In Australia, income is typically classified as either ordinary or capital income.
There are considered to be three components of Ordinary income:
- Income from personal exertion (eg. salary, wages, bonuses and overtime)
- Income from assets or property (eg. rent, dividends, interest)
- Income from carrying on a business (eg. sales or revenue)
While each of the above components are included in assessable income, it is important to distinguish between them as some deductions are dependent upon which category of income the deduction relates to, eg. whether a person is carrying on a business.
Capital income (or capital gain) was legislated on 21 September 1985 via the form of Capital Gains Tax (CGT) and includes all income which is not ordinary income. Examples of capital gains include profits from the sale of investments such as shares and property.
With capital gains, a discount of 50% of the gain may be applied if the asset has been held for over 12 months. The capital gain then becomes assessable income for tax purposes and is taxed at your marginal tax rate (according to your income tax bracket).
There are four exemptions (concessions) to capital gains taxes for small businesses being the:
- 15 year – If your business has continuously owned an active asset for 15 years and you’re aged 55 years or over and are retiring or are permanently incapacitated, you won’t have an assessable capital gain when you sell the active asset.
- 50% active asset reduction -You can reduce the capital gain on an active asset by 50%. This is in addition to the 50% CGT discount if you’ve owned the asset for 12 months or more.
- Retirement – Capital gains from the sale of active assets are exempt up to a lifetime limit of $500,000. If you’re under 55 years of age, the exempt amount must be paid into a complying super fund or a retirement savings account.
- Rollover – If you sell an active asset, the small business rollover allows you to defer all or part of a capital gain for two years, or longer if you acquire a replacement asset or you incur expenditure on making capital improvements to an existing asset.
Generally speaking, medical practices are capital gains tax exempt. Speak to us to find out more.
It is important to define the category of income as the Australian Taxation Office (ATO) determines that:
- Ordinary losses can be used to offset capital gains, whilst
- Capital losses cannot be used to offset ordinary income
In other words, business / operation / financial losses can be used to offset future capital gains. However, capital losses such as from investments cannot be used to offset ordinary income.