund reported in a particular period is substantially higher than in prior tax periods.

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278 Tax
 Example 4.4 – ATO request for information
Red Pty Limited (Red) lodged a BAS during the quarter ended 30 June 2023 which reported a GST
refund of $125,000. The GST refund was considerably higher than prior BASs lodged since Red was
incorporated.

After lodgement of the quarterly BAS, Red received a questionnaire from the ATO. The ATO’s
request for information was detailed and sought a number of pieces of information. For example, it
requested Red to provide: copies of tax invoices; any available reconciliations from the general
ledger to the BAS; any advice regarding its business model; and tax risk governance and process
documentation for the BAS process and controls.

4.1.2 Calculate net GST payable/refundable

GST framework – calculation methodology
The term net amount is used throughout the GST Act and is defined in Division 17. The net amount is the
GST amount payable by an entity to the ATO, or by the ATO to an entity, for a particular tax period – that
is, the total GST liability and input tax credit entitlement in a tax period.
The net amount is worked out using the formula:

GST liability – Input tax credit = Net amount

The net amount is then increased by the amount of any increasing adjustments for the period, and decreased
by the amount of any decreasing adjustments in the period (discussed later in this topic under special rules).

4.1.3 Taxable supplies, GST-free supplies, and input-taxed

supplies, taxable and non-taxable importations
GST taxable supplies
Overview

The notion of a taxable supply is central to the operation of the GST. GST is payable for a taxable supply,
and a creditable acquisition (discussed below) cannot be made without a taxable supply. The following flow
chart represents s 9-5 and demonstrates how an entity determines if it has made a taxable supply:

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Other taxes and interactions 279

 No GST is also payable
Have you made (or are you taken
Supply by you if:
to have made) a supply? (s 9–10)
• you have made
taxable importations
Yes
• you have acquired
new residential
No
Was the supply made for premises on after
Consideration
consideration? (s 9–15) 1 July 2018

Yes

No
Are you registered or required
Registered
to be registered? (Part 2–5)

Yes

Did you make the supply in the course No You have not made
Enterprise or furtherance of your enterprise? a taxable supply.
(s 9–20) No GST is payable

Yes

No
Was the supply connected with
Indirect tax zone
the indirect tax zone? (s 9–25)

Yes

Is the supply wholly GST-free Yes

Not GST-free or input taxed or input taxed?
(s 9–30, Div 38, Div 40)

No

You have made a taxable supply.

GST is payable

There are a number of elements to a taxable supply, and each of these must be satisfied for a supply to be a
taxable supply. Using an acronym of the above steps (SCREIN) encourages working through each of the
required elements.

Required reading
Section 9-5 GST Act

Supply

Supply is very broadly defined in s 9-10 as ‘any form of supply whatsoever’. It therefore includes the supply
of both tangible and intangible items. However, it generally excludes the supply of money (ie currency or
digital currency).
The High Court in Commissioner of Taxation v Qantas Airways Ltd (2012) 247 CLR 286 held that there is a
taxable supply where fares are received for flights booked but not undertaken by prospective passengers.
This case raised fundamental questions about what constitutes a supply for GST purposes, and when that
supply can be identified as a taxable supply.
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280 Tax
GSTR 2006/9 outlines the Commissioner’s views on the concept of supply and provides that the taxpayer
is taken to make a supply where they have entered into an obligation or provided a right or undertaking.

Consideration

Consideration is defined in s 9-15. It includes ‘any payment, or any act or forbearance, in connection with a
supply of anything’. Note that consideration does not have to be money and this ensures that barter-type
transactions (for non-monetary consideration) are also caught in the GST net. There are a number of
departures from the general consideration rules. In particular, refer to Divisions 81, 99 and 102.

Registered or required to be registered

A supply will only be a taxable supply if the entity making the supply is registered or required to be
registered. The fact that an entity is not registered does not affect the taxable status of a supply if that
entity is required to be registered.

Enterprise

Enterprise is defined in s 9-20. It includes (but is not limited to) ‘any activity, or series of activities, done in
the form of a business, or in the form of an adventure or concern in the nature of trade’. For ATO guidance
on the meaning of enterprise, refer to MT 2006/1.
An entity must be carrying on an enterprise in order to obtain an ABN and/or GST registration. An entity
can apply for an ABN without applying for GST registration if its turnover is below the compulsory
registration threshold.
There are three important exclusions from the definition of enterprise:
1. The activities of employees are stated not to amount to an enterprise. In addition, activities connected
to the earning of certain withholding payments are not an enterprise (refer to section 9-20).
2. Activities that are carried out as hobbies or recreational pursuits are not an enterprise, regardless of
whether they result in profit.
3. Activities carried on by individuals or partnerships only, but not carried on with a reasonable expectation
of profit or gain, are not enterprises.

Note that the definition of a taxable supply requires that the supply be made by an enterprise that you
carry on. Carrying on an enterprise is defined in s 195-1 to include anything done ‘in the course of the
commencement or termination of the enterprise’. A business which is in the process of being wound down
would still be an enterprise provided that the activities have not stopped completely.

Connected with the indirect tax zone

The fifth element of the definition of a taxable supply is that the supply must be connected with the
indirect tax zone (ITZ). The ITZ is defined under s 195-1 to mean Australia, excluding its external territories.
In Christmas Island, Cocos (Keeling) Islands, Territory of Ashmore and Cartier Islands, Norfolk Island and
MacDonald Islands GST does not apply.

Inclusions

Under s 9-25, a supply is connected with the ITZ if it involves:

• Goods that are:
– delivered to or made available in the ITZ (ie domestic transactions)
– being removed from the ITZ
– being brought to the ITZ and the supplier is the importer.

• Real property situated in the ITZ.

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• Anything other than goods or real property (ie intangible supplies) where:
– the thing is done in the ITZ
– the supply is made through an enterprise the supplier carries on in the ITZ
– the thing is a right or option to acquire another thing and the supply of that other thing would be
connected with the ITZ
– the recipient is an Australian consumer.

For ATO guidance on when goods are connected with the ITZ see GSTR 2018/1. For guidance on when
real property is connected with the ITZ see GSTR 2018/2. Examples of intangible supplies include digital
products such as streaming or downloading of movies, music, apps or games, and other services such as
consultancy and professional services. For ATO guidance on the supply of anything other than goods or
real property connected with the ITZ, see GSTR 2019/1.
An Australian consumer is defined under s 9-25(7). An entity that is a recipient of a supply is an Australian
consumer if:
• an entity that is an Australian resident (but not an Australian resident solely because they are a resident
of the external territories where GST does not apply), and
• either the entity:
– is not registered for GST, or
– is registered for GST and does not acquire the supply solely or partly for the purpose of an enterprise it
carries on.

However, a supplier may treat a recipient as not being an Australian consumer if the supplier reasonably
believes that the recipient is not an Australian consumer (s 84-100). For example, where the recipient
provides the supplier with a valid ABN and the registered business address of the recipient is the same as
their postal/billing address.
For ATO guidance on the meaning of Australian consumer see GSTR 2017/1.
Under s 9-27, an enterprise is carried on in the ITZ if it is:
• carried on by one or more relevant individuals who are in the ITZ, and
• carried on:
– in a fixed place in the ITZ, or
– in one or more places for 183 days in a 12-month period.

• an offshore supply of low-value goods where:

– the recipient is a consumer (s 84-75(1)), and
– the goods are brought to the ITZ with the assistance of the seller (ie retailer), an electronic distribution
platform (EDP) operator (s 84-70), or a re-deliverer (s 84-77).

For ATO guidance on when an enterprise is carried on in the ITZ see LCR 2016/1.
Low-value goods are defined under s 84-79 as goods (except for tobacco products and alcoholic beverages)
that have a customs value of $1,000 or less at the time of supply. For ATO guidance on low-value goods
see LCR 2018/1.
Consumer is defined under s 84-75(2). The definition is the same as the definition of Australian consumer
that applies to intangible supplies under s 9-25(7). However, a supplier may treat a recipient as not being a
consumer if the supplier reasonably believes that to be the case (s 84-105).

Exclusion for intangible supplies

Under s 9-26, an intangible supply is not connected with the ITZ if all of the following are satisfied:
• The supply is made by a non-resident.
• The supply is not made through an enterprise based in the ITZ.
• The thing is done in the ITZ.
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282 Tax
• The recipient of the supply is:
– an Australian based business recipient (ie an enterprise that is registered for GST), or
– a non-resident that acquires the supply for the purpose of an enterprise it carries on outside the ITZ.

By applying these rules, intangible supplies by a foreign-based business to an Australian-based business are
not connected with the ITZ under s 9-26. Where GST would have ultimately been payable on a supply but
for this exclusion, the obligations are shifted to the Australian-based business recipients that are already
registered for GST, through the operation of reverse charge provisions in Division 84.
Intangible supplies by a foreign-based business to an Australian resident individual for private consumption
are connected with the ITZ under s 9-25. The foreign-based business would need to determine if it is
required to register for GST and charge GST.

Exclusion for low-value goods

An offshore supply of low-value goods will not be connected with the ITZ if:
• the supplier reasonably believes that the goods would be imported into Australia as a taxable
importation (s 84-83).
• the goods are imported into Australia as a taxable importation (s 84-85).

Example 4.5 – Low-value goods connected with indirect tax zone

Katie is an Australian resident who purchases a computer for $500 (excluding delivery charges and
GST) from a retailer in China. The retailer posts the computer to Katie’s nominated address in
Australia. Katie is not registered for GST and she does not have an ABN.

The computer satisfies the definition of low-value goods as it has a customs value of $1,000 or less
at the time of supply (ie when the consideration for the supply is first agreed). The customs value of
the computer is $500 (ie cost excluding delivery charges and GST where applicable).

Katie satisfies the definition of a consumer as she is not registered for GST. Based on the facts, it
would not be reasonable for the retailer to believe that Katie is not a consumer.

The computer is an offshore supply of low-value goods to a consumer, because it is a supply of

low-value goods, it is brought into the ITZ with the help of the retailer (the supplier), and Katie is a
consumer. Therefore, the supply is connected with the ITZ.

Example 4.6 – Low-value goods not connected with indirect tax zone
Katie is an Australian resident who purchases a computer for $800 (excluding delivery charges and
GST) from a retailer in South Korea. Katie supplies her ABN to the retailer and declares that she is
registered for GST. The computer is to be used solely in Katie’s business in Australia. The retailer
posts the computer to Katie’s business address in Australia.

The computer has a customs value of $800 and is low-value goods (see example above).

Katie is not a consumer as she is registered for GST and has acquired the computer solely for an
enterprise she carries on. Even if Katie was a consumer (ie because she did not in fact use the
computer in her business), the retailer would be entitled to treat her as not being a consumer. It is
reasonable for the retailer to believe that Katie is not a consumer as she has provided the retailer
with her ABN and declared that she is registered for GST.

The computer is not an offshore supply of low-value goods to a consumer (although it is a supply of
low-value goods brought to the ITZ with the help of the retailer) as Katie is not a consumer.
Therefore the supply is not connected with the ITZ.

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Other taxes and interactions 283

Not GST-free or input taxed

Concerning the final element of a taxable supply, supplies that are GST-free or input taxed are not taxable
supplies (see discussion later in this chapter).
A supply that is connected with the indirect tax zone might nevertheless be GST-free or input taxed; for
example, if it is exported (s 38-185) or consumed outside the indirect tax zone (s 38-190). Therefore, just
because a supply is connected with the indirect tax zone does not mean it is subject to GST.

Liability for GST on taxable supplies

Who is liable

The supplier is liable for GST (s 9-40). However, a supplier should have adjusted the price to include the
GST so that the GST burden is passed on to the end consumer. This is what is meant when a tax is called an
indirect tax. The GST is indirectly imposed on private consumption.
Price is taken to be GST inclusive. It is critical for suppliers to note that if they fail to incorporate the GST
into the price of their supply they will bear the GST burden. This is because the supplier is responsible for
1
remitting of the price to the Commissioner as GST regardless of whether they have factored GST into
11
the price. The onus is on the supplier to ensure they accurately determine whether they provide taxable
supplies and correctly prepare tax invoices.
If the ATO determines that GST has not been correctly charged, it will require the supplier to meet the
shortfall.

Required reading
Section 9-40 GST Act

Amount of GST

The GST rate is often discussed as being 10%, but it’s not just a matter of ‘add 10%’. The GST relies on the
concepts of value and price.
Under s 9-70, the amount of GST on a taxable supply is 10% of the value. Value is defined in s 9-75 to be
10
of the price. Subdivision 9-C explains the concepts of value and price in the GST context.
11

Required reading
Subdivision 9-C (ss 9-70 to 9-99) GST Act

Example 4.7 – GST liability

SmithCo is an Australian resident company that carries on an enterprise of selling toothbrushes and
is registered for GST. It makes a taxable supply for a GST-inclusive price of $550,000. The value of
10
the supply is × $550,000 = $500,000. SmithCo should recognise this amount in its assessable
11
income for income tax purposes.

The amount of SmithCo’s GST liability will be 10% of the value, or 10% × $500,000 = $50,000.
1
Another way of determining the GST component of the price is to multiply it by . Thus,
11
1
× $550,000 = $50,000. Smith Co should remit the GST component to the ATO.
11

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284 Tax
Supplies for inadequate consideration

Under s 72-70, where the consideration for a taxable supply to an associate is less than the GST-inclusive
market value, its value is the GST-exclusive market value of the supply. However, this section does not
apply if the associate is registered for GST and acquires the item supplied solely for a creditable purpose.

Example 4.8 – GST liability: Inadequate consideration paid

Bob is an Australian resident who carries on a garden maintenance enterprise and is registered for
GST. He makes a taxable supply to his sister Jane for her private consumption (ie it is not supplied for
a creditable purpose). The consideration for the supply is $8,800 but the market value is $11,000.
10
The value of the supply for GST purposes is × $11,000 = $10,000. Therefore, Bob’s GST liability
11
will be 10% of the value or 10% × $10,000 = $1,000. Bob should remit GST of $1,000 to the ATO
when lodging his next Business Activity Statement (BAS). It does not matter that the GST Bob
actually collected from his sister was only $800.

GST-free supplies
Overview

Under Australia’s GST regime, there are a number of exemptions. These should not be confused with
transactions that are out of scope, such as supplies which are not in the course or furtherance of an
enterprise (eg a private sale of a used car). These exemptions fall under two categories – GST-free supplies
and input-taxed supplies.
GST-free supplies are supplies on which no GST liability arises, but the supplier remains entitled to claim
input tax credits on acquisitions made in making the GST-free supply (see the discussion on creditable
acquisitions above).
Division 38 covers GST-free supplies. GST-free supplies include the following:
• food, subject to specific exclusions (Subdivision 38-A)
• health (Subdivision 38-B) – including medical services other than for cosmetic reasons (eg doctors’ fees),
other health services (eg physiotherapist, optometrist, dentist or nurse fees), hospital treatment, medical
aids and appliances, medicines on prescription, health insurance premiums and feminine hygiene products
• education (Subdivision 38-C) – including school, university, professional or trade course fees if a
prerequisite for entry/practice. However, not all education costs are GST-free. For example, general
update courses or training are not GST-free
• childcare (Subdivision 38-D) – including approved childcare services and family daycare
• exports and other cross-border supplies (Subdivision 38-E)
• supplies of going concerns (Subdivision 38-J).

Food

Food is generally a GST-free supply under s 38-2. However, s 38-3 contains a list of food that is not
GST-free, including:
• food for consumption on the premises from which it is supplied (eg restaurant meals)
• food of a kind specified in the legislation or a regulation. Under Schedule 1 of the GST Act, food that is
not GST-free includes:
– prepared foods (eg sandwiches and pizza)
– confectionery, snacks (eg crisps) and ice-cream products
– bakery products, excluding bread (eg cakes)
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– biscuit products, excluding breakfast cereal.

Other taxes and interactions 285

Rather than stating which food is exempt, the legislation lists certain types of food that are not exempt.
Broadly, what this means is that exempt food:
• includes fresh products (eg fruit, vegetables, eggs, nuts, unflavoured milk and meats) and most basic
grocery items (eg bread, breakfast cereal, flour, sugar and tinned vegetables)
• excludes meals you do not prepare yourself and ‘junk food’ (ie unhealthy snacks). A good way to
understand the distinction is to look at your receipt from the grocery store. All items (ie food and other
products) on which GST has been charged should be identified.

Example 4.9 – GST treatment of food

FreshCo is an Australian resident company that operates a fruit and vegetable wholesale enterprise
and is registered for GST. It supplies fruit and vegetables for $20,000.

The supply by FreshCo is a GST-free supply as it is food that is not excluded from the concession.
Therefore, FreshCo should recognise the full $20,000 as assessable income for income tax purposes
and no GST liability.

FreshCo has subsequently decided to set up a new store and sell desserts. FreshCo successfully
establishes a good reputation and it records sales totalling $100,000 (GST exclusive).

The sale of desserts is a taxable supply. FreshCo should recognise the GST exclusive sales balance
totalling $100,000 as assessable income for income tax purposes and report $10,000 as a GST
liability. The onus is on FreshCo to correctly charge GST and remit this to the ATO.
Note: FreshCo will be entitled to claim input tax credits (ie a GST refund) for its creditable acquisitions (ie the expenses it incurs in
operating the wholesale enterprise and selling desserts).

Exports

Section 38-185 contains a list of when exports are GST-free. The focus of the TAXAU subject is on
‘Item 1 – Export of goods: general’.
A supply of goods will be GST-free if the supplier exports them from the indirect tax zone (ie Australia)
within 60 days of the earlier of the date of invoicing and the date of payment (or such further period as the
Commissioner allows).
However, a supply is not a GST-free export if the supplier re-imports the goods into the indirect tax zone
(ie Australia).
To fit within Item 1, the supplier must be the exporter. However, the ATO accepts that, if the contract
requires the supplier to arrange export (eg the contract is on a ‘cost insurance freight’ (CIF) basis), or the
supplier delivers them to the international carrier or freight forwarder, this requirement will be met.
In limited cases and subject to a number of conditions, a supply can be GST-free if the purchaser exports
the goods. However, this only applies to a purchaser who is not registered or not required to be registered.
The requirement that the goods be exported within 60 days is a rigid rule. If goods are not exported within
that time, the supply is automatically taxable. It is important for the supplier to meet the 60 days rule,
otherwise charging GST should be considered.
In limited cases, the ATO may extend this time (eg if dock workers go on strike). The supplier must apply for
additional time if this is required.

Example 4.10 – GST treatment of exports

JonesCo is an Australian resident company that operates an enterprise and is registered for GST. It
supplies goods for $200,000 to David. David is a non-resident, does not carry on an enterprise in
Australia and is not registered for GST.
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286 Tax
 The supply by JonesCo is a GST-free supply if the goods are exported from the indirect tax zone
(ie Australia) by JonesCo within 60 days and not re-imported. In this situation, JonesCo recognises
the full $200,000 as assessable income for income tax purposes and has no GST liability.
Note: If the goods were fresh fruit and vegetables, they would be GST-free food under Subdivision 38-A and the timing of the
export or re-import (if any) would not be relevant.

Supplies for consumption outside the indirect tax zone

Section 38-190 contains a list of when supplies other than goods or real property (ie intangible supplies)
are GST-free. The focus in the TAXAU subject is on ‘Item 3 – Supplies used or enjoyed outside the indirect
tax zone’.
A supply will be GST-free, but only if the recipient of the supply is not in the indirect tax zone (ie Australia)
when supply occurs, and the effective use and enjoyment of the supply takes place outside the indirect tax
zone. For example, a hairdresser in Germany provides haircuts to Australian tourists holidaying in Germany.
The haircuts are GST-free as they are consumed outside the indirect tax zone (ie Australia).
Note: These supplies will be connected with the indirect tax zone (ie Australia) where the recipient of the supply is an Australian
consumer that is not registered for GST. However, as a GST-free supply is not a taxable supply, the supplier will not have a GST liability.
For additional ATO guidance see GSTD 2020/D1.

GST input-taxed supplies

Overview

Input-taxed supplies are supplies on which no GST liability arises, but for which the supplier cannot claim
input tax credits on the acquisitions related to making the input-taxed supply. Under Division 40,
input-taxed supplies include the following:
• financial supplies, subject to specific thresholds and exceptions
• residential rent – a landlord of a rental property (eg house or apartment) does not have a GST liability.
However, the landlord is not entitled to claim input tax credits
• residential premises, subject to exceptions.

Financial supplies

Under s 40-5, financial supplies made by a registered entity will be input taxed. Financial supplies are
defined in r 40-5.09. They include most financial dealings – primary and incidental – that involve money,
the making of loans and overdraft facilities, the provision of bank accounts, debt and equity securities, unit
trusts, futures, options and warrants, underwriting, superannuation funds, life insurance, and hire purchase
arrangements. Regulation 40-5.06 defines a financial supply provider. This provision is relevant for
determining whether a taxpayer has made a financial supply.
The ATO provides guidance on financial supplies in GSTR 2002/2. For example, credit provided by a
buy-now pay-later (BNPL) provider is treated in the same way as an interest-free loan.

Financial acquisition threshold – the de minimis rule

Under s 11-15(4), an entity may still be treated as making an acquisition for a creditable purpose where the
acquisition relates to making financial supplies and the entity does not exceed the financial acquisitions
threshold. This is called the de minimis rule. Under this rule input tax credits are available where the value
of the input tax credits attributable to acquisitions relating to the financial supply is less than both of
the following:
• 10% of the entity’s total input tax credit entitlement
• $150,000 (ie $1.65 million in GST-inclusive purchases).
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 Example 4.11 – Financial acquisition threshold test
Ethical Financial Services Pty Limited’s (EFS) input tax credit totalled $1,845,500 during the year
ended 30 June 2023 of which:

• $175,500 relates to acquisitions for making financial supplies

• $1,670,000 relates to acquisitions for making taxable supplies.

EFS cannot fully claim the input tax credit. Although EFS’ input tax credit relating to financial
acquisitions is less than 10% of the entity’s total input tax credit ie $184,550, it still exceeds the
financial acquisitions threshold because the input tax credit relating to financial acquisitions is more
than $150,000. EFS cannot fully claim the $175,500 credit for making financial supplies. EFS’ input
tax credit will be capped at $1,670,000 (the portion which relate to taxable supplies).

Example 4.12 – Financial acquisition threshold test

Ethical financial services Pty Limited’s (EFS) input tax credit totalled $1,139,000 during the year
ended 30 June 2023 of which:

• $100,000 relates to acquisitions for making financial supplies

• $1,039,000 relates to acquisitions for making taxable supplies.

EFS can fully claim the input tax credit. EFS’ input tax credit relating to financial acquisitions is less
than 10% of the entity’s total input tax credit and it does not exceed the financial acquisitions
threshold ($150,000). EFS can claim the $100,000 credit which relates to acquisitions for making
financial supplies.

The test is applied for a 12-month period ending at the end of the month in which the relevant acquisition
is made. The test is also applied for the 12-month period commencing from the beginning of the
current month.
The application of the financial acquisition threshold means that some entities making a small number of
financial supplies do not need to differentiate input tax credits relating to acquisitions made for financial
supplies from those relating to taxable/GST-free supplies.

Reduced input tax credits (RITC)

Despite making financial supplies, even where an entity fails to satisfy the financial acquisition threshold,
that entity may still be entitled to partial or reduced input tax credits for certain acquisitions relating to the
making of financial supplies. Only certain acquisitions relating to financial supplies are eligible for RITC.
Other input-taxed acquisitions relating to non-financial supplies (ie residential rents) are ineligible. The types
of services that give rise to a partial input tax credit are outlined in Division 70 GST Regulations, including:
• certain transaction banking and cash management services
• some payment and fund transfer services
• some securities transaction services
• loans services, debt collection services and insurance services.
Where a supplier satisfies the requirements of Division 70 GST regulations (and the other relevant GST
regulations), it may be entitled to an input tax credit of 75% of the input tax credit that would otherwise be
available if the acquisition was related to the making of a taxable supply. GSTR 2004/1 provides further
guidance on RITC acquisitions.

Residential premises

Subdivision 40-C deals with the GST treatment of residential premises. Section 40-65 states that the sale
of real property is input-taxed to the extent that the property is residential premises to be used
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288 Tax
predominantly for residential accommodation. However, such a sale will not be input taxed to the extent
that the residential premises are either:
• commercial residential premises
• new residential premises.
Residential premises, new residential premises and commercial residential premises are defined in s 195-1.
The meaning of residential premises, commercial residential premises and long-term accommodation in
commercial residential premises is considered in GSTR 2012/5, GSTR 2012/6 and GSTR 2012/7
respectively. The meaning of new residential premises is considered in GSTR 2003/3 (and note
GSTR 2003/3A).

Example 4.13 – Residential rental property

OwnerCo is an Australian resident company that owns a residential rental property (ie an apartment,
unit or house) in Australia. OwnerCo rents the property to Julie, an Australian resident individual, for
$1,500 per week. OwnerCo’s total rental income for the year is $78,000. OwnerCo incurs expenses
of $22,000 GST-inclusive ($20,000 GST-exclusive) for the rental property.

As residential rent is an input-taxed supply, OwnerCo would not charge GST and does not have a GST
liability. OwnerCo would include the full $78,000 in its assessable income for income tax purposes.
1
( )
OwnerCo has paid $2,000 $22,000 × in GST on its acquisitions. However, as these
11
acquisitions relate to the rental income which is an input-taxed supply, they are not creditable
acquisitions. Therefore, OwnerCo is not entitled to claim any input tax credits. OwnerCo would
include the full GST-inclusive amount of $22,000 as a deduction for income tax purposes (ie a
deduction is only reduced for input tax credits that the taxpayer is entitled to claim).
Note: OwnerCo is not required to be registered for GST. GST turnover under s 188-10 excludes the value of input-taxed supplies.

GST importations
Overview

Where goods are imported into Australia, GST may be payable at the time of importation by the importer
(ie GST is payable on taxable importations).
However, where the importer uses the goods in carrying on an enterprise, the importer may be entitled to
claim a refund of the GST it paid (ie a GST input tax credit is available for creditable importations).

Taxable importations

The term taxable importation is defined in s 13-5 to be ‘an importation of goods into Australia, but not to
the extent that it is a non-taxable importation’ (refer below).
Goods are imported into Australia where they are entered for home consumption (within the meaning of
the Customs Act 1901 (Customs Act)). This is an important point. Note that the point where the goods are
taxed is not when the goods are imported into Australia within its ordinary meaning, but rather when they
are entered for home consumption (ie when they are cleared by customs for a formal local entry).
Unlike taxable supplies, it is the importer, rather than the supplier, who is liable for GST on taxable
importations. Under s 13-20, the GST payable by the importer is 10% of the value of the taxable importation.

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The value of a taxable importation is defined in s 13-20(2) to be the sum of:
• the customs value of the goods imported
• the amount paid, or payable, for international transport of the goods to their place of consignment and to
insure the goods for that transport
• any customs duty payable in respect of the importation of the goods
• any wine tax payable in respect of the local entry of the goods.
An option to calculate the value of transport, insurance and other ancillary costs of importation is available
under s 13-20(4). Under this option, a percentage of the customs value may be used for goods other than
wine or luxury cars. This is particularly useful when the actual costs are not known at the time of
importation. The percentage is currently set at 10%.

Example 4.14 – GST payable on imports

ForCo is a non-resident company that does not carry on an enterprise in Australia and is not
registered for GST. ForCo sells toothbrushes to SmithCo for $500,000. SmithCo is an Australian
resident company that carries on an enterprise of selling toothbrushes and is registered for GST.
SmithCo imports the toothbrushes into Australia and uses them for a creditable purpose (ie SmithCo
is not an Australian consumer).

At the time of acquisition, SmithCo pays $500,000 (ie not low-value goods) to ForCo and should
recognise this amount as a deduction for income tax purposes.

There is no GST paid to/collected by ForCo. ForCo does not have a GST liability. This is because
ForCo is not carrying on an enterprise in the indirect tax zone (ie Australia) and the supply is not
connected with the indirect tax zone.

However, at the time of importation (ie when the goods are entered for home consumption) SmithCo
has a GST liability as it makes a taxable importation. SmithCo’s GST liability is equal to 10% of the
value of the importation.

Assuming there are no other costs related to the import of the toothbrushes, the GST liability is
10% × $500,000 = $50,000.

SmithCo must pay this amount to Australian customs at the time of importation. It is not remitted to
the ATO in SmithCo’s next BAS. However, SmithCo can enter into a tax deferral scheme with the
ATO (see below under creditable importations).

Assuming there are other unknown costs associated with the import, the taxpayer may choose to
apply the option under s 13-20(4). Under this option, the value of the importation would be
$500,000 + 10% × $500,000 = $550,000. The GST liability on importation would be $550,000 ×
10% (GST rate) = $55,000.

Non-taxable importations

Under s 13-10, an importation is a non-taxable importation if it would have been a GST-free or input-taxed
supply had it been a supply made in the indirect tax zone (ie Australia). For example, the supply of fresh
fruit and vegetables is GST-free and therefore would be a non-taxable importation.
Supplies to consumers of imported goods (excluding alcoholic beverages and tobacco products) valued at
$1,000 or less at the time of sale are an offshore supply of low-value goods and are connected with the
indirect tax zone (ie Australia) under s 9-25(3A). Where the supply is a taxable supply, the supply is a
non-taxable importation under s 42-15. This ensures GST is not paid twice on goods that are imported to
the indirect tax zone.
For ATO guidance on the importation of goods into Australia see GSTR 2003/15 and GSTR 2003/15A3.
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290 Tax
 Example 4.15 – GST payable on import of low-value goods
Jane purchases a phone for $1,300 from a Japanese supplier for her own personal consumption. The
supplier packages and sends the phone to Jane. The phone is not a low-value good (under
Subdivision 84-C) as its cost is more than $1,000. The phone is a taxable importation. Thus, Jane as
the importer is liable for GST at the time of importation equal to 10% of the value.

Jane also purchases a watch for $500 (excluding delivery charges and taxes) from a French supplier
for her own personal consumption. The French supplier packages and sends the watch to Jane. The
watch is a low-value good (under Subdivision 84-C) as its cost is $1,000 or less. Where the French
supplier is registered for GST (or required to be registered), the supply will be a taxable supply (ie it
will satisfy the requirements of the SCREIN acronym) and is a non-taxable importation (assuming the
French supplier sends the required notices to Australian customs). Thus, the French supplier is liable
1
for GST equal to of the value of the taxable supply.
11

These examples illustrate that, while GST liability will be imposed on both transactions, depending on the
value of the goods acquired and the supplier’s GST status, GST liability will be payable either by the end
consumer or the seller.
Note: If Jane purchases, for her own personal consumption, tobacco products and alcoholic beverages from a non-resident supplier, they
are not low-value goods as defined under Subdivision 84-C irrespective of their value. If she purchases digital products from a
non-resident supplier, they are not goods – rather they are intangible supplies that are connected with the indirect tax zone under
s 9-25(5), and therefore a taxable supply irrespective of their value.

4.1.4 Creditable acquisitions, and creditable importations

GST creditable acquisitions
Overview

The other side of the GST relates to input tax credits and creditable acquisitions. An input tax credit is the
mechanism by which an enterprise claims the GST that it has paid on acquisitions, resulting in GST being
passed down the value chain to the end consumer (who cannot claim an input tax credit).
Before an enterprise can claim an input tax credit for the GST it has paid, GST must have been paid on a
creditable acquisition and a number of other conditions also met. The following flow chart (representing
s 11-5) shows how an enterprise can determine whether it has made a creditable acquisition:

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 Are you providing, or liable to provide, If you have made
No a creditable importation,
Consideration consideration for the acquisition?
(s 9–15) you are entitled to an
input tax credit

Yes

Are you registered or required No

Registered
to be registered? (Part 2–5)

Yes

Have you made an acquisition? No

Acquisition
(s 11–10)

Yes

Was the acquisition solely or partly

for a creditable purpose? No input No You have not made
For a creditable purpose tax credits for private or domestic a creditable acquisition.
purposes of relating to input No input tax credit
taxed supplies (s 11–15)

Yes

Was the supply to you a taxable No

Taxable supply
supply? (s 9–5)

Yes

You have made a creditable acquisition

and are entitled to an input tax credit

An acronym – CRAFT – may be used to recall the various steps in the process of determining whether a
creditable acquisition has been made.
As with a taxable supply, a number of elements need to be satisfied in order for an acquisition to be a
creditable acquisition. In particular, you need to understand the key concepts of acquisition and
creditable purpose.

Acquisition

Acquisition is defined very broadly in s 11-10 to be ‘any form of acquisition whatsoever’. Note that it
mirrors the definition of supply discussed earlier. It therefore includes the acquisition of both tangible items
(eg goods and real property) and intangible items (eg services, advice and information, digital property,
rights and options).

Creditable purpose

Under ss 11-15 and 15-10, you acquire or import an item for a creditable purpose if you acquire it in
carrying on your enterprise.
An acquisition is not made for a creditable purpose if it:
• relates to making supplies that would be input taxed
• is of a private or domestic nature.

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292 Tax
 Example 4.16 – Creditable purpose
Bob operates a truck and heavy machinery rental business. As part of his expansion plan, he has
decided to enter into a new leasing arrangement with Joe and rent a new office with multiple rooms.

Bob’s son (Andrew) has recently commenced a new hobby and requires a meeting room. Andrew has
agreed with Bob to rent one of the meeting rooms.

Despite the fact that Bob will be paying the rent and Andrew can commercialise the new hobby in
the future, the expense portion relating to the meeting room rented by Andrew is not considered to
be for a creditable purpose.

Note that an entity will not be taken to make an input-taxed supply and will not be denied an input tax
credit if the supply is a financial supply, and
• the value of those supplies does not exceed the financial acquisitions threshold, or
• the acquisition consists of a borrowing that relates to making supplies that are not input taxed.
For ATO guidance in determining the creditable purpose of acquisitions in a credit card issuing business see
GSTR 2019/2.

Required reading
Sections 11-5, 11-15 and 15-10 GST Act

Entitlement to input tax credits

Under s 11-20, an entity is entitled to an input tax credit for any creditable acquisition that it makes.

Amount of input tax credit

The amount of input tax credit for a creditable acquisition is the same as the amount of GST paid on the
taxable supply (s 11-25).
Where the supply is either a GST-free supply or an input-taxed supply, no GST has been paid on the
acquisition. As a general rule, if there is no GST paid on an acquisition, then there is no entitlement to claim
an input tax credit. (You cannot claim a refund for something you have not paid for).
Apportionment of the input tax credit will be required where the acquisition is only partly for a creditable
purpose (eg where the taxpayer uses the goods or services partly for private purposes).

