|Submission No. 17||Back to full list of submissions|
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23 December 1998.
Mr. John Ralph, AO
Dear Mr. Ralph,
REVIEW OF BUSINESS TAXATION
DISCUSSION PAPER – A STRONG FOUNDATION
The Australian Taxpayers’ Associations congratulate you on your appointment as Chairman of the Review of Business Taxation and we thank you for the opportunity to consult on the directions of business tax reform as proposed in your first Discussion Paper – a Strong Foundation.
The challenge of tax reform is an enormous undertaking that will have far reaching effects on us all. It is vitally important that we get it right as we enter the new millennium.
The Association supports the general direction of your first Discussion Paper and applauds you for suggesting a structural change to the current process for developing policy, legislation and administrative processes. The current system is dominated by a lack of transparency and accountability. Policy and administration is generally developed behind closed doors without any real input of inclusion of those most affected by changes in the law.
Consequently, the policy intent is often hidden or missing, laws are usually complex, the administrative systems are poorly designed and taxpayers are forced to incur unreasonable compliance costs if they are to fulfil their legal obligations.
What the Committee has proposed addresses those flaws by proposing an integrated approach that ensures accountable and transparent development of policy, legislation and administration. We support that concept. We also support the need for an Advisory Board that can act as a conduit for non-government sector input, reports to the Treasurer and has the power to interact with the integrated design process. That concept will engender confidence in the tax system and will provide much needed private sector input into policy development and design.
We support the proposition of National Objectives and Principles that are designed to provide a road map for development of the law. While we disagree with some of the Principles, they do provide a framework within which the legislators can operate to provide simple and effective laws that can be developed. It also provides a benchmark that can be used to evaluate the effectiveness of those laws in meeting national objectives. We would see the Advisory Board having a significant role in that evaluation process.
We would also see the need for the Advisory Board, or an additional Board, to have a direct input to the management and operations of the Tax Office. That is a crucial element in public confidence that is missing from the Committee’s current proposals
The Association is also a signatory to a joint submission by The Law Institute of Victoria, the National Institute of Accountants, the National Tax and Accountants Association and the Australian Taxpayers’ Associations. This submission should be read in conjunction with that submission.
The following suggestions are proffered as improvements to the foundation system proposed by the Committee. Where we have not commented on an issue that can be read as an acceptance of the proposition contained in the Discussion Paper.
Issues of concern
The ATA supports the identification of National Objectives which the Business tax system should aim to achieve. The development of such a simple concept enables both the Government and taxpayers to evaluate the efficacy of proposed and/or existing tax laws.
Ideally, there should be a requirement for all laws to be evaluated both before they are enacted and after they have been operating for a pre-determined period. Laws that do not achieve their objectives should be repealed, amended or modified.
There is a need to align the top personal tax rate with the corporate rate to minimise –
One of the thrusts of the Government’s "New Tax System" proposals is to tax companies and trusts according to the same rules and the same income tax rate in order to eliminate any distortions or taxation arbitrages that affect the taxing treatment of what are effectively the same transactions.
The ATA accepts the need for companies and trusts (indeed ALL entities) to be taxed consistently. However, it is submitted that the regime adopted by the Government in its "A New Tax System" is flawed in imposing on trusts the same inability to pass on to the underlying owners the tax concessions available at the entity level. This is a flaw of the dividend imputation system which should not be replicated in the trust area.
Further the new Deferred Company tax system effectively denies, at the entity level the ability to utilise tax concessions at the point in time when a distribution to the underlying owners is to be made. The reason for this is that since , under the new entity system, all dividends must be fully franked, any deficiency in franking credits from such tax concessions must be made good, at the time of distribution, by the payment of such deferred company tax.
The ATA notes, in this regard, the statement in paragraph 6.65 the "full integration of ownership interests would impose, at most, a single layer of taxation on all income comprehensively defined" (emphasis added). The reference to at most is explained in paragraph 6.66 as a reference "to whether ‘tax-preferred income’ retains tax relief on pass-through". The ATA strongly submits that if that feature was included then the tax treatment of companies and trusts would be then be consistent with sole proprietor and partnership entities.
