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A Platform for Consultation

Submission to the Review of Business Taxation on

A Platform for Consultation

19 April 1999

CONTENTS

A. EXECUTIVE SUMMARY

B. BACKGROUND TO THE SUBMISSION

C. OVERVIEW

D. SPECIFIC POLICY AREAS

1. REFORMS TO IMPUTATION

2. CONSISTENT TREATMENT OF ENTITIES

3. CONSOLIDATION

4. INTERNATIONAL

5. WASTING ASSETS, GOODWILL AND TRADING STOCK

6. TAXATION OF FINANCIAL ARRANGEMENTS, LEASES AND RIGHTS

7. CAPITAL GAINS TAX

8. FRINGE BENEFITS TAXATION

A. EXECUTIVE SUMMARY

The Review of Business Taxation (RBT) has given Australia a timely opportunity to enhance the international competitiveness of our business tax system. We face a rapidly evolving international economy full of fresh prospects and exciting directions. In taxation, as in other areas, Australia should seek to leap ahead of our competitors and ensure we are ready to take full advantage of emerging trends. To aim for anything less is to give up a critical chance to promote national prosperity for the benefit of all Australians.

We acknowledge the opportunity to meet these objectives is predicated on the successful implementation of the other elements of the comprehensive program of rebuilding our tax system outlined in A New Tax System. We support the broad thrust of that program and regard its passage as the most urgent task of the current reform program.

This submission on A Platform for Consultation (Platform) continues the Business Coalition's engagement with the consultative processes of the RBT. We welcome these processes as a means by which the business community and other stakeholders can offer the benefit of their experience and expertise. We urge a continuation of the consultative processes as reform proposals are further refined and as legislation is prepared to give effect to policy positions.

In view of the likelihood of a comprehensive package of business tax reform proposals and in view of the other extraordinary demands on the business community, the submission argues that a program of phased introduction of measures be worked through in full consultation with the business community.

Our submission urges the RBT to give full weight to the ongoing processes of tax design, drafting of legislation and administration in its recommendations to the government. The business community regards these features of reform as fundamental if the advantages of a recast business tax system are to be maintained and refined into the future.

The Business Coalition has almost forty members representing a diverse cross-section of Australia's business community. Inevitably this diversity gives rise to differences in priorities and in emphasis among members. While our basic approach is to build on areas of agreement, we also encourage the full expression of the differences of emphasis. We regard both of these as critical ingredients in the development of a solution on business tax.

In the eight weeks since the release of the 800 page Platform we have held wide-ranging discussions within our own membership and with a variety of tax professionals and expert advisors. In the course of this process we have seen a marked evolution of members' views. There is every reason to expect a continuation of this evolution of views over the coming months.

This submission presents the current state members' views. This embraces the areas of agreement as well as the differences of perspective. We characterise the positions in the submission as "snapshots" to reflect the dynamic nature of our processes. Part D of this submission provides the most detailed treatment of positions while Part C contains a summary of the snapshots.

While support is far from unanimous, there appears to be a clear momentum in the direction of reducing the entity tax rate to 30 cents in the dollar. While reservations and opposition exist to some aspects of the possible reform agenda, there has been a notable narrowing of differences around key aspects of that agenda. This shifting of ground can be expected to continue as the implications both of specific measures and the broader impacts of the total reform package are integrated into business's assessments.

B. BACKGROUND TO THE SUBMISSION

The Business Coalition for Tax Reform (BCTR) welcomes the opportunity to provide comment to the Review of Business Taxation on the wide-ranging set of options for business tax reform canvassed in A Platform for Consultation (Platform).

Discussion of these options comes at a time when the globalisation of trade in both goods and services, of information flows and of investment is of increasing significance and when a more competitive tax system - of which business taxation is a key component - represents a critical step forward. A better business tax system is fundamental to the business community's ability to step up its contribution in generating higher standards of living and sustainable new job opportunities to the benefit of all Australians.

If business is to make the best contribution it can, the taxation and regulation environment in which business operates must be designed not merely in response to existing patterns but with an eye firmly on the emerging directions in which local and international pressures are steering our economic system.

In this context, the BCTR congratulates the government's judgement and strength in developing a comprehensive approach to the rebuilding of Australia's taxation arrangements.

The Need for Reform

The fundamental need for business tax reform arises because our existing arrangements fall well short of world’s best practice. As indicated in the RBT’s information paper An International Perspective, Australia ranks poorly in terms of perceptions of the competitiveness of our tax system overall and, in terms of most specific features of the business tax system, generally compares unfavourably with leading practice. The BCTR believes that we should aim at nothing less than to be at the forefront of international practice.

From the point of view of the business community, even on a purely domestic assessment there are major faults with our present business taxation arrangements. As was recognised in the Review of Business Taxation's earlier discussion paper A Strong Foundation (Foundation), these problems account for much of the existing complexity, uncertainty and instability evident in the existing system. Further they are a significant cause of a growing level of discontent on the part of the business community.

If the problems with the existing system are not addressed in a comprehensive way many of the worst features of the existing system will multiply. Thus, the appropriate benchmark against which we should assess the options put forward in Platform is not so much the existing set of business tax arrangements but the likely state of affairs inherent in the retention of the current system.

The most likely outcome of an absence of reform is a repeat of the experience of the recent past. We could expect more layers of anti-avoidance legislation, crackdowns on so called "concessional" arrangements, an increasing reliance on legislation by press release and a growing tendency to see long-standing rulings suddenly withdrawn.

In contrast, the business community needs simplicity, certainty and stability of tax arrangements if it is to take the investment decisions that will underpin improvements in international competitiveness and the creation of sustainable job opportunities.

