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Submission No. 260 Back to full list of submissions
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SUBMISSION IN RESPONSE TO

THE

REVIEW OF BUSINESS TAXATION

SECOND DISCUSSION PAPER

AUSTRALIAN FOOD AND GROCERY COUNCIL

CANBERRA

APRIL 1999

 

 

1. Submission’s Authority

This Submission to the Ralph Review of Business Taxation (RBT) is made by the Australian Food and Grocery Council (AFGC), (formerly the Australian Food Council), the peak, national, representative organisation of the Australian processed food, beverages and grocery products industry.

This Submission responds to selected key issues covered in the second discussion paper issued by the RBT entitled A Platform For Consultation (hereafter referred to as Platform).

This is the second Submission made by the AFGC to the RBT and should be read in conjunction with the first – A Preliminary Response to "A Strong Foundation".

The Australian Food Council (AFC) became operational in June 1995, established as the peak, national representative organisation for the Australian processed food and beverages industry. The Australian Food and Grocery Council, operational from 1 January 1999, is a product of the merger between the Australian Food Council and the Grocery Manufacturers of Australia.

The membership of the Australian Food and Grocery Council is at Attachment 1.

The Australian Food and Grocery Council’s charter is to promote a domestic business environment conducive to international competitiveness, strong and sustained investment, business growth and profitability for our member companies, complemented by greater export market opportunities.

2. Business Tax Reform In Context

The AFGC agrees that the case for business tax reform is solid and supports the "nature" of the approach adopted by the RBT consistent with national objectives, industry interests, design features of a "good" tax system – simplicity, equity, efficiency and competitive neutrality – and the imperative for improving Australia’s international competitiveness.

This Submission is intentionally brief and reflects the AFGC’s consideration of the issues at this stage in the review process – an evolving process that reflects the complexity of the current system and proposed reforms.

The AFGC supports the RBT exercise being considered in a wider tax reform context:

  • the RBT focus is on direct business taxation reform only;
  • the AFGC recognises the importance - and priority - given by the Commonwealth Government to reform of the indirect business tax system, and in particular the need to implement a GST as proposed in A New Tax System (ANTS);
  • without indirect tax reform, the revenue take from existing indirect taxes will not keep pace with economic growth, putting upwards pressure on other elements of the tax system, including direct business taxation rates and/or the business tax base; and
  • without indirect tax reform along the lines proposed in ANTS, sensible, comprehensive direct business tax reform is at best unlikely to be sustainable, and, at worst, simply will not proceed.

 

3. "A Package" Approach to RBT Reform Proposals

The AFGC recognises the closely interdependent nature of the numerous proposals under consideration in Platform. Indeed, the AFGC considers the direct business tax reform package to be synonymous in that respect with the ANTS Package. In this regard:

  • entity taxation and tax preference issues cannot be considered in isolation from one another;
  • the relationship between the business entity tax rate, the capital gains tax rate, and the personal tax rate scale (for resident taxpayers), and the dividend withholding tax rate (for non-resident investors) will inevitably have a bearing on taxpayer responses to business tax reforms. For example, widening the gap between the tax rates may serve to create artificial incentives for closely held entities (private companies) to retain a greater proportion of earnings and realise gains through appreciated capital value. Such responses may be significant and require additional "band aid" measures adding to the complexity of the business tax system; and
  • the terms of reference for the RBT – and in particular the proposed tax rate objectives plus the objective of revenue-neutrality (relative to ANTS) - themselves imply tensions whose effective resolution again may require measures that add to the complexity of the business tax system (see Section 5).

4. Durable Business Tax Reform

4.1 The Imperative

The AFGC underscores that a stable, certain, taxation environment is a fundamental criterion to promoting an internationally competitive business environment conducive to investment, growth and profitability.

Realistically, taxation systems will evolve, and, to that end, agreed ongoing consultative processes that allow businesses and the taxation authorities cooperatively to refine the detail of the system are essential. With the best will in the world, it is almost certain that major reform proposals will not be exactly 'right' on day one. Few claim to have the answers on the 'best' approach – even at a point in time.

Notwithstanding, it is important that the fundamental architecture of the business tax system be sound at the outset. If it is not, the system will not endure the test of time.

For purposes of this submission, the AFGC recognises that comprehensive income is to be the benchmark direct business tax base – although AFGC and, we are confident, others will continue to question the conceptual and practical merits of this benchmark against alternatives such as a direct expenditure tax base as canvassed in the AFGC’s initial Submission to the RBT. For the same purposes, AFGC also accepts the key tax design feature of tax neutrality - that is, the same tax treatment across different activities, different investments, and across different legal entities.

