Reforms to business taxes
|Australia's business tax system needs improving. Business structures and investments are taxed inconsistently, resulting in complexity, uncertainty, tax minimisation, unfairness and poor investment decisions.
The Government will undertake consultation on business tax reform on two fronts. Firstly, on the implementation of the taxing of trusts like companies under redesigned company tax arrangements - while preserving income splitting through trusts and avoiding an inappropriate impact on existing trusts - and to extend the company tax arrangements to other entities offering limited liability. Secondly, to explore reform of the treatment of business investments - and the prospect that provides for achieving a reduced company tax rate.
The system reflects a bygone era
Business tax is a confused labyrinth - a poor
foundation and no framework for development
Business taxation is concerned with taxing investments in physical assets (like machinery and property) and financial assets (like bonds). It is also concerned with taxing the collective vehicles or ‘entities’ (like companies and trusts) through which these investments can be made.
The current business tax law is outdated and becoming beyond repair. It is a product of continual ‘catch-up’ amendment of a narrow legislative framework founded in the 1930s - in part in response to the increasing use of trusts and other entities for a wide variety of business purposes and in part because of a succession of responses to deficient treatment of changing values of physical and financial assets.
The continual amendments since the 1930s have been unsystematic and ad hoc. As a result, the provisions impose compliance and administrative difficulties and set up a wasteful tread-mill of avoidance loopholes and amendments - which, in turn, open up further loopholes.
The overall result is a business tax system that is complex, unstable and too often uncertain in its application and its effect. The world has changed dramatically since the 1930s and the structure of business tax law has been found wanting.
An irrational system promotes inequity and misdirected activity
The fundamental problem is that there is inconsistent taxation treatment of business entities and the investments they conduct (Figure 3.1). There are large and variable gaps between tax treatment and commercial reality.
Exactly the same investment gets very different tax treatment if conducted through different collective business structures (eg companies, trusts or life insurers). Underlying a particular market-driven after-tax return are very different pre-tax returns from different types of investments.
Figure 3.1: Inconsistent treatment of entities and investments yields fundamental distortions
This diagram shows the pre-tax return that different investments need to make in order to earn the same after-tax return of 5.3 per cent for an individual on a 47 per cent tax rate.
These outcomes are most unfair. Wealthier individuals with access to legal and accounting advice can target particular investments and structures to take advantage of the differences in tax treatment - and thus minimise the amount of tax they pay. The rest of the community subsidises the wealthier investor.
Moreover, with tax and commercial considerations often out of line, investment activity is misdirected towards less productive pursuits - activities with low pre-tax returns such as those offering ‘tax shelter’ opportunities (Figure 3.1). Investment decisions are taken more on the basis of tax-preferred status than economic worth. A bias towards activities generating low pre-tax returns reduces Australia's productivity, Gross Domestic Product (GDP) performance and job creation.
Figure 3.1 highlights the two dimensions of business tax requiring reform: business entities and the investment base.
Taxation of business entities is inconsistent
The taxation of business entities requires reform across three key problem areas: inconsistent entity treatment; inappropriate taxation of company groups; and inconsistent treatment of distributions.
Differential treatment of entities produces unfair outcomes
Under current law, vastly different treatment is accorded investment income channelled through different entities. The treatment is different both between the various entities and at the individual investor (eg shareholder) level.
Companies, fixed trusts, and discretionary trusts all offer investors the prospect of limited liability - shielding them from full personal liability for making good the entities' financial liabilities. And yet there is very different treatment across these entities of distributions out of profits freed from taxation by tax preferences (‘tax-preferred’ income). Such distributions by companies (ie unfranked dividends) are taxed in the hands of individual resident shareholders. In the case of fixed trusts these distributions are generally taxed with a delay when the interests in the trust are sold. With discretionary trusts the distributions are not taxed at all. The beneficiaries of discretionary trusts enjoy ‘the best of both worlds’, benefiting from both limited liability and the flow-through of tax preferences.
Sole traders and partners in partnerships are able to access tax-preferred income but they bear liability for losses of their businesses (unless in limited partnerships); that is, they do not have limited liability arising from the entity.
Some co-operatives are taxed differently again from companies under complex arrangements that can result in different outcomes depending on the timing of distributions.
The treatment of life insurance investments is inequitable as the returns are unlikely to be taxed at the policyholder's marginal tax rate. Different tax rates apply to life insurers depending on the type of institution offering the policy, the nature of the policy and the investor.
