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Standing Committee on Economics
(House of Reps-Friday, 5 February 2016)
CHAIR (Mr Laundy)
Mr CRAIG KELLY
- Mr Sorahan
Content WindowStanding Committee on Economics - 05/02/2016 - Tax deductibility
BARBOUR, Mr Michael, General Manager, Group Tax, Westpac Banking Group
BORDONARO, Mrs Kathryn, Vice President, Commercial Asset Finance Brokers Association of Australia Ltd
BOWLES, Ms Stephanie, Assistant Director, Employment Taxes Unit, Parliamentary Budget Office
BROWN, Mr Colin, First Assistant Parliamentary Budget Officer, Budget Analysis Division, Parliamentary Budget Office
CAPITO, Mr Alf, Partner, EY
COLQUHOUN, Mr Robert, Director, Policy, Australian Financial Markets Association
DAVIDSON, Mr Peter, Senior Adviser, Australian Council of Social Service
DAVY, Ms Kathryn, Principal Adviser, Revenue Group, The Treasury
DRUM, Mr Paul Joseph, Head of Policy, CPA Australia
EL-ANSARY, Mr Yasser, Chief Executive Officer, Australian Private Equity and Venture Capital Association Ltd
FRASER, Mr Bede, Principal Adviser, Individuals and Indirect Tax Division, Revenue Group, The Treasury
GANDOLFO, Mr David, President, Commercial Asset Finance Brokers Association of Australia Ltd
GRECO, Mr Tony, General Manager, Technical Policy, Institute of Public Accountants
HAWKINS, Mr Phillip, Acting Director, Revenue Analysis Branch, Parliamentary Budget Office
HAYES, Mr Matthew, Tax Consultant, Chartered Accountants Australia and New Zealand
HEFEREN, Mr Rob, Deputy Secretary, Revenue Group, The Treasury
HICKS, Mr Tim, Senior Manager, Economics and Industry Policy, Australian Chamber of Commerce and Industry
HIGHFIELD, Mr Richard, Private capacity
HIRSCHHORN, Mr Jeremy, Deputy Commissioner, Public Groups and Internationals, Australian Taxation Office
JOHNSTON, Mr Adam David, Proprietor, ADJ Consultancy Services
KENDRICK, Mr Adam, Assistant Commissioner, Individuals, Australian Taxation Office
LENDON, Ms Alison, Deputy Commissioner, Individuals, Australian Taxation Office
LU, Ms Faith, Senior Consultant, Australian Tax Centre, KPMG
McDONALD, Mr Anthony, Assistant Parliamentary Budget Officer, Revenue Analysis Branch, Parliamentary Budget Office
McKINNELL, Miss Anthea, Vice President, Treasury and Taxation, Woodside Energy
MORRISON, Mr Ken, Chief Executive, Property Council of Australia
MULLEN, Mr Noel Christopher, Deputy Chief Executive, Australian Petroleum Production and Exploration Association Ltd
MULLINS, Mr Greg, Head of Policy, Research Australia Ltd—via teleconference
MURRAY, Mr Geordan, Economist, Housing Industry Association
PEARSON, Mr Tony, Chief Economist and Executive Director, Industry Policy, Australian Bankers' Association
QUINLIVAN, Mr Michael, Analyst, Revenue Group, The Treasury
SCHMITKE, Mr Shaun, National Director, Industrial Relations, Master Builders Australia
SORAHAN, Mr James, Director, Tax, Minerals Council of Australia
SWIERKOT, Ms Renata, Analyst, Revenue Group, The Treasury
VARRASSO, Mr Adrian, National Chairman, Taxation Committee, Law Council of Australia
WARD, Mr Jason, Spokesperson, Tax Justice Network Australia
WARDELL-JOHNSON, Mr Grant, Partner, Australian Tax Centre, KPMG
WOLFE, Mr Graham, Chief Executive, Industry Policy and Media, Housing Industry Association
ZIRNSAK, Dr Mark, Spokesperson, Tax Justice Network Australia
Committee met at 9:20
CHAIR ( Mr Laundy ): For those of you from Canberra, welcome to your own backyard, and for those of you who have travelled, thank you very much for coming down. I declare open this round table public hearing of the House of Representatives Standing Committee on Economics. Today's round table is the key event for the committee's inquiry into tax deductibility. On 1 December 2015, the Treasurer, the honourable Scott Morrison MP, asked the committee to undertake an inquiry into options to simplify the personal and company tax income systems with a particular focus on broadening the personal and company income tax bases to fund reductions in marginal and company tax rates.
