What is exempt income?
Exempt income means any amount of ordinary income or statutory income that is not subject to taxation due to specific provisions in the Income Tax Assessment Acts (Acts) or other Commonwealth laws.
Exclusion of ordinary income from assessable income
Exclusion from assessable income
Ordinary income can qualify as exempt income when it is explicitly excluded from being considered assessable income.
This exclusion can occur either through a direct mention in the Acts, like the case of interest income received by a credit union, or it can be implied, as with an allowance paid by a parent to a student child. However, it’s important to note that this rule does not apply to statutory income.
Statutory income exemption
Statutory income is treated as exempt income only when it is explicitly made exempt under the Australian tax laws.
In situations where an amount that would not typically be considered income is included as assessable income by a provision of the Acts or another Commonwealth law and then later excluded from assessable income by another provision, it is treated as if it had never been considered statutory income in the first place. This provision aims to resolve uncertainties regarding the correct treatment of such cases.
So, it’s crucial to differentiate between exempt income and an amount that never qualified as income from the beginning because of the unique treatment that exempt income receives.
Consequences of exemption
When income is designated as exempt, several important implications follow:
Tax Free Income: The most straightforward consequence is that exempt income is not subject to taxation. In other words, individuals or entities do not need to pay income tax on these earnings.
Ineligible for Tax Deductions: Expenses incurred in the process of generating exempt income cannot be used to claim tax deductions. This means that the costs associated with earning this income cannot be used to reduce taxable income.
Capital Gains and Losses: If an asset is used exclusively to produce exempt income or if a taxpayer’s entire income falls under the category of exempt income, there will be no capital gains or losses to account for.
This is because capital gains and losses typically arise from the disposal of assets, and when those assets are used solely for exempt income, such gains and losses do not occur.
Exempt income’s impact on other tax calculations
Exempt income can still influence certain tax related calculations:
Reducing Tax Loss Deductions: Exempt income may be taken into account to reduce the deduction allowable for a tax loss. In situations where a taxpayer experiences a tax loss, having exempt income can help offset the loss to some extent.
Determining Tax Liability for Overseas Income: Exempt income may also factor into the calculation of tax payable on income earned from specific overseas projects or employment.
Exempt income for education and training
Exemption for full time students
Under Australian tax laws, an exemption is provided from income tax for certain financial benefits, such as scholarships, bursaries, educational allowances, or educational assistance, provided to full time students at schools, colleges, or universities.
The recipient student can be of any age but must be actively engaged in full time education at a recognised educational institution. In this context, full time student generally refers to someone pursuing a full time course of study, but it doesn’t exclude the possibility of holding a part time job alongside their studies.
Payment must be classified as income
A fundamental requirement is that the payment in question must be classified as income. In other words, the payment must possess the characteristics of income.
If a payment is considered a gift or a lump sum that is not a reward for services rendered and is not categorised as income, it will not be subject to taxation.
Exemptions for educational payments
Under Australian tax laws there are certain exemptions related to financial support for education. It’s important to note that while there are exemptions, certain conditions must be met, and not all educational payments are automatically exempt from taxation.
Payment not principally for educational purposes
Payments considered not to be primarily intended for educational purposes are not exempt. In other words, not all payments to students qualify for this exemption. For example:
- A fellowship payment that is not granted on the condition that research be conducted at an educational institution or that the recipient seeks an educational qualification; does not qualify for exemption.
- A grant paid through a university payroll to a government scientist for research, which could lead to a PhD but not tied to an educational qualification, is not exempt.
- A payment of education expenses by a friendly society education fund to a student undertaking full time education does not qualify for exemption.
- A loan from an employer to finance full time study does not qualify as a scholarship, bursary, or educational allowance.
Payments received as an employee
Payments received while in an employee capacity rather than as a student are not considered income derived by way of a scholarship, bursary, or other educational allowance, and so are not exempt income.
Exemption for specific payments
There are specific exemptions for certain types of educational payments:
- Payments made under Commonwealth schemes for secondary educational assistance or assistance for isolated children.
- Payments received under a grant from the Australian American Educational Foundation are exempt, provided the grant comes from funds made available to the foundation under its establishing agreement.
Endeavour research fellowships and executive awards
The Endeavour Awards Scholarship Program includes Endeavour Research Fellowships and Executive Awards, all of which are exempt from income tax.
