Architecture of Australia's tax and transfer system
In 2006‑07, the Australian government collected $262.5 billion in tax.1 Income tax levied on individuals and companies is the most significant source of tax revenue for the Australian government, accounting for around 70 per cent of its tax revenue (Chart 2.3, Panel A). Taxes on goods and services provide around a quarter of Australian government tax revenue. Of this, GST raises over half, while a third is derived from taxes on fuel, alcohol and tobacco (Chart 2.3, Panel B). Revenue from customs tariffs and a number of smaller taxes and levies contributes less than 10 per cent.
Chart 2.3: Australian government sources of tax revenue in 2006‑07
Panel A: Sources of tax revenue
Panel B: Revenue from taxes on goods and services
Source: ABS 2008a; Budget Statement 5, Budget Paper No. 1, 2008‑09, Australian Customs Service Portfolio Budget Statement; Australian Treasury estimates.
Personal income tax
In Australia, personal income tax is levied on nominal income. Generally thresholds are not indexed but some thresholds and amounts are indexed, mostly to the consumer price index (CPI).
The individual is generally the unit of assessment for the personal income tax system. However, some income tested programs applied to individuals, such as the Medicare levy surcharge and senior Australians tax offset, take into account a spouse's income and/or family circumstances.
The period of assessment is the income year, which for most individuals corresponds to the financial year. As a general rule, income is assessed and deductions for expenses are allowed in the year they arise, although special rules apply for allowable capital expenditures.
Most appreciating assets are assessed on a realisation basis. That is, in the year of disposal CGT applies to the net gain on the asset during its period of ownership. Broadly, the capital gain or loss from the disposal of an asset is calculated as the difference between the capital proceeds from the disposal and the asset's cost base. Capital gains or losses arise by way of 'events' that centre on the disposal of an asset or a change in ownership of an asset.
Calculating an individual's income tax liability
The calculation of an individual's personal income tax liability or refund is illustrated in Chart 2.4.
Chart 2.4: Calculation of an individual's income tax liability (or refund)
The personal income tax base is broad. Assessable income includes: salary and wage income; allowances; dividends; interest; capital gains; business income; pensions; rents; royalties; partnership income; and distributions from trusts.
Individuals who are Australian residents, as a general rule, pay tax on their Australian source income and their foreign income. Non‑resident individuals are subject to Australian tax on their Australian source income.
A broad array of tax concessions, each applicable to specific taxpayers or activities, can reduce the tax liability of individuals. These concessions may take the form of: exemptions from income tax for particular forms of income; deductions; offsets; reduced rates of tax; or deferrals of tax liability.
Assessable income consists of ordinary income and statutory income.
- Ordinary income comprises amounts that have the character of income according to judicial interpretation. It generally comprises: returns to labour such as salary or wages; returns from passive investments such as rent or dividends; and returns from a business. Amounts paid periodically (such as pensions) generally constitute ordinary income.
- Statutory income generally comprises gains in wealth that are specifically included within assessable income by the operation of the income tax legislation (for example, capital gains).
- Assessable income does not generally include income from gifts or hobbies. Returns from owner‑occupied housing, such as capital gains, are not taxable and no deduction is allowed for related expenses.
Some forms of ordinary and statutory income are made exempt from income tax, including a number of payments made under social security and family assistance legislation (for example, Disability Support Pension for those under Age Pension age, Family Tax Benefit Parts A and B, Maternity Immunisation Allowance and most supplementary payments).
Some other forms of ordinary and statutory income are made non‑assessable and non‑exempt, which means they are both excluded from a taxpayer's taxable income and ignored when working out how much of a taxpayer's losses can be carried forward to be offset against future income. An example of non‑assessable, non‑exempt income is fringe benefits. Dividends, interest or royalties paid to a non‑resident are subject to a withholding tax and are also made non‑assessable and non‑exempt. An individual's assessable income may be reduced through salary sacrifice arrangements (see Box 2.3).
The capital gains of an individual from an asset held for at least 12 months may be eligible for a 50 per cent discount, reducing the amount included in assessable income by half of the realised gain. Non‑resident individuals only pay tax on capital gains on a limited range of assets.
