With a $40.8 billion forecast deficit for the 2010-11 financial year, this year's Budget deficit is $16.3 billion less than that expected a year ago. Further, this Budget is being handed down against a backdrop of a far more optimistic business climate than that which was prevailing at the time of last year's Budget. Forecast real GDP growth 3.25% is anticipated in 2010-11 and 4% growth in GDP is forecast for 2011-12. Despite this renewed optimism, the broader financial outlook remains somewhat unclear because of financial turmoil outside of Australia.
In this special Gilbert + Tobin tax publication, we outline the key tax measures which have been announced by the Government in the 2010-11 Budget.
We also consider some of the issues which businesses and taxpayers in general may wish to consider as they reflect on these measures.
Business Income Tax Measures
CAPITAL GAINS TAX (CGT) CHANGES
Demerger relief extended for certain demerger groups
The Government has announced that it will correct a technical defect in the law that currently prevents certain groups from being eligible for demerger rollover relief for CGT purposes. Currently, demergers groups whose "head entity" is a corporation sole or a complying superannuation are unable to access the tax concession.
The proposed measure involves excluding corporations sole or complying superannuation entities from being members of a demerger group. The measure will apply with effect from 7.30 pm AEST on 11 May 2010.
This measure will be of particular interests to corporate groups headed up by a corporation sole or a complying superannuation entity (and their shareholders) which up until now were not able to access the demerger concession. As a result, any transfer of shares in lower tier companies to their shareholders was subject to CGT and caused a significant impediment to their restructure.
Share sale facilities and their interaction with CGT rollovers
The Government has announced the amendment of various CGT rollovers to ensure restructures using a share or interest sale facility for foreign interest holders are not adversely affected by the use of such a facility.
Share or interest facilities are frequently used in acquisition transactions because of the desire to avoid complying with foreign prospectus and securities laws requirements in many jurisdictions around the world where the shareholders may be resident. For example, a scrip offer may be made to holders in a handful of jurisdictions and the remaining scrip is allocated to an agent which then disposes of the shares on market with the proceeds distributed to affected shareholders. Technical concerns have existed as to whether the use of these arrangements jeopardised the availability of rollover relief for Australian resident shareholders.
The amendments will ensure that the use of a share or interest sale facility from 7.30pm on 11 May 2010 will not be affected by the use of such facilities. It is noteworthy that the proposals affect a number of CGT rollovers.
Look-through treatment of earn-out arrangements
The Government has announced amendments to the CGT provisions to ensure that sale proceeds structured under an earn-out arrangement are treated as if they related to the underlying business assets which have been disposed of.
Under the current law, the market value of the earn-out right is treated as having being received when the underlying asset is sold. However, anomalous outcomes can arise where the subsequent payments under the earn-out right differ from the amount estimated when the asset was disposed of. In circumstances where the payments received are greater than those originally estimated, this has resulted in taxpayers being denied the ability to access certain CGT concessions such as the discount CGT treatment and the small business CGT concession.
Under the proposed measures, the earnout right will be deemed to be related to the disposal of the underlying business asset. This will ensure that the relevant nexus remains with the appropriate taxing provisions and so entitling the affected taxpayer to obtain the relevant concession.
The measures are intended to apply from the date of Royal Assent of the enabling legislation. However, transitional provisions will ensure that certain arrangements since 17 October 2007 may be affected.
This measure should be of particular benefit to small business owners who previously were not inclined to structure the sale of their business assets using an earnout arrangement because of the unintended CGT consequences which would arise as compared to them having received upfront consideration for the sale of the business assets. It remains to be seen whether the change applies equally to reverse earn-out arrangements.
Extension of CGT rollover relief on conversion of certain indigenous incorporated bodies to companies
The Government has announced a rollover which would permit certain Aboriginal and Torres Strait Islander incorporated bodies formed under Corporations (Aboriginal and Torres Strait Islander) Act 2006 to convert to a company regulated by the Corporations Act 2001. Without this rollover, it was not possible for an indigenous incorporated body to transfer its incorporation without triggering immediate CGT consequences.