Example 4.17 – Input tax credits

SmithCo is an Australian resident company that carries on an enterprise of selling toothbrushes and
is registered for GST. It makes a taxable supply for a GST-inclusive price of $550,000 to DentistCo.
DentistCo is also registered for GST and uses the toothbrushes for creditable purposes.
10
The value of the supply is × $550,000 = $500,000. DentistCo should recognise this amount as a
11
deduction for income tax purposes.

The amount of GST paid by DentistCo will be 10% of the value, or 10% × $500,000 = $50,000.
1
Another way of determining the GST component of the price is to multiply it by . Thus,
11
1
× $550,000 = $50,000. DentistCo is entitled to claim an input tax credit (ie refund of GST) of
11
$50,000 from the ATO when lodging its next BAS.
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Exceptions

Under Division 69, input tax credits are not available if the expenditure relates to the following
non-deductible expenses:
• penalties
• relatives travel expenses
• family maintenance
• recreational club expenses (unless it gives rise to a fringe benefit and is deductible under
s 26-45(3) ITAA 1997)
• expenses for a leisure facility or boat
• entertainment expenses
• non-compulsory uniforms
• agreements for the provision of non-deductible, non-cash business benefits
• car parking for certain self-employed persons, partnerships and trusts.
Meal entertainment provided to employees is deductible for income tax purposes if subject to FBT, refer
s 32-20 ITAA 1997. In that case, input tax credits can be claimed for meal entertainment. The FBT rules for
determining the taxable value of meal entertainment fringe benefits are explained in Topic 4.2.5.

Example 4.18 – Input tax credits: Entertainment

RestaurantCo is an Australian resident company that operates a restaurant and is registered for GST.
It supplies restaurant meals (ie taxable supplies) for a GST-inclusive price of $1,100 to DentistCo. The
meals are provided to DentistCo employees and 50% are subject to FBT. DentistCo is registered
for GST.
10
The value of the supply is × $1,100 = $1,000. RestaurantCo should recognise this amount as
11
assessable income for income tax purposes.

The amount of GST collected by RestaurantCo and paid by DentistCo will be 10% of the value, or
10% × $1,000 = $100. Another way of determining the GST component of the price is to multiply it
1 1
by . Thus, × $1,100 = $100.
11 11
RestaurantCo has a GST liability of $100 and should remit this amount to the ATO when lodging its
next BAS.

DentistCo has paid GST of $100, however it is not entitled to claim the full amount as an input tax
credit. DentistCo’s input tax credit is limited to 50% × $100 = $50 as this is the portion of the
expense that is subject to Fringe Benefits Tax (FBT). DentistCo’s deduction for income tax purposes
is also limited to 50% × $1,000 = $500 as this is the portion subject to FBT.

Other exceptions to the regular process of determining creditable acquisitions include the following:
• Input tax credits are not available for the portion of the GST on a motor vehicle that is a car, as defined
for income tax purposes, that exceeds the car depreciation cost limit (s 69-10). The cost limit for the
2022–2023 income year is $64,741. Thus, the maximum input tax credit that can be claimed is $5,886
1
( of $64,741). This can be important in an income tax context. For example, the GST input tax credit
11
ceiling on cars may have an impact on the calculation of the terminating value of the cars (see s 40-325
ITAA 1997).
• Where the expenditure relates to an enterprise carried on by the taxpayer that makes input-taxed
supplies, the amount of input tax credit available to a taxpayer may be reduced.
• Cancellation of GST registration can result in an increasing adjustment if the entity retains any assets for
which input tax credits have been claimed.
• Input tax credits are denied for acquisitions of real property where the vendor and purchaser agree to
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use the margin scheme.

294 Tax
• Input tax credits are available under Division 111 for certain reimbursements made to an employee (or
their associate). The reimbursement is treated as consideration for the acquisition and the fact that the
supply by the employee is not a taxable supply (ie activities of an employee are not an enterprise, s 9-20)
does not stop the acquisition being a creditable acquisition.
• Limited registration entities are not entitled to input tax credits.

Creditable importations
In addition to creditable acquisitions, input tax credits are also available for creditable importations under
Division 15. A creditable importation is defined in s 15-5. An entity makes a creditable importation if:
• the entity imports goods solely or partly for a creditable purpose
• the importation is a taxable importation
• the entity is registered or required to be registered.
The definition mirrors that of a creditable acquisition. It also has the same effect, in that an entity can also
claim an input tax credit on a creditable acquisition.
To be eligible for an input tax credit on a creditable importation, GST must have been paid on the
importation (ie the importation must have been a taxable importation under Division 13). For example, the
importation of machinery is a taxable importation as it is not a GST-free supply or an input-taxed supply.
However, the importation of fresh fruit is not a taxable importation as it is a GST-free supply. As a general
rule, if there is no GST paid on an acquisition, there is no entitlement to claim an input tax credit. You
cannot claim a refund for something you have not paid for.
The GST on taxable importation is usually payable at the time of customs’ clearance (s 33-15). To avoid
cash flow difficulties, some taxpayers adopt the deferred GST scheme and pay the GST on the same BAS
on which they claim the credit (r 33-15.01). These two amounts will usually offset each other.

Example 4.19 – Input tax credits on imports and deferred GST scheme
Good Hygiene Pty Limited (Good Hygiene) has paid GST of $50,000 at the time of import of
toothbrushes into Australia.

As Good Hygiene uses the toothbrushes for a fully creditable purpose, it is entitled to claim an input
tax credit (ie a refund) of $50,000 for the GST paid on importation.

Good Hygiene should include this claim on its next BAS, thereby offsetting the $50,000 which it paid
on its taxable importations. Alternatively, Good Hygiene can opt into the deferred GST scheme and
offset the GST liability and input tax credit in the same BAS period, thereby effectively negating
cashflow issues.

It is important to note that Good Hygiene must report GST on a monthly basis should it opt into the
deferred GST scheme. Good Hygiene should consider its overall GST reporting process and whether
they can meet the monthly lodgement and payment due dates.

4.1.5 Other special rules

GST special and other rules
Overview

There are numerous special rules in the GST Act that apply for certain entities and for certain transactions.
These include provisions for the following:
• second-hand goods
•
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• going concern
• reverse charges
• adjustment events.
Candidates are required to have a general awareness of each of these special rules for the purposes of this
tax subject. They can have significant commercial application for particular businesses or transactions.

Second-hand goods

Division 66 sets out special rules allowing second-hand goods dealers who are registered for GST to claim
input tax credits for acquisitions of second-hand goods in certain circumstances, even though the supply of
the goods to the dealer was not taxable.
If a second-hand goods dealer acquires second-hand goods from an unregistered entity, the supply will not
be a taxable supply and, normally, no input tax credit will arise. However, the unregistered entity has paid
GST in acquiring the goods and has not claimed an input tax credit, and will factor this into the price of the
supply to the second-hand goods dealer. This will result in the second-hand goods dealer effectively paying
GST on GST when selling the goods. This is because the dealer has to charge GST on the subsequent sale of
the goods but would not have claimed GST input credit on the purchase of the goods from the unregistered
supplier. To overcome this potential double taxation, Division 66 allows notional input tax credits to be
claimed in the tax period in which the dealer makes the sale of the acquired second-hand goods.
1
The notional input tax credit is generally of the consideration paid to acquire the goods, but cannot
11
exceed the amount of the GST payable for the subsequent sale.
Note: Gold, silver and platinum are excluded from the definition of second-hand goods (subject to exceptions for antiques).

Electronic distribution platforms and re-deliverers

Where an inbound intangible supply is made by a non-resident to an Australian consumer with the help of
an electronic distribution platform (EDP) operator or a re-deliverer (eg Google Play, Steam, eBay, etc), the
EDP operator or re-deliverer may be treated as having made the supply for consideration and in the course
or furtherance of their enterprise (s 84-55). In that case the EDP operator or re-deliverer has the GST
liability rather than the non-resident supplier.
A supply is an inbound intangible supply if, broadly, it is of something other than goods or real property and
the supply is neither wholly done in the indirect tax zone (ie Australia) nor made through an enterprise
carried on in the indirect tax zone (s 84-65).

Example 4.20 – GST

Classical Work Inc (Classical Work) operates an e-commerce platform that allows Australian
consumers to buy digital products from merchants. Classical Work is registered for GST in Australia.

Michael uses Classical Work’s e-commerce platform to buy a digital product from Star Lights, a
merchant in India, for $880 including GST. Classical Work determines that it is responsible for GST
on the sales of digital products made to Michael as the merchant is outside Australia.

Classical Work is treated as the supplier for GST purposes. It returns GST of $80 on the sale to the
ATO in its GST return.

Star Lights does not report and pay GST to the ATO on the sale nor does it need to count the sale
when determining if it is required to register for Australian GST purposes.

Where an offshore supply of low-value goods is made by a non-resident, irrespective of whether the
recipient is a consumer, the rules in s 84-55 may be extended to those supplies (s 84-81). If the recipient is
not a consumer, this information will be included in the customs documentation provided by the EDP
operator or re-deliverer.
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296 Tax
For ATO guidance on the liability of EDP operators, see LCR 2018/2, and for re-deliverers, see LCR 2018/3.

Supplies of going concerns

There are two ways of transferring a business. One is to sell the entity that owns the business (eg selling
the shares in a company that owns a business). The other is to sell the assets of the business itself to a new
entity. The supply of a going concern concession can also apply on the transfer of an enterprise. An
enterprise is more than just a business (refer above to Topic 4.1.3) for the definition of an ‘enterprise’. A
one-off commercial transaction for the purpose of making a profit can be enterprise for GST purposes.
Subdivision 38-J allows some businesses to be transferred GST-free, removing the cash flow burden that
would otherwise fall on the purchaser.
Subsection 38-325(1) provides that a supply of a going concern is GST-free if:
(a) the supply is for consideration
(b) the recipient is registered or required to be registered for GST
(c) the supplier and the recipient have agreed in writing that the supply is of a going concern.

Under s 38-325(2), a supply of a going concern is made where the supplier:

(a) supplies to the recipient all of the things that are necessary for the continued operation of an enterprise
(b) carries on, or will carry on, the enterprise until the day of the supply.

GSTR 2002/5 considers this exemption in detail. The ruling states that the ‘all the things that are necessary’
test does not mean everything in a business. Rather, it means all of the attributes that are essential for the
continuation of that business. It is also applied in an objective sense – that is, if something is necessary for
the continuation of the business in general (eg business premises) but the premises are not supplied
(perhaps because the purchaser has their own premises), the exemption will not apply. For these reasons,
careful consideration of the ATO’s view is essential before relying on this exemption, particularly by
the vendor.

Example 4.21 – A supply of a going concern

New Coffee Shop Pty Limited (NCS) acquires a café on the Gold Coast. The agreement between NCS
and the vendor states that the sale is a supply of a going concern. On the settlement date, the vendor
provides NCS with the café’s tangible and intangible assets, including the furniture and fittings, lease
agreement and supply accounts to operate the café.

NCS is not subject to GST as the café was sold as a going concern for GST purposes.

Example 4.22 – Not a supply of going concern

NCS subsequently acquires a gym in a nearby suburb. The agreement between NCS and the vendor
states that the sale is a supply of going concern, however, the vendor has decided to remove various
items of essential equipment from the gym and key employees have also opted to not work.

It would be expected that the ATO will adopt a ’look-through’ approach and examine the facts and
circumstances of the transaction. Accordingly, NCS should be subject to GST as the gym was not sold
as a going concern for GST purposes.

Reverse charge

There are certain circumstances where the GST liability is paid by the purchaser (and not the supplier). This
is called a reverse charge. The amount of the reverse-charged GST is 10% of the price of the purchase.

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Under Division 83, a purchaser may agree with a non-resident seller to pay the GST on a sale, rather than
the seller pay the GST liability. This applies if:
• the non-resident seller does not make the sale to a purchaser through a business they carry on in Australia
• the purchaser is registered or required to be registered for GST
• the purchaser agrees with the non-resident seller that the GST is payable by the purchaser
• the purchaser is not required under the reverse charge rules to pay GST on the sale
• the sale to the purchaser is not made through a resident agent of the non-resident seller.
It is important to note that a tax invoice is not required for reverse charged supplies made by non-residents
(s 83-35). The reverse charge rule will automatically apply if certain conditions apply (Division 84).

Conditions of the purchase

The reverse charge rules will apply if all of the following circumstances are present:
• a purchaser acquires a thing solely or partly for an enterprise that is being carried on in Australia
• the purchase is partly of a private or domestic nature or relates partly or solely to making input-taxed
supplies
• the sale to the purchaser is for payment
• the purchaser is registered or required to be registered for GST.
In addition to satisfying each condition, a purchaser is liable for GST under the reverse charge rules if one
or more of the following circumstances occurs:
• the thing the purchaser acquires is done or performed outside Australia and the sale to the purchaser is
not made through an enterprise that the seller carries on in Australia
• the sale is connected with Australia because the thing the purchaser acquires is a right or option to
acquire another thing, and the sale of that other thing would be connected with Australia
• the sale to the purchaser is not made through a business that a non-resident seller carries on in
Australia and
– the thing the purchaser acquires is done or performed in Australia and
– the purchaser is an Australian-based business recipient.

GST adjustments

An adjustment to GST paid or amount of input tax credit claimed is necessary if there is a change to
transactions or business operations. The GST adjustment event falls into the following categories:
• changes in price or GST status (Division 19)
• debts becoming bad or overdue (Division 21)
• changes in intended use (Division 129)
• changes associated with starting, transferring or ceasing business or altering your registration status
(Divisions 137 and 138)
• other adjustments (ie third party payments Division 134).
A GST adjustment will change an entity’s net amount. Adjustments are generally attributed to the tax
period in which the taxpayer becomes aware of the event.

Example 4.23 – Division 21

Pelle Pty Limited (Pelle) operates a car maintenance business. Pelle is GST registered and adopts the
accrual accounting method. Pelle currently reports BAS on a quarterly basis.

Pelle has a corporate account with a local business called Bar. Pelle supplied car maintenance
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services totalling $110,000 (GST exclusive) to Bar during the quarter ended 30 June 2022.

298 Tax
 Bar has consistently refused to pay the amount owning due to alleged poor customer service. Pelle
decides to write off the full balance owing as a bad debt during the quarter ended 30 June 2023.

Pelle will have a decreasing adjustment when reporting the 30 June 2023 quarterly BAS.

Example 4.24 – Reverse charge (Division 83)

Peter Pty Limited (Peter) is a GST registered company. Peter currently operates a digital marketing
agency. Peter reports GST on a monthly basis.

Peter has recently acquired new computers which will boost productivity of each employee. The new
computers were directly acquired from Lee Pte Ltd (Lee) based in Singapore. Lee does not have an
Australian subsidiary.

Peter satisfied the key conditions of Division 83. Peter has agreed to apply the Division 83 rule and
be liable for GST.

It is important to note that Peter cannot voluntarily opt in to the recharge rule if Peter acquired new
computers from an Australian resident agent of Lee. In this case the resident agent will be liable
for GST.

Separately, Peter cannot voluntarily opt in to the recharge rule if a taxable supply under Division 84
was supplied by Lee (s 84-5).

Example 4.25 – Reverse charge (Division 84)

An Australian financial institution, BankAU Ltd (BankAU), acquires information about its retail
customers from an independent foreign credit agency based in the UK.

The UK credit agency is a non-resident for GST purposes and does not carry on an enterprise in
Australia. The supply of information by the UK credit agency is not connected with Australia.
However, the supply of information by the credit agency meets the reverse charge purpose
requirement because it is an acquisition that relates to making input-taxed supplies.

If the other requirements of Division 84 are met, BankAU, the recipient of the supply, has to pay GST
on that supply under ss 84-5 and 84-10.

Example 4.26 – Division 129

Nicholas is a GST registered sole trader. Nicolas is currently in the foods storage business and
operates his business from a large industrial property. Nicholas reports GST on a quarterly basis.

Nicolas acquired a new golf cart from Magnificent Pty Limited (Magnificent) on 1 April 2023.
Nicholas acquired the golf cart for business purposes. The golf cart was acquired to help with
transporting employees within the industrial property.

Nicholas paid $8,800 (GST inclusive) and claimed input tax credit totalling $800 in the 30 June 2023
quarterly BAS.

On 1 July 2023, Magnificent released a new golf cart with multiple functions which would
significantly improve Nicholas’ business process. Nicholas decided to acquire the newly released golf
cart and use the old golf cart for private purposes.

Nicholas will need to refund the previously claimed input tax credit totalling $800 in the
30 September 2023 quarterly BAS.

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4.2 Employment remuneration and fringe
benefits tax (FBT)
The fringe benefits tax (FBT) rules apply to impose a tax liability on employers on various non-cash
benefits provided to employees. The FBT liability rate reflects the top marginal personal tax rate and
levies (ie Medicare levy) which are imposed each year.
The FBT law’s coverage of employee benefits is not all-encompassing. Income tax law also contains
measures that deal with specific types of employment remuneration. These include employment termination
payments (ETP), unused leave payments, genuine redundancy payments and employee share schemes (ESS).
It is common practice for employers to pay allowances to employees. Employers typically pay an allowance
to employees to cover an expected employment related expenditure. Allowances are generally treated as
income and subject to the PAYG withholding tax rules.
Employers are required to compulsorily contribute a fixed percentage of their employee’s ordinary time
earnings (which generally equate to base salary/wage) to each employee’s superannuation fund account.
Employers are subject to significant penalties if they fail to meet superannuation rules.

4.2.1 Employees and contractors (including PAYG rules)

It is important for employers to correctly classify each worker as an employee or contractor. Incorrect
treatment means the employer has not met its compliance obligations and significant penalties can be
triggered.
The following table outlines multiple factors that, collectively assessed together, determine whether a
worker is an employee or contractor for tax, PAYG withholding and superannuation purposes (also refer to
draft Taxation Ruling TR 2022/D3).

Category Employee Contractor

Ability to The worker cannot The worker can subcontract/delegate

subcontract/delegate subcontract/delegate the work. the work.

Basis of payment The worker is paid: The worker is paid for a

• for the time worked result achieved.
• a price per item or activity
• a commission.

Equipment, tools and • The employer provides all or most of • The worker provides all or most of
other assets the equipment, tools and other assets the equipment, tools and other assets
required to complete the work, or required to complete the work
• The worker provides all or most of • The worker does not receive an
the equipment, tools and other assets allowance or reimbursement for the
required to complete the work, but cost of this equipment, tools and
the employer provides them with an other assets.
allowance or reimburses them for the
cost of the equipment, tools and
other assets.

Commercial risks The worker takes no commercial risks. The worker takes commercial risks, with
The employer is legally responsible for the worker being legally responsible for
the work done by the worker and liable their work and liable for the cost of
for the cost of rectifying any defect in rectifying any defect in their work.
the work.
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300 Tax
 Control over the work The employer has the right to direct the The worker has freedom in the way the
way in which the worker does work is done, subject to the specific
their work. terms in any contract or agreement.

Independence The worker is not operating The worker is operating their own
independently of the employer. They business independently of the
work within and are considered part of employer. The worker performs
your business. services as specified in their contract or
agreement and is free to accept or
refuse additional work.

Other factors The worker is entitled to additional The worker is not entitled to additional
benefits including annual, sick and long benefits beyond those specified in the
service leave. service agreement.

When determining whether a worker is an employee or contractor, the ATO will examine the contract as
well as the facts and actual events (ie by reference to an objective assessment of the totality of the
relationship between the parties, having regard only to the legal rights and obligations which constitute
that relationship). As an example, a legal agreement explicitly stipulating that a worker has (a) full control
over work and (b) will bear commercial risk will not automatically mean the worker is a contractor.
It is important to note that there may be instances when an employer receives services from a worker with
attributes like an employee, however the worker may still be classified as a contractor. This is the case
when an employer receives services from a non-individual entity (ie company). There may be other
circumstances where a person who is taken to be a contractor is deemed to be an employee for Super
Guarantee and PAYG withholding purposes.
In the ZG Operations Australia Pty Limited v Jamsek case, the High Court held that two truck drivers who
worked exclusively for a lighting business for multiple decades were in effect independent contractors (and
not employees). The High Court found the written agreement between the drivers as independent
contractors to the company the most important and critical factor to be considered. Additionally, the High
Court found that any expectations that the workers would not be able to work for other businesses did not
alter the contractual rights and obligations that characterised the relationship between the two truck
drivers and the company.
In a different case (CFMEU v Personnel), the High Court also emphasised that a written contract is crucial in
determining the nature of the employment relationship between the two parties. These High Court cases
should be carefully considered when undergoing the employee versus contractor test.

Withholding obligation (employees and contractors)

An employer must correctly withhold tax each time it pays salary. The PAYG withholding tax obligation is also
relevant for non-salary payments such as allowances, commissions, long service leave and termination
payments. The withholding tax calculation formula will differ depending on the nature of the non-salary
payment.
An employer does not need to withhold tax when paying a contractor if the contractor has quoted an ABN.
In the event an employer is not provided with an ABN, the employer must withhold 47% of the total
payment amount, as well as complete and lodge other forms to ensure their compliance obligations are
satisfied. Otherwise, s 26−105 can make these payments non-deductible to the employer.

Issues to consider if a worker is incorrectly classified

If an employer incorrectly classifies a worker as a contractor, the employer has breached the following
tax rules:
• PAYG withholding tax – an employer has not withheld any tax on each salary and non-salary payment
made to the employee.
• Superannuation guarantee contribution – an employer has not contributed to the employee’s
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Other taxes and interactions 301

Underpayment and non-compliance of tax, PAYG withholding and superannuation rules can lead to
significant penalties for business owners and directors of a company.
Separately, a taxpayer can only claim a tax deduction for payments made to workers (employees and
contractors) if the relevant PAYG withholding and reporting obligations have been met.
Note: In practice, incorrect classification also leads to other issues that need to be considered and addressed such as payroll tax and
WorkCover.

Gig economy
The gig economy refers to a labour market that is characterised by short term contracts, and temporary,
flexible or freelance work as opposed to permanent jobs. There is an increasing debate regarding gig
employees and their work status for tax, PAYG and superannuation fund purposes.

Example 4.27 – Employee or contractor

Depot Co Pty Limited (Depot) has recently hired John and Lily who are both software engineers.
Depot’s Account Manager has just completed their CA and is aware of how important it is to ensure
that both John and Lily are appropriately classified as either an employee or contractor.

By going through four key factors, being (a) control over the work, (b) ability to delegate, (c) equipment,
tools and other assets and (d) commercial risks are examined., Depot’s Account Manager has
determined that John has been engaged as an employee and Lily has been engaged as a contractor.

Category John (employee) Lily (contractor)

A software engineer, John, is A software engineer, Lily, enters into

employed by Depot. He designs, a contract with Depot to design,
develops, tests and installs software develop, test and install a new
programs. software program.

Control over the work Depot allocates work to John and The contract states the new
advise him the completion due date. software program needs to:

John must complete the work • be operational within three months

according to Depot’s established • meet Depot’s requirements and
protocols, guidelines and quality specifications.
standards. John must also obtain
internal approval from his direct Lily can determine how the work is
supervisor before commencing new completed. Lily is not required to
projects. follow Depot’s internal processes.

Employee characteristic – Depot has Contractor characteristic – Lily has

control over the work. freedom in the way the work is done,
subject to the specific terms in the
contract.

Ability to John is required to complete tasks as The contract does not stipulate Lily
subcontract/delegate assigned to him by Depot. If John is must personally complete the work.
running late in meeting a project Lily can engage another software
deadline, he can delegate part of his engineer to complete the work.
work to other software engineers
who also work for Depot. John Contractor characteristic – Lily can
cannot however delegate his project subcontract/delegate the work.
to anyone else.

Employee characteristic – John

cannot subcontract/delegate
the work.
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302 Tax
 Equipment, tools and John uses the computer equipment Lily uses her own computer
other assets and software provided by Depot. On equipment and software. Lily is not
occasion, as agreed with Depot, John required to use Depot’s computer
will work from home using Depot equipment.
approved laptop to write the end
user documentation and operational Contractor characteristic – Lily
procedures. provides the majority of the
equipment and assets required to
Employee characteristic – the complete the work.
business provides the majority of the
equipment and assets required to
complete the work.

Commercial risks If there are faults in the work, or it is If the software program does not
not completed on time, John is not meet Depot’s agreed requirements
personally liable. Depot would need or does not perform to specification,
to pay to correct any issues. Lily will be required to correct the
problem at her own expense. Depot
Employee characteristic – John takes has a legal right to sue. Lily if she
no commercial risks. does not satisfy agreed targets.

Contractor characteristic – Lily takes

commercial risks.

4.2.2 Allowances
An allowance is an arrangement where the employee is paid a predetermined amount to cover an
estimated expense. Allowances are ordinary income and form part of an employee’s assessable income
(ss 6-5 and 15-2 ITAA 1997).
With the exception of LAFHAs, an employee can claim a deduction against an allowance if the
requirements of s 8-1 ITAA 1997 or a specific deduction provision are satisfied.
Work expenses are expenses incurred in producing salary or wages (s 900-30), but exclude car expenses.
Work expenses are generally deductible to an individual, subject to satisfying substantiation provisions.

Example 4.28 – Allowances

Tracey is expected to incur approximately $1,000 per year for work-related phone and internet costs.

Tracey’s employer decides to pay a fixed allowance of $80 per month to cover these costs. Tracey
will declare the fixed allowance as assessable income. Tracey will be eligible to claim an income tax
deduction for work related phone and internet costs.

Tracey will need to ensure she holds adequate documentation (ie tax invoices) to substantiate
her claim.

Substantiation requirements
For an employee to claim an income tax deduction for their work expenses, the expenditure must be
substantiated (s 900-15). Substantiation generally requires the employee to have receipts, tax invoices or
other appropriate documentary evidence.
However, no substantiation is required for:
• reasonable claims against overtime meal allowances paid under an industrial instrument (s 900-60)
•
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reasonable claims against domestic travel allowances (s 900-50)

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• laundry expenses of up to $150 (s 900-40)
• other work-related expenses, where the total of all work-related expense claims (including laundry, but
excluding travel and meal allowance expenses) is $300 or less (s 900-35).
A substantiation exception also applies for reasonable claims against overseas travel allowances, except
that the taxpayer must hold written evidence for accommodation costs and, if a trip involves being away
from home for six or more nights in a row, a travel diary (s 900-55).

Allowances versus reimbursements (TR 92/15)

Some employers choose to provide allowances to their employees, instead of reimbursing actual
expenditure. Other employers use a combination of the two.
An allowance paid to an employee by an employer will typically not give rise to an expense payment benefit.
A payment is a reimbursement when:
• the recipient is compensated exactly (typically on presentation of a receipt or invoice) for an expense
that has already been incurred but not necessarily disbursed
• the employee is required to refund the unexpended portion of an allowance to the employer
• a reimbursement is an expense payment fringe benefit under the FBT law.
With the exception of cents-per-kilometre car expense reimbursements, s 51AH ITAA 1936 specifically
denies a deduction to employees for expenditure that has been paid or reimbursed in circumstances that
give rise to either a fringe benefit or an exempt fringe benefit.

Example 4.29 – Reimbursement

Tracey regularly travels interstate for work purposes. In one of her work trips, she incurred
unforeseen expenditure due to attending additional unplanned business meetings and having to
extend her stay. Tracey paid $600 out-of-pocket costs.

Tracey’s employer paid $1,000 to Tracey to cover for her out-of-pocket cost ($600) and a special
bonus to show their gratitude to Tracey for willingly extending her business trip ($400).

The $600 and $400 payments are classified as reimbursement and bonus payments, respectively, for
tax purposes.

4.2.3 Superannuation
An employer’s SG liability for an employee for a period is generally calculated as 10% of the employee’s
ordinary time earnings (OTE) for that period (increasing to 11% from 1 July 2023). OTE is generally what
the employees earn for their ordinary hours of work, and it includes payments such as bonuses and
commissions. It is important to note however that OTE does not include overtime payments. For further
details refer to SGR 2009/2.
Superannuation payments are deductible expenditure for the employer but there are important conditions
to satisfy, including meeting the relevant quarterly cut-off due date. A late superannuation contribution
made by an employer is not deductible where the employer chooses to offset the late payment against a
SGC assessment.
Employees generally do not pay income tax on employer contributions. Rather, the employee’s
superannuation fund (which is a separate taxpayer entity) must pay tax on the contribution received. The
employee’s superannuation fund pays tax at a concessional tax rate, being 15%. Where the employee is a
high-income-earner, the employee may be subject to an additional 15% high-income-earner
contribution tax.
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304 Tax
Higher contributions tax
Division 293 tax is an extra tax liability imposed on some of the superannuation contributions made by
higher income earners to reduce the tax benefits they receive from the superannuation rules.
If a taxpayer’s adjusted taxable income plus any concessional (before-tax) super contributions totals more
than $250,000 in a particular financial year, the taxpayer is liable for Division 293 tax of 15% on the
amount of concessional contributions above this threshold.
The extra 15% tax imposed under the Division 293 rules is applied because, as a high-income earner, the
taxpayer’s marginal tax rate for income amounts over $180,000 is 45% (2023 financial year). When the
taxpayer makes a concessional contribution into a superannuation account, they are effectively taxed at a
15% tax rate.
This means the taxpayer is receiving a bigger saving on their tax bill than someone earning between
$45,001 and $120,000 (marginal tax rate is 32.5%).
To make things fairer, Division 293 imposes an additional tax of 15% on higher income earners to
effectively reduce the tax saving of high-income-earners on these concessional contributions.

Example 4.30 – Division 293

In the 2023 financial year, Lily was assessed by the ATO as reporting Division 293 liable income of
$315,000 and $25,000 in Division 293 superannuation contributions.

Lily’s superannuation fund paid tax on the total employer contribution totalling $3,750
(15% × $25,000).

As Lily is over the $250,000 threshold for Division 293 tax purposes, she will be liable for an
additional $3,750 in Division 293 tax on her superannuation contribution (15% × $25,000).

This means the total tax paid on her $25,000 super contribution is $7,500 (30% × $25,000), which is
made up of the normal 15% contributions tax when the money enters her superannuation account
and an additional 15% Division 293 tax.

Her tax benefit has reduced but Lily’s tax rate on the superannuation contribution (30%) is still lower
than her marginal tax rate (45%).

4.2.4 FBT application

Overview
The following flow chart provides a format to follow when determining whether FBT applies to a benefit.
The various parts of the flow chart are explained as follows.

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 No
Step 1 Is there a benefit?

Yes

No
Step 2 Is the benefit a ‘fringe benefit’ (ie in respect of employment)?

Yes

Step 3 Determine the category of the fringe benefit FBT

does not
apply

Does the benefit qualify as an exemption for this category or Yes

Step 4
for benefits generally?

No

Determine the taxable value of the benefit, taking into account

Step 5
any relevant reductions

FBT is described by some commentators as a dragnet tax. The scope of the tax is potentially very broad
(ie you start off with the assumption that all benefits are prima facie caught), but there are many exemption
and reduction mechanisms in the law that narrow its base.
The different categories and a very broad summary of the main employer concessions are summarised in
the following table:

Categories of employers for FBT purposes

Category Type of organisation Main concession conditions

Wholly FBT-exempt Religious institutions Employee must be involved in pastoral duties, or be a

live-in carer for aged or underprivileged person(s)

Category A employers Category A employers

Partially FBT-exempt General exemption cap: $17,000
Public or not-for-profit
hospitals, public Salary packaged meal entertainment and
ambulance services entertainment facility leasing exemption cap: $5,000
(with any excess included in the general
exemption cap)

Category B employers Category B employers

Charities and public General exemption cap: $30,000

benevolent institutions
Salary packaged meal entertainment and
entertainment facility leasing exemption cap:
$5,000 (with any excess included in the general
exemption cap)

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306 Tax
 Rebateable Non-government, FBT liability is reduced by a rebate equal to 47% of the
non-profit organisations gross FBT payable, subject to a $30,000 cap threshold.
(eg religious, educational, Once the total grossed-up taxable value exceeds the
charitable, scientific or cap, the rebate cannot be claimed for the excess amount
public educational
institutions, trade unions
and employer
associations)

Fully taxable Private and public sector Not applicable

employers

* Grossed-up taxable value, per employee.

The focus of this chapter is on fully taxable employers operating in the private sector.

Required reading
Section 136(1) FBTAA 1986 – definition of ‘fringe benefit’

Division 13 FBTAA 1986 contains four particular FBT general exemptions that are frequently encountered
in practice. These four FBT exemptions are summarised in the following table.

FBT exemptions in Division 13 FBTAA 1986

FBTAA 1986
section Exemption and income tax outcome for the employer

53 Exemption for running costs associated with a car

Discussed later in this chapter under ‘car fringe benefits’

58P Minor benefits exemption

Section 58P provides an exemption for minor benefits that have a taxable value of
less than $300 (GST-inclusive) and that are infrequently provided and/or difficult to
record and value. The minor benefits exemption does not apply to benefits that are
provided under a salary sacrifice arrangement (TR 2007/12) and ‘in-house’ fringe
benefits

Example Overall tax outcome

Inexpensive Christmas gifts (eg bottle of No FBT to the employer (exempt benefit)
wine or perfume)
Deductible to the employer (s 8-1
ITAA 1997) – gifts are generally not the
provision of entertainment, so Division 32
ITAA 1997 does not apply

58X Work-related items exemption

Section 58X broadly provides an FBT exemption for eligible work-related items that
are used primarily for use in the employee’s employment (ie used more than 50% for
the employee’s employment)

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 FBT exemptions in Division 13 FBTAA 1986

FBTAA 1986
section Exemption and income tax outcome for the employer

Examples Overall tax outcome

Portable electronic device (definition of a No FBT to the employer (exempt benefit)

portable electronic device is considered in
ATO ID 2008/133) – for example, laptops Deductible to the employer as business
and mobile phones labour costs (s 8-1 ITAA 1997)

Note: The combination of no FBT and income

tax deductibility for the employer means that
these work-related items (particularly laptops
and mobile phones) offer attractive salary
packaging opportunities provided the item is
primarily for use during an employee’s
employment.

