Week 7 – Tax Offsets and Trading Stock

Offsets and rebatesTrading Stock – Division 70

Chapters 13 and 15

Income Tax Formula – s 4-10, s 4-15

Gross Income

Less: Exempt income (s 6-20 and Div 11)

= Assessable Income (s 6-5 and s 6-10)

Less: Allowable Deductions (s 8-1 & Div 25)

= Taxable Income x Tax rate + Medicare levy (1.5%) + (surcharge 1% if applicable)

= Tax payable - Less: tax offsets + rebates =

Tax refund or payment to ATO

Tax payable - Less: tax offsets + rebates

• Tax offsets and Rebates – available to individuals (except imputation credits for Companies and Entrepreneur tax offset)

• Tax offsets/rebates are deducted from tax payable. Allowable deductions – s 8-1 and Division 25 deducted from assessable income.

• Example: Your client earns $14,250 from a part time job and deducts the cost of the laundry of a uniform, $250. Taxable income is $14,000 and tax payable is $1,200. Your client is eligible for the full amount of the low income rebate (less than $30,000) of $1,200. Therefore, tax to be paid to the ATO is $0.

List of relevant Tax Offsets

Dependant rebate – s 159J and s 159H, ITAA 36– Spouse, child-housekeeper, invalid relative,

parent or parent-in-law, or parents

Low Income - $1,200

Senior Australians Tax Offset

Medical Expense

Private Health Insurance

Child Care Rebate

Important Issues

• Who is a dependent? Includes a “defacto” spouse. The number of children are not relevant for the rebate.

• Who is a “child” – only relevant as a “notional” dependent for medical expense rebate. A person under 21 years a “child” or a full-time student under 25 years.

• What is SNI – separate net income – dependents that earn their own taxable income may preclude the taxpayer from claiming a rebate. Spouse – cuts out if SNI $8,917 or more. Full time student under 25 years – no rebate if SNI more than $1,785.

Separate Net Income

• How is SNI calculated – not the same as taxable income. SNI includes gross income: salary, wages, pensions, capital gains and exempt income. Deductions consist of: net child care expenses after rebate for child care, travel from home to work, food consumed during work hours.

• From the SNI is deducted the amount of $282 and the rebate is reduced by $1 for every $4 excess.

Dependant Rebates

• Rebate reduced or denied if eligible for a Part B – Family Tax Benefit – which is aimed at assisting single income families and those on low incomes, i.e. only one spouse earning income.

• Family Assistance Office, administers A New Tax System (Family Assistance) Act 1999, but benefit paid by Centrelink.

• Assistance in the form of a Family Tax Benefit A, Family Tax Benefit B, and Child Care Benefit.

• Example: still entitled to a Part A, Family tax benefit if 1 child and income below $89,803 per annum

Dependants

• Spouse – $2,159 – no rebate if income >$8,917• Child-housekeeper - $1,759 – no rebate if income >$7,317• Invalid relative - $792 – no rebate if income >$3,449• Parent or parent-in-law - $1,583 – no rebate income $6,613• Children only notionally taken into account for medical

expense rebate or zone rebate.• Example: Your client earns $120,000 and has a spouse and child of 4

years, and is working part-time earning $2,500 per annum. No Part B Family Tax Benefit is paid. The spouse has travel expenses from home to work of $450 and child care expenses of $500. The rebate is $2,159 less SNI – 282, divided by 4. SNI = 2,500 – (450 + 500) = 1,550 – 282 = 1,268/4 = 317. The amount of rebate claimed is 2,159 – 317 = 1,842

Maintenance of Parents

• Example: Your client looks after their parents in their home. The mother and father receive a pension of $4,000 each per year. Their SNI is therefore $4,000. The maximum rebate your client can claim is $1,583 per parent.

• The amount of rebate that can be claimed is: $1,583 less ($4,000 minus 282) divided by 4 = 3,718/4 = 929.

• $1,583 less 929 = 654• Your client looks after both parents, therefore the rebate is

654 x 2 = $1,308. This amount is deducted from tax payable.

Medical Expense Rebate

• A rebate, 20%, of net medical expenses in excess of $1,500 per year. Medical expenses include payments to doctors, dentists, nurses, chemists and nursing homes etc.

• The medical expense does not include amounts refunded by Medicare or private medical insurance.

• Example: Your client has incurred total medical expenses of $8,200 during the year for the family. A son, 23 years of age and a full time university student, has incurred expenses of $3,400 and has a SNI of $1,600, and a daughter, 20 years of age, has incurred $2,000 and has a SNI of $5,000. Your client was reimbursed $3,000 by Medicare. How much is the rebate? 8,200 – 3,000 = 5,200 less 1,500 = 3,700 x 20% = 740. The expenses of the son are included because the son is a “notional” dependent because his income is less than 1,785.

Private Health Insurance Offset

• An incentive of up to 30% of the premium for private health insurance.

• It can be taken as a deduction from the cost of the premium with the insurer or as a tax offset with the tax return.

• The policy must cover hospital expenses. It can also cover ancillary and hospital or a combination of both.

