The 2018-19 Federal Budget confirmed many of the pre-Budget leaks. Scott Morrison’s third Budget is a budget of five key themes: tax relief, jobs, tax-related changes (or what the Treasurer inexplicably referred to as the Government living within its means), essential services guarantees, and safety measures. This insight will focus on the first three.
The Budget deficit for 2017-18 will be $18.2 billion, falling to $14.5 billion in 2018-19. This better than expected deficit position is being returned to voters in the form of modest tax relief to individuals, instead of providing longer term benefits to the whole community. Nonetheless, the Budget is expected to return to surplus in 2019-2020 ($2.2 billion) and increasing to $16.6 billion in 2021-22. With debt levels forecast to be at $629 billion in 2019-2020, the focus on the fabled surplus may have served to distract voters from the Government's overall debt level.
The Treasurer observed that the Government is not borrowing money to pay for everyday expenditure like welfare (in other words, the Government's debt is not "bad debt") and there has been $41 billion in Budget savings since the last election.
KEY BUDGET MEASURES:
The Budget’s central appeal to the masses is the tax relief for individuals. The Treasurer stated, “We cannot take a stronger economy for granted” and yet the Government is going to provide tax relief which will arguably have a small practical impact on most households, but could be better deployed to return the Budget to surplus sooner.
The tax relief measures comprise:
- A targeted tax offset from 1 July 2018 until 30 June 2022 for about 10 million individuals, who will receive up to $530 a year (about $10 a week) in addition to the existing offset, but only after individuals have lodged their tax returns;
- Increases to the offset from 1 July 2022 to up to $645 a year (about $12 a week); and
- Progressive movements in the tax brackets as shown by the bold blue text below:
In a clever and considered move by the Government, most of these “affordable and funded” costs of $13.4 billion (over 90% of the projected Budget deficit for the coming year, albeit spread over the forward estimates period) is expected to commence in 2019-20, the same year the Budget returns to surplus.
The change to the 32.5% tax bracket next year will provide a mere $135 a year (less than $3 a week) tax cut to 3 million people (it is currently unclear whether this is intended to include taxpayers in higher tax brackets as the change to the bracket will benefit all taxpayers above the changed bracket). The changes in 2022-23 will provide up to $1,350 per year (about $26 a week). The changes would mean, on the Government’s projections, that around 94% of individual taxpayers would have a tax rate of no more than 32.5%.
However, more than just about tax cuts, there are changes around the Medicare Levy too. The principal one, announced prior to the Budget, is retaining the Medicare Levy at 2%, instead of increasing it to 2.5%, as originally planned for next year. In addition, the low-income thresholds will be increased by what appears to be consumer price index increases.
The Budget also provides several measures targeted at older Australians. They appear to be aimed at aggrieved baby boomers who would be adversely impacted by the Labor policy of limiting franking credit refunds.
Pension loans scheme
The Pension Loans Scheme is available to certain retirees who need extra cash for a short time or an indefinite period. Broadly, Australian residents aged 65 or older who satisfy income and assets tests but own real property in Australia (which is used as security) are eligible retirees.
Under the current scheme, eligible retirees receive non-taxable fortnightly payments that accrue compound interest of 5.25%. The maximum amount that can be borrowed will increase from up to 100% to up to 150% of the aged pension and will be extended to be available to all retirees of pension age, not just part rate pensioners.
Work Bonus program
Under the Work Bonus program, aged pensioners can currently earn up to $250 a fortnight without any reduction of the fortnightly pension payments they receive. The $250 fortnightly cap will increase to $300 which equates to $1,300 each year.
The Budget does not propose a tax cut for businesses and certainly not the top end of town. Clearly, the Government is mindful of community sentiment towards big business. However, the Treasurer did call for the implementation of the Government’s enterprise tax plan, which would involve a tax cut for big businesses, with legislation currently before the Senate.
KEY BUDGET MEASURES:
There are several measures targeted at increasing jobs through growth and spending in various sectors, with particular focus on small and medium sized businesses.
Extending the instant asset write-off
Inevitably, the Government will extend the instant asset write-off for most asset purchases up to $20,000 for businesses with an aggregated turnover of up to $10 million. Regrettably, the extension is only for one year, instead of being a permanent feature of the tax law. This will no doubt mean more policy jockeying next year.