Special treatment of company grou
ps adds to costs and compromises the system's integrity
Within wholly-owned company groups the transfer of tax losses is allowed, as is capital gains tax (CGT) rollover relief for asset transfer. But other tax benefits cannot generally be transferred.
Companies are able to achieve unintended tax benefits from the present grouping provisions (together with the ‘section 46’ rebate on inter-corporate dividends). Group companies - as well as related companies with less than 100 per cent common ownership - are able to create artificial losses by cascading losses through the company chain and by shifting assets between subsidiaries at values higher or lower than their market values. Group companies are also able to create taxation benefits by manipulating transactions between companies in the group.
Anti-avoidance provisions to address these activities are complex - but have not been able to keep up with the growing use of tax strategies. The integrity of the company tax system suffers as a result. Moreover, the growing complexities in the law are imposing large compliance and administrative costs. Company groups often face heavy compliance costs to undertake even minor restructuring.
The inconsistent treatment of company distributions can penalise shareholders
Within the company tax system itself, the various ways of distributing profits from companies (through dividends, share buy-backs and on liquidation) are currently treated inconsistently. In some circumstances, shareholders may be penalised through the imposition of two layers of taxation on the same income - with possible adverse effects on the functioning of capital markets.
Moreover, refunds are not available to resident taxpayers who have insufficient non-dividend income to absorb all the imputation tax credits attaching to their company dividends. This disadvantages low income shareholders, including self-funded retirees. They may face the company tax rate on dividend income rather than their own marginal tax rates.
There are also problems in identifying the mix of contributed capital, taxed profits and tax-preferred profits in company distributions. Anti-avoidance provisions to deal with the substitution of contributed capital for dividends have been recently introduced - but they, necessarily, do not address the underlying structural issue.
Taxation of business investment lacks a coherent framework
The 1930s law ignored a critical issue: the changing value of assets/liabilities
The original 1930s legislative foundation focused on the recurrent income yielded by assets - such as annual revenue from the sale of goods and services produced by physical assets or annual interest on financial assets. It did not generally take into account the effect on income of the changing values of the assets themselves. Since then, neither with physical assets nor financial assets/liabilities has the tax treatment of changing asset values been implemented within a consistent and coherent framework driven by sound and clearly enunciated principles.
As a result, the tax treatment of changing asset (and liability) values requires consideration.
There are several inconsistent regimes for the treatment of amortisation of physical assets: plant and equipment; buildings and structures; and certain assets used in the resources sector.
The write-off allowances of many depreciating physical assets, the treatment of gains on assets that have appreciated in value and the various ways that trading stock is valued invariably keep the annual tax values of these assets out of kilter with commercial value.
Other forms of capital expenditures necessarily incurred by businesses receive no taxation write-off - such as costs of forming or relocating a business. Reflecting this tax treatment, they are referred to as blackhole expenditures.
Financial assets/liabilities and intangibles
The poor tax treatment of changing values of financial assets and liabilities distorts financial and risk management decisions, invites tax abuse and inhibits innovation. Poor asset treatment aside, even the deductibility of annual interest payments is unclear, inconsistent and uncertain.
The provisions dealing with taxation of leases over wasting assets are not consistent in effect and often involve costly administrative complexities. Capital gains taxation of lease premiums does not reflect changing values over the whole period of the lease. Similar problems arise with the up-front payment for rights - such as the right of access to others' assets. More generally, fixed life intangible assets (eg spectrum licences, intellectual property and franchise fees) are taxed inconsistently.
Use of accounting principles
Some expenditures are treated as recurrent (attracting immediate deductibility) when the associated income is to be earned over future years, sometimes with many years' delay. This is despite the fact that accounting principles would view the expenditure as acquiring an asset (with write-off depending on its subsequent change in value).
The tax treatment of business entities and investments is flawed. The piecemeal approach to changing the system has not worked in the past and if continued will add to instability, uncertainty and complexity. Systemic problems require systemic solutions. A comprehensive approach to business tax reform is required driven by clear, sound principles and involving a general move towards greater commercial reality.
This approach offers the prospect of a stable, simpler and more coherent business tax system with greater integrity - a system providing fairer, more equitable outcomes, less scope for tax avoidance and the basis for more robust investment decisions and a lower company tax rate.
Taking this approach to reform should lead to improved competitiveness, greater productivity, higher GDP growth and more jobs.
The strategy is to:
- Pursue reforms on two fronts: business entities and business investments.
