Income tax, BAS and accounting fundamentals. Modules 1-5: Extracts

Transcription

1 Income tax, BAS and accounting fundamentals Modules 1-5: Extracts

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3 Copyright notice Copyright CPA Australia Ltd (ABN ), All rights reserved. Save and except for third party content, all content in these materials is owned or licensed by CPA Australia Ltd under forceable agreement. You may reproduce the provided templates, forms and checklists and use them so reproduced, modified or adapted for your personal use and/or in your practice. Other than for the purposes of and subject to the conditions prescribed under the Copyright Act 1968 (Cwlth) (or any other applicable legislation throughout the world), or as otherwise provided for in this copyright notice, no part of these materials may in any manner or any medium whether now existing or created in the future, (including but not limited to electronic, mechanical, microcopying, photocopying or recording) be reproduced, adapted, stored in a retrieval system or transmitted without the prior written permission of the copyright owner. Modification of the materials for any other purpose than provided under this notice is a violation of CPA Australia Ltd s copyright and other proprietary rights. All trademarks, service marks and trade names are proprietary to CPA Australia Ltd. For permission to reproduce any material, a request in writing is to be made to the Legal Business Unit, CPA Australia Ltd, Level 20, 28 Freshwater Place, Southbank, Victoria Disclaimer CPA Australia Ltd has used reasonable care and skill in compiling the content of this material. However, CPA Australia Ltd makes no warranty as to the accuracy or completeness of any information in these materials. These materials are intended to be a guide only. No part of these materials or any other materials comprising the Income tax, BAS and accounting fundamentals program are intended to be advice, whether legal or professional. All names, figures, solutions and scenarios are fictitious and have been established for training purposes only. You should not act solely on the basis of the information contained in these materials as parts may be generalised and the application of exercises, examples and case studies may vary from organisation to organisation and may apply differently to different people and circumstances. Further, as laws change frequently, all practitioners, readers, viewers and users are advised to undertake their own research or to seek professional advice to keep abreast of any reforms and developments in the law. Limitation of liability To the extent permitted by applicable law, CPA Australia Ltd, its employees, agents and consultants exclude all liability for any loss or damage claims and expenses including but not limited to legal costs, indirect special or consequential loss or damage (including but not limited to, negligence) arising out of the information in the materials. Where any law prohibits the exclusion of such liability, CPA Australia Ltd limits its liability to the resupply of the information.

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5 Module 1: Income tax returns for individuals

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7 Contents 1. Module overview Reference materials Learning features Application of taxation knowledge Learning objectives Completing the individual tax return The individual income tax return Calculating taxable income for individuals The individual tax return form Commencing the return: completing the personal details Income concepts Calculation of assessable income Allowable deductions Key learning points Self-assessment questions...52 Suggested answers Rental income and expenses Overview Rental income issues Expenses incurred in earning rental income Key learning points Self-assessment questions...69 Suggested answers Calculating tax payable Calculating tax on taxable income Tax offsets Medicare levy Other tax return items Higher Education Loan Programme (HELP) Student Financial Supplement Scheme (SFSS) Key learning points Self-assessment questions Suggested answers Finalising returns: for Tom Sparks and all your clients Recap Completing and submitting the return Individual tax return checklist Key learning points Self-assessment questions Suggested answers Appendices Appendix 1: 2011 individual tax return Appendix 2: 2011 Individual tax return checklist...144

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9 2. Completing the individual tax return 2.1 The individual income tax return Individual taxpayers are required to submit a tax return based on the financial year; that is, from 1 July to 30 June of the next year. The tax year is referred to by the year in which it ends; for example, the 2011 taxation year is the period 1 July 2010 to 30 June All income tax returns are to: Be made and submitted on the applicable forms provided by the Commissioner ; for example, Tax Pack or Electronic Lodgement Services or via the internet on ATO-approved software such as E-Tax. Contain the information and particulars mentioned or referred to in the form. Be verified by declaration by the taxpayer. Be accompanied by all schedules and other documents as required; for example, rental property schedule. Other schedules, such as depreciation and capital gains, are often prepared in the course of doing a tax return for a client. However, they are not usually required to be lodged with the tax return. If the client is subsequently audited, these schedules may be required by the ATO. Taxation returns are due for lodgement as soon as practicable after 30 June and before 31 October (last day for lodgement). Extensions may be granted if written notice is forwarded to the Commissioner before 31 October. Tax agents are normally granted extensions of time beyond 31 October for taxpayers listed with the ATO as their clients (that is, tax returns are lodged according to the tax agent s lodgement program). FURTHER INFORMATION Details of the Lodgement Program , including due dates: < Section 161 of the Income Tax Assessment Act 1936 (ITAA36) gives the Commissioner power to require that certain taxpayers lodge a tax return. The Commissioner prepares a Commonwealth Government Gazette notice, on an annual basis, which stipulates who is required to submit a return. CPA Australia Ltd 2011 Page 1

