Forecasting a surplus in the 2020-2021 year, pre-announcement whispers of a 'Santa Claus' budget proved to be wishful thinking with a significant focus on taking a firmer stance on tax debts, 'improvements' to existing tax incentives and concessions and renewing commitments to past Budget announcements.
While there is limited change in the nature of comprehensive tax reform, there are a number of specific measures which will be significant for particular taxpayers, including small business as well as a number of targeted closing of perceived loopholes.
With an overarching theme of compliance in all areas of taxation (including significant expenditure promised to increase debt collection and to target individual and tax agent compliance), the most interesting announcements related to:
- a focus on trusts, including the application of Division 7A, circular distributions and testamentary trusts
- preventing sportspeople and high profile individuals licensing image rights, and stamping out Everett assignments for partners in professional practices
- eliminating deductions for certain vacant land to discourage land banking
- significant reorganisation of research and development incentive claims
- as always, some modest superannuation changes, and
- other measures in respect of small business, companies and individuals.
Naughty: Trusts under the microscope
With no further clarity on the targeted Division 7A amendments (loans from private companies) announced in the May 2016 Budget, this announcement instead focused on further integrity measures that clarify the operation of certain provisions under the ITAA36 including that:
- Division 7A will be strengthened to treat unpaid present entitlements (UPEs) as dividends unless they are structured as complying Division 7A loans or another exception applies (note that this is consistent with the current ATO approach but is likely to mean that going forward UPEs will be subject to Division 7A requirements 1 year earlier)
- specific anti-avoidance rules will be extended to apply to closely held trusts that engage in circular trust distributions to family trusts, and
- concessional tax rates available for minors receiving income from testamentary trusts will be limited to income derived from assets that are transferred from deceased estates or the proceeds of the disposal or investment of those assets.
The start date for these changes will not be until the 2020 tax year (from 1 July 2019). Additionally the announced broader reform of Division 7A based on Board of Taxation Recommendations which was scheduled to apply from 1 July 2018 has similarly been deferred for yet another year.
This means further delay and uncertainty as to which of the Board's measures will ultimately be introduced as law, and in particular leave small businesses that operate through trusts and are funding working capital with UPEs or loans from so called 'bucket companies' at a disadvantage to businesses operating in companies.
This may see a continuation of the trend of such business wishing to move to a cooperate structure.
Naughty: Crack down on Everett assignments
With immediate effect, partners that alienate their partnership income by creating, assigning or otherwise dealing in rights to the future income of a partnership will not be able to access the small business CGT concessions regarding those rights to shelter the gain that may arise on implementation.
The proposed aim of this measure is to stop partnerships from accessing small business CGT concessions relating to an assignment of a right to future income of a partnership to an entity, where that entity does not have a real role in the partnership.
This appears to directly target so-called Everett assignments and should not affect the sale of a partnership interest to unrelated parties.
On a similar note, sportspeople and high profile individuals licensing image rights to a trust or other related entity will be prevented from obtaining income splitting benefits as income from such arrangements will be deemed to still be derived by the relevant individual (and included in that individual's assessable income).
Naughty: Stamping out incentives to 'bank' vacant land
Under the proposed changes to take effect from 1 July 2019, deductions will be disallowed for expenses incurred in relation to holding vacant land for residential or commercial purposes.
The proposed change, which forms part of the Government's significant focus on tax integrity measures, aims to target taxpayers claiming deductions for expenses incurred in relation to holding vacant land (i.e. interest costs) where the land is not held for the purpose of producing assessable income.
As a result, deductions disallowed under these measures will not be available to offset assessable income (or available to carry forward for future income years). Where a deduction is disallowed but otherwise is eligible to be included as a cost base element for capital gains tax purposes (for example, borrowing expenses and council rates), the expense may form part of the cost base. However, expenses which would otherwise not be eligible to be included as cost base elements will not be recoverable.
The proposed changes will not apply to expenses in relation to holding vacant land where:
- a property has been constructed and is available for rent, or
- the land is being used by the owner to carry on a business.
In light of continuing concerns around the housing affordability crisis, this measure represents an attempt by the Government to discourage land banking, and penalise taxpayers who hold vacant land for extended periods when this could be made available for housing and other development.
Naughty: Research and development tax incentive changes
Amendments to the research and development (R&D) tax incentive will significantly impact the way that companies can claim, with the introduction of a R&D premium that links the rates of non-refundable offsets to the intensity of the company's R&D expenditure pro rata to the company's total expenditure for the year.
For client's with an aggregated turnover of less than $20 million, the premium will be a flat rate of 13.5% above the company's tax rate and cash refunds from the offset will be capped at $4 million per annum. Additionally, offsets that cannot be refunded in the current year will be carried for as non-refundable tax offsets to future income years.
