Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.
Chapter 6 - Averaging of primary producers' tax liability
Overview
This chapter covers the rules that help to even out primary producers tax liabilities from year-to-year. These rules are in Division 392 of Part 3-45 of the 1997 Act. Part A summarises these rules. Part B explains the changes to the 1936 Act. Part C explains why some provisions of the 1936 Act have not been rewritten. Part D explains the transitional provisions which set out how and when the rewritten provisions apply. Part E explains the amendments that need to be made to the 1997 Act and the 1936 Act as a consequence of rewriting the 1936 Act.
Part A summarises these rules.
Part B explains the changes to the 1936 Act.
Part C explains why some provisions of the 1936 Act have not been rewritten.
Part D explains the transitional provisions which set out how and when the rewritten provisions apply.
Part E explains the amendments that need to be made to the 1997 Act and the 1936 Act as a consequence of rewriting the 1936 Act.
A. Summary of the new law
Division 392: Long term averaging of primary producers tax liability
Is your income tax affected by averaging? [Subdivisions 392-A, 392-D]
Subdivisions A and D tell you whose income tax is subject to averaging
Averaging applies to individuals who carry on a primary production business. [section 392-10]
Most beneficiaries of trust estates that carry on a primary production business will also have their income tax liability smoothed. [section 392-20]
When does averaging first apply?
Averaging commences in the first assessment after the primary production business commences, in which basic taxable income is greater than or equal to what it was in the previous year.
In loss years, income is taken to be nil, so that two consecutive years as a primary producer with net losses will commence averaging. [section 392-10]
Some items of taxable income, such as net capital gains, are ignored in averaging calculations. Basic taxable income refers to taxable income less those items.
[section 392-15]
When does averaging cease to apply?
Averaging ceases to apply in the first year in which
- •
- the taxpayer no longer carries on the primary production business ; and
- •
- their assessable income does not include income from that business.
[section 392-10]
What if the taxpayer doesn't want averaging to apply?
You can choose not to have your income tax averaged, but that choice is final. [section 392-25]
What if taxable income is permanently reduced?
Subdivision 392-D allows averaging to recommence if basic taxable income is permanently reduced to less than two thirds of average income.
If such a permanent reduction has occurred, the taxpayer may choose that
- •
- averaging does not apply for that year; and
- •
- the Division applies in later years as if the taxpayer had not carried on a business of primary production previously.
[section 392-95]
What kind of averaging adjustment must be made? [Subdivision 392-B]
Subdivision 392-B explains how to work out the kind of averaging adjustment which can be made. [section 392-30]
Tax will be adjusted if some of the taxpayer's income is subject to averaging.
In high income years, when average income is less than basic taxable income , there will be an entitlement to a tax offset. In low income years, when average income is greater than basic taxable income, there will be a liability for extra income tax. [subsections 392-35(2), (3)]
The adjustment is the amount of tax offset or the amount of extra income tax payable to even out long term tax liability. [section 392-5]
The adjustment is worked out by comparing the income tax at basic rates on basic taxable income with a notional amount of tax. The notional amount is worked out by applying a special rate, the comparison rate , to basic taxable income. [subsection 392-35(1)]
Average income is usually the average of basic taxable incomes over the last five years. However, if averaging has applied in yourassessments for less than four years, basic taxable incomes beginning with the year before the year in which averaging first applied are averaged.
[section 392-40 and subsection 392-45(1)]
The basic rates of tax are those set out in Schedule 7 of the Income Tax Rates Act 1986 , excluding special rates such as those applied to uncontrolled partnership income. [subsections 392-35(4), (5)]
The comparison rate is the overall rate of tax that would be payable if taxable income was the same as average income. [sections 392-50, 392-55]
Working out the averaging adjustment [Subdivision 392-C]
This Subdivision determines the amount of the averaging adjustment (ie. the amount of the tax offset or the amount of extra income tax payable by the taxpayer as a result of the application of the averaging provisions.) [section 392-60]
To work out the averaging adjustment it is necessary to work out the averaging component. Basically, this is the amount of taxable income that is subject to adjustment under averaging provisions. [sections 392-75 & 392-80]
Factors affecting the averaging component
The averaging component depends on the net income derived from theprimary production business ( taxable primary production income ) and net income derived from other sources (taxable non-primary production income ). [section 392-65]
In working out these amounts, some components of assessable income are omitted, and there are special rules for apportioning deductions. A loss amount is taken to be nil. [sections 392-80, 392-85]
Taxable primary production income is always part of the averaging component. [section 392-90]
How much non-primary production income is included?
Some or all of your taxable non-primary production income may also be included in the averaging component:
It is included in full where taxable non-primary production income is less than $5000 (the non-primary production shade out amount is included where taxable non-primary production income is between $5000 and $10,000.)
If the taxable non-primary production income is $10,000 or more, the averaging component equals the taxable primary production income.
[subsection 392-90(1)]
B. Discussion of changes
Restructure the existing law to provide answers to practical questions in a logical order.
