Simplified tax system - a guide for tax agents and small businesses (current to 30 June 2007)

Important information

This document has been archived. It is current only to 30 June 2007.

The simplified tax system (STS) no longer operates for the 2007-08 and later income years, and has been replaced by the small business entity provisions. You can continue to use the concessions that were in the STS if you are a small business entity. Visit www.ato.gov.au/SBconcessions for more information.

Introduction

Chapter 1

The simplified tax system (STS) is a package of measures aimed at reducing the compliance costs faced by eligible small businesses. It provides an alternative method of determining taxable income.

The STS is an optional system that began on 1 July 2001.

If you are eligible and elect to enter the STS, you will be known as an STS taxpayer.

While most eligible businesses will benefit from using the STS, as it helps reduce compliance costs, not every eligible business will benefit.

To help you make the decision about whether to use the STS, we have developed an interactive electronic product STS - is it for you? You can also phone 1300 139 051 to order a free CD (ask for NAT 3043).

Other references Division 328 of the Income Tax Assessment Act 1997 Tax Laws Amendment (2004 Measures No. 7) Act 2005

Main elements

As an alternative method of determining taxable income, the STS has two key features:

• simplified capital allowances (depreciation), and
• simplified treatment of trading stock.

As an STS taxpayer you must use both elements where they apply. Where you have both business and non-business income (for example, salary and wages), the STS depreciation rules may also apply to your non-business assets.

Simplified capital allowances (depreciation) rules

Under the STS capital allowances (depreciation) rules:

• most depreciating assets costing less than $1,000 each can be written off immediately
• most other depreciating assets with an effective life of less than 25 years are pooled in a general STS pool and deducted at 30%
• most other depreciating assets with an effective life of 25 years or more are pooled in a long life STS pool and deducted at 5%, and
• most newly acquired assets are deducted at either 15% or 2.5% in the first year, regardless of when they were acquired during that year.

(see Chapter 5)

Simplified trading stock rules

As an STS taxpayer you do not have to account for changes in the value of your trading stock or do stocktakes for tax purposes where the difference between the value of your opening stock and a reasonable estimate of your closing stock is $5,000 or less.

(see Chapter 8)

Prepaid expenses

In addition, as an STS taxpayer you can claim an immediate deduction for certain prepaid business expenses, such as subscriptions to professional associations, rent or insurance payments, that satisfy the 12-month rule.

(see Chapter 7)

Extending the STS

The operation of the STS and the amount of tax payable by certain small businesses in the STS has been affected by changes to the law that apply to the first income year beginning on or after 1 July 2005.

The two main changes are:

• the removal of the previous requirement that an STS taxpayer must use the STS accounting method, and
• the introduction of a 25% entrepreneurs' tax offset.

Change to STS accounting method

When the STS began on 1 July 2001 an STS taxpayer was only required to account for most business income when it was received, and most business expenses when they were paid. This is referred to as the STS accounting method.

From the first income year starting on or after 1 July 2005, you are no longer required to use the STS accounting method. However, if you were an STS taxpayer in the income year that started immediately prior to 1 July 2005, then while you continue to be an STS taxpayer (from the first income year that starts on or after 1 July 2005), you can continue to use the STS accounting method.

If you choose not to continue using the STS accounting method, you will be able to calculate your taxable income using either:

• the accruals (earnings) method, that is ordinary income is recognised when it is derived and general deductions are recognised when they are incurred, or
• the cash (receipts) method, that is ordinary income is recognised when it is received and general deductions are recognised when they are paid, or alternatively, when incurred,

whichever is the most appropriate method for your circumstances.

Where you choose not to continue using the STS accounting method, business income and expenses that have not been accounted for (because they have not been received or paid) will be accounted for in the year you change to the accruals or cash method.

(see Chapter 6)

The 25% entrepreneurs' tax offset

Small businesses in the STS which have an annual group turnover of $50,000 or less will be eligible for a tax offset of 25% of their income tax liability in respect of their business income. The tax offset will progressively phase-out when the annual group turnover is between $50,000 and $75,000.

(see Chapter 10)

Modification to the five year re-entry restriction

If you had previously elected to leave the STS in an income year beginning before 1 July 2005, then you may re-enter the STS in an income year that starts on or after 1 July 2005 for up to five years after the income year that you left the STS (the five year re-entry restriction rule has been suspended for five years from 1 July 2005).

(see Exiting the STS)

Extension of roll-over relief for depreciating assets

The roll-over relief available under the STS has been extended to ensure that the optional roll-over relief available for partnerships under the uniform capital allowances regime is also available in relation to depreciating assets allocated to STS pools. This will ensure that a taxable gain or loss will only arise upon disposal of the depreciating assets. For most taxpayers the extended roll-over relief will apply for the 2005-06 and later income years.

(see Roll-over relief: extension)

Review of assessments

If you are an STS taxpayer, the Commissioner's power to review and amend your income tax assessments has generally been reduced from four years to two years for the 2004-05 and later income years. This change will provide you with more certainty as your tax affairs for a particular income year will generally be finalised two years after the Commissioner issues a notice of assessment for that income year. There are some exclusions from this shorter period of review, including where there has been fraud or evasion.

More information about periods of review and record keeping requirements is available on the corporate section of this website (see Review of your assessment and record keeping).

Eligibility

The STS is designed specifically to benefit the small business sector. To enter the STS you must meet the eligibility requirements.

Broadly, you are eligible to enter the STS in an income year if you:

• carry on a business in that year
• have an STS average turnover of less than $1 million, and
• have depreciating assets with an adjustable value of less than $3 million at the end of that year.

(see Chapter 2)

Proposed changes to the STS In the 2006-07 Federal Budget the Government announced further changes to the STS which will apply from the start of the 2007-08 income year. These proposed changes will increase the STS annual turnover threshold to $2 million and remove the $3 million depreciating asset test from the STS eligibility requirements.

You can also use the interactive electronic tool STS - is it for you? to help assess your eligibility. The tool helps you to decide whether you will benefit from using the STS, as not all eligible businesses will benefit.

The STS has grouping rules to ensure that larger businesses cannot access the benefits of the STS by dividing into a number of smaller businesses. If you are grouped with other entities, when working out your eligibility you must:

• include the turnover of those other entities in calculating your STS average turnover, and
• take into account the adjustable value of the depreciating assets held by those other entities in determining whether the depreciating assets requirement is met.

See Chapter 9 for more information about the grouping rules.

Potential benefits

The benefits of the STS for your business may include:

• an immediate write-off for most assets costing less than $1,000 each
• more generous, simpler depreciation for many assets
• relieving you of the need to perform stocktakes and account for trading stock each year
• an immediate deduction for your business expenses paid up to 12 months in advance
• the 25% entrepreneurs' tax offset, and
• a shorter period during which the Tax Office can review and adjust tax assessments for the 2004-05 and later income years.

You should also work out whether the STS will benefit you given your particular circumstances.

Chapter 4 looks at the main differences between the income tax treatment of STS taxpayers and non-STS taxpayers.

Record keeping

As an STS taxpayer, you must keep certain records for income tax purposes for five years after they are prepared, obtained or the transactions are completed. These records include:

• receipts for sales, including records of sales, cash register (till) Z-totals, deposit books and bank statements
• records of purchases and other expenses, including expense payment records, invoices and statements for purchases, receipts from small cash purchases, cheque butts and a log book for car expenses
• GST records: tax invoices, adjustment notes, written agreements or contracts, Business activity statements and the annual GST information report, or GST annual return
• wages records, including worker payment records, current employment declarations, tax file number declarations, withholding declarations, and superannuation records
• records of amounts withheld from payments where no Australian business number was quoted
• year-end records, such as stocktake sheets, or a record of the taxpayer's reasonable estimate and how that estimate was made
• records of assets that may be subject to capital gains tax (these need to be kept for five years after the sale of the assets), and
• records relating to pool calculations - opening pool balance, change in taxable purpose proportion, disposals.

You must keep the following records for at least one month if reconciled with the actual sales, or five years if not reconciled:

• receipts for supplies/sales, including credit card dockets (merchant's copy) and cash register tapes.

Eligibility

Chapter 2

This chapter explains the three requirements that you must satisfy to be eligible to be an STS taxpayer for an income year.

Eligibility requirements

To be eligible to be an STS taxpayer for an income year, you must satisfy three requirements. You must:

• carry on a business in that year
• have an STS average turnover for that year of less than $1 million (including the turnover of any entities that you are grouped with), and
• together with any grouped entities, hold depreciating assets with a total adjustable value at the end of the year of less than $3 million.

You must review your eligibility each year.

See Proposed changes to the STS

More about grouping Chapter 9 - STS grouping rules Subdivision 328-F of the Income Tax Assessment Act 1997 - Entities eligible to be STS taxpayers

Carrying on a business

The first eligibility requirement you must satisfy is that you carry on a business for part or all of the income year.

The following factors, or 'business indicators', provide general guidance on what has been taken into account by various courts and tribunals in determining if a business exists for tax purposes.

Whether the activity is better described as a hobby, recreation or sporting activity

If the manner in which you undertake an activity shows that it is more properly considered a hobby, recreation or sporting activity, then it will not constitute a business. However, a hobby may turn into a business.

Whether the activity has a significant commercial purpose or character

It is important to consider whether the activity is carried on for commercial reasons and in a commercially viable manner.

Whether there is more than just an intention to engage in business

You need to have made a decision to begin business and have done something about it, rather than just having an idea that you will do so sometime in the future. If you are still setting up or preparing to go into business, you might not have actually begun business yet.

Whether there is a purpose of profit as well as a prospect of profit

It is relevant whether you have an intention to make a profit or a genuine belief that a profit will be made. It is important that you are able to show how the activity can make a profit, even if it does not make a profit in the short term.

Whether there is repetition and regularity to the activity

While one-off transactions can constitute a business in some cases, it is often a feature of a business that similar sorts of activities are repeated on a regular basis. It is important to consider whether you undertake at least a minimum level of activities appropriate to your industry.

Whether the activity is of the same kind, and carried on in a similar manner, to businesses in the industry

It is relevant whether the manner of operation is consistent with industry norms or with businesses in the same field.

Whether the activity is planned, organised and carried on in a business-like manner

These indicators could include:

• business records and books of accounts
• business premises
• licences or qualifications, and
• a registered business name (having a registered business name is not compulsory for tax purposes and does not necessarily mean you are in business).

The size, scale and permanency of the activity

It is more likely that the activity constitutes a business if the size and scale of the activity is:

• consistent with businesses in the same field or with industry norms, and
• sufficient to allow a taxpayer to make a profit, even if not in the short term.

Partnership carrying on STS business

In accordance with general income tax principles, a business partnership is treated as the relevant entity for STS eligibility purposes, not the partners of the partnership. Consequently, the partnership is viewed as the entity that carries on the STS business.

More about what constitutes carrying on a business Am I in business? (NAT 2598) Taxation Ruling TR 97/11 - Income tax: am I carrying on a business of primary production? (The examples used in this ruling relate to primary production activities but the principles can be applied to other activities.)

STS average turnover of less than $1 million

The second eligibility requirement you must satisfy is that you have an STS average turnover for the year of less than $1 million. STS average turnover is the average of a taxpayer's STS group turnovers over a number of years.

STS group turnover

STS group turnover is used to describe the turnover of an entity for STS purposes, whether it is a single entity or grouped with other entities.

Your STS group turnover for a given year is:

• the value of the business supplies made by you during that year, plus
• the value of the business supplies made during that year by any other entities grouped with you under the STS grouping rules.

Group turnover does not include any business supplies made between you and the entities you are grouped with.

If you are not grouped with any other entity, your STS group turnover is simply the value of the business supplies made by you during the year.

The value of business supplies means the value of supplies made in the ordinary course of carrying on a business. For supplies that do not attract GST, the value is simply the price. For supplies that do attract GST, the value is the price less the GST component.

If you sell retail fuel (typically as a service station operator), your STS group turnover for an income year is reduced by the value of business supplies that relates to the supply of retail fuel.

STS group turnover includes amounts such as:

• payments for goods or services supplied
• professional fees
• commissions
• interest received on amounts deposited in business banking accounts, and
• holding or security deposits forfeited by customers.

It excludes amounts such as:

• rental income where rental activities do not form an ordinary part of the business
• amounts resulting from realisation of an investment (such as the proceeds from the sale of a capital asset used in the business)
• payments received under an insurance recovery, and
• the principal component of a loan repayment.

More about group turnover for fuel retailers Simplified tax system: fuel retailers and STS group turnover (NAT 9396)

Calculating STS average turnover

Depending on your circumstances, you calculate your STS average turnover using one of two methods:

• the look back method - using actual turnover from previous years, or
• the look forward method - estimating future turnover.

	Look back method	Look forward method
A business that has been carried on in the current and previous years	Yes	Available only where the STS average turnover is $1 million or more using the look back method
A business that started in the current year	No	Yes

Look back method of calculating STS turnover

Most taxpayers will calculate their STS average turnover using the look back method.

Under this method, your STS average turnover in a particular year is the average of your STS group turnovers for any three out of the previous four income years (excluding the current year).

Business carried on for less than four years

If you have not carried on a business for all of the previous four years, you work out the average of your STS group turnovers for those years that you have been in business.

Example: Look back method
Greg is carrying on a business. He is not grouped with any other entities. He wants to enter the STS for the 2002-03 income year. Greg must work out his STS average turnover for that year.
The STS group turnovers of his business for the past four income years are:
1998-99	$900,000
1999-2000	$950,000
2000-01	$1,300,000
2001-02	$910,000
Greg has to include the STS group turnovers for only three of the previous four years. He can ignore the highest amount, which is his STS group turnover for the 2000-01 year.
Greg's STS average turnover for the 2002-03 income year is:
$900,000 + $950,000 + $910,000 3
= $920,000

Example: Fuel retailer business
Joe and Domenico operate a service station in partnership. Besides selling fuel, the partnership also sells grocery items and has an on-site workshop for mechanical repairs. The partnership wants to enter the STS for the 2002-03 income year. It is not grouped with any other businesses. The STS group turnovers for the last four years are:
	Total sales	Less fuel sales	STS group turnover
1998-99	$3,850,000	$3,200,000	$650,000
1999-2000	$2,900,000	$2,500,000	$400,000
2000-01	$2,350,000	$2,000,000	$350,000
2001-02	$4,100,000	$3,500,000	$600,000
Using the look back method, the partnership's STS average turnover for the 2002-03 income year is: $400,000 + $350,000 + $600,000 3 = $450,000

Example: Business carried on for less than four years
Carol's business started on 1 July 2000. She wants to become an STS taxpayer for the 2002-03 income year. Carol must calculate her STS average turnover for that year. She is not grouped with any other entities.
The STS group turnovers of her business for the two years that she has been in business are:
2000-01	$976,000
2001-02	$1,010,000
Using the look back method, Carol 's STS average turnover for the 2002-03 income year is:
$976,000 + $1,010,000 2
= $993,000

Business carried on for only part of a year

If the business has been carried on for only part of a year, you must use a reasonable estimate of what your STS group turnover for that year would have been if you had been in business for the whole year.

