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Submission No. 170 Back to full list of submissions
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Australian Business


Submission to the Review of
Business Taxation

 

APRIL 1999

CONTACT:

JEFF SCHUBERT, Economic Adviser
Telephone: (02) 9927-7445 (w)
Mobile: 0417 275 476
Email: schubert@abol.net

CONTENTS

Executive Summary *
A. Introduction *
B. "Business Entities" *
C. "Business Investments" *
D. CGT *
E. FBT *
F. Revenue Neutrality *
G. Conclusion *

Executive Summary

Australian Business is an independent broad-based business improvement and membership organisation representing more than 5,000 member entities.

Australian Business supports the general goals, enunciated in the terms of reference of the Review of Business Taxation (RBT), of lowering the company tax rate and lowering the rate of tax on individual capital gains.

In relation to taxation of "business entities", Australian Business believes that the taxation system should not favour or disadvantage particular business structures over others. It believes that trusts engaged in active business should be taxed in the same way as companies, although an exception should be made for widely held trusts / collective investment vehicles.

A resident dividend withholding tax (RDWT) should be adopted in place of the deferred company tax (DFC) proposal.

Full streaming of foreign source income to non-resident shareholders should be allowed, or failing this, an expansion of the conduit rules by moving to a foreign income account applying a proportional approach. Franking credits should be allowed in respect of foreign dividend withholding tax. To maximise the benefits to Australia of its double taxation treaties a concerted program of treaty re-negotiation should be undertaken.

Australian Business notes that the RBT will be considering "the goal of moving toward a 30% company tax rate" within the constraint of "revenue neutrality" in respect of "business investments" (including "tax concessions") and changes to capital gains taxation.

In relation to "business investments", Australian Business believes that there is a case on grounds of international competitiveness for lowering the company tax rate. While the case is strong, there is also a case for the maintenance of some "income tax concessions" in several areas.

One of these areas is accelerated depreciation for plant and equipment. Australian Business believes that a system equivalent to a 20% loading, as defined in "A Platform for Consultation", should be kept in place. Australia’s present accelerated depreciation regime is not significantly out of line with that in other countries, but risks becoming so in a complete move to schedules based on effective life.

Income tax concessions for R&D expenditure should be maintained.

The revenue cost of the concessions which Australian Business wishes to maintain is such that it may not be possible to reduce the company tax rate to 30% without relaxation of the revenue neutrality constraint.

There is also a concern that the trade-off between reduced concessions and a lower company tax rate may not be as sustainable as suggested in "A Platform for Consultation". For example, while the removal of accelerated depreciation alone might yield sufficient revenue to push the company tax rate down to 31.5% in 2003-4, it might be associated with a higher company tax rate in later years.

Australian Business believes that there is a case for relaxing the "revenue neutrality" constraint as sensible reforms will undoubtedly act to boost economic activity and tax revenues. However, it also recognises that there may be difficulties associated with this.

In relation to capital gains taxation, Australian Business supports "extending the CGT roll-over provisions to scrip-for-scrip transactions".

As far as individual CGT is concerned, a stepped rate with a ten-year phase-down is preferable to a 30% cap.

Australian Business does not believe that a $1,000 individual CGT threshold, as discussed in "A Platform for Consultation", provides benefits to the economy and this should not be implemented.

Australian Business believes that FBT should be dispensed with and the full value of fringe benefits attributed to the relevant employee, who would then be liable for tax at the relevant individual marginal rate.

The table below shows a summary of revenue implications of the approach preferred by Australian Business. The data are for 2003-4 and ignore transitional and sustainability issues (which are discussed in this submission).

The table shows that, at least in the year 2003-4, changes supported by Australian Business would raise $4.3bn in extra tax revenue. As, on the basis of data in "A Platform for Consultation", this is less than the $4.9bn revenue cost of the changes that Australian Business is aiming for it is recognised that some compromise may be necessary on these changes.

Such a compromise would need to take into account the above issue of sustainability past 2003-4 when it may not be possible to maintain a 30% company tax rate which depends mainly on changes to accelerated depreciation. If 30% is not sustainable, it may be better to compromise and accept a higher rate now than to lower the rate to 30% now and then increase it in the future.

