5. Taxation
Australia’s income tax legislation is one of the longest and
most complex in the world.
It is contained in two statutes, the Income Tax Assessment
Act, 1936 (1936 Act) and the Income Tax
Assessment Act 1997 (1997 Act). The 1997 Act
is a re-write – in modern language and using modern taxation law
concepts – of a steadily increasing portion of the 1936
Act. The un-rewritten part of the 1936 Act operates
in tandem with the 1997 Act.
During World War II, the income taxing powers of the Australian
states were taken over by the Commonwealth and have not been
revived, with the result that Australia has only one income tax,
and that is a tax imposed at federal level.
The un-rewritten parts of the 1936 Act have been
extensively amended over the last 20 years under successive
Australian governments.
In 1985, Australia introduced a capital gains tax (CGT). The
Australian CGT regime taxes worldwide capital gains of Australian
residents and capital gains of non-residents who dispose of an
asset comprising direct or indirect interests in Australian real
estate. The CGT regime re-characterises net capital gains (capital
gains less capital losses) of a taxpayer as income of the taxpayer
and imposes income tax on it, although individuals (including
individuals sharing in the gain through trusts) are taxed on only
50% of the gain where the asset has been held for more than one
year.
In 1991, a controlled foreign corporation (CFC) system and a
transferor non-resident trust regime were introduced, followed by a
foreign investment fund (FIF) system in 1992. These regimes, which
have a direct impact on the Australian tax treatment of certain
trusts, are discussed below.
Australia’s CFC regime is substantially based on the US tax
model.
b. Tax system
i. General concepts of tax liability
The Australian tax system taxes income when it is ‘derived’,
irrespective of whether it has been physically received by the
recipient or paid by direction on the recipient’s behalf to a third
party. The Australian tax system taxes the worldwide income and
capital gains of all Australia’s residents, regardless of the
source of the income, subject to a foreign tax credit system and
tax treaty relief where a double tax treaty (DTT) is in force
between Australia and the source country.
The Australian tax system also taxes the Australian source
income of all non-residents, including the capital gains derived by
non-residents on direct and indirect interests in Australian real
property assets (including rights associated with land, such as
mining rights).
Beneficiaries of trusts are taxed on the share of trust ‘net
income’ to which they have a present entitlement in the particular
year of income as a matter of trust law, irrespective of whether
they actually receive a physical distribution of the trust income.
Where no beneficiary is entitled to any part of the net income of
the trust, the trust itself is liable for tax on the trust net
income where the trust income is sourced in Australia or where the
trust is a resident Australian trust estate.
In 1985, when the CGT regime was introduced, assets acquired
before 20 September 1985 were treated as being pre-CGT assets,
exempt from CGT until sold, gifted or otherwise transferred to
another owner, at which time they become CGT-assets subject to the
CGT regime.
The CGT regime treats the excess of the disposal consideration
for a CGT asset or, where the transaction occurs on a non-arm’s
length basis, the asset’s market value at disposal date, less its
cost base as capital gain, which, after being netted off against
the taxpayer’s capital losses, becomes a net capital gain included
wholly (for a company) or as to 50 per cent (for an individual) as
taxable income of the taxpayer.
ii. Rates and tax incentives
Beneficiaries of trusts who are individuals are taxed at the
individual rate of tax, which is a graduated rate. The rates as
from 1 July 2008 for residents are:
Income | Tax rate
AUD0–6,000 | 0%
AUD6,001–AUD34,000 | 15%
AUD34,001–AUD80,000 | 30%
AUD80,001–AUD180,000 | 40%
AUD180,001+ | 45%
The rate for non-resident individuals for the first AUD34,000 is
29 per cent.
In addition, a Medicare levy of 1.5 per cent applies above an
individual threshold of AUD17,605. Income earners with a taxable
income above AUD100,000 (or couples with a combined taxable income
above AUD150,000) without private health insurance will be subject
to a Medicare surcharge of 1 per cent on top of the mandatory 1.5
per cent Medicare levy, bringing the top marginal tax rate to 47.5
per cent.
The Australian tax system is integrated with a number of tax
benefits for families, particularly those with dependent children.
The interaction can be quite complex but at lower income levels
results in significant amelioration of the rates set out above.
Resident Australian taxpayers are entitled to a credit for the
lesser of, on the one hand, the foreign tax paid by the taxpayer on
foreign source income less any tax relief available in the source
country and, on the other hand, Australian tax payable on that
income.