- Consult on a framework for taxing trusts like companies, as well as transitional and implementation details - and on the extension of that framework to other business entities. In the interim, introduce immediately provisions that address tax minimisation activity through the use of trusts.
- Consult on the extent of reform of business investments with the prospect of further CGT relief and of moving towards a 30 per cent company tax rate to the degree that progress is made. Extend immediately the arrangements which provide CGT ‘rollover’ relief and retirement exemption for small business.
Reforming the taxation of business entities
Taxing trusts like companies
Addressing tax minimisation through complex trust structures
Moving towards consolidated group taxation
Achieving consistent treatment of entity distributions
Taxing trusts like companies - under redesigned company taxation
It does not make sense for exactly the same investment to attract very different tax treatment simply because it is put through a trust rather than a company.
The Government will consult on the achievement of consistent taxation of discretionary and fixed trusts like companies under a clear, fair and simple regime of redesigned company taxation. The Government intends that the regime commence in the 2000-01 income year.
Key features of the redesigned company tax arrangements are:
- A simplified imputation system involving full franking of all profits paid to individuals or other entities outsid
e consolidated groups. The full franking would involve the taxing of all distributed profits at the entity level - with all distributed profits then having attached imputation credits for the tax already paid.
- Refunds of excess imputation credits for resident individual taxpayers and complying superannuation funds. Special arrangements would apply to registered charitable organisations (see below)
- Trusts would be able to continue to realise the benefits of income splitting among beneficiaries.
- The refunds would mean that each individual beneficiary would be taxed on trust distributions at their marginal tax rates. The same would apply to individual shareholders.
- Transitional arrangements to avoid an inappropriate impact on existing trusts.
Taxing trusts like companies means the imposition of tax on distributions by trusts of tax-preferred income. The transitional arrangements need to recognise the difference in the current tax treatment of the tax-preferred income of discretionary trusts and fixed trusts. With discretionary trusts, tax-preferred income can at present be distributed tax free to individual beneficiaries. With fixed trusts, however, distributions of tax-preferred income are already taxed - although usually not until the beneficiaries' interests in the trusts are sold because the distributions of tax-preferred income reduce the CGT cost base of those interests.
Despite these differences between discretionary and fixed trusts, the transitional conversion of tax-preferred income into contributed capital would maintain the current treatment of that income with both types of trust. It would maintain tax free status with discretionary trusts and CGT taxation with fixed trusts.
The key components of the transitional arrangements for discretionary and fixed trusts are as follows.
- Current tax status would be maintained for distributions out of the following amounts from businesses and assets held in trusts at the commencement of the new regime (including gains accrued after the start date):
- realised gains on pre-CGT assets;
- realised inflationary gains on post-CGT assets; and
- realised gains subject to the exemption of 50 per cent of CGT otherwise applying to goodwill on the sale of a small business.
- Current tax status would be maintained for distributions by trusts out of other tax-preferred income earned prior to the new regime (excluding unrealised gains on trust assets) - as well as prior taxed income.
Beyond these transitional arrangements, some features of current arrangements would be retained on an ongoing basis. After the commencement of the entity tax regime:
- current tax status would be maintained for distributions out of realised profits freed from tax by the small business 50 per cent goodwill exemption for new businesses in existing and future trusts; and
- income distributed from existing and future trusts would continue to attract the primary producer averaging provisions and the farm management deposit arrangements.
Apart from primary producer averaging, maintenance of current tax status for distributions out of the above profits would be maintained by adding the amounts to contributed capital - usually at the time of sale of the associated assets. This approach and the transitional arrangements should mean that asset valuation should not be a significant issue at the start of the new regime.
The introduction of entity taxation arrangements would mean that trust distributions to charitable funds and organisations are made from post-tax income. In order not to penalise genuine charities, provisions would be included in the law to establish a registration process for such organisations. Only those organisations listed on the register would be tax exempt or able to qualify for gift deductibility. Registered organisations would also be allowed to claim refunds of excess imputation credits for tax paid at the trust level on donations to them by way of trust distributions. These refunds would maintain the current net tax position of such donations.
Reaping the benefits of a consistent regime
Achieving consistency of treatment across companies and trusts under these redesigned company tax arrangements would provide simplicity, clarity and fairness in treatment. It would also address techniques that have come to light through the High Wealth Individuals project which take advantage of highly complex structures.
