Australian Income Tax Laws - Essay Example

?Problem Question 1A Australian income tax laws regard any forms of ordinary income as taxable. However, the Income Tax Assessment Act of 1997 merelystates that assessable income comprises of income that has been derived from ordinary principles1 as well as income from other statutory sources. Other than this explanation, there is no concrete definition provided for ordinary income. In order to define income as ordinary in the Australian legal system, help is often taken from Scott v Commissioner of Taxation2. According to the judgement handed down by Sir Fredrick Jordan in the subject case, receipts that must be treated as ordinary income must follow “ordinary concepts and usages of mankind”. In John’s case, he is an employee of a real estate agent but he is carrying out personalised investment activities. This can be seen with the purchase of the motel in order to sell it out as a kindergarten later. A purchase of this kind can be considered as an investment carried out with the intention to make a profit. In terms of the bigger picture, John’s investment activity can be considered as a business activity in ordinary usage since he invests money in order to derive a profit. Receipts or profits created through business activities are treated as ordinary income for most circumstances3 4. In cases where there may be payment complications or where receipts cannot be created from proceeds of business, income may not be seen as ordinary5. However, in John’s case, if the real estate sold out it would have produced a simple income receipt that would have been considered as ordinary income. The onset of the flood and the clearing up of the land can further be considered as business activities on John’s part in order to add value to his property. The assessment that John’s land carried underground hot water reservoirs merely added even more value to his land. John is now being offered money based on the value addition on the motel site he purchased. The value addition activities of John can be seen as business activities analogous to any other value addition properties carried out by any other business. As long as there is “sufficient connection” between John’s income derived from the sale of land and value addition on the land, John’s income will be categorised as ordinary income according to FCT v Consolidated Press Holdings Ltd (No 2)6 7. A scrutiny of John’s circumstances reveals that he purchased land with a view to make profit and his final transaction with Green Energy results in profit. Such income is considered ordinary income for taxation purposes. Problem Question 1B The capital gains tax (CGT) applies to any forms of capital gains made when an asset is disposed off except for certain exemptions. Most exemptions related to CGT in Australia are based on items of personal use as well as exemptions to promote certain business activities. Moreover, the CGT enforced in Australia provides for rollovers under certain circumstances. The contention behind CGT is to tax income that falls within the capital gain category so that it cannot be drained off for other purposes. Assessments for CGT rely on considering any net gains as part of the taxable income structure for a single tax year8. The net gains may result from the sale of owned assets or from any other forms of disposal of assets. Any form of assets held by an individual for a period of one year or more are given a fifty percent discount when considering the CGT on disposal9. CGT was introduced to Australia in 1985 and any assets held by a person before this are exempt from CGT. Assets acquired by a person in or after 1985 are considered alone in CGT deductions10. In the case of Kimberly, her assets were mostly formed well after 1985 so CGT applies to most of her assets except those that are exempt under current CGT laws. In addition to this observation, it is noteworthy that up to 1999, CGT applied after an assessment of the consumer price index (CPI). Under this scheme, changes in the price of an asset due to consumption inflation (assessed by CPI in preference to WPIi and SPIii) were discounted from the final capital gain used to assess CGT. However, after 1999 this assessment procedure was changed to remove the inclusion of inflation adjustment11. CGT application to capital assets created before 1999 imply that inflation adjustments on those assets can be carried out until 1999 even if they are disposed off currently. Two methods are available for such disposal. The disposing party could either choose to use CPI based indexation factors to discount CGT or the disposing party can use the fifty percent flat discount introduced after 199912. This indicates that Kimberly can choose to utilise either the indexation adjustment method or utilise a fifty percent discount on her assets acquired before 1999. Given that Kimberly acquired her business based capital assets in 1996, the use of indexation factors for CGT assessment would leave her at a disadvantage. The total adjustment that Kimberly could demand under the indexation adjustment would be lower than fifty percent since inflation levels were low prior to 2000. In Kimberly’s case, it would be more beneficial if she chose to utilise the flat fifty percent discounts on individual capital asset holdings. In addition to changes in CPI assessment of CGT after 1999, the assessment of CGT for small businesses was reformed as well. The introduction of these changes allowed concessions to owners of small businesses who planned to retire, planned to sell an active asset to procure another and for selling active asset