Explanatory Memorandum(Circulated by authority of the Treasurer,the Hon. Peter Costello, MP)
Chapter 4 - Core Provisions
This chapter explains the core provisions of the Income Tax Assessment Bill 1996.
This chapter discusses Chapter 1 of the Income Tax Assessment Bill 1996 - Introduction and Core Provisions.
Chapter 1 is a major innovation in the way income tax law is presented. It sets a logical starting point in understanding the law, especially for those coming to it for the first time. It has three primary features which are not found in the existing law.
- A guide to this Act (Part 1-2) will give readers (particularly first time readers) a helpful overview of the law, and how to come to grips with it.
- The core provisions (Part 1-3) will bring together, in one place, the main rules about how to work out your income tax position.
- Checklists (Part 1-4) will help fill in the detail of what is covered by general concepts used in the core provisions and are a valuable new point of reference.
The Income Tax Assessment Act 1936 is complemented by a large body of judicial precedent and Commissioner rulings that have evolved over almost 60 years, since the Act was introduced. It is important that the value of this material not be lost, especially as most provisions are being rewritten without any intention of changing their effect.
This issue has already been addressed, at a general level for all Commonwealth legislation, by the introduction of section 15AC of the Acts Interpretation Act 1901 . That section provides that, if:
- legislation is rewritten; and
- the rewritten law appears to express the same ideas as in the old law; and
- the rewriting of the law is done to use a simpler or clearer style;
then the meaning is not to be taken to have changed merely because different words are used in the new law.
The Bill contains a provision to the same effect as section 15AC. The reason for including it in the Bill when it is already in the Acts Interpretation Act 1901 is to draw it directly to the reader's attention and give emphasis to the essential nature of the rewrite objectives.
The note at the end of clause 1-3 mentions provisions that would be introduced into the Taxation Administration Act 1953 by this package of Bills. Proposed sections 14ZAAM and 14ZAXA of the Taxation Administration Act 1953 (discussed in Chapter 12 of this Explanatory Memorandum) will preserve the operation of public and private rulings on the old law to the extent that the new law expresses the same ideas.
The introductory Guide aims to help readers in 2 ways:
- Division 2 will tell you how to use the new Act, which has a number of distinctive features not found in existing tax laws; and
- Division 3 will tell you what the Act is about.
The Guide will tell you:
- how to find your way around the Act, using the navigation tools and other techniques being supplied to assist readers;
- how the Act is arranged in a logical structure that resembles conceptually a pyramid;
- how to identify defined concepts and terms, and find the definitions;
- how to follow the new numbering system; and
- what legal status explanatory features will have.
Most significant areas of the new law will have their own guides to orient readers before they reach the operative provisions. Guides are not operative provisions and will have a strictly limited legal status. That status is formally set out in Chapter 6 of the Bill - The Dictionary.
Here you will get a general overview of what the income tax law is about.
It will explain that income tax law deals not just with income tax, but also with other taxes (such as the Medicare levy and the various withholding taxes eg. on interest and on dividends).
The introductory Guide poses 7 key questions that most taxpayers will need answers to, and tells you where to find those answers.
This is the heart of the Income Tax Assessment Bill 1996. First time readers and others needing to become familiar with it would enter the law at this point. The Core will give them a bird's eye view of what the income tax law requires - it tells them whether they may have to pay income tax and, if so, how to work out how much. It will then signpost them to more detailed parts of the law that deal with what their circumstances require.
It is made clear that every individual and company with a taxable income for an income year potentially is liable to pay income tax on that income. The amount of tax could prove to be nil (eg. your taxable income could be below the tax-free threshold or your offsets (rebates) could exceed the tax payable on your taxable income).
Some other entities may also be liable to pay tax. The new law will specifically list, in one place, all of those entities [clause 9-1] . The existing law does not do this.
The rewritten law will include an explicit statement of the general formula for determining the amount of income tax that must be paid (if any). Under the existing law, the elements of the formula are scattered throughout the Act.
A preliminary step is to determine the period for which tax may be payable.
Income tax is payable on an annual basis, for the year ending on 30 June (the financial year ). Tax is generally worked out by reference to the amount of taxable income in a particular period, called the income year . The financial year and the income year will usually be the same. This is the case with most individual taxpayers. However, the income year and the financial year can be different periods.
For companies, the income year is the year before their financial year (for example, tax would be payable for the 1996-97 financial year based on the taxable income of, and rates applying to, the 1995-96 financial year).
The Commissioner can allow companies and other taxpayers to adopt an income year ending on a day other than 30 June, referred to as a substituted accounting period . Substituted accounting periods are sometimes adopted to align a subsidiary company's assessment period with the accounting period of its parent (perhaps an overseas company).