The refunds of excess franking credits would provide a fairer outcome for low income people - in a way consistent with the original objectives of the full imputation system. The overall tax paid on profit distributed by a company or trust to low income resident individuals would reflect their marginal tax rates. They would not be disadvantaged simply because tax was first paid on the profit by the company or trust. The benefits of income splitting would apply consistently across all companies and trusts.
The full franking of dividends would simplify considerably the operation of the imputation system, removing the need to distinguish between franked and unfranked dividends. The current complex anti-avoidance provisions to address the streaming of franked and unfranked dividends could be repealed.
Full franking also underpins the design of the arrangements, discussed later, that would achieve consistent treatment of distributions of profits and capital. And its introduction would minimise the need for specific anti-avoidance measures through the entity chain outside the full consolidation regime being considered for entity groups.
The Government intends to broaden the benefits of these redesigned company tax arrangements by applying them to other business entities offering limited liability to their owners: limited partnerships, co-operatives and life insurers. This would mean that life insurers' income would be taxed uniformly at the company tax rate (with imputation credits for investment policyholders). Co-operatives are already taxed like other companies if less than 90 per cent of their business is with their members. Limited partnerships, too, are already taxed as companies (although their public company status will be the subject of consideration in the consultative phase).
Other partnerships (and sole traders) would not be part of the entity taxation regime. The flow-through of tax preferences in these cases is consistent with the full personal liability applying in relation to the financial liabilities of the business activities involved.
Refining the framework through a process of consultation
While it is the Government's intention to introduce the framework outlined above to achieve consistent entity taxation, the Government considers it important for consultations to be pursued on that framework, as well as associated transitional and implementation details. Consultations will be particularly important in relation to: the full franking arrangements, the refunding of imputation credits, international considerations, other trust issues and the taxation of life insurers.
i. How full franking arrangements would work
There is considerable complexity in the present system caused by dividends being either franked or unfranked depending on whether they are paid out of taxable income or not. Virtually all company profits are taxed. But only taxable income is subject to company tax (with distributions of these taxed profits being franked). Other tax-preferred profits are taxed in the hands of individual resident shareholders as unfranked dividends when distributed.
Under a full franking system, taxable income would, as now for companies, be subject to company tax. In contrast to current arrangements, however, distributions of other profits would be taxed (at the company tax rate) at the entity level, rather than at the shareholder level. This deferred company tax would subject distributed tax
-preferred income to tax at the entity level so that all distributions of profit would then be franked. Company tax paid would then be creditable under the imputation system to resident individual shareholders, beneficiaries, members of co-operatives or policyholders. These individuals would be paid the excess franked credit where their marginal tax rate is less than the company rate.
Deferred company tax would not only apply to dividends paid to individuals and superannuation funds. It would also apply to distributions of tax-preferred income from one entity to another (other than in the case of consolidated groups) - with arrangements to ensure that double taxation did not occur through the entity chain.
Figure 3.2 shows the operation of the full franking arrangements. At the current 36 per cent company tax rate, $100 of company or trust income would give rise to a potential franked dividend of $64 and $36 of company tax (regardless of the mix of taxable and tax-preferred income in the $100).
How imputation would work at the entity level
ii. How the refunding of imputation credits would work
Taxable resident recipients of franked dividends would be assessed on the cash dividend ‘grossed-up’ by the attached imputation credits - with the credits then creditable against tax payable. In Figure 3.3, the 17 per cent marginal tax rate recipient of a $64 dividend has $17 tax payable on $100 of grossed-up dividend and receives a tax credit of $36.
17 per cent marginal rate taxpayer
Both resident individual taxpayers and complying superannuation funds would be eligible for refunds of excess imputation credits where other tax payable cannot absorb them. The taxpayer in Figure 3.3 would receive a refund of $19 if he or she had no tax payable on other income. That would ensure that the imputation system operates as it should - imposing overall tax on distributed profits at the marginal tax rates of resident individual taxpayers. And this would be of major benefit to low income earners, including self-funded retirees, who are unable to fully utilise imputation credits because they have insufficient taxable income to absorb them. Under the entity tax regime this would benefit not only low income shareholders but also low income investors in equity unit trusts and life insurance policies.
