While the Budget provides significant announcements, including the increase in the Managed Investment Trust (MIT) final withholding tax rate from 7.5% to 15% effective 1 July 2012, it is as much characterised by what is not in the Budget. Importantly, there are no changes to the thin capitalisation rules, including reducing the safe harbour maximum debt limit below 75% on a debt to total assets basis, no threat to the arm's length debt test, no tinkering with the new Research & Development (R&D) tax incentive, and no retraction of tax benefits for particularly the mining/resources sector, including the immediate deduction for expenditure on exploration or prospecting for minerals or the reduction in Fuel Tax Credit entitlements. Certain of these possible reform initiatives were being evaluated by the Business Tax Working Group (BTWG) at the request of the Federal Government (Government) and were of significant interest to the resources, infrastructure, property and financial services sectors.
Very little has been achieved through the Budget regarding critical tax policy development and implementation, particularly with respect to initiatives impacting the Taxation of Foreign Income (including controlled foreign companies and foreign accumulation funds), the Taxation of Trusts and proposed reforms to Transfer Pricing and the General Anti-avoidance Provision (Part IVA).
The highlights for business of the Budget are as follows:
- Increase in the MIT withholding tax rate to 15% effective 1 July 2012
- Strengthening the integrity provisions of the Capital Gains Tax (CGT) scrip-for-scrip rollover provisions
- Tightening bad debt write-off provisions for related parties and deductions on capital expenditure financed by limited recourse debt
- Introduction of a limited loss carry-back scheme for small business/companies
- Abandonment of the proposed reduction in the corporate tax rate (remains 30%), reduction in Fuel Tax Credit entitlements and tax incentives for Green Buildings
- The deferral of the Goods & Services Tax (GST) cross-border measures (these were intended to commence on 1 July 2012 and no fixed start for the measure has been announced).
INCREASE IN MIT WITHHOLDING TAX RATE TO 15%
The Government will increase the MIT final withholding tax rate from 7.5% to 15%, with effect from 1 July 2012. This is a significant increase in the existing withholding tax rate for MITs, which has only been in place since 1 July 2010.
The 15% withholding tax rate was the original rate proposed when the MIT regime was first announced in 2007, which was also reflected in the withholding tax clauses of the 2008 Australia/Japan Double Tax Agreement for Real Estate Investment Trusts; Article 10(7). This rate is also comparable with withholding tax rates in other countries, such as in the US and Japan.
Nonetheless, the doubling of the final withholding tax rate to 15% may deter or hinder foreign investment in Australia (and create uncertainty) and seems contradictory to the broader Government policy of promoting Australia as a financial hub.
No transitional or grandfathering provisions have been announced. Thus it appears that all existing and future MITs will be subject to the higher rate of withholding tax from 1 July 2012.
COMPANY TAX RATE CUT CANCELLED
The Government will not proceed with the proposed reduction in the company tax rate to 29% that was announced in last year's Budget. The corporate tax rate will remain at the current rate of 30% for all companies (including small businesses).
It had become clear to the Government that the rate reduction would not be approved by Parliament. The savings from not proceeding with the rate reduction were redirected towards other corporate tax measures such as the loss carry-back arrangement for companies and certain personal tax measures.
CGT SCRIP-FOR-SCRIP ROLLOVER AMENDMENTS
Announcements included an intention to amend the CGT scrip-for-scrip roll-over provisions to prevent certain tax benefits from arising, including those identified in the Full Federal Court decision of FCT v AXA Asia Pacific Holdings Ltd  FCAFC 134.
This roll-over provides relief for shareholders when, in the context of a takeover, they exchange interests in one entity for interests in another entity.
The proposed changes will be designed so that entities are unable to:
- Circumvent integrity provisions (such as the significant and common stakeholder provisions) by holding rights which convert into shares (as opposed to holding shares in the target entity itself), such as convertible preference shares
- 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 proposed measures will also change the integrity provisions by:
- Extending 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 in respect of the repayment of such debts, as it undermines the effectiveness of the integrity provisions
- Ensuring that the integrity provisions apply appropriately to trusts.
These measures will have effect from 8 May 2012.
RESTRICTIONS ON BAD DEBT DEDUCTIONS
Bad debt deductions will not be available for any bad debts written off after 7.30pm 8 May 2012 where the debtor is a related party of the lender. Bad debts between members of a tax-consolidated group are already ignored for income tax purposes. However, this measure is designed to deny deductions for bad debts between members of nontax consolidated groups, or where there is any other related party relationship.
The Australian Taxation Office has recently lost two cases in the Federal Court where in-house finance companies were successful in claiming bad debt deductions for multi-billion dollar losses on loans between related members of the group (BHP and Fosters group). While the scope for claiming such "intra-group" deductions has been reduced by the implementation of the consolidations regime, these measures are forecast to result in an $80 million increase in revenue over the forward estimates period.
LIMITED RECOURSE DEBT
The Government will amend the definition of limited recourse debt to ensure that it covers arrangements where the creditors right to recover the debt is effectively limited to the financed asset or security provided. This measure is stated to have effect from 7.30pm on 8 May 2012, but the exact transitional arrangements are not clear.
