business solutions September/October 2012 LIVING AWAY FROM HOME ALLOWANCE TRUST DEEDS - CHANGES FINALISED - THE IDEAL FEATURES

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1 business solutions September/October 2012 LIVING AWAY FROM HOME ALLOWANCE - CHANGES FINALISED TRUST DEEDS - THE IDEAL FEATURES

2 September/October 2012 BIMONTHLY ARTICLE Page No Who s LAFHAing Now? The recently-announced changes to the living away from home allowance (LAFHA) have been deferred until October This article examines how the new rules will apply in practice, including the special transitional arrangements. 3 Directing Your Fees Recently the Tax Office announced a crackdown on accruing directors fees. Paid by most companies towards the end of the financial year, this article is essential reading for all companies that pay directors fees as well as employee bonuses. 6 Healthy, Wealthy and Wise Following the introduction of new means-testing rules, this article looks at how to claim your private health insurance rebate for 2012/2013. For the many people who have private health insurance, we detail how you can enjoy a cash flow benefit in making your claim. 7 Contractor Kit As the labour market becomes more flexible, an increasing number of workers are being engaged as contractors rather than employees. This article is a one-stop shop for contractors informing you of your special income tax, superannuation, GST, recordkeeping and insurance requirements. 8 Understanding Depreciation Depreciation is something which impacts many businesses often representing a sizeable deductible item during the year. In this first of a two-part series, we look at those items you can claim as an immediate deduction 12 Index ARTICLE 2012/2013 Tax Office Individual Targets The Tax Office recently announced its 2012/2013 Compliance Program, highlighting the target areas for the coming 12 months. This article looks at the areas the Taxman will be focusing on during the next 12 months from an individual, perspective /2013 Tax Office Business Targets September/October 2012 Vol 13 No.5 ABN: Print Post Approved /10030 Page No In this second of a two-part series, we look at the Tax Office s recently released Compliance Program, this time from small business perspective. Will the Tax Office be targeting your business in the coming 12 months? What a Super Deduction Anecdotal evidence suggests there is confusion around when you can claim a deduction for personal contributions you make to superannuation. Contrary to popular belief, many more people than just the self-employed may be eligible to claim a deduction. Doing a Good Deed With the dust having now settled (for the time being) on trust law, this article provides an overview of what trust deeds should cater for following recent Tax Office rulings and court decisions. For the more than trusts in Australia, this article is essential reading. Ch Ch Ch Changes Tax Time 2012 With 30 June having passed, the tax return season is now upon us. This article details the changes to be aware of when completing your 2011/2012 individual tax return in the coming months ATR Australian Taxation REPORTER Published by Australian Taxation Reporter, PO Box 2255, Southport BC Qld Phone , Fax com.au Web:. Australian Taxation Reporter is a trading name of Australian Taxation Reporter Pty Ltd ABN IMPORTANT DISCLAIMER This publication is in accordance with the legislation as it stands at July Tax Legislation is complex and subject to constant change. Subscribers or readers of this publication should not act on the basis of information contained herein without seeking their own professional advice as to its applicability to their own circumstances. This publication is issued on the understanding that the authors and publishers are not responsible for the results of any actions taken on the basis of information in this publication, or for any error in or omission from this publication. Australian Taxation Reporter Pty Ltd is not engaged in rendering legal, accounting or other professional advice. COPYRIGHT This newsletter has been written and designed for Australian Taxation Reporter Pty Ltd. No part of this publication that is covered by copyright may be reproduced without the express permission of Australian Taxation Reporter Pty Ltd. 2

3 KEY DATES September October Final date for eligible quarterly GST reporters to elect to report GST annually 21 September August monthly Activity Statements due for lodgement and payment 30 September Annual TFN withholding report for closely held trusts where a trustee has been required to withhold amounts from payments to beneficiaries during 2010/2011 due date for lodgement October October September monthly Activity Statements due for lodgement and payment 28 October Due date for superannuation guarantee contributions for July-September to be made to employee funds If an employer does not make the minimum contributions by this date, they must pay superannuation guarantee charge by 28 November October PAYG withholding where ABN not quoted annual report due date for lodgement These amounts are also reported at W4 on your activity statement 31 October Due date for 2011/2012 individual tax returns (unless you are lodging via a tax agent and are on their lodgement list by this date) WHO S LAFHAing Now? The recently-announced changes to the Living Away From Home Allowance have been deferred until October This article looks at how the new rules will apply in practice, including the transitional arrangements. Background In the Federal Government s Tax Forum in October 2011 concerns were raised that the Living Away From Home Allowance (LAFHA) was being exploited, and that the rules should be tightened. In the National Tax and Liaison Group FBT sub-committee meeting of 17 February 2011, the Tax Office also raised concerns over how the allowance was being exploited, citing cases of remuneration packages being heavily weighted towards the LAFHA component including one such case where the LAFHA component made up 90% of the total remuneration received. The LAFHA has increased in popularity in recent years as it subject to concessional tax treatment for both the employer and the recipient employee: For the employer, the LAFHA is FBT-free up to certain limits, and no superannuation is payable on the amounts; For the employee, LAFHA amounts are tax-free, and a range of other associated tax-free benefits can be enjoyed such as moving expenses. The Changes To address the above concerns, the Government has made the following changes: Limiting LAFHA access to employees who maintain a home for their own use in Australia, that they are living away from for work; Limiting LAFHA access to a maximum period of 12 months in respect of an individual employee for any particular work location; Require all LAFHA recipients to substantiate their actual expenditure on accommodation and food beyond a statutory amount. To provide employers with an opportunity to adapt, the start date for these changes has been deferred from 1 July 2012, and will now commence on 1 October Employee Tax Treatment In a total overhaul of the allowance, from 1 October the tax treatment of LAFHAs will come under the income tax system rather than the FBT system. LAFHAs will from this date, broadly speaking, be treated in the same way as motor vehicle allowances and laundry allowances. Employees who maintain a home in Australia for their own use, and who are required to live away from home for work purposes will be able to claim an income tax deduction for reasonable substantiated expenses incurred on accommodation and any food and drink expenses beyond $42 per adult and $21 per child per week. The deduction will be limited to 12 months per location (other than for fly-in-fly-out workers). To be eligible for the deduction, the employee s usual place of residence must continue to be available for their immediate use and enjoyment at all times while they are living away from home. That is, you must incur expenses such as rent, mortgage repayments, rates etc. In other words, your residence cannot be rented out or sub-let while 3

4 September/October 2012 BIMONTHLY you are living away from home. You must be able to return to the home at any time and take up immediate occupancy. This component of the allowance (i.e. reasonable accommodation expenses and the food and drink component in excess of the $42/$21 amounts) will also be assessable income to the employee and be required to be reported on their payment summary. To claim the deduction, all individuals in receipt of a LAFHA will be required to substantiate their actual expenditure on accommodation. Food expenses will also need to be substantiated where the expense exceeds an amount specified in a determination by the Commissioner (not yet released). If employees claim a deduction for amounts in excess of this amount, the full amount must be substantiated. Cameron comes to Australia from America to work as a solicitor for two years with a view to eventually becoming a permanent resident. He purchases a house in Brisbane. One year into the contract, his employer asks him to relocate to Sydney for a period of six months. Cameron rents out the house in Brisbane while he works in Sydney. Cameron is not entitled to clam a deduction for reasonable expenses that are substantiated for accommodation and food and drink exceeding $42 for an adult or $21 for a child per week incurred while living in Sydney. Although he owns a home in Australia, by renting it out it is not available for his immediate use and enjoyment. This component of the allowance will be assessable income for Cameron and be required to be reported on his payment summary. Employer Tax Treatment From an employer standpoint, if an employee satisfies the requirements to claim an income tax deduction and has provided the employer with a declaration, then the LAFHA representing $42 for an adult or $21 for a child per week will be treated as a fringe benefit to the employer. Employers will then be able to apply the otherwise deductible rule to this component to reduce the value the fringe benefit to zero. The following table, adapted from the Explanatory Memorandum to the legislation, summarises the changes: NEW RULES -Most LAFHA payments will be assessable income to the employee -Employees who are required to live away from home by their employer for work purposes, and maintain a home in Australia will be able to claim an income tax deduction for a period of 12 months in respect of any one location OLD RULES -LAFHA are a fringe benefit taxable to the employer -The taxable value of the benefit is reduced by the reasonable accommodation and reasonable meal component -Exemptions and concessions apply to accommodation, food or expense payments provided by the employer for reasonable expenses that are substantiated for accommodation and food and drink expenses exceeding $42 for an adult or $21 for a child per week -If an employee satisfies the requirements to claim an income tax deduction and has provided the employer with a declaration, then the LAFHA representing $42 for an adult or $21 for a child per week will be treated as a fringe benefit to the employer CASE STUDY Bill and Edna are married and both work for the same national company. On 10 October 2012, they are posted to Perth for a period of nine months. During this time, they continue of maintain their home in Brisbane to which they return for occasional long weekends. Because they are maintaining their home while living away from it for work purposes, Bill and Edna will be able to claim a deduction for their own share (i.e. 50%) of accommodation and food and drink expenses exceeding $84 per week ($42 each). This ensures that only additional expenses are deductible. This component of the allowance (i.e. the accommodation expenses and the food and drink component in excess of the $42/$21 amounts) will be assessable income to Bill and Edna and be required to be reported on their payment summaries. Where Bill and Edna have provided a declaration to their employer that includes a statement that they will incur food and drink expenses, the $42/$21 per week will be treated as a fringe benefit. If this declaration is not provided, these amounts will be assessable income to Bill and Edna. Employer Withholding From 1 October 2012, employers will be required to withhold PAYG from the part of the allowance that is assessable income to the employee (i.e. accommodation expenses and the food and drink component in excess of $42/$21). However, the Tax Office proposes to put in place a class PAYG withholding variation so that employers do not have to withhold tax from a LAFHA where the employee is expected to incur deductible LAFHA expenses up to or in excess of the allowance paid to them. Withholding will still however be required where the employee is not expected to incur expenses up to the amount of the allowance paid to them. Transitional Arrangements No FBT is payable on the reasonable accommodation or reasonable food component The changes will generally apply from 1 October