 

 

$bn extra revenue at 2003-4

Accelerated depreciation to 20% loading

1.7

Other depreciation changes (net)

0.2

Tax leases as loans

0.1

Thin capitalisation etc

0.5

Sub-total

2.5

FBT changes on cars

0.5

FBT re: institutions

0.3

Total FBT

0.8

Remove CGT indexation

0.6

Remove CGT averaging

0.2

Total CGT

0.8

Growth dividend

0.2

Total

4.3

 

$bn cost to revenue at 2003-4

Company tax (new base) to 30%

3.1

Franking credits for foreign DWT

0.2

Sub-total

3.3

Remove car parking FBT

0.1

Entertainment non-deductability/non-FBT

0.5

Shift FBT liability to employee

0.2

Total FBT

0.8

Stepped CGT, 10 yr phase down

0.8

Total (CGT)

0.8

Total

4.9

 

 

 

 

 

A. Introduction

Australian Business (formerly the NSW Chamber of Manufactures) is an independent broad-based business improvement and membership organisation. It has more than 5,000 member entities. As one of Australia’s largest business service organisations, it provides information and expert advice on business, management and employer related issues.

More than 80 services are integrated from eight complementary core groups: business improvement; workplace relations; occupational health and safety; learning and skills development; international trade; information and online services; labour market and recruitment; health services.

Australian Business has developed a major internet presence through Australian Business Online—for instant business information, Tradehub—for electronic commerce opportunities, and Top Jobs on the Net—for online recruitment advertising.

Australian Business strongly supports the view that Australia’s business taxation arrangements are in need of urgent and significant reform. It believes that the Review of Business Taxation (RBT), under the chairmanship of Mr. John Ralph, is an important step in this process.

While it is understood that governments need to raise taxation revenue and the RBT is acting under a revenue constraint, there may be a case for some relaxation of that constraint.

Australian Business welcomes the goals of a 30% company tax rate and reduced capital gains taxation for individuals.

However, it also supports a number of other taxation goals, some of which are catered for at present and some of which may be catered for by changes introduced as part of the taxation reform process. Two notable examples, are the maintenance of some element of accelerated depreciation and the more active encouragement of start-up and venture capital businesses.

Given the revenue constraints facing the Review, there may thus be a need for compromise on the company tax and individual CGT goals.

There appears to be some uncertainty as to whether the existing R&D tax concessions are subject to the processes of the RBT. Australian Business is a strong supporter of this concession and because of this uncertainty addresses this issue in this submission.

B. "Business Entities"

  1. Business Structures

Australian Business believes that as a general rule the taxation system should not favour or disadvantage particular business structures over others. For example, it believes that trusts engaged in carrying on active business should be taxed in the same way as companies. In moving to such an arrangement for trusts, however, it is imperative that there be appropriate transitional arrangements.

Widely held trusts / collective investment vehicles are effective and transparent entities allowing large numbers of individual investors access to investments that might otherwise be denied. Australian Business believes that many of these might continue to be taxed as they are now – that is, in the hands of the investors and with flow through of tax preferences.

It therefore welcomes the announcement that cash management trusts will continue to be subject to flow through taxation, and the possibility that this might be extended to other similar entities.

(2) Deferred Company Tax (DCT)

A resident withholding tax (RDWT) should be introduced in place of the proposed deferred company tax (DCT). It would meet the main objectives of the DCT while minimising the adverse consequences.

The DCT would increase the level of tax in respect of unfranked dividends paid to foreign shareholders. As these shareholders are unlikely to receive a credit in their own jurisdiction for this tax paid in Australia, the net returns to these shareholders will decline. Thus, even where there is a double taxation treaty in place, the tax rate of distributed unfranked dividends would rise from 15% to the company tax rate.

The proposed DCT would also be a charge against company reported profits, so reducing earnings per share. Given the nature of financial markets, this may adversely affect the valuation of companies and thus increase the cost of raising capital.

The RDWT would meet the DCT aim of adding to the integrity of the tax system by collecting tax on unfranked dividends at the time these are paid to resident shareholders. As with a DCT, it would maintain the Australian tax liabilities of Australian resident companies at their present levels.

