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Submission No. 181 Back to full list of submissions
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SUBMISSION

TO

REVIEW OF BUSINESS TAXATION

April 1998

EXECUTIVE SUMMARY

Overview

  1. The focus of this submission is on the issues that impact directly on the building and construction industry.
  2. MBA is concerned that the reforms recommended by the Review of Business Taxation be appropriately balanced to maintain the viability of industry sectors that are capital-intensive in nature including the construction industry. Similarly, in respect of those recommendations the Review of Business Taxation should also recognise the proper role of small business in the economy, many of whom are unincorporated.
  3. MBA is concerned that for many small and medium enterprises (SMEs) the proposed timetable for the implementation of the business tax reforms will represent a significant problem. MBA therefore recommends that the reforms be phased in over a reasonable period of time, say three to five years.
  4. The Review of Business Taxation should, in any business tax reforms it may recommend to Government, be mindful of the Government’s commitment to reducing the compliance burden on small business.
  5. MBA also recommends that the Review of Business Taxation include the implementation of a comprehensive program of awareness raising and education, and to allocate appropriate resources, to help small business change their business practices during the transitional period.
  6. There are significant areas in regional and remote Australia which are likely to experience different distributional effects from the proposed business tax reforms relative to the eastern economic triangle and appropriate recommendations should be made to take into account the regional distributional effects. It would be unacceptable for the Review to dismiss this concern on the basis that it was not part of its terms of reference and that the responsibility lies with Government.
  7. Taxation of Entities

  8. MBA opposes the taxation of trusts as companies in certain circumstances and recommends that certain discretionary and closely held trusts used for the protection of family assets be quarantined from the proposal to treat trusts as companies.
  9. MBA is concerned to see that the flow-through benefits of collective investment vehicles be extended beyond cash management trusts. For equity and consistency reasons this approach should also be applied to other, similar vehicles which distribute their income annually, such as property trusts.
  10. MBA opposes the option of imposing a deferred company tax (DCT) and believes that a DCT would be strongly anti-business.
  11. MBA supports the introduction of a resident dividend withholding tax. This option is not as onerous for family companies and trusts and is seen as a better alternative to deferred company tax.
  12. Taxation of Physical Assets

  13. MBA recommends that accelerated depreciation for plant and equipment be retained to encourage the take-up of state-of-the-art technology, such as that relating to the reduction of greenhouse gas emissions. MBA further recommends that consideration be given to the establishment of a Committee comprising the Australian Tax Office and representative members of the Australian Building Energy Council (ABEC) to review the depreciation schedules for plant and equipment.
  14. MBA supports buildings and structures being brought into the depreciation regime applying to all physical assets, that is buildings and structures are valued at the actual cost of the asset to the investor not its original construction cost. MBA recommends that a special ATO/industry committee be established to examine this matter and to formulate appropriate depreciation schedules that are consistent with current commercial practices.
  15. Taxation of Capital Gains

  16. MBA supports the underlying principle contained in the stepped-rate approach for individuals but recommends that the stepped-rate option be extended to trusts and companies. MBA also recommends that a special committee be established to further examine such a proposal and to determine how the tapered scales should be set.
  17. MBA recommends that capital losses be allowed to be offset against any form of taxable income. The next preferred option is the carry back of capital losses on assets acquired after 1 July 2000.
  18. Taxation of Fringe Benefits (FBT)

  19. The current FBT arrangements impose a high level of compliance and MBA accordingly recommends that:

(a) The liability for FBT be transferred from the employer to the employee (ie the recipient of the benefit).

(b) On-premises car parking be removed as an FBT item.

(c) Removal of entertainment as an FBT item and a return to the pre-1995 non-deductible status.

 

INTRODUCTION

Master Builders Australia, Australia's peak building and construction industry association, is the federal body representing the interests of the nine Master Builders Associations who have 17,000 members operating in the following sectors: housing; commercial/industrial; civil engineering; manufacturing and supply; and specialist contracting.

