Effect Of Specific Deductions On Income Tax Return Filing Of Australian Individual Resident Taxpayer

Aims and Objectives

The system of taxation in Australia allows wage-earning taxpayers to claim certain specific expenses, classified as Work Related Expenses (WREs), as deductions from their taxable income. The Australian Taxation Office (ATO), the controlling authority, has never been able to provide a rationale for these provisions. This paper looks into the reasons behind the possible rationale, especially their effects on equity and efficiency of the considerations. Although a broad analysis tends to suggest that the deductibility of WREs has a neutral equity impact. But their impact on efficiency is more prominent, if not controlled properly. The long-term effect can lead to disruptions in consumption and production. When combined with their high compliance costs which the ATO has to bear for implementing these provision, the findings, discussions and analysis of these Specific Deductions justify the recommendation of this paper to abolish WRE deductibility. 

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This paper aims at understanding the Australian Individual Taxpayer’s trend regarding Specific Deductions while filing their Income Tax Returns during the income years 2011-12 to 2015-16. This paper will analyze the trends by making a comparison on the basis of male/female taxpayers and on the basis of deductions claimed on the basis of income brackets and the quantum of deductions claimed. 

On the basis of the aims and objectives, the research question has been limited to –

“Effect of Specific Deductions on Income Tax Return Filing of Australian Individual Resident Taxpayer”. 

The present structure of Australia’s taxation system is reliant on the nineteenth century rulings when each of Australia’s six states (then referred to as colonies) had a very distinct tax system and this was entirely dependent on imposing customs and excise duties. Reinhardt & Steel, 2006 have pointed out in their paper “A brief history of Australia’s tax system” that the aim of imposing the tax system was driven by the administrative concerns of the authorities, rather than on principles of equity or efficiency. Reinhardt & Steel, 2006 further state that the major changes in the administration of taxes took place between 1915 and 1942. Although income tax was levied both at state and federal level, it did not make things easier for individual taxpayer and subsequently led to more complexity and inequitable taxation at the individual taxpayer level. 

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Fiona Martin, author of “The Socio-Political and Legal History of the Tax Deduction for Donations to Charities in Australia and how the Public Benevolent Institution Developed” is very sceptical at the ATO’s partisan outlook on taxation concerning individual taxpayer. In her paper she points out how the contributions (termed as donations) of individual taxpayers to specific charities is declared tax-free for the recipients. This creates excessive burden on the individual taxpayer, who has to bear the cost of this tax exemption. This is acting like a two-sided sword hurting the innocent and obedient individual taxpayer (Martin, 2017). Taking her argument further, Martin, 2017 says that it is essential for the authorities to understand the implications of these concessions, in particular the deductions allowed to donations. Martin, 2017 has also pointed out that imposition of tax by a government is based on a social process and if any contradictory rules are imposed, the taxpayer finds it difficult to understand why taxation has been developed. Martin, 2017 says this makes it impossible for the individual taxpayer to comprehend this kind of taxation system and how can such dynamics bring about a change in the society. As per Martin, 2017, an understanding of how and why the taxation system is developed and can precipitate a change for further promotion and evolution of opinions, does have a big impact on fruitful future policy directions. 

Research Question

According to Reinhardt & Steel, 2006, the biggest challenge for the Federation was to create a two-tier system of government, wherein the States abolished the Customs and Excise duties and thus started the sharing of taxes between the Federal and State governments. Federal controlled most of the direct and indirect taxes whereas the States were given a free hand in levying State taxes. The biggest change, say Reinhardt & Steel, 2006, occurred in the field of deductions, especially for individual taxpayers. Every State formulated or offered concessions, depending on the socio-economic pattern of its society. 

As per Martin, 2017, Federal introduced the Payroll Tax in 1941 and this was fixed at 2.5% of an individual’s payroll. The individual taxpayer welcomed the ruling as it was aimed at promoting Child Welfare Schemes in the Commonwealth, as per Reinhardt & Steel, 2006. However, argues Martin, 2017, with surmounting tax competition between the States and intense lobbying by big employers, it led to several exemptions and this reduced the payroll tax base, greatly affecting the National Child Welfare agenda of the Federal. 