By not including such a design feature, then the Government’s desire to obtain tax neutrality is not achieved as the tax outcome for a particular transaction will vary greatly depending on whether the taxpayer operates through a company or trust, or a sole proprietor or partnership. The effect will be that beneficiaries will be treated equally unfairly as are shareholders by losing the effect of tax concessions and sole proprietors and partners will continue to obtain the advantage of tax concessions. That is hardly neutrality and is it hardly fair or consistent.
The new entity approach will not apply to Partnerships and Sole proprietors. Partners will continue to be taxed at marginal tax rates on their share of the net income of the partnership. Sole proprietors and partners will retain entitlement to the tax free indexation component of capital gains made on business assets. They will still be able to withdraw the unrealised component of asset revaluation reserves tax free. Unlike companies and trusts, partners and sole proprietors will not be able to retain profits in their business and have those profits taxed at a lower tax rate.
In short the changes announced in the Government’s "A New Tax System" do not achieve parity between businesses. Consequently, the tax system will continue to drive distortions and influence the nature of business structures.
With the possibility of further reductions in the corporate tax rate flowing from any changes recommended by the Committee, those distortions will be magnified (as noted at paragraph 6.72 of the Discussion Paper) as the difference between the top personal tax rate and the corporate tax rate increases.
Australia has amongst the highest marginal tax rates in the world and those rates apply at very low taxable income levels. Even with the tax cuts proposed by the Government, that outcome remains largely unaffected especially for those individuals whose taxable income exceeds $70,000. With the continued increase in the development of intellectual property as the commodity of the future and the provision of services taking a more prominent place in business, there is the potential for the mobility of labour to increase.
The nature of most services and intellectual property is that they can be delivered from any location in the world effectively and efficiently. There is a real issue of a brain drain from Australia to countries with more favourable tax rates.
While it is accepted that the Business Tax Review is not specifically directed towards personal income tax rates, it is nonetheless an important issue that will ultimately affect business unless there is a closer relationship between the corporate rate and the top personal tax rate.
It is arguable that such an objective is inherent in the objective to ‘Optimise Economic Growth’. However it should be more clearly identified.
One of the most serious issues facing Australia is its declining savings rate and our need to import capital (as notes at paragraph 6.78 of the Discussion paper) to finance business and infrastructure development. The introduction of the compulsory Superannuation Guarantee Scheme has failed to address this situation and more recently, the introduction of the Superannuation Surcharge has exacerbated the downward trend.
Further the cut in personal tax rates, while welcome and long overdue, is likely to exacerbate the declining national savings problem without any corresponding adjustment to the taxation of superannuation. In the future, superannuation is likely to comprise compulsory superannuation contributions only.
A careful examination of the current level of contributions to superannuation will reveal that much of the heralded increase in contributions is nothing more than a transfer of discretionary existing savings.
The ATA strongly submits that the taxing of superannuation benefits (including contributions) should occur when the benefits are received. The current system of taxing contributions and the inequitous Superannuation surcharge are cynical revenue raising exercises designed to pay for current expenditure. If that expenditure was specifically allocated to infrastructure development that would benefit the future there would be logic in the bringing forward of revenue. That is not what is occurring. The effect of the current policies then is to rob the future of much needed revenue to create that infrastructure.
This is an urgent need for simplification of Australia’s tax laws. As the Committee has rightfully identified the current system is a ramshackle collection of seemingly uncoordinated and unconnected provisions that are difficult to comprehend and even more difficult to comply with. It is a problem that is driving a wedge between the taxing authorities and tax professionals and taxpayers generally.
As noted at paragraph 4.41 of the Discussion paper, there has been little capacity, in the past, for any meaningful consultation on the policy intent of legislation or the administrative complexity needed to make it work. From an organisational perspective, it has been impossible to have any consultation on the policy development, legislation formulation or the design of administrative systems until after the provisions have become law.
When there has been consultation, it has usually occurred as a result of severe public criticism that has resulted in embarrassment for the government because of ‘intended or unintended’ circumstances that may have been caught by the proposed legislation. In fact there is a feeling amongst tax professionals that legislation is deliberately drafted to catch everything and then only to back off on some issues in the face of public anger. In effect consultation with business and community experts has been replaced by a process where those experts have been used as a form of quality control.