Your income tax is generally calculated by applying the tax rates to taxable income. From that basic income tax liability tax offsets are deducted. The result is the income tax to be paid for the financial year:
Income tax = Taxable income x rates - Tax offsets
The rates at which tax is payable are set out in the Income Tax Rates Act 1986 . More than one rate may have to be applied to taxable income.
For individuals who are Australian residents, there is a progressive rate system:
- for income up to a certain limit there is no rate of tax (the income is tax free); and
- for income above the limit, progressive rates apply across particular income bands.
For companies, income tax is imposed at a flat rate.
Other entities are subject to tax at different rates again (eg. trustees of superannuation funds) and there are special rates that apply to particular kinds of income (eg. assessable income that is diverted under certain tax avoidance arrangements).
Offsets is a new term combining what are known as rebates and credits in the existing law. Rebates and credits both have the effect of reducing basic income tax liability.
An offset reduces a basic income tax liability. It is distinguishable from a deduction in that it reduces tax directly (rather than reducing taxable income).
If offsets exceed the basic income tax liability, there is generally no entitlement to a refund. Some offsets can be carried over to later years to reduce a tax liability in those years.
Income tax is generally calculated on taxable income . In most cases, taxable income is simply the difference between total assessable income and total deductions:
Taxable income = Assessable income - Deductions
If total deductions exceed total assessable income:
- there is no taxable income; and
- there may be a tax loss that can be deducted in a later year.
There are several cases where taxable income is worked out in a different way. The Bill will, for the first time, list these cases in the one place [subclause 4-15(2)].
For example, a company whose ownership changes during the income year may have to calculate its taxable income in a different way [subdivision 165-B, discussed in Chapter 7 of this Explanatory Memorandum] .
Assessable income is one of the main components in calculating taxable income. Exempt income is not assessable income. The following diagram shows how to work out whether an amount is assessable income, exempt income or neither.
Diagram showing how to work out assessable income and exempt income
The diagram starts by asking whether an amount is ordinary income .
Ordinary income is a succinct label for income according to ordinary concepts , which is a major concept in the present law. The courts have developed principles for determining what is ordinary income. However, there is no complete set of rules for determining that question.
Some amounts are clearly ordinary income (for example, salary, wages and interest). Often, whether an amount is ordinary income has to be determined by applying the court-developed principles to the facts of a particular case. (That will remain the position.)
The law contains provisions that modify how some ordinary income is treated. They might affect when it is assessed, how much is assessed or even to whom it is assessed. However, those provisions do not alter the fact that those amounts are ordinary income.
If an amount is not ordinary income, it may be statutory income . Statutory income is an amount the law specifically includes in assessable income (for example, section 160ZO of the Income Tax Assessment Act 1936 includes net capital gains in assessable income).
If an amount is included by such a provision, and is not ordinary income, the amount is statutory income [subclause 6-10(2)] .
To make it easier for readers to work out if a particular amount is statutory income, the new law will list the specific provisions that include an amount in assessable income [clause 10-5] . Initially, the items in the list will refer mainly to provisions in the Income Tax Assessment Act 1936 . The references will change progressively to references to the new Act as the existing Act is rewritten.
The list will also contain provisions that vary:
- when an amount of ordinary or statutory income is assessable;
- to whom an amount of ordinary or statutory income is assessable; and
- how much of an amount of ordinary or statutory income is assessable.
If an amount is neither ordinary income nor statutory income, it cannot be assessable income or exempt income.
The existing Act does not expressly distinguish the concepts of ordinary income and statutory income, although they are implicit in the Act. The main reason for the Bill making this distinction is that the rules about what statutory income is exempt, and what ordinary income is exempt, are different. It will also provide convenient labels where only one kind of income is relevant to particular provisions of the law.
The Bill does not use the term 'income' because of confusion surrounding its meaning in different provisions of the present law. Therefore, 'income' will appear as part of compound expressions eg. income tax and ordinary income .
The existing law is applied so that both ordinary income and statutory income are only assessable income if they have a sufficient link to Australia. The rules are:
- for a resident of Australia , all ordinary and statutory income is assessable (including amounts from sources outside Australia), unless it is exempt; and
- for a non-resident , all ordinary and statutory income from Australian sources is assessable, unless it is exempt.
This is less clearly expressed in the terms of the existing Act.
Most ordinary and statutory income from foreign sources is not assessable to foreign residents. However, there are limited cases where an amount is assessed on a specifically expressed basis (eg. the capital gains and losses provisions bring to account gains and losses on the disposal of a 'taxable Australian asset' rather than on Australian-sourced capital gains and losses).