The Business Coalition for Tax Reform

The Business Coalition for Tax Reform (BCTR) was formed in October 1997 to help inform the business community of the options for tax reform and to promote the case for rebuilding the Australian tax system. The BCTR is an expression of the business community's well-founded dissatisfaction with the existing tax system and the direction in which it has been headed over the past decade.

Since October 1997 the membership of the BCTR has grown to include almost 40 industry associations from all sectors of the economy representing small, medium and large business. Our membership is listed below:

Aluminium Council

Association of Consulting Engineers Australia

Association of Superannuation Funds of Australia

Australasian Railway Association

Australasian Soft Drink Association

Australian Bankers Association

Australian Business Chamber

Australian Chamber of Commerce and Industry

Australian Constructors Association

Australian Food and Grocery Council

Australian Hotels Association

Australian Industry Group

Australian Institute of Company Directors

Australian Institute of Petroleum

Australian Retailers Association

Australian Society of CPAs

Australian Stock Exchange

Business Council of Australia

Corporate Tax Association of Australia

Electricity Supply Association of Australia

Employers Federation of NSW

Federal Chamber of Automotive Industries

Institute of Chartered Accountants

Insurance Council of Australia

Investment and Financial Services Association

Master Builders Australia

Minerals Council of Australia

National Association of Forest Industries

National Farmers Federation

Property Council

Restaurant and Catering Australia

SA Employers Chamber of Commerce & Industry

State Chamber of Commerce NSW

Tasmanian Chamber of Commerce and Industry

Tourism Council of Australia

Urban Development Institute of Australia

Victorian Automobile Chamber of Commerce

Victorian Employers Chamber of Commerce and Industry

West Australian Chamber of Commerce and Industry

Clearly our membership is very diverse and this inevitably gives rise to differences in priorities and in emphasis among members. Accordingly, the BCTR has pursued reforms to the tax system on which there is a high level of agreement among our members. At the same time, we have not attempted to constrain individual members from advocating their own particular priorities. Through this approach we have harnessed the benefits of co-operation in the promotion of our overall approach while preserving the freedom of individual members to give full expression to their own priorities.

From the outset we agreed to take a comprehensive view of tax reform. Following a detailed process of consultation with a broad cross-section of the community and on the basis of a concerted research effort, we emphasised the need for reform of indirect taxes at both the Federal and the State/Territory levels; of personal income tax arrangements and their interactions with the social security system; of Federal/State financial arrangements as well as business taxation.

The BCTR supports the broad direction of reform outlined by the government in A New Tax System and acknowledges the changes put forward represent the most comprehensive proposal to remodel the tax system in over a generation.

We have also recognised the interrelationships between the different elements of reform and the importance of considering the individual components in the context of the overall changes to the entire set of tax arrangements.

The Ongoing Tax Reform Agenda

In all aspects of the tax system there will naturally remain further improvements to be made after the current round of reform measures is implemented. We include in this the need to address the payroll tax question and the associated questions of further change to Federal/State relations, the tax treatment of long-term savings, the outstanding high effective tax rates associated with the interaction of the social security and income tax systems and the need to meet the inevitable tax challenges of the growth in electronic commerce.

As discussed below, there is a need for serious attention to be given to the ongoing development of the business tax system. Similarly, the BCTR argues that processes should be put in place to facilitate future progress in these other areas of taxation. The manner in which this could be achieved should be settled with the business community as well as with other stakeholders.

Business Tax Reform

From the first half of 1998 the BCTR argued for an independent review of business tax arrangements. Furthermore we maintained that the fundamental problems with both the design and administration of business taxation called for an ongoing co-operative effort on the part of both the taxation authorities and the business community. A little over a year ago the BCTR made the point that:

"to have any chance of success, comprehensive reform of the business tax system would have to be consultative and would have to draw on the expertise of practitioners …. It would also have to be done at a pace that allowed proper digestion of proposals and their implications. To do otherwise would be self-defeating."

Against this background the BCTR welcomed the Government's announcement of 14 August 1998 establishing the Review of Business Taxation (RBT) under the Chairmanship of Mr John Ralph AO. The BCTR also welcomed the subsequent appointment of Mr Rick Allert AM and Mr Bob Joss to the Review. The BCTR is committed to engage constructively with the Review's processes.

In developing our approach to business taxation the BCTR has maintained our overall objectives for reform.

BCTR Objectives for Tax Reform

"To enhance international competitiveness and fairness in taxation and to create a climate favourable for investment, job creation and saving."

In addition, we have conducted discussions over the broad principles we consider should form the basis of business taxation changes. The development of the BCTR business tax principles is ongoing and revolves around the six draft principles set out below.

BCTR Draft Business Tax Principles

"1. The business tax system should be simple, transparent and minimise uncertainty.

"2. The tax system should not favour or disadvantage particular business structures over others.

"3. Taxation for the purpose of raising revenue should not favour particular industry sectors or firms over others. At the same time potential should be preserved for the use of taxation measures to assist in achieving particular industry and social objectives. Such objectives should be justified on the basis of transparent and rigorous criteria and on the condition that the tax system provides a suitable instrument for achieving the stated objectives.

"4. The tax system should avoid the double taxation of business income and provide relief for all business expenses.

"5. The tax system should not impede organisational restructuring.

"6. The business tax system should be internationally competitive and supportive of increased national savings."

A Strong Foundation

The BCTR welcomed the release of the first RBT discussion paper A Strong Foundation (Foundation) in November 1998. In particular the BCTR welcomed the emphasis on improving the processes of tax policy design, drafting of legislation and administration of taxation. Two of the more critical areas for the BCTR are worth restating here. They are:

the introduction of substantial avenues for genuine and ongoing consultation with the business community as an integral part of reformed processes of design, drafting and legislation

the establishment of an independent Board of Directors or advisory Board to enhance the design, implementation and administration of business taxation arrangements on an ongoing basis.