The Government will continue its 10 year rolling $75 billion infrastructure plan, with investment across the whole nation on significant infrastructure projects, mainly centred around transport.
Federal Budget Infrastructure allocation 2017/18 - 2018/9
In addition to the infrastructure plan, two new road traffic-focussed measures were announced:
- $1 billion for an Urban Congestion Fund to help States fix pinch points and improve traffic flow and safety – we suspect this will be a much sought after pool of funds!
- $3.5 billion for the Roads of Strategic Importance program to upgrade key road freight routes and help support regional economies.
Public technology infrastructure
The final key infrastructure measure is a $2.4 billion investment in public technology infrastructure that will benefit the community at large, including supercomputers, satellite imagery, accurate GPS, technology improvements for the Bureau of Meteorology, research into artificial intelligence, and (interestingly) a space agency!
Other measures to increase jobs include:
- $250 million extra for the Skilling Australians Fund;
- Support for medical research projects, new diagnostic tools, clinical trials of new drugs, scientific collaboration and development of new medical technologies that can be exported; and
- $500 million investment over 10 years by the Medical Research Future Fund on genome research.
KEY BUDGET MEASURES:
There are several tax-related changes of interest, some of which have been announced previously. In his speech, the Treasurer warned “If we make the wrong calls, other countries will ‘cut our lunch’.” We have previously raised concerns about the way some of the measures are targeted against foreign investors and multinationals. As with all measures, the devil is in the detail and we await draft legislation to see how the Government will manage this tricky balance.
Research and development
At long last, the much anticipated research and development (R&D) changes are here. The following changes will apply from 1 July 2018:
It is important to note clinical trials will not count towards the above caps.
The Government has also introduced an "incremental intensity" test for larger businesses – a twist on the "intensity threshold" recommended under the 2016 Review of the R&D Tax Incentive. Intensity is calculated based on R&D expenditure as a proportion of total business expenditure. The mantra is simple: the greater the proportion of your business that comprises of R&D, the more your business will be rewarded. In undertaking the intensity calculation, it is unclear whether a claimant should consider total business expenditure as a proportion of its global group or just Australian operations. If it is the former, Australian R&D hubs of global groups may be ineligible for higher R&D premiums.
Masked in the Treasurer's speech are hints that broader changes are on the horizon so only expenditure that is "over and above what others would just do anyway" would be eligible (that is, the so called "business as usual" expenditure would not be eligible R&D expenditure).
The measures are expected to save $2 billion over the next four years.
In addition, the Australian Tax Office (ATO) will be empowered to publicly disclose claimant details and R&D expenditure they have claimed – much like the current disclosure of company tax payments. There will also be a tightening up of extensions and amendment provisions, requiring taxpayers and advisers to be better prepared in order to claim R&D incentives.
The most interesting reform for multinationals is the measure dealing with the digital economy, and what will be the biggest change in a generation for many taxpayers and tax advisers. Although no details regarding the reform were released on Budget night, the Government will release a discussion paper in the coming weeks that will most likely address the matters raised in Action 1 of the October 2015 Base Erosion and Profit Shifting (BEPS) report on the tax challenges of the digital economy.
Some jurisdictions are ahead of the curve and have taken steps to tax businesses on their "fair share" of digital profits – albeit in different forms.
India introduced an Equalisation Levy of 6% in 2016, essentially a withholding tax, on specified digital services (such as online advertising revenue) provided by foreign e-commerce entities.
The European Commission (EU) has made a two-pronged proposal to tax profits of businesses in the digital economy. First, the concept of a "taxable digital presence" or virtual permanent establishment is proposed to be introduced for certain e-commerce businesses. This will allow profits to be allocated to (and ultimately taxed in) the jurisdiction where the business creates contracts or interacts with users, even if no physical presence exists. Secondly, the EU also proposes an interim tax on revenues from certain digital activities such as selling online advertising spaces and user data, as well as profits derived from digital intermediary activities such as online marketplaces.
We will have to wait to see how the consultation paper deals with the interaction of the proposed reforms with existing treaty obligations and integrity measures, such as the general anti-avoidance rules in Part IVA, the Multinational Anti-Avoidance Law (MAAL) and Diverted Profits Tax (DPT). The extent to which the reforms will increase the cost of doing business in Australia, and whether this will be passed on to consumers or disincentivise startups, will need to be considered.
