|Submission No. 9||Back to full list of submissions|
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NATIONAL BUSINESS-TAX OBJECTIVES
– Economic Growth objective is paramount, to serve Australia's interests
– Certainty and clarity are the drivers of simplification
POLICY DESIGN PRINCIPLES
International Competitiveness is a first-order Policy Design Principle - it must be used to test every tax policy proposal
Investment Neutrality Principle must be revised
Proposed Additional Policy Design Principles
Policy Design principle 2 "Taxation of Comprehensive Income" is not appropriate
Principle concerning Tax Incentives should either have general application, or be deleted
Risk Neutrality Principle needs more consideration: - consider the transferability of tax concessions for economic growth
Horizontal and Transitional Equity Principle requires review
LEGISLATIVE DESIGN PRINCIPLES
Consultation with Users
Anti-Avoidance Rules: Recent drafting is inappropriate
BUSINESS TAX PROCESS REFORM
Advisory Board for the Australian Taxation Office
Improved Political Process regarding Business Tax System
ADMINISTRATIVE DESIGN PRINCIPLES
Two Additional Administrative Design Principles
Improvements in Tax Administration
Improvements in the Rulings Process
Arthur Andersen supports the Government's openness to reform of Australia's business taxation system. We support the approach of the Review to align the business taxation system with national objectives and clear design principles, in a principled approach.
We note that Australia's national objectives are served by not restricting the focus to economic growth domestically. Australia's interests are served by the global penetration of Australian business, and the overseas growth of multi-national businesses (large and small) feeds back into the development and growth of Australia.
The national objectives must clearly identify the primacy of economic growth as the national objective. This is the key factor that will "lead to more robust investment decisions, improved competitiveness, greater productivity, higher gross domestic product growth and more jobs." The pre-eminent emphasis to economic growth should be entrenched in:
(a) the stated national objectives;
(b) the policy design principles; and
(c) the taxpayers' charter.
We agree with the Review in respect of its work towards simplification, however we suggest adjustment of the drafting of the national objective. Clarity and certainty are paramount and progress towards simplification must not be at the expense of certainty.
We submit that the Policy Design Principles need to be adjusted in various ways.
International competitiveness of Australia’s tax system is a first order Policy Design Principle. This needs to be promoted as do the other principles dealing with economic growth. International competitiveness is key to the business tax system, and An international perspective (the international comparisons paper commissioned by the Review) demonstrates that this principle is a key design factor being followed in other countries. The perceived lower priority given to this principle could lead to distortions, in our view.
In particular, international competitiveness and economic growth will be critical in the Review’s consideration of the entity tax and Deferred Company Tax proposals. We demonstrate how these proposals will require the most searching analysis and adjustments to fulfil Australia's national objectives. In their currently-understood form, the proposals are not appropriate for Australia, in our view.
We recommend that the Investment Neutrality principle needs to be revised. In our view, there is no policy impediment to differential taxation of business entities. In fact this is legitimate to balance flexibility against simplicity. We demonstrate that international trends are to allow for differential taxation of:
Because this principle appears to be the main basis for proposals for "one size fits all" entity taxation and Deferred Company Tax, we recommend rethinking of this principle.
As well, in respect of investment neutrality, we make clear our expectation that the Review will look more widely at Australia’s capital gain tax (CGT) and its defects – not just the two items mentioned expressly in the terms of reference. The CGT regime is a key element of Australia’s business taxation system and is not working well.
We suggest three additional policy design principles:
We consider the taxation of comprehensive income (including revaluations of assets) (policy principle 2) and believe strongly that this principle is not a feasible benchmark in the context of Australia’s business taxation regime. The value of business assets is volatile and such "comprehensive income" proposals – whatever their technical attractions - are inappropriate for Australia’s business taxation system.
Principle 10 "tax incentive provision" is in our view one-sided and inappropriate. We suggest that the principle be reworked to apply a rigorous process to revenue-raising measures as well as tax incentives, or alternatively that this principle be excised.
The risk neutrality principle notes the quarantining of business losses arising from a perceived need to protect the revenue raising functions of the business tax system. Australia’s loss-quarantining measures are internationally uncompetitive, and are one of the factors which distort business decision making in Australia, by causing a bias away from risk neutrality. We suggest that the Review should formally consider the transferability of tax concessions by way of more liberal tax-benefit transfer arrangements, as apply in other countries.
We identify the additional work required for policy design principle 6, especially "transitional equity". Australia’s tax system is undergoing much change and will continue to do so. The Review should develop a standard methodology for tax transitional rules, which will facilitate the Review’s objectives of simplification, economic growth and equity.
To be constructive, we use examples throughout this submission to illustrate various propositions. These are meant as constructive criticism, illustrating the difficulties of the administrators and policy-makers working within the current defective system. We would not wish our constructive comments to be misinterpreted, or to dampen the enthusiasm of all stakeholders to create A New Tax System.
Legislative Design Principles
Turning to legislative design principles, we:
We outline our recommendations concerning the Board for the Australian Taxation Office (ATO). We believe that this Board will not only provide oversight for the ATO, but could also act as a champion for the ATO to introduce desirable initiatives.
We propose improved processes for government involvement in taxation measures due to the pressure of work on the Treasurer and Assistant Treasurer. We recommend an enhanced political process, whereby business taxation can be given due attention.
Administrative Design Principles
We support the administrative design principles proposed by the Review. We suggest two additional principles:
We comment also on the Review's proposed:
Fringe Benefits Tax
We support the Review's decision to consider Fringe Benefits Tax (FBT). Real improvements could be made from a policy re-analysis of FBT. Recently-introduced legislation to implement A New Tax System proposes a matching by employers of most fringe benefits to employees (although the compliance will be costly because that measure can be improved). In this environment, Australia's business tax system could see over time a move away from FBT.