based businesses. Small businesses were classified under this scheme by two chief methods. Any business was considered a small business if its assets did not exceed six million Australian dollars. Moreover, a number of individuals could own the business but it had to have a single controlling individual with more than fifty percent of the economic interest13. Given these conditions, Kimberly’s business can be classified as a small business since it meets both conditions. The primary condition for business owners who are planning to retire is that their age needs to be fifty five years at the time of the sale and that the sale of business is for retirement purposes only. Business owners who are retiring due to permanent incapacitation (without any regard to age limits) may also use this condition. In case that this condition applies, the business owner of a small business is given complete exemption from CGT. However, in Kimberly’s case, her age is only forty eight years at the time of the transaction and she is not permanently incapacitated for any reason. This means that Kimberly is not eligible for this form of relaxation for small businesses. Another retirement exemption under the subject law states that small business owners retiring under the age of fifty five can be eligible for total exemption on CGT if they pay the capital gain into a superannuation fund. However, under this condition a maximum of half a million Australian dollars can be exempted from CGT in a lifetime. Under other normal circumstances, a small business owner is provided an overall seventy five percent CGT discount. The owner is provided a fifty percent discount for active asset reduction and is then provided another fifty percent discount on the remaining assets for ownership of more than one year14. Since Kimberly has sold one store to Bianca, the proceeds of the subject disposal are subject to CGT. Kimberly could put half a million Australian dollars from the proceeds of the sale to a superannuation fund since she plans to retire. This would allow her a complete CGT exemption for this amount of money. As far as the goodwill and money from inventory sales is concerned, Kimberly would have to pay CGT accordingly. Since no other small business exemption or concession applies in Kimberly’s case, she can avail a maximum discount of seventy five percent on the remaining money. The other transaction carried out by Kimberly concerns her city apartment that she bought in 2002. Since the apartment does not form part of her business, so it is beyond the exemptions and concessions for small businesses. The apartment was purchased in 2002 so the CPI based inflation adjustment measures do not apply to the current transaction. Previously Kimberly used the city apartment as her primary residence but this was later changed to another house owned by Kimberly. Since the city apartment is not the primary residence of Kimberly so it does not fall under the exemption category in CGT application. The sale of Kimberly’s city apartment would be considered as a business transaction. Since Kimberly owns the city apartment for more than one year, so she can avail the fifty percent discount for owning an asset for one year or more. However, the sale of the apartment cannot be considered as a small business so no other concession or exemptions can apply. The cost of damaged windows replaced by Kimberly in the city apartment can be claimed as losses within the value of the active capital asset. However, the inclusion of such a loss would not amount to much since the amount of loss is very small compared to the overall value of the city apartment. Question 2 Before the recent changes to private health insurance and Medicare levy surcharge, anyone demanding a rebate on private health insurance was provided a fixed 30% offset. In addition, previously the Medicare levy surcharge was kept fixed at 1% but this has been changed. The contention behind providing such private health insurance offsets was to facilitate people confronted with immediate out of the pocket medical expenses as well as people dealing with chronic medical problems and the corresponding large medical bills. In recent years, it was felt that the current private health insurance rebate scheme and the Medicare levy surcharge were unfair to low income earners especially older people. This made sense since the medical bills paid by low-income earners especially older people represented larger out of the pocket expenses when compared to high-income earners as a percentage of the overall income levels15. In order to remove the disparity between high-income earners and low-income earners on the issue of private health insurance rebates and Medicare levy surcharge, the government decided to categorise the users of the healthcare system to differentiate the applicable rates. Under the new scheme, four different tier levels have been achieved by creating three new tier levels for income. The basic tier level that has seen no changes in rebate levels belongs to individuals earning less than 84,000 AUD and families earning less than 168,000 AUD. The first tier level comprises of individuals earning 84,000 AUD to 97,000 AUD as well as families earning between 168,000 AUD and 194,000 AUD. The second tier comprises of individuals earning 97,000 AUD to 130,000 AUD and families earning between 194,000 AUD and 260,000 AUD. The third tier comprises of individuals earning 130,000 AUD or more as well as families earning 260,000 AUD or more16. Table 1 - Revised private health insurance rates and Medicare levy surcharge under the new policy Singles $130,001 