10 Who is required to submit a return for the 2011 income year? Every individual carrying on a business or profession regardless of profit or loss. Every individual with a rental property, regardless of profit or loss. A taxpayer earning $6,000 or less who has had tax withheld from that income (if he or she wishes to recover the tax). A taxpayer who earns more than the tax-free threshold of $6,000. Note that the tax-free threshold is less in certain circumstances, such as: An individual who became, or stopped being, a resident during the year (as his or her threshold is adjusted for the number of months he or she has been a resident). A non-resident with certain income that is taxable in Australia (as non-residents are taxed from the first dollar). A taxpayer who is under 18 years of age at 30 June 2011 and their taxable income exceeds $3,334 (where this income is not from salary or wages). A more detailed guide to determine whether a taxpayer must lodge a tax return: FURTHER INFORMATION < Only one taxation return can be lodged by an individual in any one year. If an error has been made in the original return, an amendment must be sent to the ATO. 2.2 Calculating taxable income for individuals The basic legislative framework for calculating taxable income is set out in the Income Tax Assessment Act 1936 (ITAA36) and the Income Tax Assessment Act 1997 (ITAA97). The calculation of taxable income follows a simple conceptual formula. Assessable income less allowable deductions provides us with taxable income, which is used to calculate the tax payable. The concepts of assessable income, allowable deductions and taxable income are akin to the business concepts of revenue, expenses and profit. However, these concepts are adapted by the legislation to allow for differences between the accounting and tax concepts. These variances exist for various compliance and policy reasons. Assessable income is the income earned by the taxpayer that is potentially taxable. It excludes exempt income. Receipts that are included in assessable income are determined by the legislation and case law. Allowable deductions are expenses that are generally related to the earning of assessable income, usually in connection with the taxpayer s principal vocation or occupation. Outgoings that are allowed as deductions can be ascertained by reference to the legislation and case law. Page 2 CPA Australia Ltd 2011

11 Taxable income is simply the difference between assessable income and allowable deductions (like taxable profit, but such a term is inappropriate when applied to individual taxpayers). Taxable income is the basis on which tax is levied, after it has been adjusted for other aspects of taxation including levies, offsets and other charges. 2.3 The individual tax return form Each year, the Australian Taxation Office (ATO) issues an individual tax return form, enabling taxpayers to disclose all information relevant to determine the taxable income and tax payable for the taxpayer for that income year. The form varies from year to year as the tax laws change. The individual tax return form is divided into the following main areas: Items used to calculate taxable income and tax payable Income Deductions Tax offsets Supplementary section (the less common income, deduction and offset items are listed separately at the rear of the return form). Other items used to calculate tax payable include: Personal details contained on the first page of the return Medicare related items Adjustments and credits Spouse details Other schedules 2.4 Commencing the return: completing the personal details This ongoing scenario will be used in successive worked examples to progressively illustrate the process by which a CPA practitioner (who is a registered as, or is supervised by, a registered tax agent) may collect the data that is required to complete an income tax return. Refer to the 2011 Individual tax return supplied in the Appendices. APPENDIX CPA Australia Ltd 2011 Page 3

12 SCENARIO A new client, Tom Sparks, has arrived in your office. Your front office staff have greeted him, provided him with a cup of coffee and shown him into the interview room. Tasks Determine: 1. What type of taxpayer is being dealt with: an individual, company, partnership and/or trust? 2. How often and when do the returns have to be supplied to the ATO? 3. What forms are to be used to submit the return? 4. Complete the first page of the return. Principles illustrated Your ongoing interview with Tom Sparks illustrates some general principles of interviewing and record-keeping. While these techniques and questions represent good practice, they are not the only practices that are acceptable Individual Tax Return For all these worked examples, ensure you have a blank 2011 Individual Tax Return form to use. You can use your firm s tax software or download your own copy of the form from the ATO website at the link below: < Note how the interview questions follow the basic sequence required to complete one of these forms. Interview and calculations Q: Tell me about your job. A: I work for Quickie Constructions as a specialist welder. I am based at their Adelaide workshop. Q: How long have you worked there? A: For nearly 20 years. I am going to take long-service leave next year. Q: Are they good to work for? A: Yes, the people are good: I get paid overtime if I work out-of-hours and at weekends, and there is a good superannuation scheme and sick leave arrangements. Q: How have you done your taxation returns before coming to us? A: I have done them for years. Over the past few years I have used the Tax Pack, but I am finding it more and more difficult to understand with all these changes in tax. Last year I had a tax agent around the corner from home do the return, but I was unhappy with the outcome. So I have brought all my papers with me in this box for you to do it for me. Page 4 CPA Australia Ltd 2011