Our detailed comments are set out below.
We agree that the development of business taxation in Australia must be aligned with national objectives and design principles.
We recommend that optimising economic growth – by minimising interference with best use of our business resources - must be clearly identified as the pre-eminent national objective. Economic growth is the key factor that will "lead to more robust investment decisions, improved competitiveness, greater productivity, higher gross domestic product growth and more jobs."
The objectives of equity and simplification may be laudable and important politically in establishing support for tax reform, but they will not enhance Australia’s competitiveness or facilitate greater productivity, higher gross domestic product growth and more jobs.
We recommend an express ranking of national objectives as pivotal in the Review's second discussion paper. The emphasis on economic growth and international competitiveness should be entrenched in:
(a) the stated national objectives;
(b) the policy design principles; and
(c) the taxpayers' charter.
Such a clear prioritisation will be critical when the Review considers the Deferred Company Tax (DCT) and Entity Tax System proposals. We are extremely concerned that the DCT proposal may not be consistent with the economic growth of Australia, without action to ensure that it will be internationally competitive – as discussed below.
If the Review does not establish the primacy of this objective, there will be two risks:
(a) future bureaucracies will re-prioritise the objectives and principles to create laws which stifle initiative, are not geared to growth, and add bulk to the legislation.
(b) the work of the Review might be channelled into measures:
(i) leading to administrative convenience instead of facilitating growth; or
(ii) simplifying legislation at the expense of providing flexibility to facilitate economic growth.
Growth includes international activities of Australian enterprises
Australia's national objectives should not restrict the focus to economic growth domestically. Australia's interests are served by the global penetration of Australian business, and the overseas growth of multi-national businesses (large and small) feeds back into the development and growth of Australia.
International activities of Australian firms – whether they be a small service firm operating in Asia, a technology/biotechnology manufacturer or a large public company operating globally – add to Australia's growth. This merits express mention in the national objective.
We agree that the Australian tax system is excessively complex and we support simplification.
However business is complex, the world is complex, and not every business tax measure can be homogenised.
For example, figure 3.3 shows 37 different categories of capital expenditure. Many of these are express statutory tax concessions designed to promote investment in socially and economically desirable activities.
We support the Review's stance on harmonisation of the legislative structure for the tax concessions. However, the provision of tax concessions, in a way consistent with processes discussed in the foundation document will over time cause a re-growth of special situations. We are not troubled by that process, if carried out in a principled way.
The tax system is enhanced by certainty. Compliance costs are then reduced, and business can go about its task of enhancing Australia's growth.
In our view, certainty – coupled with clarity of rules – enhances simplicity.
Simplification should not be pursued at the expense of certainty – otherwise the failings of our current tax system will be perpetuated.
We recommend that the Review should clearly express certainty through clarity as being of equal weight as simplification.
International Competitiveness is a first-order Policy Design Principle - it must be used to test every tax policy proposal
We agree with the introductory comments to A Strong Foundation that:
For this reason we believe that the Review should prioritise and re-arrange the policy design principles set out in box 6.2, to promote those relating to economic growth – currently nos. 7 – 10 – to the first rank.
In particular, the principle currently shown as No. 9:
"balanced taxation of international investment: taxation of inbound and outbound investment and other cross-border business activities should be consistent with Australia’s national interests, including its competitiveness, while respecting Australia’s international obligations"
should be promoted to be the first, in our view.
The current ordering implies a lower significance and could be mis-read by future regulators and legislators.
The central theme emerging from the Review's paper – "An International Perspective - Examining How other countries approach Business Taxation" (An International Perspective) is that numerous countries have made and are considering changes to their taxation systems to assist their national competitiveness, to attract global capital and to assist their local companies to expand on the world stage. An International Perspective notes that to:
"redesign a tax system which does not take sufficient account of international factors would be to risk a declining revenue base, poorer economic outcomes, inadequate foreign investment in Australia and a poor competitive position for Australian enterprises and Australian based multinationals."
The international tax-system trends result from the mobility of business, as demonstrated in the following examples:
a) the headquarters of a major public company can be moved overseas or a public company can be taken over by a company located in a more business-friendly tax system.
b) the operations and principals of an information technology or service firm can easily migrate,
c) a funds management organisation managing international capital can move to a more business-friendly regime or
d) a resources company with investment opportunities in every country can decide to look to overseas opportunities, in partnership with other-country entities, instead of investing in Australia.
Overseas countries are responding to these issues in the redesign of their tax systems. An International Perspective notes that the treatment of foreign source income and the availability of foreign tax credits, coupled with the globalisation of world economies has "elevated this point to a key policy issue … there are increasing threats from multinationals that they will change residence". Various countries are focusing on techniques to enable international companies to generate overseas income and pass that income to shareholders without undue distortions.
We recommend that the Review adopt a clearly stated focus on retaining Australia's competitiveness as a critical principle in relation to all matters affecting international capital and international business.
We know that various corporate groups in Australia are already exploring whether the Deferred Company Tax proposals will cause them to relocate their headquarters activities – groups which:
Australia's tax system must broadly align with other countries' tax systems. Otherwise:
(a) Policy mismatches will cause disincentives to operate in Australia;
(b) There will be a tendency to "fix the problems" with specific solutions which add complexity – which will defeat the objective of simplification.
We expect therefore that any proposals for discussion in the next Discussion Paper will have been tested against:
a) Their effect on investment from and into our major trading partners, including interaction with the treaties, and
b) effect on Australia's international competitiveness.