Box 2.3: Salary sacrifice arrangements
Under a salary sacrifice arrangement, an employer and an employee agree to reduce the employee's salary or wages in return for non‑cash benefits. The arrangement means that an individual is subject to less tax on their salary or wages, while their employer may be required to pay tax on their non‑cash benefits (this is discussed further in relation to FBT).
Technological changes mean that it is now much easier for employers and employees to utilise salary sacrifice arrangements. Several companies specialise in providing these arrangements, further enhancing their accessibility.
Chart 2.5 shows that superannuation is the most common item for which salary sacrifice arrangements are utilised (around 520,000 individuals), while motor vehicles represent the highest average amount (approximately $290 per week).
Chart 2.5: Salary sacrifice by category
Number of people and average amount per week in 2005‑06
Source: Australian Treasury estimates.
The personal income tax system allows for a range of general and specific deductions. Private expenses are not generally deductible.
General deductions are available for any loss or outgoing to the extent that it is incurred in gaining or producing assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. These include work‑related expenses and expenses incurred in earning business or investment income (other than capital expenses). In the case of allowable capital items, deductions are spread over a number of years.
Work‑related expenses are claimed by a high proportion of taxpayers and account for the largest amount of personal taxpayer deductions.
Individuals can deduct the costs of self‑education expenses that have sufficient connection to their current employment. These costs are not deductible if the new skills are for a new career direction. The costs of training employees, as with other costs incurred in earning assessable income or carrying on a business, are generally deductible for the employer.
A range of specific deductions are also allowed in the income tax law — for example, for certain superannuation contributions, donations to organisations with deductible gift recipient status (see Box 2.4), and the expenses an individual incurs in managing their tax affairs.
Box 2.4: Tax concessions for philanthropic organisations
Organisations endorsed as charities and/or deductible gift recipients (DGRs) are eligible for various tax concessions. There are currently around 50,000 endorsed charities and approximately 25,000 DGRs. Chart 2.6 indicates the overlap between charity and DGR status.
Chart 2.6: Relationship between charities and DGRs
Charities are eligible for a range of tax concessions, including refunds of imputation credits, income tax exemptions and GST concessions. To be eligible for endorsement as a charity, an organisation must be operated for public charitable purposes. Charitable purposes are: the relief of poverty, sickness, or the needs of the aged; the advancement of education; the advancement of religion; and other purposes beneficial to the community. A charity can only carry on a business or commercial enterprise where that activity is merely incidental to its charitable purpose.
DGRs are eligible for refunds of imputation credits, GST concessions and deductible gifts. In order to be a DGR, an organisation must fall within one of the general categories set out in the gift provisions of the Income Tax Assessment Act 1997, or be specifically listed by name under those provisions.
The general categories of DGRs include: public benevolent institutions (PBIs); public universities; public hospitals; approved research institutes; arts and cultural organisations; environmental organisations; school building funds; and overseas aid funds. As specific listing involves a legislative amendment, the general approach of government has been to consider DGR listing only in exceptional circumstances and where the organisation can demonstrate that it contributes to the broad public interest.
Negative income returns (where deductions exceed assessable income) arising from one source of assessable activity can generally be offset against an individual's other income. Non‑commercial losses and capital losses are exceptions. For example, capital losses arising from assets subject to CGT can only be offset against capital gains. Box 2.5 provides further detail about the treatment of losses.
Box 2.5: The tax treatment of losses
Whenever a taxpayer has a 'tax loss' their taxable income for that period is generally deemed to be zero. The tax loss may be carried forward indefinitely and deducted against assessable income of a later income year.
Restrictions apply to the utilisation of losses in certain circumstances.
There are a number of provisions that make certain types of tax losses easier to use or ensure the value of the loss does not erode over time. Certain expenditure may be eligible for a refundable tax offset (research and development and films). Under the petroleum resource rent tax, carried forward losses are indexed to ensure the value of the loss is maintained.
An individual's taxable income is determined annually by subtracting their deductions and any prior year taxable losses from their assessable income.
Where, in aggregate, there is insufficient assessable income to fully offset deductions in the tax year, the individual will have a taxable loss. A taxable loss, unused CGT losses and non‑commercial losses can be carried forward indefinitely and offset against assessable income in a future period, subject to certain loss offset restrictions (see Box 2.5). Losses derived from unrestricted activities, such as net rental losses, may be offset against income from any source, including capital gains.