While I note the 2012 review by the Business Tax Working Group, which examined options to broaden the company tax base through changes to deductions, it is timely for the committee to review certain personal and company tax deductions. Today's round table will enable discussion on some of the current issues surrounding tax deductibility and how these issues might be addressed through tax reform. The committee is interested in robust discussion to get to the core of these matters and how we can move forward to help address the problems inherent in the current tax arrangements.
The day has been structured into two discussion themes as outlined in the briefing paper and program. The first theme examines the personal income tax system, including the deductibility of costs incurred by individuals in earning their income, with the two key categories being deductions for work related expenses, WREs, and for investment related expenses. Options for changes to deductions will be canvassed, in particular considering the feasibility of changes to WRE deductions and how cuts to the marginal tax rates could be funded. The second theme examines the company income tax system, with the focus on the deductibility of interest incurred by business in driving their income. Discussion on this theme will include options to simplify the company income tax system, focusing on broadening the base to fund reductions in company tax rates.
I remind round table participants that although the committee does not require you to give evidence today under oath, this hearing is a legal proceeding of parliament and warrants the same respect as proceedings of the House itself. The giving of false or misleading evidence is a serious matter and may be regarded as a contempt of parliament. The evidence today will be recorded by Hansard and will attract parliamentary privilege. Before commencing, I refer the members of the media to the requirement to fairly and accurately report the proceedings of the committee.
There are a large number of participants today, both in person and via teleconference, so to maintain the structure and order of proceedings, all witness comments must be addressed through the chair. To assist committee members, other participants, and in particular Hansard, witnesses should identify themselves and their organisation whenever they wish to make a comment, in particular the teleconference participants. Comments by witnesses should be succinct and relevant to the topic being discussed so that differing perspectives and the focus issues can be covered in the time available.
What I might say, before I throw to the Parliamentary Budget Office for an introduction, is that I really want today to be a discussion and an ordered discussion. If you want to jump in at any stage, you can either grab my attention by flicking me a wave or a wink, or yell, 'Hello.' I do not want it to be precious insofar as people can go without their being checks and balances. So I do not mind it being robust, in other words, because I think it will be more productive if it flows that way rather than a series of longwinded statements, if you like.
I now welcome a representative from the Parliamentary Budget Office, Mr Colin Brown, First Assistant Parliamentary Budget Officer, to give a brief overview of the personal income tax system.
Mr Brown : Thank you chair and thank you to the committee for the opportunity for the Parliamentary Budget Office to present this morning to the round table an overview of the personal income tax system and where deductions fit into that.
Consistent with the PBO's mandate, our submission presented factual analysis of the level, type and distribution of deductions to help inform the committee's deliberation. Our position in the debate is not one of weighing up policy considerations or whatever but, rather, is one of contributing factual information to assist other parties to make those deliberations. Our presentation here today will outline some of the key facts presented in our submission in order to provide some context to help frame discussions. The presentation that I will give is in several parts: I will give an outline of the personal tax framework, I will give a quick run through on total deductions, I will talk about work related expenses and then I will talk about rental expenses and business expenses and just how they fit into the picture. I will also give some concluding points.
In terms of the personal income tax system, the framework and where deductions fit is something we need to keep in mind. This simple diagram shows how the personal income tax system operates. Tax relief can be categorised into three broad types of tax relief that are provided in the system. First of all, deductions included in the calculation of total deductions in the income tax return and reported the ATO tax statistics can be categorised out. Those are tax deductions. They are the principal things that we are talking about here today.
We also have expenses which reduce total income in some categories. In areas where we are looking at investment income and business income deductions are taken out of that income to derive net investment income or net business income, which is what is included in an individual's tax return. The way the statistics are prepared, net business income is actually included as a separate item. That needs to be analysed separately. Business expenses are not in the scope of the terms of reference of the committee so we have not looked at those particularly, but we have looked at investment expenses.
Finally, there are tax rebates and credits. Those are things that are included in the calculation of tax after the amount of tax on taxable income has been calculated. Tax deductions impact on taxation revenue by reducing taxable income, so we are working out how much income is subject to tax. Deductions come off in that calculation. You then have to apply the individual's marginal tax rates to the taxable income that is calculated in order to work out tax payable. In other words, when we are talking about the volume of deductions, that is not the amount of tax that we are talking about. We are talking about something that is coming off taxable income. That is important just in terms of working out what the financial impact is.
