1 Week 1—Introduction to revenue law in

Australia
Introduction
In all modern economies, governments fund their activities through taxation and by borrowing, and in some
cases by carrying on profit making commercial activities. Such funding is required to provide the infrastructure
and services demanded by modern society.
For an efficient and effective tax system to operate, there must exist some objective standard to identify
taxpayers and how much they should pay, and some government instrumentality which can effectively collect
such tax.
This module will provide you with an historical perspective of the development of the Australian taxing regime,
and introduce the framework and key concepts required to operate in the current taxation environment.

Objectives
On completion of this module, students should be able to:
• explain the Constitutional basis of Federal income tax
• discuss the evolution of the Australian taxation system
• explain the scheme of the Australian income tax legislation
• identify the roles of the legislation, Courts, and Commissioner in the taxation environment
• identify the key concepts in application of the taxation legislation.

Readings
For all modules in this course you will need your textbook by you.

Textbook Foundations of Taxation Law

Ch. 1, Ch. 2, Ch. 3, Ch. 4, Ch. 5, Ch. 6, Ch. 7, Ch. 8
Optional reference Australian Master Tax Guide
Ch. 1

While the readings in the text for this week are quite extensive, you should aim for a general overview and
broad understanding of the matters, rather than a deep understanding. These materials are designed to set the
context for the substantive issues that follow in later modules.
The reading material for this module will give you the necessary background to understand the structure upon
which all further modules will be based.

Imposition of taxes
Reasons for taxation
The underlying reason for taxation is to divert economic resources from the private sector for use by the
government sector. Under public finance theory, the expenditure functions of government which necessitate
taxes fall into three groups:
1. provision of public goods—that is, goods better provided by the public sector, or those which the private
sector would not provide; for example, defence, provision of a legal system etc.
2. economic stabilisation—that is, stabilising economic fluctuations through government intervention
3. distributive and redistributive function—that is wealth redistribution to assist those who may be
disadvantaged; and arguably to assist in maintaining a democratic system.

Types of taxation
In general terms taxes may be seen as being one of two types:
1. direct tax on earnings, that is income, capital gains etc.
2. taxes on consumption or expenditure, for example, GST.
Consumption tax may itself be subdivided into:
• direct consumption tax, being levied when income is consumed rather than saved
• indirect consumption taxes, including stamp duty, customs duty and excise etc.
Direct taxes are so called as the incidence of tax falls to the taxpayer, that is the tax cannot be passed on. Direct
taxes are generally based on ability to pay, and with Australian income tax, the tax is a progressive tax,
increasing with income, with an exemption below a threshold level. With indirect taxes, however, the level of
tax is uniform with no regard to level of income. Since indirect taxes generally do not take account of ability to
pay they are generally considered regressive and unfair.
Australian regimes impose both direct income tax, and direct and indirect consumption taxes. This course will
predominantly deal with income tax, but will also examine the GST (goods and services tax) and FBT (fringe
benefit tax).
Alternatives to taxation for raising revenue, almost all of which have been used at different times in history,
include commandeering resources, creating money, borrowing, or applying user charges.

Evaluation of tax systems

Criteria for evaluating tax systems are derived from economic theory. The criteria used relate to how well the
tax system operates in creating equity, efficiency or neutrality, and simplicity, in regard to taxpayers affected by
the system, and business decisions made within the system.
Equity
The equity criterion comprises two components. Horizontal equity suggests that taxpayers on an equal level,
that is with the same wealth or with the same income, should be taxed equally. Vertical equity looks to
taxpayers with a higher level of wealth or income being taxed at a higher rate than those on lower levels, thus
introducing the concept of a progressive tax system which is the system operating on income tax in Australia,
where marginal rates increase at higher income levels.
As will be apparent, the difficulty with these concepts is the measurement of wealth or income in deciding at
which level taxpayers are situated.
Efficiency or neutrality
The concept of efficiency or neutrality is concerned with the impact of the tax system on business or investment
decisions. In theory, the tax system should have no impact on business decisions, these being made on a purely
commercial basis, in which situation the tax system will be considered neutral, with market investment
decisions resulting in the most efficient use of available resources.
It may be (and often is) the case that decisions are made by governments to use the taxation system to give
concessions to certain industries or investments so as to encourage such undertakings. In this way the system
becomes non-neutral in that tax considerations then act to influence commercial decisions.
Simplicity
The final criterion of simplicity concerns compliance considerations, in that taxpayers, be they individuals or
corporations, should be able to access, interpret, and comply with the requirements of the taxation system,
without incurring undue cost. A simplicity initiative of the Government was the introduction of the
‘TAXPACK’, and more recently e-tax.
In terms of accessibility, the ATO website now contains a great deal of information designed to assist
practitioners and the public by providing easy access to required information.
A system which meets all of these criteria will be judged to be a preferable system for both revenue collecting
authorities and taxpayers. As noted, however, the tax system can be used by governments to achieve aims other
than raising revenue, and from an economic viewpoint the system then becomes sub-optimal.
Among a variety of other matters that should be considered, are:
• need to prevent tax avoidance and evasion
• need to recognise impact of inflation on tax system
• interaction of tax and social security systems
• harmonisation of Federal, State and Local taxes.