These two areas are interdependent. In the BCTR Submission on Foundation, the following comments were made:

"The Board should be responsible to report on the effectiveness of the business tax system, including:

Adequacy of resources within the ATO

Quality of consultation

Quality of action following consultation.

"It is imperative that for the Board to have a genuinely beneficial impact on the level of community trust and confidence in the business tax system, it must be effective in influencing the consultative process.

"The BCTR submits that the establishment of a proper, independent Board is a fundamental aspect of the reform process which requires further consultation with stakeholders."

C. OVERVIEW

The business community's attitude to options for reform of the business tax system continues to evolve. Convinced of the need for an internationally competitive regime, and mindful of relevant international benchmarks of best practice, a convergence of position on many possible changes is occurring.

While reservations and opposition exist to some aspects of the possible reform agenda, there has been a notable narrowing of differences around key aspects of that agenda. This shifting of ground can be expected to continue as the implications of both specific measures and the broader impacts of the total reform package are integrated into business's assessments.

The BCTR Approach to Business Tax Reform

Both the diversity of members' views and the changing character of business's attitudes to reform - are critical to the interpretation of this submission.

A central and consistent feature of the BCTR's approach to tax reform has been to insist our deliberations are informed by principled arguments and expert opinion on the one hand and the particular interests and concerns of our members on the other.

In our discussions of tax reform measures there is always a creative tension between these two sets of forces. The expert opinion and the particular perspectives of members are in a state of continual interaction and evolution. Over the past year or so the position of members on a wide range of business tax issues has changed considerably. All indications are that this process has accelerated since the release less than eight weeks ago of the 800 page Platform. There is no reason to suspect attitudes have stopped evolving.

Accordingly, the submission attempts to capture the areas of agreement and the diversity of opinion of BCTR members and is essentially a snapshot in time of the state of the evolutionary development of the attitudes of BCTR members.

Clearly, therefore, the snapshot presented in this submission should not be taken as a final position. Rather we fully expect members' attitudes to continue to evolve.

General Issues

Before examining the snapshots of BCTR members' positions on particular policy areas, there is a range of general issues that lay the foundation for many of the more specific items considered later.

Revenue Assumptions

Discussion of the options in Platform has been conducted without a full knowledge of the revenue implications of the full range of measures. This is particularly important given the overall context of a revenue neutral trade-off of various features of the present tax system for a decrease in the entity tax rate.

Chapter 39 of Platform provides estimates of some of the more important options. However even where estimates are provided there is an important qualification:

"some costings need to be viewed as indicative. In some cases the costings rely on assumptions about the extent of the relevant tax base and behavioural responses to the change in the taxation treatment being examined. The revenue impact may need to be modified if further information becomes available during the consultation process."

While, as a part of the consultation process the RBT has been helpful in explaining the basis of the indicative revenue estimates, there is an understandable residual disquiet over some of the costings. This is particularly so in view of the historical experience with highly conservative estimates of revenue under, for example, the capital gains tax and the fringe benefits tax.

One point made in the face of this disquiet is that experience shows that while there is considerable room for error in respect of any given number, there are always swings and roundabouts so that losses in some areas tend to be offset by gains in others.

While this defense provides some consolation when there is a large number of small costings to deal with, it is less comforting when there is a heavy reliance on a single costing. This explains why in the response to Platform the costing of the removal of accelerated depreciation has attracted considerable attention.

Of a possible reduction in the company tax rate of 6 percentage points, the removal of accelerated depreciation would account for over 4.5 percentage points. If other elements of the move to an effective life basis for capital write-off are taken into account, the contribution amounts to around 5 percentage points.

In assessing the impact of the possible lower entity tax rate financed largely from the removal of accelerated depreciation, individual businesses and industry associations have generally assumed that the relationship between the cost of reducing the entity tax rate and the removal of accelerated depreciation as indicated in Platform is sustained over time. To the extent there is support for the trade-off of accelerated depreciation for a lower entity tax rate, this support should be interpreted as being predicated on the sustainability of this relationship.

Implementation of measures

As noted earlier, the present state of Australia's business tax system presents a compelling case for comprehensive business tax reform. Furthermore, this submission indicates the considerable strength of support on the part of the business community in favour of wide-ranging reform.

At the same time however it is critical to recognise the difficulties presented by the timetable for reform as it is currently envisaged (i.e. with measures to take effect from 1 July 2000). At is stands, over the coming fourteen months:

the RBT will make its recommendations about a full range of business tax issues

the Government will then decide on what it assesses as the appropriate course of action in each area

exposure legislation will be prepared

the business community will have an opportunity to examine and provide comment on draft legislation

suitably amended legislation will be submitted to and debated in the Parliament

new procedures and systems will be put in place to accommodate the new business tax arrangements.

Over the same time period the business community also has to prepare for the indirect tax reforms foreshadowed in A New Tax System and, in addition, is dealing with the "millenium bug" issue.

In view of this, the start-up date of 1 July 2000 date for all measures is not felt to be realistic (this is particularly the case for early balancing companies). It is certainly not felt to be compatible with the need for business to have an appropriate opportunity to consider and provide input into draft legislation and also to be given adequate time to prepare for changed arrangements.

The BCTR considers that process by which the proposed changes to the business tax system are to be implemented should be fully in line with the consultative and transparent processes of policy development advocated in Foundation. Furthermore, ideally they should be implemented under the guidance of a Board of Directors or advisory Board.