13 You have deduced what you need to know. That is, Tom is an individual taxpayer with no complications (on the face of it) and will need to complete a 2011 Individual Tax Return form. You will start by filling out the personal details on the form. You may as well do this first, and fill out any records required by your practice at the same time. Q: Tom, we need to start at the beginning of the form. What is your tax file number? We need this to be able to lodge electronically. SCENARIO A: On my previous return, the number provided was You now enter the details on the 2011 Individual Tax Return form, completing the box at the top of the page for the tax file number. Ensure it is accurate, and compare it with any documentation that Tom is able to provide. Tax File Number (TFN): Complete the remainder of the front page of the return as you gain the answers from the interview. SCENARIO Q: I take it that you are an Australian resident? A: Yes. Q: What are your given names (not your surname)? A: Thomas John. Q: Have you changed your surname during the year? A: No. Q: Where do you live? Do you have a postal address that is different to where you live? A: My postal address is the same as where I live. Q: What is your date of birth? A: What do I have to give that for? It seems that the government gets to know everything about us. Q: It is one of the common identifiers of people. Very few, if any, people have the same name and birth date. A: Okay, there it is on the sheet. Q: Would you like your refund to be paid electronically? If so, I will use the details on your bank statement. A: Yes please. CPA Australia Ltd 2011 Page 5

14 Income tax, BAS and accounting fundamentals: Extract You now need to copy into the appropriate boxes the bank account details from the bank statement: The BSB number is the first six digits and identifies the bank, the state and the branch number. The remaining numbers (often eight, but not always) are the account number. You have now completed the front page of the 2011 Individual Tax Return form. Compare your completed form against the following: Page 6 CPA Australia Ltd 2011

15 TIP Ask open-ended questions to gain information from clients. The tax law is too technical for most non-accountants. The general prompt of Tell me about your job, is much less threatening than Are you a contractor who has carried forward a loss? Another example is the concept of tax residence. Most taxpayers would not understand this concept. However, you could ask the client if he or she has been overseas in the last few years. If he or she has been, you may have to question further to determine if the person is an Australian resident for tax purposes. 2.5 Income concepts The income tax legislation does not contain a definition of the word income. However, it provides the following guides: Gross income is total income from all sources, irrespective of whether or not it is exempt or non-assessable. It is total income. Exempt income is income specifically exempted under the ITAA97. Non-assessable non-exempt income is ordinary income or statutory income that a provision of an Act expressly states is neither assessable income nor exempt income and is not assessable by operation of law (this income has often been the subject of an administrative ruling or a legal decision). Assessable income is defined under the ITAA97 as ordinary income (according to ordinary concepts) or statutory income. Assessable income is defined as having the meaning given by Division 6 of the ITAA97. An Australian resident includes in his or her tax return income derived from all sources, (inside and outside Australia) whilst a non-resident includes only that income having a source in Australia. Generally, a taxpayer is an Australian resident for tax purposes if that person has: always lived in Australia moved to Australia to live here permanently, or been in Australia continuously for six months or more, has settled in a home and/or has taken up employment. The issue is less clear where a taxpayer s usual home is overseas, or is living overseas for an extended period, albeit temporarily. To determine whether your client is a resident or a non-resident for tax purposes, consult the ATO publication Residency what you need to know : FURTHER INFORMATION < htm>. Taxable income is assessable income minus allowable deductions. CPA Australia Ltd 2011 Page 7

16 Other concepts that help us determine what is income include: Ordinary income has generally been held to include income from: rendering personal services property (investment income) carrying on a business (sale of goods/sale of services). Statutory income includes amounts that are not ordinary income but are included in assessable income by provisions about assessable income included in the ITAA97 and ITAA36 (such as capital gains). Income that may be caught under both of the above is only counted once in assessable income. WARNING The ITAA36 distinguishes between income from personal exertion and income from property: Personal exertion includes personal earnings (salary/wages), superannuation payouts, termination payments, certain prizes, back pay, pensions, benefits, allowances, income from illegal activities and can include business income. Property includes interest from money invested, dividends, rents and royalties Non-assessable receipts include income from hobbies, bequests under a will, gambling wins, gifts unrelated to services, lottery wins and one-off game-show prizes (that is, windfall gains). Exempt income refers to income specifically exempted by the Income Tax Assessment Acts. The three main classes of exempt income (both ordinary and statutory income) are: income of entities that is exempt irrespective of the type of income (for example, religious and charitable organisations) income that is exempt no matter who derives it (for example, pooled development fund company dividend) income that is exempt if derived by a particular entity (for example, family tax benefit, defence force member allowances and disability service payments). WARNING Capital receipts are not ordinary income; so the rent from an investment property is assessable as income, while the sale proceeds, if the property is sold, are capital and are subject to the capital gains tax (CGT) rules (see Module 3). Page 8 CPA Australia Ltd 2011

