House of Representatives

Tax Laws Amendment (2010 Measures No. 1) Bill 2010

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 4 Restricting eligibility to the entrepreneurs' tax offset through an income test

Outline of chapter

4.1 Schedule 4 to this Bill amends Subdivision 61-J of the Income Tax Assessment Act 1997 (ITAA 1997) by introducing an income test into the eligibility criteria for the entrepreneurs' tax offset (ETO). The income test will restrict the eligibility of individuals whose income is over a threshold amount of income for ETO purposes ($70,000 if they are single and $120,000 if they have a family).

4.2 All of the legislative references in this chapter are to Subdivision 61-J of the ITAA 1997 unless otherwise specified.

Context of amendments

4.3 The ETO was introduced into the ITAA 1997 by the Tax Laws Amendment (2004 Measures No. 7) Act 2005 and applies to assessments for income years commencing on or after 1 July 2005. The ETO was introduced to provide an incentive for very small, micro and home-based businesses in the very early stages of business development.

4.4 The ETO provides eligible taxpayers with a maximum tax offset of 25 per cent of their income tax liability that is attributable to their net small business income for the income year. The ETO begins to phase out at aggregated turnovers of $50,000 and eligibility ceases when aggregated turnover reaches $75,000.

4.5 Eligibility for the ETO is not currently restricted for taxpayers who have other significant sources of income (income not referable to the relevant small business).

4.6 As part of the 2008-09 Budget the Government announced that the ETO would be income tested, reducing the offset that could be claimed by those taxpayers with other significant sources of income (income not referable to the relevant small business). In the 2009-10 Budget the Government deferred the income test's start date from 1 July 2008 to 1 July 2009 to ensure that the proposed income test commences at the same time as, and is consistent with, the Government's broader means testing reforms, also announced in the 2008-09 Budget and enacted in the Tax Laws Amendment (2009 Measures No. 1) Act 2009 .

Summary of new law

4.7 The ETO calculated after applying the aggregated turnover test will phase out at 20 cents for every $1 of income for ETO purposes over the threshold amount. For singles the threshold amount of income for ETO purposes is $70,000 and for families the threshold amount is $120,000. This reduction will operate in addition to the current eligibility requirements applicable to the ETO (in particular, the aggregated turnover test phase-out where aggregated turnover of the small business exceeds $50,000).

4.8 The income for ETO purposes will include both the claimant's and their spouse's (if they had a spouse at the end of the income year) taxable income, reportable fringe benefits total, reportable superannuation contributions and total net investment loss for the year. However, the claimant's net small business income (or share of that income) that has already been considered in determining eligibility for the ETO under the existing law is not taken into consideration for the purposes of the income test.

Comparison of key features of new law and current law

New law Current law
The ETO calculated after applying the aggregated turnover test will phase out for singles at 20 cents for every $1 of income over $70,000. No equivalent.
The ETO calculated after applying the aggregated turnover test will phase out for families at 20 cents for every $1 of income over $120,000. No equivalent.

Detailed explanation of new law

Taxpayers required to meet the income test

4.9 In addition to the eligibility requirements currently contained in Subdivision 61-J, individuals will also be required to meet an income test, which will restrict the ETO for singles with incomes for ETO purposes over $70,000 and families with incomes over $120,000. [Schedule 4, item 8, section 61-523]

4.10 Broadly, small business sole-traders, partners in small business partnerships, and beneficiaries of small business trusts will be required to meet the income test requirement to be entitled to claim the ETO.

Example 4.1 Jared carries on a tax agent business as a sole-trader. In the 2009-10 income year this business had an aggregated turnover of $70,000. Jared also has other sources of income. Applying the turnover test, Jared is able to claim the ETO in respect of the small business income attributable to his tax agent business. However, Jared will also be required to apply the ETO income test (in relation to his other income) in determining the amount of ETO, if any, he is entitled to.

4.11 As the intent of the measure is to ensure that individual recipients of the ETO with other, significant sources of income, are ineligible for the ETO, company and trustee claimants of the ETO will not be required to meet the income test. Companies are unable to fully pass on the benefit of the ETO to individual shareholders due to the dividend imputation system. Moreover, trustees can only claim the ETO in limited circumstances (where they are liable to pay tax on the small business income of the trust). However, they are only liable in their capacity as a trustee and their own income (non-trust income) is not relevant.