It would be a great disservice to Australia if the effect of DCT and other measures was to push internationally-competitive sectors out of Australia.
Some countries' corporate tax systems have some similarity to the DCT, but none are identical, and all involve lower rates of tax than Australia's – France has a precompte "top up" of company tax to 33.33%, Germany has an equalisation tax of 30%, Finland may require a further 28%, Israel has a withholding tax of 25% to resident shareholders and Norway has an Advance Corporation Tax offset against future corporate tax.
a) the U.K. and Ireland are terminating their Advance Corporation Tax systems in 1999, for reasons including the adverse effects on international competitiveness.
b) most countries using this approach provide special treatment for international activities (e.g. treaty limitations, or conduit taxation)
An International Perspective confirms that such "top up" tax approaches are not an emerging trend – and are largely confined to capital-exporting countries.
Australia is not a capital-exporting country.
Arthur Andersen believes that any such system would need to be very carefully tailored to meet Australia's requirements, and the review and Government would need to undertake searching scrutiny of the effect on Australian companies, and the effect on international perceptions of investment in Australia, before such a move could be introduced.
In particular, any discussion in the Second Discussion Paper must as a minimum cover the following issues:
1. Effect on Australian companies' reported earnings – favouring a withholding tax instead of an entity tax.
We are conscious of the effect of some Deferred Company Tax proposals on reported earnings. This was a defect of the UK ACT system. We express a strong preference towards a withholding tax system rather than an additional entity tax)
2. Flow-through of foreign earnings of international businesses to foreign shareholders.
Coupled with the current Australian anti-dividend-streaming rules, Australia is already a sub-optimal location for various Australian companies competing on the world stage. This disadvantage must be:
a) remedied and
b) must not be magnified
in the Reform process.
3. Elimination of undue complexity
4. Interaction with Australia's tax treaty network
Australia cannot afford years of uncertainty as complex measures are integrated into our tax relationships with our major trading partners. The second discussion paper should consider every proposal against the current treaty network and should outline the program for any necessary changes, and how these will be integrated into the timetable for implementation.
We comment on the proposition that one of the three key problem areas of the business tax system in Australia is "the differential taxation of different business entities" (para 9, A Strong Foundation), and the resulting discussion of this issue.
We recommend that the Review should analyse the claimed severity of the problem. In our view the proposed policy design principle is inappropriate, as discussed below.
1. Differential taxation of business entities is legitimate to balance
We will hold back our major submissions on the entity tax proposals until after the second discussion paper – as requested by Mr John Ralph AO.
However in our view the proposed Policy Design Principle 7 (box 6.2) that "business tax arrangements should avoid differentially taxing … the type of entity…" competes with and has the potential to undermine:
We recommend that the proposed Principle requires searching re-analysis. This is critical because this principle permeates the discussions of DCT.
Many international taxation systems provide for differential taxation of different business entities. Other countries, in providing the correct economic stimuli or enhancements of business, typically differentiate between:
(i) Large scale trading operations (which typically receive treatment like companies in Australia).
(ii) Passive investment pools (which typically receive treatment similar to that afforded to managed funds operated through trusts in Australia – that is, flow-through treatment of greater or lesser degree).
(iii) Small business groups where limited liability is constructed for legal reasons, but flow-through treatment is afforded for tax purposes (often by using flow-through companies taxed as partnerships, like the treatment of trusts in Australia).
(iv) "Flow-through" or so-called "hybrid" entities to facilitate the transmittal of tax-preferred income in various circumstances (eg US limited liability partnerships or limited liability companies).
We disagree with the proposal that "one size should fit all" – the apparent underpinning of the entity tax proposal, and Deferred Company Tax proposal, that all business entities should be taxed alike.
We see this proposal as being inconsistent with:
As we stated this to the Federal Treasury when the review of trust taxation was initiated following the 1997 Federal Budget, if trusts are to be "legislated away" for tax purposes, any new rules will need to contain:
which will operate as proxies for trusts. We wonder, then, what will be the net economic benefit of creating such "churn" of our taxation system.
We accept that some element of simplification is called for in relation to the taxation of ordinary non-business taxpayers. For example, we accept that it should be easier for individual taxpayers to collect dividend income without the complexity of the current taxation-of-dividends rules.
However, some degree of complexity can be tolerated in the tax system. The business environment is complex, and for this reason business tax incentives can acceptably have an element of complexity.
Trusts appear to be used rarely in countries outside Australia and New Zealand for the conduct of active business, but are frequently used for their historic purposes of asset protection and inheritance planning, to deal with passive investment income and not with active income. Tax rules that apply to trusts are often designed to inhibit their use for income splitting, and are often complex, but nonetheless flow-though rules exist.
Various countries provide concessions may be provided for certain companies or similar business entities. eg the US "S corporation" – summarised in An International Perspective.
Partnerships are common in all countries. Limited partnerships are recognised in most of the countries examined. The treatment of losses in limited partnerships tends to restrict the loss of the limited partner to the amount of capital contributed. Otherwise, limited partnerships are generally taxed like standard partnerships.
Many countries allow flow-through treatment for various business undertakings. This conflicts with the proposals in ANTS for entity taxation – which limit the ability to flow through tax preferences.
An International Perspectiveshows that, in almost every country, pooled investment funds are generally conduits using:
Only Chile and New Zealand appear to tax the fund at normal rates – the approach which appears to be favoured in the ANTS document.
We think that the conduit treatment is particularly appropriate given the growth internationally of tax-exempt superannuation funds as collective pools of capital.
The proposals for Deferred Company Tax – as currently understood - will cause elimination of the current concept of "tax-preferred" income distributions from certain entities.