In the 1936 Act, the answers to common problems such as how to calculate adjustments are obscured by a less than helpful arrangement of provisions, and a web of interlocking definitions. The rewritten law adopts three key building blocks:
- •
- the assessments it applies to;
- •
- the nature of the tax adjustment; and
- •
- the amount of that adjustment.
The rewritten law works through calculations in a logical sequence.
Clarify existing definitions and clearly define new terms.
The 1936 Act defines some key terms more than once. The rewritten law defines eachtermonce,and labels each term so as to indicate its meaning. The definitions, and their equivalents in the 1936 Act, are as follows:
| New term | Old term | Commentary |
|---|---|---|
| apportionable deductions | apportionable deductions | Definition unchanged in substance. Reference to the redundant deduction for rates and land taxes deleted. Currently defined in subsection 6(1). |
| assessable non-primary production income. | (no equivalent) | New definition. Calculation of this amount is implied by the 1936 Act. |
| average income | average income | No change. Currently defined in subsection 149(1). |
| basic assessable income | (no equivalent) | New definition for an existing concept in paragraph 149A(1)(a). Definition overcomes the confusion caused by the approach in the 1936 Act of redefining the term assessable income for averaging purposes. |
| basic rates | (no equivalent) | New label for an existing concept in paragraphs 156(4)(b) and (4A)(b). |
| basic taxable income | (no equivalent) | New label for an existing concept in paragraph 149A(1)(b). |
| comparison rate | (no equivalent) | New label for an existing concept in Schedule 8 to the Income Tax Rates Act 1986 . |
| gross averaging amount | (no equivalent) | New label for an existing concept in subsections 156(4) and (4A). |
| non-primary production deductions | (no equivalent) | New definition. Calculating this amount is implied by the 1936 Act. |
| non-primary production shade-out amount | notional taxable income from primary production | New label for an existing definition in section 156(1). |
| primary production deductions | relevant primary production deductions | New label for an existing definition in section 156(1). |
| averaging adjustment | (no equivalent) | New definition for an existing concept; the result of the formula in sections 156(4) and (4A). |
| averaging component | deemed taxable income from primary production | New label for an existing definition. |
| taxable non-primary production income | non primary production profit | New label for an existing definition. |
| taxable primary production income | actual taxable income from primary production | New label for an existing definition. |
Section 392-10 Continuation of averaging where primary production business has ceased
Allow a taxpayer who receives income from a primary production business which ceased in an earlier year to even out their tax liability.
Under the 1936 Act, only individuals who carry on a primary production business in an income year qualify for averaging in that year. For many years, the Commissioner has applied averaging to taxpayers on the basis of continuity of income from year-to-year, even where the business has ceased. The rewritten law incorporates this administrative practice.
Section 392-95 Permanent reduction of income
Clarify that it is optional to recommence averaging when a permanent reduction of income occurs.
In the 1936 Act, averaging recommences if a taxpayer establishes that taxable income has been permanently reduced. The rewritten provision makes it clear that averaging recommences only if a taxpayer, having established that taxable income has been permanently reduced, chooses to recommence averaging. This is consistent with current administrative practice.
Specify when the choice to recommence averaging must be made.
The 1936 Act is silent about the period within which taxpayers may choose to recommence averaging. The rewritten law spells out that the choice to recommence averaging can be notified at any time prior to lodgement of the return for the year in which income was permanently reduced. The Commissioner can extend the time limit.
C. Provisions of the old law that have not been rewritten
Two redundant 1936 Act provisions are not included in the rewritten law. They are summarised in the following table:
| Provision | Subject | Reason for omission |
|---|---|---|
| Subsection 151(3) | Taxpayers assessed at an average tax rate under the 1922 Act are subject to averaging under the 1936 Act. | No current or ongoing application. |
| Section 152 | Taxpayers in 1942 and earlier years only average incomes of years in which they are carrying on any business. | No current or ongoing application. |
D. Transitional arrangements
The purpose of the transitional provisions is to explain how taxpayers who are currently subject to primary producer averaging under the 1936 Act can continue to have their tax liabilities averaged under the 1997 Act.
When explaining how a specific provision of the 1997 Act is to apply, the transitional provision uses the same section number as the corresponding 1997 Act provision.
