Taxation of income
Australian residents (excluding temporary residents) are generally taxed on income and capital gains earned domestically and in foreign jurisdictions. Income is taxed at rates that depend on the identity of the relevant taxpayer, using the following rates:
- Individuals are taxed under a progressive system with the highest marginal tax rate of 47 per cent (including a 2 per cent Medicare levy).
- Trusts are generally taxed at a rate of 47 per cent.
- Companies are generally taxed at the corporate tax rate of 30 per cent.
Taxable income is calculated by deducting allowable deductions from assessable income. These include deductions for expenses incurred in carrying on a business, capital allowances for depreciating assets, and tax losses from previous years, which may be carried forward to be offset in later years (indefinitely, until absorbed).
However, a distinction is drawn between revenue losses and net capital losses. Revenue losses may be carried forward for offset against later assessable income and gains. A net capital loss carried forward may be offset only against later year capital gains. Special integrity rules or restrictions apply to the prior year tax losses of companies and trusts to prevent trafficking in losses.
Non-residents who do not become Australian residents (either temporary or permanent) are generally only taxed on their Australian-sourced income; excluding dividends, royalties and interest, which are subject to withholding tax. So, non-residents are generally not taxed on their foreign income or on any capital gains from their assets that are not taxable Australian property.
Similar treatment may apply to individuals who are or who become temporary residents of Australia for tax purposes (regardless of the time spent in Australia). Individuals who hold a temporary visa and fall within the definition of temporary resident may be exempt from Australian tax on income from sources outside Australia. However, they will be taxed in respect of employment or services income earned while a temporary resident. Interest payments by temporary residents to non-resident lenders are not subject to interest withholding tax obligations.
Where a foreign enterprise has a branch office (permanent establishment) in Australia, and a double taxation agreement applies, profits are attributed to the permanent establishment as they would be if the permanent establishment were a separate enterprise dealing independently with its head office and other parties. The foreign enterprise is taxed in Australia, in relation to the profits of its permanent establishment, at the general corporate rate. Gains on capital gains tax assets used by a permanent establishment in conducting its business are also taxed in Australia.
If a foreign enterprise has no Australian permanent establishment and earns business profits sourced in Australia, and a double tax treaty applies, its effect will generally be that the business profits will not be subject to Australian tax.
Capital gains tax
Assets are subject to capital gains tax (CGT) where a taxable event occurs, creating a capital gain or loss. Capital gains or losses are not recognised for assets acquired before 20 September 1985. Certain exemptions apply and there are various categories of CGT rollovers (tax deferrals). Duplication is prevented by a rule that gives priority to ordinary income taxation if a transaction would otherwise be taxed under both regimes.
Capital gains are offset against any capital losses (current or prior year) and the net capital gain for the year is included in assessable income. A net capital loss may be carried forward to a later tax year, but may be offset only against a capital gain in a later year.
The net capital gain of a corporate taxpayer is taxed at the general corporate tax rate. Resident individuals may qualify for a 50 per cent discount in the assessable capital gain for assets held for at least 12 months. However, that discount does not apply to corporate or non-resident taxpayers.
Particular capital gains tax rules apply if an individual ceases to be a resident (which can result in the taxation of capital gains). However, capital gains (and losses) of foreign residents are only recognised in relation to certain Australian assets. These include taxable Australian real property, indirect interests in Australian real property, the business assets of an Australian permanent establishment, and any options or rights to acquire such assets.
Capital gains that are made and losses incurred by eligible temporary residents from their assets (assets that are not taxable Australian property) are not recognised for Australian tax purposes. An exception applies to gains from employee shares or options attributable to employment or services in Australia. Where all or part of a relevant employment is performed in Australia, employee share or option discounts may be partially taxable or exempt, depending on the nature and timing of the discount benefits, and of any gains from the shares or options (and other factors). Certain capital assets are taxable Australian property so that capital gains are assessed to non-resident.
A withholding regime, introduced with effect from 1 July 2016, applies a 12 per cent withholding obligation (taxed at the source) to disposals of taxable Australian real property (except residential property) by non-residents.