The Program aims to attract leading researchers, executives, and students to Australia for study, research, and professional development in various disciplines. These awards are granted to postgraduate students, postdoctoral fellows, and high achievers in business, industry, education, or government in Australia and participating countries.
The typical duration for research fellowships and Executive Awards is between one and six months.
Defence related payments
These are payments made to members of the Australian Defence Forces and are exempt from income tax. They include various types of payments:
Allowance or bounty
Any allowance or bounty prescribed in the regulations and payable to a member of the Australian Defence Forces is tax exempt. This includes allowances paid under specific determinations, but no tax deductions are allowed for expenses connected with these allowances. However, pay earned by Defence Forces personnel remains taxable.
Rations and quarters
The market value of rations and quarters provided to Defence Force members without charge is also exempt from income tax.
Compensation for loss of deployment allowance
Compensation payments for the loss of deployment allowance for warlike service are tax exempt. This exemption applies to compensation for the loss of the allowance when a Defence Forces member is repatriated to Australia due to injury on warlike service.
Part time emergency reserve forces
Pay, allowances, and gratuities for part time members of the Emergency Reserve Forces were previously tax exempt but are no longer exempt from income tax.
Pay and allowances for reserve forces
Pay and allowances for members of the Australian Naval Reserve, Army Reserve, or Air Force Reserve are exempt from tax. However, this exemption only applies to pay and allowances for part time services and does not cover full time duty.
Compensation for former reserve members
Compensation payments for the loss of pay and/or allowances as a former member of the Naval Reserve, Army Reserve, or Air Force Reserve are exempt. This exemption applies to compensation for the loss of pay and/or allowances for former members who resigned due to injury sustained while performing employment for one of these Reserve Defence Forces.
F 111 deseal/reseal ex gratia payment
These are one time payments to certain personnel involved in the maintenance of F 111 aircraft fuel tanks. They are made in recognition of the challenges personnel faced in their working environment and are exempt from income tax.
Payments under the defence force ombudsman scheme
Reparation payments under the Defence Force Ombudsman Scheme related to abuse in the Defence Force are exempt from income tax. This scheme was established in response to allegations of abuse within the Defence Force.
Welfare and exemptions
Payments made to support family and social welfare and aid recovery from natural disasters like floods and bushfires, are exempt from income tax. These include:
Maintenance Payments: Payments made to a spouse or child that are considered periodic payments in the nature of maintenance are exempt from income tax. However, this exemption doesn’t apply to payments from selling income producing assets or diverted pre tax income.
Disaster Recovery Payments: Ex gratia disaster recovery payments may be given to New Zealand citizens in Australia when a natural disaster occurs. These payments are tax exempt when made to New Zealand citizens holding a special category visa who are affected by a major disaster.
Thalidomide Compensation: Payments made by the Commonwealth to individuals under the Support for Australia’s Thalidomide Survivors Programare tax exempt. These payments are exempt because they are regular and relied upon by recipients, similar to ordinary income.
Payments from Thalidomide Australia Fixed Trust: Payments from this trust to individuals as beneficiaries or for their benefit are exempt from income tax.
All these exemptions aim to provide financial support to individuals in specific situations without imposing income tax on these payments.
Compensation for loss of pay or allowance for warlike service
Compensation payments related to the loss of pay or allowances due to injuries or diseases sustained during ADF service are exempt from income tax, provided the specific criteria are met.
Eligibility: To qualify for exemption, a compensation payment must be made under the Safety, Rehabilitation and Compensation Act 1988. This payment is meant to compensate ADF members for the loss of pay or allowances due to injuries sustained during their service.
The injury for which compensation is granted must be defined as an injury under the Safety, Rehabilitation and Compensation Act 1988.
Moreover, the injury must have occurred while the recipient was covered by a certificate issued under ITAA 1936 s 23AD(1)(a). This certificate is issued by the Chief of the Defence Force and indicates that the person was on eligible duty with a specified organisation in a specified area outside Australia.
The injury should have directly resulted in the loss of the recipient’s pay or allowance. This pay or allowance should have been payable under the Defence Act 1903 or a determination under that Act.
Alternatively, compensation for the loss of pay or allowance for warlike service can also be exempt if it is made under the Military Rehabilitation and Compensation Act 2004.
Compensation for loss of deployment allowance for non warlike service
This exemption applies to compensation for the loss of a deployment allowance or other specified exempt allowances under the Defence Act 1903 for non warlike service.