5 2012 Transitional rules will however apply to permanent residents and temporary or foreign residents who had LAFHA arrangements in place prior to 8 May 2012 (Budget Night) as follows: Transitional Arrangements for Permanent Residents The requirement that permanent residents must be maintaining a home in Australia for their own personal use and enjoyment and that they can only claim deductions for accommodation and food and drink expenses for the first 12 months that they are required to live away from home for work, will not apply to permanent residents with a pre 8 May arrangement in place until the earlier of: 1 July 2014; or The date that a new employment arrangement is entered into or a material variation is made to an existing arrangement. Transitional Arrangements for Temporary and Foreign Residents The requirement that an employee who is a temporary or foreign resident can only claim deductions for accommodation and food and drink expenses for the first 12 months that they are required to live away from home for work will not apply to temporary or foreign residents with a pre 8 May arrangement in place until the earlier of: 1 July 2014; or The date that a new employment arrangement is entered into or a material variation is made to an existing arrangement. The requirement that they maintain a residence for their own personal use and enjoyment will however apply to all temporary and foreign residents from 1 October 2012, irrespective of whether they had a pre 8 May arrangement in place. TRANSITIONAL ARRANGEMENTS - A STING IN THE TAIL! Any material variation to an existing employment arrangement triggers the commencement of the new arrangements. According to the Explanatory Memorandum, the following will constitute a material variation : An extension of time of an existing contract; A change in salary of an employee; A change in the working hours of an employee. Thus, while the transitional provisions sound generous (allowing existing arrangement to continue until 1 July 2014), in many cases the transitional provisions may be rendered redundant, with many employees receiving an annual increase in salary. Note that changing an employee s name on an employment agreement (for example, they get married and change their last name), or fixing a typo on an employment agreement will not, according to the Explanatory Memorandum, constitute a material variation for the purposes of the new rules. Jason is a permanent resident who has a three-year employment contract (which includes a LAFHA) with his employer which expires on 1 January 2013, at which point he re-signs for another year. Until he re-signs, the new requirement that he must maintain a home in Australia, and that he can only claim a tax deduction for 12 months in respect of his employment at any one particular location will not apply to Jason and his employer until 1 January The other changes (i.e. income tax treatment etc.) will apply from 1 October Action Points Employees/employers and their advisors need to review their existing arrangements and ensure that they are still subject to the transitional arrangements. If not, then they will need to comply with all the new rules from 1 October All employers, irrespective of when an arrangement was entered into, should ensure that the arrangements are properly documented as the Tax Office has recently flagged a massive crackdown on LAFHA arrangements. What About Travel Allowances? For its part, the Government states that these measures will not affect the tax treatment of travel and meal allowances which are provided to employees who are required to travel from their usual place of work for short periods (generally up to 21 days). Provided they are within the Tax Office benchmark amounts, these allowances will remain as per current treatment that is: Tax deductible to the employer Not required to be shown on the employee s payment summary; Not required to have tax withheld; The employee does not need to provide written substantiation (e.g. receipts) except in respect of overseas accommodation costs. Because they are now subject to different tax treatments, it is important to distinguish between LAFHAs and travel allowances. On the one hand, LAFHAs are paid where an employee has moved and taken up temporary residence away from his or her usual place of residence so as to be able to carry out their job at the new but temporary workplace. They do however have a clear intention/expectation of returning home on the cessation of work at the temporary location (in this sense, they are absent for a limited/finite period of time). On the other hand, a travel allowance is paid for specific trips because the employee is travelling in the course of performing their employment duties but has not temporarily relocated as a LAFHA recipient would. The existing work location continues to be the employee s regular place of work. In travelling away from home, the employee simply takes travel items as opposed to residential belongings such as furniture. Employees receiving a travel allowance will also typically use temporary styles of accommodation such as hotels. 5

6 September/October 2012 BIMONTHLY DIRECTING YOUR FEES Recently, the Tax Office announced a crackdown on accruing directors fees. Paid by most companies towards the end of a financial year, this article is essential reading for all companies that pay directors fees. The Alert In late 2011, the Tax Office released Taxpayer Alert 2011/4 which describes an arrangement where a company claims a deduction for directors fees notwithstanding that there is no payment to the directors of these fees in the current or in subsequent income years. The intention in such arrangements is to never make the payment even though the company has passed a resolution that the fees be paid at some future time. To be clear, the Tax Office is not concerned about the quite common arrangement where a company resolves to make a payment for directors fees before 30 June, claims a deduction in that year, but then does not make the payment until early in the following financial year. The arrangements that concern the Tax Office have the following features: (a) Prior to 30 June in an income year, a directors meeting of a private company is held to consider the remuneration of the directors for that year. (b) The meeting resolves that directors fees of a specific amount be paid to the directors and the minutes reflect that the company is immediately, definitely and irrevocably committed to the payment. (c) The meeting qualifies this resolution by further resolving that the directors fees be paid at a time to be determined having regard to future cash flow and that amounts be held in a directors fees payable account until payment can or is made. (d) The company claims a deduction for the directors fees in the year of resolution but makes no payment to the directors. (e) The directors do not include any amount in their assessable income until such time as the company pays an amount to them. (f) In the following year, the company makes nil or minimal payments to directors despite the company declaring profits and, in some cases, making loans to directors. (g) The practice may continue in later income years. MISCHIEF The advantage that is being derived in such arrangements and what concerns the Tax Office is that the mismatch between the payment and the deduction creates a tax advantage for the company i.e. while the company is claiming a deduction for an amount paid, the director is not being assessed on that amount as they have not received it. Getting it Right Although the Alert applies to the payment of directors fees, it is equally applicable to staff bonuses. It s quite common for companies to resolve at year-end to pay staff bonuses, but not actually make the payment until the following financial year. So what steps should your company take in order to avoid falling foul of the Taxman? It should at least consider the following: 1. Unconditional Resolution In Income Tax Ruling IT 2534 the Tax Office outlines its views on the taxation treatment of directors fees stating that accrued directors fees and staff bonuses are only deductible if the employer is definitely committed to making the payment. Consequently, it s essential that your company, via an appropriately worded minute, makes an unconditional resolution in the shareholders meeting making the company definitely committed to making the payment. The resolution must not be conditional; it must not be subject to cash flow considerations etc. COMPANY ABC PTY LTD Minutes of Shareholders Meeting Venue: Brisbane St, Brisbane Date: 30 June 2013 Present John Smith, Sue Jones Directors Fees: It was resolved to pay directors fees (staff bonuses) to the directors for their services to the company during the 2012/2013 income year. The following amounts are payable: 2. Time Limit As stated, the Tax Office is not concerned about arrangements where resolutions are made towards the end of one financial year, but not paid until the next financial year. Indeed in relation to both directors fees and staff bonuses it s sometimes actually necessary to delay the payment of the amount until the next financial year as the amount may not be known at 30 June. For example, a staff bonus could be dependent on financial year profits of the company (which may not be known until after 30 June), or the amount could be dependent on employee performance for the month of June (which may not be finally determined until July). Unfortunately the Tax Office does not provide any concrete guidance as to when amounts that have been resolved to be paid must be paid. It only states in IT 2534 that they must be paid within a reasonable period and acknowledges that this could extend outside the immediate year of income. As to what is a reasonable period, as a rule of thumb, the payment generally should be made by the end of the calendar year, and certainly never later than the end of the next financial year. 3. Other Documentation In terms of substantiating the amount that has been resolved to be paid, a journal entry recording the directors fees or staff bonus should be recorded as at 30 June. With respect to staff bonuses, you should also review employment agreements to ensure that they make provision for the payment of a bonus. 6