17 2.6 Calculation of assessable income Income items for the 2011 income year The following are the income items as they appear in the 2011 income tax return used to calculate taxable income (not including the supplementary income items). Also listed are some tips in dealing with these items: Item Item 1 Salary and wages Item 2 Allowances, earnings, tips, directors fees etc. Description This relates to salary and wage income only. Your client should provide you with one or more PAYG payment summaries individuals non-business. Where this item is completed, the occupation description and code must be present. TIP If your client has lost or has not received any PAYG Payment Summaries: the relevant information may be available on the ATO Tax Agents Portal after entering your client s tax file number, select Client reports, then Pre-filling report 2011 if the information is not available on the portal, your client should attempt to recover the payment summary from the employer If the above options fail, a statutory declaration can be completed by your client in place of the payment summary. The declaration can be sourced at the following link to the ATO website: < This includes any other income from working in addition to salary and wages. It includes fees received for Jury Duty. Allowances listed on the PAYG Payment Summary are always in addition to any wages or salary at Item 1. WARNING Where the allowance is to compensate the employee for a deductible expense, a corresponding deduction may be allowable. However, receipt of an allowance does not automatically entitle the employee to a corresponding deduction. The usual deductibility rules should be applied. TIP Where a travel allowance is not shown on your client s PAYG payment summary and the rate was less than or equal to the reasonable allowance amount, there is no need to disclose the allowance at Item 2 where the allowance has been fully expended on deductible travel expenses. However, no claim should be made at Item D2. FURTHER INFORMATION TD 2010/19 provides the Commissioner s reasonable travel allowance expense amounts for (the Commissioner publishes these amounts each year): < CPA Australia Ltd 2011 Page 9

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19 Module 2: Income tax issues for sole traders, partnerships, trusts and companies

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21 Contents 1. Module overview Reference materials Learning features Application of taxation knowledge Introduction Learning objectives Taxation aspects of business entities Overview Is my client in business? Australian Business Number (ABN) The goods and services tax (GST) Employing staff The personal services income rules Small business entities Key learning points Self-assessment questions...37 Suggested answers Individuals in business Overview Advantages and disadvantages of being an individual in business Taxation of an individual s business income The non-commercial loss rules Individuals in business summary Questions to ask clients Key learning points Self-assessment questions...52 Suggested answers...53 Chapter 4: Partnerships Overview Advantages and disadvantages of partnerships Taxation of partnership income Salaries to partners Non-commercial losses and partnerships Entry and retirement of partners Partnerships summary Questions to ask clients Key learning points Self-assessment questions...85 Suggested answers...86

22 Chapter 5: Discretionary trusts Overview Advantages and disadvantages of discretionary trusts Key terms, concepts and requirements Payments to principals The trust loss recoupment rules Family trust elections Making distributions Discretionary trusts summary Questions to ask clients Key learning points Self-assessment questions Suggested answers Chapter 6: Private companies Overview Advantages and disadvantages of private companies Taxation of company income Payments to directors or shareholders The imputation system The company loss recoupment rules Loans, payments and debts forgiven to shareholders and associates (Division 7A) Private companies summary Questions to ask clients Key learning points Self-assessment questions Suggested answers Appendices Appendix 1: Partnership tax return Appendix 2: Trust tax return Appendix 3: Company tax return Appendix 4: Trust tax return preparation checklist Appendix 5: Company tax return preparation checklist...224

23 2 Taxation aspects of business entities 2.1 Overview Often, clients are carrying on activities on their own account, rather than working as an employee. When this is the case, there is more that needs to be considered than income tax alone. The business will need an Australian Business Number (ABN) and will need to register for GST where business turnover exceeds $75,000. If your client employs staff, there are other obligations that need to be considered. Aside from the obligations of our business clients, there are also concessions that small businesses enjoy that we, as advisers, must be aware of. These concessions, discussed later in this chapter, are available to businesses that qualify as small business entities, and include favourable treatment for income tax, capital gains tax, GST, PAYG, and FBT purposes. 2.2 Is my client in business? If your client s activities are a hobby, any receipts are not assessable, and any expenses are not deductible. Further, your client will not be entitled to an ABN or required to register for GST. On examination of client activities, it is often obvious whether activities constitute a business or hobby. However, where the activity is smaller, or is just starting out, it can be less clear. The factors that the ATO consider when determining whether particular activities are a business or hobby are outlined below: TIP Does the activity have a significant commercial purpose or character? Is there more than just an intention to engage in business? Is there a purpose of profit as well as a prospect of profit? Is there repetition and regularity to the activity? Is the activity carried on in a similar manner to other businesses in the industry? Is the activity planned, organised and carried on in a business-like manner? Does the activity have characteristics of size, scale and permanency? Am I in business? : < FURTHER INFORMATION CPA Australia Ltd 2011 Page 15