Example: Business carried on for only part of a year

Continuing the previous example, if Carol's business had started on 1 February 2001, she would need to make a reasonable estimate of her STS group turnover for the 2000-01 year.

She considers that a reasonable estimate of her STS group turnover for the whole of 2000-01 can be made on the basis of her STS group turnover for the five months she was in business.

There are no seasonal or other factors to suggest the five months are not representative of the full year's turnover.

Her total STS group turnover for that period is $400,000. Her average monthly turnover is:

$400,000 5

= $80,000

Carol's reasonable estimate of her STS group turnover for 2000-01 is:

$80,000 x 12

= $960,000

Using the look back method, Carol's STS average turnover for the 2002-03 income year is:

$960,000 + $1,010,000 2

= $985,000

Look forward method of calculating STS turnover

You can only use the look forward method of calculating STS average turnover if you:

• have an STS average turnover of $1 million or more under the look back method, or
• started your business in the current year.

Using this method, your STS average turnover is the average of the reasonable estimates of your STS group turnovers for the current year and the following two years.

Where the STS group turnover for the current year is known, you can use the average of that figure and the reasonable estimates of STS group turnover for the following two years.

Example: Look forward method
William wants to enter the STS in the 2002-03 income year. His business comprises two hardware shops. His STS group turnover is $1.2 million for 2002-03 and exceeded $1 million in each of the past four years. William's STS average turnover using the look back method would be greater than $1 million, so he can use the look forward method to work out his STS average turnover for 2002-03. In July 2003 William sells one of his shops. He estimates that his turnover will reduce by 50% as a result. William's STS group turnover for 2002-03 and his estimate for the next two years are:
2002-03 (current year)	$1,200,000
2003-04 estimate	$600,000
2004-05 estimate	$600,000
Using the look forward method, his STS average turnover for the 2002-03 income year is: $1,200,000 + $600,000 + $600,000 3 = $800,000

Example: Business started in current year
Derrick started his business in January 2003. He is not grouped with any other entities. He wants to become an STS taxpayer for the 2002-03 income year, so he must calculate his STS average turnover for that year. Derrick started to carry on his business in the current year, so he must use the look forward method to calculate his STS average turnover. Derrick's STS group turnover for the six months to 30 June 2003 is $400,000. His reasonable estimate of his STS group turnover for the whole year is $800,000.
Using his business plan and projections, his reasonable estimates of his STS group turnovers for the next two years are:
2003-04	$900,000
2004-05	$1,000,000
Using the look forward method, Derrick's STS average turnover for the 2002-03 income year is: $800,000 + $900,000 + $1,000,000 3 = $900,000

Making a reasonable estimate of STS group turnover

To make a reasonable estimate of STS group turnover for a year, you should estimate the value of business supplies likely to be made by you, and any entities you are grouped with, in the ordinary course of business in that year.

Factors that may be relevant to making this estimate include:

• the type of business activity undertaken, considering the nature and type of turnover of similar businesses in that industry
• any orders placed and/or forward contracts entered into, and
• the current scale of the activity and investment in the activity.

More about STS average turnover Taxation Ruling TR 2002/11 - Income tax: Simplified Tax System eligibility - STS average turnover

Depreciating assets with a total adjustable value of less than $3 million

The third eligibility requirement you must satisfy to be eligible to be an STS taxpayer in an income year is that you, together with any entities you are grouped with, have depreciating assets with a total adjustable value of less than $3 million at the end of that year.

Broadly, the adjustable value of an asset is its cost less its decline in value since it was first used, or installed ready for use, for any purpose whether business or private. It is the adjustable value of the asset at the end of the year of income that is relevant in determining your eligibility.

Once you are in the STS you must review your eligibility each year.

You must add:

• the total of the closing pool balances to
• the total of the adjustable values of any non-pooled depreciating assets at the end of that year.

You must also include the values of the depreciating assets of any entities you are grouped with.

Land is excluded as it is not a depreciating asset.

Most buildings are also excluded when determining whether you meet this requirement. For example, income producing buildings that are deductible at the rate of 2.5% or 4% under Division 43 of the ITAA 1997 ('Deductions for capital works') are excluded.

See Chapter 5 - STS depreciation rules for more information.

Entry and exit

Chapter 3

If you are subject to the alienation of personal services income, or non-commercial business losses provisions, you can enter the STS provided you meet all three eligibility requirements.

Entering the STS

If you are eligible and choose to enter the STS, you must make an election to become an STS taxpayer. This is done by completing the STS election boxes on your income tax return for the year that you choose to enter the STS.

When you choose to enter the STS for a particular income year, you are treated as an STS taxpayer for the whole of that year.

As an STS taxpayer, you must review your eligibility each income year.

Exiting the STS

There are two ways that you can exit the STS.

• You can choose to exit the STS in any year. However, if you choose to exit you cannot re-enter the STS for at least five years after the year in which you chose to exit.
• You must exit the STS if you do not satisfy all three eligibility requirements in a particular year. If you exit the STS because you are no longer eligible you may re-enter in the year in which you again become eligible.

See below for information about a modification to the re-entry restriction

Where you leave the STS in a particular year, either by choice or because the eligibility requirements are not satisfied, you are treated as a non-STS taxpayer for the whole of that year. You must indicate that you are exiting the STS in the income tax return for that year.

Modification to the five year re-entry restriction

Where you choose to leave the STS, you cannot re-enter for at least five years after the income year in which you left the STS.

However, transitional provisions suspend this rule from 1 July 2005 for five years if you had exited the STS prior to 1 July 2005.

This means that if you had exited the STS before 1 July 2005 you will be able to re-enter the STS from 1 July 2005 without having to wait five years.

The five year re-entry restriction will recommence from 1 July 2005 if you choose to exit the STS after this date.

More about entry and exit Taxation Determination TD 2003/29 - Income tax: Simplified Tax System: can an entity that has notified the Commissioner of its choice to stop being an STS taxpayer for an income year, later cancel that choice for that year? Taxation Determination TD 2003/30 - Income tax: Simplified Tax System: can an entity that has notified the Commissioner of its choice to become an STS taxpayer for an income year later revoke that choice in respect of that year? Taxation Determination TD 2003/31 - Income tax: Simplified Tax System: can an entity notify the Commissioner of its choice to become, or stop being, an STS taxpayer for an income year, after it has lodged that year's income tax return?

Comparison of STS with non-STS treatment

Chapter 4

This chapter provides an overview of the main differences between the income tax treatment of STS and non-STS taxpayers.

	STS taxpayer	Non-STS taxpayer
	An STS taxpayer is a taxpayer that is eligible and elects to enter the STS.	A non-STS taxpayer is a taxpayer that carries on a business but has not yet entered the STS.
Capital allowances (depreciation) See Chapter 5 for more information.

'Assets' mean depreciating assets. The rules about capital allowances for non-STS taxpayers have also changed from 1 July 2001.

Low-cost assets (generally assets acquired on or after 1 July 2001 costing less than $1,000)	most are eligible for an immediate deduction for the taxable purpose (eg business use) proportion of the cost of the asset See Chapter 5 for more information.	no immediate deduction for assets used in the business (including assets costing less than $300) but a deduction is allowable for certain tangible assets costing $100 or less Either: allocate to a low-value pool and deduct at 37.5%, or at half the pool rate (18.75%) in first year regardless of when during the year the asset is first used or installed ready for use, or calculate deduction for each asset based on effective life
Assets with effective life of less than 25 years	allocate most to a general STS pool pool treated as a single asset - no need to do separate calculations for each asset deduction calculated at the rate of 30% See Chapter 5 for more information.	do separate calculations for each asset deduction calculated for each asset based on the asset's effective life
Assets with effective life of 25 years or more	allocate most to a long life STS pool pool is treated as a single asset deduction calculated at rate of 5% See Chapter 5 for more information.	do separate calculations for each asset deduction calculated for each asset based on the asset's effective life
Assets acquired during an income year	deducted at half the pool rate (either 15% or 2.5%) regardless of when during the year the asset is first used or installed ready for use	must calculate the deduction on a pro-rata basis, based on the date the asset was first used or installed ready for use (unless allocated to low-value pool or an immediate deduction is available)
Primary producers	primary producers can choose between the specific primary producer provisions and the STS provisions for some assets once a choice is made in respect of an asset, it cannot be changed deductions for other assets based on effective life See Exclusions and options for more information.	there are specific primary producer provisions that apply to some assets and they must be used where they apply deductions for other assets based on effective life
Disposals	pooled asset - relevant pool balance is reduced by the taxable purpose proportion of the termination value low-cost asset - taxable purpose proportion of the termination value is included in assessable income See Disposals for more information.	an amount based on the taxable purpose (eg business use) proportion of the termination value and the adjustable value of the asset is an assessable or deductible balancing adjustment amount
Capital gains tax	no capital gain or loss taken into account in determining taxable income where the asset was deducted under the STS depreciation rules	capital gain or loss arises if an asset is used to any extent for a non-taxable purpose

More about assets costing $100 or less purchased by a non-STS taxpayer ATO Practice Statement Law Administration PS LA 2003/8: Taxation treatment of expenditure on low cost items for taxpayers carrying on a business.

Accounting See Chapter 6 for more information.	STS taxpayer	Non-STS taxpayer
Accounting method, debtors and creditors	Prior to 1 July 2005 - must use the STS accounting method. Must include most business income in assessable income when received and deduct most business expenses when paid. from 1 July 2005, depending on circumstances, use either STS accounting method, accruals method or cash method the requirement that an STS taxpayer must use the STS accounting method was removed as from 1 July 2005. See Accounting methods for STS taxpayers for more information.	depending on circumstances use either accruals or cash method must include business income in assessable income when derived (which may be before it is received) and deduct business expenses when incurred, or alternatively, when paid

Prepaid expenses	STS taxpayer	Non-STS taxpayer
Prepaid expenses See Chapter 7 for more information.	immediate deduction where: the payment is made for a period of service of 12 months or less, and the period of service ends in the next income year See Prepaid expenses for more information.	no immediate deduction for prepaid business expenses must apportion the expense over the period of service transitional rules may apply

Trading stock	STS taxpayer	Non-STS taxpayer
Trading stock See Chapter 8 for more information.	not required to account for changes in value of trading stock or do a stocktake unless the difference between the value of opening stock and a reasonable estimate of closing stock is more than $5,000 can choose to account for the difference where it is $5,000 or less but must accurately determine the value of trading stock at the end of every income year, usually by carrying out a stocktake See STS trading stock rules for more information.	must account for changes in the value of trading stock must accurately determine the value of trading stock at the end of every income year, usually by carrying out a stocktake

25% Entrepreneurs' tax offset	STS taxpayer	Non-STS taxpayer
25% Entrepreneurs' tax offset See Chapter 10 for more information.	from 1 July 2005, a 25% tax offset on the income tax liability attributable to business income for an STS taxpayer that has an annual turnover of $50,000 or less where STS turnover is greater than $50,000 the offset will be progressively phased out between $50,000 and $75,000	no equivalent

STS capital allowances (depreciation) rules

Chapter 5

This chapter explains the depreciation rules for STS taxpayers.

As an STS taxpayer, if you have non-business income, such as salary and wages, you can also claim a deduction for depreciating assets used in earning your employment income under the STS depreciation rules.

In general, most:

• depreciating assets costing less than $1,000 each can be written off immediately
• other depreciating assets with an effective life of less than 25 years, such as motor vehicles and computers, are pooled in a general STS pool and deducted at the rate of 30%
• depreciating assets with an effective life of 25 years or more, such as wharves and cement silos, are pooled in a long life STS pool and deducted at the rate of 5%, and
• newly acquired assets are deducted at either 15% or 2.5% in the first year, regardless of when they were acquired during that year.

Some assets are excluded from these rules.

Where you are entitled to claim a GST credit for a depreciating asset, the amount of the GST credit that you can claim must be deducted from the asset's adjustable value before calculating the deduction for depreciation.

This chapter includes a series of examples based on a business called Fi's Flowers, showing how the STS capital allowances (depreciation) rules apply in practice.

The examples in this chapter use GST-exclusive figures.

Other references Subdivision 328-D of the Income Tax Assessment Act 1997 - Capital allowances for STS taxpayers Taxation Ruling TR 2000/18 (including addenda) - Income tax: depreciation effective life Guide to depreciating assets (NAT 1996)

Low-cost assets

A low-cost asset is one whose cost at the end of the year in which it was first used or installed ready for use for a taxable purpose is less than $1,000 (excluding horticultural plants).

As an STS taxpayer, you can claim an immediate deduction for low-cost assets in the income year that those assets are first used, or installed ready for use, for a taxable purpose. An asset is used for a taxable purpose if it is used to produce assessable income. However, the immediate deduction is only available if the asset is acquired during a year in which the taxpayer is in the STS.

The deduction is calculated as follows:

asset's adjustable value x taxable purpose proportion

Broadly, the adjustable value of an asset is its cost less its decline in value since it was first used, or installed ready for use, for any purpose whether business or private. Cost excludes any amount that you are entitled to claim as a GST credit.

The taxable purpose proportion is your estimate (expressed as a percentage) of how much you use a depreciating asset for a taxable purpose - for example, for producing assessable income.

Example: Fi's Flowers (part 1)

Fiona operates a florist, Fi's Flowers. She has operated the business since August 2000. She is eligible, and chooses, to enter the STS in the 2002-03 income year. During the 2002-03 income year, Fiona acquires the following assets: a cash register, acquired on 12 July 2002 at a cost of $800, that she uses solely in her business, and a photocopier/fax, acquired on 15 September 2002 at a cost of $1,100, which she estimates she uses in her business for 80% of the time - the taxable purpose proportion of the adjustable value of the photocopier/fax is: $1,100 x 80% = $880. Fiona can claim an immediate deduction of $800 in the 2002-03 income year for the cash register, which is a low-cost asset. Fiona cannot claim an immediate deduction for the photocopier/fax because it cost more than $1,000 (even though the 80% taxable purpose proportion brings the amount below $1,000). The photocopier/fax would be included under the STS pooling arrangements (see part 3 of the Fi's Flowers example).

