Income Tax for Australian Business Taxation Concessions

Question: Write a discussion onIncome Tax. Answer: Section 6-5 of the Income Tax Assessment Act 1997 (Cth), referred to as ITAA, 1997 explains the core concept of ordinary income in context to Australias income tax provisions. A further elaboration is given in Sub-section 6 5 (1) of the Act where it is provided that an assessable income of a taxpayer includes income derived according to ordinary concepts, which in general terms is known as ordinary income. Apart from these references, the terms income or ordinary concepts have not been defined either in ITAA, 1997 or anywhere in the Income Tax Assessment Act 1936 (Cth) (ITAA, 1936). Since the inception of income tax laws under the 1936 Act, the explanation of these terms has been left to the courts. The lawmakers left it to the courts to interpret the meaning to income and income according to ordinary concepts according to the circumstances of the transaction occurring between the parties involved. This concept becomes relevant to the current case study of Ragco, where the company entered into a commercial transaction. It is pertinent to apply the decision taken by the High Court of Australia in the case of Westfield Ltd v FCT to this case study, as the transactions in this case and that of Ragco mentioned above are both beyond the definition of the specific type of receipt   both are inducement payment, which are received by the taxpayer as an incentive for business transaction involving the concept of a lease.As there does not exist any specific test to determine What is ordinary income? in each individual case, Australian courts developed certain principles to answer this question. Most of these principles used for determining what constitutes as ordinary income are general in nature. Some very specific ones which have particular traits attached with them and include Personal Exertion, Business Income and Property Income. Why these principles become important in the context of the term ordinary income can be found in the explanation given by Jordan CJ in the case of Westfield Ltd v FCT to the term income according to ordinary concepts and I quote: what forms of receipts are comprehended within [income], and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind unquote.Another significant observation of the courts has been that these concepts as well as usages of the term mentioned above never remain constant but keep changing. This is followed by the notion that in case the ordinary concepts and the usages keep changing with time, then the definition of income shall also keep changing. Hence, income cannot be taken as having a specific meaning which shall remain static or fixed forever. In establishing this process, Australian courts identified certain factors which are considered relevant and which were found to be decisive in their individual or collective nature. The Australian Taxation Tribunal , in the case of California Copper Syndicate Ltd v Harris (Surveyor of Taxes) observed that, and I quote:To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipients purpose in engaging in the transaction, venture or business unquote. Conclusion: While concluding this case study, it is important to mention that prior to the case of Westfield Ltd v FCT and California Copper Syndicate Ltd v Harris (Surveyor of Taxes), there were certain principles considered relevant to the business income and these were based on the fact that when a business is being carried-on, it does not automatically convey the meaning that each receipt and every profit of the business entity shall be ordinary income. Although in case the receipt or the profit earned has been made in the course of carrying-on a business and which shows a sufficient connection which in itself establishes a fact of significance, then there is a case of establishing the fact to determine whether ordinary income has been derived.However, it has been observed that the sufficient connection may also exist in case the transaction undertaken is one-off transaction but is still carried out in the ordinary course of business as was undertaken by Ragco with Bonzacash and which was in cidental to the business activity of Ragco. Hence, this shall not constitute this transaction as ordinary income for Ragco as described under ss 25 (1) and 26 (a) of the Act. When this incident is viewed under the traditional approaches adopted while classifying receipts either as income or capital, the conclusion will be that this receipt was of capital nature because it is an isolated and non recurrent transaction and has been received in lump-sum under the once and for all condition. Introduction The Australian Taxation Office (ATO) introduced Capital Gains Tax (CGT) with effect from 20 September 1984 as part of the Income Tax Assessment Act, 1997 (ITAA, 1997) and effective this date, all assets which a taxpayer acquired, commenced or built were to be subject to the new CGT