House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Small business framework

This Bill introduces a standard eligibility criterion that applies across the small business tax concessions. Entities that satisfy an aggregated turnover test of $2 million per annum are able to utilise those concessions that meet their business needs (if they also satisfy any additional conditions, not related to the business size, that currently apply to those concessions).

This Bill also implements several 2006-07 Budget announcements:

•

the increase in the capital gains tax maximum net assets threshold from $5 million to $6 million;

•

the extension of the roll-over relief available under the uniform capital allowance system to small business entities;

•

an increase in the simplified tax system (STS) turnover threshold from $1 million to $2 million;

•

the removal of the $3 million depreciating assets test from the STS eligibility requirements; and

•

an increase in the goods and services tax cash accounting turnover threshold from $1 million to $2 million.

Date of effect : This measure will generally take effect for the 2007-08 and later income years, and from 1 April 2007 for the fringe benefits tax amendments.

Proposal announced : This measure was announced jointly by the Treasurer and the Minister for Small Business and Tourism in Press Release No. 123 of 13 November 2006.

Financial impact : This measure has these revenue implications:

Compliance cost impact : This measure will reduce compliance costs for many small business entities because they will only have to meet the standard eligibility threshold to gain access to multiple concessions.

Chapter 1 - The small business framework

Outline of chapter

1.1 Schedule 1 amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide a single definition of a 'small business entity' for the purpose of accessing any of the small business tax concessions. Item 2 in Schedule 3 amends the ITAA 1997 to list the concessions available to small business entities.

Context of amendments

1.2 The current tax laws contain a number of special arrangements for smaller businesses (variously defined), which are often loosely referred to as 'small business concessions'. Each concession has its own set of eligibility criteria based on the particular group of taxpayers being targeted. The criteria are tailored to the specific characteristics, policy objectives and constraints of each particular regime.

1.3 Multiple eligibility criteria across small business concessions, however justifiable when considered individually, are a source of complexity and unnecessary compliance costs for small businesses.

1.4 Table 1.1 outlines the current threshold eligibility tests for the concessions under the simplified tax system (STS), the goods and services tax (GST), the capital gains tax (CGT), the fringe benefits tax (FBT) and the pay as you go (PAYG) instalments.

1.5 Under the new small business framework, eligibility for all these concessions will be based on one test about the size of the business. Small businesses will be able to access these concessions provided they also satisfy any additional criteria that currently apply to each concession that do not relate to determining whether the taxpayer is a small business.

1.6 Amendments to the existing STS, CGT, GST, FBT, and PAYG instalments provisions to give small business entities access to those concessions are discussed in Chapter 4. Consequential amendments to the wine producer's rebate under the wine equalisation tax are also discussed in Chapter 4.

Summary of new law

1.7 An entity is a small business entity if it:

•

carries on a business; and

•

satisfies the $2 million aggregated turnover test.

1.8 These two elements together are referred to as the 'small business entity test'.

1.9 Any entity that satisfies the small business entity test can choose to access the following concessions (subject to any additional criteria set out in the particular concessions):

•

CGT 15-year asset exemption;

•

CGT 50 per cent active asset reduction;

•

CGT retirement exemption;

•

CGT roll-over;

•

simplified depreciation rules;

•

simplified trading stock rules;

•

immediate deduction for certain prepaid business expenses;

•

choice to account for GST on a cash basis;

•

annual apportionment of GST input tax credits;

•

choice to pay GST by instalments;

•

FBT car parking exemption; and

•

PAYG instalments based on gross domestic product (GDP) adjusted notional tax.

1.10 Partners in partnerships that are small business entities can also access the small business CGT concessions (see Chapter 4).

Comparison of key features of new law and current law

Detailed explanation of new law

The small business entity test

1.11 This chapter discusses the small business entity test, including the notion of 'carrying on a business', and describes the three ways in which an entity can satisfy the $2 million aggregated turnover test. The actual method for calculating an entity's aggregated turnover, and what needs to be included in it, is discussed in Chapter 2.

1.12 An entity is a small business entity if it:

•

carries on a business; and

•

satisfies the $2 million aggregated turnover test.

1.13 These two elements together are referred to as the small business entity test. Small business entities are eligible for the concessions listed in section 328-10. [Schedule 3, item 2, section 328-10 of the ITAA 1997]

1.14 The $2 million aggregated turnover test applies to the business income of the entity, not to each business conducted by the entity.

Example 1.1

Edward is a sole trader who carries on two businesses, one as a robotics manufacturer and another as a software developer. Edward is a small business entity. It is Edward, not the robotics manufacturing or the software development business that needs to satisfy the small business entity test.

Edward satisfies the aggregated turnover test when both of his businesses, considered together, have a turnover of less than $2 million.

1.15 A definition of 'small business entity' is inserted into the Dictionary of the ITAA 1997. [Schedule 1, item 7, definition of 'small business entity' in subsection 995-1(1) of the ITAA 1997]

Carrying on a business

1.16 To be a small business entity, an entity must carry on a business. [Schedule 1, item 1, paragraph 328-110(1)(a) of the ITAA 1997]

1.17 'Business' is defined broadly in the ITAA 1997 to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. Carrying on a business is not defined in the tax law and therefore takes its ordinary meaning.

Winding up a business

1.18 An entity is taken to be carrying on a business for the purposes of the small business entity test in an income year if:

•

the entity is winding up a business it formerly carried on; and

•

it was a small business entity in the income year that it stopped carrying on the business.

[Schedule 1, item 1, subsection 328-110(5) of the ITAA 1997]

1.19 This rule ensures that a small business entity continues to be eligible for small business concessions while it is winding up a business it previously carried on.

1.20 An entity winding up a business will need to calculate what their turnover would have been had the entity carried on the business for the entire income year. The rules relating to this are discussed in Chapter 2.

The $2 million aggregated turnover test

1.21 There are three ways an entity can satisfy the $2 million aggregated turnover test:

•

the entity's aggregated turnover for the previous income year was less than $2 million;

•

the entity's aggregated turnover for the current income year, worked out as at the first day of the income year, is likely to be less than $2 million; or

•

the entity's aggregated turnover for the current income year, worked out as at the end of the current income year is actually less than $2 million.

1.22 These tests relate to the timing of the calculation and the relevant time period for the calculation (as discussed below). The meaning of aggregated turnover is discussed in Chapter 2.

Test 1: The entity's aggregated turnover in the previous income year was less than $2 million

1.23 If an entity's aggregated turnover in the previous income year was less than $2 million it satisfies the $2 million aggregated turnover test regardless of its likely or actual aggregated turnover for the current year. [Schedule 1, item 1, subparagraph 328-110(1)(b)(i) of the ITAA 1997]

1.24 Most small business entities will only need to consider this test because their aggregated turnover in the previous income year will be under $2 million.

Example 1.2

In the 2007-08 income year, Michael carried on an IT consultancy business. His aggregated turnover for that income year was $1.9 million.

For the 2008-09 income year, Michael is a small business entity because his aggregated turnover for 2007-08 was less than $2 million. This is irrespective of his likely or actual turnover in the 2008-09 income year.

Test 2: The entity's aggregated turnover in the current income year is likely to be less than $2 million

1.25 Even if last year's aggregated turnover was greater than $2 million, an entity will satisfy the $2 million aggregated turnover test if it is likely that its aggregated turnover for the current income year will be less than $2 million. [Schedule 1, item 1, subparagraph 328-110(1)(b)(ii) of the ITAA 1997]

1.26 In Test 2 an entity's aggregated turnover is worked out as at the first day of the income year. References to as at the first day of the income year mean that the assessment needs to be based on the entity's state of affairs that existed as at the first day of the income year. It does not mean that the assessment of the entity's situation must be performed on the first day of the income year. [Schedule 1, item 1, paragraph 328-110(2)(a) of the ITAA 1997]

Example 1.3

Rick is carrying on a business in the 2007-08 income year. He did not assess his eligibility to be a small business entity, because he decided that none of the concessions would be suitable for his business needs.

However, on 1 January 2008 Rick starts thinking about selling one of his business assets and is therefore seeking to determine whether he satisfies the small business entity test in order to access small business CGT concessions.

Rick needs to work out his aggregated turnover as at 1 July 2007. However he may do this at any time in the income year. Undertaking the calculation in mid-January does not affect the result.

What is meant by references to 'likely'

1.27 Any reference to likely means that, on the balance of probabilities, it is more likely than not that the entity's aggregated turnover will be under $2 million.

Example 1.4

Hua carries on a business and had an aggregated turnover of $1.8 million in the 2006-07 income year, and $2.1 million in the 2007-08 income year.

Hua is planning to retire in the 2008-09 income year. When she retires, she intends to gradually ease out of work by not taking on any new customers (rather than selling the business as a going concern). In the income year that Hua starts this process, her aggregated turnover will fall under $2 million.

Hua does not satisfy Test 1 for the 2008-09 income year because her aggregated turnover in 2007-08 was greater than $2 million.

However, it is more likely than not that she will begin winding down her business in the 2008-09 income year and her aggregated turnover is therefore likely to fall below $2 million. Consequently, she satisfies Test 2.