This measure would be of particular interest to those indigenous incorporated bodies looking to be incorporated under the Corporations Act 2001 (Cth).
MEASURES AFFECTING FINANCIAL INSTITUTIONS
Phase down of interest withholding tax paid by financial institutions
As recommended in the Australia's Future Tax System Final Report (the Henry Review), the Government has decided to proceed with a phase down of interest withholding tax on interest paid by financial institutions on their offshore borrowings. The measure will apply from the 2013-2014 income year. Initially, there will be reduction of the interest withholding tax rate down to 7.5% (down from the current 10% rate). This will then be reduced to 5% from the 2014-2015 income year. The Government has announced that it wishes to reduce the rate to nil, subject to its medium term fiscal objectives.
The Government has also announced that foreign bank branches "borrowing" from their overseas head offices will also have their interest withholding tax reduced on imputed interest. Like with domestic financial institutions, the phase down will only commence from the 2013-2014 year – initially down to a rate of 2.5% (down from the current rate of 5%). However, the amounts will be completely exempt from interest withholding tax from the 2014-2015 income year.
Importantly, the phase-down will not apply to retail deposits from non-resident account holders.
The announced phase-down of interest withholding tax is a welcome move but falls short of the Henry Review's recommendation of the complete abolition of interest withholding tax on interest paid by Australian financial institutions. Also, the considerable time which will pass from the announcement of the measure to the proposed start date will mean that the potential benefits of banks being able to tap cheap deposits sitting overseas to pass on to their Australian borrowers will not materialise for a some years.
MEASURES AFFECTING THE FUNDS MANAGEMENT INDUSTRY
Extending the definition of managed investment trust
The Government has announced further changes to the definition of a managed investment trust (MIT) for withholding tax purposes.
The MIT withholding regime will now cover wholesale managed investment schemes and certain widely-held pooled superannuation trusts.
The Government has also announced that trusts which have a single member will be now be able to qualify for the managed investment trust regime provided that that member is itself a specified widely held entity.
These measures will affect those entities starting from the first income year on or after the date of Royal Assent of the enabling legislation.
The announced measures will significantly broaden the scope of the MIT withholding rules. Further, as those rules are also interrelated with the MIT deemed capital account provisions, the measures will ensure that entities that were previously not able to qualify for that regime will now qualify for that regime as well. The announcement will no doubt result in the MIT being used as a vehicle of choice for foreign funds looking to invest in Australia.
It appears that the announced measure is related to the Exposure Draft legislation released on 16 April 2010 and the Assistant Treasurer's press release dated 10 February 2010. These both indicated the amending legislation was intended to apply from 1 July 2010. In order for the Government to meet this deadline, the legislation will need to be enacted before 30 June 2010.
Government to consult on new investor manager regime
Following on from of the Australian Financial Centre Forum "Australia as a financial centre: Building on our strengths" (the Johnson Report) issued in January of this year, and as well as the Henry Review, the Government will review its long term tax policy associated with the taxation of funds under Australian management.
The Government has announced that it will consult in two stages. The first stage involves the issue of a Consultation Paper on the Investment Manager Regime (IMR) concerning the tax treatment of foreign conduit income paid to non-residents. The main aim of the IMR will be to ensure that non-residents investing in foreign assets will face no further tax on their investments when using Australian fund managers than what they would have had they used non-Australian managers.
The Consultation Paper will not address the taxation of non-resident investment in Australian assets. This will be referred to the Board of Taxation as part of a broader review into the taxation of collective investment vehicles (CIVs). The Board of Taxation will be charged with:
- reviewing the continued appropriateness of current collective investment vehicles such as the Venture Capital Limited Partnership to see if they are still necessary and consistent with the Government's objectives.
- considering the appropriateness of extending tax "flow-through" treatment to other collective investment vehicles taking into account developments in the MIT tax framework.