24 2.3 Australian Business Number (ABN) A key element of our tax system is the identification of businesses through the issue of an Australian Business Number (ABN). Applying for an ABN is necessary for all enterprises, including businesses. An ABN is an 11-digit identifier used for all dealings with the ATO and for future dealings with government departments and agencies at all levels. It has already supplanted the Australian Company Number system for companies in many areas. To apply for an ABN, you must be either a company or an entity carrying on an enterprise. Employees, hobbyists and individuals who are conducting activities without a reasonable expectation of profit are not eligible for an ABN. WARNING If a business does not have (or does not provide) an ABN for goods and services it supplies, then all payments made to it by a registered entity may be subject to a withholding tax of 46.5%. For this reason, the ABN should appear on all business stationery. Each entity receives one ABN, regardless of the number of activities it undertakes. TIP 2.4 The goods and services tax (GST) Business clients must also consider whether it is necessary to register for GST. It is necessary to register for GST if the taxpayer is carrying on a business or enterprise, and: Its current or projected annual GST turnover is $75,000 or more ($150,000 or more for nonprofit organisations) it provides taxi travel, or it wishes to claim fuel tax credits. Otherwise, a taxpayer can choose to register for GST. GST is a tax of 10% on most goods and services sold in Australia. The tax is collected by entities that are registered for GST purposes at each step in the supply chain. Such registered entities remit the GST (less any credits they are entitled to) to the tax office either monthly, quarterly or annually on the business activity statement (BAS). Generally, where a business makes a purchase with GST in the price, it may claim a credit from the ATO for the GST if eligible. This is called an input tax credit. There are 3 different types of supplies for GST purposes taxable supplies, GST-free supplies and input taxed supplies. Page 16 CPA Australia Ltd 2011

25 Taxable supplies Most goods and services supplied in Australia are taxable supplies. A registered supplier must charge GST on such supplies and is entitled to claim input tax credits on acquisitions in relation to making those supplies. GST-free supplies The GST legislation sets out which supplies are GST-free. They include: basic food for human consumption, for example, fruit, vegetables, plain milk and bread exports some health services and education courses some activities of charitable institutions childcare religious services water and sewerage services the sale of a going concern (such as a business). A registered supplier does not charge GST on such supplies. However, the registered supplier is entitled to claim input tax credits on acquisitions in relation to making those supplies. Input taxed supplies The GST legislation sets out which supplies are input taxed. Input taxed sales include: financial supplies (for example, bank loans) residential rent. A registered supplier does not charge GST on such supplies, and is generally not entitled to claim input tax credits on acquisitions in relation to making those supplies. TIP GST is not a part of taxable income or the cost of tax deductible acquisitions if the business is registered for GST. However, where the business is not registered for GST, the whole of the supply price is included in assessable income for taxation purposes, and GST forms part of the cost of tax deductible acquisitions. See Module 4 for a detailed discussion on the GST. FURTHER INFORMATION CPA Australia Ltd 2011 Page 17

26 2.5 Employing staff When business clients employ staff, it is also necessary to consider the obligations this imposes on our clients. When the business owner is an employee of the business, this can also provide some opportunities. Employees can include principals where the relevant business structure is a company or trust. TIP PAYG withholding A business will be required to register for PAYG withholding if it makes certain payments, including payments of salary, wages, commissions, bonuses or allowances to an individual as an employee (this can include the business owner where the business is operated through a company or trust). PAYG is generally reported and paid to the ATO via the activity statement. FURTHER INFORMATION PAYG withholding : < Superannuation contributions Employers must provide superannuation guarantee contributions for eligible employees and certain contractors. The minimum contribution for employees is currently equivalent to 9% of each employee s ordinary time earnings. The contributions must be made at least quarterly and should be paid to a superannuation fund. PROPOSED LEGISLATIVE CHANGES In the Federal Budget, the Government announced that it proposes to increase the superannuation guarantee rate to 12 per cent. If enacted, this increase will occur in increments between 1 July 2013 to 1 July 2019 (at the time of writing, these amendments were not yet law). An employer also has the obligation to report reportable employer superannuation contributions (RESC) on the employee s payment summary for the year (from the 2010 income year). This is the amount of employer superannuation contributions over the compulsory employer contributions that are influenced or able to be influenced by the employee (for example, the contribution is negotiated as part of employee remuneration). RESC does not include the 9% superannuation guarantee contribution. TIP Page 18 CPA Australia Ltd 2011