Also, the exception to Test 2 (discussed in paragraph 1.31) will not apply to Hua, given that her aggregated turnover in the 2006-07 income year was less than $2 million.

1.28 Whether an entity's aggregated turnover is likely to be less than $2 million is an objective test. Some factors to consider in determining whether it is likely an entity's aggregated turnover would be under $2 million include:

•

the entity's aggregated turnover in previous income years;

•

exceptional sales or particular product lines last year that will not occur this year;

•

whether the entity is likely to have reduced staff this year;

•

whether the operating hours of the business will decrease;

•

whether aspects of the location of the business, or its industry, indicates a declining turnover (eg, if a drought is declared in an area, or if prices in the industry decline); or

•

whether the business will face increased competition.

Example 1.5

In the 2007-08 income year, a company carried on a professional painting business. The company's aggregated turnover for that income year was $2.5 million, and it had 11 staff.

On 1 July 2008, the company received resignation letters from eight of its 11 employees. The company's sole director anticipates that it will be difficult to replace these workers during the current income year.

For the 2008-09 income year, the company would fail the $2 million aggregated turnover test under Test 1, because its aggregated turnover in the previous income year was greater than $2 million.

However, given that the company's director anticipates difficulty with replacing its staff, it is likely that its aggregated turnover will be under $2 million for the 2008-09 income year.

Starting to carry on a business in the current income year

1.29 If the entity starts to carry on a business part-way through an income year, they work out their aggregated turnover as at the day they started to carry on a business, rather than working out their aggregated turnover as at the beginning of the income year. [Schedule 1, item 1, paragraph 328-110(2)(b) of the ITAA 1997]

1.30 However, entities that start carrying on a business in the current income year need to calculate what their turnover would have been had the entity carried on the business for the entire income year. The rules relating to this are discussed in Chapter 2.

Exception: If the entity's aggregated turnover in the previous two income years was greater than $2 million

1.31 An entity cannot use Test 2 if its aggregated turnover in each of the previous two income years (worked out as at the end of those years) was greater than $2 million. However, the entity may be able to access some of the small business concessions at the end of the income year if its turnover for that year was actually under $2 million (see paragraphs 1.33 to 1.36). [Schedule 1, item 1, subsection 328-110(3) of the ITAA 1997]

1.32 This exception prevents abuse of the 'likely' test. It will also reduce the need for the Commissioner of Taxation to engage in costly compliance activities in order to establish that an entity with aggregated turnover greater than $2 million for multiple consecutive years is not likely to have an aggregated turnover of less than $2 million this year.

Example 1.6

The income year is 2009-10, and David is attempting to determine whether he satisfies the $2 million aggregated turnover test. In the 2007-08 and 2008-09 income years he carried on a business as a surfboard maker and his aggregated turnover was $2.2 million and $2.4 million respectively.

In both of those years he claimed he was a small business entity under Test 2, on the grounds that it was likely that his aggregated turnover would be under $2 million.

David will not be a small business entity for the 2009-10 income year under Test 2, even if it is likely that his aggregated turnover will be under $2 million for that year. This is because his aggregated turnover in the previous two income years was greater than $2 million.

However, David may be able to rely on Test 3 (see paragraphs 1.33 to 1.36) in order to access some of the small business concessions if his aggregated turnover actually turns out to be under $2 million as at the end of the 2009-10 income year.

Test 3: The entity's aggregated turnover for the current income year is less than $2 million

1.33 The final test applies to the entity's aggregated turnover in the current income year, worked out as at the end of that income year. The turnover calculation is based on the entity's actual aggregated turnover for the income year in which the concessions are sought. [Schedule 1, item 1, subsection 328-110(4) of the ITAA 1997]

1.34 If the entity started to carry on a business part-way through the income year, they need to calculate what their turnover would have been had the entity carried on the business for the entire income year (in line with paragraph 1.30).

1.35 This rule exists so that, despite an entity's previous aggregated turnover, or the entity's likely aggregated turnover, an entity is a small business entity if its actual aggregated turnover is less than $2 million in an income year.

1.36 An entity that is a small business entity by means of Test 3, determined at the end of an income year, will not be able to access the concessions that are used throughout an income year, namely:

•

paying PAYG instalments based on GDP-adjusted notional tax;

•

accounting for GST on a cash basis;

•

making an annual apportionment of GST input tax credits for acquisitions and importations that are partly creditable; and

•

paying GST by quarterly instalments.

Example 1.7

Jenny carried on an agricultural business in the 2008-09 income year. In the 2007-08 income year her aggregated turnover was $3 million and, as a result, she fails Test 1 of the $2 million aggregated turnover test.

At the beginning of the 2008-09 income year, it is likely that her aggregated turnover will continue to be greater than $2 million.

However, on 1 January 2009, a bushfire destroys part of her property. As a result of this unanticipated event, her actual aggregated turnover for the 2008-09 ends up being just $500,000.

When filling out her 2008-09 tax returns, Jenny may access the income tax concessions (including CGT) and the FBT concession provided that she meets the additional criteria for each concession. However, Jenny may not access the GST and PAYG instalment concessions.

Application and transitional provisions

1.37 These amendments apply to the 2007-08 income year and later income years.

Winding up a business

1.38 Transitional arrangements apply for any entity that, in an income year before the 2007-08 income year, was an STS taxpayer and stopped carrying on any business. These entities can continue to use STS concessions in the 2007-08 and later income years if they are winding up the business they previously carried on (see Chapter 4 for more details).

Chapter 2 - Aggregated turnover

Outline of chapter

2.1 Schedule 1 amends the Income Tax Assessment Act 1997 (ITAA 1997) to create the concept of aggregated turnover, which is used for determining whether an entity is a small business entity.

2.2 Schedule 3, item 165, amends the Income Tax (Transitional Provisions) Act 1997 to allow for transitional arrangements for the calculation of aggregated turnover in the 2005-06 and 2006-07 income years.

Context of amendments

2.3 Currently, access to the simplified tax system (STS) and goods and services tax (GST) concessions rely on the concept of 'turnover'. However, turnover is defined differently in each case. Other concessions rely on other measures of business size such as the net value of assets, instalment income, or ordinary and statutory income.

2.4 Furthermore, both the STS and the small business capital gains tax (CGT) concessions contain grouping rules which are designed to stop larger businesses from artificially splitting their operations to gain access to the concessions. While these rules are similar, they vary in a number of ways.

2.5 The small business entity test discussed in Chapter 1 is based on satisfying a $2 million aggregated turnover test. This Bill introduces a single concept of aggregated turnover to determine eligibility for the STS, GST, CGT, fringe benefits tax (FBT) and pay as you go (PAYG) instalment, small business concessions.

Summary of new law

2.6 This chapter outlines how an entity calculates its aggregated turnover in order to determine whether it satisfies the aggregated turnover test described in Chapter 1.

Comparison of key features of new law and current law

Detailed explanation of new law

2.7 This chapter describes the method an entity uses to calculate its aggregated turnover for the purposes of determining whether it satisfies the $2 million aggregated turnover test discussed in Chapter 1.

Steps to calculate aggregated annual turnover

2.8 For an entity to calculate its aggregated turnover, it must first calculate its annual turnover, secondly apply the aggregation rules, and thirdly calculate its aggregated turnover.

2.9 Note - an entity's aggregated turnover is the same as its annual turnover if no other entities need to be aggregated with it.

Step 1: calculating annual turnover for the income year

2.10 An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business. [Schedule 1, item 1, subsection 328-120(1) and item 4, definition of 'annual turnover' in subsection 995-1(1) of the ITAA 1997]

2.11 Some special rules apply to certain entities and certain dealings (see paragraphs 2.17 to 2.30).

The basic rule: ordinary income in the ordinary course of carrying on a business

2.12 'Ordinary income' is a term defined in section 6-5 of the ITAA 1997 as 'income according to ordinary concepts'.

2.13 An entity's annual turnover therefore includes all income according to ordinary concepts derived in the ordinary course of carrying on a business, but not other income, such as salary or wages.

Example 2.1

Pamela is employed as a senior manager in a multi-national corporation, and also carries on a business as a professional musician. Her ordinary income derived as a manager in the 2007-08 income year was $2 million. Her ordinary income derived in carrying on a business as a professional musician was $100,000.

Pamela's turnover for the purposes of step 1 is $100,000. Any income derived not in the ordinary course of carrying on a business, such as employment as a manager, does not need to be included in her annual turnover calculation.

What does 'in the ordinary course of carrying on a business' mean?

2.14 The phrase 'in the ordinary course of carrying on a business' is not defined in income tax law. It must therefore be interpreted according to its ordinary meaning.

2.15 In general, income is derived in the ordinary course of carrying on a business if the income is of a kind that is regularly or customarily derived by the entity in the course of carrying on its business, arising out of no special circumstance or unusual event. Similarly, the income is derived in the ordinary course of carrying on a business if the income, although not regularly derived, is a direct result of the normal activities of the business.