Income thresholds

4.12 The ETO will begin to phase out for single individuals when their income for ETO purposes exceeds $70,000. The ETO will begin to phase out for 'members of a family' when the combined income for ETO purposes of the taxpayer and their spouse (where applicable) exceeds $120,000. A taxpayer will be a member of a 'family' (and can therefore take advantage of the higher income threshold) if they have a spouse on the last day of an income year, or a dependant on any day in an income year. [Schedule 4, item 8, definition of 'threshold amount' in section 61-523]

4.13 Broadly, a dependant is a child less than 21 years of age (not being a student), a student, an invalid relative and a parent of the taxpayer or the taxpayer's spouse. A spouse includes a wife or husband; someone (whether of the same sex or a different sex) who, although not legally married to the taxpayer, lives with them on a genuine domestic basis in a relationship as a couple; and someone (whether of the same sex or a different sex) with whom the taxpayer is in a relationship that is registered under a state law or territory law prescribed for the purposes of section 22B of the Acts Interpretation Act 1901 . [Schedule 4, item 8, definitions of 'non-ETO small business income' and 'threshold amount' in section 61-523]

Definition of income for the purposes of the ETO income test

4.14 Income for ETO purposes is defined as 'non-ETO small business income' and consists of the taxpayer's taxable income, reportable fringe benefits total, total net investment loss and reportable superannuation contributions for the relevant income year. [Schedule 4, item 8, definition of 'non-ETO small business income' in section 61-523]

4.15 If a taxpayer has a spouse on the last day of the income year their income for the purposes of the ETO income test will also include their spouse's taxable income, reportable fringe benefits total, total net investment loss and reportable superannuation contributions for the relevant income year. [Schedule 4, item 8, definition of 'non-ETO small business income' in section 61-523]

Example 4.2 The only income Daniel receives for the 2009-10 income year is from a computer supply business he carries on as a sole-trader from an office in his house. This business has aggregated turnover of $45,000 for the 2009-10 income year. Applying the turnover test Daniel is able to claim the ETO in respect of the small business income attributable to his computer supply business.Elizabeth is Daniel's spouse on the last day of the 2009-10 income year. For the 2009-10 income year Elizabeth has taxable income, reportable fringe benefits total, total net investment loss and reportable superannuation contributions of $100,000. This amount will be taken into account in determining whether or not Daniel's ETO claim is affected by the income test. Example 4.3 In the 2009-10 income year, Aaron runs a bookkeeping business from his home. The net income from his business is $20,000 (that is, $32,000 turnover less $12,000 business expenses). This amount is Aaron's net small business income. In addition he works as an accountant and receives salary and wages of $75,000. Aaron has no dependants and he is in a defacto relationship with Lisa. Lisa works part-time and earns $15,000 per annum. Aaron and Lisa have no other income. On 3 June 2010 Aaron and Lisa legally separate.Applying the existing eligibility criteria, Aaron would be entitled (before the application of the income test) to an ETO of $1239.32.As Aaron does not have a spouse as at 30 June 2010 the lower threshold amount will apply for the purposes of the ETO income test. The relevant threshold amount will be $70,000. Aaron's salary and wages ($75,000) are taken into consideration in determining the amount of non­ETO small business income. Aaron's net small business income of $20,000 is not included in this amount. Lisa's income is not included as she was not his spouse on the last day of the income year.As Aaron's non-ETO small business income is above the $70,000 threshold, the income test will reduce Aaron's ETO of $1239.32 for the 2009-10 income year by $1,000. As a result, Aaron is entitled to an ETO of $239.32 ($1239.32 - $1000) for the 2009-10 income year.

4.16 In determining a taxpayer's income for the purposes of the ETO income test, the 'net small business income' of the ETO claimant which has given rise to their ETO entitlement will be excluded.

4.17 In respect of beneficiaries of trusts and partners of partnerships, it will be their share of the net small business income (rather than the entire net small business income) of the trust or partnership that is excluded. Such income would already have been taken into account when determining eligibility for, and the quantum of, the ETO under the turnover test, so its exclusion will prevent double counting of the income in the ETO turnover test and the income test. However, any net small business income of the claimant which has not given rise to an ETO entitlement will not have been subject to the turnover test and will not be excluded from a taxpayer's income for the purpose of the ETO income test. Further, any net small business income of a taxpayer's spouse will not be excluded from the spouse's taxable income, reportable fringe benefits total, total net investment loss and reportable superannuation contributions for the relevant income year. [Schedule 4, item 8, definition of 'non-ETO small business income' in section 61-523]

Example 4.4 Michael is a partner of a partnership that is a small business entity with aggregated turnover of $70,000 for the 2009-10 income year. Applying the turnover test, Michael is eligible to claim the ETO in respect of any distribution from this partnership. Michael receives a partnership distribution of $25,000 for the 2009-10 income year.Michael is also a beneficiary of a small business trust with an aggregated turnover of $120,000 for the 2009-10 income year. As the trust's turnover is more than $75,000, its income (including that distributed to beneficiaries) will not be eligible for the ETO. Michael is required to include a $30,000 trust distribution in his assessable income for the 2009-10 income year.In addition to the income received from the partnership and trust, Michael also earns $41,000 in the 2009-10 income year from investments he holds. As such, for the 2009-10 income year Michael has income of $96,000. However, for the purpose of the ETO income test Michael will be regarded as having income of $71,000.