We observe that these proposals conflict with Policy Design Principle 4 that "for business tax purposes … entities should be considered as extensions of their ultimate owners."
These proposals also conflict with Principle 6 "Horizontal and transitional equity" which requires that "all income … should be taxed comparably." In our view:
If the results are worse when using a funds management vehicle – as occurs under the DCT proposal as currently understood – a disservice is done to Australia's competitiveness and growth.
Principle 10 requires a formal assessment of the net impact of tax incentives on national objectives. We recommend that, before any proposal is considered which eliminates the value of tax incentive provision in the Australian economy – as does the DCT proposal in its currently-understood form – that the most searching economic justification similarly needs to be provided in the second discussion paper.
In our view, the DCT proposals will require numerous adjustments to conform to:
The adjustments needed to the DCT reflect the fact that the DCT in its current form is not an appropriate design feature for Australia's tax system at this stage of our pursuit of international competitiveness.
The net effect of grafting the changes onto the DCT proposals will be to create great change or to "churn" the Australian taxation system, to churn Australia's business structures (especially those sectors involved with Australia's savings and Australian international business) and create enormous change-management tasks for little ultimate advantage.
We counsel against such a process without a clearly-demonstrated economic benefit.
We expect that the Review will consider Australia's Capital Gains Tax (CGT) system – a key element of business taxation – against the principles outlined in A Strong Foundation.
As well as the two issues specifically outlined in the Terms of Reference:
we assume that the Review will examine the myriad other defects in our CGT system
We observe that:
a) Australia's CGT provides few concessions for development of emerging businesses, and is internationally uncompetitive – as outlined in An International Perspective;
b) this retards Australia's economic growth in our view, and encourages:
1. Proportionality - illustrated by consolidated-group proposals
A feature of Australia's tax system has been the focus by law-makers and administration on a defensive anti-avoidance stance in the tax law, and in particular:
a) the orientation towards highly complex rules aimed at plugging every gap and preventing every loophole – even at the expense of complex and costly compliance tasks, and complex administration;
b) a tendency to introduce a multiplicity of anti-avoidance rules, with multiple factors to be considered – in every new measure.
We recommend that the Review should facilitate a transparent approach to identification of the perceived defects in the law, or at least subject the perceived defects to scrutiny by its private-sector advisers. This is needed to build confidence in the need for change.
We agree that tax reform is desirable. That does not, necessarily require demolition and removal of every aspect of the existing tax system.
We recommend that a Policy Design Principle be expressed along the following lines:
"Business taxation policies will be developed to balance enhanced taxpayer compliance against revenue requirements. Tax policies, even when well-designed, will occasionally result in unforeseen arbitrage opportunities for some taxpayers, but the desire to eliminate every arbitrage opportunity at the cost of disproportionate complexity or heavy compliance requirements for all taxpayers will conflict with the national objectives."
In this context, we are concerned about the comments in ANTS about the perceived abuses perpetrated by corporate groups, including cascading of losses.
We have no access to the statistics concerning the precise problems, and so we cannot test their correctness. We make the following observations:
a) We hope that there will be a transparent explanation of the current perceived abuses, in the second discussion Paper;
b) As we understand the proposed consolidation regime, from the brief outline in ANTS, it will be complex, with complex compliance, recording and reporting issues:
c) The first indications are that the proposed thresholds for consolidation – 100% common ownership, irrevocable elections for every entity in the group – are set higher than those for our trading partners – e.g. New Zealand, UK, US.
We are concerned about the breadth of the proposals, and whether these are proportional to the perceived defects in the current system.
In the circumstances we wonder if a better approach might not be:
a) a tightly-focused package of any necessary corrections to the relevant law,
b) and a more flexible consolidation regime.
We applaud the principles set out in relation to business and user involvement in post-legislation administration of the tax laws.
However, there appears to be no process for business to be involved in the design of policies and legislation in box 6.3.
The Review's proposal - a combination of working groups comprising the Australian Taxation Office, Federal Treasury and Office of Parliamentary Counsel, reporting to the Federal Treasurer - will improve the process over its current position.
However, without an integrated process whereby business can be involved at a pre-legislation stage in the design of that legislation, we fear that the legislation will be flawed and the user-based design (principle 4, box 6.3) will be difficult to achieve.
We recommend that the private sector must be involved as a stakeholder in the policy– and legislation–development process. This can occur in various ways:
(a) through a strongly-empowered Board advising the Federal Treasurer; or
(b) by way of a group of advisers (whether they be "on loan" to the policy team, or former tax practitioners or businesspeople) providing independent input into the policy design phase.
In relation to a recent package of legislation, where the explanatory memorandum stated that "… there will be minimal impact on genuine commercial transactions and taxpayers' compliance costs will be kept to a minimum…" a senior official was quizzed, given the obvious complexity of the rules. The taxation official suggested "don’t pay any attention to that statement, it’s standard wording in all explanatory memoranda leading to the introduction of Bills". This illustrates a need for independent involvement in the policy development process.
We are concerned that the process, if left wholly in the control of three public service groups, will carry the risk that the processes will not achieve their objectives.
Any project – even one with a Strong Foundation – requires a maintenance program.
We believe that a significant cause of Australia’s current defective income tax system is the inadequacy of resources devoted to maintaining the system.
We recommend that Australia's tax system should have a systematic process for:
(a) ongoing and continuous evaluation of the law; and
(b) ongoing repairs and maintenance by way of technical corrections.
Currently, many errors and oversights have been identified in Australia’s income tax legislation, and are known to the Australian Taxation Office. However we understand that parliamentary drafting resources are in short supply, and various matters have been de-prioritised and postponed into later years.