Additional compliance measures will also enable the ATO to publicly disclose R&D claimant details (including expenditure claimed).
These measures have been announced in response to the 2016 Tax Incentive Review and at first blush, impact the refunds available for start-ups that rely on and use the R&D incentive.
Nice: Shake-up of SMSF rules
From a super perspective, one of the more noteworthy announcements out of the 2018 Budget is the proposed expansion to the maximum number of allowable members in new and existing self-managed superannuation funds (SMSFs) from 4 to 6 members (from the 2019-2020 financial year).
While increasing SMSF members may introduce complexity in terms of the ongoing control and governance of the fund, the proposal allows for larger families to begin implementing strategies for intergenerational succession and management of long-term capital investments (i.e. commercial or business real property).
Although the Budget did not directly address any changes for limited recourse borrowing arrangements (LRBAs), should it pass, the increased number of members in SMSFs provides an opportunity for managing the fund's cash flow for the acquisition of LRBA property.
It is also worth noting that, from 1 July 2019, it is proposed to introduce an exemption from the work test for voluntary superannuation contributions by individuals aged 65-74 with superannuation balances below $300,000 in the first year that they do not meet the work test requirements.
To round out our budget re-cap, we have summarised some of the additional measures with immediate or short term benefit to your clients below.
Nice: Personal income tax cuts
As well as renewing its commitment to the reduction of the company tax rate, in a move that shocked no one, the Government has announced its seven year plan for staged tax rate cuts for low to middle income taxpayers.
From 1 July this year, the Low and Middle Income Tax Offset will reduce the tax payable by up to $530 (for those with taxable income of $87,000). The benefit of the offset will phase out as income approaches $125,333. Above this income level taxpayer will have a more modest saving of a mere $135 per annum from a slight change of the starting point of the 37% tax rate threshold.
For taxpayers that are more patient (and optimistic) it is proposed that more substantial tax savings will apply for medium to high income earners from the 2024 tax year (and even more in 2025)! However given that these proposals are some years (and elections) away, time will tell whether or not they ultimately proceed.
In a recently announced win for taxpayers the Government has also decided not to proceed with the long debated increase to the Medicare levy (originally proposed to increase from 2% to 2.5%).
Nice: Instant $20,000 asset write-off
In welcome news to small businesses, as part of the Government's continued commitment to support small business, it has announced that it will extend the accelerated depreciation (currently an instant asset write off threshold of $20,000) for small businesses by a further 12 months to 30 June 2019.
This means that small businesses (i.e. those with an aggregated annual turnover of less than $10 million) will be able to immediately deduct purchases of eligible depreciating assets that:
- cost less than $20,000
- were acquired between 1 July 2017 and 30 June 2019, and
- were first used or installed ready for use by 30 June 2019 for a taxable purpose.
If the assets are greater than $20,000, small business owners can continue to use the small business depreciation pool and depreciate at 15% in the first income year, and 30% in each subsequent year.
Naughty: Non-compliant payments to employees and contractors are non-deductible
As an incentive for businesses to meet their PAYG obligations, measures were introduced to prevent businesses from claiming deductions for:
- payments to their employees where they have not complied with their PAYG obligations, and
- payments to contractors where no ABN is provided by contractors and businesses do not withhold PAYG.
This measure is proposed to commence on 1 July 2019.
Naughty: Illegal phoenix activities
It comes as no surprise, given announcements over the past 12 months that a number of sweeping reforms have been announced to 'deter and disrupt' phoenix activities as part of the Federal government's broader focus on the so-called Black Economy.
In short, the proposed reform promises:
- new offences to target those who conduct or facilitate phoenix activity, and
- increased focus on director liability and prosecution, including the extension of director penalty notices to company debts such as GST and restricting related (read 'friendly') creditors from voting on the appointment, removal or replacement of external administrators.
Without having seen the proposed measures in their final form, it is hard to say how this will directly impact innocent clients who are simply caught-up in the regime.
However it is just another example of the government's commitment to ensuring the ATO (not to mention ASIC) have considerable powers. While few would begrudge the targeting of blatant phoenix arrangements, depending on the ultimate form of the amendments, they could also expose directors to, for example, personal liability for unpaid GST in a broader range of circumstances.
This Budget will have a relatively modest impact on many individuals and businesses, with a small tax reduction for many medium income earners. That said, business taxpayers in particular may be substantially impacted by specific targeted measures, and there will continue to be uncertainty under the 'Division 7A rules' and their application to trusts and UPEs for at least another 12 months.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.