Various forms of capital gains tax rollover relief are provided. These effectively defer or disregard a capital gain or loss with respect to a particular asset or replacement asset. Certain rollovers facilitate corporate restructures that satisfy prescribed conditions. This is generally based on the economic continuity of the ownership interests that are held. Share-for-share and unit-for-unit exchanges, and demerger relief are often important elements of corporate reorganisations.
Australian multinational companies and their controlled foreign companies are, subject to certain conditions, entitled to capital gains tax reduction in connection with the sale or disposal of non-portfolio (10 per cent or more) share interests that are held in a foreign company with an active business.
Taxation of business entities
Companies (resident and non-resident) are generally treated as separate taxpayers. Australia’s tax consolidation regime allows companies that are 100 per cent Australian-owned, as well as partnerships and trusts, to choose to be taxed for income tax purposes as a single consolidated entity as though subsidiary members were merely divisions of the head company.
Tax consolidation is also available for groups that are wholly owned by foreign parents where there is no single Australian resident holding company – these are known as multiple entry consolidated groups. Where an election is made, all wholly owned entities must be included in the consolidated group.
The head company of a consolidated group is liable, in the first instance, for all group tax liabilities. In the event of default, subsidiary members may have joint and several liabilities. However, this may be prevented by the operation of a valid tax-sharing agreement between group members that deals with the allocation of liabilities.
Although certain distinctions are maintained for taxation purposes between private and publicly listed companies, the same general corporate rate of taxation applies to both.
Trusts are not treated generally as taxpayers. Although a trust income tax return is required, distributions of trust income are taxed at the level of the beneficiaries.
Managed Investment Trusts (MITs) are subject to certain tax rules that do not apply to other types of trust. Importantly, MITs are subject to a specific withholding regime that applies to certain fund payments (at potentially concessionary withholding tax rates) when distributions are made to non-residents.
The tax rate that applies to the withholding will depend on where the non-resident investor resides for tax purposes. If it is a country with which Australia has an Exchange of Information (EOI) agreement, the rate of withholding tax will be 15 per cent.
A concessional withholding rate of 10 per cent applies if the MIT holds only newly constructed energy-efficient commercial buildings. In all other circumstances, the rate that applies is 30 per cent.
Australia’s recently enacted attribution managed investment trust legislation has established an alternative mechanism for the taxation of certain trusts, typically where they are used as public investment vehicles.
Superannuation funds, approved deposit funds and pooled superannuation trusts are subject to special taxation provisions. These categories are linked to the regulation of resident superannuation funds by the Australian Prudential Regulation Authority.
Partnerships are subject to pass-through taxation treatment (the shares of partnership profit or loss are taxed at the level of the partners), although a partnership is required to file, what is in effect, an information tax return.
Capital gains and losses in relation to partnership interests and CGT assets of a partnership are made by the partners individually. Certain categories of foreign hybrid limited partnerships and limited liability companies may qualify for similar partnership treatment.
Limited partnerships that meet the description of “corporate limited partnership" under the income tax laws, are taxed as companies, however.
Joint ventures typically occur where each venturer contributes something and shares in the output. Accordingly, participants who receive income jointly may be subject to taxation as tax partners.
In other circumstances, joint venturers who separately derive their individual shares of the joint venture proceeds are treated as separate taxpayers.
Dividends paid by a company
Under the imputation system of taxation, dividends that are paid to shareholders by an Australian resident company may be franked with an imputation credit that reflects the amount of corporate tax already paid on the company’s profits. Individual shareholders who receive franked dividends are required to include both the cash dividend and the attached franking credits in their assessable income. They are then entitled to a tax offset equal to the franking credit that reduces or eliminates the tax payable by them on the dividend.
In general, different rules apply depending on whether dividends are paid to individuals, trusts, partnerships, superannuation funds and related entities, life assurance companies or corporate shareholders.
Companies and other corporate tax entities that receive franked dividends are required to apply the same treatment as that which applies to individuals. This means including it in their assessable income and applying a tax offset to reduce the corporate tax payable. Companies and other corporate tax entities are not, however, entitled to a refund for excess franking offsets (but in certain circumstances, the excess franking offsets may be converted into a carried-forward tax loss).
