08 Oct 2020 This week in tax
The Treasurer, Josh Frydenberg, handed down his second Federal Budget on 6 October 2020, unveiling a whopping estimated $213.7 billion deficit for 2020–21. Andrew Mills, CTA (Life) and Robyn Jacobson, CTA, reflect on whether the Budget delivered on expectations and identify the opportunities for future change.
The Budget we needed but the Tax Reform we didn’t get
Times like these …
It may be surprising to some that this is only Josh Frydenberg’s second Federal Budget, but when becoming Treasurer in September 2018, he could not have expected the economic maelstrom that the pandemic wrought.
As a result, it is fair to say that the Budget is appropriate for the economic conditions. As was revealed on Tuesday night, the numbers were as bad as we were led to believe. Unemployment will remain much higher than we are used to for the next few years. Only in 2023–24 is it expected to fall below the Government’s 6% figure that suggests a change in fiscal strategy. GDP, while poor at the moment, is expected to recover by 2021–22 to 3.25% and increase from there to healthier levels that we are more familiar with.
The deficit for 2020–21 is a number that we most of us thought we would never see — $213.7 billion. It must be remembered that this is in the context of total revenue collections by the Federal Government for 2021–22 of $424.6 billion (or $364.7 billion excluding GST which is passed to the States and Territories). While the deficit numbers improve over subsequent years, the 2023–24 income year is still projected to have a substantial deficit of $66.9 billion. As a result, the Government’s gross debt will rise to over $1.1 trillion by 2023–24, a number we associate with other countries.
As expected, the Budget focused on the measures needed for an economy requiring some significant pump priming. In the course of doing so, it is fair to say that some of the measures, while temporary, are reformist in nature. One can only hope, therefore, that these measures represent the appetiser and that the main course of real and substantial tax reform that the economy so desperately needs is in our foreseeable future.
Personal tax cuts
Bringing forward Stage 2 of the already legislated Personal Income Tax Plan was not unexpected and will bring relief to thousands of middle-income earners sooner rather than later. What was unexpected was the retention of the low and middle income tax offset (LMITO) until 1 July 2021, given it had already been legislated to be repealed when the Stage 2 cuts were originally scheduled to commence on 1 July 2022.
Someone earning between $45,000 and $90,000 will be $1,080 better off in 2020–21, and someone earning more than $120,000 will pocket an additional $2,565 in 2020–21.
The tax cuts will be delivered with immediate effect from 1 July 2020. The Shadow Treasurer, Jim Chalmers, has advised the Commissioner that the measures have bi-partisan support. Accordingly, without waiting for Royal Assent of the enabling legislation, the ATO can now set about preparing new PAYG withholding schedules to take into account the changing income thresholds, for implementation within a matter of weeks.
Further, there is an expectation that the withholding rates for the remainder of 2020–21 will be adjusted to accommodate the year’s worth of tax cuts into an eight-month period. This could cause unexpected tax bills following lodgment of the 2021 income tax return for a worker who was not subject to PAYG withholding for the whole of 2020–21. Alternatively, the new rates could be designed on the basis that the worker was employed for the whole income year, resulting in a possible tax refund on lodgment.
Whatever the design, it remains that these tax cuts deliberately target middle-income earners. Low income earners were prioritised in the delivery of the Stage 1 cuts, and high income earners will fare considerably better under the Stage 4 cuts, unchanged from their legislated start date of 1 July 2024.
NANE treatment of State and Territory government business support grants
The decision to treat the Victorian Government’s business support grants for small and medium businesses as non-assessable non-exempt income (NANE) is sensible. It ensures that the full benefit of the grant can be enjoyed by the business, rather than a portion being effectively transferred to the Commonwealth in the form of taxation. Also, sensibly, the tax law will be future proofed to ensure that all similar State and Territory government grants are treated as NANE income.
Such grants are also excluded from GST turnover for GST and JobKeeper purposes, as the entity is generally not taken to have made a supply to receive the grant.
