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Inquiry into Business Taxation Reform
Table of Contents

Chapter 2

THE GOVERNMENT'S PROPOSALS

Introduction

2.1 On 21 September 1999, the Treasurer released the report of the Review of Business Taxation (hereafter referred to as the Ralph Report) along with the first phase of the Government's response, in press release no. 58. A further press release, no. 69 of 21 October 1999, accompanied the introduction into the House of Representatives of the first package of legislation to implement the Government's proposed business tax reforms. A second stage response to the Ralph Report came with press release no. 74, issued on 11 November 1999. This dealt primarily with anti-avoidance measures and with improving the operation of the tax system. It also announced in principle support for replacement of the existing law based on legal definitions of income with an approach which calculates taxable income on a cashflow/tax value basis, an approach widely known as Ralph's `Option 2'. The proposed business tax reform measures announced to date relate to the company tax rate, changes to entity measures announced in ANTS, depreciation and small business measures, capital gains tax measures and integrity measures, as outlined below.

Company tax rate

The present situation

2.2 The general rate of tax payable by companies in Australia, as per the Income Tax Rates Act 1986, s.23, is 36 per cent at present. In 1996-97, revenue from company tax was $19 173 million, representing 17.9 per cent of the total revenue collection; in 1997-98 the comparative figures were $19 406 million and 17.2 per cent and in 1998-99 $20 733 million and 16.9 per cent. [1] This company tax rate is claimed by the Government to be internationally uncompetitive, compared with Hong Kong – 16 per cent, Singapore – 26 per cent, Germany – 30 per cent, Indonesia – 30 per cent, Thailand – 30 per cent, United Kingdom – 30 per cent, Korea – 31 per cent, New Zealand – 33 per cent, and the United States – 35 per cent. Such headline rates are somewhat misleading, however, and it is preferable to consider the effective company tax regime.

Government proposals

2.3 The Treasurer's press release of 21 September 1999 announced the Government's proposal to introduce a phased reduction in the company tax rate to 34 per cent in relation to the 2000-01 income year and to 30 per cent for the 2001-02 income year and thereafter. The rationale for the proposed change is that it will make the headline rate of corporate tax internationally competitive; non-portfolio foreign investors in Australian companies will benefit because they will be better placed to utilise foreign tax credits available in their home jurisdictions; for portfolio investors who receive no credit in their home country for underlying company tax, reducing the tax rate directly increases their after-tax return from investing in Australian stocks. By increasing Australia's attractiveness as an investment location, a lower company tax rate should strengthen Australia's prospects for investment, economic growth and jobs.

2.4 Most of the redesigned company tax arrangements, including the consistent treatment of entities, and the Simplified Tax System for small business, are deferred to 1 July 2001, in recognition of the current demands on businesses associated with the need to address Y2K compliance issues and the introduction of the GST on 1 July 2000. [2] Imputation credits attached to franked dividends paid to shareholders will be based on a 34 per cent rate for 2000-01 and 30 per cent for 2001-02 and subsequent years. The value of existing franking account balances will be preserved by converting them to the equivalent franking account balance at the new rates.

2.5 A 30 per cent company tax headline rate will align the company tax rate with the 30 per cent marginal tax rate applicable to most individual taxpayers. Also, according to the Ralph Report, reducing the corporate tax rate will enable Australian companies to maintain dividend flows to shareholders while increasing the levels of retained income and, therefore, investment. [3]

2.6 The fiscal impact of the lower company tax rate has been estimated by Government as follows: [4]

Changes to entity measures announced in ANTS

2.7 The Government's revised proposals are designed to achieve a unified entity regime, as outlined in A New Tax System (ANTS). The proposals are:

• taxing trusts, life insurers, cooperatives and limited partnerships as companies;
• simplifying the imputation system;
• refunding excess imputation credits to resident individuals and superannuation funds to improve equity between taxpayers;
• providing consolidation for groups of companies and trusts, while addressing value shifting; and
• achieving a consistent treatment of entity distributions.

2.8 The rationale for the changes is that at present, entities are treated inconsistently for tax purposes. The unified entity regime is, with minor exceptions, to commence on 1 July 2001.

2.9 The fiscal impact of the changes to entity measures announced in ANTS has been estimated by Government as follows: [5]

Depreciation measures

Removal of accelerated depreciation

2.10 Accelerated depreciation is where the tax deduction allowed for the decline in value of an asset is brought forward relative to the economic life of the asset.

2.11 To partly offset the lower company tax revenues, the Ralph Report proposed, and the Government accepted, that the current accelerated depreciation measures be removed. The proposed new system will be based on one that calculates the rate of depreciation based on the effective lifetime of the business asset. It will apply to plant and equipment assets covered by Division 42 of the Income Tax Assessment Act 1997 except for assets acquired or commenced to be constructed before the time of effect (11:45am AEST 21 September 1999). Taxpayers will be able to reassess the effective life of their assets, having regard to changing market or technology developments.