• Dependents includes a “child” under 25 years who is a full-time student or a child under 18 years. If over 18 years and not a full-time student then not a dependent.

Low Income Rebate

• Only a resident individual is eligible for the $1,200 rebate provided their taxable income is below $30,000.

• The rebate phases out if the taxable income is more than $60,000. The rebate reduces by 4 cents for every dollar over $30,000

• The effect of the low income rebate is that no tax is payable on taxable incomes less than $14,000 (not $6,000)

• Example: client has a taxable income of $36,000. As the taxable income exceeds $30,000, the rebate is less than $1,200. $36,000 less 30,000 x .04 = 240. The rebate is 1,200 less 240 = 960

Trading Stock

• 70-10 Trading stock includes:– (a) anything produced, manufactured or

acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

– (b) live stock.

• Note 1: Shares in a PDF are not trading stock. See section 124ZO of ITAA 1936 .

Definition – Trading Stock

  Includes items integrated into trading stock  Includes consumable goods (which become part of

manufactured goods, eg raw materials, labels, packaging etc)

Spare parts? - not trading stock unless for resale Land? Shares? – Business dealing -trading vs.

passive investing  Standing or growing crops, unshorn wool? -

become trading stock when severed, shorn: Tax Ruling, TR 95/6

ACCOUNTING FOR TRADING STOCK

FOR TAX PURPOSES

• The difference between trading stock on hand at the beginning and the end of the year is brought to account - s 70-35(1)

• If the value of trading stock on hand at end of year greater than at the beginning of the year: the difference is Assessable income (s 6-5) - s 70-35(2)

ACCOUNTING FOR TRADING STOCK

FOR TAX PURPOSES

• If the value of trading stock on hand at the end of the income year is less than at the beginning of the income year: the difference is deductible (s 8-1) - s 70-35(3)

• Deduct purchases of trading stock – s 8-1 and s 70-15. Cost is normally the basis of the purchase price, but if seller and buyer not dealing at arm’s length - cost of trading stock is it’s Market Value- not actual purchase price – s 70-20

Tax Treatment

• Assessable incomeSales – s 6-5 $2,500Excess of closing stock over opening stock s70-

35(2) 500

$3,000• Allowable deductions

Purchases – s 8-1 $1,500Operating expenses – s 8-1 300

$1,800• Taxable income $1200

Accounting Profit & Loss Treatment

Income: Sales – s 6-5 2,500Less COGSStock - Beginning 1,000Purchases – s 8-1 1,500

2,500Stock - End 1,500

1,000Gross Profit 1,500

Less Operating expenses – s 8-1 300Net Profit $1,200

Meaning of "on hand" - s 70-35 - at end of year?

• “On hand” for the purposes of valuing the closing stock.

• Stock is “acquired”, and therefore, “on hand”, even though taxpayer has no legal title or possession - but when taxpayer has power to deal with trading stock as if it is its own. eg, “floor plan” arrangement: FCT v Suttons Motors (page 819)

“On hand”

• legally owned by the taxpayer - even if has no physical possession: - All States Frozen Food Pty Ltd v FCT - goods in transit still on ship. (page 822)

• the taxpayer has dispositive power over the trading stock: Farnsworth v FCT Taxpayer had sent fruit to a central packing house -ceased to be on hand -lost dispositive power-only had a contractual right to enforce packing house to deal with fruit according to rules of the association.

FCT v Raymor (NSW)

• Concerned the valuation of trading stock ‘on hand’. Pre-paid for stock prior to 30 June, and claimed a deduction pursuant to s 8-1.

• Stock take value did not include pre-paid stock because it was not on hand. (page 814). Therefore gave rise to ‘tax avoidance’.

• Section 70-15 introduced to overcome this problem.

Value of Trading Stock

• Value of Trading stock at Start of Year - s 70-40(1) - the value of trading stock on hand at the beginning of the year must be the same as the value adopted at the end of the preceding year.

• Value of Trading stock at end of the Year - s 70-45(1) - taxpayer has the option to value each item of trading stock on hand at the end of the year at either:

– cost;

– market selling value; or

– replacement price.

Value of Trading stock

• Under s 70-50, the taxpayer may elect a lower value than any of above, e.g. in the case of obsolescence. Reasons for election?Tax rates increasing or decreasing in next year, losses to absorb?

• Normally market cost greater than replacement cost and greater than Cost. Therefore electing market cost instead of cost will increase taxable income by increasing the value of ending stock over opening stock.

• Generally, to minimise Taxable Income, choose the lowest possible value of closing stock, unless you want to absorb carry forward losses or other deductions.

Obsolescence and Non-arm’s length

• Section 70-50 – stock can be valued at less than the three methods provided by section 70-45 – namely cost, market value or replacement value.

• Stock must be obsolete and value reasonable.• If stock sold outside normal business practice

then market value must be used. Section 70-90(2) – amount received NANE. Section 70-95 – purchaser is deemed to have acquired the trading stock at market value. Sales income – s 6-5.

Small Business Entity – trading stock

• Concession for small business entities

• If the difference between the opening and closing stock value is less than $5,000, an option not to include the difference.

• See section 328-285 – taxpayer has a choice if under the SBE system.

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