58Z Taxi travel exemption

Section 58Z provides an exemption for taxi travel (other than by limousine) that is:

A single trip beginning or ending at the employee’s place of work

A result of sickness or injury to the employee and that is between an employee’s

place of work, place of residence or other appropriate place

Note: ‘Taxi travel’ is defined in s 136(1) FBTAA 1986 to mean travel that involves transporting
passengers, by taxi or limousine, for fares. However, despite the definition including travel by
limousine, it is specifically excluded from the exemption. Therefore, exempt taxi travel would
include travel in a vehicle licenced as a taxi, ride-sharing services and other for-hire services
where the vehicle used is not a limousine (Uber v CoT).

Example Overall tax outcome

Taxi home after extended work hours No FBT to the employer (exempt benefit)

Deductible to the employer as business

labour costs (s 8-1 ITAA 1997)

There are many other exemptions in Division 13 FBTAA 1986 that are too numerous to cover in detail. The
table below highlights the most commonly used exemptions – note that each exemption only applies if the
employer satisfies the specific requirements of the relevant section. (To help you to categorise the
concessions, they are grouped under subject headings not used in the FBTAA 1986.)

Miscellaneous FBT-exempt benefits – Division 13 FBTAA 1986

Benefit FBTAA 1986 reference

Work-related items – other

Attendance at an employment interview or selection test (eg airfare) s 58A

Newspapers and periodicals related to employment s 58H

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308 Tax
 Medical tests, preventative health care, counselling s 58M

Subscription to a professional or trade journal, entitlement to use a s 58Y

corporate credit card or airport lounge membership

Compassionate travel

Compassionate travel (ie for an employee or their close relative to s 58LA

attend a family funeral or visit a sick relative)

Employee relocation benefits

Services of a relocation consultant s 58AA

Removal and storage of household effects s 58B

Incidental costs of selling or acquiring a dwelling s 58C

Costs of connecting or reconnecting utilities (eg gas) s 58D

Leasing of household goods while living away from home s 58E

Relocation transport s 58F

Remote area housing (some employers, such as hospitals, may be s 58ZC

eligible for this exemption even if located in regional areas)

Work-related items – health benefits

Benefits relating to work-related trauma that is covered by workers’ s 58J

compensation arrangements

First aid facility, clinic, etc on or near an employer’s premises s 58K

Medical transport or evacuation while working overseas s 58L

Emergency assistance to obtain health care s 58N

Other specific exemptions and FBT reduction mechanisms will be identified in the discussion relating to
the various types of benefit categories (eg car fringe benefits or expense payment fringe benefits) below.
From 1 April 2021, eligible entities with an aggregated turnover of $10 million or more and less than
$50 million will be entitled to:
• a fringe benefits tax exemption in relation to small business car parking
• a fringe benefits tax exemption in relation to the provision of multiple work-related portable
electronic devices.
Effective 2 October 2020, an FBT exemption will apply for retraining and reskilling benefits provided by
employers to redundant or soon to be redundant employees where the benefits may not be related to their
current employment.

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Benefits provided overseas
Where an employee who is a resident of Australia for income tax purposes is working overseas and paid by
an overseas employer with no connection with Australia (eg no branch in Australia), the Australian FBT law
does not apply to any benefits provided to the employee (see TD 2011/1). This is because such payments
are considered ‘extra-territorial’ (ie outside the scope of Australian law).
However, this means that an employee in this situation is exposed to Australian income tax on both:
• assessable foreign-sourced employment income (s 6-5 ITAA 1997)
• the value of benefits received (s 15-2 ITAA 1997), because s 23L(1) ITAA 1936 does not exempt these
benefits from income tax.
Therefore, an employee seconded overseas could pay tax on their airfares and accommodation under
s 21A ITAA 1936 and s 6-5 ITAA 1997.

Example 4.31 – Benefits provided overseas

Maryann is an Australian resident taxpayer whose main source of employment income is her work as
a ski instructor.

Maryann has accepted an offer of employment from a New Zealand-based company to work in New
Zealand during the ski season. As part of Maryann’s short-term employment contract, her employer
provides her with free accommodation near the ski slopes.

The New Zealand employer has no staff or operations in Australia and therefore has no connection
with Australia. Although Maryann’s wages are assessable income in Australia because she is a resident,
her non-resident employer has no obligation to withhold Australian PAYG tax from her wages.

As there is no obligation to withhold Australian PAYG tax, no obligations under the FBTAA 1986
arise for the New Zealand employer.

Maryann will be required to include her foreign employment income (and possibly the value of the
benefits received) in her Australian assessable income under s 21A ITAA 1936 and s 6-5 ITAA 1997.

4.2.5 FBT taxable value

The rules for calculating the taxable value of a fringe benefit vary according to the type of benefit. There
are multiple methods to calculate the taxable value of certain types of fringe benefits and the taxpayer has
a choice to adopt the most favourable tax method.
A taxpayer’s FBT taxable value may be reduced if the otherwise deductible rule applies and/or if there is an
employee contribution.
The otherwise deductible rule applies where the employer provides an employee with a benefit but the
employee would have been able to claim a tax deduction had the employee paid for the benefit
themselves. The taxable value of the benefit is reduced to the extent that the employee could have claimed
a tax deduction.

Example 4.32 – Otherwise deductible rule

Karen, the manager of a hairdressing salon, pays for a junior stylist to attend a hair straightening
course run by a hairdressing association. The course, paid for by Karen, is to reward the junior for his
work performance over last year.

There is no FBT payable because the junior stylist would be entitled to a full income tax deduction
for the cost of attending the course, if they had paid for it by themselves.
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310 Tax
Car fringe benefits
Scope

A car fringe benefit arises when a car, typically owned or leased by an employer, is made available for
private use by an employee or an associate of an employee (s 7(1) FBTAA 1986). A car is also considered to
be available for private use when the car either is:
• not at the business premises and the employee is allowed to use it for private purposes
• garaged at or near the employee’s home.
The following arrangements do not give rise to a car fringe benefit:
• A car used for taxi travel (other than a limousine) and short-term rental car arrangements.
• When a vehicle owned by an employee is used for work-related travel. However, where the employer
reimburses the employee for running costs, this may give rise to an expense payment fringe benefit.
A car is defined in s 136(1) FBTAA 1986 (using the meaning from s 995-1 ITAA 1997) as a motor-powered
road vehicle (except a motor cycle or similar vehicle) designed to carry a load of less than one tonne and
fewer than nine passengers. Therefore, the following types of vehicles (including four-wheel drive vehicles)
are cars:
• Motor cars, station wagons, panel vans and utility trucks (excluding panel vans and utility trucks designed
to carry a load of one tonne or more).
• All other goods-carrying vehicles designed to carry less than one tonne.
• All other passenger-carrying vehicles designed to carry fewer than nine occupants.

Exemptions

There are various types of vehicles which would not be classified as a car for FBT purposes. An example
would be an employer providing a bus to an employee for private purposes. As a bus does not technically
meet the car definition under s 136, the car fringe benefit rules will not apply. The employer will need to
assess whether the residual fringe benefits rule may apply.

Particular types of cars

Under s 8 FBTAA 1986, specific exemptions apply for:

• taxis (ie cars that are used for taxi travel (but not limousines)), panel vans, utility trucks and other
non-passenger road vehicles that:
– are designed to carry a load of less than one tonne, and
– there is no private use other than:
○ work-related travel of the employee, which as defined under s 136(1) FBTAA 1986 includes
home-to-work travel, and travel that is incidental to travel in the course of performing the duties of
employment, and
○ any other private use by the employee or their associates that is minor, infrequent and irregular (eg
going to a rubbish collection site a few times a year).

• unregistered cars used in business operations

• car fringe benefits where the entity providing the car cannot claim an income tax deduction because of
the application of the personal services income (PSI) rules.

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Under section 8A FBTAA 1986, the provision of an electric car to an employee for private use is also
exempt where the first retail sale is below the luxury car tax threshold for fuel efficient cars (see below).
The car must be a battery electric, a hydrogen fuel cell electric or a plug-in hybrid electric vehicle. The car
must also be first held and used on or after 1 July 2022. The exemption will end on 1 April 2025.
The ATO has released guidance on what constitutes minor, infrequent and irregular private use of a vehicle
provided for business purposes in PCG 2018/3. The guide sets out a safe harbour methodology for employers.
The requirements include the following:
• The employer takes reasonable steps to limit and monitor private use.
• The vehicle is not provided as part of a salary package.
• The vehicle has a GST-inclusive value of less than the luxury car tax threshold. For the 2022–2023
income year this threshold is $84,916 for fuel efficient cars and $71,849 for other vehicles.
• In respect of the use:
– Any diversion between home and work adds no more than two kilometres to the journey.
– Wholly private travel (excluding home-to-work) cannot exceed 1,000 kilometres in total for the FBT
year, and each return journey cannot exceed 200 kilometres.
– The exemption for work-related vehicles applies to vehicles other than cars as well (eg a ute with a
carrying capacity of more than 1 tonne).

Running costs

Under s 53 FBTAA 1986, where a car fringe benefit is provided, the associated running costs (eg fuel,
repairs) are treated as an exempt fringe benefit. This is because the costs are already covered by the
valuation rules for car fringe benefits (eg the operating cost method).

Why a ‘fully maintained’ car remains an attractive fringe benefit

FBT liability FBT concessions

Car fringe benefit is taxed 1. Statutory formula may assume

FBT calculated using either: greater than actual business use
• statutory formula (based on 2. Car running costs are an exempt
car’s based value, ie cost), or benefit (s 53 FBTAA 1986)
• operating cost method No FBT applies to car:
(based on operating costs) • expense payment benefits
(eg reimbursed fuel, repairs)
• property benefits
• residual benefits

This means that car fringe benefits are often provided on a fully maintained basis, with a
vehicle’s running costs being packaged in such a way that they are reimbursed by the
employer from the employee’s pre-tax salary.

Note: Where car expenses like fuel, repairs, etc are not provided in connection with a car fringe benefit and are provided as an expense
payment fringe benefit instead, the s 53 exemption does not apply. An expense payment fringe benefit is where the employer simply
reimburses an employee’s monthly car lease payments or expenses related to an employee owned car, for example. In this situation, the
substantiation requirements for car expenses must be satisfied in order for the taxable value of the benefit to be reduced on the basis that
the car expenses would have been otherwise deductible.

Required reading
Sections 7, 8 and 136(1) FBTAA 1986 – definition of ‘car’.

Section 995-1 ITAA 1997 – definition of ‘car’ (this definition applies for FBT purposes, as well as for
income tax purposes).

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312 Tax
Calculation method

The taxable value of a car fringe benefit is determined under either the:
• statutory formula method (default method)
• operating cost method (applies only if an employer elects to use this method).
The method used applies on a car-by-car basis, thus allowing employers to select the method that
produces the lowest tax outcome based on the particular employee’s car usage. Furthermore, the method
used for a particular car may differ from year to year.

Statutory formula method

Under the statutory formula method (s 9(1) FBTAA 1986), the taxable value is calculated as follows:

Number of days car

Base
Taxable Statutory fringe benefit Recipient’s
= × value × −
value fraction provided in FBT year payment
of car
Number of days in FBT year

Each element of the statutory formula is explained below.

Statutory fraction

The statutory fraction is 0.20 (20%) (s 9(1) FBTAA 1986). The statutory fraction is 20% regardless of the
kilometres travelled.

Base value

If an employer owns the car (including hire-purchase arrangements), its base value equals its cost price
(s 9(2)(a)(i) FBTAA 1986).
The term cost price is defined in s 136(1) FBTAA 1986 to mean those costs that are directly attributable to
the acquisition or delivery of the car. The cost price includes the following:
• Purchase price (including GST and any luxury car tax) net of any discounts, employee trade-ins and
employee payments that reduce the purchase price. However, if an employer provides a trade-in to
reduce the cash payable, the base value includes the trade-in value because the trade-in of a car is akin
to the payment of cash (TR 2011/3).
• Delivery charges.
• Customs duty (but not registration and stamp duty).
• Cost of fitted non-business accessories.
Base value is reduced by one-third if the car has been held for four complete FBT years – that is, when
completing the fifth FBT return (s 9(2)(a)(i) FBTAA 1986). This reduction does not apply to non-business
accessories fitted after the car was acquired (TD 94/28).

Example 4.33 – One-third reduction rule

Aqua Limited (Aqua) purchases a new BMW for $90,000 on 1 July 2018. Aqua can reduce the base
1
value of the car by ($30,000) in the FBT year beginning 1 April 2023. From that FBT year onward,
3
the FBT is calculated on a base value of $60,000 instead of $90,000.

If an employer leases the car, its base value equals the leased car value (s 9(2)(a)(ii) FBTAA 1986). The
leased car value is the cost to the employer to buy the car from the lessor or, if leased as a new car, the cost
price to the lessor (s 136 FBTAA 1986).
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Days that a car fringe benefit is provided

A car fringe benefit arises on any day where there is actual or deemed private use of a vehicle by an
employee or associate of an employee. In practical terms, private use occurs on any day the employee (or
their associate) has custody and control of the car.
To reduce the FBT exposure, some employees and employers keep detailed records of days when no car
fringe benefit arises, such as when the car is:
• kept wholly on the business premises, with no private use permitted
• being repaired and off the road for more than a day
• garaged away from the employee’s residence and the keys not held by, or available to, the employee or
their associate.

Recipient’s payment

Under s 9(2)(e) FBTAA 1986, a recipient’s payment is the payment (if any), evidenced in documentary form,
made either:
• directly to the employer by the employee for use of the car (contributions must be made from the
employee’s after-tax income and included in the employer’s assessable income), or
• by the employee to a third party for the car’s operating costs (eg fuel, car washes etc). Note:
contributions from the employee are not included in the employer’s assessable income (ie they are not
taken to be constructive receipts).

Operating cost method

Under the operating cost method (s 10 FBTAA 1986), the taxable value is calculated as follows:

Operating (100% – Business Recipient’s

Taxable value = × −
cost use percentage) payment

Each element of the operating cost formula is explained below.

Operating cost

If an employer owns the car, the operating costs are the:

• actual operating costs regardless of who paid for them (eg fuel, service and repairs, but not repairs
covered by insurance) (s 10(3)(a)(i) FBTAA 1986)
• registration and insurance, which are apportioned if the car is a fringe benefit for part of the year
(s 10(3)(a)(ii) FBTAA 1986)
• deemed interest and deemed depreciation (s 10(3)(a)(iii) FBTAA 1986), which is apportioned if the car is a
fringe benefit for part of the year (TR 2011/3).

(FBT) Number of days in FBT

Deemed depreciation
= undepreciated × 25% × year car was owned /
(s 11(1) FBTAA 1986)
value1 Number of days in FBT year

Opening (FBT) Number of days in

Deemed
undepreciated value Statutory FBT year car was
interest (s 11(2) = × ×
+ value of non- rate2 owned / Number
FBTAA 1986)
business accessory of days in FBT year

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Notes:
1. Cost price – accumulated FBT depreciation. FBT depreciation is not income tax depreciation, so the car
limit does not apply (see ATO’s Fringe Benefits Tax – A Guide for Employers).
2. Statutory rate for the FBT year commencing 1 April 2022 is the benchmark interest rate of 4.52%.
3. Refer also to Example 4.55 to see how the operating cost rules apply.

If an employer leases the car, the operating costs are the lease payments 10(3)(a)(v) FBTAA 1986) rather
than the deemed interest and deemed depreciation.
If an employer purchases the car on a hire-purchase basis, the employer is considered to own the car
(s 7(6)). Therefore, the car rules that apply where the employer owns the car outlined previously are applied.

Business use percentage

The business use percentage of a company car is defined in s 136(1) FBTAA 1986 and calculated as:

Business kilometres ÷ Total kilometres

The percentage is calculated by reference to a logbook kept for a 12-week period and odometer records.
The following details must be recorded in the logbook for each business journey:
• the date on which the journey began and ended
• the odometer reading at the start and end of each journey
• the kilometres travelled
• the purpose of the journey.
The ATO can challenge a taxpayer’s logbook and business usage claim if insufficient detail is recorded.

Recipient’s payment

This has been covered earlier, see ‘recipient’s payment’ under ‘statutory formula method’ above.

Debt waiver fringe benefits

Scope

Where an obligation to pay or repay an amount is waived, the waiver is taken to be a benefit provided at
the time of waiving the obligation or debt (s 14 FBTAA 1986).

Calculation method

The taxable value of the debt waiver, calculated under s 15 FBTAA 1986, is the amount of payment or
repayment waived.

Example 4.34 – Debt waiver fringe benefit

XYZ Pty Ltd (XYZ) lends $5,000 to one of its employees, John. John encounters financial difficulties.
In exchange for a partial repayment of $1,000, XYZ agrees to release John from any further
obligations for the debt.

In this case, a debt waiver fringe benefit arises. The taxable value of that benefit is $4,000.

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Loan fringe benefits
Scope

A loan fringe benefit arises where an employee receives a loan from their employer and the rate of
interest charged on that loan is less than the statutory rate of interest set each year by the ATO
(s 16 FBTAA 1986).

Exemptions

Section 17 FBTAA 1986 exempts certain loan benefits from FBT where the employer:
• is in the business of lending money (eg a bank) and makes fixed or variable rate loans to employees on
the same terms as loans it makes to the public
• provides short-term (up to six months) advances to cover employment-related expenses
• provides temporary (up to 12 months) advances to cover security deposits.
A loan provided by an employer that is a company to an employee who is a shareholder in the company is
also exempt from FBT under s 109ZB ITAA 1936. That is, FBT would generally not apply to loans which are
subject to the rules in Division 7A ITAA 1936.

Calculation method

The taxable value of a loan fringe benefit is calculated under s 18 FBTAA 1986. The taxable value may be
further reduced by otherwise deductible amounts.

Statutory interest rate method

Under s 18 FBTAA 1986, the taxable value of a loan fringe benefit is calculated as the difference between
the interest that would have accrued during the FBT year if the statutory interest rate had applied to the
outstanding daily balance of the loan, and the interest that actually accrued.
The statutory interest rate for the FBT year commencing 1 April 2022 is the benchmark interest rate
of 4.52%.

Example 4.35 – Loan fringe benefit

ABC Accountants lend $100,000 to one of its employees at an interest rate of 2% per annum on
1 July 2022. The employee uses that money for non-income-producing purposes.

The loan fringe benefit has been provided for 274 days of the FBT year. Therefore, the taxable value
of the loan fringe benefit is calculated as:

$100,000 × (4.52% – 2%) × 274 / 365 = $1,891

Otherwise deductible rule

The loan fringe benefit category contains a provision that enables the taxable value of these fringe benefits
to be reduced. The reduction mechanism is known as the otherwise deductible rule (s 19 FBTAA 1986).
The otherwise deductible rule requires the employer to answer this hypothetical question: ‘Assuming the
loan was interest-bearing, would the employee have been entitled to an income tax deduction if they had
been required to pay interest on the loan?’ If a deduction would have been available, the taxable value of
the loan fringe benefit is reduced by the deductible percentage.

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The otherwise deductible rule only applies to loans to employees and not to a spouse or other associates of
the employee. Where an interest-free or low-interest loan is provided jointly to an employee and their
associate to acquire an income-producing asset (eg a rental property), reducing its taxable value under the
otherwise deductible rule is limited to the employee’s share of the loan.

Example 4.36 – Loan fringe benefit: Otherwise deductible amounts

ABC Accountants lends one of its employees $100,000 at an interest rate of 2% per annum on
1 July 2022.

As in the previous example, the taxable value of the fringe loan benefit is $1,891. The formula for
calculating this amount takes into account the 2% interest actually paid by the employee.

However, assume that the employee is a director of ABC Accountants, who uses the loan to
undertake a Master of Business Administration course at university. The director works in the firm’s
management consulting practice and the course content is directly relevant to her work.

The otherwise deductible rule in s 19 FBTAA 1986 can be invoked by ABC Accountants, by asking
this hypothetical question: ‘Assuming the loan was interest-bearing, would the director have been
entitled to an income tax deduction if she had been required to pay interest on the loan?’

Looking at this from the employee’s (ie the director’s) perspective, a deduction under s 8-1
ITAA 1997 would be allowed for self-education expenses (including the interest on funds borrowed
to undertake self-education) if the study leads to an increase in the employee’s income from current
income-earning activities (FCT v Hatchett; TR 98/9).

In response to the hypothetical question, the director would be entitled to a 100% deduction.

Assuming ABC Accountants obtains a declaration from the director by the time it lodges the annual
FBT return, the taxable value of this loan fringe benefit will be further reduced by 100% under the
otherwise deductible rule. The result is that the taxable value will be reduced to $nil and no FBT will
be payable on the loan fringe benefit.

Example 4.37 – Loan fringe benefit: Otherwise deductible amounts

HP Pty Limited (HP) lends $10,000 to its employee, Sam, at an interest rate of 4% per annum during
the period 1 April 2022 to 31 March 2023.

Sam uses 75% of the fund to invest in shares and the remaining 25% of the fund to fund his child’s
schooling fee.

The taxable value of the loan fringe benefit before taking into consideration the otherwise deductible
rule is calculated as follows:

($10,000 × 4.52%) – ($10,000 × 4%) = $52

The reduced taxable value after taking into consideration the otherwise deductible rule is calculated
as follows:

$52 – ($10,000 × 4.52% × 75%) – ($10,000 × 4% × 75%) = $13

As Sam has not fully borrowed for income producing purposes, HP will be subject to FBT.

Sam has to submit written documentation to HP to confirm that 75% of the loan borrowed is for
income producing purposes.

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Expense payment fringe benefits
Scope

The most commonly encountered fringe benefit is the expense payment fringe benefit. Businesses typically
incur a wide range of expenses through their employees’ activities (eg client entertainment, travel costs,
phone calls, parking) and have arrangements in place to reimburse their employees for authorised
expenditure. These arrangements sometimes involve corporate credit cards. They may also reimburse
non-business benefits like school fees and mortgage payments.
Section 20 FBTAA 1986 states that an expense payment fringe benefit may arise in either of two ways:
• Where an employer pays a third party for expenses incurred by one of its employees.
• Where an employer reimburses one of its employees for expenses incurred by the employee.
In either case, the expenses may be business expenses or private expenses, or a combination of the two.
Under section 51AH, where all or part of the expense is reimbursed, and the reimbursement constitutes a
fringe benefit under FBTAA 1986, or would constitute a fringe benefit if it was not an exempt benefit, the
expense is not deductible to the employee to the extent it was reimbursed.

Exemptions

The expense payment fringe benefit category contains the following specific exemptions:
• Benefits covered by a no-private-use declaration (s 20A FBTAA 1986). This is an annual declaration by
an employer that covers all expense payment fringe benefits for an FBT year, and states that the
employer’s policy is to only pay or reimburse work-related expenses.
• Exempt accommodation expense payment benefits (s 21 FBTAA 1986). This exemption is available
where the employee satisfies the living-away-from-home allowance (LAFHA) requirements relating to
maintaining an Australian home and for a period of 12 months or less, or the requirements relating to
fly-in-fly-out/drive-in-drive-out employees (see later in this chapter under LAFHA).
• Per-kilometre car expense reimbursements (s 22 FBTAA 1986).

Calculation method

The taxable value of an expense payment benefit depends on whether it is an in-house or external benefit
(see below). The taxable value may be further reduced by:
• otherwise deductible amounts
• $1,000 concession for in-house benefits.

In-house and external benefits

In-house expense payment benefits can be either:

• in-house property expense payment fringe benefits
• in-house residual expense payment fringe benefits.
An in-house (property or residual) expense payment fringe benefit arises where the expenditure paid for, or
reimbursed by, an employer was incurred in the purchase of goods or services that the employer or an
associate of the employer sells to customers or clients in the ordinary course of business.
An external expense payment fringe benefit arises where there is an expense payment fringe benefit that
does not meet the definition of an in-house expense payment fringe benefit. This typically occurs where
the employer reimburses an employee for an expense incurred from purchasing goods or services from a
third party provider.

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 Example 4.38 – Expense payment fringe benefit: External versus in-house
The rules for determining the taxable value of an external versus in-house expense payment fringe
benefit are as follows.

Type of expense Taxable value = Value – Recipient

payment fringe contributions
benefit Example Where value equals:

External expense Aussie Furniture and Interior Design The amount reimbursed
payment benefit Pty Ltd (Aussie Furniture) reimburses its
employees who incur taxi fares while
travelling between stores for
work-related purposes

In-house expense Aussie Furniture manufactures The amount that would be the
payment – property furniture, which it sells through taxable value under the property
benefit independent retailers. It reimburses its fringe benefit rules if the sale of
employees 20% of the amount they pay the goods to the employee by the
for Aussie Furniture products from retailer had constituted an
retailers at the full retail price in-house property fringe benefit

In-house expense Aussie Furniture also runs a franchise The amount that would be the
payment – residual home decorating advice business. It taxable value under the residual
benefit reimburses its employees 20% of the fringe benefit rules if the service
amount they pay to engage the services had constituted an in-house
of the franchisees residual fringe benefit

Example 4.39 – Expense payment fringe benefit

YU Pty Limited (YU) is currently in the process of negotiating a remuneration package for a new
incoming COO (John). John is a highly experienced and successful COO in the industry.

As part of John’s remuneration package, YU agree to pay for childcare fees for each of John’s two
children. The total fees are expected to be $30,000 ($15,000 per child). A clause is inserted in John’s
employment contract which mandates John contribute up to 50% of the total childcare fees if he
does not meet all KPIs.

John has completed his first year with YU and he does not meet each assigned KPI. Accordingly, John
is required to contribute 50% of the total childcare fees.

The FBT taxable value is $15,000 for YU.

Otherwise deductible rule

The taxable value of an expense payment fringe benefit may be reduced under the otherwise deductible
rule if the recipient of the benefit is an employee (but not a spouse of the employee) (s 24 FBTAA 1986).
The taxable value of the benefit is reduced by the amount that the employee would have otherwise been
entitled to claim as an income tax deduction if the employee had incurred the expenditure themselves and
had not been reimbursed by the employer.
A common example of an otherwise deductible expense payment benefit is when work-related travel is
reimbursed by the employer. Where the travel expenditure would have otherwise been deductible for the
employee, the taxable value of the expense payment benefit is reduced by the extent to which the
employee would have been entitled to a deduction.

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The key requirements for applying the otherwise deductible rule are:

Key requirements – otherwise deductible rule

The otherwise deductible rule only applies if the expense payment fringe benefit is provided to an employee (not
to an associate such as a spouse)

The deduction that would otherwise have been available to the employee must have been a once-only deduction
(ie 100% deductible in year 1) (s 24(1)(b) FBTAA 1986)

This means that the otherwise deductible rule does not apply where the deduction would be for the decline in
value of depreciating assets over a period of time, except where 100% of the cost would have been deductible to
the employee in a single income year (eg the cost is no more than $300 (s 40-80(2) ITAA 1997)) or where the
effective life is one year

FBT substantiation rules may apply (see below)

FBT substantiation for otherwise deductible amounts

For practical business reasons and to obtain GST input tax credits, employers require employees to provide
tax invoices as evidence to support their expense claims. However, the FBT law also specifically requires
employers who invoke the otherwise deductible rule to obtain certain types of documentation to
substantiate how much of an expense payment would be otherwise deductible for the employee.
A travel diary (or detailed itinerary) is required where the employee’s expense relates to:
• travel within Australia for more than five consecutive nights and which is not exclusively for performing
work-related duties, or
• travel outside Australia for more than five consecutive nights.
An employee expense payment benefit declaration is also required where an employee’s expense (other
than an expense incurred regarding a car they own or lease) is not incurred exclusively while performing
work-related duties; for example, home telephone or internet costs that have part-business and
part-private components.
Car expenses (eg petrol, oil, registration, insurance and maintenance) which are not connected to a car
fringe benefit require more extensive substantiation, including log books, odometer readings, special
declarations, etc.

Example 4.40 – Substantiation

ATL Pty Limited (ATL) sells software and anti-virus solutions to small and medium-sized businesses.
Each sales executive of ATL is expected to travel to these businesses which are based in metro and
regional locations.

Emma, a high performing sales executive, incurred business-related travel costs totalling $1,500
during the year. To ensure Emma is not financially disadvantaged, ATL choose to fully reimburse
Emma for her business-related travel costs (as opposed to paying an allowance).

Because the total cost incurred wholly related to income producing purposes, ATL is eligible to adopt
the otherwise deductible rule. As part of the FBT reporting process, ATL will require the following
information from Emma:

• logbook to demonstrate that each trip related to work

• receipts and tax invoices of costs incurred
• written documentation (including relevant declarations) from Emma to confirm that the costs
incurred related to work.
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320 Tax
Concession for in-house benefits

Section 62 FBTAA 1986 provides a reduction of $1,000 per employee per FBT year for the total taxable
value of all in-house benefits (ie expense payment, property and residual). However, under s 62(2), this
concession does not apply if the benefit is given under a salary sacrifice arrangement.

Living-away-from-home allowance fringe benefits

Scope

A LAFHA benefit arises where an employer pays an allowance to an employee to either partly or wholly
compensate the employee for additional non-deductible expenses they incur (and other additional
disadvantages) during periods when their duties of employment require them to live away from their
normal residence (s 30(1) FBTAA 1986).
Under s 136(1) FBTAA 1986, normal residence means:
• the employee’s usual place of residence in Australia, or
• if the usual place of residence is not Australia, the employee’s:
– usual place of residence, or
– the place in Australia where the employee usually resides when in Australia.

Example 4.41 – Normal residence

Harry, a French citizen, comes to Australia to work for two years. He intends to return to France at
the end of the period. His usual place of residence is France.

Harry takes out a lease and rents a home in Sydney for the duration of his employment in Australia.

After Harry has been in Australia for a few weeks, his employer asks him to work in the Melbourne
office for the remainder of his time in Australia. While working in the Melbourne office, Harry is paid
an allowance to cover his Melbourne food, drink and accommodation expenses.

Even though Harry has taken out a lease of the Sydney home for two years, Sydney would not be
considered to be his normal residence in Australia because he had lived there only briefly. That is,
Sydney could not be considered the place where Harry usually resides while in Australia. His normal
residence in this case would be his usual place of residence in France.

Therefore, as Harry’s duties of employment requires him to live away from his normal residence, he
qualifies for the LAFHA benefit.

Travelling allowance versus a LAFHA

Some employers provide a travelling allowance to their employees in circumstances similar to those in
which a LAFHA is provided. It is important to distinguish between the two allowances, because, unlike a
LAFHA, a travelling allowance will form part of an employee’s salary and wages and attract PAYG
withholding tax, rather than FBT. The employees may claim deductions against their travelling allowance.
The distinction between a travelling allowance and a LAFHA, and determining whether a deduction can be
claimed by an employee, is summarised in the following table.

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 Travelling allowance and LAFHA summary

Allowance Description Deductions

Travelling Compensation to the employee for A deduction under s 8-1 ITAA 1997
additional deductible expenses incurred by would typically be available to the
the employee. The key considerations for employee for work-related travel
the deductibility of travel expenses related expenses (including travel, food,
to accommodation and meals, as set out in accommodation and incidentals)
TR 2021/1 and TR 2021/D1, include the claimed against the allowance
following:
• the employee’s work activities require The following provisions may apply:
them to undertake the travel • income tax substantiation rules in

• the work requires them to sleep away

Subdivisions 900-B and 900-F
from home overnight ITAA 1997
• restrictions on deductions for
• the employee has a permanent home
elsewhere entertainment (Division 32
ITAA 1997).
• the employee does not incur the
expense during relocation or when living
away from home.

LAFHA Compensation to the employee for No deduction would be available to the

additional non-deductible expenses employee against the LAFHA
incurred by the employee because the
employee’s duties require them to live The employee’s expenditure on
away from home accommodation and food is inherently
private in nature (s 8-1(2)(b) ITAA 1997)

Exemptions

There are no exemptions specific to the LAFHA fringe benefit category. However, various concessions are
available when calculating taxable value.

Calculation method

The taxable value of a LAFHA is the amount of the allowance (s 31B FBTAA 1986). However in limited
circumstances, it may be reduced by (s 31(2)):
• the exempt accommodation component (ie actual accommodation costs incurred)
• any exempt food component (ie additional food costs incurred over a statutory amount or actual food
expenditure provided the employee can substantiate the expenditure).
A reduction in the taxable value of a LAFHA for arrangements that are not fly-in fly-out or drive-in
drive-out is only available for:
• a maximum of 12 months (s 31D FBTAA 1986)
• an employee who (s 31C FBTAA 1986):
– is living away from their normal residence in Australia
– maintains their normal residence for their immediate use and enjoyment at all times
– will return to that residence at the end of the assignment.

Thus, there is no reduction in the taxable value of a LAFHA (for arrangements that are not fly-in fly-out or
drive-in drive-out) where an employee rents their normal residence to a third party, or an employee’s
normal residence is located outside Australia.

‘Fly-in fly-out’ or ‘drive-in drive-out’ employee rules

A reduction in the taxable value of a LAFHA is available for an employee working in Australia under a fly-in
fly-out or drive-in drive-out arrangement where their normal residence is in Australia or overseas (s 31E
FBTAA 1986).
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322 Tax
Such employees:
• do not have to maintain a home in Australia for their own use and enjoyment
• continue to receive concessional tax treatment on the LAFHAs they receive beyond a 12-month period.
This concession recognises the important economic role these workers play in sectors with operations in
remote locations or regions where there is a shortage of skills (eg on oil rigs).
Fly-in fly-out and drive-in drive-out status arises where all of the following requirements are satisfied:
• The employee works for a number of days on a regular and rotational basis and has a number of days off
that are not the same days in consecutive weeks.
• The employee returns to their normal residence during their days off.
• Such arrangements are customary for employees performing similar duties in that industry.
• It is unreasonable to expect an employee to travel to and from work while living at their normal residence
on a daily basis, given the locations of the employment and their home.
• It is reasonable to expect that an employee will resume living at their normal residence when their
employment duties no longer require them to live away from home.

Exempt accommodation and food components

There is a reduction in the taxable value of a LAFHA that may be available for any exempt accommodation
and food components.
This reduced taxable value is the amount of the LAFHA paid after subtracting:
• the exempt accommodation component, which is the component of the allowance that is reasonable
compensation for the cost of the accommodation of the employee and their family members (typically,
this is the actual cost of the accommodation while living away from home)
• the exempt food component, which is the component of the allowance that is reasonable compensation
for the employee’s increased expenditure on food. This is calculated by taking the amount provided by
the employer, reducing this to the amount of the reasonable food component (if no substantiation of
expenditure held) and then reducing this further by the statutory food component (currently $42 per
adult as defined under s 136(1) FBTAA 1986). The reasonable food component figures released by the
Commissioner annually provide estimates of food costs that an employee would incur if they were living
at home. For the FBT year commencing 1 April 2022 the reasonable food component for one adult
within Australia is $289 per week.