27 Guide to superannuation for employers : < FURTHER INFORMATION Fringe benefits tax Fringe benefits tax (FBT) is paid on certain benefits provided to employees or their associates (such as family members) in relation to their employment. The tax is based on the taxable value of the various fringe benefits provided. The Fringe Benefits Tax Assessment Act 1986 (FBTAA) sets out how the taxable value should be calculated for each type of benefit. Fringe benefits may include any of the following: use of a work car by an employee or associate for private purposes providing an employee with a low interest or interest free loan paying an employee s private expenses, such as school fees, or mortgage repayments providing services to an employee (such as legal advice by a law firm) reimbursing private expenses of an employee, or providing entertainment to an employee by way of food, drink or recreation. This may include benefits provided to the business owner where the business is conducted in a company or trust. WARNING FBT is paid by the employer. Fringe benefits and FBT payable are reported to the ATO by lodgement of a Fringe Benefits Tax return form. Employers who are liable to pay FBT instalments make those payments on the activity statement quarterly. An employer also has an obligation to report the grossed-up taxable value of certain fringe benefits with a total taxable value of more than $2,000 to an employee in an FBT year (1 April to 31 March) on the employee s payment summary for the corresponding income year (1 July to 30 June). FURTHER INFORMATION Fringe benefits tax what you need to know : < CPA Australia Ltd 2011 Page 19

28 Refer to CPA Australia s Fringe benefits tax essentials program you can access a brochure at the following link: FURTHER INFORMATION < Salary packaging Salary packaging involves an agreement between an employer and an employee where the employee agrees to forgo cash salary in lieu of fringe benefits. This means that the employee does not pay tax on the salary forgone. However, the employer may have a FBT liability in respect of the benefit. The employer usually costs the FBT to the salary packaging so that it is ultimately borne by the employee. Despite the existence of FBT, there are still a number of fringe benefits that can be packaged tax-effectively. This is because some benefits are taxed concessionally under the FBT rules so the effective rate of tax on the benefit is less that the tax that would be paid on the equivalent salary (that is, the salary forgone to receive the fringe benefit). Such benefits can include: Cars. Exempt property benefits such as in-house lunches. Eligible work related items such as a laptop computer, portable electronic device, computer software, protective clothing, briefcase and tools of trade (note the item is only exempt where it is primarily for use in the employee s employment and is limited to one item per year (unless the item replaces another). Superannuation. Exempt benefits such as: a subscription to a trade or professional journal an entitlement to use a corporate credit card an entitlement to use an airport lounge membership. exempt taxi travel. Further, some employers are exempt from FBT or pay a reduced rate of FBT. In those circumstances, it can be most beneficial to salary package. WARNING For salary sacrifice arrangements to have the desired tax effect, the agreement between the employee and employer should be entered into before the work is performed by the employee. That is, the agreement must be prospective (TR 2001/10). Page 20 CPA Australia Ltd 2011

29 Salary sacrifice arrangements for employees : < FURTHER INFORMATION Travel allowances To claim a deduction for travel expenses, the taxpayer is generally subject to rigorous substantiation requirements. This means obtaining written evidence of all expenses incurred. For travel that involves being away for six or more consecutive nights a travel diary must also be kept. Many taxpayers have deductions disallowed in an audit because they are unable to comply with the stringent substantiation rules. In addition to having the deduction disallowed, penalties are also generally applied. However, where an employer pays a reasonable travel allowance for work related travel to an employee, the exception from substantiation provided for domestic and overseas travel allowance expenses can be utilised. A reasonable travel allowance is an allowance paid to an employee for meals, accommodation and incidental expenses incurred while travelling on business where the allowance is within the Commissioner s published guidelines. Where a reasonable travel allowance is paid: The employee will not be required to substantiate a deduction for travel expenses if the amount claimed as a deduction is not greater than the reasonable amount The employer is not required to show the allowance on the employee s payment summary When the reasonable allowance is not shown on the payment summary, and the allowance has been fully spent on deductible travel expenses, neither the allowance nor the expenses need to be disclosed on the employee s income tax return Where the employee spends less than the allowance received on deductible travel expenses, the employee s income tax return must include the allowance and the expense claimed. FURTHER INFORMATION The Commissioner s reasonable travel allowance expense amounts for income year are set out in TR 2010/19. These amounts are changed annually: < TIP A significant opportunity arises in relation to travel by the principal where a company or trust structure is being used to operate the business and the principal is an employee of the business. Where a sole trader or a partner in a partnership travels for business purposes, that person is subject to the substantiation requirements and cannot enjoy the exception from the substantiation requirements. CPA Australia Ltd 2011 Page 21

