Explanatory Memorandum
(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)Chapter 2 - Low-income taxpayer rebate
Outline of chapter
2.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to remove the ability of minors (children under 18 years of age) to use the low income tax offset to reduce tax due on income subject to Division 6AA of Part III of the ITAA 1936.
Context of amendments
2.2 Special rules apply in calculating the tax payable on income of minors. These rules have been in place since 1980 and are contained in Division 6AA of Part III of the ITAA 1936. Under the rules, unearned income (income from property such as dividends, interest, rent and royalties) of minors over a certain level is taxed at the highest marginal rate of tax (45 per cent in 2010-11 and 2011-12). Taxable income subject to the special tax rates is called 'eligible taxable income' in Division 6AA.
2.3 The rules apply to income derived by the minor directly or through a trust. Where the minor is an Australian resident the special rules do not apply if the eligible taxable income is $416 or less. Eligible taxable income between $416 and $1,307 is taxed at 66 per cent on the part of the relevant taxable income exceeding $416, thereby phasing in the special tax rates. Eligible taxable income of $1,308 and more is taxed at a flat 45 per cent.
2.4 A foreign resident minor is taxed at 29 per cent on the first $416 of unearned income, at 66 per cent on eligible taxable income between $416 and $732 and at 45 per cent on relevant income of $733 and more.
2.5 The aim of these rules is to discourage income splitting within families by directing income from adults to children to avoid higher marginal tax rates.
2.6 In recent years the low income tax offset has increased significantly as a means of providing targeted tax relief to low-income earners. The low income tax offset has been available to all taxpayers with incomes below its cut-out threshold, including minors. An increasing amount of distributions from discretionary trusts have subsequently taken advantage of this concession to direct an increasing amount of income from adults to minors in order to minimise tax. There is a significant spike in distributions from discretionary trusts at around the point where the effective tax-free threshold for minors has applied in each recent tax year, and that spike has moved broadly in accordance with increases to the effective tax-free threshold for minors.
2.7 Removing the eligibility of minors to use the low income tax offset to reduce tax payable on their unearned income will discourage families from splitting income with their children - protecting the integrity and improving the fairness of the income tax system.
2.8 Minors will still be able to use the low income tax offset to reduce tax payable on their work income.
Summary of new law
2.9 This Schedule removes the ability of minors to use the low income tax offset to reduce tax due on income subject to Division 6AA of Part III of the ITAA 1936.
Comparison of key features of new law and current law
| New law | Current law |
| The low income tax offset cannot be used to reduce tax on income of the taxpayer that is subject to Division 6AA of Part III of the ITAA 1936.
The low income tax offset is still available to reduce tax on other income of the taxpayer. |
The low income tax offset can be used to reduce tax on any income of a taxpayer, including taxpayers whose income is subject to Division 6AA of Part III of the ITAA 1936. |
Detailed explanation of new law
2.10 These amendments restrict the eligibility for the low income tax offset of taxpayers with income subject to Division 6AA of Part III of the ITAA 1936.
2.11 Item 1 of this Schedule includes a definition of 'basic income tax liability' in subsection 6(1) of the ITAA 1936. 'Basic income tax liability' has the meaning given to that term by section 4-40 of the Income Tax Assessment Act 1997 (ITAA 1997). Basic income tax liability is worked out using the income tax rate or rates applying to the taxpayer for the income year and any special provisions that apply to working out that liability. [Schedule 2, item 1, subsection 6(1)]
2.12 Item 2 of this Schedule includes a definition of 'eligible taxable income' in subsection 6(1) of the ITAA 1936. 'Eligible taxable income' has the meaning given by section 102AD of the ITAA 1936. Section 102AD defines which income is subject to Division 6AA of Part III of the ITAA 1936 and is therefore taxed at the special rates of tax that are applicable where Division 6AA applies. [Schedule 2, item 2, subsection 6(1)]
2.13 Item 3 of this Schedule adds three new subsections to section 159N of the ITAA 1936. These subsections provide that a taxpayer who has income subject to Division 6AA of Part III of the ITAA 1936 has a limited eligibility for the low income tax offset.
2.14 Where a taxpayer has income subject to Division 6AA of Part III of the ITAA 1936 the taxpayer is not entitled to the low income tax offset to the extent that the offset would be applied against the part of the taxpayer's basic income tax liability that is attributable to the eligible taxable income of the taxpayer for that year of income. (The eligible taxable income of the taxpayer is that income that is taxed as unearned income of the taxpayer.) [Schedule 2, item 3, section 159N]
Example 2.1
Fiona has income from part-time work of $10,000 and income subject to Division 6AA of Part III of the ITAA 1936 (unearned income) of $2,000. Her $10,000 of work income is subject to the normal income tax rates and tax due on this income is $600. Her $2,000 of unearned income is taxed at 45 per cent and tax due on this income is $900. Fiona has a total gross tax liability of $1,500. Under the old rules Fiona was able to use the low income tax offset to reduce tax on her total income to zero. Under the new rules Fiona can still reduce tax on her work income to zero by using the low income tax offset but is not able to reduce tax on her unearned income. Fiona now has a net total tax liability of $900.
2.15 In calculating tax on the taxpayer's income the taxpayer may still apply the tax offset listed in item 15 in the table in subsection 63-10(1) of the ITAA 1997 against that part of the taxpayer's basic income tax liability that is attributable to the taxpayer's eligible taxable income. This particular provision ensures that eligible taxpayers are still able to use the pensioner tax offset, where applicable, to reduce tax on their unearned income. It is only the low income tax offset that can no longer be used to reduce tax on unearned income.
2.16 Items 4 and 5 of this Schedule amend section 63-10 of the ITAA 1997. This section has priority rules for applying tax offsets against a taxpayer's basic income tax liability. Item 4 provides that the low income tax offset is the fourth offset in order of priority for applying tax offsets against a taxpayer's basic income tax liability, after the senior Australians tax offset (applied both to individuals and to trustees) and the pensioner tax offset. [Schedule 2, item 4, subsection 63-10(1)]
2.17 Currently the low income tax offset is covered by the category of any tax offset not covered by another item in the table in section 63-10. The low income tax ofset now ranks ahead of all such offsets.
2.18 Item 5 adds a note to section 63-10 providing that rules about applying the low income tax offset are set out in new subsection 159N(4) of the ITAA 1936. [Schedule 2, item 5, subsection 63-10(1)]
2.19 Item 6 refers to the application of this Schedule. [Schedule 2, item 6]
Application and transitional provisions
2.20 These amendments commence on the day this Bill receives Royal Assent.
2.21 These amendments apply to income tax assessments for the 2011-12 and later income years.