Where an individual has taxable income for the income year, the personal tax rate scale is applied to determine their gross tax liability. The existing and projected personal rate scales for resident individuals are summarised in Table 2.2 (a separate tax rate scale applies to non‑resident individuals). The Australian Government has announced an aspirational goal of reducing the number of personal income tax rates to three (15 per cent, 30 per cent and 40 per cent) by 2013‑14. This goal is dependent on national and international economic conditions and maintaining, as a general principle, sound budget surpluses.
Under the PAYG withholding system, amounts are withheld from certain types of payments or transactions made by payers to payees (including salary and wages). These withheld amounts are remitted to the ATO and go toward meeting the payee's tax liability for the year. The excess of withheld amounts over the final amount of tax assessed for the year is refunded to the taxpayer.
Table 2.2: Current and projected personal tax rate scale for resident individuals
|From 1 July 2008||From 1 July 2009||From 1 July 2010|
|0 — 6,000||0||0 — 6,000||0||0 — 6,000||0|
|6,001 — 34,000||15||6,001 — 35,000||15||6,001 — 37,000||15|
|34,001 — 80,000||30||35,001 — 80,000||30||37,001 — 80,000||30|
|80,001 — 180,000||40||80,001 — 180,000||38||80,001 — 180,000||37|
|180,001 +||45||180,001 +||45||180,001 +||45|
Tax offsets can be applied to reduce an individual's tax liability. A range of offsets apply in the current system, including the low income tax offset, senior Australians tax offset, zone tax offset, foreign income tax offset, lump sum payment in arrears and employment termination payment tax offset, and the superannuation contribution annuity and pension tax offset (see Table 2.10). Most offsets are non‑refundable. That is, they can only reduce an individual's net tax liability to zero. However, a refund can be claimed for some offsets where the value of the offset exceeds the individual's tax liability.
From 1 July 2008, a 50 per cent education tax refund can be claimed for eligible education expenses. Eligible families can claim up to $750 of eligible expenses for each child undertaking primary school studies (equivalent to a refund of up to $375 per child per year) and $1,500 for each child undertaking secondary school studies (a refund of up to $750 per child per year).
Medicare levy, Medicare levy surcharge, and Higher Education Loan Program/Student Financial Supplement Scheme repayments
In addition to basic income tax, individuals are subject to the Medicare levy, which is a general income tax levied at a rate of 1.5 per cent of taxable income and paid into the Consolidated Revenue Fund. Low‑income individuals and families are not liable for the Medicare levy. For those taxpayers with income marginally above the relevant threshold, the Medicare levy is currently phased in at a rate of 10 cents for each dollar of taxable income above the relevant threshold. In addition, some taxpayers are able to obtain an exemption from the Medicare levy based on their current circumstances (for example, members of the Australian Defence Force who are provided with fee‑free medical services).
The Medicare levy surcharge is an additional 1 per cent tax, payable by individuals with a taxable income above the relevant income threshold who do not have prescribed levels of private health insurance.
Where relevant, Higher Education Loan Program (HELP) repayments and Student Financial Supplement Scheme (SFSS) repayments are added to the individual's income tax assessment to determine their final tax liability (or refund). The HELP and SFSS payments are education loan schemes, managed through the tax system. HELP is described in Box 2.6.
Box 2.6: The Higher Education Loan Program (HELP)
Students in higher education are required to contribute to the cost of their education. Students can either pay their contribution upfront, with a 20 per cent discount, or defer the contribution via a Higher Education Loan Program (HELP) loan (formerly the Higher Education Contribution Scheme).
Students who choose to defer their contribution repay the loan through the tax system in future years when their taxable income exceeds a specified threshold ($41,595 in 2008‑09). The repayment rate starts at 4 per cent and increases incrementally to 8 per cent for incomes of $77,248 and above. The deferred payment arrangements allow students who are unable to pay for their tuition upfront to participate in higher education.
The student contribution differs between courses. The contributions are set with reference to the potential higher lifetime wages that students receive from completing particular degrees. A lower student contribution rate applies to courses that the Australian Government determines are of national priority. From 1 January 2009, these courses will be education, nursing, mathematics, statistics and science.