However, these benchmarks which the RBT has set in A Strong Foundation, are frequently violated by the reform proposals presented in A Strong Foundation and in Platform. In some critical cases, these deviations are driven by the business tax rate/capital gains tax rate/revenue neutrality constraints imposed on the RBT by its terms of reference.

 

For example:

  • deviations from the comprehensive income base are evident – the treatment of losses is not symmetrical with the treatment of gains, for example – because of concerns about costs to revenue in the context of securing a lower 'headline' business tax rate; and
  • there is no consistency of taxation proposed across business entities: companies and many trusts, as well as superannuation funds, will be taxed directly, but other entities (including collective investment vehicles) will benefit from 'carve-out' arrangements. Again, the practical entity neutrality solutions – to tax all entities like trusts, and/or to allow full flow-through of whatever tax preferences remain to all ultimate beneficiaries, have been ruled out because of concerns about costs to revenue in the context of securing a lower 'headline' business tax rate.

4.2. The Threat To Durability Of Business Tax Reform

AFGC is increasingly concerned that the deviations proposed both from the benchmark business direct tax base [comprehensive income] and practical neutrality across business activities, investments and entities will:

  • themselves necessitate other adjustments to the tax system that will make it more complex rather than more simple - possibly more complex even than the status quo;and/or
  • induce behavioural responses that over time will undermine the sustainability of the business tax reforms themselves.

AFGC requests the RBT to have regard for these general concerns in framing its Report to the Government.

If, on reflection, the RBT concludes that some of the tensions generated by its terms of reference pose threats either to the revenue and/or to the need to develop a simpler, rather than a more complex, business tax system, then AFGC recommends that these concerns should be identified in the RBT Report to Government, and the widest possible range of options to deal effectively with these concerns should be canvassed for consideration by the Government.

Not do so, as indicated, runs the risk of business tax reform that is:

(1) more complex;

(2) threatens the revenue base over time;

(3) renders reduction in headline corporate tax rates unsustainable; and/or

(4) necessitates more concessions to be traded off to support durability.

 

5. Key Issues For AFGC Members

This section of the AFGC's Submission summarises member reactions to six specific RBT issues/proposals considered important to the Australian food and grocery industries.

 

 

5.1 Business Entity Taxation

Most AFGC members operate as companies. A few operate, at least in part, as cooperatives.

In general, therefore:

  • most AFGC members are unconcerned about proposals to tax other business entities in the same way as companies; and
  • some, however, are concerned to secure a 'carve out' in relation to cooperatives.

That said, AFGC members also note that consistent treatment of business entities is not a feature of Platform and that a range of entities will enjoy preferential treatment over companies, most trusts, and superannuation funds in that respect.

Most AFGC members support an optional consolidation regime, and also believe that it should be allowed where there is less than 100% wholly owned Australian resident ownership.

If consistency of tax treatment of business entities is a goal - and the RBT says that it is - then business entity taxation and the flow-through of tax preferences must be considered together.

There are three in-principle solutions that would achieve consistency:

  1. tax all business entities like companies: tax preferences will then 'wash out' for all beneficiaries on distribution of dividends;
  2. tax all business entities like trusts: tax preferences will then pass through to the ultimate beneficiaries in all cases; and
  3. retain a hybrid system, with some entities directly taxed and others not, but with all distributions - including of tax preferences - fully franked: in this case, minor timing details aside, the effective taxation of all business entities' income will be consistent.

The AFGC recognises that RBT faces a dilemma:

  • option 1 has been ruled out by businesses, because of understandable and real problems that would confront CIVs, and others. However, that encourages businesses to maximise the scope of 'carve out' arrangements;
  • option 2 has been ruled out by the RBT terms of reference - on revenue-cost grounds - and by ANTS itself; and
  • option 3 presumably also would be ruled out by the RBT terms of reference, and in particular by revenue-cost considerations, the equity case for such an approach notwithstanding.

Notwithstanding, the AFGC considers that the correct, and consistent, treatment of tax preferences, on which practicable neutral treatment of business entities heavily depends, is as follows:

  • establish the case for or against tax preferences;
  • those for which there is a good case should be retained;
  • in those cases, consistent with the conceptual basis for imputation - that it is no more than an advance payment in respect of the shareholders' liability - distribution of tax preferred income (as well as other income) should be fully franked; and
  • when that is in place, the timing of tax collections from different business entities - the remaining issue - becomes a third- or fourth-order problem.