MBA is a strong advocate of comprehensive tax reform and has given its broad support to the Government's "Tax Reform Plan - Not a new tax, A New Tax System" (ANTS). MBA is an active member of the Business Coalition for Tax Reform (BCTR) and has worked with the other members of the BCTR in developing policy positions and responses to the Government's current tax reform initiatives.

The focus of this submission is on the issues that impact directly on the building and construction industry. In this regard our views on some of the issues may differ to that formulated by the BCTR. This should however not be seen in any way as a lessening of MBA's support for comprehensive tax reform but rather a response to the practical commercial reality in maintaining efficient and effective businesses in the building and construction sector.

The building industry is highly sensitive to the state of the economy, the wealth base of the nation, the extent and depth of its industry base and the welfare of the individuals measured by factors such as employment and income.

A strong economic base generates direct demand for buildings such as houses, offices, retail centres, factories, warehouses, economic infrastructure such as roads, bridges, railways, etc. The construction of these physical structures adds to the nation's wealth by facilitating additional economic activity and has therefore direct wealth-building and employment outcomes.

Taxation regimes have a significant influence on investment decisions in all sectors of the economy including the building industry. While MBA welcomes the comprehensive nature of the work of the Review of Business Taxation it is concerned that the impact of the proposed reforms in A Platform for Consultation will not be uniformly felt across industry sectors, business entities and regions.

MBA is concerned that the reforms recommended by the Review of Business Taxation be appropriately balanced to maintain the viability of capital-intensive industries including the construction industry. Similarly, the impact of those recommendations should recognise the role of small business in the economy, many of whom are unincorporated.

 

MBA is particularly concerned with any impacts from the proposed business tax reforms that may fall unduly and unfairly upon small business. Small business plays an important role in Australia's economy and while many may not have an international focus, they do nevertheless make a significant contribution to generating employment and to providing the necessary infrastructure for other businesses.

 

Implementation Timeframe

The Government's timetable for the implementation of the recommendations resulting from the consultation process is scheduled for 1 July 2000. This coincides with the implementation, should this be passed by the Senate, of another major and welcome change to Australia's taxation regime, the Goods and Services Tax (GST).

MBA is concerned that for many small and medium enterprises (SMEs) this compressed timetable will represent a significant problem. Many of our members will not have the necessary resources to manage the change nor the capacity in the short term to fully understand the impact on their business of the enormity of change contained in the reforms. These circumstances will therefore make this group of affected businesses vulnerable to the tax reform changes.

It is for these reasons that MBA recommends that the Government phase in the reforms over a reasonable period of time, say three to five years. Given that the reforms will be adopted on a revenue-neutral basis, there should be no impact on Government revenue.

 

The Needs of Small Business

The majority of businesses in building and construction are small and medium enterprises. MBA while a strong supporter of the Government's current tax reform strategy, remains concerned at the impact and cost of compliance that some of the reforms may have on small business.

The Australian Bureau of Statistics has estimated that there were 194,300 businesses in the construction industry in 1996-97 (ABS No. 8772.0). The overwhelming majority, 80 per cent, were SMEs with many of these operating as unincorporated entities.

A number of the proposed tax reforms if adopted will not necessarily provide SMEs with the same benefits that are likely to accrue to large companies. Yet these SMEs provide the necessary economic infrastructure to enable the efficient sub-contracting of works and services which in turn adds to the economic efficiencies of large companies. SMEs are also generators of direct employment. These important economic characteristics should therefore be taken into account in pursuing tax reform.

The reforms proposed in A Platform for Consultation have the objective of simplicity and horizontal equity yet the practical reality is that the impact of their outcomes falls unevenly between large and small business. The Review of Business Taxation should therefore fully take this into account in framing its recommendations to the Government.

 

Compliance Costs

The compliance costs of Government regulations and taxation fall unduly on SMEs. This real concern was substantiated by the work of the Small Business Deregulation Task Force in 1996 (Bell Report). It found that "The small business community is frustrated and overwhelmed by the complexity and cost of dealing with Government regulation and paperwork."(p1). It also reported that "Difficulties with the taxation system were the most important issues small business raised with the Task Force. The system is too complex in terms of the number of taxes, the uncertainty of the law, the frequency of changes, the difficulty of interpretation, the burden of record keeping and costs of compliance. Small business wants simplicity and certainty in taxation matters."(p2).