Naturally such an outcome is resented by those who are forced to become a part of that quality assurance process.
In many instances the law is silent or unclear on the tax outcome of a transaction or event. That is unacceptable as it creates complexity due to the uncertainty of the law and is costly for taxpayers to comply. There are even instances where the same income is effectively taxed twice. Technical amendments to the law are quite difficult to achieve even when both tax professionals and the Tax Office agree on the need for such amendment.
Over the years, the National Tax Liaison Group and its many sub-committees have been developed between the Tax Office and the tax profession in an attempt to overcome the many policy, legislative and administrative difficulties created by the existing system and the process used to create that system. The frustration for the participants on those various committees is the inability to have an input into the development of the legislative package. In essence the role of those committees has been largely about trying to make a flawed system operate as best it can.
The ATA strongly supports the proposal of having simplicity as a National Objective. Simplicity is the cornerstone of any good tax system. A system in which the policy intent to be articulated clearly and simply enables taxpayers to understand the nature of the law and leads to lower costs of compliance both for the public and private purse. It also allows the enabling systems to be better designed to meet policy and operations needs.
It is vitally important that simplicity embraces the following principles –
Unless the law promotes certainty then the objective of simplicity will not achieve its goal.
In the interest of achieving simplicity and integration, the ATA would also strongly support a change to the rules on interpretation to require the Explanatory Memorandum to become the statement of purpose of policy and legislation. The legislation would be limited, in its application to those issues clearly stated in the EM. Any unintended consequence that was outside the stated purpose would not be affected by the legislation. This would ensure certainty as it would require the drafters to clearly establish the boundaries of the policy purpose and extent of the legislation.
Under the current rules the Explanatory Memorandum is meant to provide a clear understanding of the policy intent of legislation and the rudimentary process to achieve that policy outcome. Unfortunately, under the Acts Interpretation Act, that Explanatory Memorandum can only be used as extraneous evidence of the policy intent where the legislation itself is unclear or uncertain. In many instances the stated purpose in an EM is contrary to the law itself and consequently.
The Committee has identified the need for design principles in the three areas of defining policy, drafting the legislation and creating the administrative systems needed to ensure that the system works.
The ATA supports that broad framework as it will provide a uniform and consistent guide for the development of all future legislation. It will also enable existing legislation to be evaluated to determine whether it achieves its stated purpose. The proposal, in effect, creates a template for the better managing of tax law. That is to be applauded as it provides a transparent set of guiding principles that must be considered on every occasion. Any departure from those principles will need to be justified and communicated.
Both the Government and the development teams should be required to set out the weightings to be used for any tax law and to provide precise reasons for determining those weightings. That reasoning should address how those weightings will achieve the stated policy intent of the legislation.
Appropriate methodology will also need to be designed to benchmarking and evaluating the effectiveness of original proposals as well as reviewing existing law.
Except where stated the ATA supports the design principles as set out in the Committee’s Discussion paper No 1.
Under the Integration principle, the Committee has recognised that for tax purposes (as distinguished from commercial or legal purposes) entities should be considered as extensions of their ultimate owners, yet we continue to have different tax outcomes for the ultimate owners depending on the nature of the business entity.
At a conceptual level, the concept of comprehensive income (without any distortions) is an admirable goal. However, the Committee seems to accept the need to continue with a system that contains fundamental flaws because of its effect on the revenue. That will result in continued distortions that will affect business decisions especially for small business.
The ATA would only support taxing unrealised income if unrealised losses of both a capital and revenue nature were also included as envisaged in the comprehensive income tax outlined at paragraph 6.53 of the Discussion Paper..
As the Committee itself accepts, that may not be possible due to revenue constraints. Nonetheless there is an urgent need to ensure that realised income and losses (whether on capital or revenue account) are treated consistently. The current system discriminates against capital losses in denying a tax deduction for such losses and only allowing them to be offset against current or future capital gains. It also discriminates against the owners of companies that hold or dispose of appreciating assets (or benefit from other tax concessions) as compared to the position of beneficiaries in a trust, partners and individuals. Reference should also be made to the comments appearing at "Point 2" of this submission concerning the flawed proposals to tax companies and trusts consistently.