(3) International

Full streaming of foreign source (and thus unfranked dividend) income to non-resident shareholders (who have no use for franked dividends) should be allowed, or failing this, an expansion of the conduit rules by moving to a foreign income account applying a proportional approach (as discussed in "A Platform for Consultation")

Moreover, franking credits should be allowed in respect of foreign dividend withholding tax.

Finally, Australia does not appear to presently have a series of double taxation treaties that maximise the possible benefits. For example, most other countries have much more favourable treaty rates with the US than the 15% dividend withholding tax rate that applies to Australian based companies receiving dividends from their US operations. A concerted program of treaty re-negotiation should be undertaken.

 

C. "Business Investments"

  1. "Concessionary" Taxation

(a) Accelerated depreciation

Australian Business agrees that the current taxation of wasting assets, where the cost of the asset is deducted over a shorter period than its effective life, lacks a coherent and consistent framework and needs reform.

Much discussion has focussed on the issue of using the removal of accelerated depreciation to provide additional tax revenue which would in turn be forgone to allow a cut on the company tax rate from 36% to 30%. According to "A Platform for Consultation", this requires around $0.5bn in 2003-4 for each percentage point reduction in the company tax rate.

"A Platform for Consultation" presented the following data on the revenue ($m) effect of these changes.

1999-0

2000-1

2001-2

2002-3

2003-4

30% company rate--existing base

-120

-1980

-2140

-1930

-2190

--ANTS base

-190

-3040

-3240

-2880

-3110

Remove accel. depreciation

0

90

990

1900

2390

The first line of data is based on the existing company tax base. If the ANTS measures are included (eg taxation of trusts as companies) these numbers becomes larger as the move from 36% to 30% is made on a broader base. For example, $2,190m in 2003-4 becomes $3,110m.

The removal of accelerated depreciation itself does not provide sufficient revenue to cut the company tax rate to 30% on the proposed broader base in 2003-4. It would only account for about 4.5 percentage points at that date.

The removal of accelerated depreciation (for assets purchased after the date of introduction of any change) also provides relatively little revenue in the early years. As a result, a possible phase-down of the company tax rate has been suggested.

As already indicated, Australian Business supports the goal of a 30% company tax rate but has several concerns about the suggested trade-off with the removal of accelerated depreciation.

One such concern relates to its sustainability.

Accelerated depreciation brings forward depreciation deductions for taxation purposes with the result that later deductions are reduced. It means that as far as the relevant assets are concerned company tax revenues are now lower than they would otherwise (‘normally’) be. It also means, however, that as far as those same assets are concerned company tax revenues in the future will be higher than they would otherwise (‘normally’) be because the depreciation deductions will be smaller.

It is not clear from "A Platform for Consultation" whether the $2,390m revenue gain (in 2003-4) from removal of accelerated depreciation refers to:

  1. a period in which such deductions are at their peak ("A Platform for Consultation" indicates that 2003-4 is the "first year in which the overall revenue estimates are considered to be broadly indicative of the longer run revenue trade-off" page 65);
  2. or

  3. the revenue gain becomes larger in subsequent years due to the effect of no accelerated depreciation (for assets purchased after the introduction of any change); or
  4. the revenue gain begins to decline as those assets subject to accelerated depreciation reach the latter part of their lives when the deductions are smaller ("A Platform for Consultation says that if a change from accelerated depreciation to effective life depreciation were implemented, "the revenue savings in early years would be significantly greater than the ongoing savings in later years" page 118).

Even if the revenue gain from the removal of accelerated depreciation stabilises at, or rises from, the $2,390m in 2003-4, it is not clear that this would continue to provide sufficient revenue to allow a 4.5 percentage point reduction in the company tax rate. This is because of the likely continued growth of the economy, and thus continued growth in aggregate company profits.

Thus, the ability of the removal of accelerated depreciation to finance a lower company tax rate may not be as clear cut as presented.

A second concern is that it is not clear what the trade-off associated with any changes to accelerated depreciation will actually be once the ATO has updated of its effective life schedule for depreciation (as outlined in "A Platform for Consultation"). If this update results in a lengthening of effective lives in the ATO schedule it will initially result in more taxation revenue due to smaller (non-accelerated) annual depreciation deductions. While this would boost the amount of revenue available to contribute to a lower company tax rate, it would also add to the adverse effect of any wind back in accelerated depreciation.