The Budget announcements are a welcome development. Since the announcement of the MIT elective capital account regime in last year's Budget, there has been considerable discussion within the industry of benefits associated with using currently endorsed tax flow through vehicles such as Venture Capital Limited Partnerships (VCLPs) and Early Stage Venture Capital Limited Partnerships (ESVCLPs). Of particular interest will be the impact of this review on existing structures. For instance, if the VCLP and ESVCLP regimes were to be abolished, the deemed capital account treatment of carried interests under those regimes would also cease to apply. We note that the proposed MIT capital account rules specifically provide for a deemed revenue account treatment of carried interests and this policy may be extended to any new flow-through vehicles recommended by the Board of Taxation review.
TAX CONSOLIDATION MEASURES
The Government has announced a number of measures related to the tax consolidation regime. These are outlined below along with some of the key implications for companies.
Calculation and collection of income tax liabilities
The proposed amendments to the rules relating to the calculation and collection of income tax liabilities from consolidated groups and multiple entry consolidated groups (MEC groups) will clarify:
- that the Commissioner may recover unpaid PAYG liabilities under the liability for payment rules, effective from 11 May 2010;
- the liability for payment of tax rules applies to MEC groups, effective 11 May 2010;
- that an entity that pays its contribution amount under a tax sharing agreement can leave a consolidated group or MEC group clear from any further liability with effect from the 2004-2005 income year;
- that where there is a change in the provisional head company of a MEC group during an income year, any PAYG instalments paid by the former provisional head company on behalf of the group are attributed to the group with effect from 1 July 2002; and
- clarifying that relevant parts of the tax law apply to MEC groups in the same way they apply to consolidated groups, effective from 1 July 2002.
While these amendments are welcome refinements to the tax consolidation provisions, they do not represent significant changes from a policy perspective and would generally accord with existing practice of most companies.
Changes to the application dates of previously announced measures
While the Budget Papers do not provide specific details, the Government has announced that the dates of effect of various measures affecting the consolidation regime are to be modified to ensure that consolidated groups are not disadvantaged by retrospective changes to the law. The relevant measures are those referred to in the press release of 13 May 2008 issued by the Treasurer and the then Assistant Treasurer and Minister for Competition Policy and Consumer Affairs.
Non-membership equity interests
In what is a welcome technical modification to the tax consolidation rules, non-membership equity interests issued by an entity that joins or leaves a consolidated group are to be taken into account under the tax cost setting rules effective from 10 February 2010. However, taxpayers will have the option to apply the measure with effect from 1 July 2002.
The issue with these types of interests in the past has been that they may not form part of the step 1 calculation for the purposes of computing the allocable cost amount (ACA) of a joining entity and similarly may not fall within the step 2 calculation which is about liabilities of joining entities being taken into account in the ACA calculation. Not only will this measure have effect for entry into a consolidated group but will also apply when an entity leaves a consolidated group. This means that a tax cost will arise for non-membership equity interests owed to members of the group which the entity is leaving. Furthermore, if the leaving entity has issued non-membership equity interests to entities that are not members of the group, this measure will ensure that the tax costs of the membership interests held by the group are not overstated by the value of those interests.
Refinements to improve the operation of the consolidation regime
The Government has announced that it will amend the consolidation regime by:
- simplifying the approach to making various consolidation choices effective from 1 July 2002;
- allowing a company that was a member of a MEC group since formation to be eligible to be appointed as the provisional head company of the group with effect from 1 July 2002;
- as a transitional rule, allowing consolidated groups to make a choice to preserve the CGT treatment of gain or loss that arises prior to 23 August 2006, when an amount received in payment of a foreign currency trade receivable exceeds its tax cost setting amount, effective from 1 July 2002; and
- amending the formula for working out the adjustment for inherited deductions under the tax cost setting rules that apply when an entity leaves a consolidated group, effective from 10 February 2010.
While there are no details provided in the Budget Papers relating to these changes, the Budget Papers state that the measures will ensure that a choice to form a consolidated group remains effective despite a defect in the notice to advise the Commissioner of the choice.
Overall, these measures represent technical refinements to the legislation rather than any significant policy shifts.
Goods and services tax (GST)
The underlying themes of the GST announcements in the Budget are "simplification" and "clarification", which are themes which were present in the GST announcements in last year's Budget. This year's announcements consolidate the various reviews conducted by Treasury after last year's Budget in response to the various recommendations of the Board of Taxation from its review of the application of GST to various transactions.
