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Submission No. 66 Back to full list of submissions
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Property Council of Australia

Response to the
Review of Business Taxation’s
A Strong Foundation Discussion
Paper

December 1998

Summary

1. The Property Council supports the process proposed for reforming the business tax system, namely: set national objectives, agree on design principles, audit the existing system, forge a new tax framework and reform ongoing administrative procedures.

2. The definition of revenue neutrality should take account of the long-term benefits of reform when calculating changes in government revenues.

3. The national objectives need to be expanded to include international competitiveness and national savings.

4. Simplification is not more important than equity and economic growth – a wider view of the meaning of `simplicity' is required.

5. A broad-based income approach should not be used to characterise important business tax deductions as concessions, thereby setting them up for elimination.

6. The logic used to justify the identical tax treatment of business entities is flawed - a more sophisticated approach is needed.

7. The tax treatment of public unit trusts is a model for taxing all business entities.

8. Taxing trusts as companies will harm ordinary Australians.

9. The Property Council supports proposals to reform the administration of the tax system.

Overall, the Property Council supports the proposal to move to a more consistent framework for taxing business. However, it does not believe that means all entities and taxpayers should be treated in exactly the same manner.

Simplistic and narrow consistency would be inequitable, undermine leading drivers of economic growth and place Australia at an international disadvantage.

A consistent framework that recognises the importance of special savings entities that allow the flow through of business income and deductions to the hands of individuals is called for. Such an approach causes no loss of government revenue from current levels and would satisfy the national objectives outlined below.

Introduction

The Property Council’s members develop, own and manage property assets for around nine million Australians who rely on their superannuation, life insurance policies and public unit trusts to build retirement wealth.

The Property Council also represents private investors and corporations that capitalise and develop the built infrastructure that underpins the productivity and competitiveness of businesses.

Property Council members finance, own and manage the countries most valuable office, shopping, industrial and leisure investments, as well as an increasing volume of civil infrastructure and commercial residential property.

The Property Council welcomes the review into business taxation. This response to A Strong Foundation deals only with the conceptual issues raised in that document.

Future submissions will deal with specific reforms recommended by the Review of Business Taxation. In addition, the Property Council will submit its views on:

    • the taxation of trusts;
    • capital gains tax reform;
    • tax benefit transfer;
    • simplifying the relationship between the
      amortisation and depreciation systems;
    • rates of amortisation and depreciation; and,
    • negative gearing;

The Property Council endorses the submission made by the Business Coalition for Tax Reform.

Responses to A Strong Foundation

The Property Council agrees that the business taxation system is fundamentally flawed. It agrees the best approach to reform is to develop a new foundation based on:

    • a set of national objectives that provide a rule against which a new business tax system can be measured;
    • a set of design principles to be used to test all aspects of the current system and then forge a superior business tax framework; and,
    • a new process for managing the business tax system and guiding it toward best practice.

The Property Council endorses the reform principles established by the Business Coalition for Tax Reform:

    • the elimination or reduction of as many indirect taxes as possible;
    • adoption of a single-rate consumption tax levied on broad as base as practicable;
    • a remodelling of Federal/State financial relations;
    • reductions in marginal rates of tax on income and simplification to company taxation; and,
    • a reworking of the interface between the tax and social security systems to reduce high effective marginal tax rates.

The Property Council contends that the business tax review should also provide recommendations for reforming the capital gains tax system and rationalising the relationship between the amortisation and depreciation systems.

The review of business taxation is constrained in only recommending revenue neutral proposals.

The Property Council recommends this stricture be observed in terms of the potential long term benefits of reform.

Reforms that decrease short-term government revenues but result in more investment, greater economic growth, higher corporate profitability and more jobs should not be ruled out - they are likely to result in enhanced government revenues.

A Strong Foundation suggests economic growth, equity and simplicity are the three guiding objectives for shaping the business tax system.

The discussion paper implies that a relatively neutral business tax system, one that does not distort investment decisions, is more likely to result in an optimal allocation of resources.

However, the business tax system does not exist in isolation. It interacts with other spheres of public policy making – for instance, policies that determine savings, which in turn influences the availability and price of capital essential to economic growth.

For this reason, the Property Council believes the national objectives should be expanded to include the drivers of economic growth.

In short, the business taxation system should:

    • foster international competitiveness;
    • foster a climate of national savings that provides a source of capital needed to drive investment, growth, jobs and higher living standards.

These objectives should be stated specifically.

The Property Council endorses the argument for national savings outlined by the Investment and Financial Services Association in its submission to the review.

Simplicity is important, however it does not outweigh the factors identified above. Notwithstanding the injunction that governments should settle trade-offs between differing national objectives, the Property Council reads sections 6.27 and 6.28 of A Strong Foundation to imply that the simplest approach should be taken when a conflict between various national objectives arises.