A third concern relates to international competitiveness. As "A Platform for Consultation" notes, the RBT’s "An International Perspective" paper concluded that Australia provides accelerated depreciation for short-lived assets more or less in line with the average for the countries considered, although Australia’s depreciation tends to be more favourable for assets with lives beyond about 8-10 years. While there would appear to be scope for some scaling back of accelerated depreciation, it may not be in Australia’s competitive interests to eliminate it as only three of the 25 countries surveyed in the "An International Perspective" paper do not have some form of accelerated depreciation and/or investment allowance.

All out pursuit of a lower company tax rate at the expense of accelerated depreciation may thus result in one lop-sided arrangement being replaced by another.

A fourth concern is that some of the support being expressed for the removal of accelerated depreciation reflects an expected weakening in expenditure on plant and equipment in the near future and does not take sufficient account of capital expenditure associated needs in later years.

In summary, Australian Business supports some scaling back of accelerated depreciation in the interests of achieving a lower company tax rate. However, it is concerned that the trade-off may not be quite as clear and sustainable as is sometimes presented, that the changes may go too far and create a different distortion, and that insufficient attention is being paid to longer-term perspectives.

"A Platform for Consultation" notes that one option is "retaining a form of accelerated depreciation based on applying uniform loadings to effective lives" and that "this form of accelerated depreciation provides an equal advantage to all wasting assets to which it applies regardless of their effective lives". Australian Business supports such an option, although with some qualifications (discussed below).

"A Platform for Consultation" indicates that "a loading with an equivalent revenue cost to the current system as it relates to plant and equipment would approach 100%" and "would allow assets to be written off over approximately half of their effective lives".

Australian Business submits that a 20% loading should apply to effective life (as revised by the ATO) across the board on all wasting assets. A 20% loading would mean, for example, that a write-off rate under effective life of 10% per year would become 12% per year.

Furthermore, all wasting assets should be deductable within a period of no greater than 20 years. This is justified on the basis that current inflation rates erode the value of depreciation deductions, particularly for plant with long effective lives.

Australian Business also submits that taxpayers should also have the option of either adopting published effective life rates (following review by the ATO as proposed) and applying the 20% loading to these or of self assessing if the taxpayer has a "reasonably arguable position" in relation to effective life.

Furthermore, Australian Business submits that individual plant items costing less than $1,000 be allowed immediate write-off, up to a total of the greater of $10,000 or 10% of such expenditure. This would bring tax depreciation rules into closer alignment with accounting practice, which typically expenses plant items costing less than $1,000. This would significantly reduce compliance costs.

Some of the issues in relation to accelerated depreciation are addressed in an attachment to this submission, "Tax Reform and Investment", which has been prepared for Australian Business by The Allen Consulting Group.

(b) R&D

There appears to be some uncertainty as to whether the existing R&D tax concessions are subject to the processes of the RBT. Australian Business is a strong supporter of this concession and because of this uncertainty addresses this issue in this submission.

Australian Business has been a long-standing supporter of government assistance and incentives for research and development (R&D) by business in Australia. R&D in Australia benefits not only those entities undertaking it, but by adding to the general stock of skills and knowledge in the community contributes to general economic welfare.

R&D tax concessions are more effective than grants in providing assistance to income earning firms because of their much greater flexibility. Tax concessions leave businesses free to make decisions during the uncertain process of R&D expenditure, whereas grants can act to lock in sub-optimal expenditure.

The Industry Commission’s 1995 report on Australian Research and Development concluded that the R&D tax concession has brought net benefits to the Australian economy.

This conclusion was based upon the findings of an earlier exhaustive analysis carried out by the Bureau of Industry Economics (BIE), augmented by a special assessment carried out by the Industry Commission for their report.

While the estimated additional R&D generated by the tax concession was not particularly large (estimated at between 60 cents and $1 for each $1 of the overall cost of the concession), the tax concession was considered to have a more pervasive and longer-term beneficial impact than is captured by its estimated net contribution to levels of R&D expenditure.

The reason for this is that it helps businesses to improve their capacity to formulate and to execute R&D projects and programs via ‘learning by doing’.