30 WARNING For overseas travel allowance expenses, the employee is still required to give written evidence for accommodation expenses and is still required to keep travel records if the travel involves the employee being away for six or more nights in a row. Keeping your tax records travel expenses : FURTHER INFORMATION < content/30327.htm&page=9&h9> Living away from home allowances A living away from home allowance (LAFHA) is the only cash allowance that is subject to the FBT provisions and not assessable to the employee. The benefit of paying a LAFHA is that the whole or a part of it may not be subject to tax depending on the particular circumstances. A LAFHA is an allowance paid by an employer to an employee to compensate for additional expenses incurred and any disadvantages suffered because the employee is required to live away from their usual place of residence in order to do their job. To receive a genuine LAFHA, it is necessary that the employee has moved to a new locality with an intention to return to their previous locality at the end of a finite term (for example, moving interstate for 6 months to establish a new branch office). The additional expenses for these purposes are non-deductible expenses such as meals and accommodation while living away from home. Whilst meals and accommodation expenses are deductible where an employee is travelling on business, these expenses are instead private in nature and non-deductible when an employee is living away from home. A LAFHA will not be subject to income tax or FBT where the allowance is solely compensation for the reasonable accommodation costs and additional food costs incurred as a result of living away from home. TIP The receipt of a tax-free living away from home allowance is an opportunity available to principals that are employees (of a company or trust) that is not available to sole traders or partners in partnerships. Living-away-from-home allowance fringe benefits : < FURTHER INFORMATION Wages to associated persons Under section of the ITAA97 and (section 65 of the ITAA36) the Commissioner may disallow the whole or part of the deduction for a salary or other payment paid to a related entity of the business owner if the amount of the payment is deemed to be unreasonable. Page 22 CPA Australia Ltd 2011

31 Related entity includes a relative (for example, spouse, child) or a partnership in which the relative is a partner. Reasonable is not defined but the ATO will interpret it to mean the amount that would have been paid had that entity not been a related entity, and the payment was at arm s length. TIP Keep records of your calculations To avoid the Commissioner applying section 26-35, your clients should keep records confirming how any payments to related entities were calculated and evidencing that they are reasonable. For example, details of the hours worked and the type of work undertaken should be kept, together with written advice from an independent agency as to the amount that would need to be paid had an independent entity been employed instead. CPA Australia Ltd 2011 Page 23

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33 Module 3: Other business issues: Depreciating assets, capital gains and accounting

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35 Contents 1. Module overview Learning features Learning objectives Decline in value and other capital allowances Overview The uniform capital allowance provisions Decline in value of software Low-value pooling The simplified depreciation rules for small business entities Business related capital costs ( blackhole expenditure ) Small business and general tax break Questions to ask clients Key learning points Self-assessment questions...31 Suggested answers Capital gains and losses Overview CGT events What is a CGT asset? What are capital proceeds? What is the cost base? Reduced cost base Methods for calculating the capital gain or loss Date of acquisition or disposal of assets CGT exemptions CGT rollovers Small business CGT concessions Record-keeping for CGT Questions to ask clients Key learning points Self-assessment questions...69 Suggested answers From client records to financial statements Examining the trial balance Bank reconciliation General journal entries Bookkeeping procedures and journal entries required Identifying client errors Profit distributions Assets transactions Bad and doubtful debts Amortisation of intangible assets...113

36 4.10 Key learning points Self-assessment questions Suggested answers Appendices Appendix 1: Sample journal pro forma Appendix 2: Procedural checklist...120

37 2. Decline in value and other capital allowances 2.1 Overview Some business outlays (such as the cost of acquiring capital assets) are not immediately allowable as deductions. Capital assets are those that provide a benefit over a number of years, for example, motor cars and machinery. The value of such assets usually reduces over time as they approach the end of their effective lives. Assets that lose value in this way are said to decline in value. In recognition of this, the cost of capital assets used in producing assessable income can be written off over a period of time as tax deductions. The capital allowances regime, contained in Division 40 of the Income Tax Assessment Act 1997 (ITAA97), enables taxpayers to depreciate or write off various kinds of expenditure relating to various income-producing capital assets over a number of years. In this way, Australian tax legislation recognises the economic loss to a business resulting from the deterioration in the condition of certain business assets through wear and tear which would otherwise not be recognised by the general deduction provision contained in section 8-1 of ITAA97. TIP The law relating to decline in value (depreciation) and capital works deductions is contained in Division 40, Division 43 and Division 328 (for taxpayers who are small business entities) of the ITAA97. The principles of decline in value (or depreciation) for tax purposes differ somewhat to depreciation principles for accounting purposes (discussed in Chapter 4). This reflects Division 40 s role as a tool for encouraging and/or discouraging certain expenditure in accordance with government policy and simplifying and streamlining the calculation of the decline in value on depreciating assets. It is therefore common for entities to report different decline in value or depreciation expense amounts for accounting and tax purposes. FURTHER INFORMATION Guide to depreciating assets : < 2.2 The uniform capital allowance provisions The uniform capital allowance (UCA) provisions allow decline in value deductions on most depreciating assets, which range from cars and machinery to expenditure on computer software (including the licence to use that software). CPA Australia Ltd 2011 Page 29