Example 4.42 – LAFHA

Assume an employee who qualifies for the LAFHA concessions receives a food allowance of $289
per week for 26 weeks while they are required to live away from their usual place of residence. The
employee does not hold receipts for all of their expenditure on food during this time. However, they
have some receipts and also kept a list of their food expenditure which shows that they spent at least
their allowance on food each week.

Their exempt food component is calculated as:

$289 allowance – $42 statutory food

= $6,422
× 26 weeks component × 26 weeks

Therefore, the taxable value of the LAFHA is calculated as:

$289 allowance – =
$6,422 $1,092
× 26 weeks

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 Example 4.43 – LAFHA
Alex has been sent on a temporary secondment to a regional town. Alex satisfies the normal
residence test and is paid a LAFHA of $900 per week. Of that allowance:

• $500 is compensation for the cost of accommodation, which is fully spent by Alex on
accommodation. Alex substantiates his accommodation expenditure.
• $320 represents compensation for the total food costs while living away from home. This amount
is more than the Commissioner’s reasonable food amount and the employee actually spends $260
on food. Alex substantiates his total food expenditure.

The remaining $80 is compensation for disadvantages associated with having to live apart from
family and in a town without facilities that would normally be enjoyed at home.

The taxable value is calculated as follows:

Total allowance $900

less (minus):

Exempt accommodation component $500

Exempt food component $260 $760

Taxable value $140

* In
this case, the exempt food component is $320 - ($42 - $0) = $278. However, because the
employee only spent $260 (and this can be substantiated) this becomes the exempt food component.

Car parking fringe benefits

Scope

A series of steps is applied to determine whether, on a particular day, a car parking fringe benefit arises
under s 39A FBTAA 1986.
These steps are summarised in the following diagram:

Is the employee’s (or associate’s) car parked in a

parking facility on the employer’s business
Step 1
premises for more than four hours in total
between 7 am and 7 pm?
1 km
Yes

Is there a commercial parking station within

Employee car Step 2 1 km of the parking facility that charges a fee
parked >4hrs greater than the car parking threshold per day?
1 km 1 km
Yes

Is the car parked in the vicinity of the place of

Step 3
1 km employment?

Yes

Step 4 Is the car used to travel from home to work?

Commercial parking station

The car parking threshold for the FBT year commencing 1 April 2022 is $9.72.
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The legislation uses the proximity (within a one-kilometre radius) of an employer to a commercial car
parking station to establish whether a liability arises. The one kilometre is measured according to the
shortest practicable route (by foot, car, train, etc) from the parking station to the employer’s premises. The
one-kilometre test is a black-line test. If the car parking station is 999 metres away, the employer is subject
to car parking fringe benefits rules.
The decision in FCT v Qantas Airways Limited held that an airport car park that is open to the public is a
commercial car park. The ATO has released TR 2021/2, which comes into effect on 1 April 2022.
TR 2021/2 stipulates that a car parking facility may qualify as a commercial parking station even if the
facility has another purpose other than providing all-day parking. Previously, shopping centre car parks and
other similar facilities such as university car parks were not considered to be commercial parking stations
(for FBT purposes). The Taxation Ruling may have a significant impact for FBT liable businesses providing
car parking benefits to its employees where FBT has previously not been paid.

Exemptions

Although there are no specific exemptions in the car parking fringe benefit category, a number of
miscellaneous exemptions may apply. The most relevant of these are the exemptions for:
• employees of religious, charitable or public education institutions and not-for-profit scientific institutions
(s 58G FBTAA 1986)
• employees of small business entities, where an employee’s car is not parked at a commercial parking
station (s 58GA FBTAA 1986). To be eligible, the employer cannot be a public company (ie a listed
company) or a government body and:
– the employer must be a small business entity in the preceding year, or
– the employer’s ordinary and statutory income for the income year preceding the start of the FBT year
must be less than $100 million.

As noted previously, from 1 April 2021, eligible entities with an aggregated turnover of $10 million or more
and less than $50 million will also be entitled to a fringe benefits tax exemption in relation to small business
car parking.
Employees who have a disabled persons parking permit are also eligible (r 3A Fringe Benefits Tax
Regulations 1992).

Calculation method

An employer can elect to apply any one of the following methods:

• For each actual car parking benefit provided on a particular day:
– Commercial parking station method – determine the lowest fee charged by a commercial parking
station operator within a one-kilometre radius reduced by recipient contributions (s 39C FBTAA 1986).
– Market value method – determine the arm’s-length amount the employee could be expected to have
paid reduced by recipient contributions (s 39D FBTAA 1986).
– Average cost method – determine the average of the lowest fees charged by any operator of a
commercial car parking station within a one-kilometre radius on the first and last days of the FBT year
reduced by recipient contributions (s 39DA FBTAA 1986).

• For each car parking space for which there is at least one car parking benefit:
– Statutory formula method (s 39FA FBTAA 1986):

⎛ ⎞
Number of days in
Daily
⎜ ⎟
Taxable ⎜ availability period ⎟ Recipient
=⎜ rate 228 ⎟−
value × in relation to the space × contributions
amount
⎜ ⎟
⎜
⎜ 366 ⎟
⎟
⎝ ⎠

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 – 12-week record-keeping method (s 39GB FBTAA 1986):

⎛ Total value ⎞
of car Number of days of
⎜ ⎟
Taxable ⎜ 52 ⎟ Recipient
=⎜ parking car parking benefits ⎟−
value × 12 × contributions
⎜ benefits 366
⎟
(register)
⎜ ⎟
⎜ ⎟
⎝ ⎠

The daily rate amount and the total value of car parking benefits for a space are amounts worked out using
the commercial parking station method, the market value method or the average cost method (as if there
were no recipient contributions).
Both methods can only be used if the taxpayer elects to do so. The taxpayer can elect for either method to
apply to all employees, a specific class of employees or specified employees.
Note: The above formulas use 366 days, rather than referring to the number of days in the FBT year, as this drafting anomaly is
specifically included in the FBT legislation.

Example 4.44 – Car parking fringe benefits

ABC Accountants has an office in Melbourne. ABC provides on-site parking to 20 employees.
The nearest commercial parking station is 500 metres away, which charges the public a flat fee
of $10 per day.

A 12-week register is kept and this reveals that 900 car parking benefits were provided during this
time. The results can be used for the whole FBT year.

Assuming that no FBT exemption applies, the taxable value of the car parking fringe benefits using
the two methods is calculated as follows:

12-week record-keeping method

52 366
900 × $10 × × = $39,000
12 366

Statutory formula method

366
20 × $10 × × 228 = $45,600
366

Choosing the 12-week record-keeping method will result in a lower taxable value of the benefits.

Example 4.45 – Car parking fringe benefits (commercial parking station and
recipient contribution)
A company employee is allowed to park her privately owned car in the basement of the company’s
building for ten weeks (five days a week). There are two permanent all-day commercial car parking
stations within one kilometre of the employer’s building. The employee drives the car from home to
work each day and parks it there for more than four hours each day between 7.00am and 7.00pm.
The employee contributes $5.00 each day the car parking is used.

At the beginning of the 2022 FBT year and also during the ten week period, parking station number
one charges $7.50 a day and parking station number two charges $10.00 a day. Since there is a car
parking station that charged more than the car parking threshold of $9.72 on 1 April 2022, there is a
fringe benefit. To calculate the taxable value, the employer can use the lowest rate, that is, $7.50.

The taxable value of the car parking fringe benefit provided is calculated as follows:

(50 days × $7.50) – (50 days × $5.00) = $125

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In practice most companies use the statutory formula method and find the lowest car parking rate in
the vicinity.

Property fringe benefits

Scope

Where an employer provides an employee with property free or at a discount, a property fringe benefit
arises under s 40 FBTAA 1986.
Property is defined in s 136(1) FBTAA 1986 as both tangible and intangible property. It includes food and
drinks (TR 97/17), goods, real property (eg land and buildings) and choses in action (eg shares or bonds).
Property also includes any other kind of property and includes money (Essenbourne Pty Ltd v FCT (2002) 51
ATR 629; Caelli Constructions (Vic) Pty Ltd v FCT (2005) 147 FCR 449). The case of Caelli Constructions v FCT
involved payments to an employee redundancy fund. These were found to be property fringe benefits paid
for employment, as they were paid under an industrial agreement and based on the salary of the employee.

Exemptions

Section 41 FBTAA 1986 states that an exempt benefit arises where all property, including food or drink, is
provided to, and consumed by, current employees (not by an associate, such as a spouse) on working days
at an employer’s premises (eg a working lunch, morning tea, stationery, office supplies, etc).
The exemption does not apply if food and drink is provided under a packaging arrangement as defined in
s 136(1) FBTAA 1986 (s 41(2) FBTAA 1986).

Calculation method

The taxable value of a property fringe benefit depends on whether it is an in-house or external benefit (see
below). The taxable value may be further reduced by:
• otherwise deductible amounts
• $1,000 concession for in-house benefits.

External benefits

All property fringe benefits other than in-house property fringe benefits (see below) are external property
fringe benefits.
The taxable value of an external property fringe benefit under s 43 FBTAA 1986 is summarised in the
following table.

External property fringe benefits – taxable value under s 43 FBTAA 1986

Taxable value = Value – Recipient’s contribution

Situation Where value equals:

1. The provider is the employer who purchased the Cost price of the property
property in an arm’s-length transaction

2. The provider is not the employer and the employer Expenditure incurred
has incurred expenditure through payment to the
provider in an arm’s-length transaction

3. Any other case Arm’s-length value

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In-house benefits

Broadly, in-house property fringe benefits arise where the employer carries on a business that consists
of, or includes, the provision of identical or similar goods principally to outsiders. The most common
examples of such benefits are staff discounts provided to employees working in the retail, wholesale or
manufacturing sectors.
The taxable value of a property fringe benefit where the property provided is an in-house property fringe
benefit under s 42 FBTAA 1986 is summarised in the following table.

In-house property fringe benefits – taxable value under s 42 FBTAA 1986

Taxable value = Value – Recipient contributions

Situation Where value equals:

1. A benefit given under a salary sacrifice arrangement Arm’s-length price employee could expect to pay
(has priority over all other categories)

2. Where the employer manufactures, produces,

processes or treats the property provided, and the
property is:

• Identical to goods normally sold by the employer to Lowest arm’s-length selling price
manufacturers, wholesalers or retailers

• Identical to goods sold to the public 75% of the arm’s-length selling price

• Any other case (ie where similar but not identical 75% of the arm’s-length price employee could be
goods sold by the employer) expected to pay

3. Where the employer purchases property for resale in Lesser of:

the normal course of business • arm’s-length purchase price paid by employer
• lowest arm’s-length price employee could expect
to pay

4. Any other case 75% of arm’s-length price employee could expect

to pay

Otherwise deductible rule

Section 44 FBTAA 1986 provides an otherwise deductible rule for property fringe benefits. For the
otherwise deductible rule to apply, the deduction that would otherwise have been available to the
employee must be a once only deduction (ie 100% deductible in Year 1) (s 44(1)(b) FBTAA 1986).

Link between FBT and income tax for entertainment

The FBT exemption under s 41 FBTAA 1986 often needs to be considered together with the income tax
treatment of entertainment expenditure.

Example 4.46 – Food and drink consumed on employer’s premises

ABC Accountants (ABC) provides a range of food and drink to current employees at various functions
that are held on its business premises. The provision of food and drink to employees involves the
provision of property to the employees.

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 ABC uses the actual method for determining the taxable value of its property fringe benefit (ie it has
not elected to apply the meal entertainment fringe benefit category). Therefore, where the property
is consumed on business premises, ABC can apply the FBT exemption in s 41 FBTAA 1986.

However, an exempt property benefit (under s 41 FBTAA 1986) is not a fringe benefit as defined in
s 136(1) FBTAA 1986. Therefore, the exclusion from the income tax rules for entertainment that is a
fringe benefit (s 32-20 ITAA 1997) does not apply where ABC provides entertainment by way of
food and drink to employees on business premises (ie the entertainment will be non-deductible for
income tax purposes under s 32-5 ITAA 1997).

It is important to remember that entertainment generally only arises where the food or drink is
provided at a social function (TR 97/17).

Circumstances in which food and Employer’s

drink is provided to current Entertainment FBT applicable? expenditure tax
employees during a working day context? deductible?

Morning tea and cake to celebrate No No Yes

employee’s birthday (s 41 FBTAA 1986) (s 8-1 ITAA 1997)

Celebratory champagne lunch in Yes No No

firm’s in-house dining facility for (s 41 FBTAA 1986) (s 32-5, and Item 1.1
employees who make the Merit in s 32-30 ITAA 1997)
List in the Chartered Accountants
Program

Friday night drinks (eg beer, wine, Yes No No

soft drinks) and snacks consumed (s 41 FBTAA 1986) (s 32-5 ITAA 1997)
on premises

Residual fringe benefits

Scope

Any benefit not covered by a more specific category (Divisions 2 to 11 FBTAA 1986) is a residual benefit
(s 45 FBTAA 1986). In practical terms, the residual fringe benefit category usually covers employer-provided
services or entitlements to use (but not acquire) an employer’s property. Such benefits can be:
• In-house – For example:
– ABC Accountants (ABC), a registered tax agent, offers every employee a 50% discount on income tax
return preparation fees.

• External – For example:

– ABC arranges for a third-party law firm to grant a 50% discount on legal fees to all ABC’s employees
drawing up a will.
– ABC allows an employee to use a motor vehicle other than a car for private purposes (eg a utility truck
with a carrying capacity of one tonne, or a motorcycle).

Example 4.47 – In-house residual benefit

Michael has recently started a new graduate role at Lee Architects. Michael directly works for the
owner (Lee).

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 Michael inherits $250k from his grandfather and decides to improve his home. Lee offered free
architectural services to Michael, which were not provided under a salary packaging arrangement.
The market rate of the total service received amounted to $11,000 (GST inclusive).

Michael has received an in-house residual benefit.

FBT payable
Lee Architects is subject to FBT liability as it has provided fringe benefit to its employee (Michael).

The taxable value of the benefit is calculated as follows:

($11,000 × 75%) - $1,000 (in-house benefits concession, see below) = $7,250

The FBT payable is therefore $7,250 × 2.0802 × 47% = $7,088.

Exemptions

Section 47 FBTAA 1986 contains the following specific exemptions:

• Employee transport provided by employers who are public transport providers.
• Recreational or childcare facilities located on business premises (eg company gym).
• Use of property (but not a motor vehicle) that is usually located on business premises, principally in
connection with the employer’s business operations (eg toilet and bathroom facilities, vending machines,
tea and coffee making facilities).
• Accommodation for eligible family members where an employee is living away from (and maintaining for
their ongoing use) their usual residence for a period of 12 months or less (where provided as part of a
LAFHA fringe benefit – see discussion earlier in this topic).
• Use of a motor vehicle where there is no private use other than:
– work-related travel of the employee, which as defined under s 136(1) FBTAA 1986, includes home-to-
work travel, and travel that is incidental to travel in the course of performing the duties of employment
– other private use by the employee or their associates that was minor, infrequent and irregular.

The motor vehicle exemption does not apply if a motor vehicle is used for taxi travel (other than a
limousine) or a car, unless it is a car which is a panel van, utility truck or non-passenger road vehicle.
Use of a motor vehicle that is a car may give rise to a car fringe benefit or an exempt car fringe benefit. It
generally will not give rise to a residual fringe benefit or an exempt residual fringe benefit. Motor vehicles
that may give rise to a residual fringe benefit or an exempt residual fringe benefit include a utility truck
with a carrying capacity of one tonne or more, and a motor cycle.
Employers can also consider making a no-private-use declaration under s 47A FBTAA 1986 stating that all
residual benefits provided attract the otherwise deductible rule and have a taxable value of nil. Residual
benefits covered by such a declaration are exempt benefits.

Calculation method

The taxable value of a residual fringe benefit depends on whether it is an in-house or external benefit (see
below). The taxable value may be further reduced by:
• otherwise deductible amounts
• $1,000 concession for in-house benefits.

External benefits

For external residual fringe benefits, the taxable value under ss 50 and 51 FBTAA 1986 is determined in a
similar way as for external property fringe benefits. For example, where an employee is provided with the

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330 Tax
use of an employer’s property for private purposes, the taxable value is the notional value (ie arm’s length
value) of the benefit reduced by recipient contributions.
Where the employer’s property is a motor vehicle other than a car, one acceptable method is a cents per
kilometre basis (MT 2034).

In-house benefits

For in-house residual fringe benefits, the taxable value under ss 48 and 49 FBTAA 1986 is determined in a
similar way as for in-house property fringe benefits. For example, where the benefit is not provided under a
salary sacrifice arrangement, the taxable value of the in-house residual benefit is generally 75% of the
lowest price charged to the public for the same type of benefit reduced by any recipient contributions.

Otherwise deductible amount

Section 52 FBTAA 1986 provides an otherwise deductible rule for residual fringe benefits. The key
requirements for its application are consistent with those for other categories of benefits. For example, it
only applies to employees (not associates), and it must relate to a once-only deduction.

Example 4.48 – Residual fringe benefits

ABC Accountants, a registered tax agent, offers to prepare the income tax return of an employee, Bill
Smith. The preparation of the return will cost the firm $500. The firm’s financial planning division
also provides a free one-hour consultation to Bill valued at $700 to help him develop an initial
investment strategy. The benefits do not form part of Bill’s salary package.

Both benefits are services and give rise to residual fringe benefits.

• For the tax return preparation service, the otherwise deductible rule will reduce the taxable value
of this benefit to $nil (s 52 FBTAA 1986) because Bill can deduct the tax return preparation fees
under s 25-5 ITAA 1997.
• For the initial investment advice, the otherwise deductible rule is not available because costs
connected to the setup of the investment portfolio are capital in nature. Bill would not have been
eligible to claim a deduction had he personally incurred the $700 cost. The outlay would have been
incurred before the derivation of investment income and would also have been of a capital nature
(TD 95/60). However, the $1,000 in-house benefit concession in s 62 FBTAA 1986 will apply to
reduce the taxable value of the benefit to $nil.

During the initial consultation process, Bill was recommended to pursue a property investment
opportunity which is managed by ABC Property, a business unit which is part of ABC. Bill agrees that
the property investment opportunity is suitable for him. Bill will pay $5,000 for initial advice and to be
registered on the ABC Property’s investor portal. ABC Property agree to offer Bill a 25% staff discount.

The subsequent investment advice provided by ABC Property is a residual fringe benefit. The
otherwise deductible rule is not available for this benefit because costs connected to the setup of the
property investment portfolio are capital in nature.

Meal entertainment fringe benefits

Scope

Entertainment is probably the most difficult area of fringe benefits for identifying and calculating taxable
values, as there are so many different types of benefits and ways in which to calculate their taxable values.
There is no single entertainment fringe benefit category. Numerous fringe benefits categories may be
relevant and the entertainment must fit into one of these. These types of fringe benefits include:
• meal entertainment fringe benefits (ie benefits provided by way of food or drink, but only if the employer
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elects to treat these benefits as meal entertainment fringe benefits – discussed below)

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• expense payment fringe benefits (eg the cost of a ticket to a cricket match purchased by the employee
and reimbursed by the employer)
• property fringe benefits (eg employer provided food and drink at a staff family picnic day held at a local
park, but not if the employer has elected to treat these benefits as meal entertainment fringe benefits)
• residual fringe benefits (eg provision of accommodation or transport for a staff social event)
• tax-exempt body entertainment fringe benefit (eg entertainment provided by an employer that is exempt
from income tax).
Division 9A (ss 37A–37CF FBTAA 1986) applies to meal entertainment fringe benefits. It only applies if an
employer elects to use it for calculating the taxable value of meal entertainment that would otherwise fall
within another FBT benefit category (eg expense payments, property and residual fringe benefits).
Once an employer elects to apply Division 9A FBTAA 1986, it must classify all fringe benefits arising from
the provision of meal entertainment during the FBT year as meal entertainment fringe benefits. To avoid
duplication, no other fringe benefit category can apply (s 37AF FBTAA 1986).

What is entertainment?

The provision of entertainment includes entertainment by way of food, drink or recreation;

or accommodation or travel in connection with, or to facilitate, the provision of entertainment. The FBT
law definition of entertainment (s 136(1) FBTAA 1986) links to the circular definition in the income tax law
(ie ‘entertainment means entertainment …’ – see s 32-10 ITAA 1997).
In an employment context, entertainment includes staff social functions, amusements, sport and similar
leisure-time pursuits, business lunches and drinks, and cocktail parties.
However, employers commonly make the mistake of treating gifts of products (eg wine, hampers or
televisions) to employees as entertainment. Such gifts no doubt bring the employee much joy, but they are
not necessarily provided in an entertainment context.
The ATO’s TD 94/55 suggests two references for determining whether gifts have been provided in an
entertainment context:
• Timeliness – does entertainment occur soon after the provision of the gift? Does the usefulness of the
gift expire after consumption?
• Direct connection – is there a direct connection between the gift and the entertainment? Does
entertainment arise from the use of the item of property?

What is the ‘provision of meal entertainment’?

The provision of meal entertainment is defined in s 37AD FBTAA 1986. The FBT definition of meal
entertainment differs from the income tax definition of entertainment (s 32-10 ITAA 1997). For example, it
excludes recreation and makes no reference to the various concessions available under the income tax law,
which allow deductions for entertainment in limited circumstances. Therefore, at a single entertainment
function or event (eg a Christmas party) meal entertainment fringe benefits may be provided with other
categories of fringe benefits that are entertainment but not meal entertainment.
The Commissioner has issued a comprehensive ruling, TR 97/17 Income Tax and Fringe Benefits Tax:
Entertainment by Way of Food or Drink, which examines a broad range of circumstances in which food and
drink is provided to employees. The ruling includes a helpful test for identifying entertainment scenarios:
the ‘Why, What, When and Where’ test. This test demonstrates that entertainment does not occur every
time that food, drink or recreation is provided. It is necessary to determine whether the food, drink, etc was
provided in an entertainment context. For example:
• Providing morning or afternoon tea to employees (and associates of employees) on a working day, either
on the employer’s premises or at a worksite of the employer, does not qualify generally as the provision
of entertainment when applying the TR 97/17 test because it is mere sustenance. Therefore, it cannot be
treated as a meal entertainment fringe benefit and it is deductible under the general deduction provision
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for income tax purposes (ie it is not excluded from deduction under the entertainment provision).

332 Tax
• TR 97/17 also states that light meals (eg sandwiches, finger food, salads and orange juice) are treated in
the same way as morning and afternoon tea. However, if alcohol is provided at morning or afternoon tea,
or at a light meal at the employer’s business premises or worksite, that would constitute the provision of
entertainment because an element of festivity would be involved by implication.

Exemptions

There are no specific exemptions in the meal entertainment fringe benefit category.
The following limitations apply to miscellaneous exemptions:
• Where the employer chooses to apply the meal entertainment fringe benefit category, the property
fringe benefits exemption for property consumed on business premises on a work day cannot be
applied to meal entertainment expenses (s 41 FBTAA 1986). This is because s 37AF FBTAA 1986 states
that, when an employer chooses to apply the meal entertainment fringe benefit provisions, no other
fringe benefit category can apply (and therefore specific exemptions within those categories cannot
apply). However, the property fringe benefit exemption will continue to apply to food and drink
consumed on work premises on a work day where it is not entertainment (eg morning and
afternoon teas).
• Due to differences in the drafting of the two methods for calculating the taxable value of meal
entertainment fringe benefits, the minor and infrequent benefits exemption in s 58P FBTAA 1986 is:
– available to an employer who uses the 12-week register method. However, this exemption cannot be
applied to in-house benefits
– not available to an employer who uses the 50:50 split method.

Calculation method

Division 9A FBTAA 1986 allows an employer to elect to calculate the taxable value of the provision of meal
entertainment fringe benefits in one of two ways:
• 50:50 split method – the taxable value is 50% of the employer’s total meal entertainment expenditure
(s 37BA FBTAA 1986).
• 12-week register method – the taxable value is a percentage of the employer’s total meal entertainment
expenditure, with the percentage ascertained from keeping a 12-week register of meal entertainment
benefits (s 37CB FBTAA 1986). The 12-week register is valid for the FBT year in which the register is set
up and for the next four FBT years, unless expenses in providing meal entertainment are 20% higher in a
year other than the year in which the register was kept (s 37CD(3) FBTAA 1986).
For tax purposes, both methods provide the employer with some relief from the need to create
detailed expense coding procedures and obtain relevant receipts from employees. However, the
apparent simplicity of the 50:50 split method in particular should not be allowed to mask the obvious point
that, for most employers, this method usually overstates the extent to which meal entertainment is
provided to employees (ie a business owner typically spends more on entertaining clients than employees).

Link between FBT and income tax – meal entertainment fringe benefits

An employer who elects to apply Division 9A FBTAA 1986 to meal entertainment expenditure must use
the same method for claiming income tax deductions. Therefore, income tax deductions for meal
entertainment expenditure will be claimed on either the 50:50 split method (s 51AEA ITAA 1936), or
12-week register method (s 51AEB ITAA 1936).
GST credits can be claimed for the cost of providing entertainment that is a fringe benefit. If GST is
claimed, an employer claims the GST-exclusive amount as an income tax deduction.

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 Example 4.49 – Meal entertainment: Division 9A
ABC Accountants chooses to apply the 50:50 method under the meal entertainment fringe benefit
category. It incurs $2,200 (including GST of $200) in meal entertainment at a local restaurant for one
employee and three clients. The following are the FBT, GST and income tax consequences for the
employee portion:

• The taxable value of the fringe benefit is $1,100 (50% × $2,200).

1
( )
• The GST input tax credit entitlement is $100 $1,100 × .
11
• The tax deduction is $1,000 ($1,100 – $100) (s 51AEA ITAA 1936 and s 27-5 ITAA 1997).

The client portion of $1,100 is not a fringe benefit, is not income tax deductible (s 32-5 ITAA 1997),
and there is no entitlement to a GST input tax credit (Division 69 GST Act).

As noted, if an employer elects to apply the meal entertainment fringe benefit category, the FBT and
income treatment of certain benefits may change.

Example 4.50 – Meal entertainment: excluded exemptions

ABC Accountants has chosen to apply the 50:50 method under the meal entertainment fringe benefit
category. As a consequence, the following meal entertainment expenses would be subject to FBT:

• 50% of any infrequent employee restaurant meals costing less than $300 (ie benefits that would
otherwise be an exempt minor and infrequent benefit under s 58P)
• 50% of the cost of any Friday night drinks (ie benefits that would otherwise be an exempt property
fringe benefit as it is consumed on business premises on a work day under s 41).
Note: For morning and afternoon tea (ie mere sustenance and not entertainment), the FBT treatment as an exempt property
fringe benefit under s 41 FBTAA 1986 and the income tax treatment as a deductible expenditure under s 8-1 ITAA 1997 would
not change where a meal entertainment fringe benefit election is made.

Example 4.51 – Meal entertainment: minor and infrequent

After reviewing actual transactions incurred, ABC Accountants has decided to not adopt the 50:50
method the following FBT year (2023 FBT year).

ABC Accountants held one meal entertainment event during the period 1 April 2022 to 31 March
2023. The total cost of the event was $1,200 (GST inclusive) and six staff members attended the event.

ABC Accountants is eligible to adopt the minor and infrequent meal entertainment exemption.

Link between FBT and income tax – Other fringe benefits

Where Division 9A FBTAA 1986 does not apply (ie where an employer has not chosen to apply the meal
entertainment fringe benefit category), the taxable value of the fringe benefit is based on actual meals (and
associated travel and accommodation) provided to employees and their associates. This is commonly
referred to as the ‘actual method’.
In the usual case, where an employee takes a business client to a business lunch and the employer
reimburses the employee for the cost of both meals, the tax consequences are as follows:
• The cost of the employee’s meal is subject to FBT as an expense payment fringe benefit (subject to the
minor benefit exemption in s 58P) and is deductible for the employer (ss 8-1 and 32-20 ITAA 1997).
Where s 58P applies, the meal would be an exempt benefit and would not be deductible.
• The cost of the client’s meal is not deductible for the employer and is not a fringe benefit (ss 32-5 and
32-20 ITAA 1997, and s 63A FBTAA 1986).
For practical reasons, the Commissioner allows the cost of the meal entertainment for both the employee
and client to be split on a per-head basis (TD 94/25).
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334 Tax
 Example 4.52 – Meal entertainment: Expense payment benefit
ABC Accountants incurs $2,200 (including GST of $200) in meal entertainment at a local restaurant
for one employee and three clients. It has not chosen to apply Division 9A FBTAA 1986. The
following are the FBT, GST and income tax consequences of the employee portion:
1
( )
The taxable value of the expense payment fringe benefit is $550 × $2,200 .
4
1
( )
The GST input tax credit entitlement is $50 $550 × .
11
The income tax deduction is $500 ($550 – $50) (s 32-20 and s 27-5 ITAA 1997).

The $1,650 client portion is not a fringe benefit, is not income tax deductible, and there is no GST
input tax credit entitlement.

Entertainment facility leasing

Scope

Entertainment facility leasing expenses is defined in s 136(1) FBTAA 1986. The benefit captures expenses
incurred by the employer in hiring or leasing (a) a corporate box, (b) boats or planes for the provision of
entertainment or (c) other premises or facilities for the provision of entertainment. It is important to note
the benefit does not include expenses that are attributable to (i) the provision of food or drink or (ii) to
advertising and is a deduction.

Calculation method

Under s 152B FBTAA 1986, an employer can elect that the taxable value of benefits provided by
entertainment facilities that are hired or leased is 50% of all the expenses (50:50 split method). This is a
compliance cost-saving measure that alleviates the practical problem of keeping an actual headcount of
those who use the facilities.

Recipient contributions
If an employee pays an amount to the employer for the benefit, this amount will be a recipient’s contribution
or employee contribution. The taxable value of that fringe benefit is reduced by the gross amount of the
payment (including GST). The amount must be paid from the after-tax income of the employee.
To qualify as a recipient contribution, the amount would generally be paid within the FBT year. However,
there is no actual time frame stipulated in the legislation. Provided the employee agrees to pay the
contribution by the end of the FBT year, the ATO will accept it as a contribution for the year that has just
ended even where it is received after the FBT return is lodged.
In ATO ID 2005/210, the ATO accepts that excess recipient contributions in a particular FBT year can be
carried forward and used to reduce the taxable value of benefits in a later FBT year.
In the case of car fringe benefits, the recipient contribution can be made by making a payment to the
employer from after-tax pay (usually done by payroll deduction) or by the employee paying the packaged
car expenses (eg fuel, repairs, insurance and registration). Other costs paid by the recipient, such as bridge
and road tolls, will not be treated as a recipient’s contribution.

Example 4.53 – Expense payment fringe benefit and otherwise deductible rule
Gayan started a new job at ABC Accountants (ABC) on 1 July 2022. ABC has a hybrid working model
that allows employees to work from both the office and from home. ABC pays Gayan’s internet
service provider directly a monthly payment of $55 (GST inclusive) on behalf of Gayan. Under this
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 arrangement, Gayan will reimburse ABC for the portion that represents any private use at the end of
each FBT year.

At the end of the FBT year ended 31 March 2023, Gayan provides ABC a declaration stating that he
used the internet 80% for employment-related (and income tax deductible) purposes and 20% for
private purposes.

The taxable value of the expense payment fringe benefit (without the otherwise deductible rule) is
$495, and Gayan makes an employee contribution of $99 to ABC on 31 March 2023. ABC
Accountants can apply the otherwise deductible rule as follows:

Step Action Result

1 Disregard any employee contribution from Gayan and $495

calculate the taxable value of the expense payment fringe
benefit as if there was no employee contribution.

2 Now suppose that Gayan had paid an amount for the home $495 × 80% = $396
internet connection himself equal to the amount of the
taxable value calculated in Step 1. How much of this
hypothetical expenditure would have been income tax
deductible to Gayan? This is the otherwise deductible
amount.

3 Now look at the actual fringe benefit situation. If Gayan has $495 less recipient’s
made a contribution towards the expense payment fringe contribution of $99 = $396
benefit, what is the taxable value?

4 Finally, the taxable value of $396 (Step 3) may be reduced $396 − 396 = nil
by the otherwise deductible amount of $396 (Step 2).

4.2.6 FBT payable

Overview
Up until now, the focus of this chapter has been on identifying and (if necessary) calculating the taxable
value of particular fringe benefits.
The next step is to calculate the actual amount of FBT that is payable by the employer.
Building on the flow chart methodology used in Steps 1–5 earlier in this chapter, the next two steps are
depicted below.

Calculate taxable amount

Step 6 = (Taxable value Type 1 benefits × Type 1 gross-up factor) +
(Taxable value Type 2 benefits × Type 2 gross-up factor)

Step 7 Calculate FBT liability = Taxable amount × FBT rate

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Step 6 – Calculate taxable amount
To calculate the taxable amount under s 5B:
• identify each fringe benefit as either a Type 1 or Type 2 benefit
• multiply the taxable value of each fringe benefit by the applicable gross-up factor.

Type 1 and Type 2 benefits

The entitlement to a GST input tax credit for the fringe benefit determines whether a fringe benefit is a
Type 1 or Type 2 benefit:
• Type 1 benefit – employer is entitled to an input tax credit for GST paid on benefits provided.
• Type 2 benefit – employer is not entitled to an input tax credit for GST paid on benefits provided.
Section 149A FBTAA 1986 states a benefit provided for an employee’s employment is a GST-creditable
benefit, where an entitlement to a GST input tax credit arises under Division 111 of the GST Act because
of the provision of the benefit. Where the benefit is covered by the GST Act, it must have been acquired or
imported within the meaning of the GST Act.

Example 4.54 – Type 1 and Type 2 benefits

CA7 Pty Limited (CA7) provided the following type 1 and type 2 fringe benefits to its employees:

Type 1
Domestic holiday package for its top sales performer

Movie or concert tickets to all employees

Type 2
Loan benefit to an employee who faced financial hardship due to unexpected family issues

University fee for an undergraduate cadet

Gross-up factors

Gross-up factors are used in calculating an FBT liability for two reasons:
1. To make employers and employees indifferent to either packaging fully taxable FBT benefits or paying
cash salaries sufficient for employees to acquire the benefits from their after-tax salaries. This assumes
that employees are in the top marginal tax bracket.
2. To acknowledge the GST input tax credit that employers sometimes obtain when purchasing benefits
that are provided to their employees.