The Prime Minister in his statement on 24 March 1997 in response to the Bell Report, committed his Government to embark upon a process to reduce the paperwork and compliance burden on small business.

The Review of Business Taxation should, in any business tax reforms it may recommend to Government, be mindful of the Government’s commitment to reducing the compliance burden on small business.

The reforms canvassed in A Platform for Consultation have major implications for SMEs. Typically, SMEs do not have the resources to engage professional tax advisers and accountants to manage their business affairs. MBA is concerned therefore that the Review of Business Taxation in its consideration of recommendations to the Government maintains a strong focus on the impact of compliance costs for SMEs.

MBA recommends that the Review of Business Taxation include the implementation of a comprehensive program of awareness raising and education, and to allocate appropriate resources, to help small business change their business practices during the transitional period for implementing business tax reforms.

 

Regional Distribution Effects

The focus of the Review of Business Taxation has been on "developing recommendations for an internationally competitive and structurally sound business taxation system for Australia. The overarching objective is an internationally competitive economy providing optimum economic growth, encouraging savings and investment to provide employment opportunities for Australians."

The discussion in the paper and the tax reform options have been framed in an aggregated national context. There is an implicit assumption that the benefits and outcomes are equally distributed across all sectors of the economy and across all regions of Australia.

The reality however, is that there are significant areas in regional and remote Australia which will experience different distributional effects from the proposed business tax reforms compared to the eastern economic triangle.

Regional and remote Australia is where some of the most capital-intensive economic activity is undertaken, generating considerable wealth for Australia. This investment generates considerable externalities for the communities in those areas. In particular, companies provide significant private investment in public infrastructure such as roads, accommodation etc. that normally would not be provided by Governments. In turn, this investment facilitates and sustains a raft of SMEs adding to the employment opportunities in those areas.

MBA recommends that the Review of Business Taxation in developing its recommendations in moving towards a more coherent and structurally sound business taxation system for Australia take into account the regional distributional effects. It would be unacceptable for the Review to dismiss this concern on the basis it was not part of its terms of reference and that the responsibility lies with Government.

Key Issues - Building and Construction

 

A Platform for Consultation covers nine broad areas for business tax reform, not all of which have a direct impact on the building and construction industry. MBA however recognises that a business tax system which is coherent and has a sound structural framework will improve the climate for investment and productivity and thereby create employment and improve Australian's standard of living.

As a member of the BCTR, MBA has contributed to the formulation of broad principles in response to the reform options put by the Review of Business Taxation.

MBA's submission is limited to those areas of direct interest to the building and construction industry and includes the following:

 

  1. TAXATION OF ENTITIES
  • Taxing Trusts as Companies
  • Collective Investment Vehicles
  • Redesigned Imputation System.

 

  1. TAXATION OF PHYSICAL ASSETS
  • Accelerated Depreciation
  • Wasting Assets - Buildings and Structures.

 

  1. TAXATION OF CAPITAL GAINS
  • Moving Towards a Stepped-Rate Regime
  • Quarantining of Capital Losses.

 

  1. TAXATION OF FRINGE BENEFITS.

 

 

1. TAXATION OF ENTITIES

Taxing Trusts as Companies

The argument put forward for the more uniform treatment of entities is that investments attract different tax treatment simply because they are put through trusts rather than through companies. It would appear that the underlying principle behind the entity taxation proposal is to stop the flow-through of
tax-preferred income out of trusts of all kinds.

MBA is concerned that the options put forward, rather than dealing with the problem of the tax-preferred income issue, have sought to impose a new regime that will disadvantage small business. It will reduce their flexibility to manage their financial affairs and more importantly increase their compliance costs.

MBA endorses the argument put by the Institute of Chartered Accountants in Australia that challenges the assumption that the system of company taxation is currently superior or will be with the various amendments foreshadowed in A Platform for Consultation.

