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House of Representatives

Income Tax Rates Amendment Bill (No. 1) 1997

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

General outline and financial impact

Amends the Income Tax Rates Act 1986, in relation to family tax assistance, to:

·
ensure that family tax assistance is properly allowed to taxpayers with a special income component (such as a capital gain) and a liability to pay complementary tax;
·
prevent entitlement to family tax assistance from causing an increase in the rate of penal tax on uncontrolled partnership income; and
·
adjust the complementary tax provisions in relation to family tax assistance to take account of taxpayers with reduced tax-free thresholds.

Date of effect: 1 January 1997.

Proposal announced: Not previously announced.

Financial impact: Negligible cost to the revenue.

Compliance cost impact: No additional compliance costs, over and above those already associated with family tax assistance.

Chapter 1

Summary of the amendments

1.1 The amendments contained in this Bill are consequential upon the introduction of family tax assistance, and will remove some anomalies in the application of the family tax assistance rules and make some technical corrections.

1.2 This Bill amends the Income Tax Rates Act 1986 (the Rates Act). Other amendments in relation to family tax assistance are contained in Taxation Laws Amendment Bill (No. 3) 1997.

Background to the legislation

1.3 The family tax initiative commenced on 1 January 1997. It has two components - family tax assistance (FTA) which is delivered through the tax system, and family tax payments, which are cash payments delivered by the Department of Social Security.

1.4 The main provisions of the law relating to family tax assistance are found in Division 5 of Part II of the Rates Act.

1.5 Uncontrolled partnership income: Broadly speaking, uncontrolled partnership income is income which is deemed to be the product of income splitting (see section 94 of the Income Tax Assessment Act 1936). It is subject to further tax at a penal rate calculated according to formulae contained in subsections 12(7) and 12(8) of the Rates Act.

1.6 As the law stands, entitlement to FTA has the unintended effect of increasing the penal rate, because it reduces the gross tax figure at "B" in the formulae.

1.7 Special income component: Section 20F of the Rates Act applies to a taxpayer whose taxable income includes a special income component e.g a capital gain, or income derived from activities as an artist, inventor and sportsman. A taxpayer in this category pays tax at an average rate on each dollar of taxable income from $1. Section 20F reduces the rate of tax otherwise payable by a taxpayer with a special income component by an amount which represents the taxpayer's FTA entitlement.

1.8 At the moment, unlike most taxpayers with primary production income, a taxpayer with a special income component, whose FTA benefits exceed his or her ordinary tax liability, cannot claim FTA against complementary tax. Other taxpayers, without a special income component can reduce complementary tax to take account of FTA.

1.9 Partial thresholds: Section 20G of the Rates Act allows a complementary taxpayer, with FTA entitlements in excess of ordinary tax liability (if any), to reduce the rate of complementary tax by a rate equivalent to the value of the excess FTA entitlements.

1.10 If a taxpayer has no ordinary tax liability, he or she can deduct the whole of his or her FTA entitlements from complementary tax. In that case, the calculation of the rate reduction is different from the calculation for a taxpayer with some ordinary tax liability, who is only deducting the balance of FTA entitlements from complementary tax. Section 20G uses the figure of $5,400, which is the tax-free threshold for most taxpayers, to distinguish between the two cases.

1.11 A taxpayer who becomes, or ceases to be, an Australian resident during the year of income, or who ceases full-time study for the first time, will have a reduced or partial threshold, based of the number of months when the taxpayer was a resident or had stopped studying.

Explanation of the amendments

Uncontrolled partnership income

1.12 Paragraphs 12(7)(a) and 12(8)(a) of the Rates Act will be amended to exclude FTA from the calculation of "B" in the formulae in those paragraphs. This will ensure that a person who is entitled to FTA benefits will not pay the further tax on uncontrolled partnership income at a higher rate than a person who is not entitled to FTA. [Items 1 & 2, Schedule 1]

1.13 Amendments are not required to paragraphs 12(7)(b) and 12(8)(b) of the Rates Act, which apply when a taxpayer has uncontrolled partnership income and primary production income. In that case, the figure at "B" is worked out by reference to notional rates in Schedule 8 to the Rates Act, which under clause 3 of Schedule 8 are calculated as though the FTA provisons did not apply.

Special income component

1.14 If a taxpayer has a special income component, and a complementary tax liability, and the taxpayer's FTA benefits are worth more than the taxpayer's ordinary tax liability, the taxpayer will be able to offset the excess FTA benefits against the complementary tax liability. This will put taxpayers with a special income component in the same position as other taxpayers, with regard to complementary tax and FTA.