legislation. It was soon observed by experts that this legislation did not have provisions for retirement benefits of small business owners as the equity they accumulated while building-up their business was the only superannuation they had after retiring. In this context, there are various CGT concessions available under specific circumstances to the stakeholders when the Small Business Entity (SBE) makes a capital gain. These concessions for SBEs are described under Division 152 in Part III of the ITAA, 1997. Small Business Concessions Now that the rules have been put in place and assuming that the stakeholder has complied with the requirements of stated in Subdivision 152A, it is time now to look at the applicable concessions which the stakeholder will be eligible on the capital gain which it has been, says Taylor, (2003). Subdivision 152C: 50% Active Asset Concession In those cases where the stakeholder is unable to fulfil the conditions of Subdivision 152-B, it has the option of availing the 50% concession provided it satisfies the conditions of Subdivision 152A. The stakeholder can also avail the 50% Active Asset Concession along with any other concession for which the stakeholder becomes entitled to. This can result in the stakeholder paying only 25% CGT on the capital gain which it makes from the sale of the small business asset, as per CCH Editors, (2011). Subdivision 152D: Small Business Retirement Exemption A stakeholder can avail this concession only after the application of the 50% active assets concession, provided it plans to utilise the proceeds received from the sale of its small business assets for funding its retirement needs, as specified under Section 152-305. For this, the individual stakeholder should satisfy the conditions mentioned under Subdivision 152A and should be over 55 years of age. In case of stakeholders below 55 years of age, who satisfy the conditions mentioned in Subdivision 152A, this concession is available provided they use the proceeds for investing into a complying superannuation fund. As per Section 152-320, there is a lifetime limit of $500,000, say CCH Editors, (2012). Subdivision 152E: Roll-over Roll-over provision implies that the stakeholder uses the proceeds from sale of small business assets for purchasing other assets to replace the sold ones. The purpose of this concession is to defer the CGT liability till a later CGT event takes place. Section 152410 states that if the stakeholder satisfies conditions of Subdivision 152A then only it can elect of using the roll-over concession. However, the stakeholder must note that the rollover concession shall be fully reversed if the proceeds are not invested in the purchase of replacement active assets within 2 years of the relevant CGT event. The reversal happens only after the stakeholder triggers CGT Event J5 as per Section 104197, as per Smith Koken, (2011).The stakeholder must note that Section 104-198 states that in cases where the cost of the replacement active assets is less than the cost of the disposed-off assets, then it is liable to CGT payment on the difference between the two amounts provided CGT event J6 has been triggered. To evaluate the CGT liability, the stakeholder must first calculate the capital gain it made on the disposed-off asset, then it should apply any applicable discounts, as the prescribed under Division 115 and Subdivision 152C. Only then should it reduce the discounted capital gain from the replacement assets cost as stated under Section 152415, explain Smith Koken, (2011).Record KeepingDivision 121 implies that all stakeholders must keep records which can help the authorities to ascertain:1. Date of acquiring the capital asset.2. Amounts which essentially form part of the assets cost base.3. Date of disposal of the capital asset.4. Amount of the capital proceeds received by the stakeholder.Hence, records should be maintained for all CGT assets even if the capital gain is not subjected to CGT. The following assets are the only capital assets which do not require maintenance of records as capital gain or loss is always disregarded on their sale: Motor Vehicles (as detailed under Section 1185). Collectible and personal use assets costing less than the threshold (as detailed under Section 11810). Depreciable Assets (as detailed under Section 18824) Trading Stock (as detailed under Section 11825), as per Newnham, (2016).Summary of the STS RegimeThis paper has discussed various CGT concessions available to the stakeholders of an SBE (Small Business Entity) when it makes a capital gain. The concessions, as described under Division 152 in Part III of the ITAA, 1997 are subjected to the eligibility rules as detailed under Subdivision 152A. It is mandatory for an SBE to fulfil these requirements before applying for the CGT small business concessions. The ambiguities do not end even after the stakeholders fulfil the requirements of Subdivision 152A, they are required to follow Subdivisions 