STS pools

Most depreciating assets costing $1,000 or more and assets first held by you prior to entering the STS are allocated to an STS pool.

There are two pools:

• the general STS pool for assets with an effective life of less than 25 years, and
• the long life STS pool for assets with an effective life of 25 years or more.

Generally, the effective life of an asset is the period it can be used by anyone for a taxable purpose or for the purpose of producing exempt income, having regard to reasonable wear and tear and assuming reasonable levels of maintenance.

Taxable purpose

As an STS taxpayer, you must estimate how much you will use a depreciating asset for a taxable purpose. You must make a new estimate of the taxable purpose proportion of each asset allocated to:

• the general STS pool - for each of the first three years after the year in which it was allocated to the pool, and
• the long life STS pool - for each of the first 20 years after the year in which it was allocated to the pool.

The taxable purpose proportion of the adjustable value of each asset is allocated to the appropriate pool. Each pool is then depreciated as a single asset. The pool deduction is calculated as follows:

• opening pool balance x 30% for the general STS pool, and
• opening pool balance x 5% for the long life STS pool.

Calculating the opening pool balance

When you first enter the STS you must calculate the opening pool balance of each pool.

The opening pool balance is the taxable purpose proportion of the adjustable values of all depreciating assets allocated to a pool.

The opening pool balance for a later income year is the closing pool balance from the previous year except where an adjustment is made to reflect the changed business use of a pooled asset.

See Calculating the closing pool balance and Exiting the STS for more information.

Example: Fi's Flowers (part 2)
On entering the STS, Fiona held the following depreciating assets for use in her business: A station wagon with an opening adjustable value of $15,000. Fiona estimates that she uses the vehicle 70% of the time to produce assessable income. The taxable purpose proportion of the station wagon's adjustable value is: $15,000 x 70% = $10,500. A computer with an opening adjustable value of $3,000. Fiona estimates that she also uses the computer 70% of the time to produce assessable income. The taxable purpose proportion of the computer's adjustable value is: $3,000 x 70% = $2,100. A refrigerated cabinet with an opening adjustable value of $1,500. The cabinet is used solely for producing assessable income. The taxable purpose proportion of the cabinet's adjustable value is: $1,500 x 100% = $1,500. All of these assets have an effective life of less than 25 years. Fiona allocates these assets to the general STS pool. Fiona calculates the opening pool balance for the 2002-03 income year by adding the taxable purpose proportion of the adjustable values of the existing assets: $10,500 + $2,100 + $1,500 = $14,100 To work out her deduction for the general STS pool in the 2002-03 income year, Fiona multiplies the opening pool balance by the pool rate: $14,100 x 30% = $4,230
Asset	Adjustable value	Taxable purpose proportion	Amount added to pool
Station wagon	$15,000	70%	$10,500
Computer	$3,000	70%	$2,100
Refrigerated cabinet	$1,500	100%	$1,500
Opening pool balance			$14,100
Deduction (opening pool balance x 30%)			$4,230

Treatment of assets acquired by an STS taxpayer during an income year

Where a depreciating asset is acquired by you part way through an income year, a deduction at half the pool rate can be claimed in that income year (see part 3 of the Fi's Flowers example). This applies regardless of when during the year the asset was acquired.

The deduction is 15% for an asset in the general STS pool and 2.5% for an asset in the long life STS pool.

The taxable purpose proportion of the adjustable value of the asset at the time the asset is acquired is then allocated to the relevant STS pool at the end of that income year and included in the closing pool balance.

Example: Fi's Flowers (part 3)
During the 2002-03 income year, Fiona acquires the following assets: the photocopier/fax referred to in part 1 - the taxable purpose proportion of the adjustable value of the photocopier/fax is: $1,100 x 80% = $880 a new refrigerated cabinet to replace the old one, acquired on 1 April 2003 at a cost of $5,000 - as it will be used exclusively for business purposes, the taxable purpose proportion of the adjustable value of the cabinet is: $5,000 x 100% = $5,000, and a delivery van, acquired on 1 May 2003 at a cost of $20,000 - Fiona estimates that the van will be used 70% for a taxable purpose, so the taxable purpose proportion of the adjustable value of the van is: $20,000 x 70% = $14,000. Fiona is entitled to deduct assets that were acquired during the year that cost $1,000 or more at half the appropriate pool rate: ($880 + $5,000 + $14,000) x 15% = $2,982
Asset	Adjustable value	Taxable purpose proportion	Amount added to pool
Photocopier/fax	$1,100	80%	$880
New refrigerated cabinet	$5,000	100%	$5,000
Delivery van	$20,000	70%	$14,000
Taxable purpose proportion of the adjustable value of assets that were first used, or installed ready for use, for a taxable purpose during the income year			$19,880
Deduction ($19,880 x 15%)			$2,982

Treatment of cost addition amounts for pooled assets

Cost addition amounts include the cost of capital improvements to assets and costs reasonably attributable to disposing of or permanently ceasing to use an asset (this may include advertising and commission costs or the costs of demolishing the asset).

Where a cost addition is made to an asset in an STS pool, the taxable purpose proportion of that cost is allocated to the same STS pool as the relevant asset. For example (see part 4 of the Fi's Flowers example), air-conditioning installed in a car after delivery would be considered an improvement to the vehicle.

If the asset was allocated to a pool in an earlier income year, the taxable purpose proportion of the cost addition amount is deducted in the year the cost addition is made, at the rate of:

• 15% for the general STS pool, and
• 2.5% for the long life STS pool.

The taxable purpose proportion of the cost addition amount is then allocated to the relevant pool at the end of the income year and is included in the closing pool balance.

If the cost addition is made in the same income year that the asset is acquired, the taxable purpose proportion of the cost addition amount simply becomes part of the original cost of the asset.

Example: Fi's Flowers (part 4)
During the 2002-03 income year Fiona made the following improvement to an existing asset: the installation of a high-speed internal modem in her computer on 1 August 2002, at a cost of $1,200. Fiona has already estimated that the computer is used 70% for business purposes, so the taxable purpose proportion of the adjustable value of the modem is: $1,200 x 70% = $840. The new modem is an improvement to the existing computer that was acquired in a prior year and had been allocated to the general STS pool. Fiona is entitled to claim a deduction at half the pool rate in the first year that the modem is used: $840 x 15% = $126
Asset	Adjustable value	Taxable purpose proportion	Amount added to pool
Modem (including installation)	$1,200	70%	$840
Taxable purpose proportion of the cost of improvements made to assets in the pool during the year			$840
Deduction ($840 x 15%)			$126

Changes in taxable purpose proportion

In certain circumstances if you change the extent to which you use a pooled asset for a taxable purpose, you will need to adjust the opening pool balance prior to calculating your pool deduction.

You must make an adjustment if the extent of the taxable purpose proportion changes by more than 10 percentage points from the estimate or any previously adjusted estimate for each asset allocated to:

• the general STS pool - for each of the first three years after the year in which it was allocated to the pool, and
• the long life STS pool - for each of the first 20 years after the year in which it was allocated to the pool.

The adjustment will ensure that the pool deduction is based on the correct estimate of the asset's taxable purpose proportion for the current and future income years.

Adjustment formula

The adjustment is calculated using the following formula:

Adjustment

=

reduction factor

x

asset value

x

(current year estimate - last estimate)

The glossary contains more information about the reduction factor to be used for assets allocated to the general pool.

The asset value of a depreciating asset is its adjustable value before it is either:

• added to an STS pool, or
• first used or installed ready for use for a taxable purpose.

The asset value for a depreciating asset that was first used, or installed ready for use, for a taxable purpose while you were not an STS taxpayer is its adjustable value at the start of the income year in which it was allocated to a pool.

The asset value for a depreciating asset that was first used, or installed ready for use, for a taxable purpose while you were an STS taxpayer will be the asset's adjustable value at the time the asset was first used, or installed ready for use, for a taxable purpose.

The asset value includes the cost of any improvements.

The difference between the current year estimate and the last estimate represents the change in your estimate of how much an asset will be used for a taxable purpose. The last estimate is either the original estimate or the last estimate that resulted in an adjustment being made.

If the adjustment is the result of an increase in the taxable purpose proportion, the opening pool balance is increased and as a consequence the pool deduction for the year will be increased. If the adjustment is the result of a decrease in the taxable purpose proportion, the opening pool balance is reduced and as a consequence the pool deduction for the year will be reduced.

Example: Adjustment formula

Grace elects to enter the STS in the 2002-03 income year. Prior to entering the STS she had a car that she used 60% for business purposes. The taxable purpose proportion (60%) of the car's adjustable value ($12,000) is included in the general STS pool. During the 2003-04 income year Grace increases her taxable purpose proportion of the car from 60% to 75%. As this is an increase of 15 percentage points, Grace must make the following adjustment to the opening pool balance for the 2003-04 income year: Adjustment = 0.7 x $12,000 x (75% - 60%) = $1,260 The opening pool balance is increased by $1,260 to reflect the changed taxable purpose proportion and this in turn increases the pool deduction for the year. Grace needs to make an estimate of the taxable purpose proportion of the car and make any necessary adjustments (where the estimate differs by more than 10 percentage points) only for the income years up to and including the 2005-06 year.

Other reference Section 328-225 of the Income Tax Assessment Act 1997 - Change in business use

Cars

As an STS taxpayer, if you deduct car expenses using either the cents per kilometre basis or the 12% of original value method, you cannot also claim a deduction under the STS depreciation rules.

In these circumstances the car is allocated to the general STS pool with a taxable purpose proportion of zero per cent. This means that no deduction for depreciation is allowed under the STS rules.

If you change from either the cents per kilometre or 12% of original value method to either the log book or one-third of actual expenses method, the taxable purpose proportion will change from zero per cent to your estimate of the taxable purpose proportion. You must use the adjustment formula to adjust the opening pool balance to reflect any change of more than 10 percentage points.

Example: Raoul's car expense

Raoul began business in September 2002 and elects to enter the STS for the 2003 income year. In his first year in business Raoul claims his car expenses on a cents per kilometre basis. This is also the first year Raoul uses the car for a taxable purpose. The car is allocated to the general STS pool with a taxable purpose proportion of 0%. Consequently, there is no STS depreciation deduction for the car in that year. In 2003-04, Raoul decides to claim his car expenses using the log book method. Using this method Raoul is entitled to claim depreciation in respect of the car. Raoul determines from his log book that he uses the car 60% for a taxable purpose in 2003-04. The adjustable value of the car at the time it was allocated to the pool in 2002-03 was $12,000. Because there has been an increase of more than 10 percentage points in the taxable purpose proportion, Raoul must adjust the opening pool balance using the adjustment formula. Raoul increases the opening pool balance by: 0.85 x $12,000 x (60% - 0%) = $6,120

Car limit

There is a limit on the cost used to calculate depreciation of motor cars and station wagons, including four-wheel drives. The limit for 2001-02 is $55,134. For the years 2002-03 to 2006-07 (inclusive) it is $57,009.

Balance of pool falls below $1,000

If the balance of an STS pool (after taking into account any additions and disposals but before calculating any deduction) is below $1,000 but greater than zero, you can claim a deduction for the remaining amount. The closing pool balance then becomes zero.

Disposals

When you stop using a depreciating asset for any purpose or the asset has been disposed of, sold, lost, or destroyed, a balancing adjustment event has occurred.

The asset's termination value must be adjusted to the taxable purpose proportion.

The termination value could be monies received from the sale of an asset or insurance monies received as the result of the loss or destruction of an asset.

Where a balancing adjustment event occurs to a depreciating asset because of a partial change in the STS partnership that owns the depreciating asset, then roll-over relief may be available. The effect of the roll-over relief is that the balancing adjustment event is ignored for the asset until the asset is disposed of.

If the disposal is a taxable supply, the termination value must be reduced by the amount of GST payable (except where the termination value is deemed to be the market value of the asset).

No capital gains liability arises in respect of the disposal of a depreciating asset that has been deducted under the STS depreciation rules.

Low-cost assets

If an immediate deduction has been claimed for a low-cost asset and you dispose of that asset, the taxable purpose proportion of the termination value must be included in your assessable income.

Pooled assets

If a pooled asset is disposed of, the taxable purpose proportion of the termination value is deducted from the pool balance at the end of the income year.

Where the disposal of an asset results in a negative pool balance, the amount of the balance is treated as assessable income. The closing pool balance then becomes zero.

Example: Fi's Flowers (part 5)
During the 2002-03 income year Fiona disposes of the following assets: the old refrigerated cabinet, sold for $1,000 on 1 April 2003 - the taxable purpose proportion of the asset's termination value is $1,000 because it is used 100% in the business, and the station wagon, traded in for $10,000 on the new delivery van on 1 May 2003 - the station wagon was used 70% for business purposes, so the taxable purpose proportion of its termination value is: $10,000 x 70% = $7,000. Fiona must reduce the closing pool balance for the 2002-03 income year by the taxable purpose proportion of the termination values of the old refrigerated cabinet and the station wagon: $1,000 + $7,000 = $8,000
Asset	Termination value	Taxable purpose proportion	Amount deducted from pool
Old refrigerated cabinet	$1,000	100%	$1,000
Station wagon	$10,000	70%	$7,000
Taxable purpose proportion of the termination value of any pooled assets disposed of during the year			$8,000

Disposal of an asset in a pool where the taxable purpose proportion has changed

If a disposal occurs of an asset and the taxable purpose proportion has been changed, the termination value must also be adjusted. The taxable purpose proportion must be recalculated to reflect the average taxable purpose proportion applied during the income years in which the asset was in an STS pool.

Example: Reasonable estimate

Continuing the Example: Adjustment formula (above), Grace further increases her business use of the car from 75% to 90% in the 2004-05 income year. She sells her car for $3,000 at the start of the 2006-07 income year. Grace must now average the estimate of taxable use for the car for the year it was allocated to the pool and the next three years to work out the taxable purpose proportion of the termination value. The average is worked out as follows: 60% (2002-03 original estimate) plus 75% (2003-04 estimate) plus 90% (2004-05 estimate) plus 90% (2005-06 - no change on previous year) = 315% 4 = 79% The taxable purpose proportion of the car's termination value is: $3,000 x 79% = $2,370

Calculating the closing pool balance

As an STS taxpayer, you must calculate the closing pool balance at the end of each income year using the following method statement.