2.12 The Government proposes that small businesses, defined as businesses with three-year average turnovers of less than $1 million per annum, (including over 95 per cent of businesses and 99 per cent of primary producers), will have access to simplified depreciation provisions, a cash accounting regime and a simplified trading stock regime from 1 July 2001.

2.13 The fiscal impact of the depreciation and small business measures, is estimated by Government as follows: [6]

Capital gains tax measures

2.14 A capital gains tax liability occurs when there is a real capital gain in the value of an asset acquired after 20 September 1985 at the time of its disposal. At present, the acquisition price and the cost base are adjusted by the rate of inflation, if the taxpayer owns the asset for longer than one year. An averaging system applies which attempts to ensure that the taxpayer is not taxed on capital gains at a marginal rate higher than that which applies to the taxpayer's other income. However evidence from the Ralph committee points to significant abuse of these provisions by some taxpayers.

2.15 The Government's proposed changes are to halve the CGT rate for individuals, meaning that they will pay no more than 24.25 per cent on nominal capital gains held for at least one year (this rate reducing proportionately for taxpayers on lower marginal tax rates). Complying superannuation funds will be taxed at two-thirds of the difference between the disposal price and the original cost. Indexation of the cost base for calculating capital gains is proposed to be frozen at 30 September 1999 and averaging of capital gains will be discontinued effective from 21 September 1999.

2.16 The reasons outlined by Government for the proposed changes are to invigorate asset management, to stimulate greater participation by individuals in investment, to achieve a better allocation of capital resources and to make Australia more competitive internationally as an investment location.

2.17 In addition, small businesses with net assets of up to $5 million will have a 50 per cent active asset exemption; will be able to roll the remaining gain into replacement assets or CGT retirement exemption; and will be exempt from CGT where active assets are held for 15 years or more.

2.18 The Government also proposes to provide CGT rollover relief when there is an exchange of interests in companies or fixed trusts because of a takeover. CGT liability will be deferred until the ultimate disposal of the replacement asset. This removal of impediments to scrip-for-scrip takeovers with more than 80 per cent acceptance by the target company shareholders is intended to enable start-up enterprises to undergo capital restructuring without triggering a CGT liability and to encourage such businesses to remain in Australia.

2.19 Venture capital investment will be encouraged in two ways. Non-resident tax-exempt pension funds that are tax exempt in their home jurisdiction will be exempt from income tax on the disposal of investments in new equity in eligible venture capital investments; and Australian widely-held superannuation funds will be provided with a CGT exemption where they receive income from a Pooled Development Fund representing gains on the disposal of eligible venture capital investment.

2.20 The fiscal impact of the capital gains tax measures is estimated by Government as follows: [7]

Integrity measures

2.21 As proposed by the Government when announcing its stage one response to the Ralph Report, the Treasurer made a second announcement in a press release, no. 74, of 11 November 1999, relating to the business tax reforms. This concentrated largely on a number of integrity measures to contribute to the fairness and equity of the business tax system. They include: limiting the extent to which non-commercial losses can be used to reduce the tax paid on other income; restricting the ability of individuals to reduce tax by diverting the income they earn from their personal services to an entity; requiring prepayments in respect of tax shelter arrangements to be deductible over the period during which the services are provided; improving the general anti-avoidance rule (Part IVA of the income tax legislation) and streamlining its operation; losses on certain interposed companies will be denied for tax purposes; and the holding period for dividend streaming and franking credit trading rules is proposed to be reduced and the exemption for small transactions raised from $2000 to $5000.

2.22 The fiscal impact of the integrity measures announced on 21 September 1999, on 21 October 1999 and on 11 November 1999 is as follows: [8]

Other measures

2.23 Other significant measures have been proposed by the Government. They include: allowing imputation credits for foreign dividend withholding tax; tightening thin capitalisation rules for inbound investment; introducing gearing rules for outbound investment; imposing CGT on the sale of non-residential interposed entities; providing effective life depreciation for mining and quarrying; recognition of blackhole expenditures; and assorted tax design reforms.

2.24 In addition, the Government has indicated its intention to establish a non-statutory Board of Taxation, to facilitate an integrated and consultative approach to business tax matters and to establish a working group to assist in the development of a new approach to calculating taxable income based on cashflow/tax value.

Footnotes

[1] Commissioner of Taxation, Annual Report 1998-99, p. 28.

[2] Treasurer, The New Business Tax System, Press Release no. 58, 21 September 1999.

[3] Review of Business Taxation, A Tax System Redesigned, July 1999, pp. 424-25.

[4] Treasurer, Introduction of Legislation on Business Tax Reform, Press Release no. 69, 21 October 1999, Table 1.

[5] Treasurer, The New Business Tax System: Stage 2 Response, Press Release no. 74, 11 November 1999, Attachment O, Table 1.

[6] Treasurer, The New Business Tax System: Stage 2 Response, Press Release no. 74, 11 November 1999, Attachment O, Table 1.

[7] Treasurer, The New Business Tax System: Stage 2 Response, Press Release no.74, 11 November 1999, Attachment O, Table 1.

[8] Treasurer, The New Business Tax System: Stage 2 Response, Press Release no.74, 11 November 1999, Attachment O, Table 2.

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