These arrangements should not change significantly the overall tax payable over time by resident beneficiaries in relation to profits distributed by fixed trusts, including cash management trusts. Nevertheless, the timing of tax payments by trusts under the proposed pay as you go system (Chapter 4) and of refunds of excess imputation credits for low marginal tax rate beneficiaries will be an important design issue for consultation.
iii. How consequential changes would be made in relation to investment in Australia by foreign investors and offshore investment by Australian residents
The Government is committed to maintaining the attractiveness of Australia as an investment location and a financial centre in the context of the changes outlined above - while ensuring foreign investors pay their fair share of tax on Australian source income. This commitment is made recognising that the deferred company tax under the entity tax regime would impose tax at the company rate on dividends paid out of tax-preferred income to foreign investors. Currently those dividends attract dividend withholding tax, generally at 15 per cent. Consequential changes to international taxation arrangements would therefore be necessary. Relevant too is the possibility of moving towards a company tax rate of 30 per cent as a result of the proposed consultative process with industry on reforms to the business base.
The Government is also committed to ensuring that offshore investment - including through non-resident trusts - is not used by Australian residents to avoid paying their fair share of tax.
The process of consultation in relation to changes that would be needed to international taxation arrangements under the entity tax regime will be set against the above commitments and the following principles.
In relation to investment in Australia by foreign investors, the principles are to ensure that: interest on Australian debt continues to be subject to the current 10 per cent interest withholding tax (IWT) arrangements - including the current range of IWT exemptions; total tax borne on profits distributed to foreign investors is in line with the company tax rate; maximum possible creditability overseas of Australian tax is achieved; the Australian taxation system does not unduly impede offshore income passing through Australia to non-residents (‘conduit’ income); and the taxation of branches of foreign entities is in line with the entity tax regime.
In relation to residents' foreign source income, the principles are to: tax residents' interests in non-resident trusts to ensure outcomes consistent with the entity tax regime; and strengthen the accrual taxation rules and transferor trust arrangements that apply to foreign trusts to address exploitation of current deficiencies. Changes implemented in line with these latter principles should ensure that Australian residents cannot avoid paying their fair share of tax through the use of foreign trusts.
iv. How other issues arising from taxing trusts under the entity tax regime would be handled
The principle guiding the consultation process on transitional and implementation details will be that trusts should, as far as possible, be taxed like companies - excluding the special arrangements outlined above. Thus, distributions ‘out of’ unrealised profits would be subject to tax and provisions covering private company loans to shareholders would be extended to discretionary trusts and closely held fixed trusts. While a wide range of additional issues will need to be discussed, particularly in relation to discretionary trusts, the coverage of consultation will include the following areas.
Which trusts should be excluded from the entity tax regime?
The Government envisages that certain trusts would be excluded from the entity tax arrangements and attract tax in line with the current treatment of discretionary trusts.
Consultation will be on the basis that the general principle for exclusion would be where a trust has been created and settled only as a legal requirement or subject to a legal test or sanction. In these cases, the beneficiary (and parent/guardian) would usually not have any real choice about using the trust.
On this basis, trusts excluded would include constructive trusts (eg imposed by a Court in relation to embezzled money) and trusts arising in a range of circumstances where the sole beneficiary is subject to a legal disability or is legally incapacitated.
How should trust losses be treated?
Under the recent trust loss measures, trusts generally cannot allow trust losses to be transferred or used by other entities - although losses may be used within a family group.
The principle of treating trusts as much as possible like companies means that fixed trusts would continue to access their own past year losses if they meet a 50 per cent continuing ownership test. Discretionary trusts would need to meet the ownership, control and pattern of distributions tests in the recent trust loss measures. Trusts would also be able to utilise losses under the same business test applying to companies.
Similarly, discretionary and fixed t
rusts would be part of the group consolidation regime under consideration. Thus the ability to use losses within a family group of entities would be formalised within a consolidation regime.
Discretionary trusts could be part of a consolidated group of trusts and companies if each trust and company were only able to distribute to the members of the same family - as defined in recent trust loss measures.
v. How the entity tax regime would apply to life insurers and their policyholders
Extension of the entity tax regime to life insurers would allow the wide variety of tax rates currently faced by life insurers to be removed and their investment policyholders to attract tax at personal marginal tax rates.
Consultation with the life insurance, friendly society and superannuation industries will include the technical and transitional issues associated with implementing these arrangements.
How would life insurers be treated?
Under the entity tax regime, from the 2000-01 income year, the company tax rate would apply to a life insurer's income and deductions generated in relation to:
- ordinary life insurance business - presently taxed at a separate trustee tax rate (39 per cent for life insurance companies and 33 per cent for friendly societies);
- policies held by superannuation funds - both complying (currently attracting 15 per cent) and non-complying (currently 47 per cent); and
- contractual obligations on annuity contracts - with a deduction allowed for the ‘interest’ component of annuity payments and associated expenses. Income from this business is currently exempt and associated deductions are not allowed.