The Type 1 gross-up factor is calculated as follows:

FBT rate + GST rate

(1 − FBT rate) × (1+GST rate) × FBT rate

The Type 2 gross-up factor is calculated as follows:

1
1 − FBT rate

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The following table summarises the FBT rate and gross-up factors for particular FBT year ends.

Fringe benefits tax

Year end 31 March Rate Type 1 gross-up factor Type 2 gross-up factor

2016 and 2017 49% 2.1463 1.9608

2018 and later 47% 2.0802 1.8868

Note: The FBT year end covered in this offering of the TAXAU subject is 31 March 2023.

Step 7 – Calculate FBT payable

FBT payable is calculated by multiplying the taxable amount by the applicable FBT rate.

Example 4.55 – FBT payable

Background facts
Luxury Australia Pty Ltd (Luxury Australia) is a subsidiary of a listed UK corporation, Luxury Ltd (LL).
LL is the parent company to a number of subsidiaries that own and operate hotel chains around the
world. Luxury Australia owns and operate resorts in Sydney, Brisbane, Adelaide, Perth and
Melbourne, Australia. Jason is the Global Sales Director of LL who is transferred to Sydney effective
1 July 2022 to work for Luxury Australia. It has been agreed that the remuneration package to be
provided by Luxury Australia to Jason, in addition to salary and wages and superannuation, will
include the following items.

• Jason may take furniture to the value of $8,000 from the Sydney CBD hotel to fit out his
apartment in August 2022. The furniture will become Jason’s property which he can keep or sell at
the end of his 2-year contract.
• A motor vehicle will be provided to Jason for use during his employment with Luxury Australia. A
car was acquired by Luxury Australia for $120,000 (GST inclusive) on 1 July 2022. It is not
anticipated that Jason will need to use the car very often for work purposes during the first year as
he will be living and working in the city. For one week in February 2023, Jason cannot use the car
as it is in the workshop for repairs. The estimated kilometres to be travelled by Jason in the FBT
year ended 31 March 2023 would be less than 5,000 kilometres. It is not expected that Jason
would keep a log book for his motor vehicle travel.
• Newspapers to be used by Jason in keeping abreast of business and industry issues will be
provided by Luxury Australia.
• Luxury Australia will pay for Jason and a friend to attend three music events in Sydney during the
transfer. Jason will buy the tickets and then be reimbursed by Luxury Australia for his expenditure.
The total reimbursement balance for the 2023 FBT year amounted to $3,200 (GST inclusive).
• Jason is entitled to engage a solicitor (of his choice) to help with his personal legal affairs. Luxury
Australia will reimburse the total cost up to $5,000 (GST inclusive). The total reimbursement
balance for the 2023 FBT year amounted to $1,200 (GST inclusive).

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338 Tax
 FBT tax consequences

Taxable
Fringe benefit category Determination of taxable value value

Furniture External property FB Cost of acquiring the furniture $8,000

Motor Car FB No logbook kept so statutory formula method $17,556

vehicle is used

Taxable value of the car fringe benefit is

calculated using the statutory method.

Statutory fraction is 0.20

Cost $120,000

Number of days available for private use from

1 July 2022 to 31 March 2023 less seven days
in for repairs: 274 days – 7 days = 267 days

Taxable value 0.20 × $120,000 × 267 days /

365 days = $17,556

Newspapers Exempt FB Section 58H as primarily for work purposes –

Tickets Expense payment FB Amount reimbursed for cost of tickets $3,200

Legal fees Expense payment FB Amount reimbursed as the otherwise $1,200

deductible rule does not apply as the cost was
not incurred for income-producing purposes.

Total taxable value $29,956

FBT payable = $29,956 × 2.0802 × 47% = $29,288

Example 4.56 – FBT payable

Simon’s employer purchased a car in March 2022 at a cost of $44,000 GST inclusive and provided
the car to Simon on 1 April 2022.

Simon garages the car at his home each night during the 2023 FBT year. Simon travelled 20,000
kilometres in the car during the year, and the odometer and logbook records show that 5,000
kilometres were for business purposes and 15,000 kilometres were for private purposes.

The operating costs of the car (not including deemed depreciation and deemed interest) were $9,000
(GST inclusive). Simon made a contribution totalling $5,000 and provided all the necessary
documents for his employer to calculate his FBT liability.

Assuming the employer elects to use the operating cost basis, the total taxable value is calculated as
follows.

Operating cost $9,000

Deemed depreciation $44,000 × 0.25 × 365/365 = $11,000

Deemed interest $44,000 × 0.0452 × 365/365 = $1,989

Total operating costs = $21,989

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Other taxes and interactions 339

 Taxable value is calculated as total operating cost ($21,989 × 15,000/20,000) - $5,000 = $11,492.

FBT payable is calculated as $11,492 × 2.0802 × 47% = $11,236.

* Deemed depreciation and interest rates are published by the ATO. The deemed depreciation rate is
25% for all cars purchased after 10 May 2016. The ATO publish an annual Taxation Determination
which outlines the deemed interest rate.

4.3 Interactions between taxes and transactions

The Australian taxation system is highly complex and consists of approximately 125 taxes including Federal
taxes such as, income tax, superannuation and goods and services tax. As covered in Topics 4.1 and 4.2,
taxes can be imposed on non-income transactions (ie consumption of goods and services) and the tax rules
have been designed to specifically target certain stakeholders (ie employers pay tax for benefits provided
to employees).
Tax practitioners must have good knowledge of each tax area as this is critical to understanding how the
tax sections interact. The Australian tax system has been designed to prevent double taxation and equally
importantly, double dipping of tax benefits. This topic will cover interactions between various tax rules
and exceptions.

4.3.1 Deductibility and assessability of taxes

FBT
An employer treats FBT as a tax-deductible expense under s 8-1 ITAA 1997 because it has a clear
connection with the cost of labour used in the employer’s business.
The lack of alignment between the income year for income tax purposes (typically 1 July to 30 June) and
the FBT year (see ‘Collecting FBT’ above) creates a timing issue when claiming a deduction for income tax
purposes.
The ATO accepts that the FBT instalment relating to the June 2023 quarter (paid in July 2023) is incurred by
the employer in the income tax year ended 30 June 2023 (ie the deduction is back-dated). The result is that
the June quarter instalment is deductible in the year ended 30 June 2023 even though it is paid after the end
of the income year (TR 95/24). Correspondingly, the FBT instalment relating to the June 2022 quarter (paid
in July 2022) must be excluded from the income tax calculation for the income year ended 30 June 2023.
This timing issue is illustrated by the following diagram.

Income year

Starts Ends
1 July 2022 30 June 2023

FBT year

Starts Qtr 1 Qtr 2 Qtr 3 Ends Qtr 1

1 April 2022 31 March 2023

FBT instalments are tax deductible in the income year ended 30 June 2023
FBT instalment is tax deductible in the income year ended 30 June 2022

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340 Tax
 Example 4.57 – FBT instalments
Print Pty Limited (Print) paid the following FBT instalments during the period 1 January 2022 to
30 June 2023.

Quarter FBT instalment

31 March 2022 $12,500

30 June 2022 $15,000

30 September 2022 $15,000

31 December 2022 $15,000

31 March 2023 $15,000

30 June 2023 $12,500

Print will claim an income tax deduction totalling $57,500 for the 2023 financial year. The FBT
instalments paid for quarters ended 31 March 2022 and 30 June 2022 form part of Print’s 2022
financial year income tax deductions.

Employees who receive fringe benefits are not subject to income tax as FBT is a tax liability which is paid
by the employer. Employees do need to report the amount of reportable fringe benefit received in their
income tax return. The reportable fringe benefit amount is used to calculate an employee’s non-income tax
and levy-related liability and entitlement; including Medicare levy surcharge, family assistance payments
and Division 293 tax liability.

GST
To prevent double taxation of transactions, GST liability on a taxable supply is excluded from GST
registered entities’ assessable and exempt income in determining their taxable income. Similarly, GST credit
on a taxable supply is excluded from GST registered entities’ deductions.
For entities which are not GST registered or operate an input-taxed GST supply enterprise, GST credit on
purchases is deductible if the purchase satisfied the income tax deduction rules. This is on the basis that
the GST credit on purchases cannot be claimed from the ATO.

Example 4.58 – Input tax GST

Janice owns a residential investment property. Janice paid expenses totalling $3,300 for the
investment residential property during the 2023 financial year.

Total GST credit included in the purchase was $300. Janice is not entitled to claim any GST credit
from the ATO. She will declare total expenditure including GST credit ($3,300) as a deduction.

Example 4.59 – Taxable supplier

Janice subsequently acquires a new commercial investment property. Janice paid a total of $5,500 in
expenses relating to the property during the 2023 financial year.

The total GST credit included in the purchase was $500. Janice is entitled to claim GST credits of $500
from the ATO. She will declare total expenditure excluding the GST credit (ie $5,000) as a deduction.

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Other taxes and interactions 341

 It is important to note that, in the event Janice incurred expenditure which related to both her
residential and commercial investment properties, the GST credit portion which she cannot claim
back from the ATO will be deductible.

Payroll tax
Payroll tax is a State and Territory tax that employers have to pay once the total assessable wage exceeds
the wage threshold (note: each State and Territory currently have different wage thresholds).
Payroll tax liability is an income tax deductible expenditure under s 8-1.

Stamp duty
Stamp duty is a State and Territory tax. It is a form of tax that State Governments and Territories charge for
documents and transactions, including the transfer of a property.
Stamp duty is not automatically deductible. The tax treatment of stamp duty usually follows the tax treatment
of the main purchase transaction (revenue versus capital). As an example, stamp duty paid on acquiring a
property is not deductible as the purchase of a property is considered to be a capital transaction event.
In the event the stamp duty payment is not considered to be immediately deductible under s 8-1, the
stamp duty payment will usually form part of the CGT cost base.

Example 4.60 – Stamp duty

Janice acquired a new office premises and paid stamp duty totalling $30,000. The office will be used
for her real estate property management business.

Janice is not entitled to claim a tax deduction for the stamp duty. Rather, the stamp duty will form
part of the CGT cost base and she can reduce her future capital gain by the stamp duty amount.

4.3.2 Interaction between taxes and transactions

FBT and income tax
A fringe benefit is considered to be non-assessable non-exempt (NANE) income in the employee’s hands
for income tax purposes (s 23L(1) ITAA 1936). However, exempt benefits are not fringe benefits as defined
in s 136(1) FBTAA 1986.
With one exception, an exempt benefit is considered to be exempt income in the employee’s hands for
income tax purposes (s 23L(1A) ITAA 1936). Therefore, exempt benefits use up any income tax losses the
employee may have.
The exception is employer-reimbursed car expenses (typically paid on a per-kilometre basis), which are:
• an exempt benefit under the expense payment fringe benefit category (s 22 FBTAA 1986)
• included in assessable income for income tax purposes (s 15-70 ITAA 1997).
Unlike other fringe benefits, there is a direct link between the treatment of entertainment expenditure for
FBT purposes and its income tax treatment.

FBT and GST

The interaction between GST, FBT and income tax are summarised in the following table.

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342 Tax
 Interaction of FBT, GST and income tax

Situation Tax Consequences

Employer GST Employer

provides Although an employer makes a taxable supply when providing a fringe
benefit benefit, the employer is only liable for GST on the supply in the form of a
(assume recipient’s payment or contribution (s 9-75(3) GST Act)
employer is
registered for The employer will be entitled to GST input tax credits for most expense
GST) payment fringe benefits (eg reimbursement of taxi fares incurred by an
employee while travelling for work) (Division 111 GST Act). Tax invoices need
to be obtained from the employee, although not for minor amounts
However, no GST input tax credit entitlement arises where the employer
reimburses non-deductible expenses (eg the client portion of a restaurant
meal, or the cost of beer and wine etc consumed at a social function held on
business premises during a work day: Division 69 GST Act)
Employee
No consequences

FBT Employer
Taxable value of the benefit for FBT purposes is calculated on a GST-inclusive
basis (TR 2001/2 paras 21, 22, 23 and 26)
Employee
No consequences

Income tax Employer

Any amount assessable to employer does not include GST (s 17-5 ITAA 1997)

GST component of the cost of a fringe benefit is not deductible if the

employer is eligible for an input tax credit (s 27-5 ITAA 1997)
An employer can deduct FBT as a labour cost (s 8-1 ITAA 1997)
GST paid by employer (eg on an employee contribution) is not deductible
(s 27-15 ITAA 1997)
Employee
Employee does not pay income tax on benefit received

Employee GST Employer

makes
Employee contribution can affect the GST payable by the employer on the
contribution
taxable supply it makes (see above)
to employer
Employee
No consequences

FBT Employer
Employee’s contribution towards the benefit reduces the taxable value of the
fringe benefit and hence, the employer’s FBT liability
Employee
No consequences

Income tax Employer

The employee contribution will typically be income according to ordinary
concepts in the hands of the employer (s 6-5 ITAA 1997)
Employee
Contribution towards private component of a fringe benefit is not deductible
for an employee (s 51AJ ITAA 1936)

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Other taxes and interactions 343

 Interaction of FBT, GST and income tax

Situation Tax Consequences

Employee GST Employer

makes
No consequences
contribution,
but not to Employee
employer
No consequences

FBT Employer
Employee’s contribution reduces the taxable value of the fringe benefit and,
hence, the employer’s FBT liability
Employee
No consequences

Income tax Employer

No consequences for the employer (there is no constructive receipt under
s 6-5(4) ITAA 1997)
Employee
Employee contribution towards private component of a fringe benefit is not
deductible to employee (s 51AJ ITAA 1936)

Capital allowances, capital works, CGT asset and trading stock

The tax treatment of a capital item (ie shares and heavy machinery) will depend on whether the taxpayer is
holding the capital item as an investor, carrying on a business as a trader, or intend to use the capital item
for operating a business. It is important to clearly find out the taxpayer’s intention at the time of acquisition
of the capital item and assess facts to determine correct tax treatment.
Using a factory unit as an example, a factory unit can be classified as:
• Depreciable asset (capital allowances and capital works) – a business can claim depreciation under
Division 40 and Division 43 on the basis that it acquired a factory unit to operate its business
• CGT asset – an investment firm can treat the factory unit as a CGT asset on the basis that it intends to
derive rental income from the factory unit and sell it in the long term
• Trading stock – an investment firm can treat the factory unit as a trading stock on the basis that it
intends to develop and trade this in the short term.
The tax treatment of the initial purchase and holding cost can significantly differ depending on the
classification.

Example 4.61 – CGT asset

Daniel decides to invest in warehouses as there is high demand for these assets.

Daniel has $500,000 of his own funds available to purchase three warehouses and, in addition, he
has access to a $1,250,000 borrowing facility through his bank.

Daniel’s objective is to identify storage warehouses that will rent well to local businesses. He does
not intend to sell the warehouses at a profit after holding them for a brief period.

Based on the above facts, it would be reasonable to conclude that the warehouses will be classified
as CGT assets. No deduction under s 8-1 can be claimed for the initial purchase and incidental costs.
The purchase and incidental cost will form part of the CGT cost base.
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344 Tax
 Example 4.62 – Trading stock
Daniel subsequently receives independent financial advice and decides to engage in trading of
warehouses.

In the income year, Daniel conducted 15 transactions: 9 buying and 6 selling. All the transactions were
conducted through a real estate specialist. Daniel spent considerable time researching and identifying
warehouses suitable for short term profit. The average time that Daniel held warehouses before
selling them was fourteen weeks. Daniel’s activities resulted in a profit of $250,000 after expenses.

Daniel’s activities show all the factors that would be expected from a person carrying on a business.
His trading operation demonstrates a profit-making intention. Daniel’s activities are regular and
repetitive, and they are organised in a business-like way.

Based on these facts, it would be reasonable to conclude that the warehouses are classified as
trading stock. Daniel will need to apply Division 70 tax rules.

Example 4.63 – Refresher example GST, income tax and FBT

ABC Accountants (ABC) reimburses an employee’s internet bill for six-months. Total cost amounted
to $770 (GST inclusive). The employee uses the phone 30% for his employment.

GST: The supply of internet phone services is a taxable supply, and therefore subject to GST. As ABC
makes taxable supplies,(it is entitled)to an input tax credit on the reimbursement. Importantly, the
1
input tax credit is $70 × $770 . The fact the employee uses the internet only partly for their
11
income-producing activity is not relevant to the ABC’s input tax credit question.

FBT: The prima facie taxable value is $770. The otherwise deductible rule applies to give an
otherwise deductible amount of $231 ($770 × 30%). This reduces the taxable value to $539
($770 – $231). The taxable value is grossed-up by the Type 1 FBT rate because ABC obtained an
input tax credit on the provision of the benefit. The FBT liability is calculated as follows:
[($770 – $231) × 2.0802 × 47%] = $527

Income Tax (employer): ABC’s deduction for the cost of the benefit provided is $700. It is not $770
because the input tax credit is not a deduction. The full amount is deductible because the cost
incurred relate to carrying on a business (s 8-1). FBT of $527 is also deductible.

Income Tax (employee): The employee has not made assessable income on receipt of the $770
reimbursement. The employee also does not obtain a deduction for cost of the internet service
because they have been reimbursed the cost.

Chapter summary
This chapter covered various aspects of GST, employment remuneration, FBT and considered the
interactions between taxes and transactions.

GST
The GST rules were implemented in Australia to tax consumption transactions. This chapter covered the
GST concepts of taxable supplies, taxable importations, creditable acquisitions and creditable importations.
It also covered the main GST exemptions (ie GST-free supplies and input-taxed supplies) and examined
certain transactions and special events.

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Other taxes and interactions 345

Employment remuneration and FBT
Australian employers are subject to complex tax rules. This chapter examined employment remuneration
and the tax treatment of various non-salary payments for employers and employees. The tax treatment of
superannuation guarantee contributions for employers and employees was also reviewed.
This chapter also covered the FBT consequences of different types of non-cash benefits provided to
employees.

Interactions between taxes and transaction

Finally, the chapter highlighted how different taxes interact with each other and how Australian tax law has
been designed to prevent double taxation.

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346 Tax
Index

absolute entitlement to trust assets loans 158 calculate net GST payable/refundable
211, 231 payments and use of company 279
accounting consolidation 178 assets 158 capital allowances 344–5
accounting loss, and net income assessability of income 247, 248 balancing adjustment 94–8
218 assessable branch profit 261 CGT and trading stock 98–101
accounting profit assessable income decline in value
distribution of 218 deductible expenditure 50–1 reductions 94
and net loss 218 defined 45 tax depreciation 89–93
acquisition 31, 56, 61, 63, 64, 68–9, exempt income 49–50 overview 84–9
90, 91, 96, 99, 111, 119, 124,
gain or loss 51 splitting and merging assets 98
125, 132, 133, 274, 276, 279,
285, 287–95, 313, 344 NANE income 50 capital gains component 222
active income test 245, 251, ordinary income 49 capital gains tax (CGT) 31, 82, 84,
254, 255 statutory income 53–4 108–18, 186, 202, 250, 257
adjusted tainted income 245, work-in-progress amount 52 application 108–14
253, 254 events 115–18
assessable income base rate entity
administration and compliance of GST passive income 41–2 exemptions 124–39
registration 274–6 asset additions pre-CGT asset integrity provisions
returns, payments and refunds allocated to pool 241 139–41
277–9 and trading stock 98–101, 344–5
existing assets 240
tax periods and attribution capital loss utilisation rules 122–4
immediate deduction 241
276–7
asset disposals 242 capital works 58, 84, 92, 101–2,
aggregated turnover 17, 41, 42, 67, 111, 143, 155, 189, 229,
77, 87, 88, 92, 93, 149–51, attribution, GST 276
344–5
156, 157, 184, 188, 198, 210, attribution regimes 270
overview 101–2
232–4, 236–8, 309, 325 Australian consumer 275, 282, 287,
car fringe benefits 307, 309,
allowances 303–4 290, 296
311–15, 330, 335
versus reimbursements 304 Australian income tax law
car parking fringe benefits 324–7
substantiation requirements fundamental feature of 32
carry forward loss provisions 166
303–4 Australian Taxation Office (ATO)
13, 137 carry forward tax losses 167–73
alternative condition rule 169
Australian taxation system 1, 340 business continuity test
amalgamated loans 163
169–71
anti-overlap provisions 124–39
continuity of ownership test
exempt/loss-denying transactions bad debt provisions 166
167–9
131 base rate entity 41, 42, 44, 79,
control test 171–2
general insurance 138 145, 149, 151, 156, 157, 232,
236, 237 modified COT 172–3
life insurance 137–8
passive income 156 carrying out business 40–1
pooled superannuation trusts
BCT see business continuity test cash versus accruals 277
138
benchmark percentage rule 217 CAT see current annual turnover
residence exemption 132–7
blackhole expenditure 60, 84, 155, central management and control
APES 110 Code of Ethics for
235, 240, 243–4 37–42, 209
Professional Accountants
(including Independence budget amendments 240 CGT events relating to trusts
Standards) 2–3 business activity statement (BAS) 5, absolute entitlement to trust
APES 220 Taxation Services 18, 277 assets 231
3–4 business continuity test (BCT) disposal of CGT asset to a
application, private company loans 169–71 beneficiary 231
commissioner’s discretion 159 same business test 169–71 establishment of trusts 230
debts forgiven 159 similar business test 171 non-assessable trust distributions
227–30
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Index 347
CGT rollover relief 198, 203, 204, deemed dividends 159–60 fringe benefits tax 340–1
206, 207 distributable surplus 161–2 goods and services tax 341–2
change in partnership composition interaction with FBT 161 payroll tax 342
199–203
subsequent dividends 160 stamp duty 342
change in partnership structure –
consideration 281 deductibility of expenses 248
CGT rollover 203–7
consolidated group tax principles deductions
consequences for company
206–7 consolidated income tax calculation method 66
return 182 commercial bills and promissory
consequences for partners 205
key features and tax attributes notes 61
eligibility conditions 204–5
179 deemed dividends 49, 151, 154,
change in taxpayer choice or status
membership rules 176–7 158–60, 162–5, 174, 187
243
single entity rule 180–2 depreciating asset 53, 58, 60, 72,
Chartered Accountants Australia and
tax sharing agreement 182–3 83–100, 110, 113, 116, 118,
New Zealand (CA ANZ) 2
119, 128, 129, 131, 143, 155,
closing pool balance 89, 240, 242–3 consolidated income tax return
181, 188, 189, 191, 193, 199,
182–3
commercial bills 55, 61 201, 205, 240–3, 320
consumer 275, 282–4, 287, 290,
commercial debt forgiveness rules depreciating assets
291, 296
19, 29, 180 application 240
consumption outside the indirect tax
commissioner’s discretion 159, 217, asset additions 241
zone 287
225
continuity of ownership test (COT) asset disposals 242
common allowable deductions
167–9 change in taxpayer choice or
sections 54–9
percentage of rights 169 status 243
common assessable income sections
tracing rules 168–9 closing pool balance 242–3
46–9
cost price 313, 315 decline in value 242
common law duty of care 5, 28
COT see continuity of ownership exclusions 240
company 146
test opening pool balance 240
carry forward tax losses 167–73
Country-by-Country (CbC) 5 primary producers 243
consolidated group tax principles
176–83 creditable acquisitions, GST 274, depreciation 20, 58, 71–3, 81,
285, 291–5, 345 87–93, 126, 174, 192, 201,
current year losses 173–6
creditable importations, GST 274, 214, 237, 240, 243, 294, 314,
losses and bad debts 166–7 315, 339, 340, 344
289, 295, 345
private company loans 157–65 diminishing value method 58, 85,
creditable purpose 285, 287, 290,
residency test for 40–2 292–3, 295 90–1
assessable income base rate Crimes Act 1914 4, 11 discount capital gains
entity passive income 41–2 application 118–19
Crimes (Taxation Offences) Act
carrying out business 40–1 1980 4 calculation method 120–1
central management and criminal legislation 4 discount percentage 119
control 41
current annual turnover (CAT) 275 integrity measures 119–20
current year aggregated
current year aggregated turnover dishwasher in rental property 192
turnover 41
41 disposal of CGT asset to a
incorporated 40
current year losses 173–6 beneficiary 231
voting power 41
loss carry back rules 174–5 distributable surplus 158, 161–3,
tax rate and offsets 155–7 180
notional loss or notional taxable
company losses and bad debts income 174 distribution of accounting profit
166–7
partitioning the income year 174 and higher net income 218
bad debt provisions 166
taxable income and tax loss for the and lower net income 218
carry forward loss provisions 166 year 174 diverted profits tax (DTP) 24
current year loss provisions 166 current year loss provisions 166 Diverted Profits Tax Act 2017 24
loss anti-avoidance arrangements
Division 7A (ss 109B–109ZE) ITAA
166–7
debt waiver fringe benefits 315 1936 157
unrealised loss provisions 166–7
debts forgiven 152, 157, 159, 161 Division 230 financial
company tax payable 157 arrangements 61
decline in value
company tax rate 146, 156, 157, exclusions 65
low pool balance rule 242
175, 177, 236
reductions 94 GST and 64
concessions applicable to
tax depreciation 89–93 interest expenses 60–1
companies 173
deductibility and assessability of taxes lease arrangements 71
consequences, private company loans
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348 Index
 non-commercial business loss foreign branch 154, 233, 245, general interest charge (GIC) 14
rules 61 247–9, 251–7 general value shifting rules 18
other exceptions that allow 65 income and capital gains gig economy 302–3
overview 60 exemption 251, 253–5
goods 281–3
pre-commencement and post- foreign equity distribution exemption
goods and services tax (GST) 1
cessation expenditure 61, 62 154, 248, 249, 251, 252, 256–7
administration and compliance of
prepayments 66–8 foreign hybrid 249
274–9
scope 64 foreign income 247–50
amount of 284
specific deductions 63 foreign income tax offsets (FITO)
asset and trading stock 344–5
78, 150, 156, 245, 246, 255,
tax losses 74–5 calculate net GST
257–62
Division 6 ITAA 1936 component payable/refundable 279
foreign investment 246, 248, 249,
222, 223, 226, 227 creditable acquisitions 291–5
254
double tax agreements 42–3, creditable importations 295
foreign rental property asset 246,
247, 271
249 free supplies 285–7
double tax treaties 37, 263,
foreign subsidiary – controlled fringe benefits tax and 342–4
270, 271
foreign company (CFC) 248
importations 289–91
duty of care 5, 28
franked dividends
input taxed supplies 287–9
component 222
EDCI see eligible designated liability 284
paid to a trust 226
concession income payment 278
free supplies, GST
electronic distribution platforms and refunds 278
re-deliverers 296 consumption outside the indirect
returns 277–8
tax zone 287
eligible designated concession special and other rules 295–9
income (EDCI) 254 exports 286
taxable supplies 279–85
eligible Division 166 company 172 food 282–6
Goods and Services Tax Act 1999
eligible taxable income 195, 200 overview 285
(GST Act) 20
employment remuneration and fringe fringe benefits tax (FBT) 1
gross-up factors 337–8
benefits tax (FBT) 273, benefits provided overseas 310
GST see goods and services tax
300–40 car fringe benefits 311–15
GST group 179
allowances 303–4 car parking fringe benefits 324–7
employees and contractors debt waiver fringe benefits 315
300–3 head company 152, 153, 176–82
entertainment facility leasing hybrid mismatch arrangements
superannuation 304–5 335–6 250, 270
enterprise 291 expense payment fringe benefits
entertainment facility leasing 306, 318–21
335–6 impact of streaming 215
and goods and services tax
exempt accommodation expense importations, GST
341–2
payment 218 non-taxable importations 290–1
and income tax 342
exempt branch profit 261 overview 289
loan fringe benefits 316–17
exempt dividend 81, 260 taxable importations 289–90
meal entertainment fringe benefits
exempt income 49–50 331–5 in-house and external benefits 318
exemptions 250–2 payable 336–9 income of the trust 23, 146, 209,
expense payment fringe benefits 212–15, 217–19, 223, 225–7,
property fringe benefits 327–9
318–21 230, 266
recipient contributions 335–6
exports 286–7 income received by non-resident
residual fringe benefits 329–31 company 269
taxable value 310–36 income tax 1
family trust concession rule 168
Fringe Benefits Tax Assessment Act assessable income 45–54
FBT see fringe benefits tax 1986 (FBTAA 1986) 20
deductions 54–75
financial acquisition threshold 287,
288 double tax agreements 42–3
general anti-avoidance rule
financial supplies 287, 288 (GAAR) 19 FBT and 342
first statutory test 33, 34, 37, general rules 19–22 resident company 37–40
39, 40 significant global entity rules 23 resident entities 42
FITOs see foreign income general income tax rates resident individual 33
tax offsets source of income 33
for non-residents 194
food 285–6 taxable income 43–5
for residents 193–4
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Index 349
income tax (cont.) travelling allowance versus, 321–2 net taxable income 212–13
tax offsets 75–8 loan fringe benefits 316–17 proportionate allocation approach
tax rates 79 loans 164 214–15
tax reconciliation 80–2 loans in an income year trust income tax returns 215
Income Tax (Transitional Provisions) Act amalgamated loans 163 net income retains its tax
1997 92, 241 character 213
application 163
Income Tax Assessment Act (ITAA) net taxable income 212–13
exception under s 109N 163
1936 9, 23, 31, 142 deductions for interest 212–13
loans in subsequent years
income tax payable 11, 16, 19, net income retains its tax
application 163
43–5, 79, 195, 258 character 213
exception 163–4
incorporated, company 40 no present entitlement 218
minimum yearly repayment 164
indirect tax 275, 281, 283, 284, general rule 218–19
286, 287, 290, 291, 296 loss anti-avoidance arrangements
special rule – deceased estate
166–7
indirect tax zone (ITZ) 275, 281, 219
283, 284, 286, 287, 290, 291, loss carry back rules 167, 174–5
non-assessable non-exempt
296 franking account 176 income (NANE) 15, 93,
individual tax structures integrity rules 176 103, 261
taxable income see taxable limitations 175 non-assessable trust distributions
income 227–9
losses caused by excess franking
tax offsets 195 offsets 175 non-residents 42
tax rates see tax rates relevant offset year 175 non-resident withholding
individual with FITOs 262 relevant years 175 certain activities 268
input tax credits 57, 67, 86, 276, tax consolidation 176 taxable Australian
285, 287–9, 293–6, 320, 343 property 268
turnover threshold 175
input taxed supplies, GST non-taxable importations 290–1
low-value goods 275, 282, 283,
financial acquisition threshold 290, 291, 296 normal residence 321–4
287–8 notional loss 174
financial supplies 287 managed investment trust (MIT) notional taxable income 174
overview 287 withholding 268
reduced input tax market value substitution rules opening pool balance 89, 240,
credits 288 103–4 242, 243
residential premises 288–9 meal entertainment fringe benefits operating cost method 312–14
intangible supplies 275, 282, 294, 329, 331–5
ordinary and statutory income 35,
283, 296 membership rules 176–9 43, 50, 150, 200
interest payments on refinanced accounting consolidation 178 ordinary concepts test 33, 34
amounts 207–8 consolidatable group 177 ordinary income 47, 49
inter vivos trusts 230 GST group 179 ordinary time earnings (OTE)
ITZ see indirect tax zone head company 177 300, 304
multiple entry consolidated group OTE see ordinary time earnings
LAFHA see living-away-from-home 178
allowance fringe benefits
subsidiary member 177–8 partitioning the income year 174
legal disability 219–20
minors 200 partnership
legal professional privilege 8–9
multi-national anti-avoidance law change in partnership composition
lessees (MAAL) 23 201–2
accounting issues 71 multiple entry consolidated (MEC) change in partnership structure –
documentation expenses 73 group 178 CGT rollover 203–7
payments 72 refinancing 207–8
tax adjustments for 72–3 net amount 276, 278, 279, 298 PAT see projected annual turnover
tax issues for 71–2 net capital gain pay as you go (PAYG)
termination payments 73 calculation method 121–2 instalments 16–18
living-away-from-home allowance capital loss utilisation rules withholding 15–16
fringe benefits (LAFHA) 122–4
pay or notify rule 217
321–4 tax implications 124
paying tax on income earned in
exempt accommodation and food net income or loss, trust 212–15 Australia 35
components 323 accounting income 213–14 payments
‘fly-in fly-out’ or ‘drive-in drive-out’ impact of streaming 215 GST 278
employee rules 322–3
Pdf_Folio:350