7 HEALTHY, WEALTHY AND WISE Following the introduction of new means-testing rules, this article looks at how the private health insurance rebate is to be claimed for coverage in 2012/2013. For the many people who have coverage, we detail how you can enjoy a cash flow benefit in making your claim. Background Effective 1 July 2012, the private health insurance rebate has been means-tested. The following table sets out the new Medicare levy surcharge (MLS) and private health insurance rebate rates which are now law. Under the changes, affected taxpayers are broken into three tiers: Tier 1 Singles with income between $ $97 000; and couples/families with income between $ $ Tier 2 Singles with income between $ $ ; and couples/families with income between $ and $ Tier 3 Singles with income of $ or more and families with income of $ or more The private health insurance rebate will be 20%, increasing to 25% at 65 years of age, and 30% at 70 years of age The Medicare levy surcharge for not having private health insurance will remain at 1% The private health insurance rebate will be 10%, increasing to 15% at 65 years of age, and 20% at 70 years of age The Medicare levy surcharge will increase to 1.25% No private health insurance rebate is available for taxpayers of any age The Medicare levy surcharge will increase to 1.5% INCOME For MLS purposes (and for rebate purposes in the table above), your income is the sum of your: Taxable income (including the net amount on which family trust distribution tax has been paid); Reportable fringe benefits (as reported on your payment summary); Total net investment losses (including losses on shares and rental properties); Reportable employer superannuation contributions (including those made under salary sacrifice arrangements) and deductible personal superannuation contributions Exempt foreign employment income Less If you are aged 55-59, any taxed element of a lump sum superannuation benefit, other than a death benefit, which you received that does not exceed your low rate cap (which is $ for 2012/2013). Your spouse s income for MLS purposes is the total of their: Taxable income (including the net amount on which family trust distribution tax has been paid); 2012 Reportable fringe benefits (as reported on your payment summary); Total net investment losses (including losses on shares and rental properties); and Reportable employer superannuation contributions (including those made under salary sacrifice arrangements) and deductible personal superannuation contributions Making a Claim Despite the changes to the rebate, the methods for claiming your rebate remain the same, as follows: 1. Your health fund can provide the rebate as a premium reduction this can be done at any time in 2012/2013 by notifying your health fund. 2. Where the full, upfront cost of the premiums has been paid, you can apply for a cash payment from the Government via your local Medicare office. This can be done at any time in 2012/2013 by going to a Medicare office; or 3. The rebate can be claimed as a tax offset through your tax return if the full, upfront cost has been paid. For amounts paid after 1 July 2012, this can only be done when completing your 2012/2013 tax return. For amounts paid before 1 July 2012, the Tax Office has confirmed on its website that you will be able claim the full 30% offset for those 2012/2013 premiums in your return. This is a strategy we flagged in our May/June newsletter and is a bonus if your 2012/2013 earnings are likely to exceed the relevant thresholds! Under Methods 1 and 2, you have to estimate the total of your and spouse s 2012/2013 MLS income in order for Medicare Australia or your private health fund to calculate your rebate entitlement. The final calculation of your entitlement to the rebate will be done by the Tax Office when you lodge your return, as it is only then when your and your spouse s income for 2012/2013 will be known. Your Final Payment Where your income estimate is incorrect and you have claimed too much rebate (via Methods 1 or 2) the Tax Office will recover the amount as a tax liability. This amount will be displayed on your 2012/2013 Notice of Assessment. On the other hand, where you have under-claimed, the Tax Office will credit this amount to you on your 2012/2013 Notice of Assessment as a refundable tax offset. TAX TIP If you over-claim (by understating your income), there are no penalties for doing so. Conceivably, you can claim the full 30% rebate via Medicare or your health fund (by stating that your income falls below the Tier 1 threshold) and enjoy the cash flow benefit of the full 30% rebate and not have to pay it back until up to 12 months later when you lodge your 2012/2013 tax return. 7

8 September/October 2012 BIMONTHLY CONTRACTOR KIT The changing social and economic environment has seen a marked increase in the use of independent contractors as opposed to employees in the labour market. Generally workers will be classed as either independent contractors or employees, with each classification attracting a range of very different income tax, GST, record keeping and insurance requirements. If you are contractor, this kit provides you valuable information about these requirements. Getting Started Check Your Classification Because they have such markedly different requirements, it s important at the outset to confirm your status as either an employee or contractor. In making this determination, the Tax Office takes into account a range of factors, none of which on its own is decisive: of your status as an employee or contractor, rather than make this common law determination yourself, you should confirm with your advisor (particularly given the markedly different consequences that can flow from the two different categories). Trading Structure As a contractor, you can choose to provide your services through a company, trust, partnership or as a sole trader. Each structure has its strengths and weaknesses with your choice ultimately depending on a range of factors such as asset protection, establishment costs, ongoing compliance costs, your ability to admit other business partners etc. The following table offers a simplified, comparative snapshot of the merits of each structure. Bear in mind you can always change your business structure as your business and needs evolve, however be mindful that there may be stamp duty and CGT consequences in doing so. Factors to Consider Company Trust Partnership Sole Trader Factors to Consider Employee Contractor Cheap to set up and administer No No Yes Yes Control over work/ independence Method of payment Commercial risks Ability to delegate Tools and equipment Nature of engagement The employee s working conditions (hours etc.) are generally regulated and so to is the manner in which they complete their work. Employees work in the business Payment is based on the period of time worked The employer is legally responsible for any work performed by the employee Employees must perform the work personally Employers supply the tools and equipment Employed on an ongoing basis, with recurring tasks Although your task is specified, you have freedom/ discretion in the way the task is completed Payment is dependent on the performance of the contract The contractor bears the legal risks in respect of the work and is responsible for rectifying defects Unless otherwise specified, contractors can delegate or subcontract the work to a 3 rd party Contractors generally supply their own at their own expense Engaged to complete a specific task To assist in making this determination, the Tax Office has designed an Employee/Contractor Decision Tool which is available for use on its website. Although in clear cut cases the tool can be useful, it can be inflexible and in complex cases can provide incorrect determinations. Where you are unsure Limited record keeping and reporting Minimal legal requirements Profits are added to your personal income Ability to admit business partners/ succession planning friendly Protection from personal liability No No Yes Yes No No Yes Yes No* No* Yes Yes Yes No Yes No Yes Yes No No CGT friendly No Yes Yes Yes *See PSI rules section on the following page. Registration As a contractor, consider registering for the following: ABN As a contractor you will be deemed under the law to be carrying on an enterprise. Therefore, you will need an ABN and will need to quote this ABN on the tax invoices that you provide to your payers. If you fail to register for an ABN or fail to quote your ABN on invoices, there is a legal obligation on the payer to withhold 46.5% tax from any payment made 8