All profit from funds management, underwriting and other life insurance and annuity business (largely untaxed currently) would also be taxed at the company tax rate. The friendly society tax rate would remain at the current 33 per cent rate until 2000-01. The present treatment of Retirement Savings Accounts would be retained.
Consistency would require that the income underlying the pension and annuity business of superannuation funds be taxed at the 15 per cent rate (with deductions allowed for the ‘interest’ component and associated expenses). This change would not affect the tax treatment of recipients of pension or annuity payments by superannuation funds.
These reforms would improve the efficiency of the financial system and further the objectives of financial system reform. They would also improve the certainty of the taxation treatment that applies to life insurers. Life insurers, for example, would no longer need to undertake complex and costly allocations of income and deductions into different tax ‘baskets’.
How would life insurance policyholders be treated?
Currently, life insurance income distributed on investment policies held for more than ten years is exempt in the hands of policyholders. It is, however, taxed to the life insurer - at 39 per cent for a life insurance company and 33 per cent for a friendly society. That disadvantages low marginal tax rate policyholders and advantages high marginal tax rate policyholders. Furthermore, assessment and rebate arrangements applying to income distributed on policies held for less than ten years also do not result in that income being taxed at policyholders' marginal tax rates.
Under the entity tax regime, income assigned to investment policies (not risk policies) would attract tax at the marginal tax rates of policyholders regardless of the period of investment (including with policies held for more than ten years). This would mean that investment policies would be treated in the same manner as company dividends and income from unit trust investments.
Bonuses (including terminal bonuses) assigned to individual investment policies would have imputation credits attaching to them for the tax paid by the life insurer. These credits (which would be refundable) would result in investment income being subject to the policyholder's marginal tax rate in the same year that a bonus is assigned to the policy.
Those with a marginal tax rate less than the company rate (including complying superannuation funds) would attract net credits to reduce tax on other income, or be refunded. The availability of refunds would ensure that no more than 15 per cent tax applied to the income of superannuation funds. Other policyholders would attract additional net tax on their grossed-up bonuses to the extent that their marginal rate was higher than the company rate. With tax being potentially payable on bonuses not received in cash, policyholders would have the choice of being taxed on the bonuses either when they are assigned to their policies or when they are ultimately distributed.
Similar treatment would apply to returns from investment-linked policies as income is distributed to policyholders.
As a transitional measure, individuals holding policies written before the commencement of the entity tax regime would continue to attract the current treatment of their bonuses after commencement: exemption for policies held for more than ten years and assessment and rebate arrangements for policies held for less than ten years.
Addressing tax minimisation through complex trust structures
The entity tax regime would address a wide range of tax minimisation opportunities available through the use of trusts - opportunities driven by the different treatment of trusts and companies.
Pending the introduction of the entity tax regime, the Government has decided to introduce an anti-avoidance measure aimed at such practices. Legislation to implement this measure will be enacted with effect from the date of release of this package.
Trustees to identify ultimate beneficiaries
The Tax Office has evidence that certain taxpayers are using complex chains of trusts to minimise tax. There are many legitimate reasons for trust structures containing multiple trusts. Nevertheless, some taxpayers are using multiple trust arrangements to make it difficult for the Tax Office to piece together the trail of distributions from trust to trust to establish tax liability.
A special anti-avoidance rule will be introduced, with immediate effect. It will require the identification by trustees of discretionary and closely held fixed trusts of the individual or company beneficiaries, and their tax file numbers if they are residents, that are ultimately entitled to trust distributions. This will apply regardless of the number of trusts through which the distributions may pass. The measure will help establish tax liabilities by providing an administrative audit trail.
Details of the measure are provided separately.
Moving towards consolidated group taxation: a process of consultation
The complexity of tax arrangements facing company groups and the associated high compliance costs need to be addressed - as does the ability of group companies to gain unintended tax advantages from the current grouping concessions and by dealing among themselves.
The Government's intention to bring trusts within the company tax framework makes it even more essential that these problems be addressed.
The Government intends to consult on a move towards allowing groups of companies, trusts and co-operatives to consolidate their tax position. A group would only prepare one tax return and have a single franking account, one capital loss account and one revenue loss account.