The proposals in A Platform for Consultation would appear to ignore the fact that companies and trusts are different vehicles at law. Trusts allow for the separation of legal and equitable ownership and have primarily been used for the protection of family assets for the benefit of successive generations of family members. Companies on the other hand were designed to enable the aggregation of capital for business purposes.

In ANTS the argument was put that there was inconsistent taxation treatment between business entities and that this represents a case for adopting a more consistent and equitable approach. One of the stated problems in ANTS was that wealthier individuals were able to minimise the amount of tax they paid effectively meaning that the rest of the community were subsidising the wealthier investor.

These comments only heighten MBA's concern at the approach taken with the options contained in the discussion paper.

To impose a company tax regime on trusts ignores the fundamental differences between companies and trusts. It fails to recognise that many of the trusts in the community are not for business purposes. It ignores the fact that most trusts are required to fully distribute income to beneficiaries on an annual basis. Where trust deeds allow accumulation, income is taxed at either individual rates or more usually at the top marginal tax rate. Companies on the other hand are able to retain after-tax profits for a number of years, usually to fund the expansion of operations.

As noted elsewhere, a significant number of businesses operating in the building industry are unincorporated and many of these operate trusts to manage their financial affairs to suit their particular personal and financial circumstances. Sub-contractors are a very important element in delivering efficiencies in the building and construction industry. To impose a company tax regime on trusts would impose a cost compliance burden that can only lead to the weakening of this very efficient area of operations in the building industry.

MBA therefore recommends that certain discretionary and closely held trusts used for the protection of family assets be quarantined from the proposal to treat trusts as companies.

 

Collective Investment Vehicles (CIVs)

Two categories of taxation treatment for investments, individual and entity taxation have been identified as part of entity reforms. There exists an intermediate category of taxation treatment, the flow-through taxation of CIVs.

CIVs can be deemed to be substitutes for direct investment, therefore income earned by and tax preferences available to such vehicles should be taxed in the hands of individual investors the same as if such investments were undertaken directly.

Many pensioners and other non-income earning individuals increasingly use CIVs to derive income streams. CIVs are seen as a secure and low-cost means of investment for this group of people.

The principle of taxing income from CIVs in the hands of individual investors would ensure that there are no negative cash flow effects on people when receiving such distributions.

MBA is concerned to see that this flow-through benefit be extended beyond cash management trusts.

The Treasurer, The Hon Peter Costello, on 22 February 1999 announced that cash management trusts would be subject to flow-through taxation under the new business entity tax regime outlined in ANTS. The Treasurer further noted that "Flow-through taxation treatment will apply…, in principle, to other collective investment vehicles … such as … property trusts."

There is no compelling reason why the flow-through taxation treatment should not apply to property trusts. Indeed for the building industry property trusts represents an important source of capital. Impediments that make property trusts less attractive against other investment classes can only exacerbate the shortage of development capital available to the building industry.

MBA recommends that the Review of Business Taxation for equity and consistency allow property trusts and other, similar vehicles to be subject to flow-through taxation treatment, to which the Treasurer has given
in-principle agreement.

 

Redesigned Imputation System

There were a number of options put to improve the integrity through the entity chain:

  • impose a deferred company tax (DCT)
  • apply a resident dividend withholding tax
  • tax unfranked entity distributions.

MBA along with other industry groups of the BCTR strongly opposes the option of imposing a deferred company tax. MBA believes that a DCT would be strongly anti-business. The proposed DCT will reduce company profits which in turn can only reduce earnings and the value of companies thus raising the cost of capital.

The imposition of a DCT can only compound the problem by accelerating the double tax liability of family company structures and increasing the tax liability of family discretionary trusts.

MBA is therefore particularly concerned that the imposition of a DCT will exacerbate the shortage of capital in the building and construction industry.

MBA on balance supports Option 2, which is the introduction of a resident dividend withholding tax. This option is not as onerous for family companies and trusts and is seen as a better alternative to deferred company tax.

 

2. TAXATION OF PHYSICAL ASSETS

Accelerated Depreciation

It was stated during the consultation process that one of the main trade-offs in moving towards a 30 per cent company tax rate is to remove accelerated depreciation. It has been estimated that the removal of accelerated depreciation allowances will raise revenue to the value of $2.4 billion in 2003-04.