9 2012 to you for your services. You will not be able to recoup this amount withheld until you lodge your income tax return at the end of the financial year. GST Registration If the income from your contracting services is expected to be greater than $ per annum, you must register for GST you don t have a choice. Even if your contracting income is not expected to reach these heights, you can still register for GST and there are a number of advantages in doing so, including the ability to claim back the GST on your work-related purchases (e.g. stationery, equipment etc.). Without registering, you can t claim back the GST charged on such purchases. Once registered for GST, you must generally charge 10% on work you perform for payers. Paying Your Tax Employees pre-pay their tax each year by having amounts withheld from their wage each pay cycle. On the other hand as a contractor you generally don t have any tax taken out of your payment when your invoice is paid by your payer. To put contractors on an equal footing with employees, as a contractor you will be subject to the PAYG instalments system which will require you to make prepayments of your income tax generally on a quarterly basis on your BAS. This then ensures that come the end of the year you will have made provision for your annual income tax liability. In terms of how much you pay each quarter, this will generally be based on your previous year s income, and will either be worked out for you by the Tax Office (with a set dollar figure provided to you on your BAS) or the Tax Office will provide you with an instalment rate (which you then multiply by your income for the respective quarter). You can vary the Tax Office dollar figure, however penalties may apply if your variation results in you paying an amount that is less than 85% of the actual tax payable on your business and investment income for the year. Therefore, before you make a variation you should consult with your advisor. At the end of the year when you lodge your tax return, if the tax owing on your taxable income is less than your PAYG instalment prepayments, then you may receive a refund (all other things being equal). On the other hand, if the tax owing on your taxable income is more than your PAYG instalment prepayments, you will receive a tax bill. Typically speaking, there will be a tax bill faced by contractors in the first year that they perform contracting services, and sometimes even the second year. This is because there can be a significant lag between when you first start providing contracting services and when the Tax Office first start imposing a PAYG instalment obligation on you. It is therefore important in these early days to be setting aside a provision for the eventual tax bill. You should speak to your advisor about how much to set aside so that the jolt of the eventual tax bill is not as great. PSI Rules The Personal Services Income (PSI) rules are a suite of Tax Office provisions designed to prevent persons who derive income primarily from their personal services from splitting or alienating that income with other persons. If you are a contractor, irrespective of the trading structure you are using, there are a number of tests that need to be considered in order to determine whether or not the income you have derived will be deemed to be PSI. If your income is deemed to be PSI, this means: You will be unable to claim certain deductions against your PSI. Broadly speaking, your deductions will be limited to those of a normal employee; Your PSI, less allowable deductions will be attributed to you, and therefore included in your individual tax return, and taxed at your individual marginal tax rates as though your were an employee. (This means that your income if you operate through a company will not be taxed at the corporate rate of 30% or where you operate through a trust, you won t be able to distribute the PSI to other beneficiaries who have a low marginal tax rate); and You will have special tax return obligations, namely regardless of which trading structure you operate through, you will need to lodge an individual tax return and include the PSI income. Additionally, if you operate through a partnership, company or trust, that entity will also need to lodge an income tax return and also complete a Personal Services Income Schedule reporting the PSI amount. Such entities will also be required to prepare financial statements (with companies also required to make an annual filing with the Australian Securities and Investments Commission (ASIC)). On the other hand, if you operate as a sole trader, you must complete a Business and Professional Items Schedule (in addition to your individual tax return), and include the PSI in that schedule. THE TESTS To determine if the PSI rules apply, your business needs to work through a series of tests: 1. The Results Test This test is applied first. If you pass the Results Test, the PSI rules do not apply to you. (This test is failed unless 75% or more of your income during the year was in relation to you (a) being paid for achieving a result (b) needing to provide your own tools and equipment and (c) being responsible for rectifying any defects in your work) % Rule (If the Results Test is failed, you must then apply the 80% Rule. This rule simply asks: Does 80% or more of your PSI come from one client?. If the answer is yes, then the PSI rules apply. If the answer is no, then you must satisfy one or more of the following tests): 3. Unrelated Clients Test (You pass this test if you receive your PSI through two or more unrelated clients and you provide your services as a direct result of making offers or invitations (such as advertising) to the general public) 4. Employment Test (You pass this test if in an income year you get employees, partners in a partnership or other contractors to perform 20% or more (by market value) of the principal work). 9

10 September/October 2012 BIMONTHLY 5. Business Premises Test (You fail this test unless during all of the income year your business premises was (a) owned or leased by you (b) used for personal services work more than 50% of the time (c) used exclusively by you (d) physically separate from your residence and your associates residence and (e) physically separate from the business addresses of your clients and associates. Thomas is an contracting architectural consultant who operates through a company structure. During the year, Thomas undertakes work for just one client and under the terms of that contract, he is not liable for any loss arising from his work, and bears no obligation to remedy any defects. Thomas works at the client premises during normal office hours. Other details include:: The company s assessable income for 2011/2012 was $ (GST-exclusive), consisting solely of Thomas s fees for his architectural services); The deductions relating to this income (stationery, drawing boards etc.) were $15 000; He also incurs public transport expenses of $1 000 in travelling from home to the office; Thomas s company also owns a negatively geared share portfolio with deductible interest of $ (on the loan used to purchase the shares). On these facts, Thomas does not pass the results tests as more than 75% of his income related to work where he was not responsible for rectifying defects. As such, he is automatically subject to the PSI rules. Consequently, Thomas s contracting income will be assessable to him at his marginal tax rate (46.5%) rather than assessable to his company at the 30% corporate rate. Furthermore, the company will not be able to distribute that income, by way of dividends, to any other shareholders of the company. It will all be assessed to Thomas. Deductions The deductions you are entitled to claim as a contractor depend principally on whether your income is classed as PSI. If your income is PSI then your deductions are basically limited to those that you would be entitled to claim were you an employee who earned that contracting income. Therefore, you cannot deduct rent, mortgage interest, rates, land tax etc. relating to your residence (however, home office heating and lighting expenses remain deductible). You can also not deduct amounts paid to an associate to do non-principal work (e.g. amounts paid to your spouse for performing an administrative role). Typical contractor expenses may include: Briefcases, laptop cases, tablet cases etc. Income protection insurance; Professional indemnity and public liability insurance; Membership fees to professional associations; Work-related equipment such as computers, hardware, laptops, tablets, SmartPhones, ipods, calculators, furniture used in your home office, etc. Professional journals and trade magazines; Reference books; Travel expenses (e.g. train fares, parking and tolls) but only where the trip itself is deductible; Stationery; Self-education expenses and personal development courses where a strong connection exists between the subject matter and your income-earning activities; Accounting fees for preparing returns, and other tax advice; Software; Business name registration fees. Note that, the PSI regime does not prohibit deductions to the extent that they relate to: Gaining work (advertising, tendering); Engaging an entity that is not an associate to perform work; Personal superannuation contributions; Meeting obligations under workers compensation law; Deductions by SBEs in respect of depreciating assets. The entity itself (i.e. your company, trust etc.) is also entitled to claim deductions for entity maintenance expenditure (e.g. ASIC lodgement fees for a company), car expenses for a car that has no private use, salary and wages where you are employed by the entity, superannuation payable to you. Following on from the earlier example, while Thomas can claim the stationery and drawing board fees as deductions (as these relate directly to his contracting income), he cannot claim: The interest expenses on the shares (as this was not incurred with respect to his contracting income. This cost may still be a deductible expense to his company, but is not attributed to Thomas as a deduction against his contracting income); The travel from home to work. As Thomas s income is PSI, his deductions are restricted to those of a normal employee which means that travel from home to work is not deductible. If the income is not PSI then your entity can claim all its expenses it incurs in relation to gaining its assessable income. These will include prohibited items that you can t claim if your income is PSI such as: Reasonable amounts paid to an associate for performing non-principal work; Contributions to a superannuation fund in respect of an associate performing non-principal work; 10

11 2012 Expenses or FBT for more than one car that is used partly or solely for private purposes; Rent, mortgage interest, rates or land tax for your home that is used as a place of business. Following on from the earlier example, assume instead that Thomas passed the PSI tests and therefore his company was carrying on a personal services business. It would therefore have the PSI assessed to it at the corporate tax rate, and be able to distribute that income to other shareholders (perhaps on lower marginal tax rates) via a dividend. Additionally, although not directly related to the PSI, the interest on the shares can be used to reduce the PSI income. Record Keeping Records are normally required to be retained for five years from the time they are prepared or the transactions to which they relate are completed whichever is the later. Records can be kept either electronically or in hard copy, but must be readily accessible. Income Tax You need to keep records of all of the income you have received including bank statements, invoices sent out etc. Likewise, you need to retain documentation for your workrelated expenses such as receipts/dockets, tax invoices, bank account statements, credit card statements. Without such records, you cannot claim deductions. You also need to keep records showing how you worked out any private (non-business) component of an item you purchased. Note that special record keeping requirements apply to motor vehicle expenses and vary depending on the method you use to calculate your claim. TAX TIP The four methods used to calculate your motor vehicle deductions each have their own advantages: 1. Cents per Kilometer Method The advantage of using this method is that very little record keeping is required. You only need to be able to explain how you arrived at your calculation. You do not need any documentary evidence in the way of receipts etc % of Original Value Method Other than evidence of the original cost of the vehicle (which can be obtained from purchase contracts for example), or its market value at the time you first leased it, you do not need written evidence under this method, but you do need to keep a record of how you worked out your kilometres. 3. One-Third of Actual Expenses Method This is a good method to use when your operating costs are high (you can claim one-third of these). Written evidence of all expenses is required, however fuel and oil expenses may be substantiated by odometer records. 4. Log Book Method Under this method, your claim is based on the running costs and ownership costs of the vehicle multiplied by the business use percentage which is calculated over a 12 week log book sample which you are required to maintain for that period. This method generally gives the best result where the vehicle has substantial business use. GST It is essential that you retain tax invoices for your work-related purchases these substantiate the amount of your GST claim. Moreover, you cannot claim GST credits on a purchase until you are in possession of a valid tax invoice from the supplier. Superannuation As a contractor, your superannuation entitlements will vary according to the style of structure through which you operate: Sole Trader Despite being classed as a contractor you may be eligible for superannuation support by your payer. If you perform your services under a contract that is wholly or principally for your labour (i.e. more than 50%) you will be entitled to receive superannuation. A contract may be considered as wholly or principally for your labour where you (a) are paid for you personal labour and skills (b) must perform the work personally and (c) are paid by reference to your hours worked (as distinct from being paid for achieving a result). Companies/Trusts If you operate through a company or trust structure, your payer will not be liable for superannuation. Note that if your company or trust employs you and you are not caught by the PSI rules, then your company and trust may have a superannuation obligation. On the other hand, if you are caught by the PSI rules, then your company or trust will not have a superannuation obligation as PSI is not classified as Ordinary Time Earnings. Insurance Insurance is an essential piece of the puzzle for contractors. You should consider the following styles of insurance: Professional Indemnity (PI) insurance provides cover from potential threats, such as claims or alleged negligence or breach of duty arising from an act, error or omission in the performance of your professional services. Public liability insurance protects you from legal and medical costs that arise from incidents causing personal injury or property damage to third parties, should you be found negligent. Income Protection insurance provides you with a monthly income (typically up to 75% of your usual earnings) if you are unable to earn your normal income due to illness or injury. The benefit paid could be used for living expenses, regular investment or other costs. Trauma/Critical Illness insurance provides you with a lump sum benefit on the diagnosis of a medical condition e.g. cancer etc. 11