The ATA submits that the taxing outcome for the gain or loss on the disposal of assets should be consistent regardless of who owns those assets. The proposed change to tax trusts on the same basis as companies (subject to the transitional rules) is akin to treating both of those entities equally unfairly. That outcome would fail all three national objectives as it does not optimise wealth creation, it creates inequity between individuals and entity owners and requires complicated rules to ensure that tax outcome. It is also certain to generate considerable future aggressive tax planning to gain the tax advantages of the corporate rate on earnings, but avoid the CGT effect of the entity holding those assets.
The Committee has noted that "comprehensive indexation of the tax system poses a range of questions extending well beyond the business taxation scope of the Review’s Terms of Reference and of the Government’s announced strategies in "A New Tax System". However, the Discussion Paper refers to a possible compromise involving subjecting the indexation component of capital gains to tax. The ATA does not support the removal of this tax concession as only real gains should be subject to tax. There is a need to have consistent rules that apply fairly across ALL taxpayers. The proposal to tax the indexation component merely creates yet another divide between the different types of taxpayers.
Extending indexation to income tax gains is unlikely to involve the practical difficulties envisaged by the Committee. At a practical level, the use of the annualised CPI index could be used to calculate the amount of real income to be subject to tax.
The Committee accepts the need for all income to be taxed comparably to maintain equity between taxpayers of similar circumstances and especially to cater for those situations where there are transitional arrangements.
The ATA does not support that concept as it creates a conflict with the national objectives. If optimising economic growth is accepted as a national goal, then taxing all income comparably may not lead to that goal. For example, it may be desirable to tax different types of income differently to achieve the goal of optimising wealth creation e.g. a lower tax rate on capital gains. Provided all taxpayers deriving that type of income are treated the same then equity is also achieved.
Taxing all income comparably is really designed to achieve market neutrality. That is not one of the stated national objectives nor is it one of the design principles. With respect, this highlights a potential problem of principles and the weighting attached to them, where the principles may not contribute to achieving national objectives.
Subject to appropriate safeguards to prevent artificial changes in the nature of income, the Committee should seriously consider the possibility of having different tax rates applying to different types of income. If the same type of income was taxed comparably in the hands of individuals then the system would largely be symmetrical.
The ATA accepts that the ultimate responsibility for policy proposals rests with the Federal Treasurer as the responsible Government Minister. However, it is paramount that any policy is not designed in a vacuum. It is vital that the Treasurer be fully aware of all of the implications, concerns, issues and problems that might flow from his acceptance of a policy direction. It is also vitally important that citizens be able to have input to the development of policy that is intended to affect their lives.
Policy development should be a transparent process where the right policy is chosen for all of the right reasons and all parties are aware of the policy intent and understand the rules and administrative processes to achieve that end. Voluntary compliance by members of the community is likely to increase where they understand the policy intent and the rules are consistent and fair and community representatives have had an input into the legislative and administrative design.
Nothing frustrates taxpayers and their advisers more than to be informed that they are being consulted purely to make the system work, especially when it is inherently obvious that the underlying policy is flawed or deficient.
The ATA accepts the need for better and improved consultation in the formulation of policy as well as the legislative and administrative design features. In terms of legislation, this input will greatly contribute to user-based designed tax law as championed by the Committee. To be transparent it is important that ‘externals’ be able to contribute to policy development at the highest level and to be able to have input during the drafting process. There are few instances where it can be envisaged that ‘external’ involvement could not be accommodated in the interest of achieving a better outcome. If security is an issue (refer to page 101 of the Discussion Paper), then those involved could be sworn to secrecy along the same lines as public servants.
There are many instances where consultants and other ‘externals’ have been required to accept confidentiality and secrecy obligations. In few, if any, circumstances has there been any breach of that obligation. A similar process could operate in the tax area. Any breach could be punished by suitable sanctions.