A	opening pool balance for the year
B	plus (+)	taxable purpose proportion of the adjustable value of assets that were first used, or installed ready for use, for a taxable purpose during the year
C	plus (+)	taxable purpose proportion of any cost addition amounts for assets in the pool during the year
D	less (-)	taxable purpose proportion of the termination value of any pooled assets disposed of during the year
E	less (-)	deduction allowed for assets allocated to the pool for the year
F	less (-)	deduction allowed for assets first used by the taxpayer during the year
G	less (-)	deduction allowed for any cost addition amounts for pooled assets during the year
equals (=)		closing pool balance for the year

The closing pool balance then becomes the opening pool balance in the following year, except where an adjustment is made to reflect the changed taxable purpose proportion of a pooled asset.

Example: Fi's Flowers (part 6)
Using the information in parts 2-5, and the method statement above, Fiona calculates her closing pool balance for the year:
			Part	Amount
	A	Opening pool balance for the year	2	$14,100
Plus (+)	B	newly acquired assets	3	+ $19,880
Plus (+)	C	improvements to assets	4	+ $840
Less (-)	D	disposals	5	- $8,000
Less (-)	E	deduction for pooled assets	2	- $4,230
Less (-)	F	deduction for newly acquired assets	3	- $2,982
Less (-)	G	deduction for improvements	4	- $126
	=	Closing pool balance for the year		$19,482

Exiting and re-entering the STS

When you exit the STS, the general STS pool and the long life STS pool continue to operate. Deductions can still be claimed in respect of those pools. This applies where you cease carrying on a business and dispose of pool assets, providing the entity continues to exist and the STS pool balance is greater than zero. If the disposal of an asset(s) results in the pool balance falling below zero, the amount below zero is included in your assessable income.

However, no further assets may be added to an STS pool unless you subsequently re-enter the STS.

While you are not in the STS, any newly acquired assets must be deducted under the non-STS capital allowances rules, known as the uniform capital allowances system (UCA). From 1 July 2001, the new UCA rules replace the previous depreciation rules.

If you cease to be in the STS, you can no longer claim an immediate deduction for low-cost assets under the STS rules. However, an immediate deduction may be allowable under the UCA rules.

If you exit and later re-enter the STS, the opening pool balance will be the closing pool balance for that pool from the previous year plus the taxable purpose proportion of the adjustable value of any depreciating asset not yet allocated to that pool.

This means that on re-entry to the STS, you must allocate, to the appropriate pool, assets that you have begun to use, or have installed ready for use for a taxable purpose, since last exiting the STS.

See Chapter 3 for more information about entering and exiting the STS.

More about uniform capital allowances Division 40 of the Income Tax Assessment Act 1997 - Capital allowances Guide to depreciating assets (NAT 1996) Capital allowances at a glance (NAT 6405)

Contractors and consultants

If you are an STS taxpayer who has income that is a reward for your personal efforts or skills, you may be affected by the alienation of personal services income rules. If you are affected, you can still deduct amounts for your depreciating assets under the STS depreciation rules. However, a personal services entity can claim deductions in respect of only one car for which there is a private use component.

More about personal services income Alienation of personal services income: contractors and consultants (NAT 4788)

Exclusions and options

Exclusions

Certain types of depreciating assets are specifically excluded from the STS depreciation rules. They may, however, be deductible under other provisions in the income tax law.

Assets rented or leased to others

Assets that are leased out, or will be leased out, by you for more than 50% of the time on a depreciating asset lease are specifically excluded from the STS depreciation rules. A deduction will generally be available under the UCA provisions.

This exclusion does not apply to depreciating assets you lease out under a hire purchase agreement, or short-term hire agreement.

Depreciating assets used in rental properties are generally excluded from the STS depreciation rules on the basis that the assets are part of property that is subject to a depreciating asset lease.

Assets allocated to a low-value pool

Where you had assets allocated to a low-value pool prior to entering the STS, those assets remain in the low-value pool and deductions must be claimed under the UCA provisions.

Horticultural plants

Horticultural plants (including grapevines) are specifically excluded from the STS depreciation rules but may be deducted under the UCA provisions.

Software

Expenditure that you have allocated to a software development pool prior to entering the STS continues to be deducted under the UCA provisions. No other deduction is available for depreciating assets resulting from expenditure allocated to a software development pool under either the STS or UCA provisions.

Capital works

Deductions for most buildings and structural improvements cannot be claimed under either the STS or the UCA, but they can generally be claimed under the capital works provisions contained in Division 43 of the ITAA 1997.

However, some buildings and structural improvements, such as improvements for conserving and conveying water, can be deducted under the UCA provisions. As an STS taxpayer, you can choose to deduct these assets under either the STS or UCA provisions.

Investments in Australian films

The STS capital allowances rules do not apply to investments in Australian films. Deductions may be available under existing law (Division 10BA or Division 10B of the Income Tax Assessment Act 1936 (ITAA 1936).

Options

Some STS taxpayers can choose whether or not certain assets are treated under the STS depreciation rules. These options are outlined below.

Once a choice is made it cannot be changed.

Primary producers

Certain depreciating assets used by a taxpayer in the course of carrying on a business of primary production attract specific UCA provisions, such as those applying to landcare operations, water facilities, electricity connections and telephone lines. For each of these assets the taxpayer can choose whether to use the STS provisions or the UCA provisions.

Software

As an STS taxpayer, where you incur expenditure that qualifies for inclusion in a software development pool but a pool does not currently exist, you can establish one. However, once you elect to establish a software development pool, all subsequent relevant expenditure must be allocated to that pool.

Alternatively, you can allocate the adjustable value of the developed software to an STS pool at the time it is first used, or installed ready for use, for a taxable purpose. If it qualifies as a low-cost asset an immediate deduction is available.

Assets with an estimated effective life of 25 years or more that were held before 1 July 2001

As an STS taxpayer, you can choose not to allocate an asset to the long life STS pool if the asset was first used, or installed ready for use, for a taxable purpose before 1 July 2001. This choice must be made in the income year in which you first enter the STS. If you choose not to allocate the asset to the long life STS pool you can claim a deduction for the decline in value of the asset under the UCA provisions.

Roll-over relief: change in constitution of a partnership

Where an STS partnership adds a new partner or an existing partner leaves, this usually results in a balancing adjustment event. However, an STS partnership involved in a partial ownership change is able to access roll-over relief when all of the following conditions are met.

• A partnership still exists after the change, that is, one partner cannot leave the partnership resulting in the remaining partner operating as a sole trader nor can the remaining partner(s) incorporate and operate as a company.
• Both the old partnership (the transferor) and the new partnership (the transferee) choose to apply roll-over relief. This choice must be evidenced in writing and a copy of this choice must be kept for five years after the end of the income year in which the change occurs.
• At least one of the partners that had an interest in the depreciating assets before the change has an interest in the assets after the change.
• The transferee becomes an STS taxpayer for the year in which the transfer occurred and all of the depreciating assets are held by the transferee immediately after the change.
• Capital allowances deductions for the assets are calculated under Subdivision 328-D of the ITAA 1997.

The effect of the roll-over relief is that the transferor is not required to subtract the termination values of the depreciating assets from the STS general and long life pools from the closing pool balances because of the change in the partnership. The transferee simply takes over the depreciating assets pools of the transferor.

This ensures that roll-over relief from balancing adjustment events is available where either of the following occurs:

• a reconstitution of a partnership operating under the STS, or
• variations in the interests of partners in an STS partnership.

Example: STS partnership

In the 2002-03 income year an STS partnership, comprising equal partners Grace and Fiona, agree to accept Raoul as a partner with a 30% share. To accommodate this, Grace and Fiona agree to each sell Raoul the equivalent of a 15% stake in the partnership. This constitutes a balancing adjustment event. The effect of this is that the old partnership is required to subtract the termination value of the depreciating assets from the relevant asset pool balance. The partnership has five assets, all in the general STS pool and all used 100% for business purposes. The opening pool balance is $10,000. The partnership adjustment occurs on 30 June 2003 and the termination value of the assets for this balancing adjustment event is their combined market values of $12,000. The balancing adjustments that arise as a result of this change in the constitution of the partnership put the STS general pool into a negative balance. In the normal course of events Grace and Fiona would be required to account for this negative amount in the partnership's assessable income. If however, Grace and Fiona elect to apply roll-over relief, and Raoul also agrees, then the balancing adjustment event is ignored. Raoul must agree to apply the roll-over relief as he is a partner in the new partnership The old partnership of Grace and Fiona will be entitled to claim 50% of the capital allowances deduction for the 2003 income year calculated under Subdivision 328-D. The new partnership of Grace, Fiona and Raoul will be entitled to claim the remaining 50% capital allowances deduction for the 2003 income year. The assets are allocated to a depreciating asset pool applicable to the new partnership and the new partnership continues to claim capital allowances deductions in respect to this depreciating asset pool. If Grace was to leave the partnership in the 2004-05 income year, this would result in another partial partnership change. Provided all of the partners choose to apply the roll-over relief, the provisions would ensure that the old partnership would not be required to subtract the termination value of the assets from the respective pool balances. In effect, if the assets are worth $12,000 and the pool balance is $10,000 at the time Grace leaves, the partnership of Grace, Fiona and Raoul would not be required to account for the negative balance that would normally occur. The partnership is not assessed on any taxable gain as part of this partnership adjustment. Instead a taxable gain or loss will only be accounted for when the partnership ultimately disposes of the assets.

Roll-over relief: extension

The roll-over relief available under the STS has been extended by removing the requirement that both entities, before and after an ownership change, must be partnerships. The changes ensure that roll-over relief from balancing adjustment events is available where there is a change in the business structure of an STS taxpayer that involves a partnership. For example, if a sole trader takes on a partner, roll-over relief will be available to defer any adjustment to taxable income resulting from that balancing adjustment event.

For most taxpayers (other than certain taxpayers on substituted accounting periods) this applies to business structure changes involving a partnership for the 2005-06 and later income years.

The optional rollover relief for depreciating assets allocated to STS pools will now apply where:

• 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 the asset after the change, and
• the asset was a partnership asset either before the change or becomes one as a result of the change.

Other capital expenditure

Business-related costs

Business-related costs may be deducted by you under the UCA rules provided:

• the costs do not form part of the cost of a depreciating asset, and
• your business is, or was, carried on for the purpose of producing assessable income.

Business-related costs include:

• business establishment costs
• business restructuring costs
• business equity-raising costs
• defending your business against a takeover
• costs to the business of unsuccessfully attempting a takeover
• liquidating a company that carried on a business and of which you are a shareholder, and
• costs of ceasing to carry on the business.

You deduct 20% of the cost in the year it was incurred and in each of the following four years. Any recoupment of these costs is included in assessable income.

More about business-related costs Guide to depreciating assets (NAT 1996)

Accounting methods for STS taxpayers

Chapter 6

This chapter explains how, as an STS taxpayer, you account for income and deductions for income tax purposes, and the rules to be applied when entering or exiting the STS.

When the STS began on 1 July 2001, STS taxpayers were required to use the STS accounting method to calculate their assessable income and allowable deductions for an income year.

Using this method, most business income is included as assessable income in the income year in which it is received, and most business expenses are allowable deductions in the income year in which they are paid.

From the first income year beginning on or after 1 July 2005 the requirement that STS taxpayers must use the STS accounting method has been removed.

However, if you were an STS taxpayer in the income year that started immediately prior to 1 July 2005, then while you continue to be an STS taxpayer (from the first income year that starts on or after 1 July 2005), you can continue using the STS accounting method.

The removal of the requirement that an STS taxpayer must use the STS accounting method means that you are now able to calculate your taxable income using the most appropriate method for your circumstances.

That is, you will be able to calculate your taxable income using either:

• the accruals (earnings) method, or
• the cash (receipts) method,

whichever is the most appropriate method for your circumstances.

The accruals method is where ordinary income is recognised when it is derived and general deductions are recognised when they are incurred. The cash method is where ordinary income is recognised when it is received and general deductions are recognised when they are paid, or alternatively, when incurred.

More about the different accounting methods Taxation Ruling TR 97/7 - Income tax: subsection 51(1)- meaning of 'incurred' - timing of deductions Taxation Ruling TR 98/1 - Income tax: determination of income; receipts versus earnings

Pre 1 July 2005 continuing STS taxpayers

If you were an STS taxpayer in the income year commencing immediately prior to 1 July 2005, then you may continue to use the STS accounting method for income years commencing on or after 1 July 2005. If you decide to stop using this method, business income and expenses that have not been accounted for (because they not been received or paid) will be accounted for in the year you change to the accruals or cash method.

STS taxpayers who continue to use the STS accounting method after 1 July 2005

This applies to STS taxpayers who were in the STS for the income year commencing immediately prior to 1 July 2005 and who choose to continue using the STS accounting method.

When calculating assessable income at the end of an income year, if you continue to use the STS accounting method you:

• should exclude sales or other ordinary income for which payment has not been received (debtors), and
• cannot claim any unpaid business expenses (creditors).

Amounts STS taxpayers include in assessable income

As an STS taxpayer, you must include amounts of both ordinary income and statutory income in your assessable income.

Ordinary income

The main types of ordinary income that an STS taxpayer will receive include:

• income from sales of goods or services
• professional fees, and
• commissions.

Generally, an STS taxpayer using the STS accounting method includes ordinary income as assessable income in the year it is received.

Example: Ordinary income - STS accounting method

Lee is an STS taxpayer and has a plumbing business. He installs a new basin and taps for Rachel on 26 June 2003 and gives her an invoice for the work. Rachel pays by cheque, which she posts to Lee. He receives the cheque on 5 July. Although he completes the work in the 2002-03 income year, he does not receive payment until the 2003-04 income year. Lee does not include the amount in his assessable income for the 2002-03 income year, but will include it in the year he received it, that is, 2003-04.

When income is received

The table below shows when various types of receipts are considered to have been received by an STS taxpayer using the STS accounting method.

Type of receipt	Income is received on the date:
Cash	cash is received
Cheque/money order	cheque/money order is received
Postdated cheque	cheque is received *
Credit card - in person	customer signs docket
Credit card - remotely	card details are given
Debit card (EFTPOS)	transaction is accepted
Direct credit	credited to account
Direct debit	on transfer

* If you receive a cheque and it is later dishonoured, you exclude the receipt from assessable income in the income year the cheque was originally received.

In addition, you are considered to have received an amount of income where it has been dealt with on your behalf - for example, when you direct a debtor to pay the amount to a third party.

As an STS taxpayer, you should not include in your assessable income, payments of ordinary income you receive during the year if a specific rule in the income tax law delays the inclusion of all or part of that amount until a later year. For example, payment received from a double wool clip can be brought to account over several income years rather than wholly in the income year in which it is received.