12 September/October 2012 BIMONTHLY UNDERSTANDING DEPRECIATION Depreciation is something which affects virtually every business and is often a sizeable claim made each year. Effective 1 July 2012, significant changes were made to the small business depreciation rules. In this first of a two-part depreciation series, we look at the depreciation rules for all classes of taxpayers small business, business and non-business for those items that attract an immediate write-off. Three Classes The applicable rules for claiming an immediate deduction for depreciating assets depend upon the profile of the taxpayer with different rules applying to the following three categories: 1. Small Business Entity While claims for depreciation are generally governed by the uniform capital allowances (UCA) system, small business taxpayers (otherwise known as Small Business Entities (SBEs)) have access to simplified depreciation arrangements. A standard eligibility criterion applies to access the SBE depreciation, income tax, FBT and GST concessions, namely the SBE test which requires that an entity: Carries on a business; and Has a GST-exclusive turnover of $2 million or less in an income year (including the turnover of any affiliated or connected entities). In assessing your eligibility you can use the projected turnover in the current year, or your prior year turnover. To access the SBE depreciation concessions, you do not need to make an election or notify the Tax Office. The way in which you complete your tax return will be evidence of whether you are claiming the concessions. 2. Non-Business Taxpayers In terms of claiming an immediate deduction for a depreciating asset, under the UCA system special rules apply for nonbusiness taxpayers i.e. those who are using depreciating assets to earn assessable income but who are not carrying on a business. This group may include: Employees who purchase a briefcase; Share investors; Employee tradesmen who purchase tools; or A rental property owner who purchases furniture. TAX TIP Central to all of the immediate write-off thresholds, and for that matter all depreciation assets generally, is the concept of cost. Depreciation is calculated based on the cost of an asset, with the immediate write-off thresholds also based on an asset s cost. The cost of an asset consists of two elements: 1. The amount you paid to hold the asset (i.e. generally the purchase price) 2. The amount you paid to bring the asset to its present condition and location. While the first element applies to virtually all assets, the second element will only apply to some. The cost rules apply regardless of whether the asset acquired is new or second-hand. 1. SBEs New rules introduced on 1 July 2012, allow SBEs to writeoff depreciating assets costing less than $6 500 (up from $1 000). The threshold is GST-exclusive ($7 150 including GST). You can write the depreciating asset off at the end of the income year where you either: Start to use it for a taxable purpose; or Have it installed ready for use for a taxable purpose. During the 2012/2013 income year, Brett s Landscaping buys a $3 000 ride-on mower for use in its business. As the mower is a depreciating asset and costs less than $6 500, the business can claim an immediate deduction in its 2012/2013 tax return (provided the mower was used in the business during the year). If the cost of the asset is less than $6 500 but you use the asset only partly for a taxable purpose, the deduction available must be apportioned. On the other hand, if the cost of the asset is $6 500 or more, but the taxable purpose portion is less than $6 500, the asset is not eligible for an immediate write-off but must instead be allocated to the general small business pool. Following on from the earlier example, assume instead that the mower cost $7 000 but was used only 50% for business purposes. Despite the asset s depreciation value being below the $6 500 immediate write-off threshold (in this case $3 500), the business cannot claim an immediate deduction for the mower as the cost of mower exceeds the $6 500 write-off threshold. To depreciate this asset, Brett must allocate the $3 500 to the general small business pool for the 2012/2013 year (with a 15% claim available in the first year, and 30% in subsequent years). 3. Non-SBE For businesses that are not SBEs (have an annual turnover exceeding $2 million) or elect not to use the SBE concessions, your depreciation claims are governed by the UCA system. SBEs that choose to use the simplified rules, can also claim an immediate deduction for the taxable purpose portion of additions to existing assets provided the asset itself and the addition to the asset both cost less than $

13 2012 Following on from the earlier example, this time assuming that the cost of the mower is $3 000 Brett later spends a further $1 500 on a new component for the mower. This new component is a second element cost of the mower. As the second element cost of the mower is less than $6 500 and relates to an asset that is also less than $6 500, the business can claim an immediate deduction for the cost of the component. In the following income year, the business spends a further $800 on another new component for the mower. As the business has already claimed a deduction for the cost addition (i.e. the first new component), this $800 addition must be allocated to the general small business pool (with a 15% claim available in the first year, and 30% in subsequent years). What s That About Cars? As part of the new SBE rules effective 1 July 2012, the Government has introduced generous rules for the depreciation of cars, namely that SBEs can write-off $5 000 of a car costing $6 500 or more in the income year in which they start to use the car (new or second-hand). The remaining value is depreciated through the general pool at a rate of 15% in the first year and 30% in later years. With most cars under the new and old rules allocated to the general pool, the new $5 000 instant deduction in the year of purchase will provide significant cash flow relief for SBEs. Despite this new $5 000 deduction in the first year, where a car costs less than $6 500, it can still be written-off in its entirety in the year that you start to use it in your business. 2. Non-Business Taxpayers Non-business taxpayers (e.g. employees, rental property owners, investors etc. who are not carrying on a business), can claim an immediate deduction for the cost of an asset where all of the following conditions are met: It cost $300 or less; You used it mainly (i.e. more than 50% of the time) for the purpose of producing assessable income that was not income from the carrying on of a business; and It is not part of a set of that you acquired during the year that cost more than $300, and is not one of a number of identical or substantially identical items you acquired during the year that together cost more than $300. Bruce individually purchases six identical dining room chairs for his sole rental property, each valued at $280. Despite using the chairs to produce non-business income (i.e. rental income from his one property) and despite each item costing less than $300, Bruce cannot claim an immediate deduction for the chairs as they are substantially identical and together they cost more than $300. Beth, a teacher, purchases a series of six instruction books for manual arts students valued at $200 each. The books, although sold separately, are a series of books that follow on from the other. As they are part of a set, and marketed as a set, even if they are purchased each at different times throughout the year, the cost of the six books must be aggregated for the purposes of the $300 immediate write-off threshold. As such, they are not able to be immediately written-off. GST? For the purposes of the $300 threshold, the cost of a depreciating asset is reduced by any GST credits you can claim in relation to the asset, meaning: If you are entitled to claim a GST credit for the asset, the GST is not included in the $300 threshold (the threshold is effectively $330); By contrast, if you are not entitled to a GST credit for the asset, the cost of the asset includes the amount of GST included in the purchase price. 3. Non-SBE For businesses that are not eligible for or choose not to adopt the SBE concessions (e.g. those with an annual turnover of more than $2 million, including the turnover of affiliated and connected entities), your business will be able to immediately deduct tangible assets that cost $100 or less which are used in the ordinary course of your business. Examples of such assets include office equipment (such as scissors, staplers, ring binders, hole punches etc.), catering items (e.g. cutlery, cups, table cloths etc.), hand tools used by a tradesman (e.g. hammers, screw drivers etc.), tools used by primary producers (e.g. clippers etc.). However, this rule does not apply to expenditure on: Establishing a business; Assets you hold under a lease, hire purchase or similar arrangement; Assets you acquired to lease or hire to another entity; Assets included in an asset register you maintain; Any asset that forms part of a collection of assets that is dealt with commercially as a collection; or Trading stock or spare parts. The $100 threshold includes GST. TAX OFFICE A large mining business with an asset register buys a large quantity of small items each year to use in various sections of the enterprise. The items range from goggles and torches to small hand tools. As these items cost $100 or less, and are not recorded on the asset register, they can be claimed as business deductions in the year of purchase and do not have to be depreciated. 13

