Rule Making Processes of the Australian Taxation Office - Example

Rule Making Processes of the Australian Taxation Office xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Name xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Course xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Lecturer xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date Table of Contents Table of Contents 1 1.0 How Small business Qualifies 2 2.0 Derivation method 5 3.0 Whether the business can qualify as a PSB by using a PSE 6 4.0 How to maximize possible deductions under tax legislation 7 5.0 References 10 1.0 How Small business Qualifies Buzz and Fuzz are brothers who have a small business of courier whereby the owners’ pick up or deliver goods for their customers. Since it is a small business, the brothers uses Fuzz garage as their office. For a business to qualify as a small business it must not have sales exceeding $2 million. Deductions available are the expenses of carrying out the business. This must directly have been incurred in the process of carrying out the business and the business must be a profit making business under the Australia taxation laws. The expenses must be necessary (appropriate and helpful for the business) and ordinary (commonly accepted in business operations). Ordinarily an expense to be considered necessary does not have to be indispensable. However the following does not include or make up part of expenses; the capital expenses, expenses incurred in cost of goods sold and personal expenses. Operating a business with collective turnover of less than $2 million, it is qualified for a variety of concessions to assist in minimize income tax under the Australian taxation. Concessions for small business include, simpler trading stock rules, immediate deductions for prepayments, CGT concessions, and simplified depreciation rules. Therefore, Buzz and Fuzz business is a small business which enjoys the concessions since its turnover is $1m. The business expenses were higher, especially petrol and the vehicle maintenance costs. If the business stock level does not change by more than $ 2,500 the business should use the simpler trading stock rules. By using this concession, the business needs only to carry out stock take and account for the fluctuate in the trading stock if the difference is more than $2,500 between the value of the stock on hand at the beginning of the income year, a rational approximate of the value of stock at hand at the end of that year. The estimation is rationale if the level of stock is constantly maintained every year and have a rationale notion of the worth of stock at hand, if the stock level changes, estimation can be made based on the records of the bought stock. Tax deductibles are various business costs that can be deducted from the income of the company before it is subjected to taxation. Through minimizing taxable income, the subtractions minimize a company’s tax burden and thus advance its bottom line. Some of the deductions in small business include business travel expenses; one should claim this in an evidence of written expenses, travel records and especially where business travel was more than six consecutive nights far from home. A person should record the following throughout the business travel period, the nature of activity, the day as well as the estimate time the business activity started, lasting period of the business activity, the engaged location in the business activity. One of the benefits of travel expenses is that it is not taxable since it is recorded on expenses. In addition, it is increases profits in the business since the business travel can be used as a business promotion. Another deduction in the business is the advertising expenses. An individual in the business can claim deductions on most of the advertisements and sponsorship expenses paid if the expenses incurred to; sell trading stock, gaining publicity for the business name as well as hiring employees. These are business expenses which are not taxed. Through advertisements, the business gains enough publicity whereby the information regarding the business reach to new customers as well. In addition, advertisement in business increases the turnover of the business hence increasing the profit. Additionally, it creates employment whereby the business employs more workers due to the increase of the customers. On the other hand, loss occurred in a business is deductable, if a business is a company, the loss incurred cannot be distributed to the shareholders. The business should carry the loss onward until it can counteract the loss against measurable income in a later year. The loss is deductable unless; there are the same owners as well as the same control throughout the time from the beginning of the loss year to the ending of the income year; the same business is carried out throughout a particular time (Taxation Ruling 1999). If the business is operated as a company, the benefit the company gets is that it can select the amount of previous year’s tax loss it needs to claim. In addition, the loss is carried forward to a year later which would have acquired in a specific year had the company not obtained income from franked dividends. Generally, the most significant is that the loss that occurs in a business is not taxable. On the other hand, expenses associated to your home work area are deductable. In regards to this