Families $260,001 Rebate < age 65 30% 20% 10% 0% Age 65-69 35% 25% 15% 0% Age 70+ 40% 30% 20% 0% Medicare Levy Surcharge All ages 0.00% 1.00% 1.25% 1.50% This has been complemented by the creation of three differentiated tiers with respect to age. The first tier, as before, deals with people under the age of 65 years. The second tier deals with people aged between 65 years and 69 years. The last tier consists of people aged 70 years or more. Through these levels of classification, the government is “means testing” the earning capabilities of people demanding rebates on health bills. People aged 70 years or more in the unchanged income tier have been provided with a rebate of 40% which signals a 10% increase in the previous flat 30% rebate rate. Similarly, people aged between 65 years and 69 years have been given 35% rebate while people under 65 years of age have been kept constant at 30% rebate. In contrast, high-income earners from the third income tier level (individuals earning 130,000 AUD or more as well as families earning 260,000 AUD or more) have seen their rebates slashed to 0% for all age levels. The rebate levels of other income tiers have been arranged correspondingly between these rebates limits depending on age levels. The Medicare levy surcharge has also seen large changes according to income tier levels. The basic income tier has seen a decrease in Medicare levy surcharge to 0% while all other tiers have been given 0.25% increases starting at 1% for income tier one. This leaves the highest income tier with a Medicare levy surcharge level of 1.5%. The onset of these changes to the healthcare system signals two major observations – the current healthcare budget is spiralling out of control and that private health insurance rebate represents the largest cost driver. In order to deal with this situation, the government has levied this new “means testing” scheme to assess how eligible a person applying for medical coverage is17. This new health initiative is designed to shift the burden of healthcare costs from low income earning groups to higher income groups. The low-income group especially older people above 65 years of age will see tremendous benefit arising from these changes since their rebate levels have been raised and their Medicare levy surcharge has decreased to zero. In contrast, the highest income group will see the greatest rise in expense from medical bills since their rebate has been cancelled out and a fixed Medicare levy surcharge of 1.5% has been implemented. The groups in between these extremes will see corresponding changes to their budgets. The hardest hit factions in all of this will be families of high-income groups with more than an average number of children. Overall, this will affect these groups negatively as it will mean increased expenses for them. In contrast, low-income older people will see major decreases in their medical bills and hence more disposable income levels. Individuals will suffer less since their earning thresholds are lower and since they have no children to take care of in terms of medical bills. The bigger picture will see healthcare bills rising for high-income families and not high-income individuals. Since families already have a restrained budget compared to individuals, this means an unfair change for high-income families. In recent years, the cost of healthcare has gone up drastically which the government has to bear. The rising healthcare expenditures mean that other avenues of social spending such as education and infrastructure upgrades must suffer. The government has shifted the burden from its end to high-income earners in order to shoulder medical bills and other healthcare costs. This will allow state machinery to invest in other avenues such as education that require greater attention and fiscal support. Means testing the income levels of people to decide their medical rebates and Medicare levy surcharge is a positive change. However, the distribution of rebate levels and Medicare levy surcharge may need to be modified in the near future since the middle tier income groups especially families are being taxed too much. References Acts Income Tax Assessment Act 1997, Section 6-5(1) Books Adrian Raftery, 101 Ways to Save Money on Your Tax - Legally! 2012-2013 (John Wiley and Sons Australia Ltd, 2012) N E Renton, Income Tax and Investment: A Plain English Guide for Shareholders and Property Owners, (John Wiley and Sons Australia Ltd, 2nd ed, 2005) Case Law FCT v Consolidated Press Holdings Ltd (No 2) (1999) 91 FCR 574 FCT v Cooling (1990) 22 FCR 42 London Australia Investment Co Ltd v FCT (1977) 138 CLR 106 Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 Squatting Investment Co Ltd v FCT (1953) 86 CLR 570 Journal Articles Chris Evans and Jason Kerr, ‘Tax Reform and 'Rough Justice: Is it Time for Simplicity to Shine?’ (2012) 27(2) Australian Tax Forum, 385-408 Paul Kenny, ‘Australia’s capital gains tax discount: More certain, equitable and durable?’ (2005) 1(2) Journal of Australian Tax Teacher’s Association 7 Peter E Thomas, ‘Reflections on the role of less-than-comprehensive (exclusionary) private health insurance hospital products in the Australian healthcare system’, (2012) 36(3) Australian Health Review Reports Australian Taxation Office, ‘Guide to capital gains tax 2005’, (2005) David Ingles, ‘Tax Equity: Reforming capital gains taxation in Australia’, (2009) The Australia Institute, Technical Brief No. 1. Victoria University of Wellington Tax Working Group, ‘The taxation of capital gains’, (2009) Victoria University of Wellington, Background paper for Session 3. Read More