Overview of Commonwealth taxation

At present only the Commonwealth government exercises the power to directly raise income tax, with State
taxing being limited to indirect taxes. This has not always been the situation.

Evolution of Australian taxes

Prior to Federation in 1901, the States were separate colonies which could each levy its own tax, with South
Australia being the first to impose an income tax in 1884. The economic slump of the 1890’s saw other States
following suit.
Upon Federation, the Commonwealth was given general taxing powers under s. 51(ii) of the Constitution, and
exclusive power to impose customs and excise duty under s. 90 of the Constitution.
Income taxes were first raised by the Federal government in 1915–1916 for additional revenue for the war
effort, resulting in both the Federal and State governments raising income tax, with the States collecting on
behalf of the Commonwealth. This required taxpayers to complete two separate tax returns. The Commonwealth
appointed Royal Commission on Taxation (1932–1933) recommended preparation of a uniform Tax Assessment
Act, the result of which was the Income Tax Assessment Act (1936), adopted by the Commonwealth and States,
the system still retaining separate Commonwealth and State taxes.
Partly as a result of divergence again appearing between the State Acts, and partly as a war-time measure to
raise revenue for the war effort, the Commonwealth took control of income taxing in 1942. As the
Commonwealth did not have Constitutional power to prevent the States levying income tax, the approach
adopted was four-fold, with legislation being passed to:
• impose Australia wide Commonwealth income tax, at a rate to yield the same revenue as previously
collected by the States and Commonwealth combined
• require the Commonwealth tax to be paid before the State tax
• require the Commonwealth to reimburse States for revenue they would have collected, so long as the State
did not levy its own income tax
• transfer State taxation officers to the Commonwealth.
These steps effectively prevented the States from continuing to raise their own income tax, the validity of the
measures having been affirmed in South Australia v The Commonwealth (The First Uniform Tax Case) (1942) 2
AITR 273.

Reforms of the 1980s

Increasing political and social dissatisfaction with tax evasion which grew during the 1970s prompted major
taxation reforms which began in the late 1980s. The process began with the release by the treasurer of a draft
paper Reform of the Australian Tax System (RATS), and was followed by the tax summit in 1985.
The result was a substantial restructuring of the income tax system, rather than changing to a consumption tax,
with the tax base being broadened. Some of the major policy developments included:
• capital gains tax
• fringe benefits tax
• foreign tax credits for foreign taxes paid
• dividend imputation to eliminate double tax on dividends.

Reforms of the 1990s

The major push throughout the 1990s was for a broadening of the tax base to include a tax on all goods and
services, rather than the main focus being on the taxation of income.
In December 1998 the first set of measures to introduce a GST were introduced to Parliament. The GST is seen
as a broad-based indirect tax system to replace wholesale sales tax, and a number of State indirect taxes. In
broad terms the GST taxes the consumption of goods, services, and anything else in Australia, including
imports, but will not apply to consumption outside Australia, including exports. The tax is effectively a tax on
final private consumption in Australia.
The GST received Royal Assent on 8 July 1999 and was introduced from 1 July 2000.

Reforms of the 2000s

The other major tax reform in the early 2000s arose from The Ralph Report. The Ralph Report contained
numerous recommendations that have been accepted by the Government. A number of these reforms were
operative from 1 July 2001 such as the reduced company tax rate. Other reforms arising from the Ralph Report
were introduced throughout the early 2000s, such as the Uniform Capital Allowance rules, simplified
imputation, consolidation and reforms to the Taxation of Financial Arrangements (TOFA).
The Board of Taxation was also established pursuant to recommendations arising in the Ralph Report. This
Board is established as an independent, non-statutory body established to advise the Government on the
development and implementation of tax legislation and the ongoing operation of the tax system. The Board has
been involved in reviews across a number of areas of significance to the tax system such as small business
compliance costs, a GST administration review and a review into the application of consistent self-assessment
principles.
In addition to the Board of Taxation, the position of Inspector-General of Taxation was established in 2003.
This is an independent statutory office with the stated role of improving the administration of the tax laws for
the benefit of all taxpayers, providing independent advice to the Government on the administration of tax laws
and identifying systemic issues in the administration of the tax laws.