individual operating the business in full or in part from home, may be in a position to claim a deduction for the occupancy expenses such as mortgage interest rates, rent, land taxes as well as house insurance premiums. In addition, running expenses such as business calls, depreciation of office furniture and the equipment, internet fees as well as any additional heating expenses incurred by the business should be deducted. This happens when a home is turned into a business place whereby a small area is set aside for business activities. When the home is not a place of business but an area is set aside for business activities and also when work is carried out at home but no homework area. This helps an individual in working anytime hence serving the clients well as well as delivering on time. Taxation Ruling TR 1999/9 Income Tax: the operation of s165-13, 165-210, paragraph 165-35(b) s165-126, s165-132. 2.0 Derivation method The issue of derivation of income entails the measurement of this income and the timing of the same to determine when income was earned and how much was earned. Under s 6-5 ITAA (1997), ordinary income is taxed when it is derived which raises the issue of whether it is derived when it is paid for or whether it is at the point when services are rendered or goods delivered. Accounting operates on accrual basis meaning that income is deemed to be earned for a business when goods are delivered or services have been rendered whether they have been paid for or not. This is the method that is required by the generally accepted accounting principles (GAAP). For consistency purposes, expenses should be recognized in the period they are incurred whether they have been paid for or not. For tax purposes, the general rule is that income for individuals is deemed to be earned when payment has been received but that of business is deemed to be earned for tax purposes when services have been rendered and the goods delivered. However, with enactment of the Tax law amendment (small business) Act 2007, the standard definition of a small business entity was made that would allow small business take advantage of tax concessions in an effort to stimulate their growth. Among the tax concessions available to the small business entities include the excise concessions, capital gain concessions, goods and services tax (GST) concessions among others. For a business to be considered as a small business entity, it has to satisfy the following conditions. The first one is that it must be a business and the second one is that its aggregated annual turnover must be less than $2 million. Buzz and Fuzz business meets these criteria and as such qualifies as a small business entity. The business should therefore use the cash accounting basis to account for its incomes as well as its expenses. For all the income earned during this tax period, the income that will be assessable for tax purposes is the cash that has been received by Buzz and Fuzz for the services rendered to its clients. For the amounts that have not been received during the particular tax period, it will not be assessed for tax purposes but will be assessed in the following period when it is received. This also applies in the case of to expenses whereby the business cannot claim for deductible expenses for any expenses incurred by the business but have not yet be paid for. Buzz and Fuzz will only claim as deductible expenses the amount of these expenses when they have paid for them. It is however worth noting that the business is expected to be consistent in its application of the cash receipt method. (Pizza calla N.d) 3.0 Whether the business can qualify as a PSB by using a PSE Buzz and fuzz business is a personal business and therefore it qualifies to be a personal service business (PSB) under the personal service entity (PSE). Under the personal service income the income of a personal service entity is attributable to the individual who renders the service of which directly generates the income for the Personal service entity. This income is subject to tax under the marginal tax rates in Australia. The s84-5 ITAA97 defines Personal service income as the ordinary income and or statutory income that are generated mainly as a reward for personal skills or efforts an individual puts in, regardless of whether the income is earned by the individual through contracts or business structures. The income generated by Buzz and Fuzz’s business is their income because they have produced the income by use of their own motor vehicles and other assets which they personally own (not owned by the business). This therefore is a reward for their efforts and skills. For example the taxation ruling: TR 2001/7: income tax the meaning of personal service income suggested that the value contributed by an individual exceeds the value of other inputs such as the use of equipments and plants or goodwill. Where the individual’s contribution exceeds half the income it is attributable to that person. This means that any income generated from the use of business assets is not in any case a personal service income, the opposite is very true. Buzz and Fuzz’s business does not own the motor vehicles which is their primary operational tools for their courier business. The business does not own anything, the motor vehicles, equipments and the offices are owned by the two brothers. This under the TR 2001/7 ruling and under the s84-5 ITAA97 Australian taxation office exertions is a personal service income attributable to the two brothers and not the business whatsoever. 