OVERVIEW
Impact of the Review's recommendations
Introduction
A business tax system for Australia's future |
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Australia needs a sound tax system to support economic growth in a globalised world |
1 Australia needs a sound tax system to contribute to the improvement in the future living standards of all Australians. It must be capable of dealing with a changing world environment, changing technology and changing lifestyles. It must also provide enough revenue to ensure that essential Government services are available to all Australians. |
| 2 A sound tax system has to be about raising revenue in an equitable and efficient manner. It has to be about economic growth and international competitiveness. It has to reward hard work, innovation and measured risk taking. Such a tax system will help ensure that Australia has an internationally competitive economy so that Australians can enjoy improved living standards. | |
| 3 The increasing globalisation of the world economy, driven largely by technological change, means that economic activity can flow more readily than in the past to the most efficient and low cost locations. Increasingly Australian businesses will be world businesses and it is essential for Australia's future that Australians have the opportunity to own and work in successful businesses in that environment. This means that the business tax system must operate effectively and competitively in that environment. | |
Business taxes are needed to help fund Government expenditures in the context of increasing community expectations and changing demographics |
4 The Review has been conscious that business taxation plays a significant part in raising the revenue necessary to fund the provision of Government services. The revenue neutrality constraint in the terms of reference means that the Review's recommendations in total will have to maintain current levels of business tax revenue. However, it is important that the resultant tax system is not only revenue neutral in the short term but ensures that the business tax system continues to make an appropriate contribution to funding Government services over the long term. |
| 5 The community expects governments to maintain a strong and sustainable social safety net. Increasing community expectations and demographic change are likely to place significant pressure on health and social welfare expenditures. Reform of the tax system is an essential step in ensuring that Australia generates the resources to meet these aspirations and requirements. | |
| 6 Australia is undergoing a significant demographic transition associated with lower population growth and reduced mortality rates. Between 1997 and 2051 the population aged over 65 years is expected to rise rapidly. As a proportion of the total population this group increases from about 12 per cent in 1997 to 18 per cent in 2021 and around 26 per cent in 2051[1]. Based on demographic trends and historical growth rates, the National Commission of Audit Report in 1996 estimated that total health expenditure will increase by 6.1 per cent of GDP and that the age pensions will increase by 1.1 per cent of GDP by 2031[2]. | |
Background to the Review |
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The Review was to take as its starting point the proposals outlined by the Government in A New Tax System |
7 The Government announced its overall tax reform strategy with the release on August 13, 1998 of the document, Tax Reform, not a new tax, a new tax system, known as A New Tax System. A New Tax System outlined a strategy for business tax reform and some specific reforms relating to the taxation of income from entities. |
| 8 The Review of Business Taxation was set up to examine the strategy specified in A New Tax System, and to consult on the framework of reform for taxing business entities and on the extent of reform for taxing business investments, recognising the current problems and the objectives for business tax reform identified in A New Tax System. | |
| 9 The Review has been conducted based on the Government's proposals outlined in A New Tax System, incorporating the policy directions adopted by the Government in that document, and in accordance with the terms of reference. | |
| 10 Some points of particular note emerge from the terms of
reference. • The Review was asked to make recommendations on the fundamental design of the tax system, the processes of ongoing policy making, drafting of legislation and the administration of business taxation. • Consultations by the Review and associated recommendations were to be directed to the strategy for reform spelt out in A New Tax System. • The Review was required to have regard to developing an internationally competitive tax treatment of business investments, the potential benefits of bringing tax value and commercial value closer together, and the possibility of achieving a 30 per cent company tax rate. • The Review was asked to consider specific options for reform of capital gains tax. • Importantly, the Review's recommendations were to be revenue neutral in respect of reforms to investment and capital gains tax. |
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The Review's approach to the task |
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A high level of community involvement has been essential |
11 The Review has sought to promote a high level of community involvement in all its processes. The strategy has been to publish issues papers which provided background information and analysis of issues that were identified by the Review and to seek community reaction to those issues. This community response has then suggested further analysis and has been taken into account by the Review in reaching its recommendations. |
The Review published issues and information papers, sought submissions, and conducted extensive public consultations through a range of forums |
12 The Review's first discussion paper, A Strong
Foundation, provided some basic information about the deficiencies in the current
business tax system and set out some possible principles that could be used to underpin
the policy, legislative and administrative development of the business tax system. The
paper also canvassed possible reforms to the way the tax system is developed and
maintained, including: • a more open and transparent development of tax policy; • a more integrated design process; and • much more extensive opportunities for consultation on all aspects of the tax system. |
| 13 Following the release of the paper, the Review conducted an extensive range of public seminars covering all capital cities and sought submissions from the community. There were 76 submissions received relating to the issues canvassed in A Strong Foundation. Details of these are set out in Appendix B. | |
| 14 The next publication by the Review was an information paper commissioned by the Review, An International Perspective, which provided detailed information on international practice in respect of a wide range of business tax issues. | |
| 15 The Review's second discussion paper, A Platform for Consultation, provided a detailed analysis of the full range of issues before the Review and canvassed a range of policy options in respect of particular issues. | |
| 16 The release of this paper was followed by another program of public seminars. Complementing this program was a series of focus group discussions, each targeting a specific issue. The focus groups, comprising business representatives, academics specialising in taxation matters, taxation advisers and practitioners met with the Secretariat and, in some cases with Review Committee members, to discuss the options proposed in the discussion paper. The Review also called for submissions from the community on the issues canvassed in the paper. This consultative process involved 9 public seminars, 31 focus group meetings and the receipt of 300 submissions. The results of that process have been influential in improving the analysis of the issues and have been fully taken into account by the Review in reaching its judgments on particular issues. | |