The company tax rate (including that of Australian resident
corporate beneficiaries of trusts that are presently entitled to
trust net income in the year of income) in Australia as from 1 July
2001 (i.e. year ended 30 June 2002 and subsequent income years) is
30 per cent.
iii. Tax evasion and avoidance
Part IVA of the 1936 Act contains the general
anti-avoidance rule (GAAR) for the Australian income tax regime. In
addition, there are specific anti-avoidance measures.
Application of the GAAR rule by the Australian Revenue
(Australian Taxation Office, or ATO) involves objective
determination that a party, not necessarily the taxpayer, entered
into a ‘scheme’, broadly defined, for the dominant purpose of
enabling a taxpayer to obtain a ‘tax benefit’ – defined to include
not only the non-inclusion of an amount of income in the taxpayer’s
assessable income for tax purposes, but also the securing of a
deduction for an outgoing or expense and certain other tax
reductions, which would not have otherwise occurred under a
hypothetical alterative transaction which the party or parties
concerned could reasonably be expected to have entered into but for
their entry into the subject scheme.
iv. Taxable periods and filing requirements
The Australian tax system assesses tax based on a 12-month
income year, which, in the absence of an election being made to
change the tax year (which in any event must be a 12-month period
starting at the end of the previous 12-month period), commences on
1 July and ends on the following 30 June.
Tax returns must be filed by 31 October following the end of the
tax year unless a taxpayer’s tax return is being filed by a
registered tax agent, in which case the tax return is due for
filing with the ATO in accordance with the tax agent’s filing
programme.
Tax returns can be filed electronically by the due date for
filing, subject to a hard copy signed by the taxpayer being filed
with the ATO in due course after the due date for filing.
c. International
i. Residents with foreign
investments/transactions
Australian resident taxpayers are taxed on worldwide income and
capital gains regardless of source. They are entitled to a credit
for the lesser of, on the one hand, the foreign tax paid by the
taxpayer on foreign source income less any tax relief available in
the source country and, on the other hand, Australian tax payable
on that income. The Australian foreign tax credit (FTC) regime
includes a credit for withholding taxes paid in source
countries.
ii. Expatriates
Expatriate Australian taxpayers’ taxation treatment in Australia
depends on residency status. If they lose their Australian
residence, then they are taxed only in the country of their
residence and cease to be taxed as Australian residents on
worldwide income and capital gains.
Foreign national expatriates living in Australia are also taxed
based on their residency status. If the foreign nationals acquire
Australian residence, then they are taxed in Australia on their
worldwide income and capital gains.
Australia has a 183-day rule for foreign national expatriates,
which deems them to be non-residents, and hence taxable only on
their Australian source income, if they are physically present in
Australia for less than 183 days of a particular year of
income.
Temporary residents holding a special temporary resident’s visa
can obtain non-resident treatment for a maximum period of four
years.
iii. Non-residents
Non-residents are taxable only on Australian source income, of
which passive income such as dividends, interest and royalties is
taxed by a withholding tax system. The basic rates are 30 per cent
for dividends and royalties, and 10 per cent for interest. Where
there is a DTT in force, withholding tax is imposed at treaty
rates, and the non-residents must look to their country of
residence to claim FTC for Australian tax paid on their Australian
source income.
As a credit is allowed to shareholders for tax paid by a company
at the company tax rate, corporate dividends will be free of
withholding tax unless the company does not apply credits
(‘franking credits’) to the dividend in question.
Non-residents are liable to capital gains tax only in respect of
taxable Australian real property, including permanent
establishments in Australia, and non-portfolio (basically, 10 per
cent or more of the total) equity interests in companies and trusts
where such assets comprise 50 per cent or more of the total assets
of the company or trust concerned.
iv. Tax treaties
Australia is a party to DTTs with most major trading partners
and OECD member states. The standard Australian DTT is based on the
OECD Model Double Tax Convention on Income and on
Capital.
Australian DTTs all include the model OECD business profits
article, which limits Australian source-country taxing rights to
the income of an enterprise carried on in Australia through a
permanent establishment in Australia.
Australian DTTs generally limit the Australian tax on interest
and royalty income sourced in Australia to 10 per cent of the
income derived, and the limitation on the Australian tax payable on
dividend income derived by non-residents from Australian resident
companies, if otherwise taxable, ranges from 5 per cent to 25 per
cent of the dividend payable to the non-resident shareholders,
depending on the terms of the individual DTT.
d. Taxation of trusts
i. Types of trusts and tax liability
In Australia, beneficiaries are taxed on unaccumulated income,
rather than on the trust itself. The test of whether there are
beneficiaries who are ‘presently entitled’, as a matter of trust
law, to all the income of the trust at the end of the income year
is the test applied to determine who is liable to pay tax on the
net income.