Eligible groups would be 100 per cent wholly owned Australian resident companies, co-operatives and fixed trusts. A consolidated regime for discretionary trusts would encompass groups of family trusts (and companies).
Consultation with the business community will be undertaken on the basis of the following high level principles:
- groups treated as a single entity - dealings between companies/trusts in a group would be ignored for the purposes of the gr
oup's tax assessment;
- consolidation optional for whole group - eligible groups would be able to make an irrevocable choice to consolidate the entire group or to have all entities in a group subject to separate taxation treatment;
- repeal of current group concessions - the group concessions would be replaced by the consolidation arrangements;
- losses and franking balances on entry - companies or trusts entering a consolidated group would be able to bring franking account balances into the group and also carry-forward losses on a basis consistent with the principles underlying existing tax law;
- equity interests on exit from consolidation - exit provisions will determine equity cost bases for entities leaving a consolidated group by reference to asset cost bases and equity cost bases on entry and to any cost base adjustments necessary during consolidation; and
- losses and franking balances on exit - in recognition of the pooling of franking credits and losses during consolidation, companies or trusts exiting a continuing group would be unable to take with them carry-forward losses or franking account balances. The losses and franking account balances would stay with the continuing group.
A wide range of issues will need to be analysed and discussed against this set of principles including, importantly, arrangements for the transition of existing companies and trusts into a consolidation regime.
There is a strong incentive to devise workable consolidation arrangements. In the absence of a consolidation regime, solutions to current problems would need to be sought through extensive value shifting and loss cascading rules to apply within entity groups.
Arrangements will be needed to address value shifting and cascading of losses in related groups ineligible for, or remaining outside, consolidation. Those arrangements would, however, be much simplified by the application of deferred company tax down the company/trust chain outside consolidation.
Achieving consistent treatment of entity distributions
Current inconsistencies and uncertainties need to be removed in the treatment of the various ways of returning contributed capital and profits to shareholders: dividends, share buy-backs and by way of liquidation. This would complement changes in the corporations law in relation to share buy-backs and returns of capital. The reformed arrangements would apply to trusts (and co-operatives) in the entity tax regime.
The benchmark for consistent treatment across dividends, share buy-backs and liquidations is to be the current treatment of dividends. The central element of relevance here is the capital loss allowed to the shareholder who buys shares cum dividend and sells when the shares fall in value post dividend. That capital loss is needed to ensure that double tax does not occur, over time, on retained company income.
Crucial to the proposal for consistent treatment of distributions is the deferred company tax which is a key element of the entity taxation regime. Allowing capital losses to offset double taxation requires tax to be paid on the associated dividend distributions.
Consultation, against the dividend treatment benchmark, will focus on implementing arrangements to achieve consistent treatment across share buy-backs and liquidations, as well as the distribution of profits and contributed capital. Consultation will be on the basis of a regime which involves: retaining the current treatment of off-market buy-backs; addressing double taxation when a company buys back shares for cash ‘on market’; determining the split between taxed/tax-preferred profits and contributed capital in the buy-back price on the basis of the ‘slice’ of the company involved; treating all profits distributable at liquidation as dividend distributions (without affecting the current exclusion of profits from the sale of pre-CGT assets in pre-CGT companies); and introducing a general ‘profits first’ rule whereby distributions outside buy-backs would be treated as dividends so long as profits were available.
A profits first rule, together with the deferred company tax, would ensure that the current complex dividend streaming provisions would no longer be needed. Franking credit trading provisions, on the other hand, are designed to address arbitrage opportunities such as those between non-residents and tax exempt locals (who cannot benefit from imputation credits or capital losses) and taxable residents.
There would be a transitional measure relating to the application of profits first rule to trusts taxed under the entity tax regime. The transitional arrangements discussed earlier mean that for assets or businesses held in trusts prior to the commencement of the regime, realised gains on pre-CGT assets, realised inflationary gains on post-CGT assets and realised gains covered by the 50 per cent goodwill exemption would be converted to contributed capital. Under the transitional measure, these converted gains would not be subject to the profits first rule if they are distributed in the year they are realised.
Reforming the taxation of business investments
Consulting on the treatment of business investments
The Government proposes consultation on possible reform of the investment base. This consultation will be undertaken bearing in mind four considerations:
- the need to encourage business development with an internationally competitive tax treatment of business investments;
- the potential benefits of bringing tax value and commercial value closer together;
- the goal of moving towards a 30 per cent company tax rate; and
- the need to achieve overall revenue neutrality.