Consultation is an essential feature of the ongoing tax system |
17 In particular, the Review's experience with this consultative process has served to confirm its view that public consultation has an essential role to play in the development of a sound and workable business tax system. The Review is strongly of the view that it is imperative that this process should be a continuing feature of the ongoing taxation system. This will not only play a vital role in improving the efficiency and effectiveness of the system but is significant in building trust between the administrators and the users of the system. It also makes a major contribution to the understanding of the proposals being considered. |
| 18 The Review is releasing with this report draft legislation and explanatory notes on some of the Review's recommendations. This legislation, and the policy it gives effect to, has been developed in accordance with the Review's recommendations regarding the processes for developing policy and legislation in an integrated manner which takes account of policy, legislative, compliance and administration issues. | |
| 19 The legislation and explanatory notes should be regarded as a snapshot of work in progress rather than a final product. They have been produced under considerable time pressure and consequently have been a stern test of the Review's proposed approach. They are being released as part of the report to illustrate the outcomes of the reformed processes and as a basis for further consultation. | |
| 20 The use of the recommended integrated taxation design process for the development of this legislation has convinced the Review that the proposed reforms are likely to lead to simpler and more effective tax legislation. | |
| 21 There are certain measures that the Review is recommending should be implemented ahead of the main body of the recommendations. In respect of these measures, the Review has forwarded to the Treasurer draft legislation intended to amend the current tax legislation. This legislation is necessarily more consistent with the current approach than that proposed by the Review. Once the full range of the Review's recommendations are reflected in new legislation the amendments dealing with interim measures will become redundant. |
Objectives of the Review |
Choosing national objectives as the focus of the tax system |
22 In the Review's first issues paper, A Strong
Foundation, the Review proposed three national objectives as a focus for the design of
the business tax system. The consultative process revealed broad support for this general
approach, although many submissions emphasised the need for certainty in regard to
taxation outcomes. After considering the arguments put forward, the Review is recommending
the adoption of the following objectives: • optimising economic growth; • promoting equity; and • promoting simplicity and certainty. |
| 23 These objectives underpin the recommendations the Review is making. There is no one-to-one matching between particular objectives and specific recommendations. The nature of tax policy development is that judgments have to be made and accepted about trade-offs between particular objectives. However, it is possible to identify some broad correspondence. | |
Optimising economic growth |
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Aligning the tax system more closely with commercial realities will boost economic growth and create jobs |
24 The business tax system can significantly influence the efficiency with which Australia's natural resources, capital and labour are used. Ultimately the living standards of all Australians are determined by how well we allocate and use those resources. Consequently the business tax system is an important influence on Australia's future economic growth. |
| 25 A starting point for the Review's recommendations has been that transactions with similar economic substance should be taxed in a similar manner. This should generally minimise the impact of the tax system on choices between alternative investments and so help to ensure that the allocation of resources reflects market realities. | |
| 26 In some cases practical concerns relating to administration and compliance costs have resulted in deviations from this general rule. A tax system which was theoretically pure but involved high compliance and administration costs would hamper rather than promote economic growth. Considerations relating to international competitiveness have also been important. | |
| 27 Increased international competitiveness is essential for the growth of the Australian economy and the creation of jobs for Australians. In today's environment Australian businesses can only survive by being internationally competitive. Measures aimed at increasing international competitiveness, therefore, do not have to focus only on cross-border transactions, or even on import competing or exporting industries. Any tax measure which results in lower costs for Australian business, or the development of new products or new markets, contributes to improving our international competitiveness. | |
Reducing the capital gains tax rate will encourage a greater level of investment, particularly in innovative, high growth companies |
28 All Australians have an interest in the competitiveness of Australian industry. This determines the growth and vitality of the domestic economy which, in turn, determines the ability of governments to provide services such as health, education, welfare and security on a sustainable basis. |
| 29 A major motivation for reform of the capital gains tax arrangements was the desire to increase the international competitiveness of Australian business and to encourage greater investment by Australians. The Review believes lower capital gains tax will improve the workings of Australian capital markets and encourage a greater level of investment and innovation. The constraint on lowering capital gains tax to maximise investment is that imposed by the need to maintain revenue neutrality. The measures recommended in this report are also designed to encourage greater investment in venture capital and so support new high growth businesses in Australia based on innovation and development of new markets. | |
| 30 Issues of international competitiveness are central to the consideration of the accelerated depreciation/company tax rate trade-off. Further, the impact on non-resident investors in Australian entities and on the ability of Australian companies to invest offshore was a major consideration in forming the recommendations on international taxation and the taxation of entity distributions. | |
Promoting equity |
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Equity requires a consistent approach to business taxation based on clear principles |
31 Tax policy typically focuses on two concepts of equity: horizontal and vertical. Horizontal equity requires that taxpayers in similar situations are taxed in a similar manner and that transactions of similar economic substance are taxed similarly. Vertical equity requires that the tax system take account of society's views on the appropriate levels of taxation to be borne by taxpayers in different circumstances. An example of the tax system reflecting concerns about vertical equity is Australia's progressive personal income tax system which levies increasingly higher rates of tax as an individual's income increases. |