The transitional provisions, described in the following table, apply the rewritten provisions to assessments for the 1998-99 and later income years.
| Transitional section | About | Purpose of the provision |
|---|---|---|
| 392-1 | Application of Division 392 | Applies Division 392 to assessments for the 1998-99 and later income years. |
| Ensures average income in transitional years is calculated consistently with the 1936 Act, by applying the rewritten law as if it had also applied in previous years. [Schedule 6 Part 1 item 1] | ||
| 392-25 | Section 158A election | Ensures that elections to permanently withdraw from averaging under the 1936 Act continue in force under the 1997 Act. [Schedule Part 1 item 1] |
E. Consequential amendments
Amendments of the Income Tax Assessment Act 1997
The 1997 Act is amended to:
- •
- insert a signpost provision in the core provisions. This provision, section 4-25, alerts readers to the existence of a small number of provisions in the 1936 Act that apply special tax treatment to a component of taxable income. [Schedule 6 Part 2 items 2 and 3]
- •
- update references to provisions rewritten in Division 392. These are set out in the following table:
| Provision | Changes |
|---|---|
| Section 12-5 (List of provisions about deductions) | Removal of an incorrect reference to averaging of incomes in the list of specific deduction provisions. [Schedule 6 Part 2 item 4] |
| Section 13-1 (List of provisions about offsets) | Replace the averaging of incomes item in the primary production entry in the list with new items to reflect the partial rewrite of these provisions. [Schedule 6 Part 2 item 5] |
| Paragraph 42-295(3)(d) (Concessional tax rate where depreciation balancing adjustment) | Add a reference to Division 392. [Schedule 6 Part 2 item 6] |
| Section 385-5 (Table of provisions relevant to primary producers) | Add a reference to Division 392 . [Schedule 6 Part 2 item 7] |
These amendments apply to assessments of income tax for the 1998-99 and later years. This ensures that these consequential amendments take effect at the same time as Division 392.
Amendments of the Income Tax Assessment Act 1936
The provisions allowing averaging adjustments for individuals under the 1936 Act areclosed off and references to the rewritten provisions replace references to the 1936 Act.
Closing off the existing provisions
New subsection 156(1A) is inserted into the 1936 Act to close off the application of the provisions providing for averaging adjustments for individuals under the 1936 Act. This change applies to income tax assessments for the 1998-99 and later years.
Inserting references to the rewritten provisions
The provisions in the following tables are amended to replace references to the averaging provisions of the 1936 Act with references to the averaging provisions of the 1997 Act.
These amendments apply to assessments of income tax for the 1998-99 and later years:
| Provision | Changes |
|---|---|
| Paragraph 86(2)(b) | Add a reference to the 1997 Act. The existing reference has been retained pending the rewrite of the averaging provisions for trustees. [Schedule 6 Part 3 item 8] |
| Section 94 | Replace several references to the 1936 Act, generally to terms defined in section 156, with references to the 1997 Act and the new terms. [Schedule 6 Part 3 items 9, 10] |
| Sub-subparagraph 94(10C)(a)(i)(B), and subparagraph 94(10C)(a)(ii) | Inserts tables to replace existing references to notional taxable income from primary production , a concept in the 1936 Act which is redundant. [Schedule 6 Part 3 items 11, 12] |
| Section 159S | Add a reference to the 1997 Act. The existing reference has been retained pending the rewrite of the averaging provisions for trustees. [Schedule 6 Part 3 item 22] |
| Subsection 159ZR(1) | Add a reference to subsection 392-35(2). [Schedule 6 Part 3 item 23] |
The following amendments apply in working out provisional tax in respect of income of the 1999-2000 and later income years:
| Provision | Changes |
|---|---|
| Paragraph 221YBA(2)(a) | Replace a reference to the 1936 Act with references to the 1997 Act. [Schedule 6 Part 3 item 24] |
| Section 221YCAA | Add references to provisions in Division 392 of the 1997 Act. [Schedule 6 Part 3 items 25 to 29] |
Amendments of the Income Tax Rates Act 1986
Imposition of extra tax where averaging increases tax liability
Where the averaging provisions in the 1936 Act result in an increase in tax payable, subsection 12(3) of the Income Tax Rates Act 1986 sets a rate of complementary tax which effectively imposes the adjustment. Section 20G of the Income Tax Rates Act 1986 reduces this rate in some circumstances to ensure that primary producers receive the full benefit of Family Tax Assistance.
Amendments to the Income Tax Rates Act 1986 replace these provisions, to the extent that they apply to individuals, with a single provision setting the rate for extra income tax calculated by proposed subsection 392-35(3). A number of other amendments result from the above change.
References to the 1936 Act are replaced with references to the 1997 Act.
Inserting references to the rewritten provisions
| Provision | Changes |
|---|---|
| Subsection 12(3) | Repeal the 1936 Act provisions imposing the rate of complementary tax on individuals. [Schedule 6 Part 4 item 31] |
| Subsection 12(7) | Replace references to the 1936 Act with references to the 1997 Act. [Schedule 6 Part 4 items 33, 34] |
| Section 20G | Repeal the 1936 Act provision that reduces complementary tax where family tax assistance applies, to the extent that it applies to individuals. [Schedule 6 Part 4 items 35 to 37] |
| Schedule 7 | Add references to the 1997 Act. [Schedule 6 Part 4 items 39 to 42] |
| Schedule 11 | Add references to the 1997 Act. [Schedule 6 Part 4 items 43 to 46] |
The amendments to the Income Tax Rates Act 1986 apply to assessments of income tax for the 1998-99 and later years.