350 Index
payments (cont.) real property 163, 265, 268, 282, SBE see small business entity
and loans through interposed 287, 288, 294, 296, 327 SDT see special disability trust
entities 164–5 recipient contributions 325, 326, second-hand goods 296
and use of company assets 158 328, 331, 335–6
second statutory test 34
payroll tax 342 record-keeping rules 9
shortfall interest charge (SIC) 14
personal services income (PSI) rules reduced input tax credits (RITC) 288
single entity rule 180–2
19, 70, 198, 210, 311 refinancing 207, 208, 212
consequences 181
pooled superannuation trusts 124, refinancing principle 201, 207, 212
core application – income tax
138–9 refund of foreign tax 260 liability or loss 180
prepaid interest 191 refunds, GST 278–9 extended application 180–1
for sole trader 191 regimes to minimise double taxation for intra-group assets 182
prepayments 66–8, 239–40 249–50
Single Touch Payroll (STP) 16, 25
present entitlement 216–18 registration, for GST
small business entity (SBE)
anti-avoidance rules 217–18 current annual turnover 275
blackhole expenditure 243–4
deeming rules 217 projected annual turnover 275
depreciating assets 240–3
timing 217 requirements 274–5
prepayments 239–40
primary producers 17, 243 voluntary registration 275–6
tax rate and offset 236–8
prime cost method 85, 90, 91, 95 reimbursements 295, 304
trading stock 238–9
private company loans 157–64 rental property 21, 92, 94, 95,
small business tax offset 76–7,
in an income year 162–3 128, 148, 188, 189, 191, 192,
237–8
195–6, 203, 206, 240, 249,
application 158–9 sole trader 9, 61, 76, 105, 145, 183,
289, 317
consequences 159–61 191, 299
losses and change of
distributable surplus 161–2 residence 195 special disability trust (SDT) 230
payments and loans through research and development (R&D) special income tax rate
interposed entities 164–5 75, 77 for minors 195
repayment 163 residency test for non-resident working
in subsequent years 163–4 for companies 40–2 holiday-makers 194–5
professional accountants 2–3 assessable income base rate special rules in the GST 295–9
professional conduct entity passive income 41 adjustments 298–9
APES 220 Taxation Services 3–4 carrying out business 40 electronic distribution platforms
common law duty of care 5 central management and and re-deliverers 296–7
control 41 reverse charge 297, 298
criminal legislation 4
current year aggregated second-hand goods 296
professional accountants 2–3
turnover 41
tax agent conduct 5–6 supplies of going concerns 297
incorporated 40
projected annual turnover (PAT) specific anti-avoidance rules 18–19
voting power 41
275, 276 stamp duty 193, 313, 342
for individuals 33–7
property and capital transactions statement of taxable income 76, 80
first statutory test 33–4
anti-overlap provisions 124–39 statutory formula method 313,
include all ordinary and 315, 325, 327
capital allowances, deduction
statutory income 35
89–100 statutory income 35, 45, 47, 49, 50,
ordinary concepts test 33 53, 54, 148, 153, 156, 185,
capital gains tax 108–18
paying tax on income earned in 233, 263, 325
capital works, deduction 101–2
Australia 35–7 statutory interest rate
CGT exemptions 124–39
second statutory test 34 method 316
CGT measures 139–41
temporary resident streaming of trust distributions
discount capital gains 118–21 test 34–5 221–2
net capital gain 121–4 third statutory test 34 components 222
overview 83–4 resident and non-resident requirements 221
record-keeping requirements companies differences in trustee resolutions 221–2
142 taxation between 42
subsequent dividends 160
trading stock 103–8 residual fringe benefits 329–31
subsidiary member 176–82
property fringe benefits 327–9 returns, GST 277–8
substantiation 154, 189–91,
proportionate allocation approach reverse charge 297–8 303–4, 320, 323
214–15 RITC see reduced input superannuation 304–5
provision of meal entertainment tax credits
higher contributions tax 305
332, 333
Pdf_Folio:351

Index 351
superannuation guarantee charge tax risk and governance temporary residents regime 263
(SGC) 57, 69 ATO guide 7 temporary resident test 34–5
Superannuation Guarantee Charge Act interest regime 14 testamentary trusts 230
1992 69
legal professional privilege 8–9 TFA see tax funding agreement
superannuation tax offsets 78
record-keeping rules 9–10 thin capitalisation 71, 155, 270
supplies of going concerns 297
remedial power 9 third statutory test 34
supply 280–4
request information and retain timing of income 260
funds 7 trading stock 238–9
tainted assets 255 third party reporting power 9 change in purpose 104–5
Tax Act 7, 19, 31 uniform administrative penalty and depreciable plant 202
tax administration regime 10–13
disposals 103–4
pay as you go 28 tax sharing agreement (TSA) 182–3
overview 106–8
tax sources 18–24 tax sources
ownership/interest in 104
tax agent conduct anti-avoidance rules 18–24
trading trusts distribution
concessions 5 general anti-avoidance rules policy 228
regulations 5–6 19–24
transfer pricing 10, 71, 270
Tax Agent Services Act 2009 (TASA) 5 specific anti-avoidance rules
travelling allowance versus LAFHA
19–20
Tax Agent Services Regulations 2009 321–2
(TASR) 5 tax structures
trust 146–7
tax consolidated group 152, 153, company 149–83
capital gains 222–5
176–9, 181 individual see individual tax
CGT events relating to 227–32
tax consolidation 176, 178–80 structures
franked dividends 225–7
tax funding agreement (TFA) 182 overview 147–9
income tax returns 215
tax invoices 277 partnership 196–208
net income or loss 212–15
tax loss for the year 174 small business entity 232–44
streaming of trust distributions
tax losses 74–5, 122, 166, 167, tax technology
221–2
171, 175, 191–3, 201 data and analytics 25–8
taxation of net income – relevant
tax management and controls overview 24 taxpayer 215–20
professional conduct 2–6 Tax Transparency Code (TTC) 7 trust capital gains
tax administration 14–18 taxable importations 289–91 beneficiary level 222–5
tax risk and governance 7–14 taxable income trustee election 225
tax technology 24–8 from rental property 192–3 trustee level 222
tax offsets substantiation 191 trust franked dividends 225–7
foreign income tax offsets 78 tax losses 191–3 beneficiary level 226–7
individual 76 tax payable 43–5 trustee level 225
research and development 77 taxable supplies, GST 279–85 TSA see tax sharing agreement
small business 76–7 taxable value 310–36
superannuation 78 taxation of Australian-sourced uniform administrative penalty
tax periods 276 income of non-residents regime 10–14
263–9
tax planning 1 unrealised loss provisions 166–7
withholding tax 268–9
tax rates 193–5
taxation of financial arrangements voting power, company 41
companies 79
(TOFA) 46
company tax rate 236–7
taxation of foreign income of
general income tax rates see widely held company 172
residents 245–50
general income tax rates withholding obligation 301
taxation of net income 215–20
individuals 79 withholding tax 268–9
flow chart approach 215
small business tax offset 237–8 work in progress adjustments 202
legal disability 219
special income tax rate see work-in-progress amount sale of 52
minors 220
special income tax rate working holiday makers 43,
no present entitlement 218
tax reconciliation 80–2 194, 195
present entitlement 216–18

Pdf_Folio:352

352 Index
Pdf_Folio:353
Pdf_Folio:354
Pdf_Folio:355
Pdf_Folio:356
Pdf_Folio:357
Pdf_Folio:358
Pdf_Folio:359
Pdf_Folio:360
Pdf_Folio:361
Pdf_Folio:362
 Tax Australia
Taxation of foreign income –
Overview
Topic 3.2 Quick reference guide

Taxation of foreign income – Overview

This table provides a high-level snapshot of the taxation implications to be considered for an Australian resident on the
receipt of foreign income from an offshore investment. There are a number of elements that determine the taxation
sections that may be applicable, including the type of taxpayer, investment structure, investment level and the type of
income.

Receipt of foreign income

Type of Type of
Type of income Taxation implications to be considered
taxpayer investment

Non-assessable non-exempt (NANE) income under s 23AH

Foreign profits – ITAA 1936.
active income test
Not entitled to s 25-90 debt deductions.
passed
FITO not available.

‘Adjusted tainted income’ under s 23AH ITAA 1936

Foreign profits – (concessionally taxed portion thereof for a listed country
active income test branch) is included as assessable foreign income.
Foreign
failed
Australian branch – FITO available.
resident permanent
company establishme Capital gain on closing NANE income under s 23AH ITAA 1936 (subject to tainted
nt (PE) foreign branch/selling asset considerations).
assets – active and
Not entitled to s 25-90 debt deductions.
not taxable Australian
property (TAP) FITO not available.

Capital gain on closing

foreign branch/selling Assessable foreign income under s 102-5.
assets – not active or FITO available.
is TAP

Foreign interest
income (financial Assessable foreign income under s 6-5.
instrument classified
Entitled to s 8-1 general deductions.
as debt under
commercial and tax FITO available.
law)
Australian
Foreign
resident Assessable foreign income under:
company
company
• s 6-5 ordinary income/extended definition of ordinary
income, or
Foreign royalty
• s 15-20 statutory income.
Entitled to s 8-1 general deductions.
FITO available.

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 Type of Type of
Type of income Taxation implications to be considered
taxpayer investment

Not applicable (ie not taxable in Australia) unless subject

to attribution as a Controlled Foreign Company (CFC).
Foreign profits Profits taxable in foreign jurisdiction.
Note: The CFC rules are covered in the Advanced tax
subject.

CGT participation exemption under Subdivision 768-G

Capital gain on sale of (subject to active foreign business asset percentage).
shares in foreign
company Not entitled to deductions under s 51AAA ITAA 1936 if the
capital gain is the only expected assessable income.

NANE income under s 23AI ITAA 1936.

Foreign dividends –
Entitled to s 25-90 debt deductions.
previously attributed
income (from a CFC) FITO is available for foreign dividend withholding tax (as
income previously taxed in Australia).

Foreign distribution NANE income under s 768-5.

– other: at least 10% Entitled to s 25-90 debt deductions (note that the
participation interest in Government has proposed to remove the application of
subsidiary and s 25-90 to s 768-5 income from 1 July 2023).
classified as equity FITO not available.

Foreign distributions Assessable as dividend income under s 44(1) ITAA 1936.

– other: less than 10% Entitled to s 8-1 general deductions.
participation interest
or classified as debt FITO available.

Any Australian ‘conduit

Australian
foreign foreign income’ – to
resident NANE income under Division 802.
investment be distributed to non-
company
structure residents

Assessable income under s 6-5 or s 102-5.

Foreign
Any rental Foreign rental income Entitled to s 8-1 general deductions.
Australian property and capital gain on FITO available.
resident asset disposal of foreign
taxpayer (passive asset Note: Certain taxpayers are entitled to CGT concessions -
investment) Refer QRG: Property and capital transactions (Part 2) and
the CGT topic in your learning materials.

Foreign dividends –
As per Australian resident company investment in foreign
previously attributed
company above.
income

Foreign dividends – Assessable income under s 44 ITAA 1936.

Australian other: portfolio and
Foreign non-portfolio interests FITO available.
resident
company
individual
As per Australian resident company investment in foreign
Foreign interest
company above.

As per Australian resident company investment in foreign

Foreign royalty
company above.

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 Type of Type of
Type of income Taxation implications to be considered
taxpayer investment

CGT participation exemption under Subdivision 768-G not

available for individuals.
Capital gain on sale of Not entitled to deductions under s 51AAA ITAA 1936 if the
shares in foreign capital gain is the only expected assessable income.
company
Note: Certain taxpayers are entitled to CGT concessions -
Refer QRG: Property and capital transactions (Part 2) and
the CGT topic in your learning materials.

Foreign As per Australian resident company investment in foreign

Foreign interest
Australian debt, company above.
resident investment,
company or licence
or agreement As per Australian resident company investment in foreign
individual with any Foreign royalty
company above.
foreign entity

Note:

1. Additional NANE income exemptions are available for temporary residents.

2. Taxation implications may be subject to the operation of double tax agreements (DTAs). The DTA rules are covered
in the Advanced tax subject.

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 Tax Australia
Other taxes and interactions—
Application (Part 1)
Topic 4.1 Reading

Goods and services tax (GST)

Overview of supplies under GST

Types of supplies

Taxable supplies (s 9-5) Taxable importations (s 13-5) Exempt supplies Non-taxable supplies
• Must satisfy all elements • Acquirer (ie importer) liable • No GST payable • GST not applicable
of ‘SCREIN’ for GST on supply
• Supplier is liable for GST • GST is 10% of customs
• GST is normally 1/11th of inclusive value
the supply price For example:
• Special rules can apply
- GST groups
- Second-hand goods

Gifts Not registered No connection

(or required to be) with the indirect
tax zone (ie
Australia)

GST-free supplies Input taxed supplies

(Division 38) (Division 40)

For example: For example:

Education Health Supply of Exports Food Financial Residential Residential

a going (subject to supplies rent premises
concern exceptions)

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 Taxable supply - Flow chart
The following flow chart (representing s 9-5) demonstrates how an enterprise determines whether it has made a taxable
supply:

If you have made

Supply Have you made a supply? (s 9-10) taxable importation,
GST is payable

Was the supply made for

Consideration consideration? (s 9-15)

Are you registered or required

Registered
to be registered? (Part 2-5)

Did you make the supply in the

course or furtherance of your You have not made
Enterprise a taxable supply.
enterprise?
(s 9-20) No GST is payable

Was the supply connected with

Indirect tax zone the indirect tax zone? (s 9-25)

Is the supply wholly GST-free

Not GST-free or input taxed or input taxed?
(s 9-30, Div 38, Div 40)

You have made a taxable

supply.
GST is payable

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 Taxable supply and taxable importation
To determine the GST liability for an enterprise, you need to be able to apply the following common tax rules and
principles related to supplies.

This table should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Candidate Study Guide and other online learning materials.

Supplies – Key sections of assumed knowledge (on which subject is based) and new required reading

Item Section GST Act Guidance

(unless otherwise
stated)

Taxable supply: 9-5 to 9-30 See above diagrams.

SCREIN
Note: The activities of an employee are not an enterprise (s 9-20)
and therefore the supply by an employee of their services is not a
taxable supply.

GST liability: 9-40 and 9-70 A supplier has a GST liability in respect of a taxable supply that is
Taxable supply equal to 1/11th of the price charged.

GST liability: 9-75 There is no GST on supplies to employees that are subject to fringe
Interaction with benefits tax (FBT) or are FBT exempt.
FBT
However, GST may apply where an employee makes a contribution
or payment to an employer towards the cost of the fringe benefit.

Taxable and 13-5 to 13-25 The importation of goods into Australia will be a taxable importation
non-taxable unless it is a non-taxable importation. The two most common non-
importation taxable importations are:
• Goods imported by an enterprise that is registered for GST where
the customs value is no more than $1,000. Note, the value of
goods in a single shipment or consignment are added together for
the purpose of this threshold.
• Goods imported by an Australian consumer who is NOT
registered for GST where the goods are low-value goods and
therefore a taxable supply.
Where there is a taxable importation:
• It is the acquirer who is importing the goods that has a GST
liability equal to 10% of the customs inclusive value of the goods.
• The GST-liability is payable to customs at the time of importation.
Note: There is a deferral scheme available subject to satisfying
certain requirements.

Non-arm’s 72-70 Non-arm’s length supply < Market value = Deemed market value
length supplies consideration, unless:
• Associate is registered or required to be registered, and
Supply is solely for a creditable purpose.

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 Item Section GST Act Guidance
(unless otherwise
stated)

Assessable 15-17 ITAA 1997 The GST component of the price charged for a taxable supply is
income: collected on behalf of the ATO and is NANE income (ie not
Interaction with assessable and not exempt income) of the supplier.
GST liability
There are no income tax and GST interactions where:
• The enterprise is not registered or required to be registered for
GST.
• The supply is a GST-free supply or an Input taxed supply.
When determining a supplier’s GST liability, the price charge for a
supply is the GST-inclusive amount. For example, if an enterprise
that makes a taxable supply forgets to charge GST it will
nevertheless have a GST liability equal to 1/11th of the price
charged. Or in other words, an enterprise cannot choose (either on
purpose or by accident) not to charge GST.
Refer to Topic 2.1.3.

CGT: Capital 116-20 ITAA 1997 Capital proceeds are reduced by the GST component of the
proceeds: acquisition price. The GST component is collected on behalf of the
interaction with ATO.
GST liability
GST is a transaction-based tax that does not distinguish between
capital and revenue transactions.
Refer to Topic 2.2

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 GST-free supply
To determine the GST liability for an enterprise, you need to be able to apply the following common tax rules and
principles related to supplies.

This tables should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Candidate Study Guide and other online learning materials.

Supplies – Key sections of assumed knowledge (on which subject is based) and new required reading

Item Section GST Act Guidance

(unless otherwise
stated)

Food Subdivision 38-A Food that is GST-free includes:

• Fresh products (eg fruit, vegetables, eggs, nuts, unflavoured milk
and meats).
• Most basic grocery items (eg bread, breakfast cereal, flour, sugar,
and tinned vegetables).

Health Subdivision 38-B Health that is GST-free includes:

• Medical services other than for cosmetic reasons (eg doctors’
fees).
• Other health services (eg physiotherapist, optometrist, dentist or
nurse fees).
• Hospital treatment, medical aids and appliances.
• Medicines on prescription.
• Health insurance premiums.
• Feminine hygiene products.

Education Subdivision 38-C Education that is GST-free includes:

• School (including boarding) and university fees.
• Professional or trade course fees if a prerequisite for
entry/practice.
• Course material related to the above.
However, not all education costs are GST-free. For example, general
update courses/training are not GST-free.

Child care Subdivision 38-D Child care that is GST-free includes:

• Approved childcare services.
• Family daycare.

Exports and Subdivision 38-E, in A supply of goods will be GST-free if the supplier exports them from
other cross- particular s 38-185 the indirect tax zone (ie Australia) within 60 days of the earlier of the
border supplies Item 1 date of invoicing and the date of receipt of any of the consideration
for the supply (or such further period as the Commissioner allows).
However, a supply is not a GST-free export if the supplier re-imports
the goods into the indirect tax zone (ie Australia).

Supplies of Subdivision 38-J, in A supply of a going-concern is GST-free if the supply is for

going concerns particular s 38-325 consideration, the recipient is registered or required to be registered
for GST, and the supplier and the recipient have agreed in writing
that the supply is of a going concern.

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 Input taxed supply
To determine the GST liability for an enterprise, you need to be able to apply the following common tax rules and
principles related to supplies.

This tables should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Candidate Study Guide and other online learning materials.

Supplies – Key sections of assumed knowledge (on which subject is based) and new required reading

Item Section GST Act Guidance

(unless otherwise
stated)

Financial Subdivision 40-A – Financial supplies are an input taxed supply.

supplies s 40-5 and
Division 189 Acquisitions related to making a financial supply will be treated as
having been made for a creditable purpose where the entity does not
exceed the financial acquisitions threshold (the de minimus
exemption). That is, the value of the input tax credits attributable to
financial supplies is less than both of the following:
• 10% of the entity’s total input tax credit entitlement.
• $150,000 (ie $1.65 million in GST-inclusive purchases).
Note: Even where the entity fails to satisfy the financial acquisitions
threshold, that entity may be entitled to partial or reduced input tax
credit of 75% for certain acquisitions (Division 70, GST Regulations).

Residential rent Subdivision 40-B – The supply of a residential rental property is an input taxed supply.
s 40-35

Residential Subdivision 40-C The sale of residential premises used predominantly for residential
premises accommodation is an input taxed supply, unless it is:
• Commercial residential premises.
• New residential premises.

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 Overview of entitlement to input tax credits

Type of acquisition/importation

Related to:

Taxable supplies/
GST-free Financial Input taxed supply Non-taxable
taxable importations
supplies supply but not a financial supplies
• satisfy all elements
supply
of ‘CRAFT’

Subject to special Entitlement De minimus

rules, eg: to ITC on exemption
• expenditure creditable applies?
non-deductible? acquisitions and (Division 189)
(Division 69) importations
(Division 11)
GST-free
supplies
Reduced ITC
supply? No entitlement
Refer to to ITC
(Division 70)
special
rules for
entitlement

Entitlement to 75%
ITC on creditable
acquisitions and
importations
(Reg 70-5.03)

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 Creditable acquisition - Flow chart
The following flow chart (representing s 11-5) shows how an enterprise can determine whether it has made a creditable
acquisition:

If you have made

Are you providing, or liable to provide, a creditable importation,
Consideration consideration for the acquisition? you are entitled to an
(s 9-15) input tax credit

Are you registered or required

Registered to be registered? (Part 2-5)

Have you made an acquisition?

Acquisition (s 11-10)

Was the acquisition solely or partly

for a creditable purpose? No input You have not made
For a creditable purpose tax credits for private or domestic a creditable acquisition.
purposes or relating to input taxed No input tax credit
supplies (s 11-15)

Was the supply to you a taxable

Taxable supply supply? (s 9-5)

You have made a creditable

acquisition and are entitled
to an input tax credit

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 Creditable acquisition and creditable importation
To determine the GST input tax credit for an enterprise, you need to be able to apply the following common tax rules
and principles related to acquisitions.

These tables should be read in conjunction with your Assumed Knowledge from prior study and the content contained
in your Candidate Study Guide and other online learning materials.

Supplies – Key sections of assumed knowledge (on which subject is based) and new required reading

Item Section GST Act Guidance

(unless otherwise
stated)

Creditable 11-5 to 11-15, and See above diagrams.

acquisition: 15-10
CRAFT

GST input tax 11-20, 11-25, and A supplier is entitled to claim an input tax credit in respect of
credit: 11-30 expenditure relating to the making of taxable supplies and GST-free
Creditable supplies.
acquisition
The input tax credit for a creditable acquisition is equal to the GST
payable on the supply of the thing acquired.
A supplier/acquirer is not entitled to an input tax credit where:
• The enterprise is not registered or required to be registered for
GST.
• The thing acquired is itself a GST-free supply or an Input taxed
supply (as there is no GST actually paid by the acquirer).
• The supplier in making Input taxed supplies:
‒ Where a supplier owns a residential rental property that it
rents to a tenant, the rental income collected by the supplier
is an Input taxed supply and the landlord is not entitled to
claim GST input tax credits.
‒ However, where the Input taxed supply is a financial supply
an exception may apply and the supplier may be entitled to
claim GST input tax credits (see above in this quick
reference guide for details).
• To the extent the thing is not acquired for a creditable purpose.

Creditable 15-5 to 15-25 An importer is entitled to an input tax credit for a creditable
importation importation it makes equal to the GST paid on a taxable importation.

GST input tax 69-5, 69-10, 69-25, A GST input tax credit is not available to the extent that the
credit: Exception and 69-30 expenditure relates to:
for non-
• Fines and penalties (s 26-5 ITAA 1997)
deductible
expenses • Entertainment (Division 32, in particular s 32-5 and s 32-20 ITAA
1997). Note, where an employer chooses for FBT purposes to
use the 50/50 or the 12-week log book method for meal
entertainment expenses:
‒ The same split applies for income tax purposes
(s 51 AEA and 51 AEB ITAA 1936).
‒ The same split applies for GST purposes.
• The portion of the GST on the acquisition of a car that exceeds
1/11th of the car depreciation cost limit (s 40-230 ITAA 1997).
Therefore, for the income year ended 30 June 2022 the maximum
amount = 1/11th of $60,733.

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 Item Section GST Act Guidance
(unless otherwise
stated)

GST input tax 111-5 to 111-30 A GST input tax credit is general available where:
credit:
Reimbursement • A reimbursement is made to an employee, a company officer, or
made to an a partner in a partnership.
employee / • An employer pays expenses on behalf of an employee.
Interaction with
FBT However, there is no input tax credit where:
• The employee, company officer, or partner is entitled to an input
tax credit.
• It related to non-deductible expenses under Division 69 (see
above).

Allowable 27-5 GST component of acquisition price is not deductible to the

deduction: purchaser where the taxpayer is entitled to claim a GST input tax
Interaction with credit.
GST input tax
credit Thus, to the extent a taxpayer is not entitled to claim a GST input tax
credit, the GST component of the acquisition price would form part of
the expense amount and the normal income tax rules for determining
deductibility would apply.
Refer to Topic 2.1.4.

Capital 27-80 ITAA 1997 A depreciating asset’s cost is reduced by the GST component of the
allowances: acquisition price that the taxpayer is entitled to claim as an input tax
Cost interaction credit.
with GST input
tax credit Thus, to the extent a taxpayer is not entitled to claim a GST input tax
credit, the GST component of the acquisition price would form part of
the cost of the depreciating asset and the normal income tax rules for
determining the decline in value deduction would apply.
Refer to Topic 2.2.

CGT: Cost base 103-30 ITAA 1997 Cost base is reduced by the GST component of the acquisition price
interaction with that the taxpayer is entitled to claim as a GST input tax credit.
GST input tax
credit Thus, to the extent a taxpayer is not entitled to claim a GST input tax
credit, the GST component of the acquisition price would form part of
the cost base of the CGT asset and the normal income tax rules for
determining a capital gain or loss would apply.
Refer to Topic 2.2

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 Other rules
To determine the GST consequences for an enterprise, you need to be able to apply the following special tax rules and
principles related to supplies and acquisitions.

These tables should be read in conjunction with your Assumed Knowledge from prior study and the content contained
in your Candidate Study Guide and other online learning materials.

Other rules – Key sections of assumed knowledge (on which subject is based) and new required reading

Item Section GST Guidance

Act (unless
otherwise
stated)

Second-hand 66-5 to 66-15 A second-hand goods dealer who acquires second-hand goods from an
goods unregistered entity is entitled to a notional input tax credit in the tax
period in which the goods are sold.
The notional input tax credit is generally 1/11 of the consideration paid to
acquire the goods, but cannot exceed the amount of the GST payable in
respect of the subsequent sale.

Offshore Division 84 Where a supply of intangible property or low-value goods is made by a

supplies non-resident to an enterprise that is registered for GST (or required to be
registered), the recipient of the supply may be treated as having the GST
liability under the reverse charge rules, rather than the non-resident.
Where an inbound intangible consumer supply is made by a non-
resident to an Australian consumer with the assistance of an electronic
distribution platform (EDP) operator or a re-deliverer (eg Google Play,
Steam, eBay, etc.), the EDP operator or re-deliverer may be treated as
having the GST liability rather than the non-resident supplier.

Tax related 25-10 ITAA The deduction for tax related expenses does not apply to payments of
expenses 1997 GST.

Note: The administration rules in respect of GST are not covered in this guide. You should refer to your learning materials.

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 Tax Australia
Other taxes and interactions—
Application (Part 2)
Topic 4.2 Reading

Employment remuneration
To determine the income tax payable for an employee, you need to be able to apply the following common tax rules
and principles related to employment remuneration.

This table should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Candidate Study Guide and other online learning materials.

Employment remuneration – Key sections of assumed knowledge (on which subject is based) and new
required reading

Item Section ITAA Guidance

1997 unless
otherwise
stated

Salary and wages 6-5 Included in assessable income.

Allowances: Paid in cash to 6-5 and 15-2 Included in assessable income.

employee
Exception = LAFHA subject to FBT (see below).

Reimbursement: Paid to 51AH Generally, not included in assessable income and related
employee expenditure is not deductible.
Exception = Reimbursed car expenses (see below).

Employer superannuation Not included in assessable income.

contributions

Work related expenses 8-1 Deductible (subject to substantiation rules).

Refer Topic 3.1.1

Reimbursed car expenses: 15-70, 28-12, Included in assessable income. However, employee may be
Cents per kilometre method 28-25, and 28- entitled to claim a deduction for car expenses.
90
Cents per kilometre rate for 30 June 2023 = 78 cents
Cents per kilometre home charging rate for electric vehicle
home for 30 June 2023 = 4.2 cents
Refer Topic 3.1.1

Employment termination Division 82 The taxation of ETPs and genuine redundancy payments
payments (ETPs) and genuine and 83 rules are covered in the Advanced tax subject.
redundancy payments

Employee share schemes Division 83A The taxation of discounts and benefits provided under an ESS
(ESS) are covered in Advance tax subject.

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 Item Section ITAA Guidance
1997 unless
otherwise
stated

Employee personal 290-150 and Deductible (subject to satisfying conditions). However, cannot
superannuation contributions 26-55 create or increase a tax loss.

Fringe benefits: Exclusion 23L(1) and Exempt benefit for FBT purposes = Exempt income of
(1A) ITAA employee.
1936
Fringe benefit for FBT purposes (even if taxable value
reduced to $nil = Non-assessable non-exempt (NANE)
income of employee.

Fringe benefits: Employee 51AJ Generally, not deductible to employee.

contributions

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 Fringe benefits tax (FBT)

FBT application – flow chart

Is there a benefit?

Is the benefit a ‘fringe benefit’ (ie in respect of employment)?

Determine the category of the fringe benefit

FBT does
not apply

Does the benefit qualify as an exemption for this category or for benefits
generally?

Step 5 Determine the taxable value of the benefit, taking into account any
relevant reductions

FBT liability
Step 6 Calculate taxable amount
= (Taxable value Type 1 benefits × Type 1 gross-up factor) +
(Taxable value Type 2 benefits × Type 2 gross-up factor)

Step 7 Calculate FBT liability

= Taxable amount × FBT rate

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 FBT application - overview
To determine the FBT liability for an employer, you need to be able to apply the following common tax rules and
principles related to benefits.

This table should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Candidate Study Guide and other online learning materials.

FBT categories – Key sections of assumed knowledge (on which subject is based) and new required reading

Item Section FBTAA Guidance

1986 unless
otherwise stated

Fringe benefit 136(1) To be a fringe benefit as defined, the benefit must be:
• provided to an employee (or their associate), and
• in respect of their employment.
However, it must not be:
• An exempt benefit (see below under FBT exemptions).
• Salary and wages, benefits under employee share schemes,
super contributions, employment termination payments (ETPs),
and benefits that are deemed dividends under Division 7A ITAA
1936.
This means that, where the benefit is provided:
• To a shareholder in their capacity as a shareholder, FBT does not
apply. However, Division 7A may apply to the deem the benefit to
be a dividend.
• To a partner is a partnership, FBT does not apply. A partner is not
employee of a partnership.
• To another business, FBT does not apply. However, business to
business non-cash benefits may be deemed convertible to cash
under s 21A ITAA 1936 and therefore included in the business’s
assessable income.
Refer Reading: Other taxes and interactions (Part 3).

‘In-house’ fringe 136(1) A benefit where the employer’s business includes the provision of
benefits identical or similar benefits principally to outsiders.

‘External’ fringe 136(1) A benefit other than an ‘in-house’ benefit.

benefits

FBT gross-up 5B For the FBT year ended 31 March 2023:

rates
• Type 1 gross-up rate = 2.0802 (ie applicable when entitled to GST
ITC)
• Type 2 gross-up rate = 1.8868 (ie applicable when not entitled to
GST ITC)

FBT rate For the FBT year ended 31 March 2023, FBT rate = 47%.

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 FBT categories and category specific exemptions
To determine the FBT liability for an employer, you need to be able to apply the following common tax rules and
principles related to different types of benefits.

This table should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Candidate Study Guide and other online learning materials.

FBT categories – Key sections of assumed knowledge (on which subject is based) and new required reading

Item Section FBTAA Guidance

1986 unless
otherwise stated

Car fringe benefit 7, 8, 8A and 53 Arises when a car, that is held by an employer (or their associate), is
used or taken to be available for private use by an employee (or an
associate of an employee).
Taxable value:
• Statutory formula method.
• Operating cost method.
Specific exemption where:
• Car is used for taxi travel.
• Car is a panel van, utility truck, or other non-passenger road
vehicle where there is no private use other than home to work
travel, incidental travel, and other private use that is minor,
infrequent and irregular.
• Car is an electric vehicle purchased on or after 1 July 2022 and
before 1 April 2025 with a GST-inclusive cost below $84,916 for
the FBT year ended 31 March 2023
• Car is unregistered and used in business operations.
• Running costs (eg fuel and repairs) where a car fringe benefit is
provided.
Refer below under 'Car fringe benefits' for further details.

Debt waiver fringe 14 Arises when an obligation to pay or repay an amount is waived.
benefit
Taxable value = Amount of payment or repayment waived.

Loan fringe 16 to 19 Arises where an employee (or an associate) receives a loan from
benefit their employer (or an associate) and the rate of interest charged on
that loan is less than the statutory rate of interest.
Statutory interest rate 31 March 2023 = 4.52%.
Taxable value = (Statutory interest rate – Actual interest rate) × Loan
Taxable value reduction where:
• Otherwise deductible amount = Loan to an employee (but not
spouse or associate) to the extent the employee would be entitled
to claim an interest deduction (if interest was paid).
• Employee contribution.
Specific exemption where:
• Employer is in the business on money lending.
• Loan is short-term (up to six months) and for employment related
expenses.
• Loan is temporary (up to 12 months) and for security deposits.

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 Item Section FBTAA Guidance
1986 unless
otherwise stated

Expense payment 20 to 24, and 62 Arises where either an employer (or their associate):
fringe benefit
• Pays a third party for expenses incurred by one of its employees.
• Reimburses one of its employees for expenses incurred by the
employee.
Taxable value = Expenditure paid or reimbursed.
Taxable value reduction where:
• Otherwise deductible amount = To the extent the employee would
be entitled to claim a one-off (ie 100%) deduction.
• In-house benefit = $1,000 per employee (in total for expense
payment, property and residual).
• Employee contribution.
Specific exemption where:
• No private use declaration made.
• Accommodation under LAFHA requirements (see below).
• Per kilometre car reimbursements (see above, included in
assessable income of employee under s 15-70).

Living away from 30 to 31H Arises where an employer pays an allowance to an employee to
home allowance either partly or wholly compensate the employee for additional non-
(LAFHA) fringe deductible expenses they incur (and other additional disadvantages)
benefit during periods when their duties of employment require them to live
away from their normal residence.
Taxable value = Amount of allowance – Exempt accommodation
component (subject to conditions) – Exempt food component (subject
to conditions).

Meal 37A to 37CF Arises where entertainment by way of food or drink (and
entertainment accommodation or travel in connection with same) is provided to an
fringe benefit employee (or their associate), but only if the employer elects for this
category to apply. If chosen, this category must be applied to all meal
entertainment provided during an FBT year.
Taxable value:
• 50:50 split method.
• 12-week register method.
Taxable value reduction where:
• Employee contribution.
Refer below under 'Entertainment' for further details.

Car parking fringe 39A to 30GB, 58G, Arises where:

benefit and 58GA
• The employee’s (or associate’s) car is parked in a parking facility
on the employer’s business premises for more than four hours in
total between 7am and 7pm.
• There is a commercial parking station within 1km of the parking
facility that charges a fee > car parking threshold per day.
• The car is parked in the vicinity of the employee’s place of
employment.
• The car is used to travel from home to work.
• Car parking threshold for 31 March 2023 = $9.72.

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 Item Section FBTAA Guidance
1986 unless
otherwise stated
Taxable value:
• For each actual car parking benefit = Using the commercial
parking station method (ie lowest all-day fee with 1km radius),
market value method, or average cost method.
• For each car parking space which has at least one car parking
benefit = Statutory formula method or 12-week record-keeping
method.
Taxable value reduction where:
• Employee contribution.
Specific exemption where:
• Employee of religious, charitable or public education institutions
and not-for-profit scientific institutions.
• Employee has a disabled persons parking permit.
• Employer is an SBE (or from 1 April 2021, would be an SBE
applying an aggregated turnover threshold of $50 million instead
of $10 million), employer is not a public company or government
body, and the car is not parked at a commercial parking station.