| 32 While both concepts are relevant to designing a business tax system, horizontal equity is a more central concern. In Australia, vertical equity tends to be addressed primarily through the personal income tax and welfare systems. | |
| 33 Horizontal equity in the context of the business tax system is primarily about ensuring like treatment for like transactions. This has a number of dimensions. The formal application of the law must be equitable, but it is also important that limiting the scope for tax avoidance is squarely addressed. A tax system which tolerates significant levels of avoidance cannot be equitable and can be expected to fall into disrepute as the community witnesses the unfair outcomes. | |
Fairness requires a consistent and comprehensive approach to business taxation |
34 The Review believes that the best way of addressing tax avoidance and promoting fairness is to put in place a consistent and comprehensive approach to business taxation based on a sound structure and foundation. A system based on clearly enunciated principles which treats all transactions on their merits is both the best way to ensure horizontal equity and to reduce tax avoidance and hence to improve the integrity of the system. However, the Review's recommendations also directly address the issue of tax avoidance and propose a number of reforms in this area. |
| 35 Reforms of the taxation of financial arrangements, leasing and rights, income from entities, life insurance and the proposals for consolidation of company groups are all examples of measures aimed at providing a more consistent tax treatment and greater integrity for the tax system overall. | |
| 36 A major motivation of the reforms to the taxation of financial arrangements was to ensure that different financial instruments are taxed according to economic substance rather than legal form. The adoption of accruals taxation for certain financial arrangements will also reduce opportunities for unwarranted tax deferral. | |
| 37 Leases and rights are currently treated inconsistently. In some cases there is scope for avoidance by taxpayers, and in other areas the current treatment unduly penalises taxpayers. A more coherent and evenhanded treatment will underpin sound business practices and provide greater integrity to the tax system. | |
| 38 Problems with the inconsistent treatment of entities, particularly the different treatment of trusts and companies, have been well documented. The proposed treatment would simplify business arrangements while delivering more efficient outcomes and greater equity to taxpayers. | |
| 39 Without jeopardising the integrity of the system, the recommended tax treatment of income from investment earned through collective investment vehicles also improves equity and simplicity. | |
| 40 Current taxation arrangements for life insurers result in inconsistent treatment of similar investments undertaken with different life insurers -- that is, life insurance companies compared with friendly societies -- and of investments undertaken with life insurers compared with those undertaken by other entities. The arrangements also allow life insurers undue flexibility to allocate deductions to different forms of income at the expense of tax revenue. A more coherent treatment will ensure that investments with life insurers are treated in the same way as similar investments with other investment vehicles. | |
| 41 The Review's recommendations addressing the alienation of personal services income and the offsetting of losses from non-commercial activities will address a major inequity in the current taxation arrangements. | |
| 42 Generally the taxation of the full range of assets, liabilities and transactions should be based on consistent and clearly articulated principles. Correspondingly, where departures from that framework have been recommended, the reasons need to be spelt out. This helps ensure that the exceptions do not lead to unintended outcomes. | |
Promoting simplicity and certainty |
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A tax system based on clear principles also promotes simplicity and certainty |
43 A major consideration in the formulation of the Review's recommendations has been to remove anomalies and inequities between the treatment of economically similar transactions. This will allow significant simplification of the tax system. Further, the redrafting of the tax legislation on the basis of a set of consistent principles will make the treatment of particular transactions clearer and less open to dispute. All these measures should contribute to reduced compliance costs and greater certainty in the operation of the tax system. |
| 44 Recommendations to allow consolidation of company groups, while involving significant transitional costs, will markedly reduce compliance costs for groups of wholly owned companies while, at the same time, enhancing the integrity of the tax system. | |
| 45 The package of small business measures is expected to bring a substantial reduction in compliance costs for the small business sector. | |
Redrafting the tax legislation and putting in place a continuing simplification strategy will promote simplicity |
46 A much clearer and shorter statement of the law, making a
significant contribution to greater simplicity and certainty, flows from the redrafting of
the tax legislation. However, the Review, has also recommended that an explicit
simplification strategy be put in place. This strategy will have three elements: • a volume reduction strategy aimed at significantly reducing the number of pages compared with the existing law; • much more stringent control on net additions to the legislation through the integrated tax design process recommended by the Review to ensure that future additions to the law are made in the simplest and most concise manner possible; and • a major emphasis placed on making tax legislation more accessible to taxpayers. |
Effective community participation |
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A healthy and effective business tax system relies on continuing community participation in its development and administration |
47 The Review regards effective community participation in
the ongoing development of the business tax system as underpinning all three of the
national objectives. • A tax system which is well understood by business, and which takes due account of the commercial realities, will contribute to a much more supportive environment with business. It should encourage effort, innovation and measured risk-taking. Consequently, it can be expected to contribute to economic growth. It will also be easier to understand, and this simplicity will contribute to better compliance. • Effective feedback from the community on the impact of the tax system is essential in evaluating its performance in terms of equity, simplicity and certainty. Further, the input of the community when the tax system is being designed or amended will help to reduce problems in those areas. |
| 48 The Review is convinced that an effective tax system can only be maintained over time on the basis of cooperation between taxpayers and the tax administration. The foundation of such cooperation must be effective and ongoing consultation on all aspects of the tax system. | |
| 49 The Review's recommendations in respect of establishing a Board of Taxation and putting in place a Charter of Business Taxation are intended to ensure that consultation remains a high priority. | |
| 50 Commitment to continuing consultation on the business tax system will help to ensure that compliance costs for business are given appropriate weight in the consideration of both future changes and in the assessment of the ongoing effectiveness of the tax system. |