Reinhardt & Steel, 2006 are of the opinion that the scope of indirect taxes has grown in Australia in relation to the country’s economic activities and majorly due to an increase in revenue demands, both at the Federal as well as the State level. Martin, 2017 argues that major fallout started happening between Federal and State government as was evident from The Income Tax Act, 1907 (Vic), which was enacted by the State of Victoria to amend the rate of income tax and to add certain provisions to its Income Tax Act, 1895 (Vic). Martin, 2017 says that major changes were incorporated in those sections which dealt mainly with deductions of various kinds. Under Section 3 of the 1907 Act, a provision was made for allowing deductions related to Contributions to Charities or institutions of public service. However, admonishes Martin, 2017, it was still a discretionary power in the hands of the administrators as to who will be the recipient. The taxpayer, whose money was at stake, had no say in the selection of the recipient. 

According to Martin, 2017, the decision of the authorities to allow deductions for gifts, was motivated by the beliefs of influential politicians who opinionated that allowing a deduction to the taxpayer will motivate donations. But Reinhardt & Steel, 2006 do not agree with this and state that although it comes across as a strong factor in favour of deductions, the Royal Commission on Taxation was not in agreement with it. Reinhardt & Steel, 2006 also agree that this is an increased incentive towards avoiding taxation.

Professionals, such as doctors, are also affected by the deduction variations. According to Bryan, 2012, Service Trusts are a good alternative for the doctors. They provide a practice structure which allows the doctors to allow an appropriate distribution of their income to family members who are in the lower marginal tax rates slabs. Says Bryan, 2012 that a family member, who takes care of the doctor’s diary and does some administrative work in the office, can be paid by the doctor a moderate salary and which the doctor can claim as a deduction. 

Literature Review

This paper is mainly reliant on the data published by the ATO. The scope of this paper being limited to Specific Deductions of Australian Resident Individual Taxpayers, hence only data relevant to this scope has been taken for analysis purposes in this paper.

Wherever found feasible, a comparative analysis of the available data which has been found to be relevant to the aims and objectives and which satisfies the research question has been conducted under the head ‘Secondary Data’. 

10.55 million Australian taxpayers availed deductions in their tax returns for the income year 2011–12.

Per 100 people, 56 claims were from males and 44 from females. 58 claimed work-related expenses and of these, amounts claimed were:

  • Under $500 by 28 taxpayers.
  • Between $500 and $1,000 by 9 taxpayers.
  • Over $1,000 by 21 taxpayers. 

11.50 million Australian taxpayers availed deductions in their tax returns for the income year 2012–13.

Per 100 people, 52 returns were from males and 48 from females. 56 claimed work-related expenses and of these, amounts claimed were:

  • Under $500 by 19 taxpayers.
  • Between $500 and $1,000 by 11 taxpayers.
  • Over $1,000 by 26 taxpayers.

12.10 million Australian taxpayers availed deductions in their tax returns for the income year 2012–13.

Per 100 people, 53 returns were from males and 47 from females. 59 claimed work-related expenses and of these, amounts claimed were:

  • Under $500 by 21 taxpayers.
  • Between $500 and $1,000 by 9 taxpayers.
  • Over $1,000 by 29 taxpayers.

12.80 million Australian taxpayers availed deductions in their tax returns for the income year 2012–13.

Per 100 people, 50 returns were from males and 50 from females. 62 claimed work-related expenses and of these, amounts claimed were:

  • Under $500 by 26 taxpayers.
  • Between $500 and $1,000 by 12 taxpayers.
  • Over $1,000 by 24 taxpayers.

12.86 million Australian taxpayers availed deductions in their tax returns for the income year 2012–13.

Per 100 people, 52 returns were from males and 48 from females. 66 claimed work-related expenses and of these, amounts claimed were:

  • Under $500 by 24 taxpayers.
  • Between $500 and $1,000 by 11 taxpayers.
  • Over $1,000 by 31 taxpayers. 

