Chapter 6 - CGT, PPS, PAYE, SG AND TSV
Capital Gains
Tax (CGT)
6.1 Net
capital gain is included as assessable income under the ITAA. Although it is
not a separate tax, it is distinguished from income tax in that tax is not
levied until the capital gain is realised.
6.2 Capital gains tax applies in relation to
the disposal of assets after 19
September 1985. Assets
acquired before 20 September
1985 are exempt unless
something occurs which triggers a deemed acquisition of an asset after that
date or unless an asset is deemed to be disposed of for CGT purposes where no
disposal has occurred under general law.
The Complexity
of CGT
6.3 The complexity of
CGT was the subject of much criticism in evidence to the Committee.
Professor ]an Walischutzky of the University of Newcastle commented that before 1985, there was a
'fairly simple' provision consisting of less than one page of the ITAA that
taxed the profit from the sale of property acquired for the purpose of
profitable resale:
We now have ... over 200 pages of capital gains
legislation basically doing the same job.
6.4 He suggested that the 200 pages could be
replaced by simply taxing long-term profits (for example profits of assets held over five years), or
reducing it to the two main assets which produce revenue, those being land and
shares.
6.5 The Queensland Chamber of Commerce and Industry suggested that the increased
complexity and coverage of the CGT 'impeded productivity '3 higher employment,
better technology and flexibility of operations'.
6.6 The Taxation Institute of Australia (TIA)
submitted that a problem associated with the complexity of the CGT was the
issue of record keeping, viz: small businesses often do not tend to keep
separate records for CGT purposes and nor do their accountants; and
where a small business changes accountants, the latter often keep working notes
which a new accountant needs to be able to calculate CGT.
6.7 The Small Business Development Corporation
of Western Australia considered that the cost of calculating
CGT liability was often prohibitive for small businesses and was not
cost-effective for many smaller firms, the cost of assessment can be greater
than the resultant liability.
6.8 The Committee believes that the
complexity of the CGT has remained as issue for small businesses since the Beddall
Committee reported on the matter in 1990, again because of the unavailability
of economies of scale which enables larger, incorporated businesses to not only
absorb the considerable compliance costs but to defer or circumvent capital
gains tax by reorienting or expanding their business activity within a
corporate structure. Consistent with this general theme, the Committee
believes that a review of the CGT with a view to simplification, particularly
those relating to record keeping requirements for small business, is inevitable
in the long term.
Rollover Relief
6,9 Evidence was given to the Committee
that CGT limits the scope of business to restructure or form new businesses.
Recommendations included a call for small businesses to be granted an exemption
from the CGT on proceeds they receive from the sale of their businesses
provided the proceeds are reinvested in another business within 12 month S.7
This course of action was often referred to as CGT rollover relief.
6.10 The TIA suggested in evidence that while there were some
provisions which allowed limited rollover relief, the CGT regime does not
recognise the gains made in the course of business expansion, such as on the
sale of a business in order to purchase a new business'.
On an after tax basis, many business proprietors may find themselves
commencing a new business with a depleted capital base, which is a distinct
limitation and disincentive to business expansion,
6.11 The TIA
advocated more generalised rollover relief for small business in certain
situations, as exemplified in the previous paragraph, with safeguards built
into such a provision specifying a value threshold, and limiting the period of
time within which capital gains could be rolled into a new business. (For
example, 12 months recommended by PATEFA9). The TIA
also commented that
even the goodwill exemption that currently exists... will not cover
all the assets of a small business.... [for example] fixed assets... plant and
equipment, land and buildings
6.12 The thrust of this argument was
also forwarded, amongst others, by the Motor Traders Association of Australia
which commented that the CGT has an adverse effect on capital mobility (where
operators diversify and grow by moving from one business to another) due to
lack of knowledge and understanding of the operation of the CGT and the desire
of most businesses to minimise such tax obligations."
6.13 Rollover relief was considered in
detail by the Beddall Committee. That Committee concluded that the impact of
the CGT on small businesses was a major concern and recommended that rollover
relief was an appropriate measure to assist small business. 12
6.14 The Government rejected the Beddall
recommendation on the grounds that the introduction of the CGT rollover
provisions raises questions about the consistency of the Government's approach
to taxing different forms of income:
Such a proposal may also result in extensive periods of tax deferral
and would breach a fundamental principle of the capital gains tax system of
applying tax on disposal.
6.15 However, this reasoning ignores
the fact that an integral feature of the CGT system is that the realisation of
capital gain upon disposal defers the CGT liability during the life of the
business, thereby producing a substantial advantage over other taxes.