The goal of achieving a 30 per cent company tax rate has obvious merit particularly in attracting overseas capital for long term investment in Australia. In a revenue-neutral framework A Platform for Consultation has proposed to broaden the base by removing a number of business concessions with the removal of accelerated depreciation the most significant of all the revenue measures proposed.

MBA as a member of the BCTR supports the broad principles that have been adopted but at a secondary level is concerned with one area that affects the building industry in Australia.

MBA believes there is a strong case for maintaining accelerated depreciation in the case of plant and equipment because of the externalities generated by the introduction of new technology in buildings both new and existing.

The Prime Minister in November 1997 urged the building industry to formulate its own energy performance standards for the reduction of greenhouse gas emissions.

The building industry has come together and formally established the Australian Building Energy Council (ABEC) to formulate its own energy performance standards for the reduction of greenhouse gas emissions. ABEC will act as a peak strategic body articulating the views of industry on greenhouse gas emission matters.

In the medium to longer term there is an expectation by the Commonwealth Government that the building industry, among other things, will start the process of upgrading plant and equipment in existing buildings with the latest state-of-the-art technology. This reinvestment in plant and equipment for many building owners will be costly but will produce externalities and other benefits not directly accruing to the owners.

Further, such investment in new technology is unlikely to be offset by the building owner's ability to increase rents on existing leases, thereby reducing the rate of return. One of the commercial realities likely to occur is the different priorities and values put on such new technology by tenants and by the Government in seeking to reduce greenhouse gas emissions for the building industry. Building owners therefore are likely to face a situation where they are unable to recoup the cost of such investment in new technology.

MBA believes that such investment in technology is more about providing a social rate of return and therefore should be subject to the continuation of accelerated depreciation arrangements.

MBA is not opposed to replacing accelerated depreciation with 'effective life' under certain circumstances, however such support would be conditional upon the appropriate rate for effective life and one that takes into account technical obsolescence. Similarly, the option of introducing effective life plus loading may also be acceptable under certain circumstances.

MBA recommends that accelerated depreciation for plant and equipment be retained to encourage the take-up of state-of-the-art technology, particularly relating to the reduction of greenhouse gas emissions. MBA further recommends that the consideration be given to the establishment of a committee comprising the Australian Tax Office and representative members of the Australian Building Energy Council to review the depreciation schedules for plant and equipment.

 

Wasting Assets - Buildings and Structures

The cost base for deductions under current arrangements varies according to the particular activity or asset. As a matter of fairness an investor's entitlement to tax deductions should be based upon the actual cost of the asset to the investor.

The present treatment of buildings and structures limits depreciation based on the original cost of the building or structure but capital gain is calculated on the combined land and building package on realisation.

MBA supports buildings and structures to be brought into the depreciation regime applying to all physical assets, that is, buildings and structures are valued at the actual cost of the asset to the investor not its original construction cost.

As a consequence buildings and structures therefore should receive taxation depreciation in line with their effective lives and with full balancing adjustments to apply.

Under existing arrangements for building, deductions are based on the historic or construction cost of the building or structure. MBA agrees that if the above proposal were accepted then it would be appropriate to separately value land and building so that buildings and structures would receive the appropriate taxation depreciation.

In this regard, MBA is concerned to see that the current schedules for effective life for buildings be reviewed by the ATO in consultation with the industry. MBA believes that the current schedules do not reflect contemporary economic utilisation of buildings.

MBA recommends that a special ATO/industry committee be established to examine this matter and to formulate appropriate depreciation schedules that are consistent with current commercial practices. This should ensure that investment in buildings and structures is not disadvantaged against other investment classes.

 

3. TAXATION OF CAPITAL GAINS

MBA supports the objective of moving towards a more competitive regime for taxing capital gains. There is also a strong argument to simplify current capital gains tax provisions. This is particularly problematical for the building industry where there is a high compliance cost.