There may be occasions where you, using the STS accounting method, receive a payment before completing work agreed to - for example, an up-front receipt of an amount for a contract for services.

In this case, the full amount received is included in your assessable income for the income year in which it is received. This approach only applies to amounts received on or after 1 July 2003.

For amounts received by you, on or before 30 June 2003, only the proportion of the payment relating to the work completed in an income year is included in your assessable income for that year.

Example: Up-front payment on or after 1 July 2003

Ellie's Office Services maintains office equipment for a number of clients who pay a fixed price for services delivered over a two-year period. On 1 November 2003 Ellie enters a contract with Bill's Bookkeeping to service his photocopier, fax and shredder for the next 24 months, at a fixed cost of $3,000. Bill pays Ellie the full $3,000 at the time the contract is signed. If Ellie does not provide the services according to the contract, she may have to provide a refund. Ellie is an STS taxpayer in the 2003-04 income year. As an STS taxpayer, Ellie must include the full $3,000 contract payment in her assessable income for the 2003-04 income year.

More about up-front payments received Taxation Determination TD 2003/25 - Income tax: Simplified Tax System (STS): does paragraph 328-105(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to an amount received by an STS taxpayer, but not yet derived as ordinary income under the ordinary operation of section 6-5 of the ITAA 1997?

Statutory income

As an STS taxpayer, if the income tax law includes an amount of statutory income in your assessable income for an income year, you must include that amount in your assessable income for the relevant year even if you did not derive or receive the statutory income during that year.

For example, if you have a net capital gain, you include the gain in your assessable income for the year in which you made the gain, even though you may not receive the capital proceeds until a later income year.

Income subject to PAYG withholding

As an STS taxpayer, you may receive a payment for goods or services that has been subject to a 46.5% withholding under the PAYG withholding rules because you did not quote your Australian business number (ABN).

You are considered to have received the gross amount of that payment at the time you receive the net amount. The amount withheld is deemed to have been received by you because it is applied or dealt with on your behalf. Therefore you must include the gross amount in your assessable income.

More about income subject to PAYG withholding Taxation Determination TD 2003/24 - Income tax: Simplified Tax System (STS): what amount is returned as assessable income by an STS taxpayer in relation to an assessable payment to them that has been subject to the Pay As You Go withholding rules in Division 12 of Schedule 1 to the Taxation Administration Act 1953?

Working out allowable deductions

General deductions

General deductions are the expenses incurred by you in the ordinary course of carrying on your business - for example, operating expenses, wages, rent, and purchases of stock and consumables.

If you are an STS taxpayer using the STS accounting method, you can claim a general deduction in the income year in which the relevant expense is paid.

Payment method	Payment is made on the date:
Cash	cash is handed over
Cheque/money order	cheque/money order is posted or handed over
Postdated cheque	cheque is posted or handed over *
Credit card - in person	STS taxpayer signs docket
Credit card - remotely	card details are given
Debit card (EFTPOS)	transaction is accepted
Direct credit	payment is authorised
Direct debit	on transfer
BPAY	payment is authorised

* If you make a payment by cheque and it is later dishonoured, you do not claim the deduction in the income year the cheque was originally posted or handed over.

Registered to BPAY Pty Ltd ABN 69 079 137 518

In addition, deductions for managing your tax affairs, and repairs, although not general deductions, are allowable deductions for you in the year in which they are paid.

Rules in the income tax law that alter the timing of a general deduction will still apply. For example, there are timing rules for certain prepaid expenses.

(see Chapter 7)

Specific deductions

A specific deduction is a deduction that a taxpayer can claim at a particular time or over a particular period, or that cannot be claimed as a general deduction. Specific deductions include depreciation, some borrowing expenses (for example, stamp duty and legal expenses when borrowing for business purposes), bad debts and expenditure incurred by primary producers on installing mains electricity supplies.

A specific deduction is claimed in the income year (or years) allowed under the provision of the income tax law that relates to that deduction. This may not be the same income year in which an STS taxpayer pays the expense.

Trading stock

You claim a deduction for trading stock on the same basis as you claim your other expenses. If you are claiming your deductions when they are paid, as distinct from when they are incurred, you cannot claim a deduction for the cost of your trading stock until you have paid for it.

See Chapter 8 for more information about trading stock.

Payments subject to PAYG withholding

As an STS taxpayer, you may make payments from which you are required to withhold an amount that is paid in a later income year to the Tax Office under the pay as you go (PAYG) withholding system. These include payments of salary and wages, alienated personal services income, and payments to a supplier that has not quoted their Australian business number (ABN).

As an STS taxpayer, you have two options.

0. Claim a deduction for the gross amount of the payment even though the amount withheld has not been paid to the Tax Office at the end of the year.
0. Claim a deduction for the amount paid to the employee or supplier in the income year in which you paid that amount and then a deduction for the amount withheld in the later income year in which that amount is paid to the Tax Office.

As an STS taxpayer, once you have chosen one of these approaches you must continue to use that approach in future years.

More about payments subject to PAYG withholding Taxation Determination TD 2003/26 - Income tax: Simplified Tax System (STS): for which income year should an STS taxpayer claim an income tax deduction for an amount withheld under the Pay As You Go withholding rules in Division 12 of Schedule 1 to the Taxation Administration Act 1953?

Deductions for fringe benefits tax (FBT) instalments

If you are an STS taxpayer using the STS accounting method, you cannot claim a deduction for an FBT instalment you have incurred until the income year in which you pay the instalment to the Tax Office.

Amounts included on exiting the STS

If you were an STS taxpayer that was using the STS accounting method and you exit the STS you first need to determine which accounting method is most appropriate for your business.

Accruals method

If you adopt an accruals method of accounting;

• ordinary income that has not previously been included because it was not received and
• general deductions, tax related expenses and repairs that have not previously been claimed because they were not paid

are included in the year you exit the STS.

Cash method

If you adopt a cash method of accounting, any ordinary income will continue to be included when it is received. If you choose to account for general deductions when they are incurred, as distinct from when they are paid, any general deductions that have not previously been claimed (because they were not paid) can be claimed in the year you exit the STS. Alternatively they can continue to be claimed in the year they are paid. The method you choose to account for deductions must be used consistently from year to year. There can be no doubling up of deductions.

If you were an STS taxpayer after 1 July 2005 using the cash or accruals accounting method and you subsequently exit the STS and continue with the same accounting method, then no adjustments are required upon exit.

Pre 1 July 2005 STS taxpayers who cease to use the STS accounting method after 1 July 2005

From 1 July 2005, transitional provisions will apply to continuing STS taxpayers who cease to use the STS accounting method. If you adopt an accruals method of accounting these provisions ensure that any ordinary income or general deductions, tax-related expenses and repairs that have not been recognised under the STS accounting method (because they have not been received or paid) are recognised in the first year after 1 July 2005 that a business ceases to use the STS accounting method.

If you adopt a cash method of accounting any ordinary income will continue to be recognised in the year it is received. If you choose to account for deductions when they are incurred, as distinct from when they are paid, any deductions that have not previously been taken into account (because they were not paid) can be taken into account in the year you cease to use the STS accounting method. Alternatively they can continue to be brought to account in the year they are paid. The method you choose to account for deductions must be used consistently from year to year. There can be no doubling up of deductions.

Example: Remaining in the STS - change to accruals method

Zoe entered the STS in the 2003-04 income year. Before entering the STS she recognised income in the year it was derived and claimed deductions in the year they were incurred under the accruals method. Zoe included amounts owing from customers as income derived in the 2002-03 income year. She also claimed deductions for business expenses outstanding at the end of the 2002-03 income year. The STS entry adjustment rules ensured that when Zoe entered the STS: income amounts owing from a previous year were not recognised again when received, and expenses outstanding from a previous year were not recognised again when paid. Zoe wishes to remain in the STS but wants to change back to her original method of calculating taxable income under the accruals method in the 2005-06 income year. While she was using the STS accounting method she had derived ordinary income for which payment had not been received. Zoe did not include this amount as income as the STS accounting method does not recognise ordinary income until it is received. While she was using the STS accounting method she had incurred business expenses but had not paid for them. Zoe did not claim a deduction for these expenses as the STS accounting method does not recognise general deductions until they have been paid. The exit adjustment rule for ordinary income ensures that Zoe includes in assessable income in 2005-06, amounts owing to her in the changeover year. Similarly, the exit adjustment rule for deductions ensures that Zoe can deduct in 2005-06, expenses she owes in the changeover year.

Hints for STS taxpayers who are registered for GST Assessable income does not include GST payable on a taxable supply. The amount you claim as a deduction cannot include any GST credits to which you are entitled. The STS accounting method should not be confused with the simplified accounting method for food retailers, which relates to GST.

Prepaid

Chapter 7

This chapter explains the 12-month rule that applies to STS taxpayers in relation to deductions for prepaid expenses.

About prepaid expenses

A prepaid expense is an amount of expenditure made in advance, usually for goods or services that will not be fully provided within the income year that the expenditure is incurred. Examples of prepaid expenses include subscriptions to professional associations and payments such as rent and insurance made in advance.

If you are an STS taxpayer using the STS accounting method, the expense must not only have been incurred, it must also have been paid before a deduction can be claimed.

Treatment of prepaid expenses under the STS

Generally, a prepaid expense is immediately deductible to an STS taxpayer if:

• the payment is made for a period of service of 12 months or less, and
• the period of service ends in the next income year.

This rule, known as the 12-month rule, applies to both deductible business and deductible non-business expenditure made by an STS taxpayer.

Where a prepayment does not meet the 12-month rule an immediate deduction cannot be claimed. As an STS taxpayer, you must apportion the deduction over the period of service (to a maximum of 10 years).

The examples in this chapter use GST-exclusive figures.

Example: Prepaid expense that is immediately deductible

The Wichin Trust is an STS taxpayer. On 1 September 2003 it makes a payment of $24,000. This payment covers rent on its business premises for a 10-month period from 1 December 2003 to 30 September 2004.

The $24,000 prepayment satisfies the 12-month rule because it is for a period of service of less than 12 months that ends in the next year. The Wichin Trust can therefore claim an immediate deduction of $24,000 in the 2003-04 income year.

Example: Prepaid expense that is not immediately deductible
Tom is an STS taxpayer. On 15 December 2002 he pays $15,000 for business advertising over an 18-month period (546 days), starting on 1 January 2003. The prepayment does not satisfy the 12-month rule because the period of service is longer than 12 months. Tom cannot claim an immediate deduction for the prepayment. Instead, he must apportion his deduction over the period of service as follows:
2002-03 income year: $15,000 x 181 days 546 days	(1 January 2003 to 30 June 2003)	= $4,973
2003-04 income year: $15,000 x 365 days 546 days	(1 July 2003 to 30 June 2004)	= $10,027
	Total deduction	= $15,000

Exclusions

If the amount of expenditure is:

• less than $1,000
• a payment of salary or wages (under a contract of service), or
• required to be incurred by a law, or by an order of a court, of the Commonwealth, a State or a Territory (for example, statutory fees or charges payable to a Governmental body such as vehicle registration fees),

all taxpayers can claim an immediate deduction in the income year in which it is incurred, provided the expense is not private, domestic or capital in nature. This applies even if the period of service is more than 12 months.

Prepaid expenses made under tax shelter arrangements

If the expense relates to a tax shelter arrangement, special rules may apply to limit immediate deductions. Under the tax shelter rules, some prepaid expenses that would otherwise be immediately deductible can be claimed only over the period in which the goods or services under the agreement are provided. This applies whether or not the prepaid expense satisfies the 12-month rule.

More about prepaid expenses Sections 82KZL-82KZO of the Income Tax Assessment Act 1936 - Period of deductibility of certain advance expenditure Deductions for prepaid expenses (NAT 4170) Prepaid expenses - investments in tax shelter arrangements - fact sheet (NAT 4513)

STS trading stock rules

Chapter 8

This chapter explains the rules for STS taxpayers who hold trading stock.

As an STS taxpayer, you will only need to conduct a stocktake and account for changes in the value of your trading stock in certain circumstances.

You will use either the STS trading stock rules or the general trading stock rules.

Other references Subdivision 328-E of the Income Tax Assessment Act 1997 - Trading stock for STS taxpayers Simplified tax system: simplified trading stock rules (NAT 4107)

What is trading stock?

Trading stock includes anything produced, manufactured, acquired or purchased for manufacture, sale or exchange.

This includes livestock (but excludes animals used as beasts of burden or working beasts in a non-primary production business).

Trading stock does not include:

• standing or growing crops, timber or fruit - these only become trading stock when they are harvested, felled or picked
• stocks of spare parts held for repairs or maintenance to plant and equipment
• video cassettes owned by a video lending business where they are used to earn income by hire or rental, rather than manufacture, sale or exchange, or
• consumable and business inputs to manufacture, such as cleaning agents or sandpaper.

Generally a stocktake is necessary to work out the value of trading stock at the end of the income year. This involves working out the physical quantities of stock on hand and assigning a value to each item of stock. Each item of stock is valued at either cost, market selling value or replacement price.

Valuing trading stock

There are three methods for valuing trading stock.

• Cost price: This includes all costs connected with bringing the stock into existence. The cost of finished goods, for example, should include freight, customs duties and delivery charges, as well as the purchase price. For manufactured goods and work in progress, the full cost includes the cost of labour and materials, plus an appropriate proportion of fixed and variable factory overheads, such as power, rent, rates and factory administration costs.
• Market selling value: The current value of the stock sold in the normal course of business. This method does not allow a reduced valuation where you are forced to sell the stock for some reason.
• Replacement value: The price of a substantially identical replacement item on the last day of the income year purchased in your normal buying market.

You can change the method you use to calculate the value of trading stock each year and can also use different methods for different items of stock. However, the value of stock at the beginning of each income year must be the same as the value of the stock at the end of the previous income year.

The value of trading stock does not include GST where you are entitled to a GST credit.

More about valuing trading stock Subdivision 70-C of the Income Tax Assessment Act 1997 - Accounting for trading stock you hold at the start or end of the income year (Contains special valuation rules including obsolete stock and natural increase in livestock)

Trading stock rules for STS taxpayers

As an STS taxpayer, you need to conduct a stocktake and account for changes in the value of trading stock only if there is a difference of more than $5,000 between:

• the value of stock on hand at the start of the income year, and
• a reasonable estimate of the value of stock on hand at the end of that year.

You can choose to conduct a stocktake and account for changes in the value of trading stock even if the difference is $5,000 or less.

The $5,000 threshold applies to both increases and decreases in the value of trading stock.