The change appears to be in response to the June 2011 decision of the High Court in Commissioner of Taxation v BHP, which restricted "limited recourse debts" for the purpose of Division 243 to those which were legally or contractually limited at the time the funds were advanced. The amendments are likely to impose a practical test, which may look at the assets of the entity which are available.
The Government stated that the measure would ensure that tax deductions are not available for capital expenditure on assets that have been financed by limited recourse debt, to the extent that the taxpayer is not effectively at risk for the expenditure and does not make an economic loss.
This measure can be expected to impact on special purpose entities used in infrastructure and resources projects or other entities where recourse is effectively limited to the financed assets. It is likely the amended definition will apply both to Division 243 (recoupment of depreciation deductions where limited recourse debt is not repaid) as well as Division 250 (assets put to taxpreferred use).
LIMITED LOSS CARRY-BACK RULES
The Government will provide tax relief to companies, and entities which are taxed like companies, by allowing them to carry back tax losses and receive a refund for tax previously paid. Under existing rules, all entities can only carry forward losses.
From 1 July 2012, companies will be able to carry back up to $1 million worth of tax losses each year and get a refund on tax paid in the previous year. From 1 July 2013, the carry back period will be extended to two years, so that companies will be able to apply their tax losses against the taxable income of the previous two years and get a corresponding tax refund. This will provide a maximum cash benefit of $300,000 each year.
To reduce adverse consequences which may result for companies that generated imputation and franking credits, the amount of a tax refund will be limited to the balance in the company's franking account in the loss year. Importantly, companies will only be able to carry back revenue losses, not capital losses. Hence, losses resulting from the sale of, for example, certain buildings and passive investments will need to be carried forward in line with existing rules.
Similar loss carry-back provisions have been adopted in other Organisation for Economic Cooperation and Development countries (eg US, UK, Germany, France and the Netherlands).
The greatest benefit from loss carry back should be derived by previously profitable companies that strike a temporary loss position. The benefit of the measure will decrease the longer a company stays in a loss position. This measure is designed to support businesses adapting to variable economic conditions, such as competition from overseas businesses, the recent rise in value of the Australian dollar, the impact of natural disasters and costs associated with adapting and innovating a business.
It is expected that the largest beneficiaries of this measure will be companies in the construction, finance and insurance, manufacturing, scientific and professional services, and wholesale trade industries.
REMOVAL OF CGT DISCOUNT FOR FOREIGN RESIDENTS
The Government will remove the 50% CGT discount for foreign residents on taxable capital gains accrued after 7.30 pm (AEST) on 8 May 2012 (the time of the Budget announcement).
Since there is a broad CGT exemption for foreign residents, this measure will mainly impact on foreign investment in non-exempt assets such as Australian real estate and the assets of a "permanent establishment" (eg branch) in Australia. Currently, foreign investors (noncorporates) are entitled to a 50% reduction in capital gains in respect of such assets, provided they have held the asset for at least 12 months. Under the announcement, this reduction will be removed, thereby increasing the tax cost for foreign residents on the sale or disposal of such assets.
There has also been a slight increase in the tax rates for foreign residents.
LIMIT ON CONCESSIONS FOR "GOLDEN HANDSHAKES"
The Government will limit the tax concessions for Employment Termination Payments (ETP), such that the concessions are only available to the extent that the ETP takes the employee's total annual taxable income (including the ETP) to no more than $180,000. Currently, ETPs are eligible for concessional treatment (being a lower rate of taxation) to the extent the ETP is under the "ETP cap" ($175,000 in 2012-13) and is available regardless of the recipient's total taxable income.
Thus, the proposed changes are designed to prevent higher-paid employees from obtaining tax concessions for "golden handshakes" on termination of their employment.
Existing concessions will be retained for certain ETPs relating to genuine redundancy, invalidity, compensation due to an employment-related dispute and death.
TAX REFORM - ROAD MAP
The Government provided further details and direction on its vision for future tax reform, including proposed reductions to Interest Withholding Tax, tax loss incentives for infrastructure projects of national significance and proposed assistance with state tax reforms.
The BTWG will continue to identify and consult on further business tax reforms, one initial focus being on improvements to the tax treatment of losses.
It is intended that further work be undertaken to enhance the same business test for carry forward and utilisation of tax losses and further work on the reform of the corporate tax system, including potential company tax rate cuts and other reforms.
The Government has not elaborated on what these "other reforms" may comprise and businesses should not assume that possible changes to the thin capitalisation rules, exploration or prospecting expenditure deductions, statutory depreciation cap and R&D expenditure will not be revisited as part of the ongoing reform of the corporate tax system.
All businesses are well advised to closely monitor the workings and consultation of the BTWG in the coming months as it is proposed that the BTWG provide its recommendations on further tax reform by the end of 2012.
In the context of the Henry Tax Review (2010) and the Taxation Summit (2011), there are many tax reform-related options and recommendations that could resurface in the coming months. The mining/resources sector in particular has provided leadership to effective consultation and lobbying on proposed tax reform, including recently with proposed changes to the Fuel Tax Credit entitlements (which replaced the old diesel fuel rebate/offset). We expect that significant progress will be made on critical reform measures, including the taxation of trusts and the foreign income reforms, in the coming months.
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