Any move towards a 30 per cent rate will depend on the outcome of consultation with business on the extent and nature of reform to the business investment base. That decision will be strongly influenced by business support for such changes.
Reform consultation will focus on the poor treatment of changing asset (and liability) values currently in the income tax law.
There are three key areas to be considered: physical assets; financial assets and liabilities; and the potential use of accounting principles.
The Government sees scope for the taxation of investment in physical assets to be more in line with commercial practice. Hence, the following issues relating to physical assets require consideration:
- capital write-off allowances;
- balancing adjustments on disposal (where sale price differs from tax written-down value);
- trading stock valuations;
- CGT indexation and averaging; and
- scope to unify capital write-off provisions and roll the currently separate CGT provisions into them.
In this context, a number of specific reforms to CGT may be open, including: capping the rate of tax applying to capital gains for individuals at 30 per cent; extending the CGT roll-over provisions to scrip-for-scrip transactions; and introducing a $1,000 per annum CGT tax-free threshold for individual taxpayers.
The treatment of ‘blackhole’ expenditures - such as feasibility studies and export market development costs - is also an important issue for examination.
The base broadening required to achieve a 30 per cent company tax rate would almost certainly require a significant paring back of current accelerated write-off arrangements. However, consultation will focus on the desirability of such changes given the differential impact that reduced write-off concessions would have across industry sectors.
Financial assets/liabilities and intangibles
Closer alignment of tax value and commercial value is important with financial assets and liabilities in today's dynamic and innovative financial markets. On t
his basis, consultation will involve consideration of achieving greater consistency and clarity in the treatment of financial transactions, including prepayments, leases, rights over assets and fixed life intangibles. Greater recognition of commercial valuation methods should allow significant simplification of the proposals canvassed in the Issues Paper on the Taxation of Financial Arrangements released in December 1996 - particularly in relation to hedging, foreign currency gains and losses and debt/equity definitions in the context of an optional mark-to-market regime.
Scope to address current inconsistencies and uncertainties associated with the tax deductibility of interest will also be discussed.
Use of accounting principles
There may be scope over time for a closer alignment of the tax law and accounting principles. Use of accounting procedures for tax purposes could only be contemplated where that does not compromise the integrity of the tax system. But where common use is possible, compliance costs should be able to be reduced substantially.
Compliance cost savings have been raised in the area of financial arrangements in the 1996 Issues Paper on the Taxation of Financial Arrangements and in subsequent consultation on the paper. Accounting principles dealing with the timing of benefits or income from business expenditure may be able to help overcome uncertainties and inconsistencies in the tax law concerning the distinction between recurrent expenditure and capital expenditure.
Scope to dovetail accounting principle with tax principle in other areas will be further pursued during the consultative process.
Extending CGT rollover relief and retirement exemption for small business
Currently land and buildings that are used in a small business operation but which are held in a trust or company separate from the business attract neither the CGT rollover relief nor the retirement exemption for small business. That is because these assets are classed as ‘passive’ assets when held in a separate entity. A typical example is a primary producer business operated through a partnership but with associated land and buildings held in a trust controlled by the partners.
The Government has decided to extend the CGT rollover relief and retirement exemption to include land and buildings integral to a business when these assets are owned separately - rather than being owned directly by the entity through which the business is operated. The new provisions will apply where the taxpayers owning and controlling the land and buildings are substantially identical to those controlling the business.
The new provisions will have effect from the date of release of this package. Details of the measure are provided separately.
Revenue measures table: business tax
* A positive revenue number implies a positive impact on the budget balance.
- Costings based on the framework specified in Chapter 3, recognising that this framework will form the basis for public consultation. The costings do not include the effects of the proposed group consolidation regime and associated loss provisions.
- Includes taxation of trusts like companies under the redesigned company tax arrangements (including the timing impact of the new payment arrangements), as well as both deferred company tax and refundable imputation credits associated with trust distributions. Also included is the effect of changes to the treatment of non-resident trusts and the introduction of an anti-avoidance measure.
- Includes deferred company tax on unfranked dividends paid by companies to residents (less refundable imputation credits associated with such dividends) and additional revenue from deferred company tax on company distributions to non-residents.
- Includes refundable imputation credits associated with franked dividends paid by companies.
- Includes the effect of changed treatment of the life insurance and annuity business of life companies and friendly societies (including changed treatment of policyholders and retention of the 33 per cent friendly society tax rate until 2000-01), as well as the pension business of superannuation funds.