14 September/October 2012 BIMONTHLY 2012/2013 TAX OFFICE INDI- VIDUAL TARGETS The Tax Office recently announced its 2012/2013 Compliance Program. The annual Compliance Program describes the risks that the Tax Office is most concerned about and what it intends to do to address those risks. This article looks at the areas the Taxman will be focusing on during the next 12 months from an individual perspective. Armed with this information, you should take extra care when dealing in these areas. Incorrect or Fraudulent Refunds Over the coming year, the Tax Office will focus heavily on detecting incorrect and fraudulent returns. This will involve a two-stage strategy of firstly warning taxpayers about potential incorrect claims before lodging, and secondly checking lodged returns through the use of various analytical tools, chiefly datamatching (whereby the Tax Office uses third-party information from bodies such as Centrelink, financial institutions etc. and compares it to the information you include on your return). Incorrect returns may come about in a variety of ways, including: Simple errors and oversights; A misunderstanding of entitlements; A lack of documentation to support your claim; Lodgement of deliberately false claims; and Identity crime. In the last year alone, more than income tax returns were stopped for potential over-claiming or fraud with almost of those requiring a full review, eventually resulting in the capture of approximately $200 million in revenue. Work-Related Expenses In checking returns for the coming year, the Tax Office will focus on the following occupations Plumbers; Information technology managers; and Defence force non-commissioned officers. These occupations have been targeted because the Tax Office believes that people in these groups are at a higher risk of making mistakes with their work-related expenses due to the types of deductions that they may be entitled to claim. The Tax Office is planning to write to approximately people employed in these industries about assistance that is available, including new guides developed specifically for these occupations. If you fall into one of these three occupations, take extra care in completing your return this year as the Tax Office advises that it will review all claims and, if necessary, request additional information to substantiate those claims. Tax Tip Occupation Specific Guides A quick search of the Tax Office website reveals that occupation-specific guides are now available for these three occupations. These guides detail exactly what expenses workers within these industries are entitled to claim. Even if you don t work within these industries, you may find a guide that covers your occupation. To access these occupationspecific guides, go to and type industries and occupations into the search box at the top of the page. Tax Avoidance Schemes This year the Tax Office will have a particular focus on investments by medical practitioners and other high income individuals. Widely marketed financial products that promise big tax benefits will come under scrutiny. While the Tax Office recognises that high income earners are more likely to be involved in tax avoidance schemes, this is not always the case, with a significant number of middle to low income earners also at risk. TAX TIP As an investor, take the following precautions before investing in financial products: Ask the promotors of the scheme whether there is a product ruling from the Tax Office. If so, then obtain the product ruling number; Seek independent advice from your accountant; Seek the views of the Tax Office. Omitted Income The Tax Office will be particularly focussing on detecting the following income this tax season: Dividend income; Interest income (detected by using the information obtained from financial institutions and matching it with that provided on your return); Capital gains (detected in part, by examining data from the State Revenue Offices around Australia); and Foreign income (detected by using information received under various tax treaties, through automated exchange of information and from the Australian Transaction Reports and Analysis Centre (AUSTRAC). Other Tips With more than 30% of taxpayers still lodging their own return this year, self-lodgers should avail themselves of the following: The individual tax return instructions on the Tax Office website; Occupational specific guides; Private binding rulings from the Tax Office if you are unsure how the law applies to your circumstances; Tax Help (a free Tax Office service which is available to low-income earners and those from a non-english speaking background). 14

15 2012/2013 TAX OFFICE BUSINESS TARGETS In this second of a two-part article, we look at the Tax Office s recently released Compliance Program, this time from a small-medium enterprise perspective (turnover between $2 million - $250 million, 80% of which have a turnover of no more than $10 million). This segment is quite broad and includes single entity structures such as private companies, partnerships and trusts through to more complex multi-entity structures, including offshore entities. This segment also includes over public company groups, SMSFs, as well as 400 larger superannuation funds. Who and what will the Tax Office be targeting in the coming 12 months? 2012 Division 7A Treatment of Private Company Profits Division 7A is an integrity measure in the Tax Act aimed at preventing private companies from making tax-free distributions of profits to shareholders and their associates. In recent years the Tax Office has taken an educative approach to its compliance activities in this area, but this is now set to change. Over the next year, the Tax Office will be adopting a more active verification strategy. This will include undertaking more than 100 letter and phone-based verification activities aimed at ensuring SMEs have appropriate loan agreements in place. The Tax Office will also use risk models to identity higher risk cases for more intensive reviews and audits. Taxpayers need to ensure that loan agreements are properly documented and that minimum repayments have been made under these agreements where required In particular, the Tax Office will focus on the application of Division 7A to unpaid present entitlements (UPEs). Wealthy Individuals High Wealth Individuals This segment includes Australian residents who, together with their associates, effectively control $30 million or more in net wealth. Since 1996, the Tax Office has maintained an ongoing compliance focus on this segment, which will continue over the course of the coming year. Currently the Tax Office is actively monitoring the compliance of more than HWIs, and over the coming year expects to complete more than 200 reviews and 50 audits of individuals in this segment. Wealthy Australians This segment includes those controlling a net wealth of between $5 million and $30 million (with more than individuals so far identified as being in this group). Over the coming year, reviews of major business transactions and changes in financial ratios will be undertaken to ensure the correct tax treatment in returns and activity statements. All told, the Tax Office expects to complete approximately 120 reviews and 50 audits within this segment. Use of Trusts With the ongoing changes to trust law (particularly the streaming changes, and the application of Division 7A to unpaid present entitlements), the Tax Office intends to undertake extensive compliance activity. This is a distinct change of approach from recent years where the uncertainty surrounding the law had seen the Tax Office adopt a gently, gently compliance approach to trusts. The Tax Office intends to contact around trustees and beneficiaries about a range of issues including lodgement, correct reporting of trust distributions as well as compliance with the trust TFN withholding rules. It also expects to undertake more than 30 reviews and at least 15 audits of aggressive trust arrangements. For more information on trust compliance, see page 18. Capital Gains Non-Disclosure and Incorrect Reporting On the CGT front, there will be a particular focus on: Incorrectly classifying ordinary income as capital gains in order to obtain a better tax outcome; Creating a company structure to enable a back-to-back rollover to achieve a deferral of tax; Claiming small business concessions when not eligible or incorrectly making a claim; Carrying forward capital losses despite not meeting the same business or continuity of ownership tests; The sale and subsequent non-declaration of taxable Australian property by non-residents. FBT Extensive compliance activity including more than 200 reviews and audits will focus on: Non-lodgement of returns despite providing fringe benefits to employees (particularly where employer motor vehicles are used for private purposes); Living away from home allowances (although these rules have are changing from 1 October 2012, you need to ensure that past, current and future arrangements are genuine and are properly documented). GST With more than reviews and audits expected to be conducted, the two main GST focus areas this year will be: 1. The failure to report real property sales on activity statements (particularly by property developers with a history of non-compliance); and 2. The incorrect application of the margin scheme to the sale of real property. 15