If the taxation system does not receive sufficient priority on the part of government to warrant ongoing high quality maintenance, then:
(a) taxpayer cynicism grows;
(b) uncertainty about the tax system grows;
(c) frustration grows – in the ATO and the community alike;
(d) inconsistencies are exploited – either by the ATO or by taxpayers – leading to distortions over time, which tend to "overkill" whenever (many years later) amending legislation is introduced;
(e) the ATO tends to distort its Rulings process to become a de facto lawmaker – which we believe is undesirable – discussed below.
We recommend, given the large array of potential changes being contemplated by the Review, that there be an annual technical corrections process instituted, involving transparent:
(a) identification of defects;
(b) prioritisation of those defects in a way which is open to public scrutiny.
Policy Design principle 2
We note the discussion about taxation of comprehensive income –paras. 6.53 ff. – suggesting its desirability, with departures from the principles to be analysed by the Review.
Arthur Andersen is strongly of the view that taxation of comprehensive income which would "rely on constant market valuation of assets and accruals taxation of real economic gains/losses" is not a feasible benchmark in the context of Australia's business taxation regime.
We recommend further that, in the second discussion paper, the Review should state that:
(a) it is clear that the net change in the value of the taxpayer’s assets and liabilities will not automatically be bought to tax as a wealth tax; and
(b) if there is to be some allowance for the value of assets and liabilities (in the context of a "mark to market" or similar methodology) that such mechanisms are restricted only to traders or dealers in such assets – for example, banks and financial institutions, in relation to the taxation of financial assets, and should be optional.
Proposals involving terms such as "comprehensive income" raise alarm in the business community that Australia is considering a wealth tax approach. We are seeing some signs of concern along these lines.
The Review should (we submit) discuss in its next Discussion Paper that:
a) The valuation of business assets – even traded securities - is volatile.
Australis Limited (the company which launched Galaxy Pay TV) traded at up to approximately $1.65 per share before ultimately going into liquidation;
Crown Casino traded at up to approximately $2.80 per unit in 1997 while now trading at approximately $0.60;
Valuations of resources assets and companies (even leading companies) oscillate significantly depending on market perceptions and economic cycles.
b) Therefore business assets should not be subjected to valuation increments except in tightly-defined cases, such as those of dealers in financial securities.
It is instructive to review the experience of TOFA ("Taxation of Financial Arrangements") - a process by Treasury and the ATO to introduce a process for taxation of financial instruments. That process has seen – over a 6-year gestation period – a recognition that:
(a) while it is desirable to tax the value of certain fluctuating-value financial assets on a mark-to-market basis, there is a dichotomy between a dealer in assets and a business with long-term asset holdings – with business assets not listed for sale or for dealing;
(b) it is inappropriate to impose uncommercial tax-accounting methodologies – based on notions of comprehensive income - onto the business community generally.
We applaud the position put by the government at page 126 of the ANTS document, that the mark to market proposals in respect of TOFA will be optional – recognising 6 years of business submissions.
The TOFA development process has demonstrated the value of consultation with business, to progress towards user-oriented design principles.
In summary, we re-emphasise the potential:
a) inequity and
of any proposals involving an income tax system with compulsory valuation increments.
While these concepts are interesting from a theoretical perspective, they are not in our view an appropriate benchmark against which to measure Australia's business taxation system.
We suggest that Principle 10 "Tax Incentive Provision" and its discussion are not necessary. They say nothing that is not encompassed within other design principles.
For example, a statement that tax incentives should be provided after a through assessment of their net impact on taxation objectives is unnecessary. Once the other objectives are working, no tax measures will be introduced in an unstructured way.
If the principle is needed for tax incentives, it is equally necessary in relation to revenue-raising measures. Thus measures like the:
should also be subject to "improved, more rigorous, processes for proposing, implementing and evaluating the efficacy" of the measures.
The example used in para 6.79 – relating to infrastructure bonds – highlights the issue. The policy intent of the proposals was sound – to improve the risk neutrality of Australia's taxation system (Principle 8), which was very flawed. There may have been inadequate
review and consultation. However the main problem, in our view, was a lack of feedback leading to correction of the law in a timely way. The very processes and principles outlined in A Strong Foundation should reduce the risk of another such example.
We recommend that this proposed principle be either:
a) applicable to revenue-raising as well as incentive measures or
b) be excised.
We agree with the need for a rigorous evaluation of tax incentives and indeed all tax measures.
We recommend that there be an express reference to transparency and public disclosure of the forecasting and policy-setting process. We note that the comments in para 6.80 do not mention transparency (or public disclosure).
In this context we note the discussion of "selected tax concessions relating to business" at Table 2.1. In our view the table may be deceptive without further analysis. For example:
a) Several of the costings compare assets lives against effective-life treatment which might itself not be an accurate reflection of economic reality;
b) The concessions in relation to long-life assets, such as development allowance and accelerated depreciation, are in some part a historical compensation for inflationary effects – a proxy for taxation of real income;
c) Primary producer averaging is, as we understand it, an equity-oriented measure designed to smooth fluctuations in income from adversely affecting tax rates in a sharply-progressive tax system – similarly to the abnormal-income rules provided for authors.
d) Most employers now package employee compensation taking FBT into account. Thus the FBT concessions in relation to motor cars are not an FBT concession to business because their effective tax incidence (Policy Principle 11) is on the individuals employed by business.
We trust this clarification will be helpful when such tables are used in future.
We recommend above that a transparent testing of assumptions and forecasts be undertaken in relation to all policy proposals.
This is particularly important in respect of the forecasts and costing of the entity tax proposals and DCT set out in ANTS. We comment that:
a) there has been no disclosure about the build-up of the forecasts,
b) we wonder what the forecasts will be after the proposals are subjected to adjustment for the factors discussed earlier in this submission.