Table 2.3: Student contribution for courses commencing from 1 January 2009
Note: For this purpose, income is defined as taxable income plus any net rental losses, reportable fringe benefit amounts and exempt foreign employment income. Outstanding loan balances are indexed each year to movements in the CPI.
Income from sole traders, partnerships, and trusts
The business and investment income of individuals operating as sole traders or as partners in a partnership is attributed to the individuals. In the case of a partnership, the income is attributed in proportion to each partner's share and included as part of their income or loss. The net losses of a partnership can be offset against the other income of the partners. The sale of a partnership interest is treated as a sale of the partnership assets by the relevant partner.
The treatment of trust income is broadly similar, with individuals including income to which they are entitled in their assessable income. However, a trust loss cannot be passed through to the individual beneficiaries of a trust. The sale of an interest in a trust is treated separately from the underlying trust assets. Further, income that is not attributable to a beneficiary of the trust is taxed in the hands of the trustee at the highest personal income tax rate, plus the Medicare levy.
Company income tax
Company income tax is levied at a rate of 30 per cent on the taxable income of Australian companies, including incorporated and unincorporated associations, limited partnerships and some corporate unit trusts and public trading trusts. Special tax rates apply to pooled development funds, to certain classes of taxable income of life insurance companies, credit unions and non‑profit companies, to retirement savings account providers and to First Home Saver Account providers.
A group of wholly‑owned entities headed by a company is able to elect to be treated as a single company for income tax purposes (known as 'consolidation'). Consolidation allows the income and losses of a wholly‑owned group of companies to be pooled.
The calculation of taxable income for companies is generally the same as for individuals, but with some significant exceptions. These exceptions include that companies do not benefit from any discount on their net capital gains, as do individuals and superannuation funds, and that companies alone receive the research and development tax concessions, among other tax concessions. Further, most income from direct offshore investment by an Australian resident company is exempt from company income tax, regardless of whether it is retained offshore, paid as a dividend to the company or realised as a capital gain.
Under Australia's dividend imputation system, Australian shareholders receiving 'franked' dividends are provided a credit for company tax paid. A dividend can be franked up to the company tax rate of 30 per cent (fully franked), provided the company pays sufficient tax to cover the level of franking. Australian shareholders include the 'grossed‑up' value of dividends (dividend income plus the franking credit) in their taxable income. They are then able to offset their income tax liability with the franking credit. Where the franking credit exceeds the amount of tax they would otherwise have to pay, they can claim the offset as a refund if they are: an individual; a complying superannuation fund; a life insurance company where the dividends relate to shares held for the benefit of policy holders; or an eligible tax exempt body or deductible gift recipient, such as a charitable institution.
Equity investments in Australia by non‑residents are primarily subject to Australian tax through company income tax. Unfranked dividends, unless they constitute conduit foreign income, are subject to a final withholding tax upon distribution to the non‑resident.
Final withholding taxes are also levied on interest, royalties and certain distributions to non‑residents from Australian managed investment trusts. These taxes are generally levied on a gross basis (that is, on the gross income without allowing deductions) at a flat rate that varies depending on the type of income and whether a tax treaty applies. Income subject to a final withholding tax is excluded from assessable income for the purposes of Australian income tax.
Fringe benefits tax
Most non‑cash payments to employees are taxed separately under FBT, which is paid by employers and is levied at the top personal income tax rate plus the Medicare levy (currently 46.5 per cent). Australia is one of two countries in the OECD that levy a separate fringe benefits tax instead of embedding it within their personal income tax system.
Fringe benefits are not included in the employee's taxable income but the value is included on their payment summary on a 'grossed‑up' basis — that is, the value of the fringe benefit is increased to reflect the value of income tax (at the top personal rate) that would be paid if the fringe benefit were purchased out of after‑tax income by the employee. A range of benefits are excluded from these reporting requirements, such as the hiring or leasing of entertainment facilities. The value of reportable fringe benefits is then taken into account for the purposes of the income tests for most transfer programs, including income support and family assistance.
A range of fringe benefits are exempt from FBT, including: minor benefits (currently subject to a threshold of $300); recreational or child care facilities on employer premises; small business employee car parking; housing benefits provided to employees in remote areas; certain eligible work‑related items; and taxi travel to or from the workplace. These benefits are excluded from the fringe benefits reporting requirement.