Also in translating deductions into the financial impact, you have to take account of just what the behavioural impact of a change may be and how taxpayers would respond to it. That is an area of great uncertainty when you start looking at tax deductions. If an individual currently undertakes expenditure on something such as, for instance, a work related expense where they purchase their own tools of trade, if those expenses were made non-deductible, a possible response is that that cost is shifted from the employee to the employer. The net result of that, depending on how it is done, may be that the revenue gain anticipated by moving the work related expense is in fact fully negated. That is an extreme case. It would necessarily be that it was fully negated as different people respond in different ways, but it introduces an element of great uncertainty into just what the financial impact of a change in tax deductibility was.
We also would have to have some consideration of the broader macroeconomic impacts of a change. Essentially, if you are changing the amount of tax payable and incentives in the system, there could be broader impacts in the economy. Generally speaking, costings that we undertake would not pick those up because of the uncertainty related to them, but it is still something that would have to be a consideration when weighing up the merits of a case for change.
I will kick off by looking at total deductions. These are all deductions that are claimed by individuals in their personal income tax returns, excepting those which relate to things like net rental income, which are actually part of the income calculation. Looking at the total level of personal income tax deductions, what the chart shows is that since 2006-07 up to the most recent year for which we have data, which is 2012-13, the rate of deductions that people have been claiming has actually been falling. That reflects a couple of things. One is that the total level of deductions has been broadly flat or slightly declining and, in part, that reflects policy changes that have occurred in that period particularly relating to deductible personal superannuation contributions that are made by, for instance, self-employed people or basically non-employer sponsored superannuation where that is deductible. There has been a tightening of the caps on those deductions which has resulted in a decline. The picture there is one of deductions in that period being broadly flat in dollar terms and, as I say, declining as a proportion of income.
If we look at the most recent year for which data is available, which is 2012-13, the table shows just what the level of deductions claimed has been by level of taxable income. It is basically grouped by income tax brackets. Those who earn more claim a higher level of deductible expenses in absolute terms. Taxpayers in the highest income bracket, for instance, comprised less than three per cent of taxpayers in 2012-13 in absolute terms, but claimed over 12 per cent of the total value of deductions. That is despite taxpayers in the lower income tax brackets claiming a higher level of deductions as a proportion of taxable income than those in the higher tax brackets. So people in the lowest tax bracket with taxable income less than $18,200 had deductions as a proportion of taxable income of nearly eight per cent compared to 3.3 per cent for people in the highest tax bracket. But people in the highest tax bracket have very much more income so have a much higher level of absolute deductions.
This analysis is showing some of the diversity in claims for deductions and this split deductions by gender. It was an interesting story that came out of our research. The average male claimed a higher level of deductions than the average female at all levels of taxable income in this analysis both in absolute terms and as a proportion of taxable income. The gender difference is greatest at the lower levels of taxable income. So this is one split that shows that not everybody claims the same level of deductions, and this is one dimension of looking at that.
If I look at deductions by type, this shows what the overall levels of deductions claimed by people are and how they break down. So work related expenses accounted for 63 per cent of all income tax deductions by individuals. Non-employer sponsored superannuation contributions were nine per cent, the cost of managing tax affairs deduction was eight per cent, gifts and donations was seven per cent, dividend and interest was seven per cent, and other deductions were six per cent. The point about this is that you can break down deductions into a couple of broad categories. So you have work related expenses and you have expenses which are related to earning income which are things like the dividend and interest expenses, then you have other deductions which are arguably policy decisions by governments to give support to particular activities. That is the case, for instance, in superannuation and in the case of gifts and donations where tax deductibility supports other objectives that governments may have.
If we look at the value of deductions and the proportion of taxpayers claiming deductions by levels of taxable income the chart shows that for all types of deductions the average value of expenses claimed is larger for individuals in the higher income brackets than in the lower income brackets in absolute terms. However the nature relationship is not identical for all types of deductions. If we exclude work related deductions, the average value of deductions increases steadily up to taxable incomes of around $180,000 and then sharply decreases for incomes higher than that level. For work related expenses on the other hand, the average deduction remains at around $3,000 for individuals with taxable incomes above $100,000. So it climbs and plateaus and is higher at lower levels of income. Also work related expenses are claimed more heavily by people at lower levels of income in terms of the proportion claiming. So there are some distinct patterns in terms of the claiming of deductions by levels of taxable income.
If we look specifically at work related expenses, the first chart basically shows what they are claimed for. The most common work related expense in 2012-13 was car expenses, with $8 billion claimed, and this accounts for a little bit under 41 per cent of the value of all claimed work related expenses. Other work related expenses—which include things like home office costs, tools, equipment and other assets—was the next largest category of work related expenses at $7 billion or about 35.6 per cent of the total claims. Individuals also claimed deductions for work related travel expenses of about $2 billion, uniform and clothing costs of $1.6 billion and work related self-education costs of around $1.1 billion.