However, as the cash flow boost has recently highlighted, the ultimate tax outcome of a grant that is NANE income will depend on whether it is received by a corporate tax entity:
- The tax-free nature of the grant will be retained where it is received by a sole trader, a partnership, a discretionary trust or a unit trust (yes, there is an exception to CGT event E4 for NANE income in s 104-71 of the ITAA 1997);
- The tax-free nature of the grant is lost when it is distributed by a corporate tax entity to its shareholders.
It also highlights the awkward interaction of State and Territory grants with a federal tax system.
Corporate tax residency
Corporate residency certainty has been achieved by the announcement of a new test. One might say it resembles the old test (as set out in withdrawn tax ruling TR 2004/15). Just as that was workable prior to the Bywater High Court case, this new formulation of the corporate residency test should be equally workable. Sure, the language differs slightly, but the clear intent of core commercial activities being in Australia, and separately that central management and control (CMAC) also be in Australia, is something that should address the confusion of more recent times. Hopefully, we will not engage in esoteric ‘CMAC-includes-carrying-on-a-business’ arguments again anytime soon. The measure will effectively codify in in the tax law the broad essence of the old test.
Small business concessions extended to more businesses
The proposed increase in the small business turnover threshold from $10 million to $50 million will allow a greater class of taxpayers to access 10 small busines concessions. While this measure will be welcomed by many advisers and businesses that consider themselves relatively ‘small’ (think low margin businesses), it raises the question of whether this is the right delineation for access to these measures on a long term basis. Indeed, it raises the question of whether turnover is the best test or should be the only test.
Good, but more is needed …
One of the big ticket items in the Budget, costing the Government nearly $5 billion over the next four years, is the return of a loss carry-back mechanism. Hailed in 2013 by the Gillard Government as tax relief for businesses in a patchwork economy, the legislated loss carry back was short-lived. Its fate was inextricably linked to that of the minerals resources rent tax (mining tax) which was repealed in 2014 by the Abbott Government, along with any associated measures that were funded by the mining tax revenue.
Loss carry-back will be keenly adopted by many of those who are eligible, namely corporate tax entities that were profitable, and paid tax in any of the 2018–19 to the 2020–21 income years, and which have made a tax loss in any of the 2019–20 to the 2021–22 income years. Entities will be able to elect to carry an eligible loss back and claim a refundable tax offset or carry it forward under the normal rules.
This loss carry-back will be more generous than its predecessor, which capped the refundable tax offset at $300,000. While it will be uncapped, it will nonetheless be limited by:
- Its availability only to corporate tax entities;
- An aggregated turnover threshold for the entity of $5 billion;
- The amount of the entity’s earlier taxed profits;
- The balance in the entity’s franking account; and
- Its availability only for revenue and not capital losses.
Instant asset write-off
The very generous new immediate deduction for the purchase of eligible depreciable assets for businesses with an aggregated annual turnover of less than $5 billion will be welcome and of assistance to business. It is reasonable to expect that it will encourage businesses to buy equipment and invest in growing their businesses; adding to the productive capacity of the economy. The measure will expire on 30 June 2022.
The Tax Institute is of the view that an immediate write off for depreciable assets (within certain parameters) would be a good feature in our tax system. Whether it should extend to very large businesses, as this measure does, or impose a cap on the amount of the expenditure, are design questions that should be considered and debated.
Any future reform should reduce the red tape burden on small businesses of tracking depreciable assets, having to deal with complex pooling rules and be confronted with tax liabilities when the business has spent money on building productive capacity. A permanent feature that can addresses those issues would be very welcome.
Granny flat arrangements
This is a very complex area, and one which has caused concerns to the regulator (the ATO) and taxpayers for many years, so this is a very welcome announcement.
It is expected that the start date will be the first 1 July following Royal Assent of the enabling legislation. It is a shame the changes won’t be given immediate effect from 5 October 2020 (the date of announcement), as this would have provided peace of mind to older Australians and those living with a disability.
That aside, the measure will relieve the homeowner of adverse tax consequences, and is likely to encourage granny flat arrangements to be formally documented. This will go some way to addressing wider concerns about elder and financial abuse.