Dividend withholding tax is potentially payable in respect of any part of a dividend paid by a resident company to a non-resident shareholder, to the extent that the dividend is not franked. Non-resident shareholders do not qualify for imputation credits or franking rebates, but a dividend paid to a non-resident shareholder is exempt from dividend withholding tax to the extent that the dividend is franked.
Withholding tax is imposed on the gross amount of the unfranked dividend. The general dividend withholding tax rate is 30 per cent. However, for dividends paid to residents of double tax treaty countries, the rate provided in the treaty applies (generally 15 per cent or lower).
A conduit foreign income regime currently applies to certain distributions by an Australian company to a foreign resident shareholder, with the result that the amounts are not assessable income and unfranked distributions are not subject to dividend withholding tax. Broadly, conduit foreign income is confined to offshore income and gain amounts that would not ordinarily be taxed in Australia if the company were non-resident. Examples include foreign branch income, foreign non-portfolio dividends (on a voting interest of at least 10 per cent) and gains from the sale of non-portfolio interests in foreign companies that have an underlying active business.
Debt funding of an Australian company
Interest withholding tax (IWT) is typically imposed on interest paid by an Australian resident as an expense of an Australian business to a non-resident lender that does not have a permanent establishment in Australia. It also applies to interest paid to such a non-resident lender by a non-resident borrower where it is an expense of an Australian branch of the non-resident borrower.
In addition, the conditions for liability extend to interest incurred by a non-resident borrower as an expense of an Australian business that is derived by a foreign permanent establishment of an Australian resident.
A flat rate of 10 per cent applies on the gross amount of the interest paid. In most cases this rate is not affected by double taxation treaties, but certain treaties provide exemptions for interest paid to foreign banks and financial institutions. Certain statutory debt or equity tests also apply when classifying amounts payable.
However, if the non-resident lender has a permanent establishment in Australia and the interest is effectively connected with that permanent establishment, the interest is taxable by assessment in Australia and is not subject to interest withholding tax. An exemption is available for interest paid on certain publicly offered debentures, global bonds and debt interests.
Thin capitalisation rules impose certain limitations on allowable deductions for interest and other debt expenses, based on acceptable levels of debt and equity (gearing). The object is to prevent excessive reliance by Australian businesses on the taxation treatment of debt funding, relative to the treatment of equity funding.
The measures apply to foreign entities investing directly in Australia (through a branch), foreign-controlled Australian entities, as well as Australian enterprises with controlled foreign investments. Where applicable, the rules disallow debt deductions that an entity can claim against Australian assessable income where the entity’s debt used to fund Australian assets exceeds the limit prescribed.
Royalties payable to a foreign company
Any royalties paid by an Australian company to a foreign resident are subject to a 30 per cent royalty withholding tax, though this is reduced (generally to between 5 per cent and 15 per cent) under an applicable double tax treaty. However, where the beneficial owner of the royalties carries on business in Australia through a permanent establishment and the property or right in respect of which the royalties are payable is effectively connected with that permanent establishment, the royalties will be taxed by assessment in Australia.
A withholding tax regime applies also to certain other categories of foreign resident payments. The aim is to catch particular categories of assessable income of foreign residents that lie outside the existing withholding tax categories.
The categories of payments to foreign resident entities are prescribed by regulations, which also set the rate of withholding. The first three categories are payments for promoting casino gaming junkets (3 per cent), payments for entertainment and sports activities (set at ordinary tax rates) and payments under contracts for the construction, installation and upgrading of buildings, plant and fixtures (5 per cent).
Multinational tax avoidance
International transfer pricing (profit shifting) occurs when taxable profits are shifted outside the scope of Australian tax through the use of non-arm’s length prices for goods or services passing between foreign entities and Australian entities or branches. Australian tax may be reduced where the prices charged by a foreign parent or entity to an Australian company, or charged between an overseas head office and a local branch, are excessive, or if payments received are inadequate. Low or no-interest loans may also have the effect of redirecting profits.
In certain circumstances, the Commissioner of Taxation may substitute for tax purposes arm’s length prices in relation to the supply or acquisition of property or services under an international agreement (defined broadly).