This is critical given the significance of these measures.
We note the discussion about Policy Design Principle 8 – Risk Neutrality that the non-neutral treatment of carry forward losses and the quarantining of business losses "stems directly from the need to protect the revenue raising function of the business tax system."
We suggest that the Review should critically consider that statement. We observe:
a) An International Perspective outlines that most countries surveyed allow for carrybacks of business losses;
b) Without mechanisms for businesses to cash-out their business losses, individual businesses are unable to diversify risks – which retards business growth in Australia. The comment, while perhaps true in the context of one year's taxation revenue, thus disadvantages Australia's long-run economic activity and long-run taxation revenue;
c) That proposition underpins a continuing and unresolved uncertainty in Australia about the extent of legitimate financing transactions which transfer tax benefits to other parties best able to use them – in exchange for lower funding costs to the business undertaking capital expenditure. Because these issues have not had government policy consideration, they are the subject of disputes between the ATO and taxpayers about tax rulings (see the Bellinz Case, discussed below) and the limits of acceptable practice.
We recommend that the Review should examine is the approach to be adopted towards tax transfer arrangements in respect of tax concessions, as well as loss carry-backs and quarantining measures.
There is a legitimate case to be made for efficient tax transferability of business tax concessions or tax benefits for tax losses.
If Australia’s tax system seals up tax effects of losses in individual entities – without an efficient transfer mechanism – then the risk of "locked in losses" perpetuates a "black hole" in the system causing:
(a) economic inefficiency; and
(b) loss of equity.
We recommend that the Review’s consideration of leasing transactions should ensure that policy consideration is given to tax transfer arrangements.
We note that we are not suggesting allowance for excessive or inflated values, or uncommercial transactions.
Policy Design Principle 6 discusses two aspects of equity. In our view:
a) The Transitional Equity issue should be developed by the Review into a standardised transitional code – to deal generically with transition to new tax laws. We discuss this below.
b) The Horizontal Equity comments beg the question of why savings and income should be treated as being equally liable to tax. These comments are undeveloped and, given that equity is National Objective 2, we think that they are unnecessary.
We are concerned about the comments in para 6.67 that:
" Equity concerns related to administrative and transitional fairness figure prominently in the business tax code. Since transitional provisions are often a source of tax code complexity, the more frequent their use the more often will a balance need to be struck between equity and simplification as competing national objectives."
One reason for complexity in our tax law is lack of clear policy in relation to transitional rules. A long-standing principle has been "grandfathering" of existing transactions and structures – eg. the TOFA proposals, private-company rules. Some recent tax laws have attempted to introduce measures with retrospective effect – eg. limited-recourse debt rules - causing widespread community dismay.
The Tax Reform task arising from ANTS and the work of the Review will create massive change in Australia. This issue needs to be addressed in the principled manner suggested by the Review.
We recommend that the Review should develop a standard transitional policy – to be applied to taxation measures. This should have as key elements the following two principles:
a) "grandfathering" of existing arrangements unless they are identified as involving egregious tax avoidance features.
b) a provision that, if measures are altered between the time of announcement and the issue of legislation, that taxpayers will not be adversely affected by delay on the part of the government of the day.
We recommend that the involvement of appropriate business representatives in the policy design stage should be expressed – either as a stand-alone principle or by reference expressly in other design principles.
We believe that recent experience – which the Review's own staffers from Treasury and the ATO will confirm – demonstrates that:
a) the ATO and Treasury cannot be expected to know all of the nuances of business, and the unforeseen consequences of policy proposals when they are being drafted;
Example: The proposed rules for limited recourse debt, announced in the 1997 Federal Budget, were amended by the government (based on ATO and Treasury input, no doubt) when they were introduced in 1998. The amendments contained in proposed Division 243 affected – adversely – legitimate business transactions, and after a business furore the relevant provisions were excised from the replacement Bill introduced after the government was re-elected in 1998. The measures have still not been legislated.
b) there is an unwillingness on the part of governments (of either persuasion) to countenance amendments to tax Bills after they have been introduced into Parliament – perhaps because of a perception that the measures were inadequately developed in the first place.
Therefore, we suggest, it is important that the legislation instructions be well-developed as soon as possible – and before a Bill is publicly presented. There are two solutions:
a) introduction of every tax measure in an Exposure Draft form before it becomes a Bill and/or,
b) exposure of the drafting concepts to selected private-sector reviewers before it legislation is finalised.
2. Anti-Avoidance Rules: Recent drafting is inappropriate
We recommend additional consultation concerning the approach to be taken in respect of anti-avoidance rules.
In the interests of space we confine our comments to two areas:
There has been a recent trend in income tax anti-avoidance rules to "lower the hurdle" – inappropriately.
The approach underlying Part IVA, the income tax general anti-avoidance rule, is to affect schemes which have "the dominant purpose of tax avoidance." After some uncertainty, Courts have recently interpreted the test to give it real power.
Some recent tax laws propose anti-avoidance rules skewed more strongly against taxpayers. Taxpayers can be attacked in respect of transactions which had "a purpose of tax avoidance other than a merely incidental purpose."
As demonstrated recently in respect of the franked-dividend rules, this test is unsatisfactory in its present formulation. A considerable amount of business behaviour has a lively and understandable interest in structuring those activities not to attract excessive tax. The "non-incidental purpose" test does not allow for appropriate definition of acceptable taxpayer behaviour.
The GST draft anti-avoidance rule adopts the dominant purpose test – and not the "any purpose other than incidental purpose" test. We support this.