2.16 Ordinary income may be derived in the ordinary course of carrying on a business even if it is not the main type of ordinary income derived by the entity. Similarly, the income does not need to account for a significant part of the entity's overall receipts. It is sufficient that the ordinary income is of a kind derived regularly or customarily in the carrying on of a business.

Rules that apply for certain entities and transactions

Sales of retail fuel

2.17 The STS average turnover test provided for regulations to be made to allow for different methods of calculating turnover for certain entities. Such a regulation was made for the purposes of fuel retailers, recognising that entities involved in the sale of retail fuel will often have high levels of turnover with a very low margin, so that the ordinary turnover figure would not be a true indicator of size. This Bill retains that result by bringing the effect of this regulation in to the ITAA 1997. [Schedule 1, item 1, subsection 328-120(3) of the ITAA 1997]

2.18 The result is that, for the purposes of calculating its turnover, an entity disregards any income derived from the sale of retail fuel.

2.19 Retail fuel is defined as taxable fuel within the meaning of the Fuel Tax Act 2006, that is sold by retail. [Schedule 1, item 6, definition of 'retail fuel' in subsection 995-1(1) of the ITAA 1997]

Exclusion of amounts relating to GST

2.20 Any amounts that are non-assessable non-exempt income under section 17-5 of the ITAA 1997 are excluded from an entity's turnover. [Schedule 1, item 1, subsection 328-120(2) of the ITAA 1997]

2.21 Section 17-5 describes two types of amounts as non-assessable non-exempt income (both of which are excluded from the entity's turnover):

•

GST on a taxable supply (within the meaning of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)); and

•

any increasing adjustment (within the meaning of the GST Act) that relates to a supply, an acquisition, or arises in circumstances that give rise to a recoupment that is included in assessable income.

2.22 The effect of this provision is that an entity does not include amounts relating to GST when working out their turnover.

Dealings with associates

2.23 If an entity has a dealing with an associate that was not at arm's length, the entity needs to include in its turnover any ordinary income that would have resulted from that dealing as if the dealing had been at arm's length. [Schedule 1, item 1, subsection 328-120(4) of the ITAA 1997]

2.24 This rule ensures that amounts of income derived from non-arm's length transactions are properly accounted for when considering the entity's turnover.

2.25 Note that dealings between the entity and an associate that is a relevant entity for the purposes of these provisions are excluded from the calculation of turnover (see paragraph 2.64).

2.26 The term 'associate' is a defined term in the ITAA 1997 and has the meaning given by section 318 of the Income Tax Assessment Act 1936.

2.27 The application of the associates rule would typically involve the substitution of the market value for the actual amount of ordinary income derived from the good or service being sold. However, the entity may take into account discounts, for example, that would have been offered had the dealing been at arm's length.

Example 2.2

Jamila carries on a business as a photo developer and Peter carries on a business as a wedding photographer. Jamila is a daughter of Peter, and therefore is his associate. Over the course of a year, Jamila developed 200 films for Peter and only charged him the amount it cost her to develop the films, with no profit margin.

Given that this is a non-arm's length transaction between associates, the amount that Jamila needs to include in her turnover is the ordinary income she would have derived from the developing of those 200 films had the transaction been at arm's length. A useful guide for the amount that should be used would be the price she would charge for any regular customer (taking into account bulk discounts etc).

Note that any income Jamila derives from Peter is disregarded if Peter is an affiliate of Jamila's under the aggregation rules (see paragraph 2.25)

Where an entity carries on a business for part of the income year

2.28 If an entity carries on a business for part of the income year only, its turnover must be worked out using a reasonable estimate of what the turnover would have been if the entity had carried on a business for the whole of the income year. [Schedule 1, item 1, subsection 328-120(5) of the ITAA 1997]

2.29 The intent of this provision is to ensure that the eligibility test of turnover, as an indicator of the size of a business, is based on income for a full year. Without this rule, entities that carry on a business for part of an income year would have a lower turnover than is truly representative of the size of the business.

Example 2.3

Cayleigh commenced carrying on a business on 1 June 2008, and her turnover from 1 June to 30 June was $200,000. Applying her turnover for a month to a full year, a reasonable estimate of her annual turnover for the 2007-08 income year is $2.4 million.

However, if there is something about her business that indicates that the month of June would be expected to have a particularly high or low turnover, then the reasonable estimate of her turnover would vary from the result under the equation.

An example of this may be if she carries on a ski equipment hiring business and would therefore be expected to have a high turnover in the month of June compared with her average monthly turnover. As a result, her reasonable estimate of her turnover may be less than that calculated as a simple lineal projection.

Regulations may alter the calculation of annual turnover

2.30 This Bill provides for regulations to be made that may set out different calculations of annual turnover [Schedule 1, item 1, subsection 328-120(6) of the ITAA 1997] . The regulations, however, can only have the affect of reducing the amount of an entity's annual turnover.

Step 2: apply the aggregation rules if necessary

2.31 An entity needs to determine whether another entity's annual turnover needs to be aggregated with its turnover.

2.32 The annual turnover of other entities needs to be aggregated with an entity (the test entity) if:

•

the test entity is an affiliate of another entity; or

•

the test entity is connected with another entity.

2.33 The rules that determine when an entity needs to count the turnover of another entity are referred to as the aggregation rules.

When is an entity an affiliate of another entity?

2.34 An individual or company is an affiliate of an entity where that individual or company acts, or could reasonably be expected to act:

•

in accordance with the entity's directions or wishes in relation to the affairs of that individual or company's business; or

•

in concert with the entity in relation to the affairs of the individual or company's business.

2.35 The definition of 'affiliate' is inserted into the Dictionary of the ITAA 1997. The affiliate rules are designed to ensure that entities that genuinely carry on independent businesses are not aggregated. [Schedule 1, item 2, definition of 'affiliate' in subsection 995-1(1), and item 1, subsection 328-130(1) of the ITAA 1997]

2.36 The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities are acting in concert:

•

family or close personal relationships;

•

financial relationships or dependencies;

•

relationships created through links such as common directors, partners, or shareholders;

•

the degree to which the entities consult with each other on business matters; or

•

whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity.

2.37 None of these factors are determinative in their own right.

2.38 A spouse or a child under the age of 18 years is not automatically an affiliate. This is a change to the current CGT law and is discussed in more detail in Chapter 4.

Example 2.4

Rose and Sam are husband and wife. They both share in the running of their household. Rose carries on a cleaning business with an aggregated turnover of $1.7 million while Sam carries on a bakery with an aggregated turnover of $1.5 million. They both have separate bank accounts for their businesses and have nothing to do with each other's businesses. Both businesses are run from different locations and they have their own employees. Neither Rose nor Sam control the management of the other's business.

Even though Rose and Sam are married, neither is an affiliate of the other. The reason is that they do not act in concert with each other in respect of their businesses, and neither acts in accordance with the directions or wishes of the other.

2.39 Similarly, an individual or company is not automatically an affiliate merely because of a business relationship [Schedule 1, item 1, subsection 328-130(2) of the ITAA 1997] . For example, co-directors, co-trustees or partners are not necessarily affiliates. Also, directors are not automatically affiliates of the company of which they are a director, nor would the company automatically be an affiliate of the directors.

Entities that cannot be an affiliate

2.40 Only an individual or company can be an affiliate of another entity. Entities (for tax purposes) such as trusts, partnerships, and superannuation funds are not capable of being affiliates of entities.

When is an entity connected with another entity?

2.41 The definition of 'connected with' is amended in the Dictionary of the ITAA 1997 to mean that an entity is connected with another entity if one of the entities controls the other entity, or if the two entities are controlled by the same third entity. [Schedule 1, item 5, definition of 'connected with' in subsection 995-1(1) of the ITAA 1997; Schedule 1, item 1, subsection 328-125(1) of the ITAA 1997]

2.42 Some control rules apply to all entities except discretionary trusts, others apply only to discretionary trusts, and some rules apply to any entity.

Rules that apply to all entities except discretionary trusts

The 40 per cent ownership test

2.43 An entity controls another entity where the first entity or its affiliates, or the first entity and its affiliates between them beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that between them give the right to receive at least 40 per cent of any distribution of either:

•

income;

•

if the other entity is a partnership - the net income of the partnership; or

•

capital,

by the other entity. This is known as the control percentage. [Schedule 1, item 1, paragraph 328-125(2)(a) of the ITAA 1997]

2.44 The reference to partnerships ensures that a partner of a partnership that is receiving 40 per cent or more of the net income of the partnership will be taken to control that partnership.

2.45 Where an entity has legal ownership of the interests in the other entity, but not beneficial ownership of those interests, it will not be regarded as controlling that entity. If the entity is a partner in a partnership, that entity's interest in that partnership is a type of interest that gives the partner the right to receive a distribution of income or capital by the partnership.

Example 2.5

Patricia is the sole trustee of XYZ non-discretionary trust. Patricia is also a beneficiary of XYZ non-discretionary trust, and beneficially owns 30 per cent of any distribution of income from the trust.

Although she is the sole trustee, Patricia does not control the trust. She only beneficially owns 30 per cent of its income, and therefore does not exceed the control percentage.