FBT concessions apply in respect of: cars; certain types of meal entertainment; and housing assistance provided to remote area employees.
FBT concessions also apply to certain philanthropic organisations such as public benevolent institutions (Box 2.4). The Australian Government has asked the Review Panel to examine the complexity and fairness of existing FBT arrangements for the not‑for‑profit sector, and the treatment of fringe benefits in other parts of the tax‑transfer system, and to make recommendations to improve equity and simplicity for the long term.
Taxation of superannuation
Contributions to a superannuation fund made by an employer on behalf of an employee, including those made under a salary sacrifice arrangement, are not included in the employee's personal income and are taxed at a rate of 15 per cent in the complying superannuation fund or retirement savings account. People who are not employees can generally claim a tax deduction for their personal contributions. These contributions are taxed at 15 per cent in the fund and are also subject to an indexed annual cap of $50,000 ($100,000 for people aged over 50 until 30 June 2012).
Personal contributions made by individuals from after‑tax income, for which no deduction has been claimed, are generally not subject to tax in the hands of the superannuation fund. An annual limit of $150,000 a year (indexed) applies to these contributions, with people under age 65 permitted to bring forward up to two years of future contributions.
The realised earnings of superannuation funds are taxed at a flat rate of 15 per cent. Capital gains of complying superannuation funds are subject to a 33⅓ per cent discount where the assets have been held for at least 12 months. Complying superannuation funds are ineligible for the general CGT exemption that applies to assets acquired prior to the introduction of CGT. Earnings in the fund are not taxed once an individual's account starts to be paid as an income stream (pension). Funds can claim dividend imputation credits.
Superannuation benefits may comprise a tax‑free and a taxable component.
- The tax‑free component mainly reflects contributions made from after‑tax income and amounts representing the portion of the superannuation benefit that accrued before 1 July 1983. This component is always tax‑free on distribution.
- The taxable component is the total value of the superannuation benefit less the tax‑free component. It usually consists of employer and deductible personal contributions, along with earnings on all contributions.
For 90 per cent of individuals, the taxable component is comprised entirely of contributions and earnings that are taxed in the fund. However, in some schemes, such as public sector superannuation plans, the taxable component of a benefit may include contributions or earnings that have not been taxed in the fund.
Different taxation arrangements apply to amounts that are taxed in the fund and those that are not (see Tables 2.11 and 2.12). Broadly, superannuation benefits derived from a previously taxed source are exempt from tax after age 60. Benefits paid before age 60 are taxed at concessional rates. Where the superannuation benefit is paid from a fund which did not pay tax on its contributions and earnings (such as many government superannuation funds), tax is paid on the benefit. The tax rate varies depending on whether the individual is over 60 years of age.
Different rules apply to superannuation benefits for the purposes of assessing the rate of payment for social security entitlements. Under the income test for pensions, superannuation income streams are generally assessed on the basis of gross income, reduced by an allowance for the return of the capital used to purchase the product. For the majority of people who have acquired their income stream with an accumulated lump sum, this method of assessment is not linked to the taxation treatment of the income stream.
GST is a broad based value‑added tax on most goods and services consumed in Australia. GST applies at a uniform rate of 10 per cent to the supply or importation of taxable goods and services, based on the selling price. GST revenue is paid to the States. GST is levied on businesses at all stages of the production process. Businesses are generally able to claim a credit for GST paid on business inputs. While the coverage of GST is broad, there are exemptions for some categories of goods and services including health, education, basic food and charitable supplies. GST is not levied on residential rents and financial services, but suppliers of these products and services are generally not able to claim a credit for GST paid on production inputs.
Excises are specific taxes on certain goods, including liquid fuel, alcohol and tobacco. A key feature of the excise system is the licensing of sites where excisable products are manufactured. An excise‑equivalent customs tariff is applied to imports, and is collected at the border.
Excise rates for tobacco, beer and spirits are indexed twice a year to the consumer price index. Tobacco is taxed on a per stick basis, for cigarettes and cigars, or by overall weight of tobacco for other products. Beer and spirits are taxed on alcohol volume, although there are different rates for different types of beer, with lower rates for lower‑alcohol beers and beer packaged in containers with a volume of 48 litres or more. Spirits are subject to a higher rate of excise than full strength beer.