Recent reforms
The most recent round of reforms that have occurred involve the introduction of the Clean Energy Future
legislation (carbon tax) and carbon pricing regimes with associated reforms including cuts to personal tax rates
and the raising of the tax free threshold. A raft of different legislative measures were passed in conjunction with
the carbon tax legislation which introduce a number of associated changes and other measures which are not
directly associated, but are dependent on, the revenue generated by the introduction of the carbon tax for their
funding. Other major tax initiatives that have recently been introduced are related to taxes on mining and iron
ore (mineral resources rent tax) and extensions to the petroleum resources rent tax. With the change in
Government in 2013 many of these changes are now set to be reversed. Reforms have also been made in the
area of superannuation, including the introduction of a new default superannuation product, MySuper, and the
raising of the superannuation guarantee charge from 9% to 12% over the period from 2012/13 to 2019/20. The
new Government is also proposing to slow down the rate of increase in the superannuation guarantee charge by
freezing the rate at 9.25% for a period of time.
Tax Law Improvement Program (TLIP)
Because of the partially completed rewrite of the tax legislation there are currently two main tax acts, the
Income Tax Assessment Act 1936, and the Income Tax Assessment Act 1997, with the new provisions. Both are
used in this course.
You should refer to the textbook or references as to the new structure of the legislation, as this will assist in
finding your way through the provisions. Section 2–1 to 2–45 ITAA 1997 explain the structure of the new
legislation.

Constraints on Federal taxation

While s. 51(ii) of the Constitution empowers Federal parliament to make laws ‘... with respect to ... Taxation’,
such laws cannot discriminate between States or parts of States. Additionally, s. 55 of the Constitution provides
that laws imposing taxation can deal with no other matters, and may deal with one subject of taxation only. This
limitation is generally understood to mean that one law cannot deal with the assessment and collection of tax
and also deal with the imposing of a tax by fixing the rate of tax. As is illustrated later, this limitation has been
overcome by enacting separate Acts, each dealing with only one matter.
As the revenue raising power from income tax is presently exercised solely by the Federal government,
arrangements have been put in place for the sharing of the revenue raised with the states. In the 1976 tax sharing
arrangements the States received a prescribed percentage of income tax revenue raised. In 1978, the States were
effectively allowed to levy their own income tax, the provision remaining unused and being repealed in 1989.
With the introduction of GST from 1 July 2000, revenue raised through the GST is broadly intended to be made
available to the States and Territories upon agreement with the Federal Government. This arrangement is
intended to compensate States and Territories for the indirect tax revenue that the GST replaces.

Sources of taxation law

Against this brief historical background, the sources of taxation law which you will be using in this course are
introduced. Three main sources may be identified, being Statute Law (legislation), Common Law (from decided
cases), and Australian Tax Office procedures or rulings. Statute Law and Common Law are referred to as
primary sources of law. Australian Tax Office Rulings and other sources of law are referred to as secondary
sources of law.

Statute law
As noted previously, income tax legislation is contained in several Acts. In summary, these include:
• Income Tax Assessment Act 1936—existing provisions not yet rewritten under the TLIP.
• Income Tax Assessment Act 1997—new provisions introduced as part of the TLIP.
• Income Tax Regulations—specify how certain parts of the ITAA are to be interpreted and applied.
• Rating Acts—impose the tax rates on the assessable income as determined under the ITAA.
• International Agreements—provide for co-operation between Australia and other countries in preventing
double taxation or avoidance of taxation between the countries.
• Taxation Administration Act—administrative powers of the Australian Taxation Office (ATO), and offence
and prosecution provisions.
• Fringe Benefits Tax legislation—imposes tax on fringe benefits provided to employees.
• Goods and Services Tax legislation—imposing and administering the GST.
• Crimes (Taxation Offences) Act—relates to fraudulent evasion of income tax.
• Taxation (Unpaid Company Tax) Assessment Act—provides for recovery of tax evaded.