Company-specific test: 40 per cent of voting rights

2.46 An additional test applies for the control by entities of companies. If either this test, or the 40 per cent ownership test is satisfied, then that entity controls the company.

2.47 Control of a company will be established if an entity alone or together with affiliates beneficially own, or has the right to acquire beneficial ownership of, interests in the company with at least 40 per cent of the voting power in the company. [Schedule 1, item 1, paragraph 328-125(2)(b) of the ITAA 1997]

Example 2.6

Pam carries on a business as a sole trader. She also owns interests in XYZ Company that gives her 30 per cent of the voting rights in that company. Sean, an affiliate of Pam, also owns interests in XYZ Company that gives him 30 per cent of the voting rights in that company.

As Sean is an affiliate of Pam, Pam controls XYZ Company, notwithstanding that her voting rights are below the control percentage. This is because Pam's interests, together with Sean's, amount to giving them the right to exercise more than 40 per cent of the voting rights in XYZ Company.

Pam would therefore need to include the turnover of both XYZ Company and Sean when determining whether or not she satisfies the $2 million aggregated turnover test.

Rules that apply to discretionary trusts

2.48 There are two ways in which an entity can control a discretionary trust:

•

where a special 40 per cent ownership test is satisfied [Schedule 1, item 1, subsection 328-125(4) of the ITAA 1997]; or

•

where the trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity [Schedule 1, item 1, subsection 328-125(3) of the ITAA 1997].

The 40 per cent ownership test for discretionary trusts

2.49 An entity is taken to control a discretionary trust for an income year if, for any of the four income years before that income year:

•

the trustee paid any income or capital of the trust to or for the benefit of the first entity, its affiliates, or the first entity and its affiliates [Schedule 1, item 1, paragraph 328-125(4)(a) of the ITAA 1997]; and

•

the amount paid or applied to the entity and/or its affiliates is at least 40 per cent of the total amount of income or capital paid or applied by the trustee for that income year [Schedule 1, item 1, paragraph 328-125(4)(b) of the ITAA 1997].

Example 2.7

Gavin is trying to determine whether he is a small business entity for the 2011-12 financial year. In the 2008-09 income year, Gavin received a distribution from a discretionary trust. That distribution constituted 70 per cent of the total amount of the income distributed by the trust in that financial year. Gavin will be taken to control that trust because he received a distribution of income in 2008-09 in excess of 40 per cent of the total amount of income distributed in that year.

2.50 Amounts paid to, or applied for the benefit of, exempt entities (ie, an entity that is exempt from income tax) and deductible gift recipients (ie, entities to which donations of $2 or more are tax deductible) are not relevant in determining whether these entities control discretionary trusts. [Schedule 1, item 1, subsection 328-125(5) of the ITAA 1997]

Trustees acting in accordance with other entities

2.51 If a trustee of a discretionary trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of an entity (the first entity), its affiliates or the first entity together with its affiliates, then the first entity will control the discretionary trust. [Schedule 1, item 1, subsection 328-125(3) of the ITAA 1997]

2.52 Whether a trustee is accustomed or might reasonably be expected to act in accordance with the directions or wishes of another, is determined having regard to all the circumstances of the case. For example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions or wishes would not prevent the examination of the actual circumstances to determine whether an entity controls the trust.

2.53 Some factors which might be considered include:

•

the way in which the trustee has acted in the past;

•

the relationship between the entities and the trustee;

•

the amount of any property or services transferred to the trust by the entities; and

•

any arrangement or understanding between the entities and a person or persons who have benefited under the trust in the past.

Rules that apply to all entities

Indirect control of an entity

2.54 If an entity (the first entity) directly controls a second entity, and that second entity also controls (whether directly or indirectly) a third entity, the first entity is taken to control the third entity. [Schedule 1, item 1, subsection 328-125(7) of the ITAA 1997]

2.55 This test is designed to look through business structures that include interposed entities.

Example 2.8

Matthew Co controls Simpson Co and Nareena Co, but not Oslo Co or Meniotta Co.

2.56 Certain entities such as public companies and publicly traded trusts have a very diffuse and regularly traded ownership and, as a result, it can be a complicated and difficult process to trace interests through these types of entities. Therefore, if one of these entities is interposed between a first and a third entity, the first entity will not control the third entity merely because of its interests in the interposed public company or trust. [Schedule 1, item 1, subsection 328-125(8) of the ITAA 1997]

2.57 The types of entities are:

•

companies whose shares are listed for quotation in the official list of an approved stock exchange, unless those shares are of a type that carry the right to a fixed rate of dividend;

•

publicly traded unit trusts;

•

mutual insurance companies;

•

mutual affiliate companies; and

•

any company where all of its shares are beneficially owned by one or more of any of the entities listed above.

Example 2.9

Joanna controls a publicly traded unit trust. This publicly traded unit trust in turn controls a company. There are no other relationships of control between Joanna and the company.

Joanna will not be taken to control the company through the indirect control of an entity rule. This is because the indirect control test does not apply to any entities controlled by the publicly traded unit trust.

2.58 The mere presence of an interposed entity does not result in a chain of ownership being broken. In Example 2.8, if Simpson Co was a public company, Matthew Co would not be taken to control Nareena Co. However, if Matthew Co controlled Nareena Co in some other way, such as directly owning interests in Nareena Co, then Matthew Co would control Nareena Co.

The Commissioner's discretion

2.59 Where an entity's interest in another entity is at least 40 per cent but less than 50 per cent the Commissioner may choose to ignore the interest of that entity in the other entity if the Commissioner determines that a third entity actually controls the other entity. [Schedule 1, item 1, subsection 328-125(6) of the ITAA 1997]

2.60 The Commissioner may think that another entity controls the entity either based on fact or on a reasonable assumption or inference. Whether or not the third entity has a 40 per cent interest may assist in determining whether the third entity controls the other entity, but it is not decisive.

Example 2.10

Chandra owns a restaurant with a turnover of less than $2 million and has inherited his father's 42 per cent interest in a software company. The other 58 per cent of the software company is owned by the manager of the company, and Chandra has had no dealings with the manager whatsoever.

The turnover of Chandra's restaurant will not be aggregated with the turnover of the software company if the Commissioner thinks that the software company is actually controlled by the other person with the 58 per cent interest.

Step 3: calculating aggregated turnover for the income year

2.61 An entity's aggregated turnover is the sum of the relevant annual turnovers, excluding certain amounts. Schedule 1, item 1, subsection 328-115(1) of the ITAA 1997]

Relevant annual turnovers

2.62 'Relevant annual turnovers' consist of the sum of:

•

the annual turnover of the entity seeking to satisfy the $2 million aggregated turnover test;

•

the annual turnover of any of the entity's affiliates (discussed in paragraphs 2.34 to 2.40); and

•

the annual turnover of any entity connected with the entity (discussed in paragraphs 2.41 to 2.60).

[Schedule 1, item 1, subsection 328-115(2) of the ITAA 1997]

2.63 The entity's affiliates and entities that are connected with it are called 'relevant entities' in the provisions.

Amounts that are excluded from the aggregated turnover calculation

2.64 There are three classes of ordinary income excluded from aggregated turnover to avoid double-counting:

•

ordinary income derived by the entity from a dealing with a relevant entity;

•

ordinary income derived by a relevant entity from a dealing with another relevant entity; and

•

ordinary income derived by a relevant entity while it was not a relevant entity.

[Schedule 1, item 1, subsection 328-115(3) of the ITAA 1997]

Income derived by an entity from a dealing with a relevant entity

2.65 If an entity derives any income from a relevant entity the income does not need to be included in the aggregate turnover calculation [Schedule 1, item 1, paragraph 328-115(3)(a) of the ITAA 1997] . As relevant entities are considered as a single entity, rather than multiple entities, transactions between them do not constitute part of their aggregated turnover.

Income derived by a relevant entity from a dealing with another relevant entity

2.66 Similarly, if income is derived by a relevant entity from a dealing with another relevant entity, then that amount is excluded from the aggregated turnover calculation [Schedule 1, item 1, paragraph 328-115(3)(b) of the ITAA 1997] . An example of this may be a dealing between:

•

a trust that is connected with an individual; and

•

a company that is an affiliate of that same individual.

2.67 Any income derived from a dealing between the trust and the company is an excluded amount under the aggregated turnover calculation.

Example 2.11

Victoria is an affiliate of Lorin under the aggregation rules. Victoria is also connected with Export Company.

Victoria does not need to include income from any dealing with Lorin or Export Company in her aggregated turnover calculation.

Further, any dealing between Lorin and Export Company does not need to be included in Victoria's aggregated turnover.

Income derived from a relevant entity while they were not required to be aggregated with the entity

2.68 Only income derived by an entity while it was connected to, or an affiliate of, the other entity is required to be included in the aggregated turnover calculation. [Schedule 1, item 1, paragraph 328-115(3)(c) of the ITAA 1997]

Example 2.12

From 1 July 2007 to 31 December 2007, Nerida beneficially owned interests in QYX Pty Ltd that carry between them the right to receive 50 per cent of any distribution from QYX Pty Ltd.