Table – 1: Individual Australian Taxpayers – Selected Deductions

2011-12 to 2013-14 Income Years

The ATO keeps on looking for new areas for cutting down on individual taxpayer’s take-home-pay amount, (Bobek, Roberts & Sweeney, 2007). This is done in two different ways. First one concerns lowering of the various applicable threshold limits and the second one is connected with taking out more and more of the amounts spent by the individual taxpayer from the realm of deductions, (Wenzel, 2002). In the literature review section of this paper I discussed about most of the deductions being pushed out of the ambient of charitable contributions and charging the amounts as taxable at the hands of the individual taxpayer, (Marriott & Sim, 2016). I want to highlight another such anomaly being brought to practice by the ATO and this concerns the Superannuation Contributions. With effect from 1 July 2017, Division 293 threshold has been reduced to $250,000, from its prior limit of $300,000. Although it applies to high-end taxpayers, nonetheless, it does show how the ATO is not missing any chance of tightening its control over individual taxpayers, (James, Wallschutzky & Alley). 

I found a very interesting explanation of this on the home page of Division 293 on ATO website. It explained that although the threshold limit had been reduced by $50,000, the individual taxpayers were still saving on their tax liability, (James, 2016). The argument given was that despite being under the highest tax slab of 45%, the taxpayers are being charged tax only at 15% on amounts which exceed Division 293 threshold, (Lund, 2003). This is not the only case of tightening the noose of tax around the individual taxpayer’s neck. Another important one relates to maintaining a Home Office by an individual taxpayer and claiming deductions, (Evans & Nam, 2011). The ATO divides the expenses connected with Home Office into two broad categories – Occupancy Costs and Running Costs. Rent, rates, mortgage interest, repairs and insurance are treated as Occupancy Costs, whereas gas, electricity, cleaning and decline in value of the office equipment are treated as Running Costs. Under the general deduction s.8-1 of ITAA, 1997, the individual taxpayer can claim only the apportioned value of the Running Costs. To allow the Occupancy Costs, the ATO cites provisions of s.8-5 of the ITAA, 1997, where a distinction has been drawn by ATO between use of a home office as a place of business and a home office being used just for convenience, (Black, 2016).

The Honourable Treasurer, Joe Hockey, on 30 March 2015, released Re:think – Tax Discussion Paper. The purpose of this Tax Discussion Paper was not to recommend any specific changes in Australia’s tax system. Instead the Honourable Minister intended to generate an open discussion about the future direction to be taken by Australia’s tax system. I am discussing some of the relevant portions of this paper, which I found quite pertinent to the topic of this paper, (Burman, 2009). 

I am highlighting this aspect because income is the basis for a deduction. The Discussion Paper has outlined certain disparities when ATO taxes different incomes which are derived as a result of savings, such as interest earned, franked dividends and rental incomes, (Saunders, 1982). In all these incomes, the role of dividend imputation system explained by the ATO is the main contributor to these disparities. Apart from creating disparities, this anomaly imposes huge compliance costs, both on the taxpayers and governments, (Warren, 2016). This factor has also created a bias for the Australian resident taxpayers as they are forced to invest more in Australian shares than in investments connected with foreign companies, (Cho, Li & Uren, 2017). 

In the opinion of this paper, this disparity can be removed by introducing one rate of tax for all kinds of incomes derived from savings. Moreover, all incomes from the savings need to be taxed separately from other incomes, such as employment income. Along with this, the deductions also need to be treated separately in respect of the savings income, (McGregor-Lowndes, Newton & Marsden, 2016). 

In the opinion of this paper, there are at least three examples of other countries which have successfully changed the taxation treatment of dividends. The UK has introduced a partial imputation credit, whereas in Norway there is no imputation and the shareholders are granted exemption from taxation on dividends and finally in Germany, taxation of dividends is done at the company as well as at shareholder level, (Bryan, 2012).

As pointed out in the Literature Review, Superannuation is an important segment of savings for an individual taxpayer and needs to be addressed earnestly, (Hubbard & Skinner, 1996). This segment needs to be properly alienated with the requirements of Australia’s aging population. In the recent Intergenerational Report of the Australian Government published in 2015, it has been stated that number of Australians of age 65 and above, are expected to be more than double by 2055, (Black & Krever, 2006). This will automatically lead to a decline in the number of active workers and would also place a heavy dependence of this large aging people on the superannuation system, (Sakurai & Braithwaite, 2016). 

