Executive summary
The Business Tax Working Group (Working Group) was established following the Tax Forum in October 2011 to consider what kind of business tax system will best support Australia's future growth prospects, particularly when set against the context of the major structural changes that are occurring within the economy at present.
Australian businesses are under pressure to adapt and change their business models to overcome challenges and make the most of opportunities arising from structural changes underway within the economy. Now more than ever it is important that the tax system does not get in the way of businesses wanting to invest and innovate.
Our current business tax system however, penalises investments that have some risk of failure through its treatment of losses. This penalty against risk taking can influence the kinds of investments undertaken and how much investment occurs.
The Working Group's terms of reference focus on reducing taxes on new investment to encourage Australian businesses to undertake innovation and entrepreneurial activity. We have been asked to focus initially on how changes to the treatment of tax losses might help to relieve the tax burden on new investment. In arriving at this final report on the tax treatment of losses the Working Group has provided the Treasurer an interim report, sought submissions in response to that report and conducted some limited confidential consultation. Later this year we will consider whether other changes, including a further corporate tax rate cut or a move towards a business expenditure tax system, (in particular an allowance for corporate equity) would best support new business investment in the longer term.
The Working Group is also required to identify offsetting savings from within the business tax system for any reforms it recommends. The tight timeframe and the requirement to find savings offsets have posed substantial challenges to the Working Group.
In the limited time available, the Working Group has not had an opportunity to fully evaluate the costs and benefits of discrete reforms to the treatment of losses against alternative policies such as a cut to the corporate tax rate. More time would also have been required to fully assess the potential benefits and risks of different savings options.
Nonetheless, the Working Group considers that loss carry back would be an important reform in the near term as it offers the prospect of improving incentives for investment as well as acting as an automatic stabiliser during an economic downturn. It has been implemented in a number of other jurisdictions and a range of stakeholders have indicated that they see it as a worthwhile initiative. In particular, stakeholders representing small to medium sized businesses, considered that carry back would assist businesses contemplating new investments, the costs and risks of which could result in a period of tax losses.
Under the Working Group's preferred model of loss carry back, refunds would be limited to company franking account balances and the amount of losses available to be carried back subject to a cap of not less than $1 million. While in principle a quantitative cap on loss carry back may limit its effectiveness, it would target the measure to small and medium sized businesses and help to contain the cost to revenue over the longer term. To avoid the need for businesses to amend previous tax assessments it is proposed that loss carry back be delivered through the use of a refundable tax offset.
While recognising that businesses operate through a range of legal structures, the Working Group considers that loss carry back should initially be provided to companies only. There would be significant complexity associated with extending loss carry back to trusts. Sole traders are currently less constrained in their use of tax losses than companies and trusts.
The Working Group also considered carry forward losses - recognising that the ability to carry forward losses is a relevant consideration for many firms pursuing new and innovative business activities. In its deliberations the Working Group was conscious of ensuring the right balance is struck between carry forward arrangements that support appropriate risk taking and innovation and maintaining appropriate loss integrity rules (as underpinned by the existing continuity of ownership test (COT) and the same business test (SBT)).
The Working Group came to a view that aspects of the current rules may stand in the way of the legitimate restructuring efforts of some businesses. That is, the current rules are not effective as a means for determining whether a change to a company's ownership was motivated by a tax avoidance purpose rather than commercial considerations. The SBT in particular too narrowly prescribes the range of activities that a company can engage in without risking forfeiture of its losses. Further, the application of SBT varies with a taxpayer's facts and circumstances making it difficult for taxpayers to determine prospectively whether or not they are likely to satisfy the test.
The Working Group has considered a range of options for reforming the SBT to better target the test and provide taxpayers with greater certainty. In the time available, it has not been able to develop and settle on a preferred approach. However, the Working Group sees merit in pursuing a model that includes, as its central component, modifying the SBT so that it aligns with the modern business environment. In addition, a statutory 'drip-feed' of up to ten years could be allowed on an opt-in basis for companies that fail the COT. This could complement the SBT by offering increased certainty and lower compliance costs in exchange for a slower rate of loss utilisation. The Working Group recommends that the Government commission further work in this area as a matter of priority.
The Working Group also considered whether an uplift factor should be applied to losses that are carried forward, in recognition that the Government retains the tax value of a loss and economically benefits from retaining that loss until its ultimate utilisation against future taxable income, conditional on certain tests being met. In theory, uplifting losses could benefit companies dealing with a temporary shock by ensuring that the value of those losses is maintained over the period leading up to a return in profitability. Consultation with stakeholders suggested that there was some, though limited, interest in this reform. The Working Group considers that such an approach is less likely to influence decision making than a measure like loss carry back that provides an immediate cash flow benefit, or changes to SBT that make it more likely that a loss can be used to offset future income. The Working Group therefore has not recommended a change to introduce an uplift factor.
The Working Group is required by its terms of reference to identify savings from within the business tax system that could offset the costs of any reforms it recommends. The Working Group's interim report on the tax treatment of losses was intended to elicit stakeholder views on reform priorities in this area and help us gain a better understanding of how the current system affects business decision making. It was not possible, at the time, to include any discussion about potential offsetting savings in our interim report. In light of the feedback we received in response to the interim report, the Working Group started to develop more specific reform proposals that could be costed by Treasury. Only in light of this information was the Working Group able to focus on the potential savings task and to undertake some further targeted, confidential consultation. Accordingly, there has not yet been widespread and transparent public consultation about any potential offsetting measures.
As a result of the reforms that followed the Review of Business Taxation, business tax expenditures are not as substantial as they once were. Nonetheless, Treasu ry provided the Working Group with information largely drawn from the Tax Expenditures Statement and a number of them were canvassed in recent confidential consultation, in particular: changes to the thin capitalisation rules, accelerated depreciation for some assets and industries (including oil and gas assets and assets first used in exploration) and the research and development (R&D) non-refundable tax offset available to companies with annual turnover of $20 million or more.
In the time available, the Working Group has not had an opportunity to conduct a thorough assessment of whether a particular savings option when combined with any of the potential loss reform measures would deliver a net-benefit to the economy. Further analysis and consultation is required before any conclusions could reasonably be drawn.
Conclusion
The Working Group considers that loss carry back would be a worthwhile reform in the near term. However, we have not had an opportunity to understand the relative net-benefit of loss carry back compared with other business tax reforms, particularly those we have been asked to look at in the second half of the year. We have also not had an opportunity to consider the potential impact of loss carry back on business behaviour and the macro-economy beyond the analysis set out in this report. The Working Group also recommends that the Government undertake further work to develop a model for reforming the same business test and a more extensive assessment of the costs and benefits of such reforms.
In relation to savings options, Treasury provided the Working Group with a list of options, largely drawn from the Tax Expenditures Statement, which focussed on the largest business tax expenditures. Treasury also provided the Working Group with costings of possible changes to these tax expenditures as well as possible changes to the thin capitalisation rules that could pay for reforms to the treatment of tax losses. The Working Group used this information to conduct some limited, confidential consultation on certain savings options. However, in the time available we have not had an opportunity to fully consider the benefits and risks of one or more or a combination of savings options and we have been unable to consult widely on the extent of any adverse impacts. The Working Group considers that further analysis and consultation is required before any conclusions can be drawn or any decision taken to implement them.