Chapter 1

Understanding the Australian Tax System

IN THIS CHAPTER

Breaking down the tax system

Progressing through the tax rates and rules

Determining sources of income

Paying tax if you’re a company

If you find tax a — excuse the pun — taxing subject, you’re not alone. Most people are confused by taxes and, of course, would rather not pay them. However, we all know the cliché: Death and taxes are the only sure things in life. So, put another way, you probably need to take some time to understand taxation.

This chapter goes over some basic info that you need to understand in order to lodge your tax return in Australia. I explain the basics of the Australian tax system, tell you how to work out sources of income, and examine what tax you need to pay if you’re setting up as a company.

Explaining the Australian Tax System

In Australia, two income tax assessment Acts are used by the federal government to levy tax on taxable income. They’re equivalent in size to four telephone books and are the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997. (The reason for two Acts is because the 1936 Tax Act is gradually being replaced with the more user-friendly 1997 Tax Act.)

Understanding Your Income Tax Rates

For resident individuals, tax is levied on worldwide income on a progressive basis, referred to as marginal tax rates. Your marginal tax rate can vary between 0 per cent and 45 per cent (marginal tax rates are detailed in Chapter 5). This rating system means the more income you earn, the greater the amount of tax you’re liable to pay.

Australia has numerous federal, state and territory, and local government taxes that you need to deal with.

The Australian Taxation Office (Tax Office or commonly abbreviated to just ATO) is the federal government authority responsible for administering Australia’s tax laws. To help you meet your legal requirements, the Tax Office regularly issues free-of-charge fact sheets, income tax rulings, tax determinations and interpretative decisions to explain tax issues that need clarification. You can access these fact sheets and tax rulings by visiting the Tax Office’s website (www.ato.gov.au). I reference many of these useful resources through this book too!

If you want to quickly know your tax obligations in a nutshell, visit the Tax Office website (www.ato.gov.au) and check out ‘Tax in Australia: what you need to know’. See also ‘Australian business taxes’ on the Australian Trade and Investment Commission website (globalaustralia.gov.au).

Federal taxes

The most important federal taxes include the following:

• Capital gains tax (CGT) is paid on gains you make when you sell assets you own and on the occurrence of certain CGT events. Your main residence is exempt from tax and some other concessions may potentially be available (see Chapters 11 and 17 for more).
• Customs duty is paid on certain goods you import into Australia (for example, cameras, perfume, alcohol and cigarettes).
• Excise duty is levied on certain goods manufactured in Australia, such as alcohol and tobacco. (The hefty hike in excise duty on cigarettes is enough to make you quit smoking for good!)
• Fringe benefits tax (FBT) applies to certain benefits you may receive (for example, your employer provides you with a car for private use). See Chapter 16.
• Fuel tax is levied on petrol.
• Goods and services tax (GST) is applied to most purchases and sales. See Chapter 15.
• Income tax is paid on income you derive from worldwide sources. See Chapters 5 to 7.
• The Medicare levy is used to help fund the Australian health system. The rate is 2 per cent of your taxable income.
• Withholding tax is paid on certain income derived by a non-resident (see Appendix A).

In the 2023–24 tax year, if you earned below $24,276 as an individual or $40,939 as a couple/family, you were exempt from paying the Medicare levy. Note: For each dependent child, the family threshold increases by $3,760. For single seniors and pensioners, the threshold is $38,365 and for families it’s $53,406.

If you don’t have private health insurance, you may be liable to pay a Medicare levy surcharge (MLS) if you earn more than a certain amount. For the 2023–24 tax year, the levy is 1.0 per cent if your taxable income (for the purposes of calculating your MLS) is between $93,001 and $108,000 for individuals or between $186,001 and $216,000 for couples/families. The MLS increases (in stages) to 1.5 per cent if you’re an individual earning more than $144,001, or couples/families earning more than $288,001. Note: The family threshold for the MLS increases by $1,500 for each dependent child after the first child. For more details see Tax Office fact sheet ‘Medicare levy surcharge income, thresholds and rates’ on the Tax Office website (www.ato.gov.au).

State and local taxes

Following are some of the taxes levied by states:

• Gambling tax is levied on certain gambling transactions (such as licence fees and poker machines).
• Land tax is paid on some property holdings.
• Payroll tax is levied on wages and fringe benefits an employer pays employees.
• Stamp duty applies to certain transactions, particularly when you buy a property.

In a local context, property valuation and rates charges fund local government services (such as rubbish collection).

Taxing Major Income Streams

Income is normally derived from three major sources:

• Income from personal exertion, such as salary and wages, bonuses and commissions you earn as an employee, and any allowances you receive (see Chapter 5)
• Income from property and investments, such as interest, dividends, rent, annuities and royalty payments (see Chapters 8 to 10)
• Income from carrying on (or running) a business, such as profits you earn from your business activities (see Chapter 12)

Taxing your treasures: CGT assets

You may be liable to pay capital gains tax (CGT) on profits you make when you sell CGT assets such as shares, real estate and collectables. However, just 50 per cent of the capital gain you make is liable to tax if you own the CGT asset for more than 12 months. This concept is discussed in more detail in Chapter 11.

Under the CGT provisions, your main residence is exempt from tax. If you’re temporarily absent from Australia, the good news is your main residence continues to be exempt for an indefinite period if the property isn’t used to earn assessable income. Alternatively, if you lease the property while you’re away, your main residence is exempt from tax for up to six years (for more details, see Chapter 6).

Bringing home the money: International sources of income

As an Australian resident, you’re required to disclose income you earn from worldwide sources, and non-residents are required to disclose income that only has an Australian source. Unfortunately, the tax Acts don’t provide a statutory definition of source. So it basically boils down to a ‘practical hard matter of fact’. Generally, three key tests are used to determine the origin or ‘source’ of income:

• The place where you perform the services
• The place where you sign the contract to perform those services
• The place of the payment