On 1 January 2008, Nerida disposed of her interest in QYX Pty Ltd.

Nerida was only connected with QYX Pty Ltd from 1 July 2007 to 31 December 2007 and therefore only needs to include the ordinary income derived by QYX Pty Ltd during that period of time in her aggregated turnover. The income derived by QYX Pty Ltd from 1 January 2008 to 30 June 2008 is an excluded amount for the purposes of Nerida's aggregated turnover in the 2007-08 income year.

Application and transitional provisions

2.69 These amendments apply to the 2007-08 income year and later income years.

2.70 Different application dates apply for certain concessions available to small business entities (see Chapter 4 for details).

2.71 If an entity has to work out its aggregated turnover for the 2005-06 or 2006-07 income year to determine whether it is a small business entity, the rules about aggregated turnover apply as if they had been in force for that year. [Schedule 3, item 165, subsection 328-110(2) of the Income Tax (Transitional Provisions) Act 1997]

2.72 If an entity has an aggregated turnover for 2006-07 not under $2 million and wishes to rely on its likely aggregated turnover for the 2007-08 income year to qualify as a small business entity, it needs to consider its aggregated turnover for the 2005-06 income year. To make it easier for an entity to work out its eligibility in these circumstances, the entity can use its STS group turnover figure for the 2005-06 year (as an alternative to working out its aggregated turnover figure). The entity's STS group turnover figure will be very similar to its aggregated turnover amount. [Schedule 3, item 165, subsection 328-110(3) of the Income Tax (Transitional Provisions) Act 1997]

2.73 There are special transitional arrangements in determining control of discretionary trusts for the purposes of the form STS concessions (see Chapter 4 for details).

Chapter 3 - Depreciating asset roll-over relief

Outline of chapter

3.1 Schedule 7 to this Bill amends Subdivision 328-D of the Income Tax Assessment Act 1997 (ITAA 1997) to extend the roll-over relief available under the uniform capital allowance system to small business entities who choose to deduct amounts for depreciating assets under Subdivision 328-D.

3.2 All references to legislative provisions in this chapter are to the ITAA 1997 unless stated otherwise.

Context of amendments

3.3 Subdivision 328-D sets out the rules for capital allowances for small business entities. A small business entity can choose to deduct amounts under Subdivision 328-D for depreciating assets that are used for a taxable purpose.

3.4 A small business entity that has made the choice to deduct amounts for depreciating assets under Subdivision 328-D must allocate all depreciating assets to either a general small business pool or a long life small business pool and treat each pool as a single asset. The rates of depreciation are 30 per cent for the general small business pool and 5 per cent for the long life small business pool. Assets with effective lives of less than 25 years are allocated to the general small business pool while those having effective lives of 25 years or more are allocated to the long life small business pool. There is also an immediate deduction for low-cost assets, that is, assets whose costs are less than $1,000.

3.5 Under Division 40, the uniform capital allowances system allows deductions for the decline in value of a depreciating asset over the asset's effective life. The Division provides a set of general rules to calculate the deduction to taxpayers for the notional decline in value of most depreciating assets. It also provides pooling mechanisms under which small expenditures are pooled and taxpayers are allowed deductions for the decline in value of the pool.

3.6 Adjustments may be made to assessable income under the uniform capital allowances system (balancing adjustments - section 40-285) when a balancing adjustment event occurs, for example, when a taxpayer stops holding an asset (section 40-285). Subsection 40-295(2), specifically, provides that a balancing adjustment event occurs for a depreciating asset if:

•

there is a change in the holding of, or in the interests of entities in, the asset;

•

at least one of the entities that had an interest in the asset before the change has an interest in it after the change; and

•

the asset was held by a partnership either before or as a result of the change.

3.7 Balancing adjustments are usually based on the difference between the actual value of the asset at the time of the balancing adjustment event and its adjusted value (Subdivision 40-D). Under certain circumstances, either automatic roll-over relief (subsection 40-430(1)) or optional roll-over relief (subsection 40-340(3)) is available to defer the adjustment to assessable income until actual disposal of the asset.

3.8 Amendments made to the simplified tax system (STS) by the Taxation Laws Amendment Act (No. 2) 2004, provided optional roll-over relief in relation to depreciating assets in an STS pool where there is a partial change in ownership of an asset held by an STS partnership. Roll-over relief was only available where the entities both before and after the change were partnerships. The amendments in the Taxation Laws Amendment Act (No. 2) 2004 applied to balancing adjustment events occurring on or after 1 July 2001.

3.9 Roll-over relief for STS taxpayers was extended by the Tax Laws Amendment (2004 Measures No. 7) Act 2005. This removed the requirement that both entities, before and after the ownership change, must be partnerships, thereby catering for situations where, for example, a sole trader restructured into a partnership, or a partnership restructured to a sole trader. The amendments apply to balancing adjustment events occurring on or after 1 July 2005.

3.10 This measure extends the roll-over relief available under the uniform capital allowances system to small business entities who choose to claim their capital allowance deductions under Division 328.

3.11 This measure was announced in the Treasurer's Press Release No. 039 of 9 May 2006.

Summary of new law

3.12 Amendments to Subdivision 328-D extend the optional depreciating asset roll-over relief available under the uniform capital allowances regime to small business entities that choose to deduct amounts for depreciating assets under Subdivision 328-D where:

•

a sole trader, trustee or a partnership that chooses to use the capital allowances for small business entities disposes of all assets in a small business pool to a wholly-owned company; or

•

a small business entity that chooses to use the capital allowances for small business entities disposes of all assets in the small business pool to another taxpayer as a result of a marriage breakdown.

Detailed explanation of new law

3.13 Amendments to section 328-243 extend the optional depreciating asset roll-over relief available under the uniform capital allowances regime (subsection 40-340(1)) to small business entities that choose to deduct amounts for depreciating assets under Subdivision 328-D where:

•

a sole trader, trustee or a partnership that chooses to use the capital allowances for small business entities disposes of all assets in a small business pool to a wholly-owned company; or

•

a small business entity that chooses to use the capital allowances for small business entities disposes of all assets in the small business pool to another taxpayer as a result of a marriage breakdown.

[Schedule 7, item 1, paragraphs 328-243(1A)(a) to (c) and (f )]

3.14 To be eligible for this roll-over relief, deductions for the depreciating assets must be calculated under Subdivision 328-D. Therefore, the assets subject to the roll-over relief must be allocated to the general small business pool or the long life small business pool at the time of the balancing adjustment event. [Schedule 7, item 1, paragraph 328-243(1A)(d )]

3.15 It should be noted that when a taxpayer ceases to deduct amounts for depreciating assets under Subdivision 328-D or is no longer eligible to use the Subdivision, depreciating assets that have been allocated to a general small business pool and a long life small business pool continue to be depreciated under Subdivision 328-D. This means that former small business entities, or small business entities that choose not to continue to use Subdivision 328-D, may choose roll-over relief for depreciating assets allocated to a small business pool when a balancing adjustment event occurs under subsection 40-295(2).

3.16 Roll-over relief is only available if the entity or entities that had an interest in the assets just before the balancing adjustment event (the transferor) and those that have an interest in the assets just after the balancing adjustment event occurred (the transferee) jointly choose the roll-over relief. [Schedule 7, item 1, paragraph 328-243(1A)(e )]

Application and transitional provisions

3.17 These amendments take effect from the start of the income year following the date of Royal Assent of this Bill. [Schedule 7, item 2]

Chapter 4 - Other changes to the tax law

Outline of chapter

4.1 Schedules 2 to 6 and 8 to this Bill amend a number of Acts to:

•

give effect to the 2006-07 Budget announcements detailed in Chapter 1;

•

allow small business entities access to the various small business concessions located in the different Acts; and

•

make consequential changes to give effect to the above amendments.

Context of amendments

Goods and services tax

4.2 The A New Tax System (Goods and Services Tax) Act 1999 (GST Act) contains the following three goods and services tax (GST) related small business concessions:

•

GST cash accounting;

•

annual apportionment of input tax credits for acquisitions and importations that are partly creditable; and

•

paying GST by quarterly instalments.

4.3 Currently, in order to be eligible to elect one of these concessions, an entity's annual turnover for GST purposes must not exceed either $2 million, in the case of GST instalments and annual apportionment, or $1 million in the case of cash accounting.

4.4 In the 2006-07 Budget, the Government announced that it would increase the GST cash accounting threshold to $2 million. The Government also announced that it would align simplified tax system (STS) and GST definitions of 'turnover for small business'. These proposals have been incorporated into the new small business framework.

4.5 Currently, the GST concessions are available to eligible entities that are carrying on an enterprise. The concept of carrying on an 'enterprise' is potentially broader than the concept of carrying on a 'business'. For example, an enterprise would include activities done by charitable institutions, trustees of complying superannuation funds, and some government bodies. Changes need to be made to the GST Act to ensure that entities that carry on enterprises, but do not carry on businesses, continue to have access to the GST concessions if they meet the eligibility criteria.