To qualify for exemption, the compensation payment for the loss of the allowance must either be made under the Safety, Rehabilitation and Compensation Act 1988 for an injury that resulted in the loss of the allowance, or under the Military Rehabilitation and Compensation Act 2004 for a service injury or disease that caused the loss of the allowance.
Compensation payments for loss of pay and/or allowances as a defence reservist
Compensation payments for the loss of pay and/or allowances as a member of the defence force reserves can be exempt from income tax under certain conditions:
The payment should be made under the Military Rehabilitation and Compensation Act 2004.
The injury for which compensation is sought should have occurred while serving as a member of the Naval Reserve, Army Reserve, or Air Force Reserve.
The compensation payment amount should be determined based on the recipient’s normal earnings as a part time Reservist, as defined in the Military Rehabilitation and Compensation Act 2004.
Income from eligible venture capital investments
The Australian tax laws provide an income tax exemption for income derived from eligible venture capital investments. To qualify for this exemption, the following conditions must be met:
Limited Partnership Partner: If an entity is a partner in a limited partnership, it can receive an exemption for its share of income from eligible venture capital investments made by the partnership, provided the investment meets additional requirements for ESVCLPs and the partnership was unconditionally registered as an early stage venture capital limited partnership (ESVCLP) at the time of the investment and income derivation.
AFOF Partner: If an entity is a partner in an Australian venture capital fund of funds (AFOF), it can receive an exemption for its share of income from eligible venture capital investments made by the partnership if the partnership meets specific conditions, including being an early stage venture capital limited partnership (ESVCLP) and owning the investment at the time of income derivation.
General Partners: General partners in a partnership are eligible for this exemption only if they are Australian residents. If a general partner is not an Australian resident, the exemption may apply if a double tax agreement with the relevant foreign country is in force and covers income taxation matters.
Beneficiaries’ Capital Gains: For unit trusts that are eligible venture capital investments, beneficiaries’ shares of capital gains are included in this exemption.
Gain or profit from disposal of eligible venture capital investments
The Australian tax laws exempt partners in venture capital limited partnerships (VCLPs) or ESVCLPs from income tax on their share of gains or profits from the disposal of eligible venture capital investments. The VCLP or ESVCLP must be unconditionally registered and meet specific CGT exemptions criteria.
Partners in AFOFs can also enjoy this exemption, provided the AFOF and its underlying partnerships meet certain conditions.
Gain or profit from disposal of venture capital equity
Gains or profits from the disposal of venture capital equity in a resident investment vehicle by venture capital entities or limited partnerships are exempt from taxation. This exemption applies when, if the disposal were treated as a CGT event, any capital gain or loss would be disregarded.
Moreover, the tax laws allow non resident tax exempt pension funds to disregard capital gains or losses from their venture capital equity investments in Australian resident investment vehicles, subject to specific requirements. This exemption applies to gains or profits made on a revenue account and is not subject to CGT provisions.
Interest on judgement debt relating to personal injury
Interest received on a judgement debt is exempt under specific conditions:
- The judgement debt must result from a court judgement for personal injury damages.
- The interest must relate to the period from the time of the original judgement or an earlier date if applicable, to the finalisation of the original judgement.
An original judgement is considered finalised under the following circumstances:
- If no appeal is lodged, at the end of the appeal period.
- If an appeal is lodged and a final judgement is given by a court, when the final judgement takes effect. A judgement is final if there’s no further appeal or leave to appeal has been refused.
- If an appeal is lodged but is settled or discontinued, when the settlement or discontinuance takes effect.
The term by way of interest extends the exemption to situations where post judgement interest is not directly related to the judgement debt. For example, it applies to post judgement interest amounts agreed upon in a settlement as long as they do not exceed what the compensation recipient would have received if the settlement amount equaled the judgement debt.
This exemption specifically applies to interest on judgement debts arising from personal injury cases to alleviate the tax burden on individuals who experience delays in receiving their compensation while awaiting all appeal avenues to be exhausted.
Interest on unclaimed money and property
Certain interest payments are exempt from income tax, including interest on:
- Unclaimed bank accounts.
- Unclaimed corporate property.
- Unclaimed life insurance amounts.
Interest payments under the Banking Act of the Life Insurance Act are not considered ordinary or statutory income.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.