However the GST anti-avoidance rule contains the following proposal:
"(3) An entity can get a GST benefit from a scheme even if the entity or entities … could not have engaged economically in any activities:
(a) of the kind to which this Act applies; and
(b) that would produce an effect equivalent … to the effect of the scheme or part of the scheme;
other than the activities involved in entering into or carrying out the scheme or part of the scheme." (S.165-10, emphasis added)
We are alarmed by this proposal and its inequitable outcomes for taxpayers going about their normal business, who might have severe implications from the application of anti-avoidance rules to ordinary transactions. It has received criticism.
We are surprised that such a measure could appear in draft legislation issued less than 1 month ago.
The Review should ensure that similar proposals do not appear in areas subject to the Review's terms of reference.
We agree with the Review that a Board is required to represent community and taxpayer interests in respect of the taxation system.
We recommend also that there be an enhanced political process on the part of Government in respect of the taxation system. We believe that this is within the terms of reference of the Review to look at "the ongoing processes of policy design."
The process outlined by the Review in respect of the business tax system involves multi-departmental input.
As a result, we believe it necessary for an independent board to oversee the ongoing business tax system – with a strong focus on the Australian Taxation Office, but noting other elements in the process.
Key elements of the working of the board are in our view as follows:
1. The Board must issue a public annual report, with periodic further reports as necessary.
2. The function of the Board should not be limited to exclusively reviewing and reporting on the integrity and operation of the overall business tax system. We believe that its role could include limited consultative functions – not necessarily in public hearings.
3. The Board should be clearly charged with a responsibility to report on the effectiveness of the business tax system, including:
4. The Board should concern itself with issues such as the ATO's management of:
5. A major issue for the Board to review is the backlog of Tax Rulings – not for their detail but to understand and recommend improved processes for their resolution. This would include key business-tax areas like Capital Gains Tax (discussed in more detail at page 28) and Foreign Income). Backlogs of issues signal the need for:
6. We recommend that the Board should have the capacity to:
That is, we recommend that the Board should have much the same status as a private sector Board of directors of a public company. We do not consider it necessary at this time for the Board to be a consultative "standing enquiry" into the tax system.
By having a strongly-empowered role with ability to make recommendations, the Board will:
The Board secretariat must involve private sector input, and not be controlled by current or transferee officers from the ATO.
Officers from the ATO will have a role, potentially, in the deliberations of the Board, but should in our view be the controllers of the secretariat activities. As in any other organisation, ATO officers will be constrained by their experience and organisational culture. If the secretariat was controlled by or comprised only Treasury and ATO officers:
(a) the independence of the Board will be at risk;
(b) the ability of the Board to offer creative or useful input will be reduced.
We believe that the responsibilities of the Federal Treasurer in a dynamic economy like Australia's are such that there is insufficient time for continued focus on the detail of the business tax system.
Even the initiative of introducing the role of Assistant Treasurer with a focus on taxation, is an insufficient allocation of executive resources to the business tax system. The Assistant Treasurer has responsibility over many areas not limited to business tax.
This creates a real tension and process problems under Australia's current system:
1. If the Assistant Treasurer or Treasurer are not properly advised, policy proposals put them cannot be critically evaluated, which cause political embarrassment and backdowns or – worse – a political problem in fine-tuning proposals to business realities;
2. The ATO or public service proposals might not be fully tested, and cannot be tested or consulted upon by business-people for their "real-world effect." This leads to loss of confidence in the ATO.
There are numerous recent examples.
For this reason, we recommend that the Review might consider processes whereby the political and government oversight – currently only within the Federal Treasurer and Assistant Treasurer's resources - are enhanced in their consideration of taxation matters.
Suggested improvements for the political process include:
(a) a Standing Committee or group of government parliamentarians (whether called parliamentary secretaries or assistant ministers) looking to taxation matters – clearly reporting to the Treasurer;
(b) a significantly-enhanced group of tax policy advisers for the Assistant Treasurer and Treasurer;
(c) the proposed Taxation Board;
(d) less formal round-table advisory groups for the Treasurer, Assistant Treasurer and standing committee involving selected business and state representatives [a permanent successor to the Business Coalition for Tax Reform might be considered]. The Treasurer and Ministers have various reference groups in other contexts and the Minister for Small Business has established an advisory group.
These processes are necessary to enable:
(a) adequate time to consideration of the issues by the Executive Government;
(b) a proper understanding by government of policy proposals to enable political business to be scheduled to ensure that the tax system is kept up to date;
(c) an awareness of emerging issues on the part of Government.
A key administrative design principle must be added to those in Box 6.4. We express it as follows:
Administration of the law is a separate process from policy development, and must operate within the rule of the tax law: Where existing tax law does not cover a situation or expresses no clear policy, the administration of the law is to be based on the words of the existing law, to provide taxpayer certainty and trust. The administration will make recommendations for policy development of new law. However that policy process will be clearly separate from the administration of existing law in respect of existing taxpayers.
The goals of certainty, equity, and facilitating economic growth require a clear focus on compliance with the tax law in the day-to-day administration of the tax system – by the ATO as well as by taxpayers.
In Australia's system of government the law is made by Parliament and the administration of the day operates under that law.
The very separation of different processes in A Strong Foundation into Policy (Box 6.2), Legislation (Box 6.3) and Administration (Box 6.4) demonstrates their differences.
Taxpayers – in their compliance with the law – are involved with the administration phase. Taxpayers are entitled to expect that the administration of the law will also be clearly separated from issues of policy or legislation-development.
Australia's defective tax system has caused, over the years, the administration of the law by the ATO to stray into de-facto law-making through its rulings process. This has been criticised in the community – most recently in the Federal Court in cases such as Bellinz.