In summary, the major GST announcements in the Budget include the following:
(a) restructuring the margin scheme provisions applicable to certain supplies of real property to give prominence to the main principles underlying those provisions, with exceptions set out separately and insert objects clauses for the key provisions.
This restructure however is not intended to alter the current principles or objects of the margin scheme provisions. Time will tell whether this move towards a principles based approach will reduce the complexities and uncertainties of the existing provisions which have been the subject of numerous piecemeal amendments since their enactment.
(b) amending the financial supply provisions by:
- increasing the threshold above which registered taxpayers need to interact with the financial supply provisions (otherwise known as the "financial acquisitions threshold") from $50,000 to $150,000; and
- increasing the types of acquisitions that can qualify as "reduced credit acquisitions" to include for example, lender's mortgage insurance and transactional fraud monitoring services. However, new provisions of an anti avoidance nature will be introduced to reduce the opportunities of taking advantage of the reduced credit acquisition concession by bundling services together (such as trustee and responsible entity services).
There is however no proposed change to the current reduced input tax credit rate of 75%.
(c) amending the cross-border provisions to significantly reduce the number of non residents who are unnecessarily drawn into the GST system through:
- limiting the types of supplies that would have a relevant "connection with Australia" so as to reduce the supplies made by non residents that would be subject to GST;
- expanding the reverse charge provision in respect of a supply made by a non resident so that the recipient of that supply is liable for the payment of the GST on that supply;
- broadening the GST free rules in respect of exports of goods and services; and
- removing the need for some non residents to register for GST.
(d) amending the GST law to replace the current mechanism for exempting certain Australian taxes, fees and charges (otherwise known as the "Division 81 Determination") with a principles-based legislative exemption.
The proposed mechanism will mean that the GST treatment of such taxes, fees and charges will not be dependent on the item being listed in the Division 81 Determination which spans nearly 700 pages, but will be determined against a set of legislative principles.
It is proposed that announcements (a) to (c) inclusive will be effective from 1 July 2012 (subject to in the case of (b) and (c), the unanimous agreement of the States and Territories), but announcement (d) will be effective from 1 July 2011. It is intended that the Government will consult further with interested parties on implementing some of the changes proposed above.
Personal income taxation measures
Interest income 50% discount
In response to the Henry Review, which recommended providing a discount for income tax purposes on interest income from savings, and taking into account industry submissions from various bodies, the Government has decided to give individuals a 50% tax discount on up to $1,000 of interest income earned per financial year. For example, if an individual taxpayer derives $1,000 in interest, they will only include $500 in their taxable income.
Not only does this take into account interest earned on deposits held with banks, building societies or credit unions, as well as on bonds, debentures or annuity products, it also applies to interest income earned directly or indirectly such as via a trust or via a managed investment scheme.
This measure is clearly directed to encouraging community savings and to potentially open up the domestic pool of funds which banks can then lend to personal and business borrowers.
Individual taxpayers are to be provided with a standard deduction of $500 for work related expenses and the cost of managing their tax affairs from 1 July 2012
This amount will increase to $1000 affective from 1 July 2013.
It is not intended that the standard deduction precludes taxpayers with higher expenses deductible claiming the higher amount rather than the standard deduction amount.
It would seem that this simplicity for taxpayers will mean that taxpayers will be incentivised to rely on the use of a standard deduction. An interesting outcome of this measure may well be that Australian Taxation Office (ATO) audit activity is more focussed and directed at those taxpayers who claim deductions in excess of the standard deductions.
Personal tax rates
The Budget did not propose any changes to the currently legislated tax rates for 2010-11 as previously enacted.
Increase in the Medicare levy and Medicare levy surcharge low income thresholds
The Medicare levy low income threshold is to increase to $18,488 (an increase from $17,794) for singles, and to $31,196 (an increase from $30,025) for couples. For families, the additional amount of threshold for each dependent child or student will also be increased to $2,865 (an increase from $2,757).
