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Submission No. 54 Back to full list of submissions
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OFFICE OF SMALL BUSINESS
SUBMISSION:

A Strong Foundation:
Establishing objectives, principles and processes

 

1. INTRODUCTION

1.1 The Office of Small Business (OSB) recognises there is a need for radical reform of the business taxation system and that there is widespread dissatisfaction and frustration with its operation in the small business community. The broad principles outlined in A Strong Foundation have the potential to produce a more stable, simple and coherent business taxation system.

1.2 The Government is committed to reducing the regulatory burden on small business and the OSB is particularly focused on two aspects of regulatory activity, namely improving regulatory quality and reducing the paperwork and compliance burden on small business. Its approach is to create a culture in which all regulatory agencies "Think Small First".

1.3. The OSB suggests that to deliver on the Government’s commitment it will be necessary that taxation reform be designed so as to meet the needs of the small business sector which constitute 96 per cent of all private sector Australian businesses.

1.4 The small business commercial operating environment is significantly different from that of big business. Compliance costs have a proportionately larger effect on small business, making them regressive in nature. Applying the principle -"Think Small First" – will ensure that big business also benefits from the development of a system that has far greater simplicity, certainty, uniformity and consistency of application. This is not always true the other way around.

1.5 The concepts, specific design processes and issues in tax administration mentioned in A Strong Foundation, need to be overlayed with the reality that the majority of Australian businesses are small. This will assist to ensure that unforeseen consequences for the small business sector are identified and addressed.

1.6 The issues and comments made in this submission reflect the OSB’s understanding of the views of small business, as put to the Office through its interactions with small business and relevant stakeholders.

2. SMALL BUSINESS

2.1 Small business has long been recognised as vital to the economy, especially in terms of business and employment growth. According to published and unpublished ABS data, in 1996-97 there were approximately 900,000 private sector non-agricultural small businesses. They produce about one-third of GDP and account for about 50 per cent of total private sector non-agricultural employment, and about 40 per cent of total public and private sector employment.

2.2 The Senate Economics References Committee Report of 1995 stated:

…According to research prepared for the Industry Task Force, small firms in Australia have been the source of almost all private sector employment growth since 1991. The Task Force predicted that most new jobs created in Australia up to the year 2000 will be generated by small to medium enterprises.

In fact, small business’ share of total employment has been rising since the early 1980s. The average annual growth in employment in the sector was 3.2 per cent from 1983-84 to 1996-97, slightly higher than the growth rate for larger businesses (3 per cent).

2.3 The sector’s diversity not only relates to the number of people employed or annual turnover, but also encompasses the whole range of business structures that operate across all industry sectors. The Australian Taxation Office’s (ATO) Small Business Income (SBI) business line, for example, deals with all entity types, where reported total business income per annum is less than $10 million.

Table 2.1: Composition of SBI client population

Entity

SBI Clients ‘000

%

Individuals

2,249

62.0

Companies

505

13.9

Partnerships

497

13.7

Trusts

249

6.9

Funds

125

3.4

Total

3,625

100.0

 

3. THE NEED FOR REFORM

3.1 Background

3.1.1 Small business concerns cover a wide range of issues, but taxation is by far the most important. Notwithstanding that A Strong Foundation has recognised that taxpayers interact selectively with the business taxation system (paragraph 3.30) and that the cost of compliance falls proportionately most heavily on small business (paragraph 6.101), a more detailed analysis of the potential implications for small business is considered important.

3.1.2 Inquiries as far back as the Beddall Report in 1990 considered a myriad of issues, but taxation was undoubtedly the greatest concern for small business. Submissions were made to Beddall about every aspect of Commonwealth taxation. Out of the sixty-six recommendations made, twenty-one applied to taxation.

3.1.3 Although the growing complexity of taxation impacts on all business, small business bears a disproportionate burden because of economies of scale and the inability of owners to bring costs of compliance to account as tax deductions where they perform compliance tasks in their own time. A major concern was:

…the rapid growth and complexity of taxation law, the complex and often apparently uncoordinated administration of the system which supports it, and the associated compliance and reporting costs which are particularly onerous for small business.