Interpreting tax legislation

By its nature, taxation law is often general in its language, with the basic concepts being imprecise. In the
interpretation of the legislation, two broad approaches may be identified: the literal approach and the substance
approach.
Literal approach
The principles upon which the literal approach is founded are that:
• any tax must be imposed by clear words, with ambiguity being interpreted against the Crown
• tax legislation will be interpreted according to its letter and not its purpose, that is, the literal or ’black letter’
approach
• the Duke of Westminster principle from a 1936 House of Lords decision, whereby taxpayers will be taxed on
the form of the transaction rather than the substance.
The form of the transaction refers to the outward appearance of the transaction, while the substance is the true
underlying effect of the transaction. The two may be very different, as the form may be that of an ordinary
commercial transaction, while in substance the transaction may have been designed for purely tax avoidance
reasons.
In IRC v Duke of Westminster (1936) AC 1, Lord Tomlin suggested that
Every man is entitled if he can order his affairs so as that the tax attaching ...is less than it otherwise would be. If
he succeeds in ordering them so as to serve this result, ...he cannot be compelled to pay an increased tax. This so
called doctrine of ‘the substance’ seems to me to be nothing more than an attempt to make a man pay
notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable.

The literal interpretation was summarised by Rowlatt J. in Cape Brandy Syndicate v IRC [1921] 1 KB 64 at 71,
by noting:
It means this, I think; it means that in taxation you have to look simply at what is clearly said. There is no room for
any intendment; there is no equity about a tax; there is no presumption as to a tax; you read nothing in; you imply
nothing, but you look fairly at what is said and at what is said clearly, and that is the tax.

Substance approach
During the 1980s, courts moved away from the literal approach, adopting an approach more in favour of
substance rather than form. This broader and more practical view has resulted partly from changes in the make
up of the High Court, partly from a greater willingness by courts to display greater acceptance of general
accounting principles, and partly from amendments to the Acts Interpretation Act governing interpretation of all
Federal legislation.
Section 15AA of the Acts Interpretation Act now requires that in interpreting legislation, the meaning to be
preferred is that which supports the underlying purpose or object of the legislation, whether the purpose or
object is expressly stated or not.
Section 15AB of this Act allows for consideration by courts of material outside the legislation being interpreted
where it will assist in ascertaining the meaning of the provision, but only where the meaning is ambiguous or
obscure, or the ordinary meaning would lead to an unreasonable result.
Case law (common law)
The major role for courts in taxation law has been interpretation of statutes, although overriding legislation may
be passed where the government is not satisfied that the court decision represents the correct or desired
interpretation of the law.
The doctrine of precedent holds that decisions may be legally binding or persuasive if similar matters are
litigated again. The doctrine of precedent will only apply to bind a lower court to follow a relevant decision of a
higher court, with decisions of the Administrative Appeals Tribunal having no formal status as a precedent at
all. A judgement from a court usually consists of a ratio decidendi or reason for the decision, and obiter dicta or
other things said, and it is only the ratio decidendi which is binding, although the obiter dicta may be persuasive
in another case.
For taxation cases, the significant tribunals are the Administrative Appeals Tribunal, which is generally the first
line of appeal outside of the ATO; the Federal Court which is next up the hierarchy of appeals; and the High
Court. Appeals to the High Court on taxation matters are only available with special leave from the High Court,
making the Federal Court the highest court to which access on taxation matters is available as a right.
Australian Taxation Office rulings
The Commissioner issues a number of documents designed to promulgate information to members of the public.
These documents are public rulings, private rulings, oral rulings, product rulings, class rulings and
determinations. The broad intention of these documents is to make interpretations and decisions of the
Commissioner available to the public to assist in their interpretation of the law.
A public ruling must state that it is a public ruling and will refer to a person or class of persons or arrangement
or class of arrangements. A private ruling, by contrast, will refer to a specific taxpayer, law and transaction.
Private rulings can still be published without any identifying information to identify the parties to the ruling.
Oral rulings can be sought by individuals in relation to simple tax affairs. Product rulings and class rulings
represent the ruling of the Commissioner in relation to a specific product or arrangements that relate to groups
or individuals. All rulings are binding on the Commissioner to the extent that they are favourable to the taxpayer
and they relate to an arrangement to be carried out after 1 July 1992.
Taxation determinations are designed to complement tax rulings by addressing a particular issue that may arise
in relation at a scenario which may already be affected by a ruling.
There are also a number of other types of written advice that emanate from the Australian Taxation Office but
which do not have the status of rulings as being binding on the Commissioner. These are practice statements,
interpretative decision, case decision summaries and taxpayer alerts. While these documents do not have any
legal status they are useful documents to indicate to a taxpayer what the practice of the Commissioner may be in
certain circumstances.