These learning by doing effects cannot be directly measured, but they are essential for the improved competitiveness of Australian industry. They will help to increase the ‘efficiency’ of R&D investment and multiplies the overall impact of an increase in R&D investment.

The R&D tax concession also focuses management attention on attempting to assess the likely commercial pay-offs to investment in R&D. The BIE noted that:

"between 50 and 60 percent of respondents reported that the concession had been important for encouraging a more favourable attitude to R&D, and placing R&D more centrally in their business strategy".

By focussing management attention on this aspect of resource allocation the tax concession can have irreversible beneficial effects by increasing the accuracy with which the pay-offs to investment in R&D are assessed. As the accuracy of these assessments increases, so the perceived marginal return to investment in R&D can increase, thus encouraging higher R&D investment.

The R&D tax concession is more likely to foster improvements in the accuracy of management’s assessments of the pay-offs to increased R&D investment than grants and loans such as are available under the R&D START program.

This is because the probability of having an R&D tax concession claim rejected is far lower than that of having R&D START assistance rejected. The value of the subsidy can therefore be incorporated in business planning and investment appraisals.

As long as a sufficient level of profits are forecasted, the R&D tax concession allows firms to plan future R&D investments knowing that they can receive this subsidy. Successful R&D programs commonly require medium to long term planning driven by business and technology strategies.

However the overall national impact of the R&D tax concession is reduced by the difficulties in progressing new or improved products, processes or services from the R&D stage to market introduction. This ‘innovation progression gap’ remains a major impediment to innovation in Australia.

As with discretionary grants and loans, anything that increases uncertainty for a business is de-stabilising. It is preferable to maintain the current level of relief at 125% but with a long-term commitment not to change this level further, except to increase the deduction rate.

Australian Business consequently recommends that the R&D tax concession be maintained at its current level. There may, however, be a case for some tightening of the criteria to be met to obtain the concession.

 

D. CGT

The RBT was asked to examine the scope for:

  1. "capping the rate of tax applying to capital gains for individuals at 30%";
  2. "extending the CGT roll-over provisions to scrip-for-scrip transactions"; and,

to "achieve overall revenue neutrality" in respect of these changes and taxation of "business investments".

Implicit in this is the possibility of company taxation relief (either in the form of the company tax rate or concessions) being forgone in order to finance individual CGT relief on what will often be only speculative activity. Such a development would not be welcomed by Australian Business.

Comments by RBT members have suggested a modification of the RBT’s terms of reference with CGT reform itself possibly being "revenue neutral". This has certain attractions, particularly as it would allow the focus to be on cleaning–up what is now a complicated regime.

Australian Business supports the removal of inflation indexation of capital gains and CGT averaging in return for a CGT relief for individuals and scrip-for-scrip relief for listed public companies.

The one reservation is that abolition of indexation would adversely affect the tax position of entities taxed as companies. The amount involved, however, may be relatively small and partially offset by the value of the scrip-for-scrip reforms.

Australian Business believes that the economy would be most effectively boosted if CGT relief were targeted to active businesses rather than generally at "individuals". As indicated above, speculative activity may otherwise be the prime beneficiary and there will be an effort to boost efforts to convert taxable income streams into capital gains.

If CGT relief is to be generally applied to individuals, Australian Business does not favour a 30% cap. Its preference is for a stepping down of individual CGT rates as assets are held over a 10-year period. CGT would continue to apply at the individuals marginal tax rate if an asset is disposed of in the first year, but would progressively decline after that. (In particular, Australian Business supports the option in "A Platform for Consultation" contained in table A.4 on page 810 and described as "CGT stepped rate with ten-year phase down".)

Australian Business does not believe that a $1,000 individual CGT threshold, as discussed in "A Platform for Consultation", provides benefits to the economy and this should not be implemented.

Australian Business suggests that the start-up / venture capital areas would benefit significantly from some degree of CGT relief.

Australian Business is a strong supporter of "Business Angels" programs, where investments by "Angels" average’s between $0.5m and $1m and believes CGT relief might be targeted in this area. A distinctive stepped down approach to CGT liability might be provided for particular categories of investment. As most investments will be provided by legal entities rather than "individuals" and any resulting capital gains will be taxed at the prevailing entity (eg company) tax rate, a stepped down approach might be applied to company tax as well as individual tax.

