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Are Legal Fees Tax Deductible?

Understanding the Nature of Legal Fees for Tax Purposes

The deductibility of legal fees hinges on the nature or character of the expense. This determination is guided by the benefit that is sought through incurring the expense.

  1. Capital vs. Operational Purpose: 
    • Legal fees incurred to create an asset or secure an enduring benefit are considered capital expenditures. These are not deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), as established in the Sun Newspaper Ltd case (1938). For instance, John purchased a property and incurred legal fees to secure the title deed. Since this legal expense aims to create an asset with an enduring benefit, it is considered a capital expense and is not deductible.

     

    • Conversely, legal fees incurred for operational purposes may be deductible. For example, John, a contractor, sued a client to recover unpaid wages for work completed. Since the sole purpose of the legal action is to recover assessable income, the related legal fees and costs should be deductible.

     

     

  2. Employment-Related Legal Fees: 
    • Lost Wages: If the sole purpose of the legal action is to recover unpaid wages, bonus, contract payment, or leave payments that are assessable to the client, then the legal fees and related costs should be deductible. For instance, John lost his employment unfairly, and his employer didn’t pay his annual leave and long service leave. He sued his employer for unfair dismissal to retrieve his annual leave and long service leave. Since the purpose of the legal action is to recover assessable income, the legal fees should be deductible.

     

    • Reinstatement: If an employee incurs legal fees after termination and one of the purposes is to seek reinstatement to their former position, these expenses are generally of a capital nature. According to the Australian Taxation Office (ATO), such fees are not deductible because they aim to secure an enduring benefit (i.e., reinstatement of employment). For instance, if John also sought reinstatement to his job as part of the legal action, the legal fees related to seeking reinstatement would be considered capital expenses and thus not deductible. For further guidance, refer to paragraph 5 of Taxation Determination TD 93/29.

What is the Land Tax Surcharge for foreign owners and Australian residents in NSW?

The Land Tax Surcharge is an additional tax imposed on foreign persons who own residential land in New South Wales (NSW).

Here are the key details:

  • Applicability:
    • The surcharge is specifically for foreign persons who own residential land in NSW.
    • It is charged in addition to any regular land tax that the property owner may already be paying.
    • Even if a foreign owner does not owe the standard land tax, they may still be required to pay this surcharge.
  • Definition of a Foreign Person:
    • You are generally considered a foreign person unless:
      • You are an Australian citizen, or
      • You have lived in Australia for 200 days or more in the 12 months prior to the taxing date of 31 December and are a permanent resident of Australia.
  • Taxing Date:
    • The surcharge is assessed based on the taxable value of all residential land owned as at 31 December each year.
  • No Tax-Free Threshold:
    • Unlike standard land tax, there is no tax-free threshold for the foreign owner surcharge. This means the surcharge applies to the entire taxable value of the residential land.
  • Surcharge Rate:
    • Starting from the 2023 land tax year, the surcharge rate is 4% of the taxable value of the residential land.

By understanding these points, foreign owners of residential land in NSW can better navigate their tax obligations and ensure compliance with local regulations.

I am not a business owner, so why am I liable for Pay as You Go (PAYG) Instalments?

Even if you are not a business owner, you may still be liable for Pay as You Go (PAYG) instalments if you had a tax liability in the previous financial year. This can occur due to several reasons beyond just your employment income.

For instance, you might be an employee with wages, but you also have other sources of income, such as:

  • An investment property that earns positive rental income.
  • A share portfolio that earns dividend income annually.
  • A substantial amount of cash savings that earn interest income.
  • Trust distributions from a related trust.
  • You are liable for the Medicare Levy Surcharge because you do not have appropriate hospital cover for yourself and your family, and your income is above the threshold.

In these cases, your employer only withholds tax on your employment income. However, when you file your tax return, you will need to account for the additional income from these other sources. This often results in a tax payable situation due to the positive income earned on top of your wages.

To manage this, the ATO may require you to make PAYG instalments throughout the year to cover your expected tax liability, helping you avoid a large tax bill at the end of the financial year. If you anticipate lower income this year compared to last year, you may consider varying your last quarter PAYG instalment to improve your cash flow. Feel free to reach out to Investax Group tax specialists if you need any help with this. 

