The Treasurer has delivered the 2012-13 Budget. As part of a concerted effort to ensure a budget surplus (of $1.5 billion), the promised company tax cuts have been scrapped and the tax burden for foreign investors has been increased, making certain types of investments and investment structures less attractive for foreign investors.

Foreign investors to bear the burden

MIT withholding tax rate increased from 7.5% to 15%

The Government will increase the Managed Investment Trust (MIT) withholding rate from 7.5% to 15%, with effect from 1 July 2012, for fund payments made to addresses in listed exchange of information (EOI) jurisdictions. This doubling of the tax rate for investors in EOI jurisdictions will have a significant impact on the attractiveness for foreign investors of using MITs to invest into Australian real estate.

We recommend that non-residents holding Australian assets through MIT structures consider whether a MIT remains the most appropriate structure for their investments.

Removal of CGT discount for non-resident individuals

The Government will remove the 50% capital gains tax (CGT) discount for non-residents on capital gains accrued after 7:30 pm on 8 May 2012. Broadly, the discount previously applied to non-resident individuals who held CGT assets for at least 12 months.

This will have a detrimental impact on foreign individuals investing in Australian real estate. Australian real property is one of the few asset classes subject to CGT in the hands of non-residents. Consequently, the principal effect of this change will be to reduce the attractiveness of Australian real estate for foreign individuals.

We recommend that non-residents with assets that may be affected obtain a market valuation of their assets as at 8 May 2012 to ensure that any discount available – for increases in the value of their assets up to 8 May 2012 – is not also denied.

Marginal tax rates for non-resident individuals increased

Marginal tax rates for non-resident investors will also increase from 1 July 2012. Currently, income below $37,000 is subject to a 29% marginal tax rate, increasing to 30% for income up to $80,000. From 1 July 2012 the first two marginal tax rate thresholds will be merged creating a 32.5% tax rate applicable to taxable income below $80,000. From 1 July 2015 the tax rate increases to 33%.

Fringe benefits tax – reform of LAFHA and benefits may adversely affect expatriates

The Government has announced that it will reform the tax concession for living away from home allowance (LAFHA) and benefits. The reforms aim to stop employers from being able to provide the tax concession to employees who are not maintaining a second home, or are maintaining two homes indefinitely. This measure would:

  • limit access to the tax concession to employees who maintain a home for their own use in Australia (that they are living away from for work); and
  • allow the tax concession for a maximum period of 12 months in respect of an individual employee for any particular work location.

This measure will not affect certain aspects of 'fly-in fly-out' arrangements and travel and meal allowances.

While these changes may apply to certain resident taxpayers, they are more likely to affect non-residents coming to Australia. A LAFHA is an attractive tax free component of most employment packages offered to non-residents moving to Australia. These additional requirements may make it more difficult to attract expatriates to Australia to work.

The reforms will apply from 1 July 2012 for arrangements entered into after 7:30 pm on 8 May 2012, and from 1 July 2014 for arrangements entered into prior to that time.

M&A transactions may be affected by scrip for scrip roll over amendments

The Government has announced that they will strengthen the integrity of the scrip for scrip roll over provisions.

The changes will ensure that taxpayers cannot:

  • avoid the scrip for scrip roll over integrity provisions by holding interests to acquire ownership rights, such as convertible preference shares, rather than the underlying shares; and
  • defer indefinitely the CGT liability that would have otherwise arisen under the integrity provisions for the on-sale of the target entity by the acquiring entity.

The changes will also strengthen the integrity provisions by:

  • broadening the scope of the rules that apply to intra-group debt to cover debts owed to group entities other than the head entity;
  • removing the CGT exemption for the repayment of such debts (as it undermines the effectiveness of the integrity provisions); and
  • ensuring that the integrity provisions apply appropriately to trusts.  

These changes will have effect from 7:30 pm on 8 May 2012.

Tier 2 capital instruments — certain instruments to be treated as debt

The Government has proposed more amendments to the "debt equity rules" – provisions designed to characterise various forms of financial instruments as debt or equity for tax purposes by reference to their commercial substance – as opposed to focusing solely on their legal form.

The changes will ensure that – on commencement of the Basel III capital reforms from 1 January 2013 – certain types of Tier 2 regulatory capital instruments issued by ADIs, and certain other related bodies regulated by the Australian Prudential Regulatory Authority, will be treated as debt for tax purposes where there is a risk they would have otherwise been treated as equity and non-deductible.

Definition of limited recourse debt to be amended

The Government has announced that it will amend the definition of "limited recourse debt" to clarify that it includes arrangements where the creditor's rights to recover the debt are effectively limited to the financed asset or security provided.

This will ensure that tax deductions are not available for capital expenditure financed by limited recourse debt where the debtor is not fully at risk in relation to an amount of capital expenditure and does not make an economic loss.

This measure will have effect from 7:30pm on 8 May 2012.

Limited loss carry-back

As previously announced, in 2012-13, companies and entities that are taxed like companies will be able to carry-back up to $1 million worth of losses incurred in that year to get a refund against tax paid in 2011-12. From 2013-14 and later years, tax losses can be carried-back by eligible companies and offset against tax paid up to two years earlier. This measure may provide eligible companies with a cash benefit of up to $300,000 a year.

This measure will only apply to revenue losses, will be subject to integrity rules, and will be limited to a company's franking account balance.

Bad debt deductions to be denied in respect of related party financing

The Government has announced that a creditor will not be entitled to a tax deduction for a bad debt written off where the debtor is a related party not in the same tax consolidated group effective from 8 May 2012. Correspondingly, the gain made by the debtor will not be taxed.

This is to ensure a more consistent tax treatment for bad debts between related parties irrespective of whether they are members of a tax consolidated group.

Tax reform road map released

The Government has released a tax reform road map for the next ten years with a particular focus on reducing the complexity of the current tax system. In addition to some of the other measures announced as part of the Budget, some additional proposed tax reforms include (some of which were previously announced):

  • reducing disincentives for business to invest in long term infrastructure projects of national significance, by introducing an uplift allowance so that the value of tax losses is preserved over time and exempt such tax losses from the continuity of ownership test and same business test;
  • phasing down interest withholding tax paid by financial institutions over time to potentially nil, to improve competition in the domestic banking sector. In particular, reducing the rate of withholding for foreign bank branches which borrow from their overseas head office to 2.5% in 2014-15 and to zero in 2015-16, and for other financial institutions which borrow from offshore retail deposits, down to 7.5% in 2014-15 and to 5% in 2015-16;
  • increasing the tax-free threshold to potentially $21,000; and
  • consideration of cuts to the company tax rate.

Other measures

In addition to the highlights above, a range of other measures have been introduced.  Those measures cover personal tax, business tax, and superannuation. Further details are included in the Budget papers.