A specific category of investment in entities involved in "research and development" type activities might also be subjected to such a distinctive stepped down CGT. The criteria for such a CGT concession might be the same or similar to that applied to applications for the 125% R&D tax concession.

Some scrip-for-scrip CGT relief for private companies meeting the above criteria might also be provided.

At present, foreign portfolio investors in Australian entities do not pay CGT. In order to assist "venture capital" activities, the CGT exemption could be extended to overseas entities such as US tax exempt pension funds investing through limited partnerships in qualifying venture capital funds and/or shares in qualifying start up companies. Capital gains flowing from such venture capital funds to non-residents should also be excluded from taxation.

 

E. FBT

Australian Business commends the members of the RBT for considering the issue of fringe benefits tax (FBT). This tax is levied as an employer liability and surveys consistently show that employers consider FBT compliance to be costly and complex.

Australian Business believes that liability for paying FBT should rest with the recipients of those benefits (just as it does with wages and salaries). Possible employee liability for FBT has been brought a step closer with the requirement that from 1 April, 1999 employers provide information on individual group certificates on the grossed-up value of reportable fringe benefits provided where this exceeds $1,000.

Following on from this, the logical next step is to dispense with FBT and attribute the full taxable value of fringe benefits to the relevant employee. The employee would then be liable for tax on these benefits at the relevant marginal personal income tax rate.

Australian Business supports the removal of concessional treatment of public benevolent institutions and not-for-profit organisations.

Australian Business supports proposals to bring the FBT valuation of car benefits closer in line with actual value. This is a distortion in the present system benefiting particular sectors and employees and effectively acts to boost the tax burden on others.

FBT on on-premises car parking should be removed as it is a benefit with relatively limited opportunities for abuse, but does add to compliance costs.

Australian Business would support the removal of FBT on entertainment and an accompanying move to make entertainment expenses non-deductable for income taxation purposes. The compliance costs associated with meal entertainment are particularly onerous.

However, FBT should continue to apply to ‘salary packaged’ entertainment where the employee receives such benefits as a substitute for direct monetary remuneration.

F. Revenue Neutrality

Australian Business recommends that consideration be given to relaxation of this constraint as sensible taxation reform will boost economic activity and in turn tax revenue. However, it recognises that there may be various difficulties associated with a significant relaxation of the revenue constraint. Accordingly it has framed its recommendations noting that "A Platform for Consultation" assumes a growth dividend from business taxation reform that rises to $200m by 2003-4.

 

G. Conclusion

The table below shows a summary of revenue implications of the approach preferred by Australian Business. The data are for 2003-4 and ignore transitional and sustainability issues (which are discussed later in this draft submission).

The table shows that, at least in the year 2003-4, changes supported by Australian Business would raise $4.3bn in extra tax revenue. As, on the basis of data in "A Platform for Consultation", this is less than the $4.9bn revenue cost of the changes that Australian Business is aiming for it is recognised that some compromise may be necessary on these changes.

Such a compromise would need to take into account the above issue of sustainability past 2003-4 when it may not be possible to maintain a 30% company tax rate which depends mainly on changes to accelerated depreciation. If 30% is not sustainable, it may be better to compromise and accept a higher rate now than to lower the rate to 30% now and then increase it in the future.

$bn extra revenue at 2003-4

Accelerated depreciation to 20% loading

1.7

Other depreciation changes (net)

0.2

Tax leases as loans

0.1

Thin capitalisation etc

0.5

Sub-total

2.5

FBT changes on cars

0.5

FBT re: institutions

0.3

Total FBT

0.8

Remove CGT indexation

0.6

Remove CGT averaging

0.2

Total CGT

0.8

Growth dividend

0.2

Total

4.3

 

$bn cost to revenue at 2003-4

Company tax (new base) to 30%

3.1

Franking credits for foreign DWT

0.2

Sub-total

3.3

Remove car parking FBT

0.1

Entertainment non-deductability/non-FBT

0.5

Shift FBT liability to employee

0.2

Total FBT

0.8

Stepped CGT, 10 yr phase down

0.8

Total (CGT)

0.8

Total

4.9