Div 293 Tax, What and Why?

Division 293 tax is an extra tax on superannuation contributions. It applies to people whose total income and super contributions add up to more than $250,000 in a year. This tax reduces the tax break they get on their super contributions by making them pay an additional 15% tax on top of the regular 15% tax that super contributions usually attract. 

Division 293 tax is an extra 15% tax. It is applied to the smaller amount between the excess income over $250,000 and the taxable super contributions. Check Sarah’s example below for further explanation.

Your ‘Division 293 Notice of Assessment’ will only be sent to you once the ATO receives the contribution information from your super fund.

The income component of the Division 293 tax calculation is based on the same income calculation used to determine the Medicare levy surcharge (MLS), disregarding any reportable superannuation contributions. The components of this income calculation are:

  • Taxable income (assessable income minus allowable deductions)
  • Total reportable fringe benefits amount
  • Net financial investment loss
  • Net rental property loss
  • Net amount on which family trust distribution tax has been paid
  • Super lump sum taxed elements with a zero-tax rate
  • Assessable first home super saver released amount

Example for John:

John earns a salary of $190,000, and his employer contributes $25,000 into superannuation for him. John also has a net rental property loss of $10,000.

Taxable Income:

  • Salary: $190,000
  • Net rental property loss: -$10,000

So, John’s taxable income is $190,000 – $10,000 = $180,000.

Division 293 Income:

  • Taxable income: $180,000
  • Net rental property loss: +$10,000
  • Employer super contributions: +$25,000

John’s Division 293 income is $180,000 + $10,000 + $25,000 = $215,000, which is within the limit of $250,000. Therefore, John’s entire concessional contributions (CCs) would be taxed at 15%, and Division 293 tax does not apply.

Example for Sarah:

Sarah earns a salary of $240,000, and her employer contributions for the year are $30,000. Sarah also has a net rental property loss of $5,000.

Taxable Income:

  • Salary: $240,000
  • Net rental property loss: -$5,000

So, Sarah’s taxable income is $240,000 – $5,000 = $235,000.

Division 293 Income:

  • Taxable income: $235,000
  • Net rental property loss: +$5,500
  • Employer super contributions: +$27,500

So, Sarah’s Division 293 income is $235,000 + $5,500 + $27,500 = $268,000. Since Sarah’s income exceeds the threshold of $250,000, she will pay 15% contributions tax on her employer contributions and will also be liable for Division 293 tax. Division 293 taxable contributions are the lesser of Division 293 super contributions ($27,500) or the amount above the $250,000 threshold ($18,000). Sarah will pay additional 15% tax on $18,000. 

She can choose to pay this tax personally, or she can choose to release the tax from her super fund.

ATO Reference – Div 293

Can You Buy a Property with Your Superfund (SMSF) Jointly?

Yes, it is possible for a Self-Managed Super Fund (SMSF) to own property jointly with other investors, including related parties. This is a common practice, and there are a few ways it can be structured.

Joint Ownership with Other Investors or Related Parties

An SMSF can hold property assets jointly with other entities such as family trusts, companies, or even the SMSF members personally. Typically, this joint ownership is structured as tenants in common, which means that each party’s ownership interest in the property is distinct and can be clearly identified on the property title.

Important Considerations

  1. Title and Ownership: The property title must clearly state the ownership percentages of each party involved.
  2. Income and Expenses: Income generated from the property and any expenses incurred need to be apportioned according to the ownership percentages of each party.
  3. Tenants in Common Agreement: It is usually recommended to have a formal ‘tenants in common agreement’ in place. This agreement outlines each party’s rights and obligations, ensuring clarity and avoiding potential disputes.

Alternative Ownership Structures

Another way an SMSF can invest in property is through a Unit Trust or Company. In this scenario:

  1. Buying Shares or Units: The SMSF can purchase shares in a related company or units in a related trust.
  2. Property Acquisition: The related entity (trust or company) then uses these funds to acquire the property.
  3. Funding Flexibility: This structure allows other related parties, individuals, or relatives to also buy shares or units in these entities. This collective investment can help fund the property purchase more quickly.

Are you hiring an Independent Contractor or an Employee?