The Treasurer noted that the “crack downs on multinationals have already brought around $7 billion a year in sales revenue by multinationals into our tax net.” Note – this is revenue, not taxable income, the basis on which tax is assessed! Unfortunately, he does not readily disclose this key piece of information, although other papers suggest the MAAL and the DPT, together with the Tax Avoidance Taskforce, have been instrumental in the ATO raising $5.2 billion in tax liabilities from large companies since July 2016.
Claiming there is more to be done, the Government reiterated its previously announced measures on stapled structures, to apply from 1 July 2019 (except for the thin capitalisation measure, which is to apply from 1 July 2018). The key features of these measures are:
- A 30% withholding tax on trading income distributed through a managed investment trust (MIT), except for Government-approved nationally significant infrastructure staples;
- Lowering the associate entity threshold under the thin capitalisation rules from 50% to just 10%;
- Limiting foreign pension fund withholding tax exemptions for interest and dividends to portfolio investments (up to 10%) only;
- Legislating the sovereign immunity exemption and limiting it to portfolio investments only; and
- Preventing investments in agricultural land from accessing the 15% MIT withholding tax rate.
Unfortunately, the Budget did not provide further details on these measures. Interestingly, the measures are only expected to raise $400 million over the forecast period. However, on the positive side, the Government will add a further 56 nations to the list of information exchange countries, enabling a larger pool of investors in MITs to access the 15% rate from 1 January 2019.
In addition to the thin capitalisation changes in the stapled structures measures, in an extremely sensible proposal, the Government will require valuations for thin capitalisation measures to be aligned with those for financial reports from 1 July 2019. Naturally, this will prevent companies inflating tax values when they are not prepared to present their financials in the same way.
Extending significant global entities to private entities
The MAAL and DPT measures currently apply to significant global entities. Their application will be extended from an entity which is a member of a group headed by a public company or a private company required to provide consolidated financial statements to include members of large multinational groups headed by private companies (that do not provide consolidated financial statements), trusts and partnerships, as well as investment entities from 1 July 2018. Further clarification may be required on the type of investment entities which will be captured.
Following the release of the Black Economy Taskforce's Interim Report in May 2017, draft legislation including certain measures targeting the use of technology to hide income and the understating or non-reporting of income by some contractors was introduced into Parliament in February 2018. The measures remain unpassed as at 8 May 2018.
The Government proposes to implement further recommendations of the Black Economy Taskforce, including:
- Outlawing large cash payments (more than $10,000) in business-to-business (other than those involving financial institutions) or business-to-customer transactions from 1 July 2019. We would like to see more detail on how this will be enforced.
- From 1 July 2019, expanding the taxable payments reporting system to include reporting of payments to contractors in the following industries: security providers and investigative services; road freight transport; and computer system design and related services. These are in addition to the existing building and construction, couriers and cleaning industries.
- Establishing a Black Economy Standing Taskforce to tackle the black economy through a cross-agency approach.
- Establishing a hotline for reporting black economy activities.
- Establishing mobile strike teams – tax has never been more exciting!
Expanding the no withholding, no deduction rules
The Government will deny deductions to businesses for wages and payments to contractors where the businesses have disregarded their withholding obligations, with effect from 1 July 2019. This is another black economy measure and akin to similar rules around interest and royalty withholding taxes.
The Elliott Ness measures
Measures will be introduced to better tax tobacco, prevent illicit tobacco markets and establish a multi-agency Illicit Tobacco Taskforce.
On the other hand, the Government will provide increased concessions to craft brewers and distillers:
- increasing the cap for the alcohol excise refund scheme from $30,000 to $100,000. The scheme refunds 60% of the excise paid; and
- extending the concessional draught beer excise rates to 8 litre or greater kegs (down from 48 litres).
Goods and Services Tax (GST)
Unsurprisingly, there were no major GST measures announced in this year’s Budget. The only specific GST measure announced was that there will be a levelling of the playing field in respect of the online supply of Australian hotel accommodation offshore and domestically from 1 July 2019. There were also certain other changes announced in the Budget that indirectly affect GST including measures to address illegal phoenixing and certain exemptions for overseas consulates.