Property fringe 40 to 44, and 62 Arises where an employer (or their associate) provides an employee
benefit (or their associate) with property at no cost or at a discount.
Taxable value:
• External fringe benefit = Cost paid, Expenditure incurred, or Arm’s
length value.
• Internal fringe benefit:
‒ Property manufactured/produced by employer:
○ Identical sold to other business = Lowest arm’s length
selling price.
○ Identical sold to public = 75% of arm’s length selling
price.
○ Similar but not identical = 75% of arm’s length price
employee could be expected to pay.
‒ Property purchased by employer = Lesser of arm’s length
purchase price paid by employer and lowest arm’s length
price employee would be expected to pay.
‒ Other = 75% of arm’s length price employee could expect to
pay.
Taxable value reduction where:
• Otherwise deductible amount = To the extent the employee would
be entitled to claim a one-off (ie 100%) deduction.
• In-house benefit = $1,000 per employee (in total for expense
payment, property and residual).
• Employee contribution.
Specific exemption where:
• Property (including foods and drinks) is provided to and
consumed by a current employee (not an associate) on a work
day at an employer’s premises (eg working lunch, morning tea,
stationery, office supplies, etc.).

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 Item Section FBTAA Guidance
1986 unless
otherwise stated

Residual fringe 45 to 52, and 62 Arises where none of the other categories apply. Generally, where
benefits employer provides employee (or their associate) with services or an
entitlement to use (but not acquire) an employer’s (or their
associates) property.
Taxable value = Broadly as above for property fringe benefits.
Taxable value reduction where:
• Otherwise deductible amount = To the extent the employee would
be entitled to claim a one-off (ie 100%) deduction.
• In-house benefit = $1,000 per employee (in total for expense
payment, property and residual).
• Employee contribution.
Specific exemption where (but not limited to):
• Recreational or childcare facilities located on business premises
(eg company gym).
• Use of property (but not a motor vehicle) that is usually located on
business premises and is principally in connection with the
employer’s business operations (eg toilet and bathroom facilities,
vending machines, tea and coffee making facilities).
• Accommodation under LAFHA requirements (see above).
• Motor vehicle (other than a car held by employer or their
associate) where there is no private use other than home to work
travel, incidental travel, and other private use that is minor,
infrequent and irregular.
• Motor vehicle (other than a car held by employer or their
associate) that is unregistered and used in business operations.
• Priority access to childcare facilities.
• No private use declaration made.

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 FBT exemptions - general
To determine the FBT liability for an employer, you need to be able to apply the following common tax rules and
principles related to general exemptions.

This table should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Candidate Study Guide and other online learning materials.

General exemptions – Key sections of assumed knowledge (on which subject is based) and new required
reading

Item Section FBTAA Guidance

1986 unless
otherwise stated

Car running costs 53 Exempt where associated with a car fringe benefit.
exemption

Minor and 58P Exempt where benefit has a taxable value of less than $300 (GST-
infrequent benefit inclusive) and is infrequently provided and/or difficult to record
exemption and value.
This exemption does not apply to benefits that are provided under a
salary sacrifice arrangement (TR 2007/12) and ‘in-house’ fringe
benefits.

Work related 58X Exempt where eligible work-related item is primarily for use in the
items exemption employee’s employment (ie used more than 50% for the employee’s
employment). The exemption is only available for the first item with
substantially identical functions to a later item in the same FBT year
unless the later item is a:
• Replacement item.
• Portable electronic device and the employer is a small business
entity (SBE) or from 1 April 2021, would be an SBE applying an
aggregated turnover threshold of $50 million rather than
$10 million.
Eligible items include portable electronic device (eg laptops and
mobile phones), computer software, protective clothing, briefcase,
and ‘tools of trade’.

Taxi (including 58Z Exempt where travel is:

ride share) travel
exemption • A single trip beginning or ending at the employee’s place or work.
• A result of sickness or injury to the employee and that is between
an employee’s place of work, place of residence or other
appropriate place.

Various other Refer FBT topic in your Study Guide.

exemptions

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 Car fringe benefits

Statutory formula method (s 9(1) FBTAA 1986)

Number of days car
fringe benefit provided in
Statutory Base value FBT year Recipient’s
Taxable value = × × –
fraction of car payment
Number of days in FBT
year

   

Key points Reduced by 1/3 Number of days Employee’s

if car held for employee (or their contributions for
20% four complete associate) has custody use of car
FBT years and control of the car

Operating cost method (s 10 FBTAA 1986)

(100% – business use Recipient’s

Taxable value = Operating cost × –
percentage) payment

 

Key points Includes: Business use Employee’s contributions

percentage calculated for use of car
Actual costs (eg fuel, by reference to a 12-
repairs and week logbook and
maintenance, registration odometer records
and insurance), and
Deemed costs (eg
depreciation and
interest)

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 Entertainment – Meal entertainment, Expense payment,
Property, or Residual fringe benefits
Overview
The following table provides an overview of the application of the FBT rules to entertainment.

Entertainment: Includes food, drink or recreation and accommodation or travel in connection with same.

Category Meal entertainment fringe benefit Expense payment Property fringe Residual fringe
of fringe fringe benefit benefit benefit
benefit (s 37AC)
(s 20) (s 40) (s 45)

Applies Only applies if employer elects If meal entertainment fringe benefit election made, these
fringe benefit categories only apply to benefits that are NOT
meal entertainment (eg recreational events, amusements)

Key points Includes food or drink and Includes Includes Includes

accommodation or travel in entertainment entertainment that entertainment
connection with same Morning tea, paid for by is property and related services
afternoon tea, and light lunches employee and paid for by (eg holiday
(without alcohol) are generally NOT reimbursed by employer package,
meal entertainment Refer TR 97/17 employer (eg employer accommodation at
(eg tickets to provided food at social event)
cricket paid by picnic day in local
employee and park)
reimbursed by
employer)

Taxable 50:50 split 12-week Normal rules apply

values method = 50% of register method
all meal = % of total Per head apportionment available
entertainment meal
expenditure entertainment
fringe benefits
(s 37BA and
s 51AEA ITAA (s 37CB and
1936) s 51AEB ITAA
1936)

Key Section 58P Minor and infrequent fringe benefit exemption under s 58P available (where
exemptions minor and taxable value < $300 and infrequent)
infrequent benefit
exemption NOT
available

Exemption NOT available under N/A Exemption for N/A

either method for food or drink food or drink
consumed on business premises by consumed on
employees (as only relevant to business
property fringe benefits) premises by
employees (but
not by associates)

Interaction Employees’ (and their associates’) portion of entertainment that is subject to FBT is deductible
with
income tax Client’s portion of entertainment is not deductible and not subject to FBT

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Tax (AU) CASM Study Aid 3.8
FBT fundamentals – year ended 31 March 2023
From Tax (AU) Topic 4.2

EXAM TIP
STEP 1 Is there a benefit? NO The grossed-up value
of reportable fringe
YES benefits will be reported
on an employee’s
payment summary
STEP 2 Is the benefit a ‘fringe benefit’ (i.e. in respect of employment)? NO in the corresponding
income year where
YES FBT does the total Taxable Value
not apply exceeds $2,000 in the
FBT year.
STEP 3 Determine the category of the fringe benefit
The Type 2 gross up
factor of 1.8868 is used,
irrespective of the gross
up rate applicable to
STEP 4 Does the benefit qualify as an exemption for this category or for benefits generally? YES the employer.

NO

STEP 5 Determine the taxable value of the benefit, taking into account any relevant reductions

Calculate taxable amount: *Gross-up factors (31 March 2023):

STEP 6 Type 1 benefits = 2.0802 (entitlement to ITC) Type 2 benefits = 1.8868 (no entitlement to ITC)
Taxable value Gross-up factor*

STEP 7 Calculate FBT liability (31 March 2023) taxable amount 47%

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CASM_TXAU_5-3-8_SA_3-8_FBT-fundamentals_01
 Tax Australia
Other taxes and interactions—
Application (Part 3)
Topic 4.3 Reading

Income tax, GST and FBT

To determine the income tax payable of a taxpayer, the FBT payable of an employer, and the GST liability of an
enterprise, you need understand the key differences in the common tax rules and principles and how they apply to
common transactions and events.

This table should be read in conjunction with your Assumed Knowledge from prior study and the content contained in
your Study Guide and other online learning materials.

Income tax, GST and FBT – Application

Item Income tax GST FBT

Year / 30 June Quarterly or monthly 31 March

period end

Tax rate Type of taxpayer: Flat 10%: Top marginal rate:

• Company  30% / 25% • GST-exclusive × 10% • 2017  49%
• Individual  Marginal • GST-inclusive × 1/11th • 2018 onwards  47%

Who pays Taxpayer Enterprise Employer

Registered or required to be
registered

What Income Transactions • Non-cash benefits provided

applied to to an employee or their
• Received or constructively
associate (exception
received
LAFHA)
• Non-cash business to
business benefits • Partner is not an employee
(s 21A ITAA 1936) • Shareholder only if receive
in capacity as employee
• Payments, loans and
(otherwise Division 7A may
forgiven amounts to
apply)
shareholders = Deemed
dividend (Division 7A)

Formula Assessable income GST liability Taxable value

Less: Deductions Taxable supplies × 1/11th Type 1 benefits
Taxable income × Tax rate Taxable importations × 10% Type 2 benefits
Tax on taxable income Less: GST input tax credits × Gross-up factor
Less: Creditable acquisitions / Type 1 benefits
& importations × 1/11th
Tax offsets Type 2 benefits
Net GST payable/(refundable)
PAYG instalments Taxable amount × FBT rate
Net tax payable/(refundable) FBT liability
Less: FBT instalments
Net FBT payable/(refundable)

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 Income tax, GST and FBT – Interactions

The income tax, GST and FBT legislation are contained in completely separate pieces of legislation. Therefore, they
only interact with each other to the extent a specific provision expressly provides a link.

Item Income tax GST FBT

Income and Assessable income Taxable supply Not applicable.

supplies
Ordinary income (s 6-5) • SCREIN (s 9-5)
= when derived
• Employee contribution to
• Employee contribution for FB employer for FBT =
= Assessable to employer Subject to GST
(s 9-75(3))
Statutory income (s 6-10)
• Employee contribution
• GST = NANE income
but not to employer =
(s 17-5)
Not subject to GST.
• Exempt benefit / fringe benefit =
Taxable importation and
Exempt / NANE income of
creditable importation
employee (s 23L)
• Paid to customs (not
• Net capital gain (s 102-5)
ATO) at time of import
Capital proceeds = Excludes GST
(s 116-20) • Rate = 10% × Customs
value
Cost base = Excludes GST input tax
credit claimed (s 103-30)

Deductions, Deduction Creditable acquisition Taxable value

acquisitions
General deduction (s 8-1) • CRAFT (s 11-5) • GST-inclusive amounts
and
= when incurred
benefits • Broadly follows income • Otherwise deductible to
provided • FBT paid = deductible tax treatment employee (ie for income
tax)
• Cost of fringe benefits = ‒ Deductible
deductible (subject to specific = Entitled to ITC ‒ Reduces value
rules)
‒ Non-deductible ‒ Only if once only
Specific deduction (s 8-5) = Not entitled to deduction
ITC
• GST input tax credits claimed = Type
not deductible (s 27-5 / s 27-15) ‒ Max ITC on cars
• Type 1 = If entitled to
= 1/11th ×
• Entertainment GST input tax credit
Depreciation cost
‒ Not deductible = Exempt FB limit • Type 2 = If not entitled to
/ not a FB (s 32-5) GST input tax credit
• Reimbursement to
‒ Deductible = Subject to FBT employee, company FBT rate
(s 32-20) officer, or partner =
• Top marginal tax rate
Entitled to ITC
‒ FB meal entertainment = (including Medicare levy)
(s 111-5 to 111-30)
deductible same extent
(s 51AEA and 51AEB
ITAA 936)
• Employee contribution private
portion FB = not deductible to
employee (s 51AJ ITAA 1936)
• Decline in value = Cost excludes
GST input tax credit claimed
(s 27-80 / s 27-100)

Other Refer Topic 2.1 Refer Reading: Other Refer Reading: Other
taxes and interactions - taxes and interactions -
Application (Part 1) – GST Application (Part 2) –
Employment remuneration
and FBT

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 Trading stock, CGT assets and Depreciating assets
To determine the income tax payable of a taxpayer, you need understand the key differences in the common tax rules
and principles for different types of assets.

The following tables should be read in conjunction with your Assumed Knowledge from prior study and the content
contained in your Study Guide and other online learning materials.

Trading stock, CGT assets and Depreciating assets – Application

Item Trading stock CGT asset Depreciating asset

Asset type Revenue (s 8-1) Capital Capital

Definition Anything… held for purposes Any kind of property, or legal or An asset that has a limited
of manufacture, sale, or equitable right (s 108-5). effective life and can
exchange in the ordinary reasonably be expected to
course of a business Anti-overlap decline in value over the time it
(s 70-10) • Revenue assets is used (s 40-30).
(s 118-20) Exclusions
• Trading stock • Land
(s 118-25)
• Trading stock
• Depreciable assets
(s 118-24) • Intangibles unless listed
Exemptions and Concessions Immediate write-off
• Cars & motor cycles • Business
(s 118-5)
• = $100 (PSLA 2003/8)
• Collectable & Personal
(s 118-10) • = Concessions
(s 40-82 / 40-160)
• Main residence .
(s 118-110) • Non-business = $300
(s 40-80)
• Pre-CGT
• Small businesses
‒ Sep asset (s 328-180 / s 328-181)
(Subdivision 108-D)
‒ Event K6 (s 104-230)

Trading stock, CGT assets and Depreciating assets – General rules

Item Trading stock CGT asset Depreciating asset

Key Money received/able Money received/able Money received/able

concepts = Sales = Capital proceeds (s 116-20) = Termination value (s 40-300)
Expenditure incurred Expenditure incurred Expenditure incurred
= Purchases = Cost base (s 110-25) = Cost (s 40-175)
or Reduced CB (s 110-55)
Opening stock (s 70-40) Adjustable value (s 40-85)
= Closing stock prior year = Cost – Decline in value
Closing stock
= Cost, Market value,
Replacement value, Obsolete
value (s 70-45 and s 70-50)

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 Item Trading stock CGT asset Depreciating asset

Disposal = Sales (s 6-5) Net capital gain (s 102-5) Balancing adjustment

Assessable (s 40-285)
and/or = When derived = Capital proceeds – Cost base
deductible = When stop holding
= When CGT event happens (ie not legal owner)
amounts
• Disposal = Event A1 Disposal = at settlement
at contract date
= When permanently stop using
• IF CGT asset starts being
trading stock and s 70-30 TV > Adj value = Assessable
choice to use market value =
TV < Adj value = Deductible
CGT event K4
• IF balancing adjustment for
dep asset with part non-
income producing purpose =
CGT event K7
Net capital loss (s 102-10)
= Reduced CB – Capital
proceeds
= Reduces future capital gain

Deductible Purchases (s 8-1) Not applicable Decline in value

(s 40-25 / s 328-190)
= When on hand (s 70-15)
= Using PC, DV or Pooling
Movement in value at year methods
end (s 70-35)
= Only to extent taxable
Open < Close = Assessable purpose (either DIV reduced or
Open > Close = Deductible amount pooled reduced)
= When first used or installed
ready for use
Effectively deductible in
income year stock is sold = Subject to concessions

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 Trading stock, CGT assets and Depreciating assets: Non-arm’s length rules

Item Trading stock CGT asset Depreciating asset

Acquired > Purchase cost deemed market Cost base deemed market First element cost deemed
Market value value (s 70-20) value (s 112-20(1)). market value (s 40-180(2)
Item 8).
Note: Seller also deemed
disposal at market value
(s 70-20)

Acquired < No adjustment to purchase Cost base deemed market No adjustment to first element
Market value cost. value (s 112-20(1)). cost.

Disposal > Disposal outside ordinary Capital proceeds deemed No adjustment to Termination
Market value course of business = Market market value (s 116-30(2)). value.
value included in assessable
income (s 70-90).
The taxpayer also recognises
a deduction for purchases
under s 8-1 (if acquired in the
same year) or the difference
between opening and closing
stock under s 70-35.
Note: Any amount actually
received is not included in
assessable income and is not
exempt income (ie it is ignored
for tax purposes).
Acquirer also deemed
acquisition at market value
(s 70-95). This section may
override the application of
s 70-20 for the acquirer
(however the outcome is the
same).

Disposal < As above Capital proceeds deemed Termination value deemed

Market value market value (s 116-30(2)). market value (s 40-300 Item 6).

Exception Exception if seller has no CGT If it was a private and domestic

event (eg seller issues shares arrangement (eg a gift) then:
in itself to the taxpayer).
• First element of cost for
acquirer would be deemed
to be market value
(s 40-180(2) Item 9)
• Termination value for seller
would be deemed to be
market value
(s 40-300 Item 7).

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 Trading stock, CGT assets and Depreciating assets: Other rules

Item Trading stock CGT asset Depreciating asset

Disposal Non-arm’s length / Non-arm’s length Non-arm’s length

outside ordinary course = See above table (s 116-30) = See above table (s 40-305)
of business = See above
table No consideration = Capital Change in interest = Deemed
(s 70-90 and s 70-95) proceeds deemed market value disposal at market value or cost
(s 116-30) (s 40-300 and s 40-340)
Change in interest =
Deemed disposal at
market value or cost
(s 70-100)

Acquisition Non-arm’s length Non-arm’s length Non-arm’s length

= See above table = See above table (s 112-20) = See above table (s 40-180)
(s 70-20)
No consideration = Cost base
deemed market value
(s 112-20)

Change in From trading stock CGT asset from trading stock (s Depreciating asset from
purpose (ie (s 70-110) 70-110) trading stock (s 70-110)
use of asset)
= Deemed disposal = Deemed acquisition = Deemed acquisition
= At cost = At cost = At cost
To trading stock CGT asset to trading stock Depreciating asset to trading
(s 70-30) stock
= Deemed disposal
= Deemed acquisition = Deemed disposal
IF cost = No CGT (s118-25)
= At cost or market value = At cost or market (s 70-30)
IF market value = K4 (s 104-220)

Non- Cost base reductions for certain

assessable non-assessable amounts
amounts = CGT event G1 / E4
(s 104-135 / s 104-70)

Other Refer Topic 2.2.3 Refer Topic 2.2.4 – 2.2.5 Refer Topic 2.2.1

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 Losses and other interactions
To determine the income tax payable of a taxpayer, you need understand the interaction between the tax and capital
loss rules, and the interaction between the tax loss and franking rules for a company.

The following overviews should be read in conjunction with your Assumed Knowledge from prior study and the content
contained in your Study Guide and other online learning materials.

Taxable income/(loss) calculation - Overview

Assessable income (s 6-5)

Includes:

Net capital gain = Current year - Current year - Prior year net capital - Discounts &
(s 102-5) capital gains capital losses losses not yet used concessions

Note:
If Current year capital losses > Current year capital gains, then = Net capital loss.
Net capital loss = Current year capital losses – Current year capital gains

Less: Deductions (s 8-1)

Includes:

Tax losses (s 36-15 non-company / = Prior year tax losses - Current year net exempt
s 36-20 company) not yet used income

Equals: Taxable income (s 4-15)

Note:
If Deductions > Assessable income, then = Tax loss.
Tax loss = Deductions – Assessable income – Current year net exempt income, excluding NEI amounts
applied against prior year tax losses

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 Tax losses and capital losses – General rules

Item Tax loss Capital loss

Taxable Tax losses may be included as a deduction in A net capital gain is included as assessable income
income the calculation of taxable income in the calculation of taxable income
calculation (s 36-15) (s 102-5)
A current year net capital loss is NOT included in
the calculation of taxable income
(s 102-10)

Calculation Net exempt income (s 36-20) wastes tax The order of the steps in the Net capital gain
rules losses. That is, the unused balance of prior calculation MUST be applied. Therefore, current
year tax losses is reduced by current year net year capital losses and the unused balance of prior
exempt income. It is only this reduced amount year net capital losses MUST reduce a current year
that is included as a deduction in the current capital gain BEFORE the CGT discount and
year concessions are applied
NANE income does NOT waste tax losses Capital gains and losses that are disregarded under
the CGT provisions are NOT part of the net capital
gain calculation

Carry forward Tax losses can be carried forward indefinitely Net capital losses can be carried forward
period until fully used indefinitely until fully used

Order of use Tax losses must be used in the order in which Net capital losses must be used in the order in
they are made. That is, on a first in first out which they are made. That is, on a first in first out
(FIFO) basis (s 36-15) (FIFO) basis (s 102-15)

Choices Company taxpayers can choose NOT to use A taxpayer can CHOOSE which current year capital
related to use (ie claim as a deduction) the unused balance gains are reduced by current year capital losses (or
of prior year tax losses (s 36-17) an unused balance of a prior year net capital
losses). Therefore, a taxpayer can choose to
Non-company taxpayers do NOT have a reduce current year capital gains that are NOT
choice. IF they have an unused balance of entitled to the CGT discount or concessions
prior year tax losses, then this MUST be BEFORE reducing current year capital gains that
included as a deduction in their calculation of are eligible for the CGT discount or concessions
taxable income for the current year

Limitation: Tax losses can be used to reduce ANY type of Capital losses (or an unused balance of a prior year
Type of income (ie they can be used to reduce a net net capital losses) can only be used to reduce
income capital gain) capital gains

Limitation: Not applicable Where there is a current year capital loss (or an
Personal use unused balance of a prior year net capital losses)
assets and made on a collectable asset, it can only be used to
collectables reduce capital gains made on other collectable
assets (s 108-10)
A capital loss on a personal use asset is
disregarded (ie not included in the calculation of the
net capital gain for the current year)
The CGT provision for personal use assets do NOT
apply to collectables, even if the collectable is held
as a personal use asset (ie the more specific CGT
provisions for collectables apply / take precedence
over the less specific provisions)

Limitation: Tax losses can only be used to the extent they Not applicable
Maximum reduce taxable income to nil (s 36-15)
amount

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 Item Tax loss Capital loss

Limitation: Company taxpayers MUST choose NOT to Not applicable

Excess use (ie claim a deduction for) the unused
franking tax balance of prior year tax losses IF the
offsets company has excess franking offsets (OR to
the extent using a tax loss would create or
increase the amount of excess franking
credits) (s 36-17)

Limitation: Company taxpayers can only use a current Company taxpayers can only use a current year or
Tests year or the unused balance of a prior year tax the unused balance of a prior year net capital loss
loss IF the company satisfies certain tests (s IF the company satisfies certain tests (ie the same
165-10). That is, the: rule as applies for tax losses)
• Continuity of ownership test (COT)
(s 165-12),
• Business continuity test (BCT) (s 165-13),
comprising the:
‒ Same business test (s 165-210) and
‒ Similar business test for losses on or
after 1 July 2015 (s 165-211)

Loss carry For the income years ended 30 June 2021, Not applicable
back tax 30 June 2022, and 30 June 2023 a temporary
offset loss carry back tax offset may allow a
company with a turnover of less than $5 billion
to choose to carry back tax losses (but not
capital losses) to the income years ended
30 June 2020 to 30 June 2023. The amount of
a tax loss that is carried forward to a later
income year must be reduced by any tax loss
carry back amounts

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 Tax losses and other interactions

Section
ITAA 1997
Item unless Guidance
otherwise
stated

A company can convert any excess franking tax offsets to the equivalent
amount of a tax loss for the year, which can be carried forward and deducted in
Conversion of later income years
excess
The excess franking offset is the difference between the total of tax offsets on
franking 36-55
franked dividends and the amount of income tax the company would have to
offsets into a
pay if it did not have those offsets
loss
The excess franking tax offsets are converted to a tax loss by dividing them by
the company’s corporate tax rate for imputation purposes

Tax offsets that are non-refundable to the taxpayer are applied before tax
offsets that are refundable. Thus:
Tax offset • Franking offsets are applied after FITOs for an individual. This is because an
63-10
ordering rules individual is entitled to a refund of excess franking offsets
• Franking offsets are applied before FITOs for a company. This is because a
company is not entitled to a refund of excess franking offsets

Excess franking tax offsets:

Refund of
excess • A resident company is not entitled to a refund of excess franking offsets.
67-25
franking However, it can convert the excess into a tax loss (see above)
offsets
• A resident individual is entitled to a refund of any excess franking tax offsets

Excess FITOs: Excess foreign income tax offsets (FITOs) cannot be refunded and cannot be
Use it or lose it 770-10 carried forward. The taxpayer must use the FITO in the income year to which it
rule relates or any remaining unused balance is lost

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 Tax (AU)
Practice exam A
Term 2, 2024

Question 1 (10 marks)

All amounts are in Australian dollars (AUD). Ignore GST and the small business entity CGT rules.

GP Co (GP) is an Australian tax resident company. One hundred per cent (100%) of the shares in GP are currently
owned by Gaye, an Australian tax resident individual. On 30 June 2023, GP sold two parcels of land. GP's asset
structure and history are below:

Structure

GP Co

Land 1 Land 2
acquired in 1984 acquired in 2005

History
In March 1984, Jarrod, who is an Australian tax resident, established GP. Later in 1984, GP purchased Land 1 for
$100,000.

In March 2005, GP purchased Land 2 for $800,000.

On 30 June 2011, Gaye acquired 100% of the shares in GP from Jarrod for $2,510,000. At the time of acquisition,
Land 1 was worth $1,510,000 and Land 2 was worth $1,000,000.

On 30 June 2023, GP sold Land 1 for $1,100,000 and Land 2 for $1,650,000, which were the market values of each
parcel of land at that time.

Required
Calculate GP’s net capital gain or loss for the income year ended 30 June 2023, assuming GP has no other
transactions or events. Provide an explanation to support the income tax treatment and show all workings.

10 marks

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 Question 2 (13 marks)

All amounts are in Australian dollars (AUD). Ignore GST and the small business CGT concessions.

You work at Rosie Accountants (Rosie). One of your clients is Raffy Unit Trust (Raffy), which is an Australian tax
resident unit trust and a small business entity (SBE). Raffy has made all elections necessary to minimise its taxable
income. Raffy operates a property rental business.

Raffy had the following transactions for the income year ended 30 June 2023:

Receipts (all on capital account)

1. Received $13,000 in relation to a restrictive covenant that was executed in August 2022, which prevents Raffy from
operating in a competitor's suburb for two years.
2. Sold a painting for $2,800. Raffy purchased the painting six years ago for $400.
3. Sold a block of vacant land for $890,000. Raffy purchased the land four years ago for a total cost of $930,000.
4. Sold shares for $60,000. Raffy purchased the shares in 2002 for $8,000.

Payments

5. Prepaid $5,000 on 30 June 2023 for internet services for the period 1 July 2023–30 June 2024.
6. Capital expenditure of $100,000 to purchase a new car for the CEO’s use.

Assume Raffy had no other transactions for the income year.

Required
(a) Prepare a file note explaining the income tax consequences to Raffy for any of the transactions 1–6 that
are eligible for the SBE general concessions for the income year ended 30 June 2023. (4 marks)

(b) Calculate Raffy's minimum net capital gain/(maximum net capital loss), if any, for the income year ended
30 June 2023. Explain all exclusions. Show all workings. (9 marks)

13 marks

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 Question 3 (8 marks)

All amounts are in Australian dollars (AUD) and GST-inclusive (where applicable).

Dr Kath is an Australian tax resident individual who operates her own general medical practice as a sole trader.
She operates from a converted house in the suburbs. Dr Kath is registered for GST and reports GST quarterly.
The following amounts relate to Dr Kath’s business for the quarter ending 31 December 2022:

Amount received/(paid)
Description
$

1. Fees received from patients for general consultations 75,000

2. Rental income received from a residential granny flat on the medical 6,000
practice property

3. Amount paid for the medical practice's electricity (2,500)

4. Amount paid to a large retail store for children's plastic medical toys to
(800)
sell in the practice reception

In March 2023, Dr Kath took some toys home to give to her children. The toys cost $110 and had a market selling value
of $176.

Required
(a) Calculate Dr Kath's GST payable/refundable for items 1–4 (including nil amounts) for the quarter ended
31 December 2022. Show all workings. (5 marks)

(b) Explain the GST and income tax consequences to Dr Kath's business for the toys she took in March 2023.
(3 marks)

8 marks

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 Question 4 (13 marks)

All amounts are in Australian dollars (AUD). Ignore GST.

Wong Pty Ltd (Wong) is an Australian tax resident company and the head company of a tax consolidated group. Wong
has a significant number of assets and business operations in Australia and overseas, including a branch in Tonga and
shares in foreign companies.

Wong has provided the following information about some of its receipts and payments for the income year ended
30 June 2023:

Receipts

1. $430,000 of third-party sales. Wong produced the sales income through its branch in Tonga.
2. $70,000 net capital gain. Wong realised the gain through its branch in Tonga from the sale of minority shareholdings
in Tongan companies held for long-term investment purposes. Prior to the share sale, dividend income from the
Tongan companies was assessable to Wong.

Payments

3. $10,000 interest payment to an Australian lender. The interest was paid on a loan used to fund Wong's branch in
Tonga.
4. $20,000 sales payment to Yuen Pty Ltd, an Australian tax resident company and wholly owned subsidiary of Wong.
The payment was made to acquire trading stock that Wong later sold during the income year.
5. $30,000 royalty payment to Lam Ltd (Lam), a Mauritian tax resident company. The royalty payment was made to
use Lam's intellectual property in Wong's Australian business operations. There is an ongoing dispute between
Wong and Lam about who should bear the cost of the unpaid royalty withholding tax, which Wong refuses to pay.
6. $40,000 interest payment to an Australian lender. The interest was paid on a loan used to acquire 50% of the
shares in Bao Ltd (Bao) in 2020. Bao is a profitable Fijian tax resident company that regularly pays dividends to
Wong. Bao cannot claim tax deductions in Fiji on any dividends that Bao pays.
7. $5,000 council rates payment on vacant land that Wong purchased in Australia for long-term investment purposes.

Required
For the receipts in items 1–2, calculate and explain Wong's assessable income (including nil amounts) for the
income year ended 30 June 2023.

For the payments in items 3–7, calculate and explain Wong's income tax deduction available (including nil
amounts) for the income year ended 30 June 2023.

Ignore any impact of the thin capitalisation rules and double tax treaties.

13 marks

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 Question 5 (16 marks)

All amounts are in Australian dollars (AUD) and GST-inclusive (where applicable).

Pete and Ant are Australian tax resident individuals who have formed the OG Partnership (OG). OG provides software
development and engineering services.

OG is registered for GST and uses the actual expenditure method for calculating fringe benefits tax (FBT).

During the FBT year ended 31 March 2023, OG provided the following benefits:

1. A Christmas dinner at a fancy hotel for Pete, Ant and eight OG employees. The total cost of the dinner was $4,400.
2. An interest-free loan of $22,000 to the wife of OG's general manager, Eddie. Eddie's wife received the loan on
1 April 2022, and she used it to start a coffee truck business.
3. A $770 signed cricket jersey as a ‘thank you’ gift to Cam. OG contracted Cam to develop a new software product
within six months. Cam had to use his own computer to complete the work and he was not bound by OG’s internal
policies or quality standards. Cam had never previously worked for OG.

OG also provided the following benefits to Gordon, the sales manager:

4. A new television worth $3,000 for exceeding his sales targets.

5. A reimbursement of $3,120 for car expenses. Gordon used his own car to travel to and from client sites during
which he drove a total of 4,000 kilometres. The reimbursement was calculated on a cents-per-kilometre basis.

Required
(a) For each of the items 1–3, calculate the following:

(i). The taxable value of the fringe benefits for OG (including any nil amounts) for the FBT year ended
31 March 2023. Explain all exclusions.

(ii). The GST input tax credit available to OG (including any nil amounts).

(iii). The income tax deduction available to OG (including any nil amounts) for the income year ended
30 June 2023. Ignore any deductions for FBT payable. (12 marks)

(b) Explain the income tax consequences for Gordon for items 4 and 5 for the income year ended 30 June 2023.
Provide a relevant section reference for item 5. (4 marks)

16 marks

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 Tax (AU)
Practice exam A – Suggested
solutions
Term 2, 2024

Question 1 (10 marks)

Land 1
Normally, capital gains tax (CGT) would not apply to the sale of an asset that was acquired on or before 19 September
1985 (ie a pre-CGT asset). However, where there is a change of 50% or more in the ultimate beneficial ownership of
a pre-CGT asset, Division 149 ITAA 1997 deems the pre-CGT asset as having been acquired post-CGT at its
prevailing market value.

Because Jarrod transferred 100% of his GP Co (GP) shares to Gaye, Division 149 would deem GP to have acquired
Land 1 for its prevailing market value of $1,510,000 on 30 June 2011. As Land 1 was sold for $1,100,000, there would
be a capital loss of $410,000 under s 104-10 ITAA 1997 (CGT event A1), which can be offset against the capital gain
from Land 2.

Land 2
Land 2 was acquired for $800,000 and was sold for $1,650,000. The capital gain is $850,000.

GP’s net capital gain

GP’s net capital gain is $850,000 – $410,000 = $440,000.

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 Question 2 (13 marks)
Legislative references in this question are for reference only and are not required in candidate responses.

(a) Small business concessions

File note

Client: Raffy Unit Trust

Subject: Small business entity concessions available for the income year ended 30 June 2023

This file note documents the small business entity (SBE) concessions that Raffy Unit Trust (Raffy) can claim for
the income year ended 30 June 2023.

Prepaid expenditure – $5,000

The prepaid internet services expenditure of $5,000 is fully deductible for the income year. Raffy is an SBE and
the prepayment period is for 12 months (must not be longer than 12 months) ending in the next income year.
Therefore, under s 82KZM ITAA 1936, the prepayment rules do not apply and the prepaid expenditure is fully
deductible under s 8-1 ITAA 1997.

Capital expenditure – $100,000

The cost of the car is immediately deductible up to $64,741 for the income year ended 30 June 2023. Under
s 328-181 ITTP Act, Raffy can claim an immediate deduction for capital expenditure incurred during the income
year ended 30 June 2023. However, under s 40-230 ITTA 1997, the deduction cannot exceed the car cost limit,
which is $64,741 for the income year ended 30 June 2023.

(b) Minimum net capital gain

Capital Non-
Discount
loss discount
Item capital gain Explanation of exclusions
capital gain
$ $
$

1 13,000

2 The capital gain on disposal is disregarded

0 0 because a painting is a collectable and it cost
less than $500

3 (40,000)

4 52,000

Apply capital losses (27,000) (13,000)

Remaining gain 25,000 0

Apply Discount (12,500)

Net capital gain 12,500

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 Question 3 (8 marks)
Legislative references in this question are for reference only and are not required in candidate responses.