Individual beneficiary taxpayers are taxable on their share of
the net income of the trust at the tax rates listed above under the
heading ‘5. b. ii. Rates and tax incentives’. Resident
beneficiaries may also be taxed on foreign trust income accumulated
abroad for them, and pay additional tax in respect of any period of
deferral of recognition of such income.
Trustees are only liable to pay tax on the net income of the
trust where there are no ‘presently entitled’ beneficiaries at the
end of the taxation year. In this situation, trustees are taxable
at the highest marginal rate of tax (plus Medicare levy), which is
47.5 per cent, without any graduation of tax rates or the benefit
of the tax-free threshold, where the trust is an inter
vivos trust. Where the trust is a testamentary trust, the
trust is taxable on its net income with benefit of the tax-free
threshold and graduated tax rates. The trustee has withholding
obligations in respect of income to which non-resident
beneficiaries are presently entitled.
ii. Duration and termination
The Australian tax system places no relevance on duration and
termination of trusts. It makes no attempt to penalise by imposing
higher rates of tax than would otherwise apply where trusts are of
a long duration.
However, where a trust instrument requires, or a trustee decides
under a power of appointment or discretion to implement, an
accumulation of the net income of the trust in the hands of the
trustee (regardless of whether it is capitalised and becomes an
accretion to the trust corpus), the trustee will be taxed on the
net income of the trust, because in that situation there are no
presently entitled beneficiaries in respect of the trust net
income. This will result in the trust being taxed on all of its
accumulating net income at the highest marginal tax rate, but
applied as a flat tax rate, of 47.5 per cent of the net income of
the trust.
iii. Transfers to a trust
In 1991, a transferor trust regime was introduced into the
Australian tax system. This regime essentially attributes to
Australian resident taxpayers income and capital gains of
non-resident trust estates where the resident taxpayers have
transferred either property or services to the trustee of a
non-resident trust or where they control the non-resident trust,
irrespective of whether the income or capital gains of the
non-resident trust are ever distributed to the resident taxpayer,
who need not even be a beneficiary of the trust in order to have
attribution in Australia of the trust income.
Furthermore, in the early 1990s, the foreign investment fund
(FIF) regime was introduced. Under the FIF regime, taxpayers with
an associate-inclusive control interest in an FIF (i.e. a foreign
company or foreign trust) and an interest in the income of the FIF
(FIF income) are deemed to have their share of the accrued FIF
income (i.e. the foreign source income of the FIF deemed to have
accrued to the taxpayer under the FIF regime rules on an annual
basis), irrespective of whether this trust income is ever
distributed to the taxpayer in Australia.
iv. Taxation of income earned in the trust
This topic is discussed above. The Australian tax system looks
through trusts and taxes the beneficiaries, unless there are no
beneficiaries having a present entitlement to the trust income.
v. Distributions to beneficiaries
This topic is discussed above.
vi. Non-resident trusts and foreign investment
entities
This topic is discussed above.
e. Taxation of estates
i. Estate and gift taxes
There is no federal Australian estate duty or death duty nor any
federal Australian gift tax or gift duty. Some states and
territories have estate and death duties, but these estate and
death duties no longer apply to deceased estates where, in most
cases, the deceased person has died within the last 20 to 23 years.
Estate and death duties no longer play a part in the estate
planning methodologies of trust and estate practitioners and tax
advisers in Australia.
ii. Taxation on death
On death, a taxpayer’s legal personal representative must file
two tax returns under the Australian tax system. One tax return is
for the income and capital gains derived by the deceased taxpayer
up to the date of death. The second tax return is to recognise
income of the estate from the date of death until the end of the
income year in which the death occurred, which is usually 30 June
following the date of death.
The Australian CGT regime gives the legal personal
representative and beneficiaries of the estate of a deceased
taxpayer an election to defer capital gains tax liability of the
deceased, under what is termed ‘the death roll-over’, on the CGT
assets transmitted or gifted to them under the will or intestacy
laws, until the eventual sale of the CGT assets.
Where the deceased died with pre-CGT assets, the taxpayer’s
death is treated as the conversion of the assets into post-CGT
assets which are deemed to have been acquired by the legal personal
representative or beneficiaries to whom they have been gifted at a
cost base equal to their market value at the date of death, in
order to enable calculation of the capital gain on the eventual
sale of those CGT assets in the hands of the legal personal
representative or beneficiaries to whom they have been gifted.