Considerable emphasis is placed on the need for taxpayers to create contemporaneous documentation (in place when the relevant tax return is lodged) that supports an acceptable pricing methodology. Otherwise, the consequences can be severe. The failure to prepare any contemporaneous documentation means that a taxpayer will not have a reasonably arguable position in the event of an additional tax assessment being issued.
The Multinational Anti-Avoidance Law (MAAL) is designed to prevent multinationals from avoiding their taxable presence in Australia and ensure they pay tax on the profits sourced from their economic activities in Australia.
MAAL only applies to significant global entities (foreign entities, or entities that are part of a global group, that have an annual global income in excess of A$1 billion) in situations where:
- a foreign entity makes certain supplies to an Australian customer
- activities are undertaken in Australia directly in connection with the supply
- some or all of those activities are undertaken by an Australian entity (or Australian permanent establishment) that is associated with or commercially dependent on the foreign entity
- the foreign entity derives income from the supply
- some or all of that income is not attributable to an Australian permanent establishment of the foreign entity.
MAAL also includes a test that is satisfied if a principle purpose of the scheme is to obtain a tax benefit for the taxpayer(s) in connection with that scheme. If a scheme is found to contravene the MAAL provisions, the Commissioner has the power to cancel the tax benefit obtained from the scheme. Significant penalties of up to 100 per cent of the tax avoided may apply (or even up to 120 per cent if aggravating factors are present).
Diverted profits tax is a punitive 40 per cent tax on benefits that arise from schemes that were entered into in concert with a foreign associate whose principal purpose is to secure that tax benefit. The measure only applies to significant global entities and is designed to address the diversion of profits offshore through contrived arrangements with foreign associates.
Goods and services tax
The Australian good and services tax (GST) is a broad-based consumption tax. It is imposed at the standard rate of 10 per cent on most supplies by businesses (for example, of goods, services, information, rights and real property) that are made for consideration and which have a relevant connection with the indirect tax zone (ITZ) (that is, Australia, excluding external territories and certain offshore areas); and the importation of certain goods.
GST on supplies
GST will only be payable on supplies where the entity (defined to include individuals, companies, partnerships and trusts) making the supply is registered or required to be registered for GST purposes. Generally, this is if its annual turnover for the previous 12 months or projected annual turnover for the next 12 months in relation to supplies that are connected with the ITZ exceeds A$75,000 (A$150,000 for non-profit entities).
Where a supply is made by a registered entity for consideration, and the supply is connected with the ITZ, that supply will generally be a taxable supply giving rise to a GST liability for the supplier. The GST payable on that supply will be calculated as one-eleventh of the total consideration that the entity receives for making the supply (including GST). Generally, the GST on a taxable supply must be paid to the Australian Taxation Office (ATO) by the entity making that supply. Exceptions include supplies that are reverse charged (including voluntary reverse charging) and supplies made by non-residents through resident agents.
Special rules have been introduced to extend the application of GST to the supply of digital products or other intangible supplies made by foreign suppliers to Australian consumers, as well as to the supply of low-value goods from offshore. Businesses making such supplies may be required to register for Australian GST purposes even though those businesses have no business presence in Australia
No GST is payable on supplies that are classified as GST-free – including certain health, food and education supplies, exports, and sales of businesses as going concerns. GST is also not payable on input taxed supplies (that is, Australian exempt supplies), such as those relating to financial services (but not general insurance), and the sale or leasing of existing residential property.
Input tax credit
In certain cases, an entity that acquires a taxable supply may be entitled to claim an input tax credit for the GST included in the price of that acquisition. An input tax credit will be available where the entity makes its acquisition while carrying on its business and is registered or required to be registered for Australian GST purposes. However, where the acquisition relates to making input taxed supplies or is of a private or domestic nature, the registered entity may be restricted in its ability to claim input tax credits for that acquisition.
Registered entities generally remit the GST liabilities for their supplies to the ATO on a monthly or quarterly basis, which is reported in a Business Activity Statement (BAS). At the same time, registered entities may claim back from the ATO any input tax credits for the GST included in the price of their business purchases.