Furthermore, the fundamental principle of applying tax on disposal would not be
breached as the very nature of a rollover provision would ensure that net
capital gain is not used for any other purpose for any significant period of
time. A similar principle applies for rollovers of eligible termination
payments within the superannuation regime whereby a payment is deemed to remain
inside the concessionally taxed superannuation system as long as it is rolled
into a suitable superannuation fund within 3 months.
6.16 The Committee therefore concludes
that provision for rollover relief is an appropriate measure to apply to small
businesses and consequently recommends that the proposal advocated by the Beddall
Committee be reconsidered by the Government.
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Recommendation 6.1:
The Committee recommends that CGT be
deferred on the capital gain realised on the sale of a trading business which
is rolled over by the vendor into another trading business
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Goodwill
6.17 Fifty per cent of the capital
gain that accrues to a taxpayer on the disposal of the goodwill of a business
is exempted from tax, provided certain conditions are met. Prior to 27 February 1992, 20 per cent of the capital gain on goodwill that was
disposed of was exempted where the net business interests of the taxpayer did
not exceed the exemption threshold of $1 million. This threshold was raised to
50 per cent for disposals of goodwill after 26 February 1992 where the net business interests of the taxpayer do
not exceed $2 million. 14
6.18 The ASCPA considered that the
current exemption could be better structured by applying it at flat rates on
progressive levels of goodwill.15 For example, the first $500,000 would be
exempt, phasing in through several thresholds to a maximum rate of $150,000
plus a marginal rate of 50 per cent on the surplus over $2 million.
6.19 However, the Committee does not
consider that any further adjustments to the exemptions on goodwill are called
for at this stage. As noted in paragraph 1.17 above, there was a substantial
improvement in the exemption allowed on goodwill in 1992 when it was raised
from 20 per cent to 50 per cent. This improvement also addressed the argument
that a general exemption should be allowed upon retirement in lieu of what was
submitted to be foregone superannuation. The Committee agrees with the
reasoning used by the Beddall Committee in relation to this issue that since
the introduction of the CGT in 1985, business people should have been aware
that the proceeds of the sale of their business would be subject to the CGT.
They should also be making alternative arrangements to supplement their income
on retirement through superannuation.
Long Term Assets
6.20 The ASCPA also suggested that CGT should be
progressively phased out where fixed assets are held for more than 10 or 15
years. This would act as an incentive to hold assets for a long period rather
than making speculative gains in the short term.
Section 47(1A) of the ITAA
6.21 The MTAA submitted that the
operation of section 47(1A) of the ITAA produces an anomaly in that it results
in small companies being subject to double taxation on the disposal of an asset
and subsequent liquidation: the CGT is applied to the real gain, with the
distribution of the indexed base cost to shareholders being deemed as being unfranked
dividends taxable at marginal rates - the tax effect on an unincorporated
entity is limited to the CGT. 17 While it seems that there are devices for
dealing with this anomaly, the Committee suggests that section 47(1A) should be
amended.
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Recommended 6.2:
The Committee recommends that:
(i) the Government examine the
proposal to phase out the CGT on fixed assets once they have been held for a certain period of
time, say 25 years; and
(i) section 47(1A) of the
ITAA which ignores nominal capital losses and depreciation when calculation capital gain to
be added to income, be reviewed and amended, if necessary
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Prescribed Payments System
6.22 The prescribed payments
system (PPS) is a form of withholding tax. It was introduced in the May 1983
mini-budget and brought into effect in September 1983 to be levied on contract
workers and subcontractors. It was designed to prevent avoidance of payroll
and personal income tax through the use of cash payments.
6.23 PPS is an income tax collected at source from
certain prescribed payments for work or services in specified industries, and
must be the day after the end of the month in remitted to the Tax office by the
14th day after the end of the month in which the payment from which
the deductions were made. Tax will generally be withheld at the rate of 20 per
cent unless the payee holds a current variation deduction certificate or a deduction
exemption certificate.
6.24 The PPS appears to serve its
function effectively and attracted little comment in evidence to the Committee,
with the exception of one issue raised by Mr Brian Harmer of Bowman Manser and Associates concerning
the timing of payments. The example used to illustrate the anomaly was of a
subcontractor who completes some work and submits an account late in the 1994
financial year, perhaps June, but does not get paid for that work until
the following financial year, perhaps July. The subcontractors income is
assessable on those earnings in the 1994 year even though the PPS tax is not
deducted until the 1995 year because it is withheld at the time of payment.
The subcontractor cannot, therefore, gain a credit for that tax.
