Introduction to Income Tax Chapter 1 Introduction to Income Tax © National Core Accounting Publications

© National Core Accounting Publications Overview Classification of taxes Taxation defined The Oxford dictionary defines a tax as: “a compulsory contribution to state revenue”. © National Core Accounting Publications

© National Core Accounting Publications Overview Classification of taxes Direct taxes: Company tax Personal income tax Indirect Taxes: GST Stamp Duty Customs and Excise Duties © National Core Accounting Publications

Australian taxation system Constitutional power S.51(ii) of the Constitution empowers the Commonwealth Government to impose income tax. Statutory power Legislation enacted by the Commonwealth Parliament. Income tax legislation in the form of: Income Tax Assessment Act 1936 Income Tax Assessment Act 1997 Various ancillary tax legislation - Medicare Levy Act 1986 - Income Tax Rates Act 1986 © National Core Accounting Publications

Sources of taxation law Statute law ITAA36 ITAA97 Case law Law created by the courts and the Administrative Appeals Tribunal in interpreting Statutes Practices of the ATO In making legally binding rulings and determinations © National Core Accounting Publications

Sources of taxation law s.51 (ii) of the Constitution Empowers the Commonwealth Government to impose income tax. Statutes Legislation on income tax matters enacted by the Federal Parliament. Australian Taxation Office Administers the tax system. © National Core Accounting Publications

© National Core Accounting Publications Key concepts Taxable income equals assessable income less deductions. Assessable income consists of ordinary income and Statutory income. Deductions comprise general deductions and specific deductions. Income year 1 July to 30 June of the following year. Derivation of income includes actual physical receipt and where an amount is applied or dealt with on the taxpayer’s behalf. e.g. interest credited to an account. © National Core Accounting Publications

© National Core Accounting Publications Accounting methods Cash basis Used by wage/salary earners, to most investment income, and can be used by business taxpayers Accruals basis Used by business taxpayers © National Core Accounting Publications

Accounting methods Accruals basis Assessable income on an accruals basis is calculated as follows: Cash received from cash sales and from debtors Debtors balance at end of income year Debtors balance at beginning of income year © National Core Accounting Publications

Illustration: Cash vs. Accruals basis A business taxpayer had an opening Debtors balance of $21,000 at 1 July 2013 and a closing balance of $16,000 at 30 June 2014. Cash received from cash sales and debtors for the year of income was $189,000. All amounts are net of GST.  Required: Calculate assessable income for the year ended 30 June 2014 using the: Cash basis Accruals basis   Solution: Assessable income is $189,000  Accruals basis Cash received from cash sales and from debtors $ 189,000 Plus Debtors balance at 30 June 2014 16,000 Less Debtors balance at 1 July 2013 21,000 184,000  Assessable income is $184,000 © National Core Accounting Publications

© National Core Accounting Publications Accounting methods Choice of method A taxpayer must choose the method that most accurately reflects their true income position for the year. A cash basis is likely to be appropriate for income derived as an employee, for non-business income and investment income. The cash basis may also be appropriate for businesses deriving income from providing professional services. However, the presence of the following factors may result in the accruals basis being more appropriate: The taxpayer’s activities involve the sale of trading stock, The taxpayer relies on circulating capital or consumables to produce income, or The taxpayer relies on staff or equipment to produce income.   The accruals basis is usually appropriate where a trading or manufacturing business is involved. © National Core Accounting Publications

Calculation of taxable income Gross income Exempt income Assessable Income Deductions Taxable income © National Core Accounting Publications

Calculation of Tax Payable Tax on taxable income Non-refundable tax offsets Net tax payable Medicare Levy and Medicare Levy Surcharge Tax credits, refundable tax offsets, PAYG payments Refund due or balance payable © National Core Accounting Publications

© National Core Accounting Publications Income tax rates 2013/14 Tax Rates for Resident Individuals Taxable income Tax on this income $0 - $18,200 Nil $18,201 - $37,000 19c for each $1 over $18,200 $37,001 - $80,000 $3,572 plus 32.5c for each $1 over $37,000 $80,001 - $180,000 $17,547 plus 37c for each $1 over $80,000 Over $180,000 $54,547 plus 45c for each $1 over $180,000 © National Core Accounting Publications

© National Core Accounting Publications Medicare Levy Most resident taxpayers are liable to pay a Medicare Levy equal to 1.5% of their taxable income for the year: The Medicare Levy applies as follows: Taxable Income $1 - $20,542 $20,543 - $24,167 $24,168 + Rate of Medicare Levy 0% 10% of the difference between taxable income and $20,542 1.5% of taxable income * Based on 2012/13 thresholds © National Core Accounting Publications

