Income tax fundamentals 

Australian income tax is built on a simple equation applied to a legally complex base: what counts as income, what can be deducted from it, and at what rate the result is taxed. This article sets out that basic structure and orients the rest of the taxation-and-revenue-law module by explaining how the Commonwealth and the states divide Australia's revenue-raising power.

The basic equation: assessable income less deductions

Income tax is calculated by first identifying a taxpayer's assessable income for an income year — the income the tax law treats as includable in the tax base. From that figure, the taxpayer subtracts allowable deductions, being outgoings and losses the tax law permits to be set off against assessable income because they were incurred in gaining or producing that income, or in carrying on a business for that purpose, subject to exclusions for outgoings that are private, domestic or capital in nature. The result is taxable income. Tax is then calculated on taxable income at the applicable rate, and the taxpayer's actual liability is that calculated amount, reduced by any tax offsets and adjusted for tax already withheld or paid in instalments during the year.

This assessable-income-less-deductions structure is common to every Australian taxpayer — an individual, a company, a trust or a partnership — even though the rules that determine what is assessable, and what is deductible, differ in detail between them.

Income versus capital

A foundational distinction in the income tax base is between income and capital. Historically, income tax reached only receipts with the character of income — recurrent, earned or produced amounts such as salary, business profits, rent and interest — while a gain from the mere realisation of a capital asset fell outside the income tax base entirely. Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199¹ extended this: a profit from even a single, isolated transaction can be ordinary income if entered into with a genuine profit-making purpose, regardless of whether it came from the taxpayer's regular business.

That position changed with the introduction of capital gains tax, which is not a separate tax but a mechanism, built into the income tax system, that brings net capital gains into a taxpayer's assessable income as a distinct category of statutory income. A capital gain arises on a taxable event affecting a taxpayer's asset — most commonly a disposal — and is calculated by comparing what the taxpayer receives with the cost associated with the asset, subject to exemptions, discounts and rollovers that a student must check in the current legislation rather than assume. The distinction still matters: it determines whether a gain is ordinary income, assessable in full, or a capital gain assessable through the capital gains tax provisions, potentially with concessions.

Progressive rates for individuals, a flat rate for companies

Once taxable income is calculated, the applicable rate structure depends on the type of taxpayer. Individuals are taxed under a progressive marginal rate structure: taxable income is divided into bands taxed at increasing rates, so a taxpayer's average rate rises as taxable income rises, while only the income within a given band is taxed at that band's rate. Companies, by contrast, are generally taxed at a flat rate — a single rate applied to a company's taxable income regardless of its size, though the current legislation may set more than one flat rate depending on a company's characteristics. This is a conceptual point only: this article deliberately does not state current rate figures or thresholds, which change with the federal Budget and must always be checked against the current legislation.

The Commonwealth/state revenue split

Australian revenue law divides cleanly along a Commonwealth/state line, and understanding that division is essential before studying any individual tax. The taxation power in s 51(ii) is concurrent, not exclusive, and it carries its own proviso: the Commonwealth may not discriminate between States or parts of States.² Income tax has nonetheless been, in practical effect, an exclusively Commonwealth field since the uniform tax cases of the 1940s, in which the states' capacity to levy their own income tax was effectively displaced in favour of a single Commonwealth income tax, with the Commonwealth making grants to the states in place of the revenue they gave up. No state or territory now imposes an income tax of its own.

The goods and services tax, considered in the next article in this module, is collected by the Commonwealth but is then distributed to the states and territories under a national funding arrangement, rather than being retained as Commonwealth revenue. By contrast, taxes such as duty on property transactions, payroll tax and land tax remain the states' and territories' own revenue, raised under each jurisdiction's separate legislation. That state and territory layer is the subject of a later article in this module, and the administration of income tax and GST — how liability is assessed, and how a taxpayer disputes it — is addressed separately again.

Applying this in a problem question

1. Identify the taxpayer type (individual, company, trust or partnership), since the rate structure and some assessable-income and deduction rules differ.
2. Work through the equation: identify assessable income, then allowable deductions, to arrive at taxable income.
3. For any gain connected with an asset, ask whether it has the character of ordinary income or falls to be dealt with under the capital gains tax provisions as statutory income.
4. Do not assert a specific current rate, threshold or dollar figure — describe the rate structure conceptually and direct the reader to check the current legislation.
5. If the facts touch on duty, payroll tax or land tax, recognise that these are state or territory taxes and identify the specific jurisdiction whose legislation governs.