The Budget papers indicate that a capital gain will not result from the creation, variation or termination of a formal written granny flat arrangement, so it is likely that an exemption will be provided in respect of CGT events D1 (creation of a contractual right) or CGT event C2 (the cancellation or ending of a right).
However, this would seem to address only one of the two CGT issues. It will be interesting to see whether the law is drafted to also prevent the partial loss of the main residence exemption when the property is rented under the arrangement. Ideally, the exemption will be broad enough to cover all of the various permutations of granny flat arrangements, because they are not all straightforward. Some are paid up front, some are paid over time, some are paid for later once the older parent receives funds such as an inheritance.
This issue has arisen primarily because of CGT event D1. Would giving money to an adult child ordinarily be considered a taxable capital gain? Most would regard this as a private arrangement. This is yet another example of overly complex law that leads to unexpected tax outcomes. Arguably, the measure was not even needed if we didn’t have complex laws in the first place. This announcement is welcome, but further work is needed to reform the tax system.
Although much of the SME sector is keenly awaiting any word on the long-awaited Div 7A reforms, the Budget papers were decidedly silent on this issue. While we would like certainty on this complex area of tax law, better the tortoise than the hare in this case. A sensible consultation to ensure the design of workable laws is preferable over a rushed, and possibly botched, ill-thought out series of amendments. The Tax Institute will eagerly provide input into any future consultations.
Fringe benefits tax
The proposed measures that relieve small business of FBT on car parking benefits and electronic devices provided to employees is welcome. Similarly, efforts to reduce the disproportionate compliance burden of FBT and the concession for retraining of redundant or near-redundant employees is also welcome and sensible in the current climate.
However, that these changes were necessary or desirable is instructive of the poor design and over-reach of FBT. Identifying issues with the FBT legislation, yet addressing only these concerns, should have been a prime opportunity to flag that fundamental change is needed to the design of FBT. Ordinarily, employers would be aghast to think that providing tools for their employees, retraining them or providing them with car parking proximate to their hard-to-get-to workplaces, would somehow be subject to tax. That the various nonsenses of the archaic FBT continue to exist is an indictment on successive governments of all persuasions. This is not to say that real fringe benefits should not be taxed — far from it. It is only to say that only real fringe benefits should be taxed.
We have long been accustomed to the tendency of governments to tinker with the superannuation rules. This Budget was surprisingly, and some may say happily, minimalist on superannuation changes. While continual tinkering of superannuation is unwelcome, there remain opportunities for significant improvement in certain areas. The measures in the Budget to improve transparency and governance are entirely appropriate.
However, the disincentives and complexity built into the superannuation guarantee (SG) rules, and the narrow window to take advantage of the SG amnesty, have been well documented and the subject of much commentary. Changes could have easily been addressed in this Budget, and will hopefully be addressed in the near future.
While the Budget contained no proposed changes to the operation or collection of the GST, it was interesting to note the commentary around the expected reduction in the amount of GST and the share allocated to each State and Territory. The reasons for the reduction in the expected GST collections is clear — that consumption of goods and services not subject to GST continues to rise as compared to those items that are subject to GST. The policy response seems obvious to all, but it seems that there is no political appetite among many of our State and Federal leaders to do what is required or to show strong leadership on this issue.
Readers will note that the Budget did not deliver on significant and holistic tax reform. That was to be expected. The Government’s priority is, sensibly and understandably, to get businesses back to a more normal operating capacity and get workers back to work.
Nonetheless, we have pointed out the obvious areas of improvement that could have occurred had the Government chosen to turn its mind to the fundamental issues at play in each of these areas. Further, an announcement that the Government was considering real and substantial tax reform may have provided an indication that the Government was prepared to take on the challenge of reform in the one area that pervades the entire economy: tax. As mentioned in last week’s TaxVine Preamble, effective reform will impact members’ day to day experience with the tax system for the better, from improved policy to more efficient administration.
Members can access the Thomson Reuters Weekly Tax Bulletin Budget Report here.
As always, we welcome your views and thoughts, which you can provide here.
Andrew Mills CTA (Life) and Robyn Jacobson CTA