In short the BCTR:

submits that the opportunities for fundamental reform are too great to be placed at risk from undue haste and that a program of implementation - possibly over a couple of years - should be worked out in full consultation with the business community

agrees wholeheartedly with the spirit of consultation and greater accountability expressed in Foundation and submits that the current generation of reforms should be the implemented in a way that accords fully with that spirit.

Tax Incentive Benchmark

Platform invites input from business to refine the tax incentive benchmark.

In Foundation the tax incentive principle is:

"Business tax incentives should be provided only following a formal assessment of their net impact on the national taxation objectives, and only where assessed to be an essential or superior form of government intervention."

The national taxation objectives were:

Optimising economic growth

Ensuring equity

Facilitating simplification

The BCTR and others submitted to the RBT that saving and international competitiveness should be included as objectives in their own right.

In addressing the tax incentive benchmark it is important to recognise that tax incentives are defined against a benchmark of an abstract "ideal" tax treatment. Presumably the ideal against which tax incentives would be measured in the future would embrace both the investment and the entity taxation benchmarks canvassed by the Review. Thus tax incentives would be defined as departures from the treatment that would apply under a comprehensive income tax regime and the full integration of entity and personal taxation.

Relative to these benchmarks tax incentives could be positive (i.e. they favour the taxpayer - such as the R&D tax incentive or accelerated depreciation) or negative (i.e. they favour the revenue - such as the double taxation of foreign source income or the asymmetrical treatment of losses). It would appear appropriate that whatever procedures are put in place to assess and monitor positive tax incentives should also apply to negative tax incentives.

Possible criteria for tax incentives

The BCTR's draft business tax principle 3 is a relevant starting point in discussing the criteria for tax incentives.

Taxation for the purpose of raising revenue should not favour particular industry sectors or firms over others. At the same time potential should be preserved for the use of taxation measures to assist in achieving particular industry and social objectives. Such objectives should be justified on the basis of transparent and rigorous criteria and on the condition that the tax system provides a suitable instrument for achieving the stated objectives.

While this is useful it does not overcome the inherent difficulty in specifying the criteria for tax incentives that arises from the variety of possible reasons for government support or assistance. These include equity considerations, policies to promote regional development, measures to match incentives available in competing countries as well as the more "economic rationalist" justifications for the government to provide incentives. This narrower range of criteria could include:

Tax measures to partially offset situations where the benchmark tax treatment itself creates a distortion (a clear example is to correct for the bias against saving inherent in the comprehensive income tax approach)

Where there is a robust argument for a market failure (examples could include the immediate deductibility for certain capital expenditure on land care and the equity gap that can be experienced by small firms seeking to raise venture capital)

Where there is a case to promote competitive neutrality (for example where government spending provides a selective benefit to one industry or region, tax incentives could be an effective means by which the treatment of other industries or regions could be brought into balance). Examples of this can be found in the private provision of infrastructure.

Given the potentially wide range of justifications for government intervention, it is possibly more important to distinguish the situations where intervention is most appropriately delivered in the form of a tax incentive in contrast to other means - such as direct expenditure.

Considerations that could be brought to bear on the assessment of the relative merits of incentives delivered directly or through the tax system include:

Effective delivery of assistance based on measurable effects

Effective targeting of assistance to those to whom the benefit is intended

Direct compliance and administrative costs of the particular scheme

Collateral compliance and administrative costs arising, for example, from the need for anti-avoidance measures to contain the use of the measure

Security of the measure.

Arrangements to monitor or review tax incentives

An important additional dimension of the tax incentive benchmark concerns the arrangements to monitor or review the effectiveness of relevant provisions. Any review or monitoring arrangements should include genuine input from the business community to ensure deliberations benefit from those with first hand knowledge of the relevant commercial realities.

The R& D Tax Incentive

There is very strong support for maintaining the existing Research and Development Incentive and increasing it to maintain its real value in the face of any reduction in the entity tax rate.

There is empirical evidence that suggests a close correlation between the tax incentive and the level of R&D spending by business, with a steady increase since the mid-1980’s followed by a sharp drop shortly after the rate of the incentive was halved in 1996. Various studies by the Bureau of Industry Economics, the Productivity Commission and the Mortimer Report suggest that external benefits are generated by the tax concession.

Recent measures to refine the design of the incentive, including the narrowing of the definition of R&D, the more limited registration period and constraints on the deductibility of feedstock costs now ensure the incentive is both highly targeted and very likely to influence behaviour. These changes reinforce the need for a timely increase in assistance for the critical area of research and development.

Tax preference claw back

A central feature of the present system of company taxation is the washing out of tax preferences at the shareholder level. This occurs because the unfranked distributions made from income on which Australian tax has not been paid are taxed at the shareholder’s marginal tax rate without relief. In effect there is double taxation as tax preferences, allowances for prior year losses and credits for foreign tax paid are clawed back on distribution. (In effect the claw back is a negative tax incentive.)

In Platform two arguments are put forward against addressing this problem. These are:

the cost to revenue of allowing full flow through of tax incentives

that "many incentives are currently perceived as meeting their objectives at the entity level" so the cost of flow through would generate "little apparent benefit".

There are two reasons that might support the second of these arguments:

where the interests of managers and owners are sufficiently separate, tax incentives may influence investment decisions even though the owner stands to receive no substantial benefit in terms of the after-tax value of distributions

an entity that can benefit from retaining tax preferred income can deliver the benefits of tax deferral to its shareholders.

While, on this logic, the claw back of tax preferences may be appropriate for larger entities, it is by no means apparent that the same is the case for closely held entities where the management and the ownership of the entity is unified. In cases where the entity structure is a close substitute for a partnership or sole trader, the effectiveness of tax preferences raises important issues of competitive neutrality.