The revenue constraint |
Overall, tax reform will raise more revenue from business |
51 As noted above, the Review's terms of reference require its recommendations to be revenue neutral in respect of the outcome from reforms to taxation of income from investment and from changes in the capital gains tax. It is important to note that revenue neutrality is to be measured against the increased contribution from business taxation predicted in A New Tax System. The total package of business tax measures -- those proposed in A New Tax System and those recommended by the Review -- is significantly revenue positive against the revenue generated by the current legislation and practices. |
| 52 The Review has also accepted that losses to revenue from recommendations to vary the position set out in A New Tax System -- such as the recommendation not to adopt the deferred company tax -- must be considered in reaching the required revenue outcome. Table 1 shows the combined revenue impact of the entity measures announced in A New Tax System and the Review's recommendations. |
Table 1 Revenue impact on business of all business tax reforms |
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| 99-00 $m |
00-01 $m |
01-02 $m |
02-03 $m |
03-04 $m |
04-05 $m |
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| Revenue impact of entity tax proposals in A New Tax System | 110 | 1,680 | 1,410 | 950 | 1,070 | 1,130 |
| Revenue impact of Review's recommendations | -30 | -270 | 120 | 30 | 540 | -20 |
| Total revenue impact of business tax reforms | 90 | 1,410 | 1,530 | 970 | 1,600 | 1,110 |
| 53 The Review endorses fiscal policy settings based on ensuring that fiscal balance is achieved, on average, over the course of the economic cycle in order not to prejudice the budget surplus. In this context the Review is supportive of the requirement that its recommendations should be subject to a revenue constraint. | |
A growth dividend |
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Tax reform is not a costless exercise. Those costs can only be justified if reform leads to higher growth |
54 Motivating reform of the Australian business tax system must be the delivery of higher levels of economic growth. This is the overarching objective that has motivated our deliberations. Consequently, a major issue for the Review has been the identification of the growth dividend reflecting the increased Commonwealth tax revenue likely to flow from increased economic growth attributable to the recommended reforms. Such revenue needs to be included in the revenue neutrality assessment as it is clearly a benefit of the proposed reforms. |
Behavioural responses are the desired outcome of tax reform but their size and effect on revenue are difficult to estimate |
55 At the most fundamental level, this growth dividend is simply one aspect of the behavioural responses typically taken into account when developing revenue estimates for particular tax measures. For example, the estimation of the revenue impact of capital gains tax reforms includes an allowance for taxpayers switching investment from assets returning income in the form of dividends, interest or rents, to assets returning income in the form of capital gains, in order to access the benefit of the lower rates. This will occur only to the extent that the proposed reforms are more favourable than the existing benefits of indexation and averaging, which currently provide a similar incentive. On the same basis, it is important to incorporate the expected effects of taxpayers increasing savings and investment in response to the higher after-tax returns available as a result of the lower rates. In addition, as a more efficient and equitable tax system will capture current leakages from the system, revenues from the reduction in tax avoidance have to be included, as well as revenue arising from additional growth. |
| 56 However, the effects of all behavioural responses are extremely difficult to estimate. As a result estimates are always likely to be conservative. For this reason the Review believes it is important that the assumptions made in this area be transparent. The behavioural assumptions underlying estimates for individual measures, where the effects are relatively specific to that measure, are set out in the revenue section in the body of the report. | |
| 57 The growth dividend reflects a broader efficiency gain that can reasonably be expected to flow from the combined package, over and above those gains and losses attributable to particular measures. The estimation of these effects is an order of difficulty greater than for those attributable to particular measures. | |
| 58 Table 2 shows estimates by the Review Secretariat of the revenue gain from a range of possible long-term increases in GDP attributable to business tax reform. For example, an increase in GDP of ¾ per cent means that in 2009-10 GDP would be ¾ per cent higher than it would be if tax reform was not undertaken and Commonwealth tax revenues would be $1.8 billion higher as a result. The increase in GDP would take some time to emerge and so the increase in GDP for 2004-05 would be markedly smaller and the increase in Commonwealth revenues commensurately smaller. |
Table 2 Increased business tax revenue from increases in GDP |
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It is extremely difficult to estimate the size of the likely growth dividend |
59 The Review has not commissioned a study of the likely impact of the proposed business tax reforms on Australia's economic growth. Such studies typically involve models requiring a large number of assumptions that are difficult to validate. Overseas experience has demonstrated that alternative models can give markedly different results. Drawing comparisons from overseas studies is fraught with danger given the different starting points for their reforms and the fact that many of the studies relate to nations, such as the US, that have a low reliance on foreign investment. The impact of reforming taxation of investments in a capital importing country like Australia is likely to be larger, particularly when the reforms have international competitiveness as a focus. |
There are a range of estimates available from studies that have attempted to estimate the benefits of other reforms |
60 Modelling of the gain from the proposed GST/indirect tax switch in Australia has suggested long-term revenue gains of as much as 2 per cent arising from increased efficiency in the economy. It is difficult to draw a line from these reforms to the proposed business tax reforms in terms of a likely growth dividend. The GST involves a larger revenue switch but, as its main impact will be on consumption choices, its influence on investment decisions will be an indirect one. The business tax reforms will impact on investment choices directly. |
| 61 There has been a number of other studies conducted in
Australia on the benefits of micro-economic reform in one guise or another. • The then Industry Commission estimated that the long-term boost to GDP from the competitive neutrality reforms (the Hilmer reforms) would be 5.5 per cent after 10 years. The relatively limited reforms in the Commonwealth's area of responsibility were estimated to increase GDP by 1.0 per cent. • The Industry Commission also estimated that the long run increase in GDP from Government contracting out and outsourcing could be as much as 1.7 per cent after 10 years. |
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| 62 Once again it is difficult to draw a line from these results to the likely impact of the proposed business tax reforms, although they do suggest that substantial gains are possible from reforms which result in a more efficient allocation of resources. | |