These announcements are discussed in further detail below.
1. Online Australian hotel bookings – balancing of GST treatment
Effective from 1 July 2019, the Government will extend the GST net by ensuring that offshore sellers of hotel accommodation in Australia calculate their GST turnover in the same way as local sellers of hotel accommodation.
Presently, unlike GST-registered businesses in Australia, offshore sellers of Australian hotel accommodation are not required to include sales of hotel accommodation in their GST turnover (this concession has been in place since 2005). Consequently, these offshore sellers are often not required to register for and charge GST in respect of their sales of Australian hotel accommodation. The 1 July 2019 change will remove this GST concession recognising that in today’s environment where bookings by Australian consumers through offshore based tour operators are commonplace, it would be unfair for these offshore sellers to continue to benefit from this concession.
The measure will apply to online offshore sales of hotel accommodation made on or after 1 July 2019. Sales that occur before 1 July 2019 will not be subject to the measure even if the stay at the hotel occurs after this date. The unanimous agreement of the States and Territories is required before legislation to implement this measure can be enacted.
This measure is expected to produce an immaterial revenue gain of $15 million.
2. Director penalty notices
As part of the Government’s package of reforms to disrupt illegal phoenix activity in relation to corporates, the Government will extend the Director Penalty Regime to GST, making directors personally liable for the phoenixed company’s GST debts. The cost to the budget of extending the Director Penalty Regime is estimated to be $40 million over the forward estimates, as existing GST debt is collected and paid to the States and Territories.
3. Diplomatic and consular concessions
The Government has granted new access to refunds of indirect tax, including GST, fuel and alcohol taxes, under the Indirect Tax Concession Scheme for the diplomatic and consular representations of Cote d’Ivoire, Guatemala, Costa Rica and Kazakhstan in Australia. Each of these changes takes effect from a time specified by the Minister for Foreign Affairs. This measure is estimated to have a negligible cost to revenue, and a negligible decrease in GST payments to the States and Territories.
Film Location Incentive funding program
From 1 July 2018, a Location Incentive for certain big-budget film projects will be available that effectively increases the current Location Offset rate from 16.5% to 30%. The Incentive will be capped at $140 million (the existing Location Offset has no monetary limits) and is designed to support local production as well as encourage international blockbusters to be made in Australia.
Superannuation - Protecting Your Super Package
To the relief of the superannuation industry (and perhaps Australians generally), the Budget has not proposed any major superannuation reforms. This is unsurprising given the fact the industry has been subject to significant annual legislative reform for over a decade.
The Budget introduced the Government's "Protecting Your Super Package". The measures will take effect from 1 July 2019 and include a 3% cap on passive fees and a ban on exit fees on low balance super accounts of less than $6,000. The measures also propose an "opt in" framework for insurance arrangements with members aged under 25, inactive accounts and accounts of less than $6,000.
Other changes include:
- Increasing the maximum number of allowable members for new and existing self-managed superannuation funds (SMSF) from four to six.
- Allowing certain individuals with multiple employers to nominate which of their wages the superannuation guarantee should apply to. This should prevent employees unintentionally breaching the $25,000 contribution cap.
- A three-yearly audit requirement for SMSFs with a history of good recording keeping and compliance.
The Budget contains a number of integrity measures, including:
- Tax consolidation – A simplification of two previously announced consolidation rules, namely the anti-churning rules and deferred tax liabilities transitional rules.
- Taxation of financial arrangements (TOFA) – A correction of the interaction between the TOFA regime and the provisions dealing with an entity ceasing to be tax exempt. In addition, the start date of TOFA changes announced in the 2016-17 Budget has been deferred to provide more time for enabling legislation. Broadly, the changes propose to reduce the scope, decrease compliance costs, increase certainty and simplify the current operation of the rules.
- Vacant land deductions – Deductions for expenses associated with holding vacant land (with some exceptions) will be denied from 1 July 2019.
- Changes to trusts –
- Ensuring unpaid present entitlements (where a trust makes a company presently entitled to income but does not make an actual distribution) are subject to Division 7A from 1 July 2019. Previously announced Division 7A changes (all concessionary) are also set to be deferred to 1 July 2019.