There is therefore an argument for allowing a selective flow through of tax preferred income for some closely held entities. This is taken up again below in the section on the consistent treatment of entities. The criteria for such a selective flow through should be set in consultation with the business community.

Profit retention in closely held companies

Platform raises the possibility of measures to limit the degree to which certain entities could retain income (perhaps with a distinction between income of different origins).

Such an approach would introduce high levels of complexity associated with compliance and administrative burdens.

The BCTR, along with many others, has argued consistently for an alignment of the top personal tax rate and the company tax rate to avoid this sort of complexity.

Greater use of accounting principles for tax

Platform raises the possibility of further consultation over the greater use of accounting principles for tax purposes. While there appear to be considerable attractions with this approach, it is evident that neither the revenue nor taxpayers would be comfortable with an unqualified alignment of tax and accounting rules. Additional issues revolve around the imprecision of accounting rules and the possibility that tax considerations could tend to drive the development of these rules if tax and accounting principles were aligned.

Reversion to the classical system

The business community has developed a strong attachment to the imputation system and there does not appear to be much support for this suggestion unless rates of income tax were considerably lower than is currently the case. Even then, to do so would still offend against the principle of full integration of entity and individual taxation.

Two separate revenue neutral trade-offs

Platform suggests the overall constraint of revenue neutrality be subdivided into two separate revenue neutral exercises – one relating to changes to capital gains tax and the other relating to changes to general business tax measures.

Such an approach seems to overlook the essential interrelationships between the different parts of the income tax system. An approach that preserved the maximum degree of flexibility would appear more attractive than an approach that locked in unnecessary constraints.

Summary of Snapshots of BCTR Members’ Positions on Specific Issues

In our discussions of Platform we have subdivided the wide range of issues into eight areas. Each of these eight areas is given more detailed consideration in the sections that follow and reference should be made to these sections for a fuller understanding of the diversity of members’ views. For convenience this sub-section provides a summary of the range of views on each of the specific areas. As explained above, the business position on business tax reform options is evolving. This summary indicates, in broad terms, a snapshot view of the range of BCTR members' positions.

1. Reforms to Imputation

There is a very strong preference for a Resident Dividend Withholding Tax relative to the alternative of Deferred Company Tax.

2. Consistent Treatment of Entities

Though not unanimous, very firm support is emerging to move in the direction of the more uniform taxation of entities. At the same time BCTR members are very clear about three qualifications in particular:

there should be a carve out for collective investment vehicles with a flow through of tax preferences

a facility should be available to small business for a flow through of tax preferences on a selective basis

there should be appropriate measures to ensure the tax treatment of superannuation is not adversely impacted by the entity tax proposals.

There is considerable support for a profits first rule designed in a way that ensures genuine returns of capital are not adversely affected.

While there is also support for a broader definition of dividends, there is a strong feeling that it should be based around a list of specific inclusions.

3. Consolidation

While it is fair to say there is considerable wariness about the consolidation proposals discussed in Platform, support is emerging for the development through genuine consultation of a comprehensive optional consolidation regime built around the start made in Platform.

4. International Taxation

There is extremely strong support for the introduction of a concerted program of treaty re-negotiation.

B. There is equally strong support for improving the international competitiveness of the tax system by allowing streaming of offshore earnings directly to non-resident shareholders.

C. Strong support has also emerged for an extension of relief from double taxation of foreign source income by improving the creditability of foreign tax.

D. There is support for a tightening of thin capitalisation provisions on the understanding that appropriate transitional rules would prevent hardship in the case of pre-existing arrangements.

5. Wasting Assets, Goodwill and Trading Stock

A. Support for the acceptance as a general principle (while allowing for exceptions) of a regime under which wasting assets were treated on a basis more consistent with accounting principles has a number of elements. These include:

Very strong support for deductibility to be available to the bearer of the expenditure

Equally strong support for the cost base to be the actual cost to the taxpayer

With clear exceptions, there is support for having deductions start when assets are ready for use

Emerging and qualified support for the spreading of depreciation deductions over the economic life of the asset

Support, again with some clear exceptions, for the removal of balancing charge rollover relief

Very strong support for ensuring all legitimate business expenditure can be written off or immediately deducted.

B. Again with some exceptions, there is support for treating acquired goodwill as a wasting asset.

C. There is strong support for taxpayers nominating a consistent treatment for the valuation of trading stock.

6. Taxation of Financial Arrangements, Leases and Rights

A. In respect of the treatment of financial arrangements, while there are a number of important specific concerns, there is very clear support for accepting the adoption of a timing adjustment approach where practical, allowing an elective mark-to-market approach and taxing other assets and liabilities on realisation.

B. In relation to leases:

there is broad support for the retention of the present arrangements

there is strong support, however, for measures to prevent the assignment of lease tails.

C. In relation to rights, there is very strong support for an improved treatment of expenditure on rights.

7. Capital Gains Taxation

BCTR members expressed differing degrees of support for a range of options to reform the taxation of capital gains.

A. There is very clear support allowing rollover relief for scrip for scrip and similar transactions for a range of entities (and not limited to listed companies).

B. There is strong support for allowing carry-back of capital losses in respect of assets acquired after 1 July 2000.

C. There is very clear support for targetted capital gains relief to encourage the development of the venture capital market.

With clear exceptions, there is very firm support for a tightening of averaging provisions.

E. There is very strong support for replacing the goodwill exemption for small business with a general exemption.

F. Although there are clear exceptions, there is strong support for the further evaluation of proposals to restructure relief from capital gains tax at the individual level by replacing indexation with other arrangements.

8. Fringe Benefits Taxation

With clear exceptions, there is a strong measure of support for transferring the liability for fringe benefits tax to the employee.

There is very strong support for removing on-premises car parking from the FBT regime.