6.25 The result is that when the
return is lodged, the taxpayer is taxed as if that PPS tax had not been
deducted, notwithstanding that s/he will gain a tax credit in the following
year.
6.26 The suggested solution is to
allow the credit in the year in which the income is assessable, 1994 in the
example given, despite the fact that the tax will not be remitted until the
following financial year. This course of action is consistent with the method
with which PAYE remittances are treated in the identical situation. Mr Harmer commented that PPS appeared to be an
attempt to get subcontractors treated as if they were on wages and evidence
from the ATO and the Treasury confirmed that PPS is analogous to PAYE.
6.27 The ATO response to a question about
this anomaly was that the different years was not problem of income and credits occurring in income
stream because generally an issue where a person has a regular income stream
the payments and credits even out and do not cause any difficulties for the taxpayer.
The ATO conceded that it could be an issue if the person receives an irregular
flow of income from year to year. In this circumstance, the taxpayer can apply
to the Commissioner of Taxation to have the amount of the credit refunded or
applied to other tax debts prior to assessment of tax liability.
PAYE Tax
6.28 Introduced in Australia in 1942, pay-as-you-earn (PAYE) tax is deducted in
instalments at source by the employer from the employee's wages or salary on a
quarterly, monthly, or bimonthly basis depending upon the amount involved.
Remittances must be made by the 7th day after the end of the quarter, the
month, or the half month, as the case may be.
6.29 Currently, small businesses with
an annual PAYE liability of more than $10,000 must remit taxes by the 7th of
each month. COSBOA suggested that the access thresholds of quarterly PAYE tax
collection be . raised from the current $10,000 liability to $100,000 on the
basis that, from the employees point of view, it would reduce paperwork and
exposure to tax penalties by a factor of four.
6.30 In contrast, ASCPA recommended
resisting any suggestions that the 7 day time fag be extended as the temptation
can be too great for businesses that are experiencing cash flow difficulties:
Indeed, it is a common warning signal that a business faces
insolvency when group deductions are not paid in time.
16.31 The QCCI recommended that
the payment of PAYE tax become the responsibility of the employee, maintaining
that an employees responsibility should end with advising the ATO that income
has been distributed. The QCCI also recommended that where PAYE deductions are
required by Government, then a fee for service should be paid by the ATO to the
business concerned.
6.32 When questioned about these proposals,
the QCCI responded that banks may be an appropriate institution to carry this
function. The QCCI's argument was that:
... it comes back to the philosophy that, if you are
going to organise a payment system, you should deregulate the system ... by
allowing anybody to deduct those needed PAYE taxes ... If you are going to do
something, everybody should be in there offering those services, and that means
you get a fairly competitive environment ... It does not matter what industry
you are in, whether it is electricity, water, forestry or even taxation, it is
a competitive environment and, if services are going to be utilised, anybody
should be able to provide those services.
6.33 The Committee does not
accept this line of argument because the PAYE remittances system appears
to be functioning smoothly with few complaints from industry, and because of
the possibility that, rather than ing collection costs, the creation of other
centres of tax collection ally increase costs.
Superannuation Guarantee (SG)
6.34 Superannuation guarantee (SG) is a levy
imposed on employers in relation to each individual employee earning a wage or
a salary above a certain threshold (currently $450 per month). Contributions
are required to be paid into a complying superannuation funds The level of
contribution, paid is calculated as a percentage of an employee's gross income
a there are two percentage rates applicable to employers depending on 1 size of
their payroll. There is to be a gradual phasing in of compulsory superannuation
contributions such that, by the year 2002, all employ, will be required to
contribute a minimum of 9% of an employee's wage or salary to a superannuation
fund.
6.35 PATEFA recommended that as SG diverts
funds from investment, employees should be required to make contributions to
their own superannuation to help the Government reach its target of 9% of
earnings being invested in superannuation. The Committee notes that in its
recent Budget, the Government announced an intention to phase in compulsory
employee contributions amounting to 3 per cent by 1999/2000.
6.36 J.B.
Murray & Associates contended that the
inclusion of subcontractors and non-residents into the definition of 'employee'
under the Superannuation Guarantee (Administration) Act 19,92 was
unfair' and recommended that these two groups should not be levied. The ATO
has put considerable effort into refining the definition of 'employee' as it
applies to subcontractors. The issue concerning non-residents was dealt with
in some detail by the Senate Select Committee on Superannuation in its 15th
report, Superannuation Guarantee: Its Track Record, in which it
recommended that the Government extend exemptions from SG requirements to all
non-resident workers where there is sufficient evidence that superannuation is
being paid in the country of residence.