152-B; 152-C; 152D and 152-E so as to avail the applicable concessions and to assess how to apply for the appropriate concession, assert CCH Editors, (2009).An important f actor which the stakeholders need to understand is that the SBEs CGT liability arises as soon as the SBE enters into a contract for the sale of a small business asset and not when the settlement takes place. Hence, it is necessary to take into account the timing of the sale of the asset for determining the CGT liability and its impact. In the view of this author, the stakeholders need the advice of a professional in order to understand whether they have a CGT liability or whether they can do away with the liability by deferring it to a future date, as per Newnham, (2016).SECTION 2: CRITICAL REVIEW AND APPRAISALThe Tax Regime for Small Businesses The biggest advantage of these provisions is that these concessions have been made applicable to all kinds of businesses which meet the threshold test requirements. Whether the stakeholder is a company, a trust or other type of entity, the concessions become applicable if it is relevant in terms of the provisions specified for identifying a significant individual to whom the concessions have been truly directed. Similarly, for the stakeholder to apply interaction with other applicable concessions, convenience has been provided such as in case the stakeholder does not qualify for the small business 15-year exemption, it can avail the small business 50% active asset reduction for reducing the CGT liability, explains CCH, (2012). Another advantage given to the stakeholders is the automatic application of the small business 50% active asset reduction if the basic conditions are satisfied. It is for the stakeholder to choose not to apply this provision as it may prefer instead to choose the small business retirement exemption or the provisions of the small business rollover, as per Caldwell, (2014). Choosing these options may allow a company or a trust to make large amounts of tax-free eligible termination payments under the provisions of the small business retirement exemption.These concessions for SBEs were covered under Division 152 in Part III of the ITAA, 1997. The federal eligibility rules for these concessions were detailed in Subdivision 152A and it was mandatory for the SBE to fulfil these requirements before the stakeholders apply for the CGT small business concessions. But at the state levels, states such as VIC, SA and WA did not enforce them strictly for the stakeholders to meet the requirements stated in Subdivision 152A, as they need to carefully study Subdivisions 152-B; 152-C; 152D and 152-E so as to understand the applicable concessions and to learn how to apply for the appropriate concession, assert CCH Editors, (2009).Critical ReflectionThe Simplified tax System (STS), as it was known at the time of introduction, was meant to offer the eligible SBEs a new platform to simplify their tax structure. When it was initially introduced in 2001, the STS amendments were aimed at reducing the income tax compliance burden of more than 95% business establishments. These provisions were meant for businesses having less than $1 million per annum turnovers, although their eligibility test conditions for other provisions were different, as per Caldwell, (2014). Although the Act was entitled as the Simplified Tax System (STS), from the proposed amendments, it was evident that it carried a broader agenda than mere simplification. In particular, although the new section 328 was specifically designed to introduce a regime of reduced taxes, providing simpler rules and to reduce compliance costs, it did not materialized as such in practice. Whereas the original STS allowed the eligible SBEs the option of adopting collectively the package offering four tax treatments and which comprised of simplified depreciation rules, use of cash accounting method for income tax purposes instead of accruals method, simplification of trading stock rules and ability to claim immediate tax deduction for their pre-paid expenses, there was no automatic entry but the SBEs were given the optional choic e to enter the STS, as per Newnham, (2016). However, if the SBE opted to enter the STS, it was required to compulsorily adopt all the four concessions. When it was introduced, it was estimated by the Federal Government that nearly 60% of the eligible SBEs will make the choice of entering the STS. However, the data subsequently released on 17 April 2003 by the ATO (Australian Taxation Office) revealed that not more than 14% of the eligible SBEs actually took the option of entering the STS, although in the2005 tax year, the figure increased to 27%, cites CCH, (2012).Criticisms of the SBE ConcessionsThus, contrary to what the Federal Government claimed, the ground reality remained that the small business concessions did not meet the much acclaimed promises of the governments good tax policy. The basis of these claims by this critic