Illustration: Medicare Levy Shading-in Julia Abbott, a single resident taxpayer, has a taxable income of $22,000. Required: Calculate the Medicare Levy. Solution: The Medicare Levy must be shaded in as taxable income is between $20,542 and $24,167. (22,000 less 20,542) x 10% = $145.80 Medicare Levy payable is $145.80 © National Core Accounting Publications

Medicare Levy and Families No Medicare Levy is payable if a family’s combined taxable income is ≤ $33,693 plus an additional $3,094 for each dependant child or student. Number of dependent children or students: No Medicare Levy where a couple’s taxable income is up to: Reduced Medicare Levy where a couple’s taxable income is within range: (i.e. 10% shading-in)  1.5% Medicare Levy where a couple’s taxable income is equal to or exceeds: $33,693 $33,694 - $39,638 $39,639 1 $36,787 $36,788 - $43,278 $43,279 2 $39,881 $39,882 - $46,918 $46,919 3 $42,975 $42,976 - $50,558 $50,559 4 $46,069 $46,070 - $54,198 $54,199 * Based on 2012/13 thresholds © National Core Accounting Publications

Illustration: Family Shading-in – Family Threshold Pete has taxable income of $30,500, and his wife Paige $18,000 taxable income. They have three dependant children. Required: Calculate the Medicare Levy for Pete and for Paige. Solution: Combined household income, with three dependant children, is $48,500. This is within the shade-in range. Pete earns $29,500 and Paige $17,000. Paige pays no levy and Pete pays a levy minus a family reduction amount. The family reduction amount equals 1.5% of the relevant family income threshold less 8.5% of the excess of the family income over that threshold. Pete’s Medicare Levy otherwise payable is: 30,500 x 1.5% = $457.50 Pete’s family reduction amount is calculated as: (1.5% x 42,975) less (8.5% x (48,500 – 42,975)) = $175.00 Pete pays 457.50 – 175.00 = $282.50. Paige pays nil. © National Core Accounting Publications

Medicare Levy Surcharge (MLS) Income for surcharge purposes includes: Taxable income Reportable Fringe Benefits Reportable Superannuation Contributions Total net investment losses © National Core Accounting Publications

Medicare Levy Surcharge (MLS) Single individual resident taxpayers without private patient hospital health insurance whose income for surcharge purposes is $88,000+ in 2013/14 are liable to pay a MLS on their income for surcharge purposes. For families and individuals with dependants, the MLS applies when combined income for surcharge purposes exceeds $176,000 in 2013/14. The income threshold increases by $1,500 for each dependent child after the first. © National Core Accounting Publications

Medicare Levy Surcharge (MLS) The rate at which the MLS is applied is as follows: No Tier Tier 1 Tier 2  Tier 3 Singles $88,000 or less $88,001 - $102,000 $102,001 - $136,000 $136,001 or more Families $176,000 or less $176,001 - $204,000 $204,001 - $272,000 $272,001 or more MLS rate Nil 1% 1.25% 1.5% © National Core Accounting Publications

Illustration: MLS threshold - family A couple have four dependant children and no private hospital health insurance. Required: Calculate the family’s MLS threshold. Solution: 176,000 + (1,500 x (4 - 1) children) = $180,500 © National Core Accounting Publications

Illustration: MLS - individual Josh, single and aged 36, does not have private hospital health insurance. He has taxable income of $90,000 (includes $7,000 net investment loss), and $20,000 reportable fringe benefits. Required: Determine the appropriate income tier and calculate the MLS. Solution: Income for surcharge purposes is: 90,000 + 7,000 + 20,000 = $117,000 Tier 2 applies The MLS is: (90,000 + 20,000) x 1.25% = $1,375.00 © National Core Accounting Publications

Illustration: MLS - family Tuan has a taxable income of $110,000 and his wife Thuy a taxable income of $75,000. They have no children and no private hospital health insurance. Required: Determine the appropriate income tier and calculate the MLS for each taxpayer. Solution: Tier 1 applies since family income is $185,000. The MLS is: Tuan: 110,000 x 1% = $1,100 Thuy: 75,000 x 1% = $750 © National Core Accounting Publications

Illustration: MLS – family, one taxpayer not liable Rupert has a taxable income of $240,000 and a reportable fringe benefit of $20,000. His wife Wendy has a taxable income of $17,000. They have no children and no private hospital health insurance. Required: Calculate the MLS for each taxpayer. Solution: Rupert: (240,000 + 20,000) x 1.5% = $3,900 Wendy: Nil because her income for surcharge purposes is below the $20,542 low income threshold © National Core Accounting Publications

Illustration: Part-year MLS Billy is single with no dependants. His income for surcharge purposes for the year ended 30 June 2014 is $125,000. On 15 September 2013 he took out private patient hospital insurance. Required: Calculate the MLS. Solution: The MLS surcharge is payable for the number of days Billy did not have adequate medical insurance – i.e. 76 days (1 July to 14 September). Therefore: 125,000 x 1.25% x 76/365 = $325.34 © National Core Accounting Publications

