Why do the primary producers get to fiddle with the tax rate?What is income averaging?
Why do the primary producers get to fiddle with the tax rate?
Averaging of incomes is only required because of the progressive tax rates
What kinds of people are allowed to average their income?
2 ways to avoid any disadvantages from averaging your income
How do you work out your average income?
The Income Tax Assessment Act has several measures aimed at promoting horizontal and vertical equity.
Vertical Equity - the more income you get, the greater the percentage of that income you can afford to pay in tax
… or … a dollar paid in tax costs a poor man more than 100 dollars paid in tax costs a rich man.Horizontal Equity - all people are equal, but some are more equal than others
… or … a dollar paid in tax costs a person with 10 children to support more than 100 dollars paid in tax costs a person with only one child to support.So, people on the same income should pay the same EFFECTIVE amount of tax, and those with higher incomes should pay a higher EFFECTIVE amount of tax.
To achieve this outcome, various personal tax rebates are given to taxpayers who support dependants, to alleviate the burden of the tax they must bear compared to others on the same income (and same amount of gross tax liability) who do not have the expense of looking after dependants.
Taxpayers involved in primary production businesses are provided with various concessions in an attempt to take into account the fact that a high income in good years will almost certainly be followed by a low income in drought, flood, stock disease affected years.
The most famous concession is the right to work out a customised tax rate to take into account this variability of income - the sections of the Income Tax Assessment Act authorising this benefit are known as the AVERAGING PROVISIONS.
For many years, this concession was greatly coveted by many who did not rely on primary production income for a living, but took advantage of the averaging provisions by purchasing farming properties principally for the taxation benefits they would receive.
In an attempt to confine the benefits to those for whom they were intended, the Commissioner attacked on two fronts.
The tax law was changed to restrict the averaging provisions to farming income.
An attempt was made to ensure that only those taxpayers whose activities amounted to a business operation were allowed the status of primary producers.
Averaging of incomes is only required because of the progressive tax rates
The introduction of the progressive rate scale to ensure that people who earn higher incomes pay a larger proportion of that income in tax, has unintended effects of persons whose income can fluctuate wildly, such as primary producers. This is demonstrated by the following example.
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Wage earner |
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Farmer |
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Year 1 |
Income= 20,700 |
Tax= $3,060 |
Income=nil |
Tax= nil |
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Year 2 |
Income= 20,700 |
Tax= $3,060 |
Income=nil |
Tax= nil |
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Year 3 |
Income= 20,700 |
Tax= $3,060 |
Income= $60,210 |
Tax=$18,900.70 |
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Total income = $60,210 |
Total tax = $9,180 |
Total income = $60,210 |
Total tax = $18,900.70 |
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This inequitable situation arises because of the tax rate structure. So it is fitting that it is solved by 'juggling' the rates, to take into account the uneven income flows of persons involved in primary production
This involves calculating the
tax rate which would be applied to a taxable income equal to the average of the farmer's taxable incomes for a five year period and applying that rate to the current year's taxable incomeIf the amount of tax which would be payable using this average rate is less than the tax payable on that income using the current year tax rate then a rebate is allowed.
This has the effect of subjecting the income to tax at the average rate.
If the application of the average rate to the current year's income results in more tax being payable, that extra amount must be paid by the farmer.
What kinds of people are allowed to average their income?
Before we look at how we calculate average income, let's first work out to whom the provisions apply ... Refer sec
392-10 which deals with individuals. (Section 392-20 deals with beneficiaries of trust)Section
392-10(1) confines the provisions toWhat if you have been using the averaging provisions but now no longer carry on a primary production business?
You keep averaging if your assessable income for the income year included assessable income that was
derived from, or
resulted from,
your having carried on that business. See section 392-10(2)
2 ways to avoid any disadvantages from averaging your income
first way: What if you no longer wish to have average rates applied to your income because you will be worse off?
Section
392-25 allows you to opt out, but it is a privilege you will be allowed once and once only.Second way: If you can show the Commissioner your
income has been permanently reduced to less than 2/3 of your average income, you can wipe the slate clean and start againSection
392-95 provides details - it won't help you for the current year, but thereafter, you are treated as if you had not carried on a primary production business before the reduction year.How do you work out your average income?
Refer section
392-45Step 1. Add up your basic taxable income for each of the income years over which you must average your basic taxable income.
Step 2. Divide the sum by the number of those income years.
And just what is basic taxable income
Refer to section
392-15. It is your assessable income lessCapital gains
certain superannuation payments included by section 27B(1A) of the 1936 Assessment Act
Amounts included by another income smoothing provision known as above-average special professional income included in your taxable income for the income year under Division 405.
Why deduct capital gains, etc?
Because we are trying to smooth out the income, not take into account one off type occurrences like selling some capital asset!
What if you made a loss?
Your taxable income is treated as nil.
Section 392-15(2)
Answer this question….
What is the average income of the farmer in year 5?
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Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
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$1000 |
$2000 |
$3000 |
$4000 |
$5000 |
(Just enter the amount - no $ sign or comma, please)
answer =(1000 + 2000 + 3000 + 4000 + 5000)/5 = 15000/5 = 3000
Answer this question….
A farmer derives $4000 in his first year then $3000, $2000, $1000, $2000, as in the table.
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Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
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$4000 |
$3000 |
$2000 |
$1000 |
$2000 |
(Just enter the amount - no $ sign please)
Remember, you do not start averaging until your income goes up, which happens in year 4. So to get the average income add $1000 and $2000 and divide by 2 years (that's 1500 for the numerically impaired)
.
Answer this question….
What is the average income of the farmer in year 5?
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Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
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-4000 |
-3000 |
-2000 |
-1000 |
$5000 |
(Just enter the amount - no $ sign or comma, please)
Section
392-15(2) - Any nil or negative income is treated as zero for averaging purposes. So divide 0 + 0 + 0 + 0 + 5000 by 5 to get 1000Now work out how much tax you pay on your basic taxable income
Get out your tax rates table!
Look up the tax you would pay on your basic taxable income.
Done that? Good! You have satisfied section
392-50And how much you would pay if you had derived an amount equal to your average income(We call this the comparison rate)
Keep that tax rates table ready!
Look up the tax you would pay on your average taxable income.
Done that? Good! You will use that to work out the comparison rate, which you will be using to calculate the tax offset or extra tax payable. Section
392-55 say the|
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Income tax on average income |
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Comparison rate = |
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Average income |
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