Simplified tax system

4.6 Currently, the STS is an optional system that provides for an alternative method of determining taxable income for entities carrying on small businesses with straightforward, uncomplicated tax affairs. Eligible entities that choose to use the STS have special depreciation and trading stock rules (the standard tax rules apply outside these areas). In addition, STS taxpayers can claim an immediate full deduction for certain prepaid expenses.

4.7 As part of the 2006-07 Budget the Government announced a number of changes to the STS, including:

•

increasing the STS average annual turnover threshold from $1 million to $2 million;

•

removing the $3 million depreciating assets test from the STS eligibility requirements; and

•

giving STS taxpayers access to the capital gains tax (CGT) small business concessions, fringe benefits tax (FBT) exemption for car parking benefits and the payment of quarterly pay as you go (PAYG) instalments on the basis of gross domestic product (GDP) adjusted notional tax.

4.8 These proposals have been incorporated into the new small business framework.

Capital gains tax

4.9 In the 2006-07 Budget the Government announced that the maximum net asset value for accessing the small business CGT concessions would be increased from $5 million to $6 million and that STS taxpayers would have access to the small business CGT concessions. The former has been given affect through this Bill and the latter has been incorporated into the new small business framework.

4.10 The alignment of grouping rules applying to small business CGT concessions and the new small business framework, announced by the Treasurer and the Minister for Small Business and Tourism in Press Release No. 123 of 13 November 2006, has also been incorporated in the new small business framework.

Fringe benefits tax

4.11 Giving STS taxpayers access to the FBT car parking exemption was announced in the 2006-07 Budget. This proposal has been incorporated into the new small business framework.

Pay as you go instalments

4.12 Giving STS taxpayers access to PAYG instalments based on GDP-adjusted notional tax was announced in the 2006-07 Budget. This proposal has been incorporated into the new small business framework.

Summary of new law

Goods and services tax

4.13 Under the new law, a small business entity will be eligible to adopt any of the GST-related small business concessions, providing they meet any additional specific criteria applying to the concessions.

4.14 The 'small business entity' criterion replaces the existing annual turnover criterion for entities that are carrying on a business. As a result, these entities will no longer need to work out their turnover one way for the purposes of the GST concessions and another way for the purposes of the income tax concessions.

4.15 The existing turnover test in the GST Act will continue to apply to entities that are carrying on an enterprise, but not a business.

Simplified tax system

4.16 The new law gives small business entities access to the concessions currently available to STS taxpayers, and gives them the choice to apply concessions without needing to lodge an election with the Australian Taxation Office. It is not compulsory for an entity to use any particular concessions as it was for some of the concessions available under the STS. The concessions that small business entities choose will be reflected in their tax returns and substantiated by their records.

4.17 The two-year amendment period applies to small business entities automatically.

Capital gains tax

4.18 Small business entities can access small business CGT concessions (provided they satisfy other relevant criteria). If the entity is not a small business entity, but the net value of its CGT assets is less than $6 million, it will also be able to access the CGT small business concessions. The same aggregation rules apply to the maximum net asset value test and the small business entity test (see Chapter 2).

Fringe benefits tax

4.19 Small business entities can access the FBT car parking exemption from 1 April 2007. The existing eligibility threshold for the FBT car parking exemption (ordinary income and statutory income of less than $10 million) will be retained as an alternative threshold for employers who are not small business entities.

Pay as you go instalments

4.20 Small business entities that are full self assessment taxpayers (typically companies and superannuation funds) will be eligible for the GDP-adjusted notional tax method for calculating instalment liabilities from the 2009-10 income year. From the 2007-08 income year full self assessment taxpayers can access the concession if they have base assessment instalment income (broadly, assessable instalment income in their latest income tax assessment) not exceeding $2 million.

Detailed explanation of new law

Changes to the GST concessions

4.21 Small business entities can access GST concessions subject to the entity meeting any additional criteria that apply to those concessions. [Schedule 2, items 8 to 11, 22 and 30, paragraphs 29-40(1)(a), 131-5(1)(a) and 162-5(1)(a), subsection 29-40(1) of the GST Act]

4.22 The GST concessions are:

•

accounting for GST on a cash basis;

•

annual apportionment of input tax credits for acquisitions and importations that are partly creditable; and

•

paying GST by quarterly instalments.

4.23 The Dictionary in the GST Act is updated to define a 'small business entity' by reference to section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997). [Schedule 2, item 59, section 195-1 of the GST Act]

4.24 An entity that is carrying on a business need not elect a concession for an income year as a whole. Rather, it can elect a concession at any time during an income year, subject to any due dates that currently exist - such as 28 October in the case of GST instalments. Existing provisions contained in the GST Act will dictate the date of effect of the election.

4.25 A choice or election made by a small business entity to adopt any of the small business concessions will cease to have effect if the entity is no longer a small business entity. Additionally, a choice or election made before 1 July 2007 by an entity that is carrying on a business on 1 July 2007 will cease to have effect if that entity is not a small business entity. The new rules governing the date of effect of a cessation are comparable to the existing rules. [Schedule 2, items 13, 14, 23 to 25, 29, 31 to 33 and 68 to 70, paragraphs 29-50(1)(a), 131-20(1)(c) and 162-30(1)(c), subsections 29-50(2), 131-20(5), 157-10(1) and 162-30(5) of the GST Act]

4.26 Entities that carry on an enterprise, but not a business, will continue to determine their eligibility for the concessions in the current manner. The rules governing the cessation of an election made by these entities remain the same. The threshold for accessing the GST cash accounting method is increased from $1 million to $2 million. [Schedule 2, items 9, 12 to 14, 22, 23, 26, 29 to 31, 34, 68 to 70, paragraphs 29-40(1)(a), 29-40(3)(a), 29-50(1)(a), 131-5(1)(a), 131-20(1)(c), 162-5(1)(a) and 162-30(1)(c), subsections 29-50(2), 131-20(6), 157-10(1) and 162-30(5) of the GST Act]

4.27 A note has been added to section 188-5 of the GST Act to specify that the turnover thresholds in the GST Act for cash accounting, annual apportionment and instalment only apply to entities that do not carry on a business. [Schedule 2, item 37, section 188-5 of the GST Act]

4.28 References to 'annual turnover' in the GST Act are replaced with 'GST turnover' to avoid confusion with the concept of 'annual turnover' used in the new small business framework. [Schedule 2, items 1 to 7, 16 to 21, 27, 28, 35, 36 and 38 to 58, paragraphs 23-5(b), 27-15(1)(a), 27-37(1)(a), 144-5(2)(a), 149-10(1)(b), 188-10(1)(a) and (b), 188-10(2)(a) and (b), subsections 23-10(1), 27-20(1), 27-22(1), 31-25(2), 33-10(2), 57-35(1), 83-25(1), 83-30(1), 84-5(2), 188-10(1) and (2), 188-15(1) to (3), 188-20(1) to (3), 188-24(1) and (2), and 188-40(1), sections 23-1, 188-1, 188-10, 188-15, 188-20, 188-22, 188-23, 188-25 and 195-1 of the GST Act; Schedule 2, items 61 to 65, paragraph 974-75(6)(b), subsections 974-75(7) and 995-1(1) of the ITAA 1997; Schedule 2, item 66, paragraphs 286-80(3)(c) and 286-80(4)(c) of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953 )]

4.29 A correction is made to the definition of 'turnover threshold' contained in section 195-1 of the GST Act. Previously this definition was incomplete, as it did not refer to the instalment and annual apportionment turnover thresholds. [Schedule 2, item 60, section 195-1 of the GST Act]

4.30 The rules regarding the Commissioner's obligation to revoke any permission for an entity to account for GST on a cash basis have been updated to reflect the new 'small business entity' concept. Under the new rules, the Commissioner must revoke any permission granted to a business entity allowing it to account for GST on a cash basis if the Commissioner is satisfied that the entity is not a small business entity and it is not appropriate to permit the entity to account on a cash basis. [Schedule 2, item 15, paragraph 29-50(3)(a) of the GST Act]

Giving small business entities access to the former STS concessions

4.31 The substance of the concessions currently available to STS taxpayers remain unchanged under the new small business framework.

4.32 However, minor amendments are required to:

•

allow small business entities to access the former STS concessions;

•

abolish the STS as a system, and relabel the STS concessions to make the terminology consistent with the new small business framework; and

•

provide that small business entities can choose to use only those concessions that suit their business needs.