Full pass through of tax preferences via adjustments to the present imputation system would complement the proposal (see section 5.2) to pay refunds of unused franking credits and make the label 'full' dividend imputation more accurate, rather than, as at present, quite misleading.

 

5.2 Imputation, Deferred Company Taxation & Alternative Approaches

Amongst the options proposed in Platform most AFGC members would prefer the so-called deferred company tax proposal (DCT) to be replaced by the proposed resident dividend withholding tax (RDWT) proposal:

  • RDWT does not affect reported company profits, which has at least cosmetic appeal, and does not affect (most – dividends paid to o/s holders through Australian residents are taxed) dividends paid to overseas shareholders; and
  • the DCT proposal is more inconsistent with one of the stated objectives of the RBT – to make Australia a more attractive place in which to invest - by increasing the tax burden and reducing scope for recognition of tax paid in Australia in respect of dividends paid to overseas shareholders (foreign investor will bear tax on Australian earnings on the full company tax rate, with probably no recognition of Australian franking credits).

That said, AFGC members recognise that both of these proposals effectively bring forward (albeit slightly in some cases) the point at which tax preferences are 'washed out' through the operation of imputation as it presently operates in Australia, or proposed equivalent arrangements.

 

5.3 Imputation Refunds

For many, but not all, AFGC members, the provision of refunds of unused franking credits to Australian resident shareholders unable to exhaust such credits against other current tax liabilities is not perceived as offering a material advantage to their businesses.

Nevertheless, as a matter of tax equity, and given (for purposes of the RBT) AFGC's acceptance of the tax neutrality principle, AFGC recognises that this initiative is a useful improvement in the equity of imputation arrangements, and is consistent with the intent of imputation overall. In particular, it helps reduce over-taxation of dividends relative to other forms of investment income.

 

5.4 Exchanging Existing Tax Preferences For A Lower Business Tax Rate

Perhaps not surprisingly, AFGC members have different rankings in relation to the importance attached to existing tax preferences. Consequently, their individual preparedness to accept a trade-off of abolition of specific preferences in exchange for a lower 'headline' business tax rate depends on the particular concessions to be removed or reduced.

Nevertheless, there is a net balance of AFGC members - if not consensus - that is prepared sympathetically to consider a tax preferences/'headline' tax rate trade-off.

Although AFGC members generally are significant investors in plant and equipment, the proposal to remove or reduce accelerated depreciation as a financing mechanism for a lower 'headline' business tax rate has received a perhaps surprising level of positive interest.

 

 

This interest generally is based on AFGC members taking the costings/revenue implications of various reform options presented in Chapter 39 of Platform at face value. And this favourable consideration needs to be interpreted carefully. Other considerations are also relevant:

  • in part, it may reflect the present low interest rate environment, which eases the financing costs of investment generally;
  • for some, there may be a perception that a lower company tax rate itself reduces the value of existing tax concessions (although, if the trade-off is to be genuinely revenue-neutral, this reduction must exactly match the loss of the concession);
  • in some cases it may reflect the fact that substantial re-investment programs have been completed and no new investment on any significant scale is expected for some years;
  • in other cases it may reflect members' capacity to bring forward new investment plans so that they qualify for accelerated depreciation while subsequent income streams benefit from the expected lower tax rate (at the business entity level at least);
  • in yet other cases, it may reflect business' appreciation that Platform appears to propose that all of the revenue bring-forward from removal of accelerated depreciation, rather than just the net present value of the revenue gained, is being used to finance a lower 'headline' business tax rate; and
  • in other cases a combination of some or all of these considerations might be involved.

To the extent that these sorts of considerations are the basis for AFGC support for this particular tax preference/tax rate trade-off, that support in part may reflect a perception that this trade-off will be net after tax profit-positive for AFGC members.

While that situation might be consistent with an economy-wide revenue-neutral outcome, this needs to be carefully assessed. More generally:

  • the full use of the revenue bring-forward (gain) from removal of accelerated depreciation, rather than the present value revenue gain, is questionable in its own right;
  • financing an ostensibly permanent tax rate cut by removing a concession that is inherently temporary - accelerated depreciation only delays the timing of tax payments - does not suggest a durable, revenue-neutral, reform outcome unless other factors are relevant; and
  • ignoring most behavioural responses to the sorts of proposals - especially on business and CGT tax rates - being considered by the RBT, as appears to be the case judging from some of the assumptions underpinning the costings in chapter 39 of Platform, gives rise to obvious questions about the durability of the net revenue impact over time of the rate cut/base broadening trade-offs being proposed.