Stock value at start of income year

The value of stock on hand at the start of the income year is the same as the amount that you included in your return at the end of the previous year.

If you did not have any trading stock in the previous year, the value of trading stock at the start of the year is zero. This might occur in the case of a new business, or in the first year you have trading stock.

If the value of trading stock varies by $5,000 or less and you choose not to account for the difference, the value of trading stock on hand at the end of the year is deemed to be the same as at the start of the year.

Making a reasonable estimate of stock value at end of year

As an STS taxpayer, you need to make a reasonable estimate of both the quantity of stock on hand and the value of each item of stock.

In general, an estimate of the value of trading stock on hand will be reasonable where it:

• takes into account all relevant factors and considerations likely to affect the number and value of the particular entity's items of trading stock on hand
• has been undertaken in good faith
• results from a rational and reasoned process of estimation, and
• is capable of explanation to, and verification by, a third party.

Factors that should be considered when making an estimate include:

• the type of trading stock held (for example, a large variety of items of stock but few in number or a small variety but large numbers)
• where and how stock on hand is stored (for example, is it stored in one location or several locations)
• the method used to value items of stock, whether cost, market selling value or replacement value
• whether the value of items of stock varies materially from previous income years or during the income year
• how sales and purchases of stock are recorded and the accuracy of those records
• inventory systems used and their known accuracy
• the quantity and value of stock on hand in previous income years
• information from stocktakes (where undertaken) in prior income years or during the income year, and
• significant changes from previous income years to the type and quantity of stock held.

Example: Colin's estimate of trading stock

Colin is an electrician. Mostly he does small repair and installation jobs, for which he needs fairly standard stock items. He always has a quantity of these items in his van and workshop. However, as space is limited he only carries a small number of items. In past income years this stock has been valued at year end at between $5,000 and $7,000. At the end of the previous income year he valued his stock at $6,800. Colin's business has not changed during the current income year. He estimates that the quantity of stock held at the end of the current income year is similar to the amount held in previous income years. However, he knows that the cost of most items has risen by an average 15% during the current income year. On this basis he increases the value of stock on hand at the end of last income year by 15% to arrive at a reasonable estimate of $8,000. As the difference between his opening stock value ($6,800) and his reasonable estimate of closing stock ($8,000) is not more than $5,000, Colin doesn't need to do a stocktake or account for the change in the value of trading stock when calculating his assessable income.

More about making a reasonable estimate Simplified tax system: simplified trading stock rules (Nat 4107)

Stock not paid for is included in the reasonable estimate of stock on hand

A reasonable estimate must take into account the value of all trading stock on hand, including stock that has not yet been paid for.

However, you still claim a deduction for trading stock on the same basis as you claim your other expenses. If you are claiming your deductions when they are paid, as distinct from when they are incurred, you cannot claim a deduction for the cost of your trading stock until you have paid for it.

Applying the STS trading stock rules

Value of trading stock changes by $5,000 or less

Where the difference between the value of trading stock on hand at the start of an income year and a reasonable estimate of the value at the end of the year is $5,000 or less, as an STS taxpayer, you do not have to account for any change in the value of trading stock on hand.

This means you do not have to do a stocktake for tax purposes, nor do you have to include an amount equal to the change in the value of your stock in your assessable income.

Example: Dave's trading stock (part 1)

Dave runs a small art supplies shop and enters the STS for the 2002-03 income year. The value of his stock on hand at 1 July 2002 is $5,700 and he reasonably estimates the value at 30 June 2003 to be $6,700. As the difference is not more than $5,000 he does not need to do a stocktake or account for the change in the value of trading stock when calculating his assessable income. The value of Dave's trading stock at the end of the 2002-03 income year is $5,700 - the same as at the start of 2002-03. This would be the opening value of his stock for the 2003-04 income year.

Choosing to do a stocktake

As an STS taxpayer, you can choose to do a stocktake and include the change in value in your assessable income even if that change is $5,000 or less. You might make this choice if you prefer to:

• increase your assessable income in small increments over a number of years (assuming the value of your stock is increasing) - rather than making one large adjustment when the increase in stock value reaches the $5,000 threshold, or
• reduce your assessable income immediately (assuming the value of your stock has decreased).

Where an STS taxpayer chooses to account for the change in value, the general trading stock rules apply (see below).

Example: Dave's trading stock (part 2)

Dave chooses to account for the change in value of his trading stock. He must do a stocktake and value each item of trading stock on hand at 30 June 2003 at either its cost, market selling value or replacement value. He elects to value each item at cost and values his closing stock at $6,780. Because he has chosen to account for the change in value, the difference of $1,080 ($6,780 - $5,700) is included in Dave's assessable income for the 2002-03 income year.

Value of trading stock changes by more than $5,000

Where the difference between the value of trading stock on hand at the start of an income year and a reasonable estimate of the value at the end of the year is more than $5,000 the general trading stock rules apply.

This means, as an STS taxpayer, you must value each item of trading stock on hand at the end of the year at its cost, market selling value or replacement value, and account for the change in value between the opening stock and closing stock.

The general trading stock rules apply regardless of whether the difference of $5,000 or more is an increase or a decrease in the value of stock on hand.

Example: Dave's trading stock (part 3)

Assuming Dave chooses not to account for the change in value of trading stock in 2002-03, his opening stock in 2003-04 is deemed to be $5,700. Dave reasonably estimates the value of his closing stock in 2003-04 to be $8,000. As the difference is less than $5,000 he does not need to do a stocktake or include the increase in value of his stock in his assessable income. The value of his opening stock for 2004-05 is deemed to be $5,700. Dave reasonably estimates the value of his closing stock in 2004-05 to be $12,000. As the difference between the opening stock ($5,700) and his reasonable estimate of closing stock ($12,000) is greater than $5,000, Dave must do a stocktake and account for the increase in value of his stock.

General trading stock rules

The general trading stock rules apply to you as an STS taxpayer where:

• the change in the value of your trading stock is more than $5,000, or
• the change in the value of your trading stock is $5,000 or less but you choose to do a stocktake and account for the change in value.

The general trading stock rules also apply to taxpayers who are not in the STS.

If the general trading stock rules apply, you must record the value of all trading stock you have on hand at:

• the beginning of the income year (generally 1 July), and
• the end of the income year (generally 30 June).

One annual stocktake is sufficient to meet tax obligations because the value of stock at the end of an income year will be the same as its value at the start of the next income year.

If the value of closing stock is more than that of opening stock, the difference must be included as part of your assessable income.

If the value of closing stock is less than that of opening stock, your assessable income is reduced by the difference.

Where a business starts during an income year, the total value of stock on hand at the end of that year is included in the taxpayer's assessable income.

STS grouping rules

Chapter 9

This chapter explains the STS grouping rules.

All taxpayers considering entry to the STS need to look at whether they are grouped with any other taxpayers to determine whether they meet the eligibility requirements.

When working out your eligibility for the STS, you must take into account the turnover and depreciating assets of any taxpayers that you are grouped with under the STS grouping rules.

If you are grouped with one or more other taxpayers, you do not need to enter the STS just because some or all of those other taxpayers have chosen to enter the STS.

Grouping rules

A taxpayer will be grouped with another taxpayer if:

• they are STS affiliates of each other
• one taxpayer controls the other, or
• both taxpayers are controlled by the same third party.

The remainder of this chapter explains each of these situations.

Other references Taxation Ruling TR 2002/6 - Income tax: Simplified Tax System: eligibility - grouping rules (*STS affiliate, control of non fixed trusts) Simplified tax system: grouping rules (NAT 7169)

Rule 1: Taxpayers are STS affiliates of each other

You are an STS affiliate of another taxpayer if you carry on all, or a substantial part, of your business:

• as the other directs or wishes
• in concert with them, or
• could reasonably be expected to do so.

Broadly, carrying on a business 'in concert' with another taxpayer means conducting your business with a substantial degree of dependence on, or connection with, that other taxpayer's business. Factors to consider in determining whether you are carrying on your businesses in concert with another include:

• the nature and extent of the commercial dealings between the two businesses
• any common resources, facilities or services
• the involvement of the other in their managerial decisions and day-to-day management
• financial interdependencies (for example, financial support, shared banking arrangements)
• any common flow of profits, and
• any common ownership or capital backing.

Working together on a specific venture and sharing in the profits of that venture does not automatically mean two businesses are acting in concert, if the underlying businesses continue to be operated independently

Generally, you would not be an STS affiliate of another taxpayer if you:

• have different employees
• have different business premises
• have separate bank accounts
• do not consult each other on business matters, and
• conduct your business independently in all regards.

When considered in combination these factors ensure that businesses that operate independently of each other are not grouped together under Rule 1.

Even if you are not grouped with a particular taxpayer under Rule 1 you need to consider whether you are grouped with them under rules 2 or 3. You should also consider whether you are grouped with any other taxpayers under any of the rules in the income year in question.

Example: Two taxpayers are STS affiliates of each other

Elena and Tom each operate an office outfitting business. Elena's business is run through Elena Fitouts Pty Ltd, which specialises in fitting office partitions. Tom's business is run through Tom Fitouts Pty Ltd, which installs work station units. Elena is the managing director of her company and a director of Tom's company. Tom is the managing director of his company and a director of Elena's company. Elena and Tom take an active role in the management of both companies. Elena Fitouts Pty Ltd and Tom Fitouts Pty Ltd trade from the same business premises, of which they are joint tenants. Elena Fitouts Pty Ltd employs three staff and Tom Fitouts Pty Ltd employs four staff. The staff is used by each company and they carry out work for each other's clients. Elena Fitouts Pty Ltd owns two trucks and Tom Fitouts Pty Ltd one, which all the staff uses as necessary. Elena Fitouts Pty Ltd often services the same clients as Tom Fitouts Pty Ltd and the staff of each company recommends the services of the other company wherever possible. Given the substantial connection between the two companies, each company would be regarded as an STS affiliate of the other. This means that a two-way STS affiliate relationship exists and the two companies would be grouped. Elena Fitouts Pty Ltd and Tom Fitouts Pty Ltd would be grouped under Rule 1 Elena Fitouts Pty Ltd and Tom Fitouts Pty Ltd would each have to include the turnover and value of the depreciating assets of the other with their own in calculating whether they are eligible to enter the STS. Each company also needs to determine whether they are grouped with any other entities under rules 1, 2 and 3.

Example: Only one taxpayer is an STS affiliate

Ross operates a successful plumbing business as a sole trader. Ross's son Joel helps in the business.

Business is so good that Ross cannot keep up with demand. He suggests that Joel start his own business as a sole trader. Joel agrees. Ross provides some start-up capital for Joel and refers his excess customers to him. Ross helps with any jobs Joel cannot manage, tells Joel what jobs to accept and how much to charge. He also arranges advertising for Joel. Ross takes time out from his own business to make his expertise and equipment available to Joel as required. He also orders materials for himself and Joel at the same time to benefit from bulk discounts. Ross lets Joel know each year what proportion of his profits to pass on to Ross in repayment for his initial capital contribution. Joel is running his business as Ross directs him to and in accordance with Ross's wishes. Joel would therefore be an STS affiliate of Ross. However, Ross does not run his business as Joel directs or in concert with him. As a result Ross would not be Joel's STS affiliate. Ross and Joel are not grouped under Rule 1 The businesses of Ross and Joel would not be grouped because Ross and Joel would not be STS affiliates of each other. None of the other grouping rules apply to Ross and Joel. They do not need to add the turnover and value of the depreciating assets of the other's business to determine whether they are eligible to enter the STS. </

Example: Neither taxpayer is an STS affiliate

Kathy and Ning each own and operate their own internet service provider business. Kathy and Ning operate their respective businesses independently of each other. They employ different staff, are located in different cities, have different clients and have no involvement in the day-to-day management or financial affairs of each other's business. They decide to embark on a joint undertaking to offer website design services. In relation to this specific venture they work together on matters like the marketing of the website service and the provision of suitable staff. Kathy and Ning are not grouped While Kathy and Ning work together on this particular venture and both share in the profits, it cannot be said that either conducts all or a substantial part of her business as the other wishes or directs or in concert with the other. The underlying businesses continue to be operated independently. For this reason neither would be the STS affiliate of the other. None of the other grouping rules apply. Therefore no grouping of turnover or depreciating assets would be needed.

Partners in partnerships

A partner in a partnership is not an STS affiliate of the other partner(s) in that partnership simply because they act in concert in respect of the partnership business. To be STS affiliates, the partners would need to act in concert in respect of a business separate from that partnership.

Spouses

Spouses are not STS affiliates simply because they are related people. The grouping rules must be considered separately for each person.

Example: Married couples

Bill and Maria are married. Maria owns and manages a travel agency. Bill owns his own record store. The two businesses operate from separate premises, maintain different bank accounts and employ different staff. The profits from each business flow to Bill and Maria respectively. While Bill and Maria discuss how their respective businesses are going, neither directs nor takes an active part in the management of the other's business. These businesses are not grouped

Bill and Maria would not be STS affiliates of each other and no grouping of turnover or depreciating assets would be needed.

Franchises

Franchisees and franchisors are not STS affiliates simply because of the franchise arrangement. Whether they act in concert in respect of their franchise businesses depends on, among other things, the nature of the franchise agreements between the two parties.

Rule 2: One taxpayer controls the other

Whether one taxpayer controls another will vary depending on the type of taxpayers they are - that is, whether they are a company, partnership, or trust.

Even if a taxpayer is not grouped with another taxpayer under Rule 2, they may be grouped with them under Rule 3. Also, they need to consider whether they are grouped with any other taxpayers in that year.

Control of a company

When looking at the question of control, you need to consider whether you have an interest in any company and whether their STS affiliates have an interest in any companies. If you have STS affiliates with interests in a company, you could be grouped with that company.

You control a company if you and/or your STS affiliates have shares in the company that give you and/or your STS affiliates at least 40% of the voting power in the company.

You also control a company if you and/or your STS affiliates have the right to receive at least 40% of any distribution of income or capital by the company. Again, this means that you will need to consider the interests of your STS affiliates when working out if you control a company.

Example: Control of a company by an STS affiliate

Continuing from the Example: Only one taxpayer is an STS affiliate (above), Ross and Joel are plumbers and operate as sole traders. Given the facts in that example, Joel would be an STS affiliate of Ross but Ross would not be an STS affiliate of Joel. Ross and Joel would therefore not be grouped. Joel's wife Aimee operates a bakery through her company AJ Cakes. Joel and Aimee are both 50% shareholders in AJ Cakes. Ross has no involvement with AJ Cakes

Ross has no involvement with AJ Cakes. Nonetheless, Ross would be grouped with AJ Cakes because his STS affiliate Joel has a 50% shareholding in AJ Cakes that entitles him to exercise 50% of the voting power. Ross would have to add the turnover and depreciating assets of AJ Cakes to that of his own business to see if he is eligible to join the STS. Ross does not consider Joel's turnover and depreciating assets when considering if he is eligible to join the STS because he and Joel are not STS affiliates of each other.

