Tax reform blueprint
There is little disagreement that our tax system is too complex and cumbersome and should be streamlined and simplified. The review into Australia’s Future Tax System (Henry Review) has provided a comprehensive ‘blueprint’ for the future direction of our tax system to address some of the fundamental imbalances that exist within the current system. The existing tax mix will struggle to achieve revenue adequacy in the long term in the face of rising expenditures, especially as the population ages leading to a decline in workforce participation. Consumption taxes, which are the most efficient and sustainable types of tax, are widely regarded by tax policy experts to be an integral part of reshaping Australia’s future tax reform agenda.
As recommended in the Review, nuisance taxes should be removed and our reliance on income tax should be decreased, replaced by a shift towards consumption taxes to encourage savings and investment and to provide a more sustainable revenue source. Most of the nuisance taxes, which are inefficient, distortive and inequitable, are levied by state governments and reform in these areas will undoubtedly require an examination of the adequacy of state and territory revenues. As emphasised on numerous occasions by the IPA, the base and rate of the Goods and Services Tax (GST) must be included in the discussion on tax reform.
Potential to increase GST revenue
Consumption taxes such as the GST represent one of the most efficient and sustainable tax bases available, yet Australia’s GST base is relatively narrow (covering only 57 per cent of private consumption). In addition, Australia’s GST rate is low compared to the OECD average of 18 per cent. Increasing the base and rate of the GST is one of the options for addressing the fiscal imbalance between federal and state governments. GST revenues have grown over time and they represent a far more robust source of revenue that is more stable and less susceptible to market movements than income taxes. We acknowledge that appropriate compensatory measures for low-income households will be required due to the regressive nature of GST if this option is implemented.
Set the reform agenda in motion
While we acknowledge the significant challenges of recalibrating the existing tax mix towards a greater degree of reliance on consumption and other efficient taxes, the task of reform will only be achievable if the case for change begins to be made now well ahead of its intended implementation timetable. Recent experience has seen several examples of countries succeeding in effecting meaningful reform, notably New Zealand and the UK. Both these countries have been able to shift the tax burden to less mobile and less growth-damaging bases to support economic growth.
The current mining boom is ‘hiding’ our structural deficits and when it begins to decline there will be a need to revert to the non-mining sector which already pays higher rates of tax. The Henry Review and the Tax Forum have given us a strong foundation to progress tax reform and the ability to commence the process of discussing the recommendations in order to build support for a long-term tax reform plan.
Concessionary tax rate for small business income
Being the engine room of the economy, small business would benefit from a differential rate of income tax which reflects the disproportionate regulatory burden they face. Small business income received by individuals is subject to progressive tax rates that apply to all individuals who do not have the same regulatory burdens or exposure to risks as those who run small businesses. While there are small business tax concessions in existence, most only provide marginal tax relief.
The level of complexity facing small business in respect to taxation compliance has increased substantially over the last few decades. With the introduction and development of Fringe Benefits Tax (FBT), Capital Gains Tax (CGT) and the GST, the paid parental leave scheme and compulsory superannuation, our taxation system has become too onerous for most taxpayers requiring the need to engage a professional tax adviser. Over 95 per cent of businesses engage a tax practitioner to lodge their tax return.
There is also a significant investment of small business owners’ time in meeting the administrative requirements of the regulators, including reporting requirements. Other areas such as workplace laws, OHS laws, the increase to the superannuation guarantee (SG) rate from nine per cent to 12 per cent, carbon tax and so on, all add to the regulatory burden.
To address this imbalance, we propose a concessionary rate of tax for small business income. The small business income component of an individual’s total income should receive a tax offset to compensate for the regulatory burden and risks inherent in running a business. The rebate would simply reduce the effective tax rate on small business income which would otherwise be subject to the same progressive tax rates applying to employment income. A lower tax rate applying to all small businesses would be more equitable, efficient and cost-effective.
The proposal would operate on a similar basis to the existing entrepreneurs tax offset (ETO) which the Government intends to abolish from 1 July 2013. The ETO was an initiative set up to provide an incentive for small business in their early stages of development by offering them a tax offset of up to 25 per cent of the income tax attributable to small business enterprises (SBE) with a turnover of less than $75,000. The ETO entitlement was available to all business structures including companies and trusts. However, the ETO in its current form cuts out too early for it to be of any assistance for the majority of small businesses, other than to assist micro start-ups.
There is evidence to support the proposition that the majority of small businesses would prefer a lower tax rate than having a plethora of complex tax concessions which they may not be able to fully access. The proposal would provide impetus to the small business sector and can be used with other measures to address in part the two-speed or patchy economy.