© National Core Accounting Publications Low Income tax offset In 2013/14 a maximum low income tax offset of $445 is available for resident taxpayers whose taxable income is less than $66,667. The maximum tax offset of $445 may be allowed where a taxpayer’s taxable income is $37,000 or less. However, the maximum tax offset of $445 is reduced by 1.5 cents for every $1 by which the taxpayer's taxable income exceeds $37,000. © National Core Accounting Publications

© National Core Accounting Publications Low Income Tax Offset Taxable income equal or less than $37,000 Taxable income $37,001 up to $66,666 Taxable income equal to or above $66,667 Maximum $445 tax offset Part tax offset No tax offset © National Core Accounting Publications

Illustration: Low income tax offset Ima Poorman, a TAFE lecturer, had a taxable income of $50,000 in the current income year. Required: Calculate the Low Income tax offset. Solution: $445 maximum less [(50,000 – 37,000) x 1.5%] = $250 © National Core Accounting Publications

Illustration: Limit to low income tax offset Wendy, a student, had a taxable income of $20,000 in the current income year. Required: Calculate her Low Income tax offset entitlement and tax payable. Solution: The maximum Low Income tax offset of $445. Tax payable is: Tax on $20,000 = (20,000 – 18,200) x 19% $ 342.00 less Low Income Tax offset $445 but limited to 342.00 Nil © National Core Accounting Publications

Illustration: Comprehensive – Calculation of Tax Payable Johnny Drama, a single resident taxpayer, had a taxable income of $112,400, reportable superannuation contributions of $10,000, and $6,000 reportable fringe benefits for the year ended 30 June 2014. PAYG tax withheld from Johnny’s gross wages $33,100. He does not have adequate private hospital cover insurance. Required: Calculate Johnny’s refund due/balance payable. Solution: Tax on $112,400 (17,547 + (37% x (112,400 – 80,000)) $ 29,535.00 Medicare Levy (112,400 x 1.5%) 1,686.00 Medicare Levy Surcharge ((112,400 + 6,000) x 1.25%) 1,184.00 32,701.00 Less PAYG tax withheld 33,100.00 Refund Due 399.00 © National Core Accounting Publications

© National Core Accounting Publications Tax-free threshold The standard tax-free threshold is $18,200. Exception: Where a taxpayer ceases or becomes a resident of Australia for tax purposes This may result in a reduction on a pro-rated basis to below the $18,200 threshold © National Core Accounting Publications

© National Core Accounting Publications Tax-free threshold Where a taxpayer permanently leaves Australia or enters Australia with the intention of permanently staying, their tax-free threshold is adjusted. The adjusted tax-free threshold has two components: The first is a flat amount of $13,464 The second is an additional $4,736 apportioned for the number of months the taxpayer was in Australia during the income year (including the month of departure or arrival) © National Core Accounting Publications

Illustration: Adjusted tax-free threshold Mi Grant became an Australian resident for tax purposes on 15 October 2013. From 1 November 2013 to 30 June 2014 she derived $68,000 taxable income. Required: Calculate her adjusted tax-free threshold and tax payable.   Solution: The adjusted tax-free threshold is: 13,464 + (4,736 /12 x 9) = $17,016 Tax Payable is: $ Tax on $68,000 17,016 - 0 Nil (37,000 – 17,016) x 19% 3,796.96 (68,000 - 37,000) x 32.5% 10,075.00 13,871.96 Medicare Levy (68,000 x 1.5% x 259/365) 723.78 14,595.74 © National Core Accounting Publications

2013/14 Tax Rates for Non-resident individuals Income Tax Rates 2013/14 Tax Rates for Non-resident individuals $0 - $80,000 $80,001 - $180,000 Over $180,000 32.5c for each $1 $26,000 plus 37c for each $1 over $80,000 $63,000 plus 45c for each $1 over $180,000 Taxable Income Tax on this Income Non-residents are not required to pay the Medicare Levy or the Medicare Levy Surcharge and are not eligible for the Low Income tax offset. © National Core Accounting Publications

Illustration: Calculation of Tax Payable - Non-resident Pierre is a non-resident taxpayer. His taxable income from employment in Australia was $36,000 for the year ended 30 June 2014. PAYG tax withheld from Pierre’s gross wages amounted to $10,500. Required: Calculate Pierre’s refund due/balance payable.   Solution: Tax Payable is: Tax on $36,000 (36,000 x 32.5%) $ 11,700.00 less PAYG tax withheld 11,900.00 Refund Due 200.00 © National Core Accounting Publications