Basic Tax Principles You Must Know
Tax is complex. It’s probably the most complex area of law impacting commercial endeavors.
Australians pay tax on income and on capital gains. The purpose of investing is to generate income and capital gains. So tax is everywhere. Its important you are aware of the basics regarding Tax in Australia. Some basic tax principles are explored below...
Basic tax principles
1) Taxable income and assessable income
Personal taxpayers pay tax assessed on their “taxable income” which is defined as assessable income less allowable deductions. Assessable income is a broad concept and includes amounts that are income under ordinary concepts, such as rent, and amounts that are deemed to be income under specific provisions in the income tax law, such as net capital gains on the sale of assets.
2) Tax Deductions
Allowable deductions includes costs that are deductible under ordinary concepts (the general principles of deductibility) because they are connected to generating assessable income, or more broadly are connected to an assessable income producing business, and are not private or domestic or capital in nature.
3) Capital Gains
A capital gain or capital loss on an asset is the difference between what it cost you and what you receive when you dispose of it.
You pay tax on your capital gains. It forms part of your income tax and is not considered a separate tax – though it's referred to as capital gains tax (CGT).
If you make a capital loss, you can't claim it against income but you can use it to reduce a capital gain in the same income year. And if your capital losses exceed your capital gains in an income year, you can generally carry the loss forward and deduct it against capital gains in future years.
4) Gearing & Gearing Costs
Interest (i.e. interest paid on an investment loan) is an example of such a deduction. Allowable deductions also includes amounts which are not deductible under ordinary concepts but which are made specifically deductible under a specific provision of the tax law, such as depreciation of plant and equipment and building allowance claims.
In some cases a loss or outgoing may be deductible under the general principles of deductibility and also be specifically deductible under a specific provision of the tax law. Rates and repairs are examples of such deductions. A taxpayer can only claim the deduction once, and not twice, in circumstances like these.
It’s quite common for person’s taxable income to be above $80,000, which means they pay 37 cents for every extra, or marginal, dollar of income. This phenomena drives the concept of negative gearing: for a tax payer in the 37% tax range every dollar of negative gearing loss produces a tax benefit of 37 cents (plus Medicare levy), and for a taxpayer in the 45% tax range the every dollar of negative gearing loss produces a tax benefit of 45 cents (plus Medicare levy).
These tax benefits can be seen as a second rent cheque: a reduction (or refund) of tax connected to ownership of the property and forming part of the economic return or reward for owning the property. This is actually a key point to understand: a large part of the attraction of property derives from its income tax efficacy and the tax benefits of negative gearing.
Historically these tax benefits have driven the Australian property market, particularly the residential property investment market, where the low rent yields translate to relatively higher negative gearing losses.
Investing gives rise to taxation needs
Tax permeates financial planning principles. It’s everywhere. Australians pay tax on income and on capital gains. The purpose of investing is to generate income and capital gains. So tax is everywhere.
Tax is complex. It’s probably the most complex area of law impacting commercial endeavors. Full time practitioners take decades of daily practice and study to get across the issues. Many never get there. The most they realistically achieve is a sub-specialty or two: they focus on just a few areas of the tax law, rather than the entire tax law, because this is all that is realistically achievable. There is just too much to know.
So, how can you make sure you have got the tax side of things covered? What is your solution?