Benefits of the IPA’s proposal
The removal of a host of existing and proposed small business tax concessions to flatten the tax rate applying to small business income can be used to fund the proposal being put forward by the IPA. This can be done by:
- rationalising and streamlining the current small business CGT concessions, as recommended by the Henry Review. The concessions are complex and require taxpayers to navigate a legislative maze and threshold conditions as well as additional conditions that relate to each of the specific concessions. Some of the existing concessions such as the 50 per cent reduction and the 15-year exemption are highly concessional and can eliminate any CGT liability when business owners exit their investment.
- replacing the Government’s proposal for small business to be able to claim up to $5000 as an immediate deduction for the purchase of motor vehicles with our proposal for a concessionary tax rate for small business. Not all small businesses benefit from the $5000 deduction, whereas all small businesses would benefit from a lower tax rate.
- reviewing the array of small business income tax concessions with a view to rationalising and streamlining existing concessions
- reviewing some of the existing FBT concessions to enhance efficiency and equity
- replacing the Government’s proposal to lower the corporate tax rate for small business with the IPA proposal. Given that less than one-third of small businesses use a corporate structure, this measure would not have benefited the majority of small business owners.
As the ETO framework is already in place it provides the administrative capability to implement the small business tax rate proposal in a relatively short timeframe. The IPA proposal represents a targeted form of assistance to the largest employer group in Australia and can be used to address the current imbalances that exist in our economy as well as boosting productivity and employment.
Treatment of tax losses for small corporate entities
The IPA has long advocated for a change in the treatment of tax losses and fully supports the review into the current tax loss rules by the Business Working Group. The current system treats gains and losses asymmetrically. Gains are taxed as they accrue while losses are not refunded but can be carried forward and used against future income subject to stringent loss rules. Losses incurred by sole traders and partnerships result in a considerable degree of loss utilisation as these entities are able to flow through their losses to owners without having to carry them forward to be used against future income.
While the current tax loss rules apply to all corporate tax entities, we believe there is merit in restricting the availability of loss carry-back arrangements to small businesses at first instance if budgetary constraints do not allow for an extension of such a measure more broadly.
Reforms are needed to deliver tax relief to struggling businesses facing structural changes in a volatile environment. Larger entities have greater ability to weather a ‘rough patch’ in financial performance or can apply losses to other parts of their business if they have diversified operations. Companies would be more willing to invest if they knew that if they subsequently make a loss they may be able to realise the (tax) benefit of that loss immediately. Our loss rules create disincentives for businesses to change as this could put their losses in jeopardy under the current loss utilisation rules. They can have the effect of locking companies into suboptimal operations and structures to protect the ability to use their carried forward losses in the future.
Small companies generally may have limited resources to cope with adverse trading conditions and may require short-term liquidity to meet day-to-day liabilities. This is the major shortcoming of the current tax loss treatment rules for small corporate businesses, that is, the inability to claw back previously paid taxes. Other countries provide such relief as part of their tax system which provides an automatic stabiliser during downturns.
Legal privilege for tax advice
The IPA supports the extension of legal privilege to tax advice provided by professional tax advisers. In 2007, the Australian Law Reform Commission (ALRC) conducted an inquiry into the operation of legal professional privilege in relation to the coercive information-gathering powers of various Commonwealth bodies. The report recommended establishing tax advice privilege to protect tax advice given by independent professional accounting advisers against the coercive information-gathering power of the Commissioner of Taxation. In response to this report the Government issued a discussion paper titled ‘Privilege in relation to tax advice’ in April 2011 and has yet to make any recommendations.
There is overseas precedent for extending legal privilege to accountants (eg, the US, UK and New Zealand), making Australia inconsistent with international jurisdictions. Consumers should have access to the same legal protections and safeguards regardless of whether they seek tax advice from a lawyer or an accountant. The system should encourage people to seek independent, objective advice, which should be protected.
The ATO has a non-statutory administrative arrangement (the accountants’ concession) that provides a narrow restrictive form of legal protection; however, this is often too narrow to offer adequate consumer protection.
The IPA’s preferred model is for the extension of legal privilege to registered tax agents who are members of professional accounting associations. The justification is premised on the fact that members of professional accounting bodies are qualified accountants who have undertaken further studies, hold a practising certificate and are held to higher professional and ethical standards than those who are not members of a professional accounting body. If the Government is not willing to add this further qualification then the IPA believes that legal privilege should be extended to all registered tax agents.
We can only hope that the tight fiscal constraints in the up coming budget do not de-rail progress on essential reforms which have long-term benefits.