Distinguishing between an employee and an independent contractor is vital for compliance with tax and superannuation laws. A simple contract label is not enough; the actual work relationship and duties performed are what define the status. Below, we outline the key differences to help you understand where you or your workers may stand. Just because an agreement states that a worker is an independent contractor, this does not mean that they are a contractor for tax and superannuation purposes, new guidance from the ATO warns. 

Where there is a written contract, the rights and obligations of the contract need to support that an independent contracting relationship exists. The fact that a contractor has an ABN does not necessarily mean that they have genuinely been engaged as a contractor. The ATO mentions – 

“at its core, the distinction between an employee and an independent contractor is that:

  • an employee serves in the business of an employer, performing their work as a part of that business.
  • an independent contractor provides services to a principal’s business, but the contractor does so in furthering their own business enterprise; they carry out the work as principal of their own business, not part of another.”

Here are the basic differences as pointed out by the ATO:

Employee Independent contractor
Control: your business has the legal right to control how, where and when the worker does their work. Control: the worker can choose how, where and when their work is done, subject to reasonable direction by you.
Integration: the worker serves in your business. They are contractually required to perform work as a representative of your business. Integration: the worker provides services to your business. The worker performs work to further their own business. 
Mode of remuneration: the worker is paid either:

1. for the time worked,
2. a price per item or activity,
3. a commission.

Mode of remuneration: the worker is generally contracted to achieve a specific result, and is paid when they have completed that result, often for a fixed fee.
Ability to subcontract or delegate:

there is no clause in the contract allowing the worker to delegate or subcontract their work to others. The worker must perform the work themselves and can’t pay someone else to do the work for them.

Ability to subcontract or delegate:

there is a clause in the contract allowing the worker the right to delegate or subcontract their work to others. The clause must not be a sham and must be legally capable of exercise.

Provision of tools and equipment: your business provides all or most of the equipment, tools and other assets required to complete the work; or the worker provides all or most of the tools, but your business provides them with an allowance or reimburses them for expenses incurred. Provision of tools and equipment: the worker provides all or most of the equipment, tools and other assets required to complete the work, and you do not give them an allowance or reimbursement for the expenses incurred.
The work involves the use of a substantial item that your worker is wholly responsible for.
Risk: the worker bears little or no risk. Your business bears the commercial risk for any costs arising out of injury or defect in their work. Risk: the worker bears the commercial risk for any costs arising out of injury or defect in their work.
Generation of goodwill: your business benefits from any goodwill arising from the work of the worker. Generation of goodwill: the contractor’s business benefits from any goodwill generated from their work, not your business.

 

Reference: https://www.ato.gov.au/businesses-and-organisations/hiring-and-paying-your-workers/employee-or-independent-contractor/difference-between-employees-and-independent-contractors#ato-Employeeorindependentcontractor 

When Can you Access Money in your SMSF Legally?

We get this question quite often: When can I access my super? Generally, access to your super is possible only if:

  • You retire and are 60 or older; or
  • You turn 65 (regardless of whether you’re still working).

Early access to superannuation is possible only under very limited circumstances such as terminal illness, permanent incapacity, and severe financial hardship, and there are very strict protocols to follow before any funds are paid out.

When you have a Self-Managed Super Fund (SMSF), members have full access to the superfund, and it can sometimes become tempting for members to access these funds during a financial crisis. If you access your superannuation simply due to financial strains without meeting the early access requirements, the transaction becomes illegal.

There are two common ways illegal early access occurs:

  • When the trustees (or their business) are in financial distress, and they use the superannuation account for a short-term loan; or
  • A promoter offers access through a scheme—often getting people to establish an SMSF and roll over their superannuation into the SMSF.

As an international student, am I eligible to claim the Tax-Free Threshold from my employer?

Yes, even though you may not have permanent residency or citizenship in Australia, you will still be treated as an Australian resident for tax purposes. Remember, tax residency differs from immigration residency, so don’t let this confuse you. If you are an Australian resident for tax purposes, you can claim the Tax-Free Threshold, which is $18,200. You are eligible to claim it from this payer if one of the following conditions applies:

  • You are not currently claiming the tax-free threshold from another payer.
  • You are already claiming the tax-free threshold from another payer, but your total income from all sources is expected to be less than $18,200.
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