Control and partnerships

You control a partnership if you and/or your STS affiliates have the right to 40% or more of the partnership's net income or have at least a 40% interest in partnership assets (except leased assets) used in the partnership business.

A partnership controls another company, trust or partnership if one or more partners have control of the partnership and the same one or more partners have:

• if the other taxpayer is a company - the right to receive 40% or more of any company distribution of income or capital, or to exercise 40% or more of the voting power in the company
• if the other taxpayer is another partnership - the right to receive 40% or more of that partnership's net income or at least a 40% interest in assets used in that other partnership business
• if the other taxpayer is a fixed trust - the right to receive 40% or more of any trust distribution
• if the other taxpayer is a non-fixed trust - control over the non-fixed (discretionary) trust (see below).

Example: Partnership controls another partnership

Elaine and Santokh are partners in a partnership (P1) that operates an accounting practice. The partnership has a turnover of $800,000. The partnership agreement specifies that the profits and losses of P1 are shared in the following way: Elaine - 60% share, and Santokh - 40% share. Elaine, Santokh and Robert also operate another partnership (P2) that publishes a taxation magazine. The turnover of the second partnership is $600,000. That partnership agreement specifies that the profits and losses of P2 are shared in the following way: Elaine - 30% share Santokh - 20% share, and Robert - 50% share. The grouping rules operate to treat P1 as controlling P2

Because Elaine and Santokh together have the right to receive at least 40% of the net income of both P1 and P2, the grouping rules operate to treat P1 as controlling P2. In this example P2 would also control P1. P1 would add the turnover of P2 to its own when working out its STS group turnover and P2 would include P1's turnover when calculating its STS group turnover. As well, both partnerships would include the value of depreciating assets of the other partnership with their own when calculating eligibility.

Control of a fixed trust

You control a fixed trust if you and/or your STS affiliates have the right to receive 40% or more of any distribution of income or capital by the fixed trust.

As with the control rule for companies, you will need to consider the interests of your STS affiliates when determining if you control a fixed trust.

Control of a non-fixed (discretionary) trust

Under the STS grouping provisions, you control a non-fixed trust if:

• you and/or your STS affiliates have received a trust distribution in any of the previous four income years of $100,000 or more (the 'distribution test'), or
• you and/or your STS affiliates:
  • have the power (directly or indirectly) to obtain the beneficial enjoyment of any of the trust income or capital, or
  • are capable of gaining that beneficial enjoyment under a scheme (the 'beneficial enjoyment test'), or
• a trustee of the trust is accustomed, under an obligation, or might reasonably be expected, to act in accordance with your and/or your STS affiliates' directions, wishes or instructions (the 'influence over the trustee test').

Example: Influence over the trustee

Ann owns and runs a restaurant. Ann's husband established and managed a real estate business until his death five years previously. When he died, Ann established the Jones Family Trading Trust, a non-fixed trust. The trust carries on the real estate business previously run by Ann's husband.

Ann appointed her brother Michael, a solicitor, as trustee. The trust makes distributions each year to its beneficiaries, Ann and her two children. For each of the five years that the trust has been in operation, Ann has told Michael how much of the income from the trust to distribute to herself and each child. The history of distributions made by Michael as trustee shows that Michael is accustomed to act in accordance with Ann's wishes and instructions. Anne is grouped with the Trust

Ann influences the actions of the trustee (Michael) in relation to the trust, so she controls the Jones Family Trading Trust and would be grouped with it.</

Rule 3: Both taxpayers are controlled by the same third party

Taxpayers who are otherwise unconnected will be grouped if both are controlled by the same third party.

Even if you are grouped with another taxpayer under Rule 3 you still need to consider whether you are grouped with any other taxpayers in the income year in question.

Example: Taxpayers controlled by the same third party

Nick controls company A Pty Ltd. He also controls company B Pty Ltd. Company A and company B are otherwise unconnected. The two companies would be grouped because they are both controlled by Nick.

A Pty Ltd and B Pty Ltd are grouped

A Pty Ltd and B Pty Ltd would each have to include the turnover and value of the depreciating assets of the other company with their own in calculating whether they are eligible to enter the STS.

Indirect control

Control includes indirect control. This means if you directly control a second taxpayer, and the second taxpayer controls a third taxpayer either directly or indirectly, you are taken to also control the third taxpayer.

Example: Indirect control by third party

Jenny holds 75% of the shares in company J Pty Ltd. J Pty Ltd receives over $100,000 each year in distributions from K Trust, which is a non-fixed trust. Jenny has no direct connection with K Trust.

Jenny controls J Pty Ltd and K Trust

Jenny controls J Pty Ltd, which in turn controls K Trust (see 'Control of a non-fixed discretionary trust'). Jenny would be taken to control K Trust because of J Pty Ltd's controlling interest in the trust. J Pty Ltd and K Trust would be grouped because J Pty Ltd controls K Trust. J Pty Ltd and K Trust would each have to include the turnover and value of the depreciating assets of the other with their own in calculating whether they are eligible to enter the STS. They also need to include Jenny's turnover and the value of her depreciating assets because both are controlled by Jenny. Jenny will be grouped with J Pty Ltd and K Trust and will need to include the turnover and depreciating assets of both with her own when considering if she meets the turnover and depreciating asset eligibility tests.

Flexibility regarding the control test

The Commissioner of Taxation can determine that taxpayer A should not be grouped with taxpayer B if:

• taxpayer A has an entitlement to at least 40% but less than 50% of any income or capital distributed by taxpayer B or at least 40% but less than 50% of the voting power in taxpayer B (if it is a company), and
• the Commissioner is satisfied or thinks it reasonable to assume that taxpayer B is controlled by another taxpayer.

The 25% entrepreneurs' tax offset

Chapter 10

This chapter explains who is eligible for the entrepreneurs' tax offset (ETO) and how it is calculated.

The ETO is available for assessments relating to income years starting on or after 1 July 2005.

It allows a tax offset (reduction) equal to 25% of the income tax liability attributable to the business income of a business in the STS with an annual group turnover of $50,000 or less. If the STS group turnover is more than $50,000, the ETO is progressively phased out so that the offset ceases once the STS turnover reaches $75,000.

The tax offset is non-refundable.

Other reference Subdivision 61-J of the Income Tax Assessment Act 1997

Eligibility

The ETO is available to:

• an individual or a company that is an STS taxpayer
• a partner in an STS partnership, and
• a trustee or beneficiary of an STS trust, depending on who is liable for tax on the trust income,

where:

• the STS group turnover* for the year is less than $75,000, and
• they have net STS income for the year (that is, the STS annual turnover has to be more than the allowable deductions that relate to that turnover).

• To determine the STS group turnover it is necessary to work out the STS annual turnover of each STS entity that is grouped with you.

See Chapter 2 for more information about STS group turnover.

STS annual turnover

Your STS annual turnover for a year is the total value of the business supplies you made during the year. If you are not grouped with any other entity, your STS group turnover will also be your STS annual turnover.

Unlike STS group turnover, your STS annual turnover does not include the value of business supplies made by any entities that you are grouped with.

Business carried on for only part of a year

For the purposes of the ETO, if the business has been carried on for only part of the year, there is no need to use a reasonable estimate of what the STS annual turnover or STS group turnover would have been if you had been in business for the whole year.

This is in contrast to what is required when calculating your STS average turnover or STS group turnover for the purpose of determining your eligibility for the STS.

(see Chapter 2)

Net STS income

This is the amount for an income year by which your STS annual turnover exceeds the sum of the deductions attributable to that turnover. The deductions attributable to the STS annual turnover are the allowable deductions that you can claim against your assessable income which specifically relate to that turnover.

The following allowable deductions do not specifically relate to STS annual turnover:

• tax losses from prior years under Division 36 of the ITAA 1997
• superannuation contributions under s82AAT of the ITAA 1936
• gifts or donations, and
• costs of managing your or the entity's tax affairs under s25-5 of the ITAA 1997.

Non-commercial losses

Non-commercial losses which are deferred in the loss year are not taken into account in working out net STS income. This is because amounts which are deferred are taken not to have been incurred in the loss year and therefore are not a deduction that is attributable to STS annual turnover in the loss year.

Amounts which have been deferred from an earlier year that are a deduction in a later year are attributable to STS annual turnover provided the total of all deductions relevant to that activity, including the deferred losses, does not exceed the assessable income from that business activity. If the total deductions exceed the assessable income from the business activity and the excess is again deferred, the deferred amount is not taken into account in working out net STS income in the deferral year.

Accumulated deferred losses and other amounts which are deductions attributable to STS annual turnover can only reduce net STS income to nil.

Partnership distributions and deferred losses

Deferred non-commercial losses from a partnership activity that become deductible in a later year are a deduction of the partner and therefore do not reduce the partnership's net STS income. The deferred losses that the partner is entitled to claim for income tax purposes do not reduce the partner's net STS income share from the partnership for ETO purposes.

Example: Determining the net STS income

Niki is an STS taxpayer who is not grouped with any other entities under the STS grouping rules. She runs a home-based business whose STS annual turnover for the year is $35,000. Niki claims deductions for her business expenses such as materials, stationery, postage and electricity expenses relating to her home office. These business expenses total $5,000. Niki also has salary and wage income of $60,000 for the year. She is a member of a trade union and she subscribes to a professional journal. Her work-related expenses total $1,200. In addition, Niki has a negatively geared share portfolio from which she receives $5,000 dividend income and has $6,000 of interest expenses related to borrowings to acquire the shares. Niki therefore makes a loss for taxation purposes of $1,000 from her share investments. Niki's net STS income for the year is the amount by which her STS annual turnover of $35,000 exceeds her deductions attributable to that turnover (that is, $5,000). Therefore, her net STS income is $30,000. Niki's work-related expenses and the expenses relating to her share investments do not affect her STS annual turnover. The income from her share investments is not included in her STS annual turnover as the dividends do not constitute taxable supplies.

How the ETO is calculated

The method of calculating the ETO depends on the type of entity. That is, there is a specific calculation method that applies to a taxpayer who is:

• an individual or company
• a partner in an STS partnership
• a trustee of an STS trust, or
• a beneficiary of an STS trust.

If the taxpayer is an individual or a company

Step 1:	Work out the taxable income for the year.
Step 2:	Work out 25% of the basic income tax liability on that taxable income (in working this out, use the applicable tax rates and take into account any special provisions that affect the calculation of liability, but don't take any tax offsets into account).
Step 3:	Work out the STS percentage using the formula: net STS income for the year x 100 taxable income for the year
If the percentage that results is more than 100%, the STS percentage is 100%.
Step 4:	If the STS group turnover is $50,000 or less, the tax offset is: Step 2 amount x STS percentage
Step 5:	If the STS group turnover is more than $50,000, the offset is adjusted by the STS phase-out fraction. This is worked out using the formula:
	$75,000 - the STS group turnover for the year $25,000
	The tax offset is then: Step 2 amount x STS percentage x STS phase-out fraction

Example: Company
Elpin Pty Ltd is an STS taxpayer for the year ended 30 June 2006. The company's STS group turnover for the year is $50,000, net STS income for the year is $40,000 and taxable income for the year is $80,000. Elpin Pty Ltd is entitled to a tax offset.
The Step 1 amount	=	$80,000 (taxable income)
The Step 2 amount	=	25% of Elpin's basic income tax liability of *$24,000
	=	$6,000
The Step 3 percentage	=	$40,000 / $80,000 X 100
	=	50% (the STS percentage)
The Step 4 amount	=	$6,000 x 50%
	=	$3,000
Step 5 is not applicable as the company's STS group turnover is not more than $50,000. Elpin Pty Ltd is entitled to a tax offset of $3,000. * taxable income of $80,000 multiplied by the 30% company tax rate

Example: Sole trader with other non-business income
Kalee runs a business from her home and is an STS taxpayer for the year ended 30 June 2006. The net income from her business is $18,000 (representing a turnover of $28,000 less business expenses of $10,000). In addition she has a part-time job as an employee from which she receives a salary of $27,000.
The Step 1 amount	=	$18,000 + $27,000
	=	$45,000 (taxable income)
The Step 2 amount	=	25% of Kalee's basic income tax liability of *$9,360
	=	$2,340
The Step 3 percentage	=	$18,000 / $45,000 X 100
	=	40% (the STS percentage)
The Step 4 amount	=	$2,340 x 40%
	=	$936
Step 5 is not applicable as her STS group turnover is not more than $50,000. Kalee is entitled to a tax offset of $936. * resident individual tax rates applying to taxable income of $45,000

Example: Company turnover between $50,000 and $75,000
Mitzi Pty Ltd is an STS taxpayer for the year ended 30 June 2006. The company has net STS income of $20,000 (representing annual turnover of $60,000 less expenses of $40,000) and no other source of income. Kalico Pty Ltd is a grouped entity of Mitzi Pty Ltd and has turnover of $10,000, but is making a loss. The STS group turnover of the two companies is $70,000. Mitzi Pty Ltd is therefore eligible for the tax offset.
The Step 1 amount	=	$20,000 (Mitzi's taxable income)
The Step 2 amount	=	25% of Mitzi's basic income tax liability of *$6,000
	=	$1,500
The Step 3 percentage	=	$20,000 / $20,000 x 100
	=	100% (the STS percentage)
Step 4 is not applicable as the STS group turnover is more than $50,000. Therefore the tax offset is adjusted by the STS phase-out fraction.
The Step 5 amount	= =	($75,000 - $70,000) / $25,000 0.2 (the STS phase out fraction)
Mitzi Pty Ltd is entitled to a tax offset of:
$1,500 x 100% x 0.2	=	$300
* taxable income of $20,000 multiplied by the 30% company tax rate

If the taxpayer is a partner in an STS partnership

If you are a partner in a partnership that is an STS taxpayer, the partnership's STS group turnover determines eligibility for the ETO.

However, it is the partner's taxable income and the partner's share of the partnership's net STS income (the partner's net STS income) that is used in Steps 1 to 3 of the following calculation method.