3.1.4 Taxation again rated as the single most important issue during the Small Business Deregulation Task Force, with more than 50 per cent of public submissions raising taxation as an issue. When the Task Force reported in November 1996 (Bell Report) sixty-two recommendations were made, eleven focused on reducing the taxation compliance burden and another one suggested that taxation legislation be subjected to regulation impact statements. Of particular relevance to this debate was the comment:

…Many of these problems are common to all businesses, large and small. However, large businesses are often able to cope as they are more likely to have access to systems, technology and expert advice beyond the reach of small business. Similarly, the tax system appears to be geared to the more complex circumstances of larger businesses. Tax measures appropriate for larger businesses often prove unreasonably complex and onerous for small business.

 

3.2 Unresolved Small Business Taxation Issues

3.2.1 The small business sector has articulated its concerns and been granted some consideration in view of its particular circumstances. However, some key concerns that focus on the complexity of the legislation, the cost of compliance and the lack of consultation are still unresolved.

3.2.2 In a survey conducted by the Australian Chamber of Commerce and Industry just prior to the last Federal election, small business ranked the frequency and complexity of changes to Federal tax laws and rules as its number one concern. The compliance costs with the tax system and the complexity of Government regulations ranked five and six respectively.

3.2.3 The Report into Taxpayer Costs of Compliance commissioned by the ATO confirms small business fears and states:

…For business taxpayers, the perception of regressivity of taxation compliance is confirmed, and a disproportionately high burden is borne by small business.

3.2.4 The lack of consultation highlighted in the Beddall Report has long been a concern for small business. It was still a concern for the micro business segment and was mentioned in the Micro Business Consultative Group’s report earlier this year.

3.3 Complexity

3.3.1 The complexity of the existing taxation legislation requires that small business operators must seek the assistance of professional advisers in order to ensure compliance and ensure that they are not burdened with more than their fair share of taxation.

3.3.2 This fact is exemplified by the success of small business lobby groups in advocating for concessions in particular aspects of the existing regime. Invariably, however, the interplay of the complexity of the existing Income Tax Assessment Act and lack of consultation and understanding about the small business operating environment ensure that where concessions are made they are of limited practical value for small business.

3.3.3 By way of example, small business representatives maintain that concessions such as the Capital Gains Tax (CGT) roll-over relief and retirement exemption have not achieved their full potential. While the broad policy settings were well targeted, the complexity of this legislation has imposed additional compliance costs through eligibility determination and therefore limited access for the sector that it was designed to benefit.

3.3.4 Reform of the business taxation system should provide sufficient clarity so that small business does not have to bear additional costs associated with obtaining legal advice or recourse to the courts. Of concern therefore is the comment made in A Strong Foundation (paragraph 4.23):

…The preferable course is for the legislation to establish clear principles of parliamentary intent and for the courts to explain how the rules apply to particular instances.

3.3.5 Clearly any arrangement that is intent based will be detrimental to the objectives of simplicity, clarity and reduced compliance and reporting costs sought by small business. That is to say, a key determinant about the suitability of any proposed arrangement for small business should be that there is certainty about obligations and outcomes.

3.4 Tax Concessions Relating to Business

3.4.1 If the Review is to focus on the removal of selected tax concessions as a means of moving towards a goal of a 30 per cent company tax rate, consideration of the impact of their removal on other sections or entities within the community is necessary. For example, some concessions listed in A Strong Foundation (Table 2.1) assist small business (incorporated and unincorporated) and any variations could potentially have financial implications not easily offset by end-of-year taxation relief.

3.4.2 Whilst it is acknowledged that removing concessions such as research and development, Fringe Benefits Tax (FBT) exemptions, FBT motor vehicle allowances and particularly accelerated depreciation, may be an appropriate means to lower the company tax rate, there needs to be a detailed analysis of the breadth of small business exposure to these concessions and the practical implication of their removal. By way of illustration, the total FBT tax payable on motor vehicles in 1996-97 was $1,476 million. Of this $609 million was paid by clients in SBI. More significantly out of 59,654 taxpayers, 85.9 per cent were from the SBI line.