[Schedule 3, items 1 to 78, 81 to 84, 87 to 96, 110 to 120, 149 to 159 and 162, subparagraphs 328-225(5)(a)(i) and (ii), paragraphs 104-235(4)(b), 328-170(b), 328-175(4)(a), 328-175(7)(a), 328-180(1)(a), 328-185(2)(a) and (b), 328-185(3)(a), 328-205(1)(a) and (c), 328-205(4)(b) and (c), 328-255(1)(a), 328-225(4)(a) and (b), 328-285(1)(a), 328-243(2)(b), 727-15(8)(a) and 727-470(2)(a), subsections 27-100(5), 40-25(1), 40-340(3), 40-425(7), 40-430(1), 70-5(3), 70-35(1), 70-40(1), 70-40(2 ), 70-45(2), 328-175(1), (3) and (4), 328-180(2), (3) and (5), 328-185(1) and (3) to (7), 328-190(1) to (4), 328-195(1) to (3), 328-205(1), (2) and (4), 328-210(1) and (3), 328-225(1) to (4), 328-235(1) and (2), 328-247(1) and (2), 328-250(3), 328-285(1), 328-295(1) and (2), 716-25(2), 727-470(2), 995-1(1), sections 13-1, 20-157, 328-5, 328-10, 328-170, 328-200, 328-220, 328-280, 328-285 and 727-100 of the ITAA 1997; Schedule 3, items 163 to 167, paragraphs 328-115(1)(a) and 328-115(2)(a), subsections 40-10(3) and 328-115(3) and (4) of the Income Tax (Transitional Provisions) Act 1997]

4.33 Certain provisions that are unnecessary as a result of one or more of the above changes are repealed. [Schedule 3, items 79 to 80, 85, 86 and 109, subsections 4-15(2), 328-285(1) and (2), section 328-290, Subdivisions 328-F and 328-G of the ITAA 1997]

What are the former STS concessions?

4.34 The former STS concessions available to small business entities under the new framework are:

•

the simplified depreciation regime that allows for depreciating assets costing less than $1,000 each to be written off immediately. Most other depreciating assets are pooled and enjoy an accelerated rate of depreciation;

•

the simplified trading stock regime that allows taxpayers not to account for changes in the value of trading stock or do stocktakes at the end of the income year; and

•

an immediate full deduction for certain pre-paid expenses, despite the prepayment rules that potentially apply where a taxpayer incurs expenditure for something to be done (in whole or in part) in a later income year. Where these rules apply, the deduction for the expenditure is spread over the period covered by those services, up to a maximum of 10 years.

4.35 As was the case with the STS, small business entities will generally have a two-year amendment period (instead of four years that applies to taxpayers with more complex tax affairs) during which the Commissioner can review and amend the entity's income tax assessment.

Changes to the CGT concessions

Small business entities can access small business CGT concessions

4.36 Small business entities can access the small business CGT concessions under Division 152 of the ITAA 1997, subject to satisfying the existing eligibility criteria for the concessions. If the entity does not satisfy the small business test, it may still access the small business CGT concessions if it satisfies the maximum net asset value test. [Schedule 4, items 1 to 3, paragraphs 152-5(a) and 152-10(1)(c), section 152-5 of the ITAA 1997]

4.37 Amendments are made to ensure that partners in partnerships that are small business entities can access small business CGT concessions subject to existing eligibility criteria. This change is needed because the small business entity test is intended to operate at the partnership level, whereas the CGT provisions are designed so that partners in partnerships access small business CGT concessions. In order for the CGT concessions to apply to the capital gain made on an asset, the asset must be an asset of the small business entity partnership. [Schedule 4, items 2 and 3, subparagraph 152-10(1)(c)(iii) and paragraph 152-5(a) of the ITAA 1997]

Increase in maximum net asset value test threshold

4.38 The threshold for the maximum net asset value test is raised from $5 million to $6 million. [Schedule 4, items 2, 4, and 22, 23 and 25, paragraphs 152-5(a) and 727-15(8)(b), subsections 165-115AA(1) and 165-115GC(4), section 152-15 of the ITAA 1997]

Applying the small business aggregation rules to the maximum net asset value test

4.39 The grouping rules that currently apply to the maximum net asset value test are repealed. The aggregation rules that apply to the small business entity test under this Bill will be used for entities seeking to determine whether they satisfy the maximum net asset value test. The definitions and labels that are currently used for the grouping rules for small business CGT concessions have been updated for the aggregation test.

4.40 The term 'small business CGT affiliate' is replaced with 'affiliate'. The term 'connected with' is retained, however the ITAA 1997 Dictionary is updated to link to the new definition in the aggregation rules under section 328-125. [Schedule 4, items 5 to 16 and 26, subparagraphs 152-20(2)(b)(i) and 152-40(1)(a)(ii), paragraphs 152-15(c), 152-20(2)(a) and (b), 152-20(3)(a), 152-20(2)(b) and 152-40(1)(b), subsections 152-20(4) and 995-1(1), sections 152-25 and 152-30 of the ITAA 1997]

4.41 The definitions of 'affiliate' and 'connected with' under the aggregation rules are also used for the active asset test for accessing small business CGT concessions. That is, an asset will be an active asset where it is owned by an entity, and used in the course of carrying on a business by one of the entity's affiliates, or an entity connected with the entity within the meaning of sections 328-130 and 328-125 respectively. Such an asset may be an intangible asset.

Spouses and children

4.42 The active asset test is an additional condition that must be satisfied in order for an entity to gain small business CGT concessions. The active asset test incorporated the concept of an 'affiliate'.

4.43 Under the current small business CGT concessions the definition of 'small business CGT affiliate' includes an entity's spouse or child under 18 years. The new definition of 'affiliate' will apply for the purposes of the active asset test, and does not provide for spouses and children under 18 years to be affiliates automatically.

4.44 To ensure that an asset does not lose active asset status as a result of the above amendments, an asset held by a spouse or child under 18 years is treated as an asset held by an affiliate for the purpose of the active asset test. [Schedule 4, items 19 and 20, subsections 152-40(1A) and (2) of the ITAA 1997]

Trusts with tax losses or no taxable income under the active asset test

4.45 Under the definition of 'connected with' in the current small business CGT concessions, an entity controls a discretionary trust where the trustee nominated the entity as a controller of the trust. In order for this rule to operate, a number of conditions needed to be satisfied:

•

the trust had a tax loss or no taxable income in the income year;

•

the trust made no distributions in that income year;

•

the beneficiary was one of not more than four beneficiaries so nominated; and

•

the nomination was in writing and signed by the trustee and beneficiaries.

4.46 The new definition of 'connected with' applying to the aggregation rules discussed in Chapter 2 does not allow a trustee to nominate a beneficiary in the way described above. As a consequence, without a special rule, the nomination would no longer be available for the purposes of the active asset test.

4.47 Amendments to the active asset test ensure that for the purposes of determining whether an entity is connected with another entity, in relation only to the active asset test, an entity is taken to control another entity where the entity is nominated as a controlling beneficiary. The other 'connected with' rules still apply. [Schedule 4, items 17, 18 and 21, subsection 152-40(1), section 152-42 of the ITAA 1997]

Changes to the FBT car parking exemption

4.48 Small business entities can access the FBT car parking exemption under section 58GA of the Fringe Benefits Tax Assessment Act 1986. This test will operate as an alternative to the $10 million ordinary and statutory income test that currently applies to the exemption. [Schedule 5, items 1 to 4, paragraphs 58GA(1)(d) and 58GA(2)(c), subsection 58GA(2) of the Fringe Benefits Tax Assessment Act 1986]

4.49 Subsection 58GA(3) of the Fringe Benefits Tax Assessment Act 1986 is amended to include a definition of 'small business entities'. [Schedule 5, item 5, subsection 58GA(3) of the Fringe Benefits Tax Assessment Act 1986]

Changes to the PAYG instalment concessions

4.50 Full self assessment taxpayers with a base assessment instalment income not exceeding $2 million are able to have their liability for PAYG instalments calculated under the GDP-adjusted notional tax method. [Schedule 6, items 2 and 3, subparagraphs 45-130(1)(b)(ii) and 45-130(1)(c)(i) of Schedule 1 to the TAA 1953]

4.51 Also, from the 2009-10 income year, full self assessment taxpayers that are small business entities will be able to have their liability for PAYG instalments calculated under the GDP-adjusted notional tax method. [Schedule 7, items 1 and 4 to 8, subsections 45-125(7) and 45-130(1) to (3) of Schedule 1 to the TAA 1953]

Application and transitional provisions

Goods and services tax

4.52 The changes to the GST Act apply in relation to net amounts for tax periods starting on or after 1 July 2007. Most of the consequential amendments to the ITAA 1997 that change the GST labels apply to the 2007-08 income year and later income years. The consequential amendments to the ITAA 1997 and the TAA 1953 that change the 'current annual turnover' label apply in relation to the year starting on 1 July 2007 and later years. [Schedule 2, Part 3]

Simplified taxation system

4.53 The changes to the ITAA 1997 relating to the STS concessions apply to assessments for the 2007-08 income year and later income years. [Schedule 3, Part 3]

Winding up a business an entity formerly carried on

4.54 Currently, an entity can continue to be treated as an STS taxpayer in an income year where they are winding up a business they previously carried on, if they were an STS taxpayer for the income year they stopped carrying on business.

4.55 Transitional provisions apply so that an entity that was an STS taxpayer in an income year before 2007-08 and stopped carrying on a business would be able to use the current STS concessions (ie, depreciating assets, trading stock, pre-paid expenses and amendment periods) in 2007-08 or a later income year when winding up the business. [Schedule 3, item 165, section 328-111 of the Income Tax (Transitional Provisions) Act 1997]

Control of a discretionary trust

4.56 Under the current STS grouping rules, an entity controls a non-fixed trust if in any of the previous four income years, the trustee of that trust made a distribution to the entity or its affiliates between them of an amount exceeding $100,000.