| 63 The Review acknowledges that economic models are sometimes useful in illustrating the possible impacts of reform packages such as that proposed by the Review. However, it is obvious that models fall well short of capturing all the complexities of the Australian economy and the international environment in which it operates. Consequently, the Review has accepted that the identification of an appropriate growth dividend has to be ultimately a matter of informed judgment. | |
There will be significant benefits from the Review's recommended reforms |
64 The Review has been conscious that the proposed business tax reforms will involve industry in significant transitional costs. In addition, the revenue neutrality constraint means that in the absence of a substantial growth dividend, the gains to the winners would be offset by losses of an equal magnitude to the losers. There would be no point in undertaking reform if there is not to be a significant net national gain. It is therefore only logical to proceed with such a program if there is a belief that it would contribute to higher growth. The Review is firmly of the view that if its recommended reforms are implemented there will be significant national benefits. |
A growth dividend of ¾ per cent of GDP by 2009-10 is likely to be conservative |
65 In the light of the above, the Review believes a conservative judgment about the likely growth dividend would see a minimum increase in GDP of between ½ to ¾ of a per cent by 2009-10 and even ¾ of a per cent is likely to be conservative. The collective judgment of the Review is that the national dividend will be significantly greater than this but there is no reliable basis that can be drawn upon to unequivocally demonstrate this outcome. |
| 66 Table 2 indicates that a growth dividend of ¾ of a per cent of GDP would deliver additional Commonwealth revenue of $650m by 2004-05. In order to ensure that the estimate of the overall revenue outcome of the Review's recommendations is clearly conservative only $500m of this expected revenue gain has been included in the revenue estimates for 2004-05. The estimates of the contribution to revenue from the growth dividend in earlier years have also been scaled back. | |
A compliance dividend |
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Business tax compliance costs were estimated at $9 billion in 1994-95 |
67 Business tax compliance costs under the current system were estimated at around $9 billion in 1994-95[3] . The costs would obviously be greater than this today reflecting both inflation and the growth in the number and size of businesses. However, no later estimates are available. |
| 68 The $9 billion refers to the total cost imposed on the community. The actual costs to business are reduced by the tax deductibility of compliance costs incurred and the cash flow benefits which arise in some cases from the payment arrangements. | |
| 69 These estimates refer to both the compliance costs associated with the payment of taxes on business income and the compliance costs of collecting a range of other taxes including Fringe Benefits Tax, PAYE and other taxes on employee income. The total community cost of compliance associated with business income was estimated at $4.5 billion. After allowing for deductibility and cash flow benefits this fell to $2 billion. | |
The Review's recommendations should significantly reduce compliance costs |
70 If the Review's recommendations reduce compliance costs in respect of business taxes by a conservatively estimated 10 per cent, the total community cost of compliance would fall by around $450 million in 1994-95 terms. This would mean that $450 million of the nation's resources which were previously engaged in essentially non-productive activity could be redirected to producing wealth for the nation. The initial impact would be to boost taxable income of businesses by $450 million and reduce the taxable income of those people or businesses providing compliance services by the same amount. There would appear to be little net initial impact on overall revenues. |
| 71 However, the likelihood is that the $450 million would be devoted to productive activity which earned additional income. Savings of $450 million a year, if reflected in higher levels of investment, would see a larger capital stock over a period of years with consequent increases in taxable income and revenues. | |
Substantial compliance cost savings further support the case for a significant growth dividend |
72 Given the inherent difficulties in identifying both the growth and compliance dividends, the Review is not going to claim a specific amount as a compliance dividend but the above arguments further support the case for including a growth dividend, recognising at the same time that the amount included is likely to seriously understate the potential. |
Revenue trade-offs |
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Revenue estimates are necessarily subject to a high degree of uncertainty |
73 The estimated revenue impacts of virtually all the measures considered by the Review are subject to a significant degree of uncertainty. In many cases the available data have been inadequate to provide soundly based estimates and assumptions, some highly judgmental, had to be made in order to calculate the likely impact of a measure. In other cases measures are expected to result in significant behavioural responses and there is no objective basis on which to estimate the likely size of such responses. |
| 74 The Review accepts that the estimates produced by the Secretariat, with substantial assistance from the Australian Taxation Office (ATO), are as good as can be produced. However, it is also conscious that the expected revenue impacts of measures introduced in the past have been significantly in error. For example, the actual contribution to revenue from the introduction of CGT and FBT substantially exceeded the Treasury estimates made at the time. The Review believes it has adopted a conservative approach to estimating revenue impacts and there is a likelihood that the package will be significantly more revenue positive than disclosed in the Review's estimates. If this proves to be the case, the Review believes that the extra revenue should be used to fund additional reforms to enhance further the competitiveness of the business tax system. | |
Reforms had to be judged on their relative merit given the revenue neutrality requirement |
75 The Review identified a significant number of worthwhile reforms through its analysis of the current arrangements and as a result of the many submissions made to the Review, both through formal submissions and during the many consultative meetings that were held. |
| 76 Unfortunately not all these reforms could be accommodated in the Review's recommendations. The revenue neutrality requirement imposed a tight discipline on the process and meant that the Review only decided on a final package as a result of judgments about the weight of argument for or against particular measures relative to other measures. The fact that a particular option has not been recommended by the Review does not always reflect a judgment about that option's absolute merit. In many cases it will reflect a judgment about its relative merits in terms of tax policy versus its revenue impact. | |