3.4.3 To further reinforce this point, entities other than companies make claims under the general depreciation provisions. If the concession for accelerated depreciation (which is costed at $1800 million) were removed, other entity types not able to access the benefit of a lower company tax rate would be disadvantaged. Only 13.9 per cent of SBI’s client population (outlined in Table 2.1) are incorporated. Non incorporated small business rightly advocated a less complex system, but not at the expense of an increase in the net-tax burden or proportionate increase in that burden when compared to the incorporated sector.

3.4.4 Total depreciation claims and lease payments made by businesses in 1995-96 were $34,704 million and $5,655 respectively. 30.3 per cent of the total value of depreciation claims, and 50 per cent of lease payments, were from SBI clients. It is therefore suggested that a more detailed analysis of these concessions be made to assess their impact prior to progressing any preferred position.

4. BUILDING A STRONG FRAMEWORK

4.1 National Objectives

4.1.1 A Strong Foundation is based on a framework of principles and processes, and is necessarily couched in general terms. The practical impact of this framework on any one sector of the community is therefore difficult to assess. However, small business would particularly welcome any national objectives that seek to both facilitate simplification and ensure equity.

4.1.2 A Strong Foundation has called for comments on the sources and extent of the mutual interactions amongst the national objectives and the relative importance of each objective in designing the business taxation system.

4.1.3 The necessity for trade-offs was also frequently mentioned. In this context, small business is most concerned with the complexity of the legislation and it has been suggested that:

…Many small business people expressed a willingness to forgo strict exactness in calculating tax liabilities in favour of simpler, formula-based approaches or paying more in some areas to balance revenue losses from rationalisation in others.

4.1.4 Although small business is concerned with both equity and simplicity, it would welcome A Strong Foundation's proposal for a substantially increased weighting be accorded to the national objective of simplification (paragraph 6.28). Simplification may come at a cost, but it is hoped that it would not advantage big business at the expense of small business. As has been noted, favourable outcomes for small business also benefit big business.

4.2 Policy Design Principles

4.2.1 It is accepted that policy design principles are the "conceptual anchors" to underpin possible operational settings. Against this benchmark, if the design principles are to have ongoing credibility it will be essential that trade-offs and judgements about the appropriateness of particular variations are openly and publicly debated. To do otherwise, will risk the cultural change sought and again fuel the dynamic process of exploitation and anti-avoidance endemic in the current arrangements.

4.2.2 An example of the extent to which the proposed design principles could generate some difficulties is the proposal that entities be considered as extensions of their ultimate owners (‘integration of ownership interest’) and extension of imputation system to other entities such as trusts (as proposed in the Government's tax reform strategy) would go a long way towards achieving it. It is anticipated that under this model, income of sole traders and partnerships will continue to be taxed in the owners hands, while companies and trusts will be taxed on a different basis, in that all payments out of the entity will be taxed at source. The effect of this being that tax will need to be paid on distribution of tax preferred income, thereby washing out the benefits of tax preferences.

4.2.3 In this context it is important to remember that small businesses choose the most appropriate from a range of structures recognised in the tax regime (sole trader, partnership, trust or company). If the expected model of entity taxation is implemented the ultimate owners of businesses trading as partnerships or sole-traders will receive the benefit of tax preferences available, but ultimate owners of businesses trading as companies or trusts will not. In this respect, businesses trading as companies or trusts will not be treated as extensions of their ultimate owners under the proposed regime.

4.2.4 The Government's tax reform strategy distinguishes taxation treatment of entities on the basis of limited liability. However the distinction is less clear given Corporate Law advances over the last decade, which have only served to reinforce director duties to ensure that they are jointly and severally liable for company debts (for example, where companies are in difficulty).

      1. A Strong Foundation expresses a desire to move towards closer alignment of tax and financial accounting. However, the majority of small businesses are not currently required to prepare accounts using Australian Accounting Standards on the basis that they are not reporting entities. If closer alignment of tax and financial accounting requires small businesses to prepare accounts using Australian Accounting Standards this would increase their compliance burden.