Step 1:	Work out the partner's taxable income for the year.
Step 2:	Work out 25% of the basic income tax liability on that taxable income (in working this out, use the applicable tax rates and take into account any special provisions that affect the calculation of liability, but don't take any tax offsets into account).
Step 3:	Work out the STS percentage using the formula: the partner's net STS income x 100 the partner's taxable income for the year
If the percentage that results is more than 100%, the STS percentage is 100%.
Step 4:	If the STS group turnover of the partnership is $50,000 or less, the tax offset is: Step 2 amount x STS percentage
Step 5:	If the STS group turnover of the partnership is more than $50,000, the offset is adjusted by the STS phase-out fraction. This is worked out using the formula:
	$75,000 - the partnership's STS group turnover for the year $25,000
	The tax offset is then: Step 2 amount x STS percentage x STS phase-out fraction

Example: Partner in an STS partnership
Michael and Zoe are equal partners in a partnership which is an STS taxpayer for the year ended 30 June 2006. The net income of the partnership is $44,100 (representing a turnover of $50,000 less business expenses of $5,900). In addition, Michael has a part-time job as an employee from which he receives a salary of $30,450.
The Step 1 amount	=	$22,050 + $30,450
	=	$52,500 (Michael's taxable income)
The Step 2 amount	=	25% of Michael's basic income tax liability of *$11,610
	=	$2,902.50
The Step 3 percentage	=	$22,050 / $52,500 x 100
	=	42% (the STS percentage)
The Step 4 amount	=	$2,902.50 x 42%
	=	$1,219.05
Step 5 is not applicable as the partnership's STS group turnover is not more than $50,000. Michael is entitled to a tax offset of $1,219.05 * resident individual tax rates applying to taxable income of $52,500

If the taxpayer is a trustee of an STS trust

If you are a trustee of a trust that is an STS taxpayer, the trust's STS group turnover determines eligibility for the ETO.

However, it is the net income of the trust and that part of the trust's net STS income that the trustee is liable to be assessed on under either section 98, 99 or 99A of the ITAA 1936 (the trustee's net STS income share) that is used in Steps 1 to 3 of the following calculation method.

Step 1:	Work out the net income of the trust for the year.
Step 2:	Work out 25% of the trustee's income tax liability on that net income (in working this out, use the applicable tax rates and take into account any special provisions that affect the calculation of liability, but don't take any tax offsets into account).
Step 3:	Work out the STS percentage using the formula: the trustee's net STS income share x 100 the net income of the trust for the year
If the percentage that results is more than 100%, the STS percentage is 100%.
Step 4:	If the trust's STS group turnover is $50,000 or less, the tax offset is: Step 2 amount x STS percentage
Step 5:	If the trust's STS group turnover is more than $50,000, the offset is adjusted by the STS phase-out fraction. This is worked out using the formula:
	$75,000 - the trust's STS group turnover for the year $25,000
	The tax offset is then: Step 2 amount x STS percentage x STS phase-out fraction

Example: Trustee of an STS trust
The ABC trust is an STS taxpayer for the year ended 30 June 2006. The net income of the trust for the income year was $40,000 (representing business turnover of $45,000 less business expenses of $10,000 and net rental income from a residential rental property of $5,000). The trust is not grouped with any other entity so the STS group turnover of the trust is also $45,000. Thomas is a non-resident beneficiary of the ABC trust who received all of the net income of the trust for the year ended 30 June 2006. The trustee of the ABC trust will be assessed under section 98 of the ITAA 1936 in respect of the net income of the trust which was distributed to Thomas.
The Step 1 amount	=	$40,000
The Step 2 amount	=	25% of the income tax liability of *$11,784
	=	$2,946
The Step 3 percentage	=	$35,000 / $40,000 x 100
	=	87.5% (the STS percentage)
The Step 4 amount	=	$2,946 x 87.5%
	=	$2,577.75
Step 5 is not applicable as the trust's STS group turnover is not more than $50,000. The trustee is entitled to a tax offset of $2,577.75 * non-resident individual tax rates applying to the trust net income of $40,000

If the taxpayer is a beneficiary of an STS trust

If the taxpayer is a beneficiary of a trust that is an STS taxpayer, the trust's STS group turnover determines eligibility for the ETO.

However, it is the beneficiary's taxable income and the beneficiary's share of the trust's net STS income (the beneficiary's net STS income) that is used in Steps 1 to 3 of the following calculation method.

Step 1:	Work out the beneficiary's taxable income for the year.
Step 2:	Work out 25% of the beneficiary's income tax liability on that taxable income (in working this out, use the applicable tax rates and take into account any special provisions that affect the calculation of liability, but don't take any tax offsets into account).
Step 3:	Work out the STS percentage using the formula: the beneficiary's net STS income x 100 the beneficiary's taxable income for the year
If the percentage that results is more than 100%, the STS percentage is 100%.
Step 4:	If the trust's STS group turnover is $50,000 or less, the tax offset is: Step 2 amount x STS percentage
Step 5:	If the trust's STS group turnover is more than $50,000, the offset is adjusted by the STS phase-out fraction. This is worked out using the formula:
	$75,000 - the trust's STS group turnover for the year $25,000
	The tax offset is then: Step 2 amount x STS percentage x STS phase-out fraction

Example: Beneficiary of an STS trust
The ABC trust is an STS taxpayer for the year ended 30 June 2006. The net income of the trust for the income year was $40,000 (representing business turnover of $45,000 less business expenses of $10,000 and net rental income from a residential rental property of $5,000). The trust is not grouped with any other entity so the STS group turnover of the trust is also $45,000. Sarah is a resident beneficiary of the ABC trust who received a 50% share of the net income from the trust of $20,000. Sarah also has salary of $30,000. The trustee will need to advise Sarah of the trust's STS group turnover and her share of the net STS income (50% of $35,000 = $17,500) of the trust.
The Step 1 amount	=	$50,000
The Step 2 amount	=	25% of the income tax liability of *$10,860
	=	$2,715
The Step 3 percentage	=	$17,500 / $50,000 x 100
	=	35% (the STS percentage)
The Step 4 amount	=	$2,715 x 35%
	=	$950.25
Step 5 is not applicable as the trust's STS group turnover is not more than $50,000. Sarah is entitled to a tax offset of $950.25 * resident individual tax rates applying to taxable income of $50,000

Can a taxpayer be eligible for more than one ETO in an income year?

You may be eligible for more than one ETO in the same income year, where you receive STS income from more than one source.

For example, if you are a sole trader who has elected into the STS, and are also a partner in a partnership that has elected into the STS, you may be entitled to an ETO in respect of your income as a sole trader and also in respect of your share of the STS income from the partnership.

However, if the partnership and the sole trader are grouped entities, the amount of STS group turnover has to be taken into account in determining your eligibility for an ETO.

The ETO and PAYG instalments

The ETO is not taken into consideration when determining the rate of PAYG instalments. The ETO is excluded from the determination of the rate of PAYG instalments.

If you anticipate that you will be entitled to an ETO on assessment, you may vary your instalments during the year. However, you may be liable to the general interest charge where a variation results in an underestimation of the instalments of more than 15%.

Glossary

Adjustable value

The adjustable value of an asset is the asset's cost less its decline in value since it was first used or installed ready for use for any purpose, whether business or private.

Assessable income

Assessable income is ordinary income and statutory income.

Asset value

The asset value for a depreciating asset that was first used, or installed ready for use for a taxable purpose:

• while the taxpayer was not an STS taxpayer is the asset's adjustable value at the start of the income year in which it was allocated to a pool
• while the taxpayer was an STS taxpayer-is the asset's adjustable value at the time the asset was first used, or installed ready for use, for a taxable purpose.

The asset value includes the cost of any improvements.

Balancing adjustment amount

A balancing adjustment amount is worked out by comparing the asset's termination value and its adjustable value at the time of the balancing adjustment event. If the termination value is greater than the adjustable value, the excess is included in assessable income. If the termination value is less than the adjustable value, the difference is deductible.

Balancing adjustment event

A balancing adjustment event occurs where a depreciating asset ceases to be held (for example, the asset is sold) or used for any purpose.

Cost

The cost of an asset includes both the amount paid for it and any additional amounts spent on transporting and installing the asset. Cost also includes amounts spent on improving the asset.

Cost addition amounts

Cost addition amounts include the cost of capital improvements to assets and costs reasonably attributable to disposing of or permanently ceasing to use an asset (this may include advertising and commission costs or the costs of demolishing the asset).

Current year estimate

The current year estimate is the taxpayer's estimate of how much an asset will be used to produce assessable income in the current income year.

Decline in value

The value of a capital asset, which provides a benefit over a number of years declines over the asset's effective life. A deduction is allowable for the decline in value of a depreciating asset to the extent it is used for a taxable purpose.

Depreciating asset

A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the period it is used, except land, items of trading stock and certain intangible assets.

Depreciating asset lease

A depreciating asset lease is an agreement under which the right to use a depreciating asset is granted to another person by the holder. It does not include a hire purchase agreement or a short-term hire agreement.

Diminishing value method

The diminishing value method is a method used to calculate the decline in value of an asset. It assumes that the decline in value each year is a constant proportion of the remaining value and produces a progressively smaller decline over time.

Effective life

Broadly, the effective life of a depreciating asset is how long it can be used by a taxpayer for a taxable purpose, or for the purpose of producing exempt income, having regard to reasonable wear and tear and assuming reasonable levels of maintenance.

Effective life is expressed in years, including fractions of years.

Fixed trust

A trust is a fixed trust if one or more persons have fixed entitlements to all of the income and capital of the trust.

General STS pool

The general STS pool is the pool to which depreciating assets are allocated if they have effective lives of less than 25 years.

GST credit

A GST credit is referred to as an input tax credit under the GST legislation. If an STS taxpayer is registered for GST they will be able to claim a GST credit for the GST component of the purchase price of an item they use in their business.

Hire purchase agreement

Broadly, a hire purchase agreement is:

• a contract for the hire of goods, or
• an agreement for the purchase of goods by instalments where title in the goods does not pass until the final instalment is paid.

Horticultural plants

A horticultural plant is a live plant or fungus that is cultivated or propagated for any of its products or parts.

Last estimate

The last estimate is either the original estimate or a previously adjusted estimate of how much an asset will be used to produce assessable income.

Long life STS pool

The long life STS pool is the pool to which depreciating assets are allocated if they have effective lives of 25 years or more.

Low-cost asset

A low-cost asset is one whose cost at the end of the year in which it was first used or installed ready for use for a taxable purpose was less than $1,000 (excludes horticultural plants).

Low-value asset

A low-value asset is one that is not a low-cost asset but has an opening adjustable value of less than $1,000 and deductions have been calculated using the diminishing value method.

Net STS income

This is the amount for an income year by which the entity's STS annual turnover exceeds the sum of the entity's deductions attributable to that turnover.

Non-fixed trust

A non-fixed trust is a trust in which persons do not have a fixed entitlement to all of the income and capital of the trust.

Ordinary income

Ordinary income is income according to ordinary concepts.

Person

Person includes a company.

Personal services entity

A personal services entity is a company, partnership or trust whose ordinary income or statutory income includes the personal services income of one or more individuals.

Personal services income

Personal services income is income that is mainly a reward for an individual's personal efforts or skills.

Reduction factor

For assets that were first used, or installed for use, for a taxable purpose while the taxpayer was not an STS taxpayer, the reduction factor for assets in the general pool is:

• 0.7 for the income year after it is allocated to the pool
• 0.49 for the income year after that, and
• 0.343 for the income year after that.

For assets that were first used, or installed for use, for a taxable purpose while the taxpayer was an STS taxpayer, the reduction factor for assets in the general pool is:

• 0.85 for the income year after it was allocated to the pool
• 0.595 for the income year after that, and
• 0.417 for the income year after that.

Retail fuel

Retail fuel is gasoline and diesel within the meaning of the Fuel Sales Grants Act 2000 that is sold by retail. It also includes liquefied petroleum gas sold by retail.

Short-term hire agreement

A short-term hire agreement is an agreement for the intermittent hire of an asset on an hourly, daily, weekly or monthly basis.

Statutory income

Statutory income is income that is not ordinary income and that is included in assessable income by a specific provision. A net capital gain is statutory income.

STS affiliate

An STS affiliate of a taxpayer is an entity that acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, in relation to the affairs of the entity's business.

STS annual turnover

The sum for an income year of the value of the business supplies the entity made in the year.

STS average turnover

STS average turnover for an income year is the sum of the relevant STS group turnovers divided by the number of averaging years.

STS group turnover

STS group turnover for an income year is:

• the value of the business supplies made by a taxpayer during that year, plus
• the value of the business supplies made during the year by any other entities grouped with the taxpayer under the STS grouping rules, excluding the value of any intra-group supplies.

STS taxpayer

An STS taxpayer is a taxpayer that is eligible and elects to join the STS.

Taxable purpose

An asset is used for a taxable purpose if it is used for the purpose of producing assessable income.

Taxable purpose proportion

The taxable purpose proportion is a taxpayer's estimate (expressed as a percentage) of how much they use a depreciating asset for a taxable purpose, such as for producing assessable income.

Taxable supply

A taxable supply is a supply on which GST is payable.

Tax-related expense

A tax-related expense is an expense that is for managing a taxpayer's affairs or complying with an obligation imposed on a taxpayer by a Commonwealth law as it relates to the tax affairs of an entity. It also includes the general interest charge under Division 1 of Part IIA of the Taxation Administration Act 1953.

Termination value

Generally the termination value is the amount received for an asset when a balancing adjustment event occurs, such as the proceeds of selling an asset.

Trading stock

Trading stock includes:

• anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business, and
• livestock.

Value of the business supplies

The value of the business supplies a taxpayer makes in an income year is the sum of:

• for taxable supplies (if any) the entity made during the year in the ordinary course of carrying on a business - the value of the supplies, and
• for other supplies the entity made during the year in the ordinary course of carrying on a business - the prices of the supplies.

More information

For more information see the Simplified tax system (available on the businesses section of this website) or you can:

• talk to your tax adviser
• phone us on 13 28 66, or
• write to us at Locked Bag 9000, Albury NSW 2640.

If you do not speak English well and want to talk to a tax officer, phone the Translating and Interpreting Service on 13 14 50 for help with your call.

If you have a hearing or speech impairment and have access to appropriate TTY or modem equipment, phone 13 36 77.

If you do not have access to TTY or modem equipment, phone the Speech to Speech Relay Service on 1300 555 727.

Last Modified: Thursday, 19 July 2007

Copyright

Commonwealth of Australia

This work is copyright. You may download, display, print and reproduce this material in unaltered form only (retaining this notice) for your personal, non-commercial use or use within your organisation. Apart from any use as permitted under the Copyright Act 1968, all other rights are reserved.

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ATO references:
NO NAT 6459