4.57 The aggregation rules apply a 40 per cent distribution test rather than a $100,000 test (see Chapter 2).

4.58 Consequently, an entity that had received a distribution of less than $100,000 but greater than 40 per cent of the total amount distributed would, in the absence of a special rule, be taken to control a discretionary trust for the purpose of accessing the former STS concessions where it had not been previously.

4.59 To prevent that result, a transitional provision applies for the former STS concessions so that an entity will not be grouped with a discretionary trust if, in any of the previous four income years, there was a distribution of greater than 40 per cent but less than $100,000. This transitional provision will only apply for distributions made before the 2007-08 income year. The provision will cease to have effect from the 2011-12 income year. [Schedule 3, item 165, section 328-112 of the Income Tax (Transitional Provisions) Act 1997]

Simplified depreciation concession

4.60 Assets that are currently in an STS pool - a general STS pool or a long life STS pool - continue to be subject to the pooling rules. To ensure continuity in the treatment of depreciating assets, a general STS pool or long life STS pool is treated as allocated to a general small business pool or long life small business pool respectively. The closing pool balance (with any required adjustments) of an STS pool is carried forward to become the opening pool balance of a small business pool. [Schedule 3, item 173, sections 328-185 and 328-195 of the Income Tax (Transitional Provisions) Act 1997]

Five-year re-entry restriction

4.61 The current law contains a rule that if you choose to stop being an STS taxpayer you cannot again become an STS taxpayer until at least five years after the income year you left the STS (subsection 328-440(3) of the ITAA 1997).

4.62 This notion will be retained for the simplified depreciation concession only. The new rule is that if the entity chooses to stop using the simplified depreciation concession it cannot again choose to use that concession until at least five years after the income year in which it chose to stop using that concession. [Schedule 3, item 12, section 328-175 of the ITAA 1997; Schedule 3, item 174, section 328-440 of the Income Tax (Transitional Provisions) Act 1997]

Example 4.1

In the 2007-08 income year, Daryl was a small business entity and used the simplified depreciation concession. In the 2008-09 income year he decides to cease using the concession.

Daryl will not be able to use the simplified depreciation concession until 2014-15 income year. He will need to be a small business entity in that income year to access the concession.

STS accounting method

4.63 Before 1 July 2005 STS taxpayers were required to use the STS accounting method (generally referred to as a cash basis of accounting). This was removed from the STS from 1 July 2005 and STS taxpayers have since been able to calculate their taxable income using the most appropriate method for their circumstances. If an entity was an STS taxpayer for the most recent income year starting before 1 July 2005, it could continue to use the STS accounting method.

4.64 Existing provisions ensure that if a business decided to stop using the STS accounting method, or was no longer eligible for the STS, business income and expenses that have not previously been accounted for (because they had not been received or paid) would be accounted for in the year the business changed its accounting method (see Division 328 of the Income Tax (Transitional Provisions) Act 1997).

4.65 This transitional provision will be carried into the new small business framework to ensure that a taxpayer can continue using the STS accounting method if it:

•

was in the STS in the 2006-07 income year;

•

was using the STS accounting method continuously since before 1 July 2005; and

•

is a small business entity from the 2007-08 income year.

[Schedule 3, items 168, 170 and 172, subsections 328-115(3) and (4), section 328-120 of the Income Tax (Transitional Provisions) Act 1997]

4.66 A taxpayer can continue using the STS accounting method until it chooses not to, or is no longer a small business entity.

Capital gains tax

4.67 The amendments to the ITAA 1997 relating to the small business CGT concessions apply to CGT events happening in the 2007-08 income year and later years.

Indirect value shifting

4.68 Under the current law, an interest will not be considered to be an affected interest for the purposes of the indirect value shifting regime if the owner of the interest is an STS taxpayer immediately before the commencement of an indirect value shifting scheme.

4.69 A transitional provision ensures that an interest will continue to not be an affected interest if its owner would have been an STS taxpayer at the time of the commencement of an indirect value shifting scheme, and that time of commencement was before the start of the 2007-08 income year had the provisions regarding the STS not been repealed. [Schedule 3, item 175, section 727-470 of the Income Tax (Transitional Provisions) Act 1997]

Fringe benefits tax

4.70 The amendments to the Fringe Benefits Tax Assessment Act 1986 apply to the FBT year starting on 1 April 2007 and later FBT years.

4.71 Transitional rules apply so that the FBT car parking exemption can apply to an employer that would have been a small business entity in an earlier income year (2005-06 or 2006-07), if the small business entity rules had applied in that year. This overcomes a potential technical problem arising from the small business entity rules applying from the 2007-08 income year. [Schedule 5, item 7]

PAYG instalments

4.72 The increase from $1 million to $2 million in the base assessment instalment income threshold for full self assessment taxpayers accessing PAYG instalments based on GDP-adjusted notional tax will apply to the 2007-08 income year and later income years. Full self assessment taxpayers who are small business entities will be able to access the PAYG instalments based on GDP-adjusted notional tax from the 2009-10 income year and later income years. [Schedule 6, items 1 and 4 to 8, subsections 45-125(7) and 45-130(1) to (3) of Schedule 1 of the TAA 1953]

Wine equalisation tax

4.73 The consequential amendments to the A New Tax System (Wine Equalisation Tax) Act 1999 apply in relation to producer rebates for the 2007-08 financial year and later financial years.

Consequential amendments

4.74 There is a definition of 'small business taxpayer' (and associated definitions) in the ITAA 1997 which only applies to some transitional rules. These definitions have been removed to avoid confusion with the new definition of 'small business entity'. To the extent necessary the definitions are retained in the Income Tax (Transitional Provisions) Act 1997. [Schedule 8, items 1 to 8, subsection 82KZL(1) of the Income Tax Assessment Act 1936 (ITAA 1936), Subdivision 960-Q and subsection 995-1(1) of the ITAA 1997 and section 40-340 of the Income Tax (Transitional Provisions) Act 1997]

Simplified tax system

4.75 The definition and references to STS taxpayer and associated concepts for the prepayment concession and two-year amendment period in the ITAA 1936 are repealed and amended so that small business entities can choose to access the prepayment concession and have two-year amendment periods. [Schedule 3, items 97 to 108, subsections 6(1), 82KZL(1), 170(1) and (14), section 82KZMD, paragraphs 73BA(4)(a) and 82KZMA(2)(b), subparagraph 82KZM(1)(aa)(i) of the ITAA 1936]

4.76 The entrepreneur's tax offset uses turnover definitions based on the STS definitions, which are repealed and replaced with the corresponding turnover concepts discussed in Chapter 2. References to the STS are repealed and amended so that small business entities may be eligible for the entrepreneur's tax offset. [Schedule 3, items 121 to 148, 160 and 161, sections 61-500 and 61-525, subsections 61-505(2), 61-510(2), 61-515(2) and 61-520(2), paragraphs 61-505(1)(b) to (d), 61-510(1)(b), (c) to (e), 61-515(1)(b) to (e) and 61-520(1)(b), (c) to (e) and subsection 995-1(1) of the ITAA 1997]

Capital gains tax

4.77 Consequential amendments are made to an example in the ITAA 1997 to link it to the new definition of 'connected with' under section 328-125 that applies for CGT events. [Schedule 4, items 29 and 30, subsections 104-197(2) and 152-305(3) of the ITAA 1997]

4.78 Entities of the type listed in subsection 328-125(8) cannot disregard a capital gain under the small business retirement exemption. The entities referred to are discussed in Chapter 2. [Schedule 4, item 30, subsection 152-305(3) of the ITAA 1997]

Wine equalisation tax

4.79 The wine producers' rebate provides wine producers with a rebate of up to $500,000 per wine producer or wine producer group. A wine producer group comprises a wine producer and any associated producers.

4.80 A producer is considered to be an associated producer if they are 'connected with' the other producer within the meaning of the current CGT grouping rules. As the definition of 'connected with' is moving from Division 152 to Division 328 of the ITAA 1997, the provisions in the A New Tax System (Wine Equalisation Tax) Act 1999 need to be updated to reflect the changed location of the definition. [Schedule 4, item 28, section 33-1 of the A New Tax System (Wine Equalisation Tax) Act 1999]

4.81 Also, the existing A New Tax System (Wine Equalisation Tax) Act 1999 provisions exclude the operation of the public entity exception to the indirect control of entities rule currently under subsection 152-30(8). This exclusion will continue under the new law. [Schedule 4, item 27, paragraph 19-20(1)(a) of the A New Tax System (Wine Equalisation Tax) Act 1999]

Index

Schedule 1: Small business entities

Schedule 2: Amendments relating to GST turnover thresholds

Schedule 3: STS taxpayers

Schedule 4: Capital gains tax small business concessions

Schedule 5: Fringe benefits tax: car parking exemption

Schedule 6: PAYG instalments

Schedule 7: Roll-over relief

Schedule 8: Miscellaneous amendments