The diagram also indicates that, just because a provision includes an amount in assessable income, it doesn't necessarily mean that the amount will be assessable:
- Another provision might exempt it. For example, a dividend paid out of foreign-sourced profits might be statutory income but it is made exempt for some people. Exempt income is discussed in more detail below.
- There are a few provisions that expressly exclude an amount both from assessable income and exempt income (eg. sub-clause 170-25(1) which concerns payments received for the transfer of a tax loss).
A generally accepted principle of tax accounting is that an amount accountable on a receipts basis can be your income, even if it has not been actually received, as soon as it is applied or dealt with in any way on your behalf or as you direct. In other words, an amount is treated as received as soon as the taxpayer gets benefit from it. This rule applies to both statutory income and ordinary income for amounts accounted for on a receipts basis. It is not limited to cases where a particular provision uses the word 'received' (eg. it can apply where a provision uses the word 'derived' and the amount in question is properly accounted for on a receipts basis).
The Bill will explicitly state this principle, confirming what is generally accepted as one of the ordinary principles of tax accounting. Subclauses 6-5(4) and 6-10(3) will only have the effect of treating amounts as ordinary or statutory income when they are dealt with on your behalf or as you direct if they have all the attributes of ordinary or statutory income respectively, except that they have not been received.
Although subclause 6-5(4) is worded differently from subclause 6-10(3), the two provisions operate in the same way. Subclause 6-5(4) uses the word derived to describe when an amount with an income character comes home to you and thus becomes ordinary income. Subclause 6-10(3) does not use derived because the various timing tests for statutory income are generally different.
Example: On your instructions, your employer pays part of your wages to a health fund to meet your liability to pay health insurance contributions to the fund. You are taken to have received the amount when your employer paid it to the fund and, therefore, to have derived it as ordinary income then.
The Bill doesn't exclude any constructive receipt principle which extends beyond the rule set out in the subclauses.
There is a view that the comparable present provision, section 19 of the Income Tax Assessment Act 1936 , has no operation because of defective drafting. This view interprets the provision as deeming something to be derived as income only if it is already income. But to be income, an amount must already have been derived. The new provisions will apply to any amount that would be ordinary or statutory income except that the taxpayer has not received it.
An amount of income may be included in assessable income by more than one provision of the law.
Under the existing Act, there are no express rules about what happens in such cases, although there is a presumption against double taxation.
The new law will specifically state the rules for when this happens.
If an amount falls within 2 or more provisions, it can only be assessable once. In such a case, the amount would be assessable under the most appropriate provision. You would determine the most appropriate provision taking into account, where relevant, the rule about the effect of specific assessable income provisions on ordinary income (see discussion about subclause 6-25(2) below).
If an amount is both ordinary income, and included in your assessable income by a specific provision, the specific provision will apply rather than the court-developed rules about ordinary income. However, this will not be the case if a contrary intention is apparent [subclause 6-25(2)].
An example of a contrary intention is in the calculation of a capital gain, in a case where the disposal of an asset would also produce ordinary income assessable under clause 6-5. In that case, section 160ZA of the Income Tax Assessment Act 1936 provides that the rules about ordinary income prevail, so that a capital gain is reduced by the amount that is assessable under the ordinary rules. Thus, the capital gains provisions only have a residual operation.
The rewritten law reflects the existing law in identifying what income is exempt. That is, an amount will be exempt income if:
- it is ordinary or statutory income and a provision in the Bill expressly makes it exempt; or
- it is ordinary income and a provision in the Bill excludes it (expressly or by implication) from being assessable income.
Under the existing law, it is not clear whether an exemption provision can apply to statutory income as well as ordinary income. The Bill makes it clear that an exemption provision applies to both, in accordance with the way the law is presently administered.
Also under the existing law, if an amount of ordinary income is excluded from being assessable income, it is exempt income. It is silent as to the position with statutory income. The Bill makes it clear that, if an amount of statutory income is excluded (expressly or by implication) from being assessable income, it is not exempt income. The result will be the same whether an amount is included as assessable income and then excluded or is never made statutory income at all.
An example where ordinary income is expressly excluded from assessable income is section 110CA of the Income Tax Assessment Act 1936 . This section states that the assessable income of a life assurance company does not include income attributable to the investment of premiums in respect of life assurance policies received from constitutionally protected funds.
An example where an amount of ordinary income is excluded from assessable income by implication is section 27C of the Income Tax Assessment Act 1936 . Here only 5% of the pre-July 1983 component and 5% of the concessional component of an eligible termination payment are included in assessable income. The remaining 95% of the payment is excluded by implication from being assessable income.