Liquid fuels, primarily petrol and diesel, are subject to excise of 38.143 cents per litre, which is not indexed. Fuel tax credits are provided for fuel used for certain off‑road uses and for on‑road use in heavy vehicles. Aviation fuels used for domestic trips are taxed at a rate of 2.854 cents per litre, while fuels used in aircraft on international journeys are not subject to excise. Biofuels (ethanol and biodiesel) are also taxed at a rate of 38.143 cents per litre. However, there are separate mechanisms to provide an effective excise free status for biodiesel and for domestically produced fuel ethanol. Fuels that can be used for transport that are based on compressing or liquefying gases, including liquefied petroleum gas (LPG), are not subject to excise.
Wine equalisation tax
Wine is not subject to excise. It is subject to a separate wine equalisation tax (WET), which applies as a percentage of the price of wine products. This is normally 29 per cent of the wholesale price of wine, cider, perry, mead and sake, and certain other wine‑based products. Unlike the excise on beer and spirits, the amount of tax payable on wine is independent of alcohol volume. There is a $500,000 WET producer rebate that reduces the WET paid by wine producers, often to zero in the case of smaller producers of wine.
Resource taxes and royalties
In addition to income tax, the Australian government raises revenue from the extraction of certain oil and gas natural resources through specific resource taxes and royalties. Petroleum resource rent tax (PRRT) is a profits‑based tax that applies to oil and gas production in Australian territorial waters outside the coastal limit (except the North West Shelf exploration permit area and the Joint Petroleum Development Area in the Timor Sea). PRRT applies at a rate of 40 per cent of the profits of a petroleum project, after deducting exploration, development and operating costs. Costs that are carried forward as an offset against income in a future period are uplifted at designated rates depending on the type of expense — the long term bond rate (LTBR) plus 15 per cent for exploration expenditure and the LTBR plus 5 per cent for development and operating expenditures. Exploration in certain frontier areas is currently eligible for an initial 150 per cent uplift.
The Australian government collects crude oil excise from the production of liquid hydrocarbons from the North West Shelf production area, onshore fields and coastal waters. Crude oil excise is levied on a per barrel basis. The first 30 million barrels of cumulative production from a field is exempt. There is also an annual exemption for each field of 3.1 million barrels once the 30 million barrel limit is reached. Excise is levied on an increasing rate scale tied to the level of production. The top rate for fields currently subject to crude oil excise is 30 per cent of the gross value of production. The excise scales that apply to production from each field are determined by the date of discovery and/or the commencement of production.
The Australian government collects revenue from the extraction of oil and gas resources through several royalties it shares with Western Australia (see Table 2.4). The Australian government also collects royalties on uranium mining in the Northern Territory, which are shared between the Northern Territory Government and the Aboriginal Benefits Trust Account.
Table 2.4: Petroleum royalties
|Offshore petroleum royalty and the internal waters royalty||Resource rent royalty|
|Location||North West Shelf project area||Barrow Island|
|Rate||10‑12.5 per cent of net well head value||Specific agreement payment|
|Share||Western Australia approximately two thirds and the Australian government approximately one third||Western Australia one quarter and the Australian government three quarters|
Customs tariffs apply to a range of imported textiles, clothing and footwear, passenger motor vehicles and other imported goods including foods, chemicals, industrial supplies, machinery and equipment, and household electrical items. Businesses are not credited for tariffs paid on their imports.
The luxury car tax applies to the value of a domestic or imported vehicle in excess of a certain threshold, $57,180 in 2008‑09. In the 2008‑09 Budget, the Australian Government announced an increase in the rate of the luxury car tax to 33 per cent from 1 July 2008.
There is a broad range of smaller taxes administered by a range of Australian government departments, including charges for notional cost‑recovery, penalties, levies and licence fees. These are not imposed primarily for general revenue raising purposes, but are still classified as taxes. For example, the passenger movement charge is levied on departing international travellers as a notional charge for government services relating to international travel. More than 60 separate levies are imposed on agricultural products, the revenue from which is earmarked to fund services and research within specific agricultural industries.
1 Australian tax revenue data are generally for 2006‑07 as this is the latest year for which data are available for all levels of government.
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