A Platform for Consultation makes the observation that most countries tax capital gains more favourably than ordinary income but qualifies this by stating that this is not necessarily a conclusive argument that Australia should follow the same path. MBA finds this reasoning perplexing, given the mobility of capital in the global economy.

On a national basis Australia has a shortfall in investment capital and therefore to pursue a capital gains tax policy which works against attracting foreign capital and equally important, the retention of existing investment capital in Australia would seem at odds with the objective of becoming internationally competitive. It would also seem at odds with the objectives of Government to expand the Australian economy and to generate sustainable long-term employment.

MBA acknowledges the argument against seeking to attract footloose capital. Footloose capital by its nature seeks to maximise the rate of return in a short timeframe but this argument should not form the basis for discounting CGT policies which have a positive bias towards attracting and retaining patient capital in Australia. If there is concern about revenue leakages from speculative investments then it would be appropriate for income received from speculative activities to be taxed the same as ordinary income. Such an approach would not penalise efforts to attract patient capital into Australia.

 

Moving Towards a Stepped-Rate Regime

MBA in its submission in February 1998 to the Government's Tax Consultative Task Force chaired by Senator Gibson, sought to have the capital gains tax regime replaced with a more efficient speculative gains tax regime for
non-residential construction where capital gains tax liabilities would be phased out over a ten-year period such that in year eleven no CGT liability falls due.

MBA therefore welcomes the direction of the options contained in A Platform for Consultation. In particular MBA supports the underlying principle contained in the stepped-rate approach for individuals. The option goes some way towards MBA's preferred approach in its submission to the Gibson committee which seeks for the CGT to taper to zero per cent over the long term. It has been argued that a tapered approach could increase the administrative requirements in keeping the asset. MBA believes however that the benefits of a tapered rate in providing greater certainty to investors outweigh any compliance problem that it may impose upon business.

The stepped-rate option in A Platform for Consultation is limited to individuals and is not proposed for trusts or companies. MBA believes that this is an inequity for those investors in superannuation trusts and for other corporate entities who hold property. There is no compelling reason why the tapering approach should discriminate against trusts and companies.

MBA supports the CGT stepped-rate approach for individuals but recommends that the stepped-rate option be extended to trusts and companies.

MBA also recommends that a special committee be established to further examine such a proposal and to determine how the tapered scales should be set.

 

Quarantining of Capital Losses

A Platform for Consultation proposes to quarantine losses for those assets and liabilities on a realisation basis and for those losses to be available only for offset against gains on similar assets/liabilities. The quarantining of capital losses for offset only against capital gains is fundamentally inequitable. It is argued that tax on capital gains was justified on the basis that they were seen as a form of income. It is inequitable therefore that capital losses should not be available for offset against ordinary income.

MBA supports the BCTR's view that to excise losses from the general calculation of taxable income of business operations is contrary to the underlying philosophy of the Review of Business Taxation on tax neutrality.

MBA therefore recommends that capital losses be allowed to be offset against any form of taxable income. As a second best option, MBA would support the carry back of capital losses on assets acquired after 1 July 2000.

 

4. TAXATION OF FRINGE BENEFITS

MBA has been a long time critic of the complexity of the current FBT arrangements and the high level of compliance costs they impose, particularly on SMEs. Its members consistently rate FBT as an area which generates undue administrative complexity and one which imposes a considerable compliance burden.

The 1996 Bell Report concluded, "For many in small business, the fringe benefits tax represents the worst aspects of the taxation system. It is difficult to understand and compliance is costly. Those compliance costs are dead-weight loss for small business and the economy generally."(p2).

The inclusion in recent times of entertainment and on-premises car parking into the FBT net has added to the FBT complexity and compliance burden.

The imposition of FBT at the highest marginal tax rate also means that taking fringe benefits as part of a salary package disadvantages employees on lower marginal rates.

MBA supports the broad thrust of the fringe benefits reforms contained in
A Platform for Consultation and agrees with the following reforms:

  1. The liability for FBT be transferred from the employer to the employee (ie the recipient of the benefit).
  2. On-premises car parking to be removed as an FBT item.
  3. The removal of entertainment as a non-FBT item and a return to its pre-1995 non-deductible status.