The key change to corporate taxation announced in the Budget relates to the phased reduction in the corporate tax rate over a period of 11 years. However, Treasury also announced some minor amendments to the application of the income tax consolidation rules (which will have potential application to M&A transactions), and the simplification of certain complex tax rules which will be of significant benefit to small business and private groups.
A turnover-based phased reduction in the company tax rate
The Federal Government announced plans to reduce the company tax rate to 25% over the next 11 income years.
These measures will be phased in, commencing with a reduction in the company tax rate from 28.5% to 27.5% for small business entities (those with turnover of less than $10 million) starting from the 2016-17 income year. The reduced rate will then apply to progressively increasing turnover thresholds, such that by the 2023-24 income year all companies should be paying 27.5% tax, reducing further to 25% by the 2026-27 income year. The below graph provided on the Budget website helpfully explains the phased approach:
Click here to view graph.
The Budget Papers contemplate that “franking credits will be able to be distributed in line with the rate of tax paid by the company making the distribution”, which could be expected to complicate franking account compliance. “Top up” tax will likely be required to be paid by Australian companies in receipt of franked dividends paid by lower tax rate companies, and in the inverse, corporate shareholders may potentially receive dividends franked to a higher rate than they are immediately able to pass on to their shareholders.
These measures are estimated to have a $2.7 billion cost to the revenue over the forward estimates period.
Potential amendments to the deemed dividend rules in Division 7A
Division 7A of the Income Tax Assessment Act 1936 contains measures that apply to treat certain benefits (such as low /no interest rate loans, forgiveness of debts and certain payments) provided to shareholders in private companies as though they were assessable unfranked dividends. Under the banner “Less red tape for business”, the Government announced that they would make targeted amendments to these complex rules.
With a proposed commencement date of 1 July 2018, and an unquantifiable cost to the revenue over the forward estimates period, the Government announced they will consult with stakeholders to develop targeted changes to simplify Division 7A, with the stated intention of including:
- a self-correction mechanism providing taxpayers whose arrangements have inadvertently triggered Division 7A with the opportunity to voluntarily correct their arrangements without penalty;
- new safe harbour rules, such as for use of assets, to provide certainty and simplify compliance for taxpayers;
- amended rules, with appropriate transitional arrangements, regarding complying Division 7A loans, including having a single compliant loan duration of ten years and better aligning calculation of the minimum interest rate with commercial transactions; and
- technical amendments to improve the overall operation of Division 7A.
These changes draw on numerous recommendations made by the Board of Taxation review into Division 7A. Any changes to provide greater certainty in relation to Division 7A will be welcomed by private company groups, which often struggle with the complexity of the law in the context of many ordinary commercial transactions.
Income tax consolidation treatment of deductible liabilities
In the 2013-14 Federal Budget, the then Government announced measures aimed at “closing a loophole” relating to the double counting of liabilities that could give rise to a future income tax deduction by deeming an amount of assessable income to the head company of the joined group. Broadly, Treasury was concerned that taxpayers were able to double count deductible liabilities, as the accounting value of the deductible liability was both partially included in the cost base of acquired assets, and also gave rise to an income tax deduction when paid. The most common example of a deductible liability is employee related liabilities (eg, annual leave and long service leave).
Taxpayers (and their advisers) were quick to point out that in the majority of arm’s length transaction scenarios there was no specific double benefit being obtained by the joined group, as typically any tax cost base benefit resulting from the deductible liabilities was allocated to goodwill – which is not amortisable for income tax purposes and is usually only of benefit in calculating capital gains on an ultimate disposal of the entire business.
Treasury seems to have (at least partially) heeded the call from industry participants, as the start date for the measures has been deferred from 14 May 2013 to 1 July 2016, and they have been amended in their ultimate operation. Instead of recognising deemed assessable income over the first 4 years after acquiring an entity with deductible liabilities, the modified approach involves denying the inclusion of the deductible liabilities in the cost base of assets.
In the context of M&A, the period since 14 May 2013 up to this announcement in the Budget has been relatively uncertain in relation to future deducible liabilities, as the deemed assessable income can often represent a material deal cost (particularly for labour force intensive target companies). The certainty that this measure represents for many already completed deals will no doubt be welcomed, and may potentially result in many groups revisiting past transactions and assumed tax outcomes.