Even in cases involving tax avoidance, there is strong a case for involvement of outside experts in formulating the final legislative response and to avoid any scatter gun approach that would be deleterious to genuine transactions or arrangements. This would also have the effect of expanding the response to affect other as yet unidentified avoidance arrangements. That could help to improve the response and enable the Treasurer to table the legislation simultaneously with of any announcement avoiding legislation by Press Release (see also Point 11 of this submission).
It is imperative that policy and the rules formulated to implement that policy are not developed in a vacuum, a flaw which occurs in the current system. External input is crucial to achieving a balanced outcome and community support.
There is also a need to allow the private sector and the community at large to initiate consideration of reform and policy measures and not to confine their involvement to commenting on measures proposed from within the Executive Government.
If Australia is to have ‘A New Tax System’ then there needs to be a new approach of inclusion of tax professionals and community representation in policy development and design.
The ATA supports the concept of integrated team based development of policy, legislation and administrative processes. Where possible the teams should include private sector involvement either as part of the team structure actively involved in the process, or in a consultative role to act as a conduit between the teams and the community. The private sector participants should be chosen for their expertise and knowledge of the related issues.
The current practice of ‘Legislation by Press release’ should be discontinued. Apart from being undemocratic, it also effectively (and in many cases actually) taxes transactions and events retrospectively. In most circumstances the legislation eventually introduced is far more wide ranging than the announcement. Taxpayers are penalised by rules that were not in existence at the time the transaction was entered into.
That is damaging to business as well as taxpayers who have entered into transactions in good faith. The effect is to bring the tax system into disrepute as taxpayers feel they are being unfairly treated because the rules are changed after the event.
Even in the most serious of tax avoidance cases, there is little justification for legislation by Press Release especially if the mischief has already been identified. In those cases, it would be better to have enabling legislation tabled in the Parliament on the day of the announcement (see also Point 9 in this submission).
The ATA applauds the concept of integrated business tax design and the involvement of an independent Advisory Board. The Advisory Board should be comprised solely of private sector representatives but should have the capacity to second or request the participation of public sector experts to help in their understanding of the issues and concerns influencing policy or legislative changes.
As the ATA sees the Advisory Board, it is an attempt to create a process that enables a well balanced approach to policy legislative and administrative design by ensuring that there is a consultative and independent review process aimed at improving accountability and design. It will also provide independent advice to the Treasurer.
To ensure that the Advisory Board is suitably empowered it should be able to interact with the Steering Committee and to meet regularly with the Cross functional teams to get a better understanding of both the policy intent and the design features of the proposed changes.
The Advisory Board must have the power to review and evaluate all legislation both before and after it is enacted to ensure that it is achieving its intended purpose. Where the policy intent is not being achieved or has outlived its purpose, the Advisory Board must have the power to recommend changes to the Treasurer. The Advisory Board should also have the power to set up independent sub-committees and to invite community representatives to undertake this important task.
One of the primary reasons for the establishment of the National Tax Liaison Group and its many sub-committees was to deal with the never ending task of consultation and community involvement on Tax Office administration of the tax system. This process developed as an attempt to engender community and tax professional confidence in the tax system and the Tax Office and to overcome some of the inherent policy and administrative deficiencies in the system.
The current system has not been totally effective in achieving that goal. However, it has gone a long way to improving tax administration and the relationship between the parties. That process should be enhanced and strengthened.
With the change in approach to a more transparent and accountable system, there is also a need for a change in the overall administration of the Tax Office. There needs to be a body that has carriage of administrative aspects after the law has been passed by the Parliament. The Tax Office also needs to become more transparent and to build on the community spirit developed in recent years. The ATA would support the establishment of an independent Tax Office Advisory Board (TOAB) that would interact with the Commissioner of Taxation and would be responsible for evaluating day to day administrative processes and systems.
Ideally, that Board would be directly responsible to the Advisory Board or could be totally independent and report directly to the Treasurer. The Tax Office Advisory Board would not have control over the Tax Office, but the Commissioner but would be required to consult with it on matters of administration of Government policy. The TOAB would have the power to refer matters to the Treasurer.