Simplicity is an ideal that business embraces; however, given the reality that tax policy is ultimately about the distribution of benefits to ordinary Australians it could be dangerous to apply an elementary Ockham’s razor principle to complex pubic policy issues.

In addition, ‘simplicity’ means more than fewer pages of tax law. A simpler tax system should reduce compliance effort. As noted below in relation to the proposed tax treatment of trusts, A Strong Foundation’s version of simplification would result in more work for the taxpayer. Hundreds of thousands of Australians, mainly retirees, will be forced to master the dividend imputation system and spend more time with their tax returns.

Textbook simplicity should not take precedence over equity, clarity, ease of compliance and economic reform.

A Strong Foundation dismisses alternatives to an income tax basis for the business taxation system.

The Property Council agrees with several other industry bodies that the review should at least explore an expenditure tax approach, as canvassed in a paper by Geoff Carmody submitted by BCTR.

At the very least, such an approach should be tested as a model for future reforms.

In particular, the Property Council is concerned that the broad base income model favoured in A Strong Foundation will lead to the taxation of unrealised gains; undermining of depreciation benefits; spreading over a number of years of expenditure (currently allowed as an outright deduction) and the removal of capital gains indexation.

In addition, A Strong Foundation does not affirm a basic accounting principle that costs incurred in the earning of assessable income should be deductible. Instead it implies, as part of its focus on a broad income tax base, that many such deductions are concessions. (Section 2.29 and Table 2.1).

Such approach is conceptually misleading, especially where dealing with depreciation and amortisation.

As the Property Council’s future submissions will argue, buildings wear out in the production of assessable income, like any tool or piece of plant. A tax system that recognises such a fact does not grant a concession, it merely applies a fundamental tax accounting principle.

Table 2.1 calculates a concession in terms of a difference between a so-called ‘accelerated’ write-off rate and the Tax Office’s physical life depreciation rate. This methodology is misleading in that all depreciation and amortisation rates should be based on the economic life of assets - a write off that reflects the obsolescence cycle of buildings, plant, equipment and articles.

Future submissions will address this issue in greater detail. However, the main point is that a tax system that helps business remain internationally competitive must foster depreciation practices whereby businesses replace (or recapitalise) assets at a rate that reflects their economic life.

A Strong Foundation asserts the virtues of a consistent approach to inflation by proposing a full nominal approach. Given uncertainties about the course of future inflation and the equity benefits of taxing only real gains, the Property Council can see no powerful case for removing indexation as implied in Section 6.59.

The Property Council supports the principle that the business tax system should move toward a more consistent approach to taxing entities. However, the principles for determining tax liability in A Strong Foundation are far too simplistic.

The logic stated in A Strong Foundation goes like this:

    1. The principle of comprehensive income taxation implies integration of ownership interests (Section 6.43);
    2. Therefore taxpayers should be treated as extensions of the entities in which they invest (Sections 6.45, 6.62);
    3. Any difference between the tax obligations of an individual and the tax paid by a business or investment vehicle is described as a `tax wedge’ (Sections 6.69, 6.70) ;
    4. The existence of different tax wedge points contradicts the national objectives stated for the business tax system;
    5. Therefore all individuals who invest in business entities should be taxed as companies.

In short, A Strong Foundation seeks to "kill as many birds with one stone as possible" (Section 6.95) by treating all business entities alike.

There are many problems with the text book simplicity of this line of logic:

    1. The approach deliberately ignores the distinction between classic business vehicles (such as companies) and special savings vehicles (such as widely held public unit trusts) – A Strong Foundation is happy to sacrifice the benefits of such vehicles in favour of narrow consistency;
    2. Narrow consistency ignores international realities – our major competitors provide for ‘flow through’ entities; that is, special savings entities where bona fide tax benefits and income flows into the hands of individuals at which point they are taxed. As IFSA note, at least $5 trillion of the worlds $7 trillion mutual funds assets operate on the ‘flow-through’ entity principle;
    3. It is NOT necessarily the case that the distribution of tax wedges will change the ultimate tax obligation of individuals – in widely held public unit vehicles there are safeguards to ensure there is no loss of revenue (as we summarise below);
    4. As already stated, the national objectives listed in A Strong Foundation are too narrow; consequently it is inappropriate to appeal to them as a justification for a hard line consistent entity approach;
    5. Even in their current formulation, A Strong Foundation’s the consistent entity approach contradicts the simplicity tenet of the national objectives, as hundreds of thousands of retirees will be forced to master the imputation system if it were implemented for public unit trusts – such an outcome is neither simple nor equitable;
    6. In addition, the narrow consistent entity approach in A Strong Foundation is inequitable as it will still allow wealthy investors and bank deposit holders a different tax treatment to those who invest in pooled entities, such as public unit trusts.