Calculation of the ETO following the introduction of the income test

4.18 The calculation of the ETO applying the current turnover test involves the application of a five step process to arrive at a taxpayer's offset. Step by step examples and guidance on how the ETO is calculated under the existing law can be found in the explanatory memorandum to the Tax Laws Amendment (2004 Measures No. 7) Bill 2004 (Chapter 1). The income test will operate in addition to the current eligibility requirements (namely, the turnover test) and will operate to reduce the offset amount as currently calculated (but will not operate to reduce the offset amount below zero). As a consequence, if the initial turnover test is not satisfied, the income test does not need to be applied. [Schedule 4, item 8, section 61-523]

4.19 While, under the Bill, the income test operates to reduce the offset already calculated under the existing provisions, it nonetheless acts as an additional eligibility criteria as it can operate to reduce the amount of the offset to nil.

4.20 Under the ETO income test the amount of the offset worked out under the current turnover test is then reduced by the amount calculated under the following formula:

((Non-ETO small business income for the icome year - Threshold amount) / 5)

[Schedule 4, item 8, section 61-523]

Example 4.5 : Income test for a sole trader In the 2009-10 income year, Jenny runs a physiotherapy practice from her home. The net income from her practice is $20,000 (that is, $30,000 turnover less $10,000 business expenses). This amount is Jenny's net small business income. In addition she has a part-time job as a shop assistant from which she receives salary and wages of $25,000. She is married to Geoff who works as a pharmacist and earns $98,000 per annum. Geoff has no other income.Applying the existing eligibility criteria, Jenny would be entitled (before the application of the income test) to an ETO of $816.67.As she is married as at 30 June 2010, the 'family' threshold will apply for income test purposes. Both Jenny's and Geoff's salary and wages ($25,000 + $98,000 = $123,000) are taken into consideration in determining the amount of non-ETO small business income. Jenny's net small business income of $20,000 is not included in this amount.Jenny's ETO will therefore be reduced by:

(($123,000 - $120,000) / 5) = $600

As a result, Jenny will be entitled to an ETO of $216.67 ($816.67 - $600) for the 2009-10 income year. Example 4.6 : Income test for a beneficiary of a trust ABC Trust is a small business entity, with an aggregated turnover of $50,000 in the 2009-10 income year.Marylyn is a beneficiary of ABC Trust and receives a distribution of $20,000 for the 2009-10 income year. She also receives salary and wages of $75,000 from her job as an accountant. She has no dependants and no spouse.Applying the existing eligibility criteria Marylyn would be entitled (before the application of the income test) to an ETO of $1,239.47.Marylyn's non-ETO small business income for the purposes of the income test is $75,000. As she is single with no dependants the relevant threshold amount is $70,000.Marylyn's ETO will therefore be reduced by:

(($75,000 - $70,000) / 5) = $1,000

As a result, Marylyn will be entitled to an ETO of $239.47 ($1239.47 - $1,000) for the 2009-10 income year. Example 4.7 : Income test for a partner in a partnership Lina and Geoff are equal partners in Partnership A which runs a costume-making business. The partnership has an aggregated turnover of $58,000 and net income of $50,000 in the 2009-10 income year. In addition to her costume-making business Lina has a part-time job. She earns $60,000 from this job and a further $15,000 from various investments. Lina has two young children and no spouse.Applying the existing eligibility criteria, Lina is entitled (before the application of the income test) to an ETO of $1,081.63.Lina's non-ETO small business income is $75,000 (her wages and investment income). While this amount would be above the $70,000 threshold for singles, as Lina has two dependant children the higher 'family' threshold of $120,000 applies. As Lina's non-ETO small business income is below this threshold, the income test does not impact on Lina's claim and she will be entitled to an ETO of $1,081.63 for the 2009-10 income year.

Application and transitional provisions

4.21 The amendments made by this Schedule apply in relation to assessments for income years that commence on or after 1 July 2009.


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