The TOAB could be based on an amalgamation of the existing NTLG and the other consultative arrangements that currently exist between the Tax Office, the community and tax practitioners. The current plethora of sub-committee and other consultative process that exist to help simplify administration of the tax system could continue to operate but under the watchful eye of the TOAB.
One of the shortcomings of the TLIP process was that it was only ever intended to be a rewrite of the law. The project was basically prevented from addressing policy issues.
In any continuation of that rewrite process, the integrated team must be empowered to address policy issues of not only the remaining legislation but also the previously rewritten law. If it does not, then, the goal of simplifying the law will not have been achieved. That will not be reform or progress it will further add to the existing complexity.
Many of the complexities of the existing law arise because the policy is unclear, uncertain or inadequate. Unless those issues are addressed then any rewrite will, at best, merely restate simply complex legislation. The ATA notes in passing that the rewritten law has not achieved the desired level of simplicity. In many cases ‘simplification’ has been supposedly achieved by adopting of many definitions in the main operative provisions which requires constant references to other provisions of the law. That involves simplification in form rather than in substance.
The Review proposes a Charter of Business Taxation. The ATA would support such a charter if it is incorporated into the Taxpayers’ Charter.
There is no need for a separate charter rather there is a need to ensure that a single charter applies across all taxpayers and specifically addresses the issues and concerns of any person affected by taxation.
The Taxpayers Charter is due to be reviewed within the next 18 months. It would make sense to have both processes proceed simultaneously and to have an upgraded Charter issue in due course after proper community consultation and evaluation.
As a general proposition the ATA would support the proposition that all taxpayers should be treated equally in the law and in practical terms should have equal access to the same remedies where there are disputes. In practice, however, the different market segments of the taxpaying population do have different needs, different priorities and are subject to different sensitivities. Each of those segments needs to be managed according to those needs.
Within that context, the ATA would support different settlement procedures provided the criteria was transparent and subject to scrutiny and review by the Advisory Board. That should involve compulsory mediation with independent third parties adjudicating the process.
The current tax system is an adversarial system with each party’s rights and responsibilities enshrined in legislation. The tax system mirrors other aspects of our legal system.
There is a need to break that adversarial culture in an attempt to gain efficiencies for both the public purse and taxpayers generally. The ATA would support a system of compulsory mediation to settle disputes before they proceed to the AAT or Federal Court.
The current Self Assessment system is based loosely on the concept that taxpayers are protected from penalty if they have exercised reasonable care in disclosing the information contained in their tax return. Even if the taxpayer is incorrect, no penalties are imposed if the taxpayer can demonstrate they exercised reasonable care and have a reasonably arguable position depending on the value of the transaction.
Private and Public Rulings are meant to supplement that process by providing taxpayers with certainty regarding the application of the law. Private and Public Rulings are binding on the Tax Office and provide taxpayers with a guaranteed application of the law to particular transactions. That applies even if a Ruling is found subsequently to be incorrect provided the outcome is favourable to the taxpayer and the transaction has already commenced.
In theory this system provides taxpayers with a mechanism to enable them to comply with their obligations and to enter into transactions knowing the outcome with certainty. In practice the result is quite different and the Rulings program has fallen far short both in design and deliverability.
Some of the shortcomings include –
The fundamental problem with the Rulings system is that it is designed to overcome the inadequacies of a flawed tax system by allowing the Tax Office to make administratively binding decisions. The Tax Office has shown a marked reluctance to issue Rulings on sensitive issues and has also demonstrated a marked reluctance to seek clarification of, or amendment to, the law to obtain that much needed certainty. The system needs to change to make it work.
Suggested changes would include –
As a general rule we would not support charging for Rulings as it is the Government’s responsibility to ensure that the tax laws are certain and understandable. The Tax Office has an obligation to provide Private Rulings to provide that certainty. Taxpayers should not be required to pay for deficiencies in the structure or content of the law.
However, the ATA would support a charging regime for Private Rulings only in cases where the issues were of such complexity or sensitivity that the matter could not ordinarily be dealt with within 28 days. Strict criteria would need to be developed and the need for charging would need to be agreed between the parties. It is envisaged that charging would only apply to Product Rulings and ‘Big End of Town’ issues.