The medicare low income threshold for pensioners below pension age will also be increased. The threshold will rise to $27,697 (an increase from $25,299) for the 2009-2010 year.
Raising of medical expenses rebate threshold
The medical expenses rebate threshold is to increase from $1,500 to $2,000 effective 1 July 2010. Furthermore, from 1 July 2011, the threshold is to be indexed annually in accordance with the CPI.
In addition to the announcements made in response to the Henry Review, the superannuation related changes announced in the Budget included the following.
Co-contribution matching rate reduced permanently to 100%
The Government has announced that it will permanently set the matching rate for the superannuation co-contribution at 100% and the maximum co-contribution that is payable in respect of an individual's eligible personal non-concessional superannuation contributions at $1,000. This means that previously legislated increases in the matching rate to 125% for 2012-13 and 2013-14 (and 150% for later income years) will not proceed should this measure be enacted.
This measure is clearly directed to encouraging community savings and to potentially open up the domestic pool of funds which banks can then lend to personal and business borrowers.
Furthermore, there will be a freezing for 2010-11 and 2011-12 of the indexation applied on the income threshold above which the maximum superannuation co-contribution begins to phase down. This means that the matching contribution of up to $1,000 for individuals with incomes of up to $31,920 in 2009-10 (phasing down for incomes up to $61,920) will have their thresholds frozen at the current levels for 2 years.
Other amendments proposed
Several other measures affecting superannuation were also announced including:
- minor amendments relating to excess contributions tax, and time limit for deductions;
- extending the range of benefits that are deductible by complying superannuation funds and retirement savings account providers to include terminal medical condition benefits; and
- providing CGT rollover for transfers by the proposed Commonwealth Superannuation Corporation of assets from the Military Superannuation Benefit Scheme to the Australian Reward Investment Alliance Investment Trust.
Miscellaneous tax measures
Increased regulation of Public Ancillary Funds
Effective 1 July 2011, the Government will introduce a new regulatory framework for public ancillary funds similar to that introduced in 2009 for private ancillary funds. This will prescribe legislative guidelines governing the establishment and maintenance of funds and provide the Commissioner with the power to impose penalties on trustees for breaching the guidelines. A transitional regime will also be introduced to facilitate the introduction of these new rules. A consultation process will also commence with the charitable sector in order to provide an opportunity to comment on the proposed measures.
Changes to film tax incentives
The Government has announced an improvement in the tax incentives afforded to Australia's film and associated post-production industry. It has announced that it will bolster the incentive by removing the need for productions valued between $15 million and $50 million to spend at least 70% of their production budgets in Australia. This was often a requirement which could not be met by multinational productions and accordingly those productions missed out on the location offset.
The Government has also announced the reduction in the post-digital and visual affects production threshold from $5 million to $500,000. Again, this will ensure that productions will now qualify where they previously would not have qualified because of the relatively high threshold.
Both of the announced changes are intended to apply from 1 July 2010.
Government to provide ATO with more funding to combat the cash economy
The Government has announced that it will provide the ATO with an extra $108 million over the next four years to deal with small business operators evading their taxation obligations by conducting some or all of their business in the cash economy.
The Government is expecting that this crackdown on the cash economy will result in an additional $500 million in fiscal revenue over the next four years.
Improvements for the tax running balance account provisions
The Government has announced it will provide the ATO with increased flexibility in the management of running balance accounts. The Government has also announced that it will commence paying interest where overpayments arise because of an amended franking deficit tax assessment.
The measures will commence on a date to be decided after public consultation.
Running balance accounts are the way that the ATO accounts for taxpayers' tax debts and refund entitlements.
The Government has announced that it will consult the community on the best way to simplify, improve and enhance the flexibility of running balance accounts and the associated provisions providing for the payment of interest on overpayments.
Hopefully any consultation will address the criticism of the ATO being unable to net off tax debts due in relation to one particular tax against a tax receivable in relation to another tax. This often results in the taxpayer being charged interest in relation to one particular tax even though they have an outstanding receivable in relation to another tax. Mismatches occur because interest paid on tax debts due is not the same as the interest which is paid by the ATO on amounts due to the taxpayer.