| 77 Noteworthy in this respect is the absence of a recommendation to allow a deduction for the amortisation of acquired goodwill. An argument is advanced that, given immediate deductibility of expenses helping to create goodwill and with the taxation of goodwill being only on a realisations basis, amortisation of goodwill cannot be justified on standard tax principles. However, Australian businesses in competition with overseas companies to acquire other businesses are at a competitive disadvantage because some other jurisdictions, such as the US and UK, allow for the cost of acquired goodwill to be amortised in calculating taxable income. | |
| 78 The revenue cost of allowing amortisation of goodwill would be significant and could not be accommodated within the Review's revenue neutrality constraint. The Review believes it would be worthy of serious consideration, on competitive grounds, in the future if fiscal circumstances were appropriate. | |
| 79 The revenue neutrality constraint, of necessity, meant that the Review could only recommend reductions in tax burdens on business where the revenue cost could be met by increased tax burdens in other areas. The choice that the Review faced in each instance was whether `spending' the revenue in a new way would provide greater benefits to business than if the revenue was `spent' in the current manner, or as proposed in A New Tax System. | |
| 80 In some cases the current revenue loss is as a result of tax avoidance or anomalies in the law and it was relatively easy to reach a judgment that the revenue from correcting those situations could be used to fund other measures. Furthermore, these changes would provide overall benefits to business and the nation. | |
| 81 In other cases, such as the recommendation to use revenue from the abolition of capital gains tax averaging and indexation to fund effectively lower tax rates on capital gains for individuals and superannuation funds, the judgment was more evenly balanced. | |
The
accelerated depreciation/ |
82 The most difficult judgment of all was in relation to the accelerated depreciation/company tax rate trade-off. |
| 83 A reduction in the company tax rate will move Australia more into line with our competitors for international capital flows and will thus have a positive effect on the level of investment, economic growth and jobs. This will be offset to varying extents in those sectors of the economy benefiting from accelerated depreciation. | |
| 84 Accelerated depreciation is also seen as a positive by industry and an important factor for some industries in determining their international competitiveness. If accelerated depreciation were to be retained on these grounds there may be arguments for making the degree of acceleration across particular assets more uniform. A uniform degree of acceleration is seen as being less likely to adversely affect investment decisions. However, retaining any degree of acceleration would reduce the scope to reduce the company tax rate. Retaining accelerated depreciation would also impact on other elements of the Review's recommendations in areas such as leasing and rights. | |
Other countries typically allow some degree of accelerated depreciation, particularly for mining |
85 The Review gave considerable weight to the international competitiveness issue. Clearly accelerated depreciation does provide considerable benefits to capital intensive industries. Further, the Review's information paper, An International Perspective, demonstrated that virtually all countries examined allowed some degree of acceleration, particularly in respect of mining. |
A majority of submissions favoured a reduction in the company tax rate |
86 On the other hand, there was a substantial majority of
submissions favouring a reduction in the tax rate over continuation of accelerated
depreciation. The decision as to which measure will deliver the strongest economic growth
and vitality is crucial and will have a significant influence on the future shape of the
Australian economy. It is essentially a judgment call. If the Government believes that
reducing the company tax rate will deliver the best outcome, the elimination of
accelerated depreciation will be necessary to achieve this. There are several points to
note in relation to the Review's recommendations that are relevant to this decision. • Entities that may lose through eliminating this concession will have offsetting gains through the lower tax rate and the recommended treatment of blackhole expenditures. • Modelling of the overall tax reform package suggests that those industries most disadvantaged by the removal of accelerated depreciation will benefit by a more than offsetting amount from indirect tax reform. • It should be noted that in an imputation system, such as Australia's, tax-preferred income arising from accelerated depreciation is clawed back upon distribution to shareholders. • The simplified depreciation provisions for small business, which will cover 99 per cent of primary producers, will continue to provide accelerated depreciation for businesses which fall into this category. • Elimination of accelerated depreciation will eliminate a major source of tax-preferred income. This permits greater simplification in many areas of the legislation without jeopardising the integrity of the system. |
The choice between accelerated depreciation and reducing the company tax rate is not an easy one to make |
87 However, the revenue neutrality constraint required that a judgment be made between these two options. This was not an easy judgment to make but the package of recommendations presented by the Review is predicated upon the abolition of accelerated depreciation and other revenue raising measures to finance a phased reduction in the company tax rate to 30 per cent. |
| 88 It would be possible to modify the package by including an element of accelerated depreciation at the cost of increasing the company tax rate. This would also require, however, some additional modifications to the Review's proposals in order to protect the revenue against unintended tax-preferred income transfers. A significant part of the current complexity of the tax system arises from attempts to limit access to particular concessions. This is not necessary when tax-preferred income is not a major feature of the tax system. This combination of factors led to the Review opting for the lower tax rate alternative. | |
Implementation |
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| 89 The entity tax proposals in A New Tax System were intended to commence in the 2000-01 income year. Consequently the Review has taken this as its starting point in recommending the timing of implementation of particular recommendations. Table 3 sets out the Review's proposed timing of implementation for broad categories of measures. Further detail is available in the body of the report in respect of specific recommendations. |
Table 3 Timing of implementation |
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The Review's recommendations are revenue neutral |
90 Table 4 sets out the overall revenue implications of the Review's recommendations. The cost of the company tax rate reduction has two main elements. The first is the reduced revenue gains from the Government's business tax measures announced in A New Tax System as a result of the company tax rate being reduced from 36 per cent to 34 per cent in 2000-01 and 30 per cent thereafter. The revenue loss in respect of these measures is significant. |
| 91 The second, and major, component is the cost of reducing the company tax rate in respect of the existing company tax base. | |
| 92 The changes to the taxation of investments and income from entities are costed on the basis of the proposed company tax rates. The major offsetting element is the revenue gain from the removal of accelerated depreciation. |
Table 4 Revenue implications of Review's recommendations |