4.0 How to maximize possible deductions under tax legislation Buzz and Fuzz can utilize the tax legislations to maximize their deductions. This is made possible by the fact that the income they generated from the operations of the business is their own personal income and not the business income. There are various means to alienate or split income from personal exertion. Buzz and Fuzz can split the income among their family members and thereby reduce considerably the overall tax liability as Pincus v Federal Commissioner of Taxation (1985) 85 ATC 4765, which considered s260 of the ITAA 1936, was decided. This is a legal means of tax avoidance though under the income tax assessment Act 1931 (Cth) on anti avoidance provisions of part IVA has been classified otherwise. There has been attempt to cub this behaviour among the Australians but the efforts on the part of Australian tax office as well as the administrative costs were substantial. Buzz and Fuzz must therefore use this before the tax authority comes calling as the Australian tax review of Melbourne 2004 November 26 quoted as saying, ‘the estrangement of individual service legislation is allowing the office to have their fair share of the tax evasion’. Instead of using employees in their business Buzz and Fuzz can hire and use the services of contractors as (Pennicott 2007) contributes. This will provide them with practical deductions as this issue continues unabated in the anti avoidance provisions. For instance the Case Y13 (1991) 91 ATC 191 involved a member of staff engineer who undertook part-time job via an optional trust which was used to divide the engineer’s earnings among the family members. The agreement was fruitfully struck down under pt IVA. Alternatively Buzz and Fuzz can decide to have the tax free threshold. This is lawful and it is encouraged by the Australian taxation office. They will enjoy the threshold regardless of the size of their income of one million deducting the expenses and other allowable expenses and income. This would reduce their marginal tax rate by $0.15 per dollar if they adopt it, no penalties are involved. Accordingly any income above the corporations business limit for the year is not taxable. Buzz and Fuzz can take advantage of this and increase their business operations, make more sales and the income above the small business limit will not be taxable instead it will be deductible. The Australian taxation office limit of small businesses is sales turnover not exceeding two million dollars in a business year. Buzz and Fuzz’s business made a sales turnover of one million dollars in total which is far below the limit. They can’t in this case utilize this deduction currently but they can utilize it in the subsequent operational periods. From their operations Buzz and Fuzz can utilize the capital gains tax, they have fulfilled the two requirements, being a small business and they are partners in the small business and that they own the capital goods asset. This capital goods tax exempts small businesses from taxing their capital gains if they dispose their assets. They will enjoy these benefit if they decide to sell/dispose any of their capital asset (a capital asset is an asset that is used to directly generate income for the business). Buzz and Fuzz can claim expenses which they have directly incurred in the process of carrying out the business. These expenses are claimable as deductions when they are incurred in every day running of the business. For example an expense incurred when they receive an invoice even if it’s not actually paid is deductible as (ATO 2011) explains. Another way to maximize their deductions is to maximize on the depreciation of the assets they have, the motor vehicle, equipments and the office furniture. Depreciation and wear and tear are not deductible. They should deduct this from their income to reduce the taxable income, this more so on the depreciation of the $800,000 of their assets. This amount is very big comparing the amount of income they generated for the year, using the right method of depreciation this would entitle them good depreciation amounts. Depreciation in this case will take a big part of the income hence reduce the taxable amount by a big margin. Another way of maximizing the deductions is to be aware of the losses exemptions provided by the taxation office in Australia. The taxation laws require that any business that makes losses to deduct it from profits in the next operating period. Though they have not made losses, this will help them to conjure their unawareness of the relevant channels to maximize their deductions. Buzz and Fuzz can maximize their deductions by filling their returns on time, filling their self assessment on time and filling the declaration form on the income tax. This would avoid penalties, which would reduce their income. 5.0 References ATO 2011 Australian taxation office income and deductions for small business Canberra. Pennicott, S 2007 University of New South Wales Resolving the personal services income dilemma in australia Perth. Pizza calla n.d. Australia’s tax system: is it working? Retrieved on 31, May 2013 from http://www.hlb.com.au/getdoc/deb70ed6-6540-42f7-bed1-283cbf384ea8/Paper-SEAANZ-Conference-0909-Australia-s-SME-Tax-S.aspx Read More