(a) Dr Kath's GST payable/(refundable)

Item Workings GST payable/(input tax credit)
$

Patient fees 0

Rental income 0

Electricity $2,500 × 1 ÷ 11 (227)

Toys $800 × 1 ÷ 11 (73)

GST payable/(refundable) (300)

(b) Dr Kath's GST and income tax consequences

There will be an increasing adjustment when Dr Kath reports her March 2023 quarterly business activity statement
(BAS) to refund the previously claimed input tax credit of $10 (ie $110 × 1 ÷ 11). This is because the intended use of
the toys changed from trading stock in her business to private use.

Dr Kath will be deemed to dispose of the toys at cost under s 70-110 ITAA 1997. The cost amount of the toys will be
included in Dr Kath's assessable income on a GST-exclusive basis, so the amount of assessable income will be $100
(ie $110 × 10 ÷ 11).

Notes:

• The amount in Dr Kath's assessable income will offset the deduction for the original purchase of the toys.
• From a personal perspective (ie out of scope of this question and for reference only), Dr Kath will also be deemed to
reacquire the toys at cost, which is non-deductible as the toys are held for private use.

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TAXAU_182_ASM-2-1-2_PA-A-Sol_v3-0.docx
 Question 4 (13 marks)
Legislative references in this question are for reference only and are not required in candidate responses.

Payment Amount Explanation

$

1 0 The sales income is active income, so it is non-assessable non-exempt income to Wong

under s 23AH ITAA 1936.

2 70,000 The capital gain from the sale of shares is from a tainted asset in an unlisted country, so it
is assessable to Wong (ie the branch exemption does not apply under s 23AH(8)).

3 (1,400) Interest is deductible under s 8-1 ITAA 1997 to the extent that it is incurred in deriving
assessable income.
Therefore, only $1,400 (ie [$70,000 ÷ ($430,000 + $70,000)] × $10,000) of the interest is
deductible.

4 0 Amounts paid between members of a tax consolidated group are ignored under the single
entity rule in s 701-1 ITAA 1997.

5 0 Royalty payments subject to interest withholding tax are not deductible where withholding
tax has not been withheld and remitted under s 26-25 ITAA 1997.

6 (40,000) Interest paid to derive income that is non-assessable non-exempt income according to s
768-5 ITAA 1997 is deductible under s 25-90 ITAA 1997.

7 0 Expenses paid to derive a net capital gain is not deductible under s 51AAA ITAA 1936.

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 Question 5 (16 marks)
Legislative references in this question are for reference only and are not required in candidate responses,
except for (b) item 5 relating to Gordon's car expenses.

(a) Taxable value, GST input tax credit and income tax deduction
Benefit FBT taxable value Explanation/workings GST input tax credit Income tax deduction
($) ($) ($)

Dinner 3,520 Partners are not employees for 320 3,200

FBT purposes
$4,400 × 8 ÷ 10

Loan 994 $22,000 × 4.52% Nil Nil

Jersey Nil Cam is a contractor and not an 70 700

employee. FBT only applies to
employees

(b) Gordon's income tax consequences

The television is non-assessable non-exempt income to Gordon under s 23L ITAA 1936.

The car expense reimbursement of $3,120 is assessable to Gordon under s 15-70 ITAA 1997. The car expenses that
Gordon incurred are deductible under s 28-12 ITAA 1997 (ie the expenses are not denied under s 51AH ITAA 1936).

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 Tax (AU)
Practice exam B
Term 2, 2024

Question 1 (10 marks)

All amounts are in Australian dollars (AUD). Ignore GST.

Daniella is a Polish tax resident individual and not an Australian tax resident. Daniella quit her job in Poland and
travelled to Australia for the first time on a working holiday visa for 12 months between 1 July 2022 and 30 June 2023,
after which she returned to Poland. During her time in Australia, Daniella worked for Quin Pty Ltd (Quin), an Australian
tax resident company that operates a cleaning business in Brisbane, Queensland. Quin is registered as a working
holiday maker employer with the Australian Taxation Office (ATO).

Daniella has provided the following information for the income year ended 30 June 2023:

1. Daniella received a salary of $50,000 from Quin during the income year.
2. Daniella travelled 900 kilometres for work purposes using her own car. Daniella has not maintained a logbook.
3.

(a) Quin allowed Daniella to borrow cleaning equipment once a fortnight for her private use. This was free of
charge, although Quin valued Daniella's annual use of the equipment at $1,200.

(b) Daniella paid Quin $100 from her after-tax salary as a contribution towards the cost of the cleaning supplies
she used when she borrowed Quin's cleaning equipment for personal use. The actual cost of the cleaning
supplies was $350.

4. Daniella paid $200 in cash for work expenses (unrelated to items 2 or 3(b)). Daniella did not keep any receipts or
records.
5. Daniella received interest of $250 in her Polish bank account on 1 June 2023.

Required
Calculate Daniella's tax payable/refundable for the income year ended 30 June 2023 relating to items 1 to 5. In
your calculation, state the assessable income or allowable deduction amount(s) for each of the items 1 to 5
(including nil amounts). Show all workings.

Provide a relevant legislative section reference to support your answer for the contribution in item 3(b).

Ignore any impact of double tax agreements, the Medicare levy, tax offsets and tax credits.

10 marks

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 Question 2 (16 marks)

All amounts are in Australian dollars (AUD). Ignore GST and the personal services income (PSI) rules.

Waddo Pty Ltd (Waddo) is an Australian tax resident company that provides consulting services. Waddo is not a base
rate entity but is a small business entity (SBE) that has chosen to apply the Division 328 capital allowance rules.

Waddo had the following transactions during the income year ended 30 June 2023:

Amounts received/recognised for accounting purposes

1. Waddo received $400,000 for services provided and billed during the current income year.
2. Waddo recorded $10,000 of work in progress (WIP) for services provided during June 2023 by staff on client
assignment (Dr WIP (BS) Cr Income (P/L)). This amount was billed on 10 July 2023.
3. Waddo received a dividend of $20,000 franked to 60% from an Australian tax resident company which has a
corporate tax rate for imputation purposes of 25%.
4. Waddo received a cash distribution of $48,000 from the Madden Partnership (MP) in which Waddo is a partner.
Waddo’s share of MP's net income for the income year ended 30 June 2023 is $53,000.

Amounts paid

5. Waddo paid a late lodgement penalty of $3,000 related to its 2021 tax return.
6. Waddo paid $14,500 on 15 January 2023 to acquire a photocopy machine which had an effective life of five years
for tax purposes. Waddo started using the photocopy machine on the day it was acquired.
7. Waddo paid $4,000 in borrowing costs on 1 June 2023 to establish a four-year loan facility to use for working capital
purposes.
8. Waddo paid $16,000 in lease payments under a five-year lease agreement in respect of new desktop computers.
The lease was entered into on 1 July 2022 and at that time the desktop computers had an effective life for tax
purposes of eight years and a cost of $80,000. Waddo has the option to acquire the office equipment at the end of
the lease for $5,000.
9. Waddo paid $130,000 to an employee, representing two years of wages covering the period from 1 July 2023 to 30
June 2025.

Required
(a) Calculate the assessable or deductible amount to Waddo for the income year ended 30 June 2023 for each
item 1−9 above, including nil amounts. Show all workings. (11 marks)

(b) Calculate Waddo's income tax payable/(refundable) for the income year ended 30 June 2023. Show all
workings. (5 marks)

16 marks

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 Question 3 (10 marks)

All amounts are in Australian dollars (AUD) and are GST-inclusive (where applicable).

Fort Trust (Fort) is an Australian tax resident unit trust carrying on an online photo album print business with only
Australian customers. Using Fort's online platform, customers can create their photo album, have the album printed as
a book and then have the book delivered. Fort purchases plain photo books from China, which are delivered one week
after Fort places its order. Fort prints the photo albums in Australia.

Fort is registered for GST and it has not opted to use the deferred GST scheme. The Chinese supplier is not registered
or required to be registered for GST. Fort is responsible for any import duties.

Fort provided the following information for the income year ended 30 June 2023:

1. Trading stock:
– Fort values stock at cost and had no stock on hand at 1 July 2022.

– In July 2022, Fort ordered and paid $77,000 for new photo books, which was equal to the customs value of the
order at the time of importation. There were no other costs associated with the purchase.

– During the income year ended 30 June 2023, Fort sold $66,000 worth of photo books for $132,000. Fort had
$11,000 of stock (valued at cost) on hand at 30 June 2023.

2. Shareholdings:
– On 30 June 2023, Fort sold two parcels of shares in Hume Pty Ltd, an Australian tax resident company.

– Fort made a capital gain of $8,000 on the first parcel of shares, which were purchased on 30 June 2021.

– Fort made a capital gain of $3,000 on the second parcel of shares, which were purchased on 1 July 2022.

Required
(a) Calculate each amount of GST payable or the input tax credits available to Fort relating to items 1 and 2
(including nil amounts). Show all workings. Explain any exclusions. Note: you do not need to calculate Fort's
net amount of GST payable/refundable. (5 marks)

(b) Calculate each assessable/deductible amount included in Fort's net income for items 1 and 2 for the income
year ended 30 June 2023. Show all workings. Note: you do not need to calculate Fort's net income. (5 marks)

10 marks

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 Question 4 (9 marks)

All amounts are in Australian dollars (AUD). Ignore GST.

You work at a tax practice, NMD Co. You had a meeting with John (your manager) and Catherine (your client) from
Halo Pty Ltd (Halo), an Australian resident company and a base rate entity. Halo has provided the following information:

1. Halo received a net dividend of $40,000 from its 8% investment in Elite, a Thailand resident company (the other
92% of Elite is owned by another Australian company). The dividend was paid out of previously attributed controlled
foreign company income. Elite paid Thailand dividend withholding tax of $5,000 on behalf of Halo.
2. Halo received a net dividend of $30,000 from its 5% investment in Brute, a Vietnam resident company. The dividend
was subject to Vietnamese dividend withholding tax of $3,000.

Required
Prepare an email for John to send to Catherine. In the email, calculate and explain each amount included in or
excluded from Halo's assessable income for the income year ended 30 June 2023 for items 1 and 2 above. Show
all workings. For item 1, provide two key section references to support whether the withholding tax is eligible for a
foreign income tax offset for Halo. (9 marks)

Note: do not include any of your personal information in this email – it should be from John.

Ignore any impact of the foreign income tax offset limit. Ignore any impact of double tax agreements.

9 marks

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 Question 5 (18 marks)

All amounts are in Australian dollars (AUD) and are GST-inclusive (where applicable).

Isaiah Pty Ltd (Isaiah) is an Australian tax resident company that sells sporting goods to the general public. Isaiah is
registered for GST and has elected to apply the 50/50 split method for calculating meal entertainment fringe benefits.

Isaiah had the following transactions during the income year ended 30 June 2023:

Benefit Amount Description

($)

Lunch 550 Isaiah supplied packed lunches in January 2023 for staff to consume outside of the
office (eg at the local park while enjoying the view). Each packed lunch costs $5

Membership fees 1,100 CAANZ membership fees reimbursed to Andrew, the accounts receivable clerk, in
July 2022

University fees 6,600 University fees paid in March 2023 on behalf of Stephen, the finance manager, who
is studying theology for personal pleasure

Entertainment 8,800 Entertainment and meals at a restaurant for employees in November 2022

Required
(a) Calculate the grossed-up taxable value of the fringe benefits (if any) for Isaiah for the FBT year ended 31
March 2023. Show all workings. (7 marks)

(b) Calculate the income tax deduction available (if any) to Isaiah for the income year ended 30 June 2023.
Ignore the deduction for FBT payable. (4 marks)

(c) Calculate the GST input tax credit available (if any) to Isaiah. Show all workings. (4 marks)

15 marks

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 Tax (AU)
Practice exam B – Suggested
solutions
Term 2, 2024

Question 1 (10 marks)

Item Assessable/ Reference/Workings

(deductible)
amount
$

1. Salary 50,000

2. Travel (702) 900km × 78c = $702

3a. Use of cleaning equipment 0

3b. Contribution 0 Section 51AJ or s 8-1

4. Work expenses (200)

5. Interest 0

Taxable income 49,098 $50,000 – $702 – $200 = $49,098

Tax payable 8,082 $6,750 + ($49,008 – $45,000) × 32.5% = $8,082

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TAXAU_182_ASM-2-1-4_PA-B-Sol_v3-0.docx
 Question 2 (16 marks)

Item Assessable/(deductible) Workings

amount
$

1. Service income 400,000

2. WIP 0

3. Dividend received 20,000

4,000 $20,000 × 25%÷75% × 60% = $4,000

4. Partnership income 53,000

5. Late penalty 0

6. Photocopy machine (14,500)

7. Borrowing costs (82) $4,000 × 30 days ÷ 1,461 days = $82

8. Lease payments (80,000)

9. Prepaid wages (130,000)

Taxable income 252,418 Sum of all above amounts

Tax at taxable income 75,725 $252,418 × 30% = $75,725

Less: Franking tax offset (4,000)

Income tax payable 71,725

Notes:

• For item 8: As there is an option to acquire the computers, Waddo is the 'holder' of the assets per item 6 of s 40-40
ITAA 1997. Therefore, it is entitled to an immediate deduction for the cost of the computers. The interest component
of the lease payments is also deductible, but there is no information provided to calculate this deduction.

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TAXAU_182_ASM-2-1-4_PA-B-Sol_v3-0.docx
 Question 3 (10 marks)
(a) GST payable or input tax credits available

Item GST payable/ Workings/Explanation

(ITC available)
$

1. Purchases 7,700 $77,000 × 10% = $7,700 (taxable importation)

1. Purchases (7,700) $77,000 × 10% = $7,700 (creditable importation)

1. Sales 12,000 $132,000 ÷ 11 = $12,000 (taxable supply)

2. Shares 0 The sale of shares is an input taxed supply

(b) Amounts included in net income

Item Assessable/ Workings

(deductible) amount
$

1. Purchases (77,000)

1. Sales 120,000 $132,000 × 10 ÷ 11 = $120,000

1. Closing stock adjustment 11,000 ($77,000 – $66,000) – $0 = $11,000

2. Shares first parcel 4,000 $8,000 × 50% = $4,000

2. Shares second parcel 3,000

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 Question 4 (9 marks)
Legislative references in this question are for reference only and are not required in candidate responses.

To: Catherine
From: John
Subject: Income tax consequences for Halo Pty Ltd (Halo) for the income year ended 30 June 2023

Dear Catherine

Elite dividend

The net dividend of $40,000 is non-assessable non-exempt (NANE) income under s 23AI ITAA 1936 [note:
legislative reference not required] as the dividend has been paid out of previously attributed controlled foreign
company income. Therefore, Halo will not include any amount in its assessable income relating to the dividend
Elite paid for the income year ended 30 June 2023.

Halo is entitled to a foreign income tax offset (FITO) for foreign tax it has paid on an amount included in its
assessable income. Under s 770-130 ITAA 1997, Halo is treated as having paid the Thailand withholding tax that
was actually paid by Elite. Whilst the dividend is s 23AI NANE income, under s 770-10(2) ITAA 1997, Halo is
entitled to a FITO for the $5,000 of withholding tax paid because the dividend was paid out of previously
attributed profits.

Brute dividend

The net dividend of $30,000 is assessable income under s 44 ITAA 1936 [note: legislative reference not
required]. Foreign income is included on a gross basis under s 6-5 ITAA 1997 [note: legislative reference not
required], which includes the withholding tax of $3,000. Therefore, Halo will include $33,000 (ie $30,000 +
$3,000) in its assessable income for the dividend Brute paid for the income year ended 30 June 2023.
The dividend is not NANE under s 768-5 ITAA 1997 [note: legislative reference not required] because the
shareholding is less than 10%.

Kind regards

John

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TAXAU_182_ASM-2-1-4_PA-B-Sol_v3-0.docx
 Question 5 (15 marks)
Benefit Grossed up taxable value (FBT) Income tax deduction GST input tax credit
($) ($) ($)

Lunch 550 × 2.0802 = 1,144 550 ÷ 11 = 50

550 × 10/11 = 500

Membership fees Nil 1,100 × 10/11 = 1,000 1,100 ÷ 11 = 100

University fees 6,600 × 1.8868 = 12,453 6,600 0

Entertainment 8,800 × 50% = 4,400 4,400 × 10/11 = 4,000 4,400 ÷ 11 = 400

4,400 × 2.0802 = 9,153

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 Tax Australia
Exam preparation
CASM Practice exam

Question 1 (10 marks)

All amounts are in Australian dollars. Ignore GST.

Hayley is an Australian tax resident individual and works as an operations manager in Brisbane. In December 2022,
Hayley vacated her apartment in the city, which she owns, to move back in with her parents. The apartment was rented
out fully furnished at market rates on 1 January 2023. Hayley self-manages the apartment.

Hayley has provided the following information in relation to the apartment during the income year ended 30 June 2023:

Item Description

1. Rental income Hayley received $16,000 of rental income during the income year

2. Interest Hayley paid $14,000 of interest during the income year on a fixed rate interest only loan she
borrowed to purchase the apartment

3. Prepayment On 30 June 2023, Hayley prepaid strata fees of $5,000 for the period 1 July to 31 December
2023

4. Dining set Hayley left her old dining set (a table and six chairs) in the apartment. She had purchased the
dining set from a department store on 1 January 2017 for $8,000. The dining set has an
effective life of 10 years

5. Crockery set On 31 December 2022, Hayley purchased a new crockery set for $220 for the apartment. The
crockery set has an effective life of 3 years

6. Travel Hayley spent $150 in taxi fares travelling from her work office to the apartment to attend to her
tenant’s repair requests

7. Desk On 31 December 2022, Hayley sold a desk from her apartment for $1,950. The desk was
purchased on 1 July 2022 for $2,000 and it had an adjustable value of $1,900 on 31 December
2022. Hayley used the desk 30% of the time to work from home and 70% to play video games.
Hayley calculates her work from home deductions using actual expenses

Required
Calculate the assessable or deductible amount(s) (including nil amounts) for items 1–7 to be included in Hayley's
taxable income for the income year ended 30 June 2023. Show all workings.

10 marks

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TAXAU_CASM_174_5-5-6_PracticeExam_v3-0
 Question 2 (15 marks)
All amounts are in Australian dollars. Ignore GST.

Kevie is an Australian tax resident individual. He owns 100% of three different Australian tax resident private
companies, Sterling Co, Fittler Co, and Tallis Co. All three companies operate retail businesses.

Kevie

Sterling Co Fittler Co Tallis Co

On 15 March 2023, Fittler Co entered into the following transactions:

1. Loaned $100,000 to Sterling Co. The loan is interest-free for five years.
2. Forgave a loan of $200,000. The loan was owed by Tallis Co on 15 March 2018 and did not previously give rise to a
deemed dividend when it was issued.
3. Loaned $300,000 to Kevie. The loan is interest-free for five years and there is no loan agreement. Kevie used
the funds to acquire an income-producing rental property.
4. Loaned $400,000 to Kevie under a written loan agreement. The loan has a term of six months, interest-free.
Kevie repaid the loan on 15 September 2023.
5. Paid $50,000 in mortgage repayments for Kevie’s wife.

Fittler Co had a distributable surplus of $5,000,000 as at 30 June 2023. Fittler Co’s income tax return for the income
year ended 30 June 2023 was lodged on its due date on 15 December 2023. Although Kevie is not an employee of any
company, he has heard that these transactions might result in tax consequences.

Required
Determine which of the above transactions undertaken by Fittler Co give rise to a deemed dividend and the
amount of the dividend (if any) under Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936). Justify
your answer and cite a relevant legislation reference for each transaction. Present your answer in the form of a
short email to Kevie.

Ignore the commercial debt forgiveness rules under Division 245 ITAA 1997.

15 marks

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TAXAU_CASM_174_5-5-6_PracticeExam_v3-0
 Question 3 (10 marks)
All amounts are in Australian dollars and are GST-inclusive where applicable.

Vincent Pty Ltd (VPL) is an Australian tax resident company. VPL acquires furniture from an Australian manufacturer
and retails the pieces worldwide. VPL has not elected to apply Division 9A of the Fringe Benefits Tax Assessment Act
1986 (FBTAA 1986). VPL has the following transactions during the FBT year ended 31 March 2023:

Item Description Details

1 Christmas party VPL spent $50,000 on the annual staff Christmas party, which only staff
attended. This amounted to $250 per head

2 Free furniture VPL gave 22 different staff members free bedroom furniture packages during
the FBT year. Each furniture package cost VPL $3,000 to acquire (total $66,000
for the FBT year) and had a retail price of $3,500 (total $77,000 for the FBT
year). The furniture packages do not form part of a salary package

3 Tax returns for executives VPL spent $22,000 for an accounting firm to prepare the tax returns for the
executives

Required
For each of the above items, calculate the taxable value of the fringe benefits (if any) for the FBT year ended
31 March 2023, the input tax credit available (if any) and the income tax deduction (if any) for the income year
ended 30 June 2023 for VPL.

Ignore the income tax deductions for the FBT paid (if any).

10 marks

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TAXAU_CASM_174_5-5-6_PracticeExam_v3-0
 Question 4 (9 marks)
Dave and Sarah equally own a rental property, which they acquired in 2016.

The rental market is booming, and Dave and Sarah are concerned about the amount of tax they pay on their rental
income (both are in the top personal income tax bracket of 47%). To minimise their tax payable, they have been
advised to transfer their partnership interests in consideration for non-redeemable shares in a 100% owned Australian
company called Holdco. They are in a comfortable financial position and don't need to receive the rental income.

Holdco

Required
(a) Prepare a short summary outlining how this arrangement would reduce the overall tax burden for Dave and
Sarah on the transfer and on an ongoing basis. Cite the relevant legislative reference. Present your answer in
bullet list format. You do not need to discuss any potential negative income tax consequences. (5 marks)

(b) Prepare a short bullet point summary outlining how the Commissioner of Taxation might apply the general
anti-avoidance rules in Part IVA ITAA 1936 to this arrangement. (4 marks)

9 marks

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TAXAU_CASM_174_5-5-6_PracticeExam_v3-0
 Question 5 (16 marks)
All amounts are in Australian dollars. Ignore GST and any impact of double tax agreements.

Miro and Maria are equal partners in a partnership and both are Australian tax resident individuals. The partnership
carries on a business called 'Great Ones and Tennis (Goat)' selling tennis equipment and hosting tennis events
globally.

Goat operates its non-Australian business through a branch in Austria, and through a wholly owned subsidiary called
Next Gen Ltd (NGL), a company that is tax resident in Singapore and not in any other country.

Assume that Miro, Maria and Goat are not small business entities (SBEs) and do not have any capital losses.

The following information relates to Goat for the income year ended 30 June 2023:

Item Description Amount Additional information

$

1 Sales 4,000,000 All derived on or before 30 June 2023 from Australian sources

2 Dividend received 95,000 Net dividend of $95,000 received on 31 December 2022 from
NGL. 5% withholding tax was deducted in Singapore. The
dividend was paid out of previously attributed controlled foreign
company income

3 Branch income 310,000 Net sales income derived through the Austrian branch on or
before 30 June 2023 from non-Australian sources

4 Capital gain from sale of a 600,000 The Australian store was purchased by the partnership 3 years
store ago and sold on 1 June 2023. $600,000 is the total net capital
gain before any CGT discount

5 General expenses 2,500,000 All incurred on or before 30 June 2023. This amount does not
(including remuneration include salaries/superannuation paid to any of the partners or
expenses) non-deductible entertainment

6 Trading stock – Opening 80,000 $80,000 valued at cost

7 Trading stock – Closing 120,000 $120,000 cost value; $140,000 market value; $110,000
replacement value
The income and expenses for trading stock sold during the
income year have been included in item 1 Sales and item 5
General expenses respectively

8 Partner salary 140,000 Paid to Miro

Required
(a) Calculate Goat’s minimum net income for the income year ended 30 June 2023. Show all workings. Explain
all exclusions, and elections or choices made. (12 marks)

(b) Calculate the amounts included in Miro's assessable income for the income year ended 30 June 2023.
Show all workings. (4 marks)

16 marks

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TAXAU_CASM_174_5-5-6_PracticeExam_v3-0
 Tax Australia
Exam preparation
CASM Practice exam suggested solution

Question 1 (10 marks)

Item Assessable/ Workings
(deductible) amount
$

1. Rental income 16,000

2. Interest (6,942) $14,000 × 181 ÷ 365 = $6,942

3. Prepayment (5,000)

4. Dining set 0

5. Crockery set (220)

6. Travel 0

7. Desk (decline in value (30) Opening adjustable value $2,000 – closing adjustable
deduction) value $1,900 = $100 decline in value
Decline in value deduction = $100 decline in value ×
(100% – 70% private use reduction)

7. Desk (balance 15 Terminating value $1,950 – closing adjustable value

adjustment) $1,900 = $50 balancing adjustment amount
Assessable balance adjustment = $50 balancing
adjustment amount × (100% – 70% private use
reduction)

7. Desk (CGT event K7) 0

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TAXAU_CASM_174_5-5-7_PracticeExamSol_v3-0.docx
 Question 2 (15 marks)
Email
From: Candidate
To: Kevie
Date: Today
Subject: Deemed dividend issues

I refer to your recent request for brief advice on the deemed dividend issues associated with various transactions
by Fittler Co (Fittler). As requested, I have provided a brief summary. All legislative references below are to the
Income Tax Assessment Act 1936.

Loan to Sterling Co

Loans between companies are not subject to Division 7A (refer s 109K). Therefore, the loan to Sterling Co does
not give rise to a deemed dividend for Sterling Co.

Debt forgiveness to Tallis Co

Debt forgiveness between companies is not subject to Division 7A (refer s 109G). Therefore, the debt forgiveness
does not give rise to a deemed dividend for Tallis Co.

$300,000 loan to Kevie

As per s 109D, because the loan does not meet the written agreement or interest requirement under section
109N, the loan will be a deemed dividend for you in the income year ended 30 June 2023. The loan amount of
$300,000 will be the deemed dividend if there is a sufficient distributable surplus.

$400,000 loan to Kevie

As you repaid the loan before the lodgement day, there is no deemed dividend under section 109D. Lodgement
day is the earlier of the day Fittler’s tax return was due to be lodged, and the day it was actually lodged, which in
this case are both the same day (15 December 2023).

Mortgage payment of $50,000 for wife

Your wife is an associate of you. Therefore, as Fittler is paying an expense on her behalf, the mortgage payment
amount of $50,000 is a deemed dividend in the income year ended 30 June 2023 under s 109C if there is a
sufficient distributable surplus.

Distributable surplus

Fittler’s distributable surplus of $5,000,000 under s 109Y exceeds the above dividends of $350,000; therefore,
there is no reduction in the amount of deemed dividends.

Kind regards
Candidate

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TAXAU_CASM_174_5-5-7_PracticeExamSol_v3-0.docx
 Question 3 (10 marks)
Amount FBT taxable value Input tax credit Income tax deduction
Item Description
$ $ $ $

Christmas 0 0 0
1 50,000
party

44,000 (ie 66,000 –

Discounted (22 × 1,000 in-house 6,000 60,000
2 66,000
furniture
benefits concession))

Tax return for 0 2,000 20,000

3 22,000
executives

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TAXAU_CASM_174_5-5-7_PracticeExamSol_v3-0.docx
 Question 4 (9 marks)

(a)
• CGT rollover relief under Subdivision 122-B ITAA 1997 would be available. The rollover conditions are met as each
partner would be disposing of a fractional interest in their tax partnership asset (being 50% of the rental property).
Therefore, there would be no CGT payable on the transfer.
• Holdco would be a 30% taxpayer because rent is a base rate entity passive income.
• Dave and Sarah could save the difference between tax payable at an individual level (45% + 2% Medicare levy) and
the tax payable at the company level (30%) (ie 17%) if the profits are accumulated in the company and not
distributed to them as dividends.

(b)
The Commissioner of Taxation may seek to apply Part IVA ITAA 1936 (the general anti-avoidance provisions) to the
strategy for the following reasons:

• There is a scheme or arrangement that involves the interposition of Holdco to reduce the tax liability on the rental
income.
• There is a tax benefit under Part IVA as the rent will no longer be derived by the individuals at the top marginal tax
rate (plus the Medicare levy) and will instead be derived by the corporate entity with a lower tax rate. The overall tax
liability that arises on the rental income will be lower.
• The benefit is connected with the scheme. The counterfactual, in the absence of the scheme, is that the transfer of
their partnership interests in consideration for the non-redeemable shares in Holdco would not have happened.
• Based on the facts, it could be argued that the dominant purpose of the scheme or arrangement (with reference to
s 177D ITAA 1936) was to create the tax benefit (reduction of the assessable income and therefore the tax liability
of the partners).

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TAXAU_CASM_174_5-5-7_PracticeExamSol_v3-0.docx
 Question 5 (16 marks)
Legislative references in this question are for reference only and are not required in candidate responses.

(a) Partnership net income

Amount
Item Description Explanation of exclusions, elections and choices
$

1 Sales 4,000,000

Dividend income (and any withholding tax) paid out of

2 Dividend received 0 previously attributed income is non-assessable non-exempt
income under s 23AI

3 Branch income 310,000

0 Capital gain is taxed at the partner level not in the

4 Capital gain
partnership

5 General expenses (2,500,000)

Goat should elect to value its closing trading stock at

30,000 replacement value as this produces the lowest amount of
6 and 7 Trading stock
income. As closing stock is greater than opening stock, the
difference is assessable ($110,000 – $80,000 = $30,000)

8 Partner salary 0 Salary paid to a partner is not deductible

Net income 1,840,000

(b) Miro's assessable income

Item Amount $ Workings

Partnership net income 850,000 ($1,840,000 – $140,000) × 50%

Salary (initial allocation of

140,000
partnership net income)

Total capital gain is $600,000. $300,000 share for each of Miro and
Maria per s 108-5. From Miro's share of $300,000, the 50% CGT
Net capital gain 150,000 discount can apply (as the asset was held for 3 years, which is more
than 12 months) to reduce the gain down to $150,000. Miro has no
capital losses to apply before discounting

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TAXAU_CASM_174_5-5-7_PracticeExamSol_v3-0.docx
Tax (AU) CASM Study Aid 3.1
Common exemptions for international tax
From Tax (AU) Topic 3.2

Exemption Applies to Conditions Impact

Foreign branch • Australian resident • Taxpayer must be a company • Makes foreign income and foreign capital gains on assets used
income companies with a foreign • Active income always exempt in the branch’s business (i.e. active assets) NANE income
branch through a PE • As NANE, income does not waste tax losses
(s. 23AH ITAA 1936) • Must pass the active income test
• Can apply with (i.e. < 5% tainted income) for exemption to apply to: • No FITO
interposed entities
– tainted income from unlisted country • No deductions for expenses against this income (s. 8‑1)
– tainted income that is EDCI from listed country • No deduction for debt deductions (s. 8‑1)
• CGT must not be from a tainted asset
* Does not apply where the foreign income is branch
hybrid mismatch income

Foreign equity • Australian resident • Distribution must be from a foreign company • Makes the distribution NANE
distribution companies with • Taxpayer must be a company • As NANE, income does not waste tax losses
exemption participation interests of
• Interest must be equity (as classified under debt– • No FITO
at least 10%, receiving
(s. 768‑5 ITAA 1997) equity rules) • No deductions for expenses against this income (s. 8-1)
foreign distributions (for
example, dividends) * Must not relate to a deduction/non-inclusion hybrid • Deduction available - debt deduction relating to foreign NANE
• Can apply with mismatch income (s. 25-90)
interposed entities

Previously Australian resident Dividend income must be paid out of profits that have • Dividend becomes NANE income (because previously assessed)
attributed CFC taxpayers that control a been previously assessable as CFC attributed income • FITO available (as income previously assessable)
income foreign company
• As NANE, income does not waste tax losses
(s. 23AI ITAA 1936) • Deductions for expenses available against this income (s. 8‑1)
• Deduction for debt deduction available (s. 25‑90)

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CASM_TXAU_5-3-1_SA_3-1_exempt-int-tax_02
Tax (AU) CASM Study Aid 3.1
Common exemptions for international tax (continued)
From Tax (AU) Topic 3.2

Exemption Applies to Conditions Impact

CGT participation Australian resident • Taxpayer must be an Australian • Makes portion of capital gains and losses from the disposal of a non-
exemption companies with a non- company portfolio investment in a foreign company NANE income.
portfolio investment • Shares can’t be eligible finance shares • If active foreign business asset percentage:
(Subdivision (i.e. a direct voting
768‑G/ s. 768‑505 • Shareholding must be non-portfolio – 10%, THEN no portion NANE income
percentage of at least 10%)
ITAA 1997) in a foreign company • Shares need to be held for at least – 10% – 90%, THEN actual % capital gain is NANE income
12 months in the two years before – 90%, THEN 100% capital gain is NANE income
the CGT event
• Only applies to CGT events A1 and
some others
• Capital gain or loss disregarded to
extent of active foreign business
asset percentage

Conduit foreign Non-residents who receive • Taxpayer must be a non-resident Dividend becomes NANE income of non-resident and NOT subject to
income (CFI) unfranked dividends paid • Dividend must be unfranked Australian withholding tax
exemption out of CFI
• Profits relating to dividend must be
(Div 802 ITAA 1997) declared to be CFI (e.g. s. 768‑5 NANE
income and s. 23AH NANE income)

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CASM_TXAU_5-3-1_SA_3-1_exempt-int-tax_02
Tax (AU) CASM Study Aid 3.2  ote:
N
From January 2019, the exemption
does not apply if the foreign income
Foreign branch income and capital gain exemption derived by the Australian company is
branch hybrid mismatch income
From Tax (AU) Topic 3.2

Does the Australian resident company Does the permanent establishment

YES NO
derive foreign income through a permanent fail the active income test?
establishment (branch) in another country? YES
NO

Is the permanent establishment

Foreign
located in a listed or unlisted country?
LISTED income
Is the is NANE
UNLISTED foreign income s. 23AH(2)
NO
specifically
defined as EDCI?
YES
Is the foreign income adjusted
tainted income? (e.g. passive/investment
income, or income from related parties) NO
YES

s. 23AH exemption not applicable / not available

UNLISTED YES

Is the permanent establishment Is the capital gain

LISTED EDCI? (or capital
located in a listed or unlisted country?
NO loss would have NO Foreign
been EDCI income
Did the Australian resident company
if it were a gain) is NANE
derive a capital gain or loss from an asset YES
used in deriving foreign income through a YES s. 23AH(3)
Was the capital gain or loss derived
permanent establishment (branch) NO
from the disposal of a tainted asset?
in another country?

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CASM_TXAU_5-3-2_SA-3-2-foreign-branch-income-CG-ex_06