Basic operation of income tax

This final section of the module is the most critical, in that the terms introduced here will be those you will be
dealing with for the remainder of the course, so a thorough understanding will be vital.
With the progress that had occurred on the Tax Law Improvement Program (TLIP), there are now two main
pieces of legislation, the Income Tax Assessment Act (ITAA) 1936, and Income Tax Assessment Act (ITAA)
1997. Both will be used in this course, with references to the appropriate act.
The main definition section of the ITAA 1936 is s. 6(1), and ITAA 1997 s. 995–1; but nowhere in this or any
other section is the term ’income’ defined.
Section 4–10 of the ITAA 1997 provides that tax must be paid each financial year (1 July–30 June) on the
taxable income derived during that income year by both residents and non-residents.
The income year, being defined in s. 995–1 and s. 4–10 ITAA 1997 generally corresponds to the financial year,
and runs from 1 July to 30 June.
The taxable income is the income on which tax will be calculated and paid in any year of income, and taxable
income is defined in s. 4–15 ITAA 1997 as being assessable income less all deductions. So:
Taxable Income = Assessable Income minus Allowable Deductions
Assessable income is defined in ss. 6–5 and 6–10 ITAA 1997 in terms of those amounts which are income at
ordinary concepts (as determined by the courts), and those amounts which are specifically included by statutory
provision.
Section 6–5 ITAA 1997 is very important and you must come to know it thoroughly. To fully interpret the
provision, an understanding is required of the key terms:
• resident—is the taxpayer a resident or non-resident?
• gross income—what constitutes this?
• derived—when is income derived?
• source—what is the source of the income?
• exempt income—what income is exempt?
These terms are dealt with in detail in the following modules.
The definition of allowable deduction in s. 995–1 ITAA 1997 is again of little assistance, but s. 8–1 ITAA 1997
considers what expenditure will be an allowable deduction. Again this is a critical section, and will be
considered in detail later in the course.
After calculating the taxable income, the amount of tax to be paid can be determined by applying the applicable
rate of tax to the taxable income, thus calculating the tax payable for the income year.
This is not the end of the matter however, as the taxpayer may be entitled to a tax offset (previously known as a
rebate) because of their family situation or place of living. If this is the case, the tax offset will be deducted from
the tax payable.
Finally, the Medicare Levy must be calculated based on the taxable income, and added to the previously
calculated tax, giving the final figure for tax payable.
In the form of an example, the calculation will appear as follows:

Gross income 40 000

less exempt income 2 000

Assessable income 38 000

less allowable deductions 5 000

Taxable income 33 000

Tax payable on taxable income 2 812.00

less tax offsets 500.00

2 312.00

add Medicare levy

(1.5% of taxable income) 495.00

Net tax payable 2 807.00

It is important that you fully understand the difference between the terms:
• assessable income—the gross amount of all items of income, and those to be included as income, and
• taxable income—assessable income minus allowable deduction
and between the terms:
• allowable deduction—amount deducted from assessable income to calculate taxable income, and
• tax offset—amount deducted from the gross tax payable.
While this may appear to be a simple calculation, much of this course will be spent examining in detail each of
the items in the calculation and those amounts which are included or excluded at each step of the process. You
should have the taxing formula in mind as the end result of your calculations. At each step of the subject you
will be dealing with matters which determine the values in this calculation.

Overview of course structure

Taxing formula:
Assessable income: income at ordinary concepts— Week 2 and Week 3
• residence
• source
• derivation
statutory inclusions
• capital gains and trading stock—Week 4
• exempt income—not assessable—Week 3
less
Allowable deductions incurred in earning assessable income—Week 5
Statutory inclusions—Week 6
• repairs
• capital allowances
• gifts
• etc.
Taxable income * Tax rate = Tax payable—Week 7
less
Tax offsets—Week 7
• medical
• zone
• etc.
plus
Medicare levy—Week 7

Conclusion
Taxation systems should not be considered in isolation, but need to be viewed in the context of
economic/financial circumstances and government requirements. It should be remembered that the taxation
system is probably the major fiscal measure the government has access to in pursuing its economic goals, and
can also be a major tool in policy implementation.
The consideration of the development of the Australian tax system is largely to provide a context for study of
the current system, and to provide for an understanding of the constitutional and statutory limits within which
the current system must operate.
Modules in this course will deal in turn with the detail of assessable income, allowable deductions, and tax
offsets, but in studying the details of each of these components, you should not lose sight as to where the
elements fit in the overall scheme of taxation and the development of the taxing formula.