Although there are clear exceptions there is strong support for removing entertainment from the FBT regime and, in addition, reverting to non deductibility.

While not unanimous, there is strong support for bringing the valuation of car benefits more closely into line with market values.

The Entity Tax Rate and the Steps Ahead

While support is far from unanimous, there appears to be a clear momentum among BCTR members in the direction of reducing the company tax rate towards 30 cents in the dollar.

In terms of the tangible improvement to international competitiveness and because of the signal it would impart, the business community in general would like to see a lower corporate tax rate. Clearly however, in the context of a revenue neutral business tax reform this could only be achieved through an expansion of the entity tax base.

It has been argued that business tax reform is, therefore, a zero-sum game and that a lower entity tax rate can only be financed with increases in the tax burden faced by particular sections of the business community. It is pointed out that this might imply a reduction in international competitiveness in particular areas.

This however is a static view that overlooks the critical contribution improved business tax arrangements can make:

to the expansion of commercial activity

to increases in the valuation of Australian businesses

in reducing compliance cost burdens.

Each of these areas has the potential to significantly improve revenue collections.

Platform put forward an estimated growth dividend of $200 million in extra revenue from the business tax system by 2003-04. The basis of this growth dividend is the greater economic efficiency expected to arise from a closer alignment of commercial and tax values together with the reduction in the entity rate to 30 cents in the dollar. This is acknowledged to be a conservative estimate and it is anticipated that a larger dividend would be generated in the longer term.

The summary of BCTR members' positions outlined above contains several reform measures in addition to those taken into account in the RBT's estimate of the growth dividend, that could also be expected to contribute to a greater business tax base through expanded economic activity, improved valuation of domestic businesses and lower compliance costs. The BCTR is keen to explore with the RBT the potential revenue gains from the full range of reform options.

There is a strong view that we should be able to do better that a growth dividend of $200 million particularly in the medium term. At the same time it is acknowledged that, in a more immediate sense, if all the measures canvassed above were introduced, it is still unlikely the company tax rate could be lowered to 30 cents in the dollar by 2003-04.

This presents a new challenge for business. Having made good headway to date we clearly have further steps to take in continuing to explore the directions of reform and also in prioritising the options we have before us. In this context we need to weigh alternative options against the benefits of incremental reductions in the entity tax rate in the short term and against their impact on future revenue collections.


D. SPECIFIC POLICY AREAS

1. REFORMS TO IMPUTATION

Snapshot of BCTR Members’ Positions

There is a very strong preference for a Resident Dividend Withholding Tax (RDWT) relative to the alternative of Deferred Company Tax (DCT).

Discussion

There is strong opposition to the deferred company tax option in the business community on the grounds that it would adversely impact on international competitiveness and would represent an additional charge on company profits. Relative to this option there is support for a RDWT insofar as it would meet these two objections with the DCT. While the RDWT has support, the third alternative - the taxation of inter-entity distributions - should not be ruled out as a possibly attractive alternative.

It should be noted however, that relative to the existing system the RDWT could have damaging impacts on large sections of the business community unless modifications and exclusions were introduced.

Critical Issues

Business opposition to DCT

Particular concerns with the proposed DCT system include:

the fact that DCT is a charge against company profits which could be expected to reduce earnings per share and the valuation of companies, thus increasing the cost of raising capital

DCT could be perceived to be contrary to the spirit of Australia’s double tax treaties which generally impose 15% withholding tax on unfranked dividends

DCT could be unlikely to give rise to a credit for foreign taxes to foreign investors.

These concerns are seen to outweigh the benefits of greater simplicity held out as the key argument in favour of a DCT.

As discussed below in the context of international taxation, the proposal to switch DCT for dividend withholding tax and options to permit the streaming of offshore profits to non-resident shareholders both have definite attractions. However, to date neither of these has been linked sufficiently to the DCT alternative to give reason to think that they would not be equally viable and attractive in the context of the RDWT (or other options for that matter).

Support for resident dividend withholding tax (RDWT)

There is general support for RDWT relative to the DCT alternative as it does not entail as harsh an impact on corporate profits and international competitiveness as the DCT. At the same time, RDWT would ensure that all distributions through the entity chain are subject to full corporate tax and that distributions to individuals are taxed at source, thus satisfying the government’s integrity concerns. However, complex dividend streaming rules dealing with situations, for example where franked dividends were paid to some shareholders and unfranked dividends to others would have to be addressed in ways other than through the structural reform offered by the DCT.

The RDWT would however reduce the income of entities currently in receipt of unfranked distributions. Unless addressed this could adversely impact the valuation of listed companies and result in a loss of international competitiveness in a range of circumstances. Incorporated joint ventures, in particular, may suffer an erosion of competitive position.

Taxation of unfranked inter-entity distributions

Whilst this option essentially achieves the same outcome as the first two options for inter-entity distributions, unfranked dividends paid to individual shareholders are not taxed at source but rather in the recipient’s hands. While the RBT appears unlikely to accept this alternative due to integrity concerns - i.e. the potential that unfranked dividends will not be declared as income, there is a strong case for keeping the option open in view of the possible complexity that may arise as the RDWT is considered more closely. Again, complex dividend streaming rules would potentially remain with this option, however there would be some reduction in compliance with no need to pay DCT or deduct RDWT on unfranked dividends.

Other issues

Adjustments for non-resident investors

Under the options to reform imputation, non-resident investors could be disadvantaged due to the extra tax on distributions through the entity chain. In the case of DCT, it is proposed that DCT on distributions to non-residents be refunded and replaced with a withholding tax to increase the creditability of Australian tax in the home jurisdiction. Where distributions paid between resident entities are subject to RDWT and subsequently paid to foreign investors, RDWT could be similarly refunded and withholding tax applied to the dividend (plus the refund) thus putting the non-resident investor into the same tax position as under the current regime.