1.15 Items 3 to 6 , Schedule 1 of the Bill will amend section 20F, and insert several new subsections. The new provisions will not materially change the method of the calculation of FTA benefits, in that the rate of tax will still be reduced by an amount representing the taxpayer's FTA benefit, but the reduction in rate will now be referred to as the "section 20F rate adjustment". [subsection 20F(3)]

1.16 The reason for the new section 20F is to distinguish between taxpayers with excess FTA benefits (which can be carried over to complementary tax) and taxpayers without excess benefits. Subsections 20F(1) and 20F(2) will apply where the rate of tax otherwise payable exceeds the section 20F rate adjustment. In this case, the rate of tax will be reduced by the section 20F rate adjustment.

1.17 Subsections 20F(1A) and 20F(2A) will cover the case where the section 20F rate adjustment is greater than or equal to the rate of tax otherwise payable. In that case, the rate of tax will be nil, and the taxpayer will not be liable for ordinary tax. If the section 20F rate adjustment exceeds the rate of tax, the taxpayer will have excess FTA benefits.

1.18 Subsections 20F(1) and 20F(1A) will apply to individuals, and subsections 20F(2) and 20F(2A) will apply to trustees assessable under section 98 of the ITAA.

1.19 If a taxpayer has excess FTA benefits (i.e. subsection 20F(1A) or 20F(2A) apply) and is liable for complementary tax, the taxpayer's rate of complementary tax will be reduced by an amount calculated as follows:

taxable income/deemed taxable income from primary production x balance of section 20F rate adjustment

where the "balance of section 20F rate adjustment" is obtained by subtracting the ordinary rate of tax from the "section 20F rate adjustment". If the taxpayer is a trustee, the formula will refer to "share of net income" instead of "taxable income". [New subsections 20G(2A), 20G(4A) and Items 11 and 12, Schedule 1]

1.20 In effect, the rate of complementary tax will be reduced by an amount which is the equivalent of the excess FTA benefits.

1.21

Example: For example, a taxpayer has a taxable income as follows:

Special income component $1,000
Other taxable income 6,000
-----
Taxable income $7,000
The taxpayer is a primary producer with 2 dependent children, both over 5 years old, and would be eligible for a tax-free threshold increase of $2,000. The other taxable income is all income from primary production. The taxpayer's average income was $8,000.The rate of tax under clause 2, Part I of Schedule 7 of the Rates Act is

4.57% or 320/7000.

The section 20F rate adjustment is:

tax-free threshold increase/taxable income x lowest marginal rate of tax
i.e. $2,000/$7,000 x 20% = 400/7000 or 5.71%

Since the taxpayer's section 20F rate adjustment exceeds the rate of tax under clause 2, Part I, Schedule 7, the taxpayer falls within subsection 20F(1A) and the rate of tax is reduced to nil. The taxpayer therefore has no ordinary tax liability.However, the taxpayer is liable for complementary tax. Before allowing for FTA, the rate of complementary tax, under section 12(3) of the Rates Act, is

135/7000 or 1.93%.

As the section 20F rate adjustment exceeds the rate of tax otherwise payable, the taxpayer is entitled to a reduction in the rate of complementary tax:

taxable income/deemed taxable income from primary production x balance of section 20F rate adjustment
i.e. $7000/$7000 x (400/7000 - 320/7000) = 80/7000 or 1.14%

The reduced rate of complementary tax is

135/7000 - 80/7000 which equals 55/7000 or 0.78%.

In terms of the amount of tax payable, the taxpayer's FTA benefit is worth $400 in tax. The taxpayer's ordinary tax liability is $320, apart from FTA, and complementary tax liability is $135, apart from FTA. FTA is recouped from ordinary tax liability first. The amount remaining i.e. $80 ($400 - $320) is then deducted from complementary tax, leaving a net complementary tax liability of $55.

Partial thresholds

1.22 For a taxpayer with a reduced or partial threshold, section 20G of the Rates Act will only operate as intended if the references to $5,400 are read as references to the taxpayer's partial threshold. Consequently, section 20G will be amended so that taxpayers with partial thresholds will be able to use those thresholds in their calculations, instead of the full tax-free threshold of $5,400. [Items 7, 10 and 13, Schedule 1]

Technical amendments

1.23 Schedule 2 of the Bill will make a number of technical amendments to the family tax assistance provisions. The amendments will correct several references to Part I of various Schedules to the Rates Act, which in the original provisions appeared as references to Part 1.


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