The Business Tax Working Group ('BTWG') has released its much-anticipated Discussion Paper on reforming Australia's corporate tax. This Tax Brief analyses the options being presented and some of the difficult questions that are still unresolved.
The BTWG, which was one of the outcomes of the Government's Tax Forum in October 2011, was given the task of analysing two proposals:
- the prompt introduction of a loss carry-back regime; and
- a longer-term reduction to corporate tax, accomplished either by reducing the headline rate or introducing an Allowance for Corporate Equity ('ACE').
In June 2012, the Prime Minister re-ordered those priorities, directing the BTWG to focus solely on reducing the headline rate. She said,
From today I want to see achieving this company tax rate reduction as the absolute top priority of the Business Tax Working Group. I want it to be the focus, and I want it to be the outcome. I want it dealt with before the other business tax issues in the Working Group's in-tray are dealt with.
Not surprisingly, therefore, the principal message in the Discussion Paper is about options for reducing the headline rate. The ACE proposal is consigned to an Appendix – it is too untested, too costly, and, the Paper argues, the objectives it was meant to achieve can be secured through a rate reduction instead.
So the Discussion Paper is principally directed to two issues:
- how big a cut to the headline corporate tax rate can be achieved; and
- how it is to be paid for?
How big a rate cut?
The Review of Australia's Future Tax System (the Henry Review) had recommended that Australia's corporate rate be cut to 25% and this figure seems to have appealed to the BTWG as well.
The problem is that a cut of this magnitude is very expensive. The Discussion Paper contains some Treasury estimates about the likely cost to revenue of reducing the corporate rate. The rule-of-thumb seems to be that every percentage point reduction costs about $5bn in lost revenue, over 4 years. The Paper shows:
|If the company rate were reduced from 30% to ...||then, by the end of 2016, the Government would have foregone ...|
Source, Business Tax Working Group, Discussion Paper (Table 2).
As the Paper notes, these figures assume no changes in behaviour (for example, by taxpayers shifting income and deductions between years) and no growth dividend from higher levels of investment, increasing productivity and higher wages.
However, the figures do include the claw-back of lost corporate tax at the shareholder level through reduced franking credits. To put it another way, it is principally non-resident shareholders who will enjoy the benefit of the tax cut – shareholders who are resident individuals and superannuation funds will face a commensurately higher tax bill.
How to pay for it?
The options which the BTWG could examine to pay for the rate cut were constrained in two ways. First, the Government made it clear that any reduction in the corporate rate must be made up from within the business tax base – that is, base-broadening measures. Secondly, changes to the GST were not an option. The BTWG also took the position that the rate cut could not come at the expense of changing the dividend imputation system.
The BTWG chose three main areas in the corporate tax system as the source for funding the corporate tax cut:
- restricting interest deductibility, either through tightening the thin capitalisation rules or through new limits on interest deductibility;
- adjusting the depreciation regime to delay depreciation deductions, particularly for assets with capped lives, and limiting the tax recognition of other capital outlays; and
- reducing the generosity of the R&D system.
More detail on the items in each area is set out in the Appendix to this Tax Brief.
These are the same areas that the BTWG had focussed on in its April 2012 report on funding a loss carry-back regime. In the May 2012 Budget, the Government announced that it would implement the loss carry-back recommendation but would fund that proposal by cancelling the promised reduction of the corporate rate to 29%. Hence, the same funds were potentially still available to the BTWG for this project.
There are a few obvious comments about this list:
- many of the measures are quite narrow – for example, changing the depreciation rate for helicopters not used in agriculture – and so not surprisingly few of them produce a big revenue figure;
- the range of measures chosen will inevitably have differential impacts on different industries and taxpayers. It is not clear whether the measures chosen would prejudice any particular industry disproportionately, although measures that are relevant to banking and mining appear often in the lists, and several measures would adversely affect the property sector; and
- some of the options are presented in increasing levels of restrictiveness – reducing the 4% rate for industrial buildings to 2.5% [B.14] v. moving buildings into the effective life system [B.12] v. scrapping Div 43 deductions altogether [B.13] – and so some of the revenue projections are alternatives, not cumulative.
The Discussion Paper includes revenue estimates for some of the measures being considered. The additional revenue from changes to interest deductibility is not estimated. In the April 2012 report on loss carry-backs, the changes to interest deductibility were estimated as generating around $300m per year. This Paper gives no estimate, citing criticisms of the $300m figure the last time it was used, and the sensitivity of the figure to the type of restriction recommended.
Nevertheless, it is clear from the revenue estimates in the Discussion Paper that these base-broadening measures will not generate enough revenue for a sizeable reduction to the corporate tax:
|Target area||Estimate of revenue generated|
|Interest deductibility||. $300 m|
|Capital allowances||. 10 bn|
|R&D measures||. $3.5 - 4 bn|
Source, Business Tax Working Group, Discussion Paper (Appendix E).
What this shows is that Australia's corporate tax base is very broad already – there are few remaining concessions of any size that can be closed to fund rate reductions.
Just how this disparity between the revenue foregone and revenue available is to be solved is not answered in the Paper. Two possible outcomes are:
- the BTWG will be able to recommend a rate cut of only modest proportions; and / or
- Treasury and the BTWG will have to find other 'concessions' and 'loopholes' not yet identified.
The first seems the more likely.
The BTWG is seeking comments on the Discussion Paper by 21 September and is planning to hold consultation meetings in the meantime.
It promises to release a draft of its report in October and will deliver the final report to the Treasurer in December.
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