- Extending anti-avoidance rules from 1 July 2019 for circular trust distributions – where one trust distributes to another which in turn distributes to the first in order to avoid tax.
- Clarifying that minor beneficiaries of testamentary trusts will be taxed at adult marginal tax rates only in respect of income that the trusts generate from assets of the deceased estate from 1 July 2019.
- Preventing MITs from applying the 50% capital gains tax discount prior to applying the withholding tax on distributions. Interestingly, this measure operates for payments from 1 July 2019!
- Tightening partnership concessions – Preventing partners in professional partnerships (although the measure does not appear limited to such partnerships) from accessing the small business capital gains tax concessions on assigning rights to future income from the partnership. It is interesting that the Government has not gone further given the ATO's withdrawal of its practices relating to such assignments in December 2017, almost implying that other benefits continue to be available.
- Individual's fame or image – Similar to the personal services income rules, ensuring that high profile individuals will not be able to take advantage of lower tax rates applicable to companies or other entities by licensing their fame or image to such entities from 1 July 2019.
Apart from increased funding or additional roles for the ATO described above, the ATO will also be empowered or funded to undertake further administration activities including:
- Increased focus on debt collections, both in terms of increasing the amount collected and the timeliness of collections.
- Addressing compliance issues for individual taxpayers, including income matching programs involving high net wealth individuals with foreign source income, processes for claiming personal superannuation contribution tax deductions, additional audits and prosecutions, income tax return pre-filling and educational material. Interestingly, there were no specific measures on work-related expenditure despite some pre-Budget discussions.
KEY ANNOUNCED BUT UNENACTED MEASURES
There are a number of key measures currently in the works that have been announced by the Government, in prior Budgets or otherwise, but are yet to be fully enacted:
Corporate tax rate
There are certain issues associated with changes to the corporate tax rate that still remain unresolved. These include:
- Whether legislation (currently before the Senate) will be passed excluding entities from accessing the reduced 27.5% rate where 80% or more of the entity's assessable income is of a passive nature; and
- Whether changes will be made to the imputation rules to provide relief for franking credits that will become “trapped” as a result of reductions to the corporate tax rate. With Australia’s aggregate franking account balance currently being over $300 billion, this issue will only be compounded if further reductions are implemented.
Implementing hybrid mismatch rules
The Government announced in the 2016-17 and 2017-18 Budgets, as well as the 2017-18 Mid-Year Economic Fiscal Outlook (MYEFO), that it would implement the OECD rules, aimed at hybrid mismatch arrangements. These schemes exploit differences in the tax treatment of an entity or instrument under the laws of different tax jurisdictions. In April 2018, the Government completed its consultation process on the draft legislation and associated explanatory materials.
Changes to the capital gains tax regime and housing affordability
The Bill introducing a number of capital gains tax related changes (announced in the 2017-18 Budget) is currently before the Senate. It will amend the principal asset test, remove the main residence exemption for foreign residents and introduce an additional 10 per cent capital gains discount on capital gains arising from dwellings used to provide affordable housing.
Toughening the MAAL
As announced in the 2017-18 Budget, the MAAL may soon be amended to prevent multinational entities using trusts and partnerships in artificial or contrived arrangements to avoid the taxation of business profits in Australia. The Bill is in the House of Representatives.
Giving force of law to the Multilateral Instrument (MLI)
The OECD MLI to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting was signed in June 2017. The Bill to bring the MLI into domestic law, that will enable Australia to swiftly modify its bilateral tax treaties to implement multinational tax avoidance measures, is currently sitting in the House of Representatives.
Introducing the similar business test
The Bill for the similar business test was introduced to the Senate in June 2017 and is yet to be passed. The more flexible similar business test will supplement the same business test and allow companies and trusts that have changed ownership to access losses if their current business is similar to their former business.
Implementing a new suite of collective investment vehicles
In February 2018, the Federal Government completed the consultation process on the draft Corporate Collective Investment Vehicle Bill and its explanatory materials. There is no word yet on the Limited Partnership Collective Investment Vehicle, which was the other vehicle announced in the 2016-17 Budget.
Enhancing access to asset backed financing
Diverse sources of capital should be more accessible once barriers to the use of asset backed financing arrangements are removed (such as deferred payment arrangements and hire purchase arrangements). This was announced in the 2016-17 Budget.