lies in the fact that the SBEs are actually facing more complexity as well as compliance costs on account of this regime. Observations made by this author o n the governments claim about increased simplicity have shown that it has become even more difficult for an SBE to enter the concessionary regime as they are required to furnish more detailed personalized assessments and hence create more complex layers to an already complexed regime as the assessments are not only time consuming, they are also costly, as the SBE has to seek professional advice. The increasing number of Taxation Rulings issued by the ATO for clarifying the ambiguities is creating more confusion than easing the eligibility criteria rules. This author is of the opinion that the SBE regime and the concessions are anything but simple and combined with the increased compliance costs, the claims of the authorities of providing a STS regime have gone flat.The complexities of the STS regime were also acknowledged by the Henry Review, which concluded that, and I quote: Small businesses bear a disproportionally higher share of the tax compliance burden. To reduce this burden and to provide small business with greater tax certainty, the existing small business tax concessions should be streamlined and broadened. Access to the small business tax concessions under the small business framework should be extended by increasing the small business entity test (turnover test) from $2 million to $5 million. Unquote. Going further in its criticism of the small business entity test, the Henry Review also suggested a number of changes in the concessions: Quote the small business entity capital gains tax concessions should be rationalized and streamlined. The active asset 50% reduction and 15-year exemption concessions should be abolished. The lifetime limit for the retirement exemption should be increased and taxpayers who sell a share in a company or an interest in a trust should be able to access the concessions via the turnover test. Unquote.Small Business CGT Concessions A Time for ReviewThis author firmly believes and is supported by the arguments put forwar d and discussed above that the SBE CGT Concessions need a review. In this context, the following need to be assessed by the relevant authorities to ease the situation.A. A staged increase in the threshold of turnover for the SBE from $2m to $5m. B. The 50% active asset concession should be treated at par with the 15 year concession allowed to companies. The criteria adopted should be that the capital gain made from disposal of an SBE will be treated as a non-assessable, non-exempt income as described in section 152-125 (2) of ITAA, 1997, if paid to a CGT Concession Stakeholder within 2 years of CGT events date. C. Allow those individuals, who have originally structured a sole trader or a partnership entity or if the SBE is controlled by a trust, and the same is rolled into a company by virtue of Subdivision 122A and 122B of the ITAA, 1997, to be eligible for the concessions from the date of commencement of the first business and not from the date of business being rolled into a comp any.D. Provide an alternative to the Significant Individual requirement as stated under section 152-110 (1) (c ) of the ITAA, 1997, by allowing those discretionary trusts, which are constituted as Family Trusts within the time-frame of the CGT event and which fulfill all the conditions put forward by the regime, to access the 15 year concession. E. In all its CGT concession norms, especially those which are allowed to individuals, the CGT Liability is determined by taking into consideration the effects of CPI on the CGT Gains made. A similar need is required here in case of the $500,000 lifetime limit being given under the CGT Small Business Retirement Concession. This should be subjected to the CPI at least on an annual basis. LIST OF REFERENCES Caldwell, R. 2014, Taxation for Australian Businesses: Understanding Australian Business Taxation Concessions. John Wiley Sons, Milton, QLD.CCH. 2009, A Practical Guide to Business Valuations for SMEs. CCH Australia Limited, Sydney, NSW.CCH. 2009, Small Business Tax Concessions Guide. CCH Australia Limited, Sydney, NSW.CCH Editors. 2009, Australian Master Accountants Guide. CCH Australia Limited, Sydney, NSW.CCH. 2010, Australian Master Financial Planning Guide 2010/11. CCH Australia Limited, Sydney, NSW.CCH Editors. 2011, Master Tax Examples 2010/11. CCH Australia Limited, Sydney, NSW.CCH. 2012, Australian Master Tax Guide 2012. CCH Australia Limited, Sydney, NSW.CCH Editors. 2012, Top 100 Tax Q As, 2012. CCH Australia Limited, Sydney, NSW.Newnham, M. 2016, Tax for Small Business: A Survival Guide. John Wiley Sons, Milton, QLD.Prince, J.B. 2013, Tax for Australians for Dummies, 4th ed. John Wiley Sons, Milton, QLD.Smith, B. and Koken, E. 2011, The Superannuation Handbook 2008-09 . John Wiley Sons, Milton, QLD.Taylor, L. 2003, Small Business and Tax. Pascal Press, Glebe, NSW.