There are several important consequences of an amount being exempt income:
- It is not assessable income and is, therefore, tax free [subclause 6-15(2)] ;
- It may reduce the deduction allowable for a tax loss [clause 36-10] ;
- A loss or outgoing incurred in deriving the income is not allowable as a general deduction [subclause 8-1(2)] ;
- The disposal of an asset used only to produce exempt income does not produce a capital gain or loss [sections 160Z(6) and 160Z(9)(c) of the Income Tax Assessment Act 1936] ;
- The disposal of an asset owned by a taxpayer, whose total income is exempt, does not produce a capital gain or loss [sections 160Z(8) and 160Z(9)(a) of the Income Tax Assessment Act 1936] ;
- Exempt income is taken into account in working out the income tax payable on income from an approved overseas project [section 23AF of the Income Tax Assessment Act 1936] or on income earned in overseas employment [section 23AG of the Income Tax Assessment Act 1936] .
Not all of the listed consequences apply to every amount of exempt income. For example, most fringe benefits are exempt income [subsection 23L(1) of the Income Tax Assessment Act 1936] but do not reduce a deduction for a tax loss [subclause 36-20(3)] .
Assessable income and exempt income are mutually exclusive [clause 6-15].
Some provisions make ordinary or statutory income neither assessable income nor exempt income [see, for example, section 121EG of the Income Tax Assessment Act 1936 which deals with 'offshore banking units'] .
In the absence of such an express provision, ordinary and statutory income will either be assessable income or exempt income.
To work out the amount of your taxable income, you reduce your assessable income by your deductions.
These are all of the amounts that:
- the general deduction provision [clause 8-1] allows you to deduct; or
- a specific deduction provision allows you to deduct;
and that no other specific provision prevents you from deducting.
The general deduction provision [clause 8-1] is the first place to go to find out if a particular loss or outgoing is deductible. It essentially restates subsection 51(1) of the Income Tax Assessment Act 1936 . Interpretation of that provision has evolved over many years in the courts. The Bill rewrites subsection 51(1) with a clearer structure but does not disturb its language and is not intended to affect previous interpretations.
If an amount is not deductible under the general deduction provision, it may be deductible under a specific provision. A specific provision may also prevent an amount from being deducted under the general deduction provision or may vary the amount that would be deductible. The new law will include a checklist of provisions about specific deductions to help identify these situations with more certainty than is currently possible [clause 12-5] .
Some amounts may satisfy both the general deduction provision and one or more specific deduction provisions. In such cases, you cannot deduct the same amount twice. It will be deductible under the most appropriate provision.
If an amount is deductible under both the general deduction provision and a specific deduction provision, in the absence of a contrary intention, the specific provision would generally be the appropriate one to apply.
The checklists are a new feature designed to help readers quickly find their way to the operative provisions they need to know about. When the rewrite is finished, these provisions will generally be in either Chapter 2 of the Bill (Liability rules of general application) or Chapter 3 (Specialist liability rules). Until the completion of the rewrite, some of these provisions will be in the Income Tax Assessment Act 1936 .
The two lists in Division 9 set out the kinds of entities that:
- are subject to income tax and the provisions which make them so [clause 9-1] ; and
- calculate income tax by reference to something other than taxable income and the provisions which require this [subclause 9-5(1)] .
The other six checklists in the Bill catalogue provisions that:
- include an amount in assessable income or vary when, how much of, or to whom, an amount is assessable [clause 10-5] ;
- exempt all ordinary and statutory income of a taxpayer because of who the taxpayer is [clause 11-5] ;
- exempt specified types of ordinary or statutory income, no matter who the taxpayer is [clause 11-10] ;
- exempt specified types of ordinary and statutory income if the taxpayer falls within a special category [clause 11-15] ;
- allow a deduction or vary a deduction [clause 12-5] ; and
- allow an amount as a tax offset [clause 13-1] .
The lists are intended to be comprehensive. They are not operative rules but are provided as a form of navigational help.
Paragraph 23(r) of the Income Tax Assessment Act 1936 provides that 'income derived by a non-resident from sources wholly out of Australia' is 'exempt from income tax'. The 1936 Act contains a few provisions which assess an amount on a basis not strictly expressed as having an Australian source eg. the capital gains and losses provisions bring to account gains and losses on the disposal of a 'taxable Australian asset' rather than on Australian-sourced capital gains and losses.
Under the current law, paragraph 23(r) does not exempt these amounts. It is merely a corollary of the general income provision, subsection 25(1), which assesses non-residents on all their income from sources in Australia.
The core provisions will not change this position. However, because of the rewording of the source rules for assessable income of non-residents in subclauses 6-5(3) & 6-10(5), paragraph 23(r) on its face would no longer perfectly complement these rules.
Consequently, it has been rewritten with additional words in parenthesis clarifying that the paragraph does not exempt income that a specific provision assesses on a basis other than having an Australian source.