 

 

5.5 Research & Development Tax Concession

Notwithstanding the AFGC membership’s favourable disposition to trading specific tax preferences for a reduction in the headline business tax rate, many AFGC members, particularly R&D dependent companies, consider retaining the R&D tax concession at 125%, indeed its restoration to 150%, a necessary incentive for investment and innovation.

The AFGC has consistently advocated the R&D tax concession as an appropriate and effective instrument of Government intervention to correct a market failure.

The evidence of the real impact since the rate of assistance was reduced from 150% to 125% is compelling for a restoration to 150%:

  • in the five years to 1995-96, business expenditure on research and development, increased by an average of 16% in nominal terms or around 13% in real terms, and as a proportion of GDP increased from just over 0.5% to just under 0.9%; and
  • latest data available (ABS) indicates that nominal BERD spending decreased in 1996-97. This is consistent with the survey work by the Business Council of Australia which concluded that in the three years since the changes were made to the end of the current financial year, BERD is expected to decline by about 8% per year – which equates to a level of gross expenditure approximating that of the 1992-93 year. Calculated against the trend line of continued growth in BERD had the pre 1996 circumstances remained, the opportunity cost or reduction in BERD is estimated by the BCA to be about one third or $1.5 billion (pers com).

The food industry has found the R&D Tax concession particularly attractive as it provides incentives for innovative activities which are incremental improvements in products and processes rather than substantial advances in new technologies or products. However, at the present level of 125% (representing a return of 9 cents in the dollar) compliance costs have reduced the attractiveness of the concession considerably.

 

5.6 Tax Treatment Of Capital Gains

Amongst AFGC members, different responses to different proposals concerning capital gains tax (CGT) are evident:

  • present averaging concessions are generally regarded as less important than a lower 'headline' CGT rate, if the latter requires removal of the former;
  • scrip-for-scrip rollover relief and more lenient loss offset relief is not widely regarded as important by the majority of AFGC members, although a significant number do attach importance to these measures; and
  • the merits of a trade-off between removal of indexation and a lower 'headline' CGT rate is a matter for debate within AFGC. While low inflation suggests indexation at present offers little advantage, it also suggests little benefit if abolished to finance a lower CGT rate on a revenue-neutral basis. The balance of views amongst the AFGC membership could shift significantly under conditions where inflation is higher - possibly towards retention of indexation and its extension to indexation of capital losses carried forward.

 

5.7 Fringe Benefits Taxation

Consistent with the principle that genuine fringe benefits are a close substitute for wages and salaries, and therefore should be taxed at the same rate, there is a broad consensus amongst AFGC members that:

  • the present FBT system is too complex; and
  • because they are not regarded as genuine fringe benefits, but rather as legitimate expenses incurred in earning assessable income, entertainment expenses and employer-provided car parking should not be subject to FBT. Moreover, AFGC members see a case for making both employer-provided car parking and business entertainment expenses deductible, consistent with a proper definition of (net) income for taxation purposes.

AFGC members have more mixed views about the merits of tightening up the statutory formulae in relation to motor vehicle fringe benefits.

While the in-principle merits of that proposal resting on the need to tax salary and fringe benefit substitutes at the same rate, are recognised, AFGC members are concerned about application of such changes retrospectively, given the significant number of motor vehicle benefits at present incorporated in remuneration packages.

As to the proposal to tax fringe benefits in the hands of employees, again AFGC members have mixed views:

  • on the one hand, the principle of taxing such benefits at the marginal tax rate appropriate for the beneficiary is recognised; and
  • on the other hand, some members are concerned that this change might add to the complexity of the tax system, at least in the transition period, and to their compliance costs.

6. Concluding Observations: AFGC Support For Reform Is Conditional

The AFGC emphasises that its support for specific business tax reform proposals is conditional.

In particular, if AFGC is to support removal of any existing tax preferences - notably accelerated depreciation - in exchange for a lower 'headline' business tax rate, it will do so only if that exchange is durable.

The AFGC is highly cognisant of recent instances where businesses have been offered a lower company tax rate most recently 33% in 1993-94 – also justified on the grounds of improving Australia's international competitiveness – only to see that rate increased to the present level of 36% two years later because the Budget position was such that the Government concluded that it could not afford to lower the rate.

Chopping and changing the business tax rate itself generates complexity - including as a result of the requirements of the imputation system.

Accepting the permanent abolition of particular tax preferences that exist at present, in exchange for a temporary reduction in the 'headline' tax rate, for AFGC members at least (if not Australian business generally), is no deal at all.

MITCHELL H HOOKE

EXECUTIVE DIRECTOR

AUSTRALIAN FOOD AND GROCERY COUNCIL

16 April 1999