It is already an established fact that superannuation is among the most preferred savings vehicle for individual taxpayer in Australia mainly because of its low rate of tax on the contributions as well as earnings, which are currently being taxed at the concessional flat rate of 15%. Although this is greatly favoring those in the high income brackets who receive the largest tax benefit because of their relatively high marginal tax rate, which can go up to 45% currently, when they invest their savings in the superannuation funds and pay only 15% tax, (Blackley & Follain, 1996). 

In order to remove the disparity between the lower slab taxpayer and the higher slab taxpayer, The Discussion Paper does advocate for removing the disparity and admits that opportunities do exist in improving the superannuation system. This topic was also raised in the recommendations made by the Henry Tax Review (Australia’s Future Tax System Review, Australian Government 2010). The Discussion Paper too raises those issues and also reiterates the recommendations of the Henry tax Review by making a strong appeal for doing away with these differential earnings tax rates across accumulation, at 15% and retirement at 0%, and also in fair distribution of all concessions uniformly across all segments of superannuation taxation.

A large number of taxpayers are claiming a variety of tax deductions spread across a wide range of Workplace Related Expenses (WREs) and this is adding complexity to the process of preparing the tax return for them. In The Discussion Paper many options have been proposed to address these issues, but still, The Discussion Paper does recognize a need for balancing the compliance costs of the complexities with the cost to revenue of the Government. 

In The Discussion Paper a number of options, prevalent in developed countries have been suggested –

  • No Deduction for WREs.

As is prevalent in New Zealand to disallow WRE deductions since 1980.

  • Specific Deduction for WREs.

As is in the UK, which allows a WRE to the extent it is directly related to generation of an assessable income.

  • Standard Deduction for WREs.

As was suggested by former Labor Treasurer, Wayne Swan, who proposed, in 2010, a standard deduction of $500 for every taxpayer.

Income splitting is termed as income attributed to more than one individual taxpayer. The Discussion Paper offers an example by considering a couple, who jointly have an income of $100,000. In case only one member, the husband, earned this income, his tax liability would be $24,632. However, if both members, the husband and the wife, earned and each contributed $50,000 and filed their returns as individuals, their total tax liability would be $15,594 (each being taxed $7,797). Hence, jointly earning, the couple would be in a better position and would save $9,038 in taxes. To give the best advantage to every family, The Discussion Paper suggests a legitimate strategies of reducing the tax liability of a household, without reducing the actual income and staying within the legal boundaries of anti-avoidance and other integrity laws.

The ‘bracket creep’ of the Marginal Tax Rate regime shifts taxpayers to the higher tax rate as and when the income increases over time. The Discussion Paper projects that percentage of taxpayers in the two top tax brackets shall increase from the current 30% to 45% in 2025. It has also been observed that ‘bracket creep’ affects those in the lower and middle income brackets more than those in the higher income brackets. 

Conclusion

As has been pointed out in the various parts of this paper, the Australian Individual Resident Taxpayer has been and still is at the mercy of the political administrators who control the system, make rules and govern the lives of the citizens. Contrary to the expectations which every taxpayer has from taxation laws, Australian resident taxpayers have no say in the rules and laws which are imposed on them. Purpose of deductions, from the point of view of the taxpayers, should be to allow the taxpayer to use such amounts as per their desire and requirements, (O’Donnell, 2005). But contradictions are there at each and every step. Even if a deductible amount is solely allowed for the benefit of the taxpayer, the ATO tries to compensate that deduction by imposing a tax of equivalent (sometimes of more) amount so that the coffers of the Revenue Department do not become empty, (DiPasquale & Wheaton, 1992). 

In the opinion of this paper, advantages should be given to law abiding taxpayers without a lurking disadvantage around the corner for them. In fact, each amount spent by the government, which is for the benefit of the citizens, should be pre-approved by the citizens and not simply ratified by the elected representatives, who take the reins of the law in their hands and start behaving as masters instead of acting as servers. 

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