16 September/October 2012 BIMONTHLY WHAT A SUPER DEDUCTION Anecdotal evidence suggests there is confusion surrounding the ability of an employee to claim a deduction for personal contributions made to superannuation. Contrary to popular belief, many more people than just the self-employed may be entitled to a deduction. The Conditions You are eligible to claim a deduction for your superannuation contributions during the year if you meet the following six conditions: 1. You satisfy the 10% rule; 2. You meet the age-related conditions; 3. You made personal contributions to a complying superannuation fund or retirement savings account (RSA); 4. You made the contributions in order to obtain superannuation benefits for yourself, or your dependents in the event of your death; 5. You give the trustee of your fund notice of your intention to claim a deduction. 6. Your fund has acknowledged your notice and agreed to the amount you intend to claim as a deduction. Notice Condition 6 is regularly overlooked, with many taxpayers just making an otherwise deductible contribution and claiming the amount in their return. To be clear, if you fail to meet the notice requirements, you can not claim a deduction for your contribution. The notice that you provide must be in the approved form, namely you must complete a Deduction for personal super contributions form, advising the trustee of your fund of the amount you intend to claim as a deduction. The deduction cannot exceed the amount stated on the notice. The form, which is available on the Tax Office website, must be completed by whichever of the following dates occurs first: The day you lodge your income tax return for the year the contributions were made; or The end of the income year after the income year in which you made the contributions (for example, if you made a contribution in September 2012, the form must be completed by 30 June 2014 which is the last day of the next income year). CAUTION Be careful when completing the notice form itself. A deduction for a contribution cannot exceed the amount stated in the notice. Once a notice is lodged it cannot be revoked or withdrawn however it may be varied but only to reduce the amount stated in relation to the contribution the amount cannot be increased. A notice cannot be varied after the earlier of the time you lodged your income tax return and the end of the financial year following the year the contribution was made. A notice is not valid when: You are no longer a member of the fund (for instance, your benefits may have been paid out to you or you have rolled over your benefits in full to another fund); The fund no longer holds the contribution (for instance the amount has been paid as a lump sum benefit or it has been rolled over to another fund); The fund has commenced to pay you an income stream based in whole or in part on the contribution. Age Restrictions Pursuant to Condition 2, to claim a deduction you must meet the age restrictions. If you are under 18 at the end of the income year in which the contribution is made, to claim a deduction you must have derived income in that year from carrying on a business or income that is attributable to employee activities (see later for the definition of employee activities ). The legislation also imposes a maximum age limit requiring that, to be deductible, the contribution must be made no later than the 28 th day after the month in which the contributor turns 75 (e.g. if you turn 75 in September 2012, you are ineligible to claim a deduction for contributions made any time after 28 October 2012). Additionally, the contribution rules themselves impose another restriction, namely where you are aged 65 to 74 years, your superannuation fund may only accept your contributions if you are gainfully employed on at least a parttime basis during the income year in which you make the contribution (otherwise known as the work test ). This test is met where you have worked at least 40 hours in a period of not more than 30 consecutive days in the financial year in which the contribution was made. Ruth is 66, and in July 2012 works 40 hours over the course of three weeks. Ruth will be able to make superannuation contributions for the rest of 2012/2013 even if she does not work for another day after July Because she is under 75, she may also be able to claim a deduction for any personal contributions, provided she meets all six conditions outlined earlier. Having provided the fund with notice, pursuant to Condition 5, the trustee of your fund must acknowledge receipt of the notice without delay (normally within 30 days of receipt or by 30 June of the financial year in which the contribution is made). Complying Fund While in some cases an employer can claim a deduction when they make a contribution to a non-complying fund, there is no 16

17 2012 such flexibility for employees. To be eligible for a deduction, the employee must make a contribution to a complying superannuation fund. You can make a contribution to a noncomplying fund, however no deduction is available. 10% Rule This condition is perhaps the most difficult to satisfy, and is the reason why the vast majority of employees cannot claim a deduction for their personal contributions to superannuation. To be eligible to claim a deduction, less than 10% of the following must be in respect of your employment-related activities: Your assessable income for the income year; Your reportable fringe benefits for the income year (as shown on your payment summary); and Your reportable employer superannuation contributions for the income year (including amounts that you salary sacrifice into superannuation, but not superannuation guarantee amounts). Use the following formula: Assessable income, reportable fringe benefits and reportable employer superannuation contributions attributable to activities as an employee for the income year Total assessable income from all sources, reportable fringe benefits and reportable employer superannuation contributions for the income year The test is only relevant if you engage in employment-related activities during the income year in which the contribution is made, and those activities result in you being treated as an employee for superannuation purposes (i.e. you are eligible to receive superannuation support). Therefore, if you are a contractor and your work activities result in you being treated as an employee for superannuation purposes (i.e. you are paid superannuation), then you will need to pass the 10% test. With an increasing number of people working as contractors rather than employees, many people who describe themselves as independent contractors may nonetheless be subject to the 10% test. Brett is a landscaper. For most of the income year, he carried on his own landscaping business as a sole trader (for which he earned $ assessable income). However, for the first month of that same income year he was employed by a landscaping company where he earned $5 000 salary. During his period of employment, he also salary sacrificed $2 000 into superannuation. During the year, Brett also earned $1 000 in interest from an investment. Brett decides to contribute $3 000 to superannuation during the income year and wonders whether he has passed the 10% test. If you derive none of your income from employment activities, this condition does not apply and you will be eligible to claim a deduction for your contributions if you satisfy the other relevant conditions. Therefore, contrary to popular belief, it s not only self-employed people who may be entitled to claim a deduction for their personal superannuation contributions but also the following: ANSWER Brett has passed the 10% test as his income from his employment activities ($5 000 in salary, $2 000 of reportable employer superannuation contributions and $0 reportable fringe benefits) a total of $ is less than 10% of his... combined assessable income ($ of business income, $5 000 in salary, $1 000 in interest), reportable fringe benefits ($0) and reportable employer superannuation contributions ($2 000 of salary sacrifice)...a total of $ If you run your own business; If you are a retiree who doesn t work (be aware of the work test though see earlier); If you are a volunteer worker; If you are an investor who only works part time; If you only received workers compensation payments during the year; If you were paid to do work principally of a domestic nature for not more than 30 hours per week; If you are an employee for only a small part of the year (see earlier example). Amount of the Deduction If you are eligible to claim a deduction, then the amount you claim is the full amount of the contribution (subject to the amount you have included in the notice supplied to your fund see earlier). However, while there is no limit to the amount you can claim as a deduction, there is a practical cap that exists in the form of the concessional superannuation cap of $ per year. This cap applies to all taxpayers (including those aged 50 and over). Aside from personal contributions for which you can claim a deduction under the 10% rule, other contributions that count towards this cap include salary sacrifice contributions, and superannuation guarantee amounts from your employer. It is important not to exceed this cap as a penalty tax of 31.5% applies to amounts in excess of $ (on top of the standard 15% contributions tax, a total of 46.5%). 17

18 September/October 2012 BIMONTHLY DOING A GOOD DEED With the dust now having settled (at least for the time being) on Trust law, this article provides an overview on what a Trust deed should cater for. This article is essential reading for trustees of the more than discretionary trusts in Australia. Background Over the past couple of years, there have been a number of significant events affecting Trusts. Briefly, these are as follows: A decision handed down by the Full Federal Court in March 2010, widely known as the Bamford decision. This decision impacts how Trust income is defined and the manner in which it is distributed to beneficiaries; A Tax Office Ruling in June 2010 known as TR 2010/3. This ruling impacts the very commonplace scenario where a beneficiary becomes entitled to a Trust distribution but does not actually receive the money (otherwise known as an unpaid present entitlement ); A Tax Office Practice Statement released in October 2010 and updated in June 2011 known as PS 2010/4. This contains additional Tax Office interpretations of TR 2010/3; New legislation which came into effect on 29 June 2011, widely known as the Streaming Rules. This legislation sets out a number of new requirements that must be satisfied in order for capital gains and franked dividends to be streamed to specific beneficiaries of a Trust. The main impact of these events is in the following two areas: 1. Trust Deeds This is the document that governs the overall operation of your Trust. It is critical that your Trust Deed is modern and robust, and that it adequately deals with the issues arising from the events outlined. 2. Trust Resolutions These are the documents that are produced each year to specify the distributions of income and capital to beneficiaries. It is critical that your Trust Resolutions reflect the additional requirements arising from the various events outlined. Ideal Features In light of these developments, the ideal features of a Trust Deed are as follows: Bamford Friendly Ideally the Trust Deed should provide the trustee with the discretion to re-characterise the income of the trust as either income or capital and should provide that only if the trustee fails to do so, should the trust income (Section 97) be equated to the tax income (Section 95) in default. Trust Deeds are considered sub-optimal if either: They do not allow income and capital to be recharacterised; or They contain an automatic income equalisation clause that compels Section 95 income to equal Section 97 income. Allows Streaming The Trust Deed should allow different classes of income to be streamed to different beneficiaries. Although under the new streaming laws, the Tax Office will only permit streaming of franked dividends and capital gains, to even avail yourself of this, the Trust Deed must allow for streaming in the first place. Why Stream? The whole point of streaming capital gains and franked dividends is to obtain the optimum tax outcome by distributing the income to the most tax-effective beneficiaries. If your deed was not streaming compliant, then even the most effectively crafted resolution to stream these styles of income would be redundant. As a result, capital gains and franked dividends would be assessed proportionately, which is a bad outcome possibly resulting in: Capital gains being assessed to corporate beneficiaries (this is an undesirable outcome, as companies cannot access the 50% discount). Ideally, capital gains should be streamed to beneficiaries who have some or all of the following attributes: they are non-corporate, they have a low marginal tax rate, they have capital losses. Franked dividends being assessed to corporate beneficiaries (this is an undesirable outcome, as companies cannot use excess franking credits), or to non-resident beneficiaries (this is an even less desirable outcome as such beneficiaries cannot use franking credits at all). In essence, this means that trust income that you wish to stream must be classified in one of three ways: capital gains franked distributions all other It will no longer be possible to stream subsets of the all other category to different beneficiaries for example interest income to Beneficiary A, business income to Beneficiary B and foreign income to Beneficiary C. Of course, there is more than one way to skin a cat. If there are compelling tax reasons why you need to be able to stream subsets of the all other category such as distributing interest income to a non-resident - then the approach you will need to take will be to create separate trusts to harbour the separate styles of income that you wish to stream. For pre-existing trusts, any such re-structuring will require consideration being given to CGT and stamp duty consequences. Allows Trust Resolution to be in Either Absolute, Percentage or Formula Terms Given that the Trust Resolution is being prepared (purportedly) well before the income of the Trust has been calculated, it is important that the Trust Deed allows for the Trustee to enjoy 18