Double taxation of tax preferred income

The potential for double taxation arising through tax preferences is also addressed. While four options for overcoming such double taxation are detailed, Platform maintains that double taxation is not common. In brief, the four options are:

refunding franking account surpluses on liquidation to the extent that the surplus relates to temporary tax differences

allow "double tax" payments to be offset against company tax liabilities

allow prepayments of tax on temporary tax preferences

adjust the cost base of the funding asset for distributions from unrealised gains.

Of these alternatives, the option to allow prepayments of tax in respect of temporary tax preferences would appear to be the best.

2. CONSISTENT TREATMENT OF ENTITIES

Snapshot of BCTR Members’ Positions

Though not unanimous, very firm support is emerging to move in the direction of the more uniform taxation of entities. At the same time BCTR members are very clear about three qualifications in particular:

there should be a carve out for collective investment vehicles with a flow through of tax preferences

a facility should be available to small business for a flow through of tax preferences on a selective basis

there should be appropriate measures to ensure the tax treatment of superannuation is not adversely impacted by the entity tax proposals.

There is considerable support for a profits first rule designed in a way that ensures genuine returns of capital are not adversely affected.

While there is also support for a broader definition of dividends, there is a strong feeling that it should be based around a list of specific inclusions.

A. Treatment of Trusts as Companies

The stated rationale for a more consistent treatment of entities is that:

investments should not be taxed differently whether they are housed within a trust as opposed to a company

that business tax arrangements should avoid taxing different types of entities differently.

While this argument clearly has merit, the approach taken in Platform would hardly do away with inconsistent treatment of investments as business, operating outside the entity framework (i.e. as direct investors, sole traders and partners) will be taxed differently to investors in entities. This fundamental difficulty with the approach proposed by the RBT lies at the heart of the qualifications to the consistent treatment of entities approach.

The same difficulty is also the key to understanding the dispersion of views in the business community on the issue. Under present arrangements trusts correct for a fundamental problem with the taxation of companies relative to the ideal of full integration. From this perspective, the proposal to tax trusts as companies will make matters worse rather than improving them.

i) Collective Investment Vehicles (CIVs)

CIVs are essentially close substitutes for direct investment. From the point of view of neutrality, income earned by (and tax preferences available to) such vehicles should be taxed in the hands of individual investors as if the investment were undertaken directly. This would ensure there are no adverse cash flow effects on people receiving distributions of assessable income from vehicles such as cash management trusts and that such investors also had access to tax preferences. For consistency this rule should also apply to other widely held vehicles that distribute their income annually such as bond trusts, common funds, managed funds and property trusts.

ii) Selective flow-through of tax preferences to other entities

As has been explored in Part B, there is a strong case for allowing some selective flow through of tax preferences to other entities - particularly where there is a high degree of substitutability between conducting business as a sole trader or partnership and conducting business through an entity. The criteria for eligibility for the selective flow-through of tax preferences should be subject to consultation with the business community.

iii) Superannuation

The Australian tax system grants particular tax treatment to superannuation, partly in recognition of the tax-created bias against saving inherent in an income tax approach. Consistent both with the national importance of private saving and the fact that the Review of Business Taxation has not considered superannuation in a comprehensive context, the BCTR benchmark recognises that the proposals to tax entities more consistently should ensure that the tax treatment of superannuation is not adversely affected.

B. The Profits-First Rule

Under current tax rules it is possible to choose the source from which share buy-back and cancellations are made. Under the changes proposed in Platform, where there is a termination of an equity holder's interest, a "slice" approach would apply under which the distribution will be deemed to come from contributed capital, taxed profits and the balance from untaxed profits, based on the calculated contributed capital and tax-paid franking credit balance per share. The slice approach appears to be inconsistent with a profits-first rule which taxes normal distributions in full as dividends whereas the slice approach does not treat termination of interest situations as entirely capital.

Consequently, modifications to the profits-first rule and slice approach should be adopted to ensure appropriate tax treatment in the case of a genuine return of capital.

C. Definition of a Dividend

In Platform, the definition of a dividend is proposed to be broadened under one of three options to include such things as goods and services provided to shareholders at a discount, debt forgivenesses and non-commercial loans.

The extended definition would apply even where benefits are provided to associates. Dividends would continue to be limited to profits.

The proposed definitions appear overly broad and adopt an ‘all-in’ approach with limited exclusions. A better approach would be to define items which are to be specifically included in the amending legislation.

For public companies, a $1,000 per annum threshold for each shareholder is proposed in respect of discounted goods or services provided. For example where a 5% discount on sales was offered, a shareholder would need to spend $20,000 with the company before the threshold was exceeded. In most cases such a threshold is unlikely to be exceeded and therefore it is suggested that such discounts be excluded from the definition rather than subjecting public companies to what would be a very heavy compliance burden in monitoring the situation.

Other Issues

Transitional arrangements for trusts

Rules are proposed for preserving the existing tax treatment of certain amounts earned by trusts prior to the commencement of the new entity tax system and of future capital gains on existing assets. This would be achieved by converting these amounts into contributed capital. Such amounts include for assets at the start date, realised gains on pre-CGT assets, realised inflationary gains on post-CGT assets, realised gains benefiting from the CGT goodwill exemption, other tax-preferred income earned prior to commencement and prior taxed income.

However, uncertainty remains concerning the ability of trusts taxed as companies to restructure and distribute such amounts tax-free to beneficiaries once the profits-first rule described above is overlaid.

Broad transition rules will need to apply to avoid harsh outcomes during any transition. These should be worked through in close consultation with the business community. Consideration should be given to granting relief from liabilities for capital gains tax and stamp duties arising from any significant changes to the tax treatment of business structures.