4.2.6 Regarding the policy design principle relating to tax incentive provisions, A Strong Foundation mentions the need for a formal assessment of the net impact of any such incentive provision on the national taxation objectives and that it has to be justified as an essential or superior form of government intervention.

4.2.7 As has been noted elsewhere in this submission, over the years small business has obtained a number of specifically tailored concessions/incentives. The desire to have a policy design principle covering tax incentives is not at issue, however there is a need to provide scope for the particular circumstances of the small business operating environment to be recognised and where necessary accommodated. This could be achieved within a more rigorous process for proposing, implementing and evaluating the efficacy of tax preferences advocated in A Strong Foundation.

4.3 Design processes

4.3.1 The suggestion in A Strong Foundation that the private sector have an opportunity to contribute to the formulation of tax policy will be welcomed by the small business sector. Small business would agree that the private sector has not been able to contribute to the formulation of tax policy and legislation and that the private sector would bring a different perspective and information into this process. The private sector needs this enhanced and more formal role.

4.3.2 Although there are a number of consultative fora most are only able to advise on administrative matters. Such bodies do raise policy issues but, because of the lack of integration in the process and for other reasons, are rarely able to progress these issues. It is agreed that taxation law should be designed from the perspective of those who must comply with it.

4.3.3 A Strong Foundation has recognised the need for adequate and effective consultation across a range of community interests, and that the establishment of an advisory board would be a positive step. A Strong Foundation also requested input into both its role and membership.

      1. It is important that the advisory board perform a recommendatory role to ensure the system is meeting the national objectives and that it act as a sounding board on policy issues. It is also agreed that for it to have adequate and efficient consultation, the board and any associated ad hoc committee would need to be funded for administrative costs.

4.3.5 Whether the board has an independent assessment function or would be involved in the processes themselves, it is clear there is a need to cover the full range of community interests in its membership – including those representing the interests of small business.

4.4 Tax Administration

4.4.1 Some elements discussed in the specific tax administration area of A Strong Foundation will be of concern to the small business sector. Most centre around the transference of large business procedures and processes to other sectors.

      1. It was mentioned in A Strong Foundation (paragraph 8.9) that in order to limit recourse to litigation a revised process might better allow parties to focus on the issues in dispute before the assessment is issued. The use of position papers in large audits was mentioned as an example. The need for discussion prior to amendment is not at issue, however it is important to appreciate that processes specifically adopted for large business are not automatically transferable to small business.

4.4.3 Similarly, although the suggested use of a panel of mediators is consistent with the Government’s policy of promoting alternative dispute resolution, this may not transfer well to small business. The process needs to be targeted to the needs of small business.

4.4.4 It was also suggested that charges may be imposed for some income tax rulings in appropriate cases. Although the intent would not be to involve individual taxpayers in this exercise, mechanisms need to be put in place to ensure that those less able to fund such costs are not caught within this net.

5. CONCLUSION

5.1 Small business recognises the need for radical reform of the business taxation system. Any reforms, however, need to be for the benefit of the entire business community. What may benefit big business will not necessarily transfer to the small business sector.

5.2 Small business concerns cover a wide range of issues but taxation has always dominated input to, and the outcomes of all major inquiries. The complexity of the legislation, the cost of compliance and the lack of consultation are still major issues for the sector. It has been agreed that small business bears a disproportionate burden of compliance costs and that they lack the necessary systems, technology and expert advice available to larger businesses.

5.3 Attempts by successive governments to provide concessions have also proved difficult. Small business consistently maintain that the tax system is geared to the more complex circumstances of large business. If taxation reform does not produce a system that is clear and simple, small business will still be in a position of having to obtain clarification by way of rulings or by litigation.

5.4 If the concessions listed in Table 2.1 of A Strong Foundation are used to reduce the company tax rate, small business may be disadvantaged.

5.5 To ensure this is not the case a detailed analysis of the potential consequences for the small business sector is considered essential.