38 TIP Prior to 1 July 2001, the term depreciation was used in place of decline in value. Whilst the current terminology has been in place for many years, both tax practitioners and taxpayers often still refer to decline in value deductions as depreciation Items which can be depreciated The capital allowance provisions apply to assets that: are used to produce assessable income, or are installed ready for use to produce assessable income but are held in reserve. Assets are considered depreciating assets if they: have a limited effective life, and can reasonably be expected to decline in value over the time they are used. EXAMPLE In addition to manufacturing machinery, motor vehicles and computer software, depreciable assets can include computers, electric tools, furniture and fittings (including carpets and curtains). TIP Land, trading stock and most intangible assets are not deemed to be depreciating assets. Buildings are also not generally depreciating assets, but a deduction (similar to a decline in value deduction) may be available under the separate deduction provisions for capital works Claiming decline in value deductions Only the holders of depreciating assets can claim a deduction for the decline in value of depreciating assets. The holder of a depreciating asset is determined in accordance with section Generally, the holder of a depreciating asset will be the owner or quasi-owner 1 of the asset. A person will be treated as the owner of a depreciating asset for the purposes of claiming a decline in value deduction, if they are the legal owner, or hold sufficient rights over the depreciating asset to characterise them as the owner in preference to any other person who also holds rights over the depreciating asset. When assets are acquired, whether the taxpayer is the holder of the asset, and therefore entitled to the decline in value deduction, is dependent upon the method of finance. 1 Quasi-ownership covers the situation where a depreciating asset is attached to land that a particular person did not own but has a right to use. An example of quasi-ownership is a Crown lease with attached depreciating assets to that land after the lease was acquired. Page 30 CPA Australia Ltd 2011

39 Eligibility for decline in value deductions various asset financing methods Finance method Decline in value deduction* Other deductions Loan finance/chattel mortgage Interest portion of repayments Hire purchase Interest portion of repayments Lease Lease payments Luxury car lease (see below) Interest portion of repayments *subject to the car limit (see below) WARNING Decline in value deductions are not allowable for leased assets. However, special rules apply to the leasing of luxury cars. These rules apply to luxury cars other than for short-term hiring agreements or cars that are trading stock of the lessee. Under these rules, the lessee is treated as the owner of the luxury car. The actual lease payments made by the lessee are not allowable deductions. The lease payments are divided into their underlying capital component and their finance charge component. The lessee can then claim: The finance charge component reduced to reflect non-business use. Decline in value based on the car limit (refer below), reduced to reflect non-business use Calculation of cost and effective life of depreciating assets The calculation of the decline in value deduction is generally based on the cost of the depreciating asset (calculated under Subdivision 40-C) and its effective life: Cost of a depreciating asset Cost includes the original purchase price or cost of construction, transport, installation, customs duty or relocation. Cost includes both the amounts paid or payable for an asset and any additional amounts incurred in improving it. TIP If a taxpayer is entitled to claim a GST input tax credit on the purchase of an asset, the cost of the item for decline in value deduction purposes excludes the amount of input tax credits entitled to be claimed. If a taxpayer is not entitled to claim an input tax credit, the cost of the item for decline in value deduction purposes includes the GST. TIP Motor cars and station wagons (including four-wheel-drive versions) are subject to a car limit. This means an entity cannot claim decline in value deductions for any part of the cost of such a vehicle that is more than the limit for the year in which it was first used (section ). The cost of the car is reduced by the amount of GST input tax credit before the car limit is applied. The car limit for is $57,466. CPA Australia Ltd 2011 Page 31

40 SCENARIO Tom is a contract carpenter and is registered for GST. During the 2011 year he purchased a new car for $66,000 including GST and a new compressor for $1,045 including GST. Question What is the cost of these items for decline in value purposes? Answer If Tom is registered for GST then he can claim an input tax credit on the purchase of these items, so the cost for decline in value purposes must take this into account and the GST is excluded from the cost base. The GST paid on the new car is $6,000 so the cost for decline in value purposes is $60,000. This is above the car limit of $57,466 so the cost for decline in value purposes is limited to the car limit of $57,466 (further, for GST purposes, Tom is entitled to an input tax credit of $5,224 that is $57,466/11). The input tax credit on the compressor is $95 so the cost for decline in value purposes is $ Effective life The current legislation (with the exception of the simplified depreciation rules for SBEs and certain specific items) does not provide for a decline in value rate. Rather, deductions are calculated using a statutory formula. Effective life is part of the formula for both the diminishing value method and the prime cost method (see below) and affects the rate of decline in value. Effective life, in general accounting terms, means the productive life of the asset. Taxpayers have the option of relying on the Commissioner s determinations of effective life (see below) or they may estimate the effective life of an asset themselves, considering such matters as: the physical life of the asset engineering information the manufacturer s specifications the way in which the asset is used by an industry the past experience of users of the asset the level of repairs and maintenance adopted by users of the asset industry standards the use of the asset by different industries retention periods obsolescence scrapping or abandonment practices the period of the lease (if the asset is leased) economic or financial analysis indicating the period over which that asset is intended for use where the asset is actively traded in a secondary market, conditions in that market. Page 32 CPA Australia Ltd 2011