We recommend that an express principle of administration of the tax system should recognise the separation of:
(a) administration of the current tax system and the treatment of taxpayers in relation to current transactions, from
(b) input into tax policy and improvements to the tax system.
This principle is separate from Administrative Design Principle 10 "flexibility and responsiveness" (para 6.144 and 6.145).
This is important in engendering taxpayer trust – we suggest that trust is influenced by a reliable, certain and fair tax administration – and not by an ATO which is perceived as making and developing policy.
The principle will recognise that administration will never replace Government policy, which is the preserve of Parliament and Government – using the legislative and policy design principles discussed in A Strong Foundation. Thus, it is important that the administration must be seen as responsive to the wishes of parliament and interpreting those wishes as expressed in legislation – neutrally and fairly.
We believe that this is a critical principle which must be enunciated in the group of principles in engendering taxpayer trust. Without taxpayer trust in a neutral, consistent and reliable ATO, responsive to the rule of law in the same way as are taxpayers – taxpayer confidence will be affected, which will reduce:
This principle will not restrict ATO policy role
We support the ATO providing intelligence and feedback into policy design, in line with the policy principles proposed by the Review.
We suggest that Administrative design principle 10. "Flexibility and responsiveness" should be make express reference to timeliness – or preferably that this be an additional design principle.
Time limits should be benchmarked and defined, and slow-moving matters can be identified proactively, as symptoms of defects in the system or needing other action.
The Capital Gains Tax Sub-Committee of the National Tax Liaison Group had at September 1998 an issues backlog list of 172 items. The leadership of the CGT group has recently changed, and the items represent an accumulation of issues over many years. It would be helpful for the Review to explore an aging of the issues:
a) To understand the processes involved in administration of complex law – which we discuss below - including the improvements which will arise from a clear feedback of problems being fed back into policy development;
b) To understand the problems arising in the CGT area, which will confirm the need for reform of this area.
We do not understand the comment made in 8.6 of A Strong Foundation that in relation to tax audits:
"The ATO has designed wide ranging programs to monitor taxpayer compliance in this self-assessment environment, and to make adjustments within specified time limits where it is considered that the correct tax position of a taxpayer is not reflected in the tax returns. The current arrangements do not allow enough flexibility to accommodate the full range of taxpayer circumstances"
We submit that:
(a) Taxpayers are entitled to certainty in respect of their affairs after a specified number of years. In all other developed jurisdictions there is a time limit, in relation to income tax returns, after which tax audit adjustments will not be countenanced (in the absence of fraud or evasion.)
(b) It is the responsibility of the Australian Taxation Office to have available sufficient audit resources and processes to discharge its obligations under the law.
We recommend that, if para 8.6 means that the ATO considers that it requires:
this should be stated transparently in the next discussion paper issued by the Review.
For this suggestion to be made suggests to us that the ATO does not have a champion for its position in government.
We suggest that a Board of the Australian Taxation Office would have as a focus the efficient deployment of ATO resources in order to provide taxpayers with certainty and satisfactory outcomes from the audit processes.
We agree with the concept of process reform to enhance dispute resolution. We agree that long-running disputes are problematical for publicly-listed entities. We will await with interest the next discussion paper of the Review. We recommend that measures to be considered in that discussion paper should include:
We agree with paragraph 8.20 of A Strong Foundation, that the current restrictions of the Federal Court are impediments in efficient resolution of disputes.
Because of the defective process for tax law-making in Australia, the Tax Rulings process has been distorted. As a result the rulings are often geared to:
(a) revenue maximisation at the expense of economic and system efficiency (with rulings lacking clear policy directions); by
(b) covering gaps in the system – by "papering over the cracks" – with sometimes significant gaps between the rulings and the law.
This is discussed, for example, by the Federal Court (Merkel J.) in his 1998 decision in the Bellinz Case.
The disrepair of the legislation, and weaknesses in the processes to repair the law, create a tendency for the ATO to use the rulings process for this purpose. This use of rulings and determinations to make assertions about the law – sometimes manifestly incorrect - leads to confusion and degradation of the rulings process by the administration, and causes loss of taxpayer trust.
We agree that rulings should be issued by the ATO. However, we recommend significant focus on process improvements:
(a) Independent review of rulings should continue, to ensure that they properly reflect the law;
(b) Rulings should not replace the role of Parliament, even though the law will often be defective. Rulings should be based on the law as it is stated. If unforeseen outcomes (from a viewpoint of the ATO) result, the ATO can provide input into technical corrections to the legislation;
(c) Tax determinations should either be subject to the same scrutiny as public rulings, or their significance in the context of tax penalties should be reduced. Tax determinations by the ATO receive less consideration than public rulings, and may have a greater risk of error. Their status in the context of tax penalties needs to be reduced, so that they do not have the same status as tax rulings.
Transparency of Public Rulings should extend to disclosure of submissions
The lack of transparency in the rulings process (para 8.39) extends to:
We recommend that submissions by professional bodies and taxpayers in the context of the development of public rulings should be available for access by the public.
We believe that enhanced transparency will facilitate improvements in rulings.
Private Rulings Database can be open, subject to taxpayer confidentiality
We agree - subject to appropriate protection of confidential information – with the proposal for improved public access to a data base of private rulings issues [paras 8.49 – 8.51].
Our reservation concerns taxpayer confidentiality. In some circumstances, a private ruling may relate to a transaction which is so specific that there may be severe confidentiality or strategic issues involved.
We recommend that in each case the ATO should provide a draft abstract of the private ruling to the relevant taxpayer, for approval by the taxpayer before the abstract is placed in the database. Rules can be developed to ensure that the consent will not be unreasonably withheld, and that appropriate time limits will apply.