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| (a) The estimate incorporates the impact of base broadening on revenue gained from trusts at the recommended company tax rates; that is, the measure is costed against the Review's recommendations. | |
| 93 Detailed tables showing the revenue impact of each measure are included in Section 24. |
Impact of the Review's recommendations |
Reforms are not a zero sum game despite revenue neutrality |
94 The revenue neutrality constraint might, at first glance, be thought to imply that the Review's recommendations represent a zero sum game. In fact, to the extent that the Review's reforms increase economic growth and reduce compliance costs there will be clear net gains to business, Government and the community generally. The growth dividend reflects only the part of those gains paid in tax. The remainder is a net benefit to business as a whole. |
| 95 In addition, the Review expects its recommendations to stem many of the tax leakages which currently undermine the system. The sounder structure of the legislation and the more consistent approach to issues will minimise the opportunities for avoidance. As noted, the Review believes that the revenue benefits from such an outcome, many of which are not captured in the current estimates, should be directed at further improving the international competitiveness of Australian business. | |
Accelerated depreciation/company tax rate trade-off |
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There will be both winners and losers from the trade-off, but more winners than losers |
96 The major trade-off relates to the abolition of accelerated depreciation and the reduction of the company tax rate to 30 per cent. The immediate impacts of these two measures are relatively easy to identify. |
| 97 All entities with taxable income will benefit from the reduction of the company tax rate. It will not directly benefit taxpayers facing personal tax rates and it will not immediately benefit entities in tax loss. But in evaluating the effects of tax reform regard has to be had to the total tax package, including changes to indirect taxation and the personal tax scales. | |
| 98 The reduction in the company tax rate will of course, increase the after-tax profits of Australian companies. If the lower company tax were to be fully reflected in greater dividend payments, both domestic and non-resident shareholders would receive a cash flow benefit. If the dividend payment were to be unchanged in absolute terms, the amount of income retained by the company would be greater with benefits in terms of increased investment. | |
Removal of accelerated depreciation will impact adversely on some investments |
99 Removing accelerated depreciation will impact adversely on those businesses, other than small businesses, currently taking advantage of accelerated depreciation in respect of their plant and equipment. It will also impact adversely on major resource projects which tend to be financed to a significant extent through non-recourse debt. The cash flow benefits of accelerated depreciation significantly reduce the risk of funding such projects and consequently improve funding availability. |
| 100 As noted in A Platform for Consultation (Table B.2, page 106) the rate of acceleration varies markedly across the range of plant and equipment. Consequently, the impact on particular businesses will depend not only on their capital intensity but on the rate of acceleration applying to the particular assets they use. | |
| 101 The net impact of the company tax rate reduction/accelerated depreciation trade-off on individual companies will depend on the extent to which they currently benefit from accelerated depreciation. The volume of capital intensive investments is likely to be lower than would otherwise be the case, reflecting the net disadvantage to such investments from the accelerated depreciation/company tax rate trade-off. Conversely, the volume of less capital intensive investments is likely to be higher than would otherwise have been the case. | |
| 102 To the extent that companies receiving a net benefit from the trade-off on individual companies then increase distributions of franked income, the benefit of any reduction in the company tax rate would be clawed back by the imputation system for resident shareholders. For non-resident shareholders the total amount of tax paid will have fallen from 36 per cent to 30 per cent and so they will receive a significant reduction in Australian tax. For unfranked dividends the position of both resident and non-resident shareholders will be unchanged. However, it is important to note that the accelerated depreciation/company tax rate trade-off will reduce the proportion of tax-preferred income, and consequently increase the proportion of franked dividends, paid by Australian companies. | |
| 103 Alternatively, companies may reflect any net benefits of the switch in a higher level of retained earnings. This will lead to greater levels of investment and increased future profits to the benefit of shareholders. | |
The relative impact of proposed reforms on particular industries has been modelled |
104 The above analysis focuses principally on the first round effects of the change. There will be a range of second round effects as some activities expand and others contract. The Department of Industry, Science and Resources has commissioned a study which provides some estimates of the impact of the business tax reforms on individual industries. |
| 105 The study used the Econtech MM303 model to simulate the effect of the direct impact on industry costs of those changes in business taxation which could be allocated to industry. The model captures the indirect effects arising from changes in industry costs and the prices of their outputs. The study necessarily relies on a number of assumptions which may or may not be borne out in practice. The details of the study and the results are discussed in Section 25. | |
| 106 No attempt has been made to estimate the size of any growth dividend flowing from the Review's recommendations for the reasons set out earlier. The focus was on estimating the relative impact of the Review's recommendations on industry output. | |
All industries are likely to be better off |
107 What the results indicate is that a marked disparity between the impacts on particular industries is unlikely. Some will grow marginally more slowly than might otherwise have been the case, while others will grow slightly more quickly. If the overall package results in a growth dividend of the order anticipated by the Review -- an increase of ¾ per cent in GDP over the longer term -- then all industries are likely to be better off as a result of the Review's recommendations. |
Compliance costs |
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Reduced compliance costs will be a major benefit to Australian business |
108 The Review's recommendations are intended to provide a more consistent and easily understood business tax system. |
| 109 The comprehensive examination of the full range of business tax measures has meant that anomalies and inconsistencies have been identified and removed. For example, the recommendations will replace 37 different capital allowance regimes with two simpler regimes. Transactions which are similar in terms of economic substance will be taxed in similar ways. | |
| 110 Adoption of the Review's recommendations will move tax treatment and accounting treatment closer together in many areas. | |
| 111 The tax legislation will be restructured on the basis of high level and consistent principles. Where a case has been made for deviations from these principles the deviation will be made explicitly and the reasons explained. | |