GST on imports
Finally, an entity will make a taxable importation and be liable to pay GST where it imports goods into the ITZ and enters those goods for home consumption – that is, it identifies itself as the owner of the goods to Australian customs authorities. In most cases, registered importers are entitled to recover an input tax credit for a taxable importation equal to the GST liability. Where a foreign company exports goods to Australia and does not expect to register, or be required to be registered, for Australian GST purposes, care should be taken to ensure that the person who enters the goods for home consumption is entitled to this input tax credit.
Fringe benefits tax (FBT) is a separate federal taxation regime under which the tax liability is imposed on the employer, not the employee, in relation to a wide range of fringe benefits. FBT is imposed on the designated taxable amounts of the particular benefit, grossed-up under a formula that is intended to result in a level of tax that equates with the cash equivalent of the fringe benefit. The FBT rate applied to the grossed-up amount is 47 per cent. Generally, employers are entitled to income tax deductions for the cost of providing fringe benefits and the amount of FBT paid.
Separate rules apply regarding self-assessment by the employer and the quarterly instalments of tax payments that are required. The FBT year starts from 1 April and ends on 31 March of the following calendar year.
Payroll tax is a state or territory tax that is levied at specified rates by reference to annual wages and salaries of employees that exceed prescribed threshold amounts in each state or territory. Employers are required to register with the relevant state or territory revenue authority. Rates in each jurisdiction range from 4.75 per cent to 6.85 per cent.
Particular areas of difficulty arise in connection with the very broad rules applicable to payments to contractors, and the rules relating to the grouping of employer companies for the purposes of the aggregation of wages and salaries of group employees.
Stamp duty is charged in all Australian states and territories on the transfer of real property and other types of property. The rates vary by jurisdiction and are imposed on a sliding scale. The rates are applied to the greater of the consideration paid for the property and the value of the property that is subject to duty.
The maximum rate of transfer duty ranges from 4.5 per cent to 7 per cent depending on the jurisdiction.
In addition, further duty at a rate of 3 per cent to 8 per cent, depending on the jurisdiction, applies to foreign purchasers of residential property in certain jurisdictions.
Customs duty is payable at the time goods enter Australia and generally levied on the customs value of goods, as determined in accordance with Australian law.
Meanwhile, excise duty is a tax imposed on certain goods (including tobacco, petroleum and alcohol) that are produced or manufactured in Australia.
Key considerations for employers
A uniform instalment withholding regime, the pay-as-you-go (PAYG) regime, applies to a large number of withholding payments, including payments by employers to employees.
Employers who are required to make deductions from the wages and salaries of employees must register with the ATO for PAYG withholding and report their periodic withholding obligations. This should be on a BAS, where registered for GST; or on an Income Activity Statement, where not registered for GST.
In addition, all businesses that receive goods or services are required to withhold tax at the top rate plus the Medicare levy from the payment if the supplier does not quote an Australian Business Number (ABN) on its invoice or some other document in connection with the supply. An ABN is a single identifier for use in business dealings with other businesses, the ATO and other Federal Government agencies.
Foreign companies that make supplies connected with Australia or carry on business in Australia, even for a short period of time, are generally entitled to apply for an ABN.
A Tax File Number (TFN) regime applies to certain categories of income, including salaries and wages, and various types of investment income for non-business taxpayers who do not have an ABN. Where a valid TFN is quoted, specific rates of withholding tax apply. Where a TFN is not quoted, the rate of withholding is set at the top marginal tax rate plus the Medicare levy.
Most entities are now obliged to make their PAYG instalments monthly. However, smaller entities that do not exceed A$1 billion in base assessment instalment income (threshold) are not subject to this requirement. The PAYG system also requires that most businesses pay corporate income tax and fringe benefits tax on a monthly basis, and these amounts are generally reported in a BAS.
There is a provision for a branch of a registered entity to be registered as a PAYG withholding branch. Under this system the branch may submit a separate BAS, notifying the PAYG withholding obligations of the branch. In general, non-residents are required to file annual income tax returns where any income is sourced in Australia (other than exempt income or income subject to withholding tax). A system of self-assessment applies.