Finally, there is a fundamental point that the model used to tax individuals who invest in pooled arrangements should be extended to all businesses. A Strong Foundation provides no rebuttal of the virtues of this model, which the Property Council commends as a preferred approach to the taxation of businesses.

In relation to widely property unit trusts, the Property Council offers the following points (which reinforce those provided above):

Public unit trusts aren’t used to rort tax dollars.

Every dollar distributed by public trusts is taxed. Either the beneficiary pays at their marginal rate OR trustees pay at the top marginal rate. Unit holders must provide their tax file numbers, otherwise trustees send 50% of the unit holder’s distribution directly to the Tax Office.

Taxing trusts as companies will lower the investment returns distributed to ordinary Australians.

Public unit trusts are special savings vehicles – they assist ordinary Australians pool their scarce savings to invest in profitable assets such as shopping centres, office buildings, tourism properties, office parks and infrastructure projects.

Ordinary Australians are the chief beneficiaries of property trusts – more than nine million Australians enjoy a stake in property trusts through their super funds. These trusts are popular because they generate stable income streams and create retirement wealth for families and individuals.

Property trust yields will fall if they are taxed as companies, thereby harming these Australians.

Taxing trusts as companies will hurt retirees and push them into the social welfare net.

Retirees are the big winner of the property trust sector – Of the 300,000 direct property trust beneficiaries, most are retirees. They’re not wealthy retirees either – most earn less than $20,000 a year.

Trust distributions provide retirement cashflow - retirees rely on regular distributions from trusts to maintain the self-sufficiency they deserve. The regular cash flow stops if property trusts are taxed as companies.

Retirees may be pushed into the social welfare net - If trusts are forced into the imputation system a 20-cent distribution under today’s system will become 11 cents with only the promise of more later. Retirees have less cash and have to will wait up to 9 months for the distributions they need to live on.

Retirees will be forced to learn about imputation systems, grossing up, tax credits, rebates, as well as fill in more forms – the last thing retirees want is more hassles and worries.

Governments shouldn’t give the wealthy a tax break they don’t offer ordinary Australians.

The government allows wealthy private investors who own large assets to defer their tax payment until the end of the tax year. It also gives them the benefit of depreciation deductions in their hands. Yet, the government plans to deny ordinary Australians the same benefits when they pool their scarce savings in trusts.

Both ordinary Australians and the wealthy should enjoy the same tax right – that’s only fair!

Trusts are not the same as companies – why tax them that way?

Trusts are special savings vehicles – they’re not business entities, like companies. Trusts are totally different from companies because pooled savings are used to buy assets that create collective retirement wealth. An even bigger difference is that trusts distribute all their assessable income every year.

Simplicity is no excuse for inequity – the government argues that it’s better to treat all entities the same way for tax purposes. Simplicity is a virtue, however it shouldn’t be bought at the expense of ordinary Australians, especially retirees. Equity is more important than simplicity.

Jobs will be lost.

Trusts create jobs. More than half of major infrastructure projects are funded by trusts – they make projects viable. That means more projects get off the ground, which means more jobs.

Australia will throw away its competitive advantage.

The rest of the world is copying Australia’s property trust formula. We are world leaders. Why throw away a competitive advantage for the sake of textbook simplicity?

If super funds and private investors can’t use trust vehicles in Australia they will invest in overseas trusts – at the push of a button.

It’s not fair for government to pick favourites.

The government plans to tax property trusts at source but leave the interest on bank accounts and debt products untouched until the end of the accounting year. The treatment of all savings entities should be identical.

The Solution

Public unit trusts are special savings vehicles that allow capital deductions and income to flow to the hands of beneficiaries – at which point they are taxed.

The Property Council recommends this flow through feature become an element of the consistent tax entity framework proposed by the Ralph Review into Business Taxation.

These benefits should occur for listed property trusts where:

a) At least 75% of assets are invested directly or indirectly in real property, cash or government securities; and,

b) At least 75% of gross income is derived either directly or indirectly from real property; and,

c) They are listed on the Australian Stock Exchange; and,

d) 100% of taxable income is distributed.

These benefits should occur for unlisted property trusts and syndicates where:

a) At least 75% of assets are invested directly or indirectly in real property, cash or government securities; and,

b) At least 75% of gross income is derived either directly or indirectly from real property; and,

      1. 100% of taxable income is distributed; and,
      2. Unit holders supply their tax file numbers to the trustee – in cases where no TFN is supplied the trustee pays 50% of the unit holder’s distribution directly to the tax office.

The Property Council fully supports the BCTR position on legislative and administrative design principles.

In particular, the Property Council supports the proposal to establish a Board of Directors to oversee the administration of the tax system and create a ‘living’ reform process designed to improve Australia’s ability to move into the top league of economic performers.

December 1998