Deferred tax liabilities in income tax consolidation
In September 2012, the Board of Taxation released a Discussion Paper that identified a mismatch between the commercial and tax treatment of deferred tax liabilities under the income tax consolidation rules. According to that Discussion Paper, the “deferred tax liabilities give rise to over taxation for the vendor consolidated group when an entity is sold. Where the deductible liability ceases within the purchaser consolidated group, deferred tax liabilities give rise to under taxation.”
Accordingly, and with application to transactions from the date amending legislation is introduced in Parliament, deferred tax liabilities will no longer be included in income tax consolidation entry and exit tax cost-setting calculations.
Broadening the securitised asset measure
The Government proposes to extend the application of the 2014-15 budget measure Closing Loopholes in the Consolidation Regime – securitised assets to non-financial institutions with securitisation arrangements. This will ensure that the same treatment applies to liabilities arising from securitisation arrangements within both financial and non-financial institutions. These liabilities will be disregarded if the relevant securitised asset is not recognised for tax purposes. The change will apply to arrangements commencing on or after 7.30pm AEST on 3 May 2016 with transitional rules applying to arrangements commencing before this time.
The measure was originally introduced because of unintended consequences which arose as a result of securitisation arrangements under the entry and exit tax consolidation cost setting process. These processes resulted in a double benefit being recognised in respect of securitisation related liabilities on entry of an entity into a tax consolidated group and on exit of an entity from a tax consolidated group, the double recognition of liabilities gave rise to potentially significant tax cost base reductions which did not reflect the economic outcomes for the seller and in some instances could result in material additional tax liabilities.
Taxation and financial arrangements – regulation reform
The Government proposes to reform the taxation and financial arrangements (TOFA) rules to reduce the scope, decrease compliance costs and increase certainty through a redesign of the TOFA framework. The simplified rules are intended to apply to income years on or after 1 January 2018.
The four key components of the proposed measures are as follows:
- A greater alignment with accounting, intended to strengthen and simplify the existing link between tax and accounting in the TOFA rules;
- A simplified version of the accruals and realisation rules which are intended to reduce the number of taxpayers affected by TOFA and reduce the number of arrangements where spreading of gains and losses is required;
- A new tax hedging regime which is easier to access, covers more types of risk management arrangements and removes the direct link to financial accounting; and
- Simplified rules for the taxation of gains and losses on foreign currency to preserve the current tax outcomes but streamline legislation. It is intended that the new framework will remove the majority of taxpayers from the TOFA rules and provide lower compliance costs and greater certainty while reducing the distortions in decision making. In addition to the above the Government intends to legislate certain previously unannounced measures relating to TOFA.
Increasing the small business entity turnover threshold
The Government will increase the small business entity turnover threshold from $2 million to $10 million from 1 July 2016. The $2 million turnover threshold will be retained for access to the small business CGT concessions and access to the unincorporated small business tax discount will be limited to entities with turnovers of less than $5 million.
Increasing the unincorporated small business tax discount
The Government will increase the tax discount for unincorporated small businesses incrementally over 10 years from 5% to 16%. The tax discount will increase to 8% on 1 July 2016 and remain constant at 8% for 8 years but will increase to 10% in 2024-25, 13% in 2025-26 and reach a new permanent discount of 16% in 2026-27. This is designed to coincide with staggered cuts in the corporate tax rate to 25%. The current cap of $1,000 per individual for each income year will be retained.
The tax discount applies to income tax payable on business income received from an unincorporated small business entity. Access to the discount will be extended to individual taxpayers with business income from an unincorporated business that has an aggregated annual turnover of less than $5 million.
Asset backed financing arrangements
The Government proposes to remove barriers to the use of asset backed financing arrangements which are supported by assets such as deferred payment arrangements and higher purchase arrangements. It is intended that the tax treatment of such arrangements will be clarified so that they are treated in the same way as financing arrangements based on interest bearing loans or investments. The intention is to provide access to more diverse sources of capital in Australia under this measure. The measure is proposed to apply from 1 July 2018.