3. CONSOLIDATION

Snapshot of BCTR Members’ Positions

While it is fair to say there is considerable wariness about the consolidation proposals discussed in Platform, support is emerging for the development through genuine consultation of a comprehensive optional consolidation regime built around the start made in Platform.

Discussion

The BCTR appreciates the potential benefits from the options to tax groups of entities on a consolidated basis. These benefits include the transfer of franking credits, the freeing up of loss transfers, simplified intra-group dividend flows, and fewer tax barriers to reorganisation. While reduced compliance costs and a simplified tax system are often linked with consolidation proposals, it is not clear either from international experience or from the issues raised in A Platform for Consultation, that this is really the case.

There is widespread agreement that, if adopted in their present form, the proposals in A Platform for Consultation would impose severe constraints, additional complexity and a less competitive outcome for many groups. The extent of these negatives suggests that the present proposals can not be regarded as representing an overall improvement to present arrangements.

Nevertheless, a strong case can be made to suggest that there are benefits to consolidation that can be attained if a number of improvements are made to the existing proposals. The benefits of consolidation are all the more attractive bearing in mind the likelihood that further anti-avoidance measures to counter loss duplication and value shifting will probably be considered necessary in the absence of the consolidation approach.

In the area of consolidation, perhaps even more than others, it is clear that considerable refinement of proposals through continued consultation is needed if we are to achieve the best policy outcome.

Critical Improvements to the Consolidation Proposals

The need for a resident Australian holding company

The proposed consolidation regime would only be available to foreign-owned Australian entities held by a common Australian resident parent. Some existing groups will not be able to achieve this structure without incurring prohibitive tax costs in other jurisdictions. If, as proposed in Platform, existing provisions permitting tracing through offshore entities were to be removed, the effective Australian tax rate of many groups would rise.

It is understood there are concerns about the ATO being able to satisfy itself about the 100% ownership continuing unbroken up the chain. There are also integrity concerns on exit that would not arise with an Australian resident parent. Ways of resolving these issues without forcing groups to incur significant restructuring costs should be explored. One alternative would be to allow grouping and CGT rollover to continue groups formally consolidated for tax purposes.

Forfeiture of tax losses on entry

The BCTR is mindful that concerns about loss cascading and duplication would lead to a preference for a consolidation model where pre-entry losses are forfeited on entry into the consolidated group (Option 1 on page 561). This would, however, represent a radical departure from the existing regime, which permits the carry-forward of pre-entry losses, subject to the same business test. Removal of the same business test because of concerns about loss duplication would compound an already highly punative treatment of losses in order to address the comparatively minor problem of loss duplication. It would also infringe Principle 4 on page 558 of Platform that losses and franking account balances should be able to be brought into a consolidated group.

Of the options listed on pages 561-4 in Platform, Option 5 (quarantining losses within the group) or Option 6 (leaving loss entities outside the group until the losses were recouped) would appear to offer the best solution.

An alternative of limiting the losses brought into the group to the consideration paid for the shares would have the benefit of simplicity and would appear to meet integrity concerns. This approach would be a more attractive starting point than the options listed in Platform.

Inter-company dividends

The multiple taxation of dividends flowing between companies is currently addressed through a rebate system. The rebate system works only because companies within a corporate group are treated as separate legal entities, a distinction that would be done away with under the consolidation proposals. Where a consolidated group is in an overall tax loss position, dividends received from outside the group would have to be offset against those losses, with the result that the losses would be "wasted". A number of corporate groups would suffer significant financial loss if this issue is not adequately addressed. The BCTR is attracted to one of the two possible solutions that have been put to the Review of Business Taxation – a dividend deduction or a modified exemption system.

Additional foreign tax

Under the consolidation proposals, the Australian holding company would be regarded as being liable for the group’s tax. This could result in additional "top-up" tax on other subsidiaries at home under the CFC rules of some other countries (including the US). While this is a shortcoming in the CFC regimes of those countries, to avoid a loss of competitiveness foreign-owned groups that are adversely affected should be able to opt out of consolidation and group losses and use CGT rollover relief outside of the consolidation regime.

Value shifting

Proposals to address value shifting outside consolidated groups would be improved through use of a 50% associate-inclusive control test below which the value shifting measures did not apply.

In general, measures should be designed to ensure that no unreasonable compliance burden is imposed by a requirement that companies demonstrate that normal commercial transactions do not result in a value shift.

Other Issues

The proposal that all group entities be jointly and severally liable for the group’s tax liabilities should end on exit. Otherwise tax considerations might force companies to sell assets when it would make more sense commercially to sell shares.

The characterisation of income and expenditure could be different under a consolidation regime as compared to a separate entity basis. This will need to be managed to ensure unintended consequences are avoided.

The RBT has confirmed in discussions that the consolidation regime is not intended to lead to the allocation and possible quarantining of expenditure, particularly interest. The legislation will need to specifically address this point.

Groups would prefer to be able to choose between aggregating individual entity tax returns and using modified equity accounts.

Consideration should be given to reducing the threshold for consolidation to less than 100%, as in the case of a number of comparable countries.

Rollover relief should be extended to entities that are CFC’s of Australian groups.

4. INTERNATIONAL

Snapshot of BCTR Members’ Positions

There is extremely strong support for the introduction of a concerted program of treaty re-negotiation.

There is equally strong support for improving the international competitiveness of the tax system by allowing streaming of offshore earnings directly to non-resident shareholders.

Strong support has also emerged for an extension of relief from double taxation of foreign source income by improving the creditability of foreign tax.

There is support for a tightening of thin capitalisation provisions on the understanding tha

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