Trading Stock Valuation
6.37 Trading stock is defined under
the ITAA as anything produced, manufactured, acquired or purchased for the
purposes of manufacture, sale or exchange. Where a taxpayer carries on
business, all trading stock on hand at the beginning of the year of income and
all trading stock on hand at the end of that year is taken into account in
determining whether the taxpayer has a taxable income. Trading stock is considered
to be "on hand" if the taxpayer has the power to dispose of the
stock.
6.38 Where the value of closing stock
exceeds the value of opening stock, the amount of the excess must be included
in the assessable income. Where the value of opening stock exceeds the value
of closing stock, the amount of the excess is an allowable deduction.
6.39 Trading stock is valued according to any one
of three bases for valuing trading stock:
- cost price;
- market selling value;
or
- replacement value.
6.40 Cost price refers to full
absorption cost, which is not just the invoice or purchase price, but includes
costs associated with bringing the stock into its existing condition and
location. Taxpayers are permitted to value stock at either cost, market value
or replacement cost.
Effect on Working Capital
6.41 SAECCI submitted that the obligation
to hold stock is one reason for lack of working capital available to
small businesses. Businesses that are expanding frequently require an increase
in stock holding-which locks up more working capital. SAECCI contends that:
Stock holdings, particularly for manufacturers who are
required to value stock using full absorption costing, causes them to bare a
significant tax consequence, ie the capitalising of overhead onto the value of
stock... the impact of [which] is that, as a business expands and stock
holdings increase, the profit is invested into stock and is subject to tax
thereby further eroding the working capital.
6.42 SAECCI suggest that deductions be allowed
for industries where their stock turnover is slower than averages or where
there is an excessive build up of stockholdings, claiming that this will assist
business growth through the provision of additional working capital.
The Wine industry
The wine industry echoed these concerns in relation to
the valuation of wine stocks, contending that the industry has:
Atypically strong demands for working capital due to
its long lead sale of the final product.... the absorption costing of expenses
under the wine industry situation of low stock turnover leads to understated
expenses for the current year, and subsequent overstated profits. Taxation,
therefore is paid in advance of sale, thereby calling upon additional working
capital.
6.43 In its draft report, the Commission
of Inquiry into the Winegrape and Wine Industry assessed the arguments put by
the wine industry and reported that the net effect of the differences in the
treatment of business investment on the wine industry vis-a-vis other
industries was unclear:
If the net effect is considered to disadvantage the
wine industry, then a change in the tax treatment of wine stocks into an
expenditure incurred basis (ie. taxing stocks at the time they are sold) might
improve the efficiency of resource allocation between the wine industry and
other industries, and between the different options for investment facing the
wine industry.
6.44 The Committee of Inquiry went on to comment
that changing the tax treatment of stocks only for the wine industry would
distort stock holding decisions for wine in comparison to other products:
As a consequence, a
change could only be justified of it were assessed that the relationship
between stock holding and other forms of investment in the wine industry is
more important than the relationship between stock holdings in the wine
industry and stock holdings in other industries.
6.45 The response by the WGCA and the
WFA rejected the notion that a change would confer a tax advantage on the wine
industry, arguing to the contrary for an equivalent outcome to other industries
whereby all expenses are deductible in the year in which they are
incurred."
6.46 The Committee of Inquiry
had been unable to identify a net economic benefit from changing the current
arrangements, commenting that the Treasury would be better placed to determine
whether a change to the taxation treatment of stocks for the wine industry vis-a-vis
other industries is warranted."
6.47 Perhaps more to the point is not
whether there is a net economic benefit to be gained from any changes, but
whether any changes to the current arrangements would produce fairer outcomes.
The Committee acknowledges the complexity of balancing considerations of
fairness and equity against net economic benefits. Nevertheless, it considers
that it would be unacceptable to refrain from reviewing an arrangement which
may no longer be appropriate to circumstances which have either not been fully
assessed or which have changed since its inception.
6.48 in reviewing the TSV treatment of wine stocks,
the Government could canvass the option that was floated by the Committee of
Inquiry into the Winegrage and Wine Industry that the tax treatment of wine
stocks be changed into an expenditure incurred basis, or alternatively that
they be treated as an investment.
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Recommendation 6.3:
The Committee recommends that:
(i)the Government review the method of
valuing trading stock for small businesses to ascertain its continued relevance to trading stock
where stock turnover is slower than average, or where there is a greater than normal build up of
stock necessitated by the nature of the business; and
(i) the method for
valuing trading stock for the wine industry be reviewed to recognise the
specific characteristics applying to the industry,
particularly in relation to the maturation of wine stocks which are geared to
producing premium wines.
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