| 112 All of these changes should contribute to markedly lower compliance costs for business and simpler administration for the tax authorities. | |
| 113 The Review's proposals for a Board of Taxation, a Charter of Business Taxation and a much more extensive ongoing consultation process will all work to ensure that reducing compliance costs will remain a high priority in the future development of the business tax system. | |
There has been a particular focus on reducing compliance costs for small business |
114 The focus of the small business initiative recommended by the Review is on simplifying the interaction of small businesses with the tax system. The simplified tax system for small business will be available to over 95 per cent of businesses in Australia. As noted earlier, it has been claimed that almost 40 per cent of the estimated $9 billion compliance costs incurred by Australian business is incurred by small business[4]. The Review's recommendations will lead to a substantial reduction in these costs. |
Impact on businesses |
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Recommended reforms will support the globalisation of Australian business and reduce compliance costs |
115 Where once Australia's international businesses were largely concentrated in the resource industries they are now found in almost every type of business. Australian firms are increasingly important players in a growing range of international markets. |
| 116 The Review has been very conscious of the need to ensure that the tax system facilitates the internationalisation of Australian business. The Review is recommending that imputation credits be allowed for foreign dividend withholding taxes paid on foreign source income of Australian entities, up to 15 per cent. This will remove a disincentive for Australian firms to expand overseas. | |
| 117 The Review is also recommending against the deferred company tax proposal, partly on the grounds of the adverse impact on non-portfolio foreign investors. Another important consideration was that the deferred company tax would have had a negative impact on reported company profits without advantaging shareholders, and with only a short-term timing effect on Government revenues. The treatment of so-called conduit income -- foreign source income flowing through Australian entities to non-residents -- will also be improved. | |
| 118 Consolidation will be a major benefit to large Australian business groups. It will allow transactions between wholly owned companies to take place without any tax consequences. This will result in large savings in tax compliance costs and allow decisions about such transactions to be made entirely on commercial grounds. In particular, it will allow company groups to restructure without incurring significant taxation consequences. The recommendations in this area are believed to be practicable, overcoming the major transitional difficulties, and adding significantly to the integrity of the system. | |
Impact on small business |
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The small businesses of today are the large businesses of tomorrow |
119 As pointed out earlier the simplified tax system for small business will have a major favourable impact on the compliance costs faced by 95 per cent of Australia's businesses. |
| 120 Included in the simplified tax system are simplified depreciation arrangements having the effect of shielding most small businesses from removal of accelerated depreciation as a general measure. This is particularly important in the case of unincorporated primary producers and other businesses which will not benefit from the reduction in the company tax rate, although they will benefit from the personal income tax scale reductions which are part of the total tax reform package. | |
| 121 The proposals in respect of venture capital are aimed at encouraging investment in small, innovative businesses. This is an area which could be a major contributor to higher economic growth and employment. Experience in other countries, most notably the US but also in the UK, has been that creating the right investment climate can lead to major growth of innovative small businesses. These small businesses are the large businesses of tomorrow. An economic climate that is conducive to the spawning of new businesses is more likely to generate an economy of greater vitality and creativity which is the mechanism for delivering higher living standards to the Australian community. | |
| 122 Restructuring of the small business capital gains rollover and exemption arrangements, as recommended, will also provide a simpler and more accessible concession for owners of small businesses, while still retaining the original intention of facilitating small business growth and reinvestment and helping to fund retirement. | |
Impact on investors |
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Reforms to CGT, refunds of imputation credits and the establishment of flow through taxation of collective investment vehicles will provide greater incentives for individuals to invest |
123 The proposed capital gains tax arrangements for individuals will eliminate some unintended outcomes from the way in which the averaging provisions have been used. The revenue savings can be used in a more productive way to encourage investment. This should improve the operation of Australian capital markets to the benefit of both large and small businesses. |
| 124 Refundable imputation credits will provide a major improvement in the equity of the imputation system and provide improved returns on share investments for low income taxpayers who currently are unable to make full use of their franking credits. It will also remove a disincentive for investment in shares by superannuation funds. | |
| 125 The establishment of collective investment vehicles (CIVs) outside the entity regime will ensure that small individual investors have the same opportunities to invest in a range of projects as those who have the capacity to invest directly. In this context the Review's recommendation that tax-preferred income earned through a CIV should be tax exempt in the hands of the individual investors is very important. This will ensure that individual small investors can invest in a project through a CIV on equivalent terms with wealthier individuals investing directly. | |
| 126 As noted earlier the position of non-resident investors will also be improved by a number of the Review's recommendations. | |
Summary |
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| 127 The Review is confident that its recommendations address the objectives identified earlier. A reformed business tax system based on those recommendations will support a more efficient, innovative and internationally competitive Australian business sector. This will be of enduring benefit to all Australians, in terms of higher employment, improved returns on savings and ensuring a sustainable revenue base to fund the essential services provided by Government. | |
| 128 An overview of the Review's recommendations is provided below and details of each recommendation and the rationale for them are provided in the body of the report. | |
| (Continued) |
[1] Australian Bureau of Statistics (1998a) Population Projections 1997-2051, ABS Cat No 3222.0, Canberra.
[2] National Commission of Audit (1996) Report to the Commonwealth Government, AGPS, Canberra.
[3] Evans C, Ritchie K, Tran-Nam B and Walpole M (1997), A Report into Taxpayer Costs of Compliance, Commonwealth of Australia, Canberra.
[4] Evans C, Ritchie K, Tran-Nam B and Walpole M (1977), A Report into Taxpayer Costs of Compliance, Commonwealth of Australia, Canberra, table 4.10, page 51. (Note: for the purpose of this study small business has a turnover of less than $100,000.)