19 2012 as much flexibility as possible in the drafting of the Trust Resolution. Unpaid Present Entitlement versus Loans The Trust Deed should not instantly treat a UPE as a loan, but instead should allow for it to be treated as a UPE. This affords a period of time to the Trustee to either pay out the UPE or deal with it in accordance with TR 2010/3 and PS 2010/4. Sub-Trusts The creation of sub-trusts is one potential strategy for dealing with UPEs. The Tax Office does not require that a Trust Deed expressly provides for sub-trusts. It is acceptable if the Trust Deed is silent on this subject. Care should thus be taken to ensure that sub-trusts are not expressly prohibited by the Trust Deed. Date for Making Trust Resolutions Some Trust Deeds provide for the trustee to have made resolutions by 30 June. This denies the trustee the ability to make a resolution by the later date of 31 August which is allowed by the Tax Office in the case where capital gains only are distributed. Vesting Date Care should be taken to ensure that the Trust vesting date has not been and gone. Most Trusts have an 80-year life so it is unlikely, but should nevertheless be checked for deeds that are old or not common place. Allows for Oral Resolutions It is advantageous if trustee resolutions can be made orally. This provides a further defence if ever a written Trust Resolution was said to be out of time. Confusion The Tax Office recently released a Fact Sheet entitled Trustee resolution must be made no later than 30 June. Some people would be confused by a reference in the Fact Sheet that the Tax Office will accept trustees documenting a resolution made before 30 June 2012 in official minutes made after the year end as evidence of actions to create a present entitlement in the beneficiaries by that date. This does not mean that a trustee resolution must be officially minuted to be effective (unless, of course, it is a requirement of that particular trust deed). In the Fact Sheet, the reference to official minutes is to merely inform trustees that the Tax Office will accept, as evidence of trustee resolutions, records created after 30 June of trustee resolutions made validly before 30 June. The manner in which resolutions are made is still governed by the respective deed. Specific Entitlement The new streaming laws revolve around a notion of a beneficiary being specifically entitled to income of the trust. Although specific entitlement is a different concept to present entitlement, it is expected that in most instances creating present entitlement pursuant to a Trust Deed will satisfy the requirements. Care should thus be taken to ensure that the Trust Deed provides for the beneficiary to be presently entitled to distributions made to them by the Trust. Impact of Trust Law Re-Write On 21 November 2011, the Government released a consultation paper on modernising the taxation of trust income which examines the issues impeding the effective operation of Division 6 of Part III of the Income Tax Act (1936), as well as those impeding the effective taxation of trusts more broadly. In the paper, the Government proposed three new models for the taxation of trust income going forward: 1. Retaining the existing rules while rectifying specific errors such as the definition of income, net of the trust income. 2. Requiring trust income to be allocated proportionately across different categories and classes (this would limit the ability to stream income). 3. Taxing the trustee on the income of the trust, net of any distributions paid to beneficiaries. When an announcement is finally made on which model will be adopted (submissions to the consultation paper closed in February 2012) trust deeds will again need to be reviewed. It is the considered view of a number of commentators that this over-reaching set of trust law changes will not occur any earlier than 2014, and more likely mid Thus, in the intervening period, it is very much essential to modernise your trust deed in the ways described earlier to take advantage of the current rules until any further changes are made at this still to be determined future date. Are Trusts Still Worthwhile? Absolutely! Despite all the changes and the necessity to review your Trust Deed, trusts remain a very sound structure with many advantages including the protection from personal liability, tax planning, and the ability to access a range of CGT small business concessions. It is simply the case now that a greater emphasis is required on ensuring that your Trust Deed and Trust Resolutions are modern and sound. Take Home Message If you fail to update your Trust Deed, it is possible that adverse tax consequences will occur in the future. This is because your Trust Deed does not adequately deal with the major changes that have occurred. Depending on the inadequacy of your Deed and your circumstances, the tax costs associated with this could be enormous (as outlined earlier, the consequences of not streaming capital gains and franked dividends can alone be significant). Additionally, without an updated Trust Deed, the annual cost of preparing your Trust Resolutions will be significantly more than would otherwise be the case. This is because significantly more time must be spent on resolutions when referencing out-dated deeds, particularly those that are deficient in certain areas. The Tax Office has indicated that Trust Resolutions should quote specific deed clauses and create specific allocations. To update your Trust Deed, you should seek the assistance of your accounting and legal advisors. 19

20 September/October 2012 BIMONTHLY CH CH CH CHANGES TAX TIME 2012 With 1 July now having passed, tax return season is now upon us. This article details the changes to be aware of when completing your individual 2011/2012 tax return in the coming months. Dependent Spouse Tax Offset - Phased Out If your spouse was born on or after 1 July 1971, due to recent changes made by the Government, you may now no longer be eligible to claim the dependent spouse tax offset. However, if you maintain an invalid or permanently disabled spouse, support a carer or you are eligible for the zone, overseas forces or the overseas civilian tax offset then you will be exempt from this newly imposed age restriction and will be able to claim the value of dependent spouse tax offset via an expanded invalid spouse, zone, overseas forces or overseas civilian offset. Flood Levy In response to the 2011 Queensland floods, the Federal Government introduced a flood levy to apply in the 2011/2012 income year only. The levy is additional tax on Australian resident taxpayers and non-resident taxpayers with Australian taxable income in 2011/2012. The levy applies to these individuals with a 2011/2012 taxable income in excess of $ However, there are numerous exemption categories that apply including: Being eligible for an Australian Government Disaster Recovery Payment from Centrelink for a declared natural disaster between 1 July 2010 and 30 June 2012; Being unable to access your home or being stranded in your home for at least 24 hours as a result of a natural disaster between 1 July 2010 and 30 June 2012; Your principal place of residence being without electricity, water, gas or sewerage service for at least 48 hours as a result of a natural disaster between 1 July 2010 and 30 June Exempt taxpayers must claim an exemption from the levy by completing the new flood levy exemption question in this year s return. To find out the other exemption conditions under which you may qualify, go to the Tax Office home page www. ato.gov.au and type flood levy exemption into the search box at the top of the page. If you are not exempt from the levy, then the Tax Office will work out your liability for you you do not need to complete any special label on your return. Replacement of TaxPack For many years, individual taxpayers have used TaxPack to help them to complete their individual returns. This year TaxPack has been replaced by a suite of instructional materials which are shorter and simpler. More complex material has been removed but is still however available on the Tax Office website Removal of Education Tax Refund In early 2012, the Government announced the abolition of the Education Tax Refund. The refund has been replaced by the School-Kids Bonus from 1 July As part of the transition to the new School-Kids Bonus, the Education Tax Refund for 2011/2012 was paid in full to all eligible taxpayers in June Consequently, the Education Tax Refund does not appear in the 2011/2012 return as eligible taxpayers have already been paid the full entitlement under the law. As the amount has been paid automatically, there is no need to retain any substantiating documentation (e.g. receipts) to prove your 2011/2012 claim. Minors and the Low Income Tax Offset From 1 July 2011, minors (children under 18 years of age) are no longer eligible for the low income tax offset on unearned income unless they are an excepted person. The Income Tax Act lists the following as an excepted person and therefore eligible for the offset: Minors engaged in full-time employment on the last day of the income year or for three months during the year (following which they did not return to full-time education); The minor is a person in respect of whom either of the following amounts are payable on the last day of the income year: o Carer allowance; or o Double orphan pension; The Commissioner has received a certificate from a legally qualified medical practitioner certifying that the minor is: o A disabled child; o A person who has a continuing inability to work; o Permanently blind; or o A person who, by reason of a permanent disability, is unlikely to be able to engage in a full-time occupation and the Commissioner is satisfied that the minor was such a person on the last day of the income year; The minor is a principal beneficiary of a special disability trust; or The minor was in receipt of a disability support pension on the last day of the income year. Unearned income (to which the low income tax offset will no longer apply unless the minor is an excepted person ) includes distributions from discretionary trusts, dividends, interest, rent, royalties etc. All minors will still however be eligible for the offset in relation to salary/wages, as well as income earned from the investment of any property transferred to them as a result of compensation payments, inheritances or marriage breakdown. As this law has a 1 July 2011 start date, this change will impact the 2011/2012 return. Note that the low income tax offset is calculated by the Tax Office. The key take-home message is that as a result of the changes, minors may this year need to lodge a tax return if they have more than $416 of unearned income and are not an excepted person. Before this change, this threshold was $

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