If we look at the average value of work related expenses claimed by level of taxable income, the value of tax deductions claimed per taxpayer increases were taxable income for all work related expense types—with the exception of self-education and uniform expenses, which remain relatively flat across the income distribution. You see car expenses and other work related expenses climbing up to about the $100,000 mark and then plateauing. The proportion claiming work related expenses also shows quite distinct patterns. You have, essentially, the highest proportion of taxpayers claiming work related expenses somewhere between the $60,000 to $100,000 mark. That is where it, basically, starts to plateau and then it flattens out above about the $120,000 mark of income.
Rental expenses were something that we looked at because these expenses come off rental income in the calculation of net rental income. This is also an area which has been looked at fairly intensely in the past and we thought we would include information on that as well. The tax return form does not include rental expenses and total deductions so it has not been included in figures we have looked at already—however, they can be claimed against gross rental income to give net rent, which is then included in taxable income.
Rental expenses provide a useful point of analysis—both in aggregate terms and by focusing, solely, on those reporting a rental loss, so we will look briefly at both. In 2012-13, $41.7 billion in rental expenses were claimed. Those expenses were reported in three categories: interest, which was $22.4 billion; capital works, which were $2.4 billion; and other, which were $16.9 billion. As with total deductions, the values of these claimed expenses increased with income. The kinds of things that are included, in here, are things like rates, body corporate fees, maintenance costs, agent expenses and asset depreciation.
The graph shows that rental expenses have increased broadly in line with rental income over recent years. So rental income is the line with the crosses on it and the bars show their levels of total deductions—this also shows that over that period you have net rental losses being reported. So the impact of rental activity is to reduce the taxpayer's overall income—on average—in all of those years, and that has been rising.
This graph presents the total value of expense claims in 2012-13 by taxable income for the three types of rental expenses, and it is mapped against taxable income. A point to note, here, is that a significant proportion of rental expenses are claimed by those at the lower end of the taxable income distribution—the largest expenses, in terms of the total value claimed, are amongst lower-income earners in the distribution.
If we look at rental losses for those with negative net rental income—and this is a time series of this—of the 1.9 million taxpayers with rental income in 2012-13, just over one-third reported a rental profit, with two-thirds reporting a rental loss. The median net rental income for individuals with a rental loss was a negative amount of just short of $6,000, with the total loss equating to $12 billion. In contrast, median net rental income for those with positive net rental income was $5,302, for a total gain of approximately $6.6 billion. The aggregate level of net rental losses for those claiming negative rental income has fluctuated between $11 billion and $14 billion over the seven years shown in the chart. This chart shows that a high proportion of taxpayers with rental losses have low levels of taxable income. In this case, we are just looking at negative net rental income—the level of net rental loss and the proportion of taxpayers with net rental losses. The two lines actually track quite closely as well. It shows that the lower income levels have the largest amounts of negative net rental income and also that the proportion of people claiming a loss also has a similar pattern.
Some concluding points regarding deductions in our system come from that. I will try to give it some perspective. First of all, the revenue impact of deductions depends on the marginal tax rates of taxpayers, and assessing what the revenue impact would be would also require an assessment of the behavioural responses to any change. Total deductions have not increased significantly in recent years. In the years that we looked at, which were from 2006-07 to the most recent year of data, total deductions have been quite flat and declining as a proportion of taxable incomes. Deductions are not evenly distributed across taxpayers. You cannot say that all taxpayers claim the same proportion of taxable income as deductions. In fact, we see that that changes quite a bit by levels of income. The other dimension we looked at in the charts was gender. There would also be other dimensions that it varies by that we had not included.
For work related expenses, low-income earners have a higher rate of claims. The largest absolute claims, on average, are claimed by high-income earners but the largest claims as a proportion of income are by low-income earners. Rental deductions are also skewed towards low-income earners.
CHAIR: Thank you very much. The committee will now move to discussion on theme No. 1, personal income tax deductions. The committee's focus in relation to the personal income tax system is on various existing deductions, including work related expenses and options to simplify the system. I will kick off with a question to you, Mr Brown, on your first concluding point. Hopefully, that will stimulate some conversation. You said both in the presentation and in that first concluding point that it is hard to model for changes in behaviour. Aren't there changes in behaviour now due to how the tax system is set up? Isn't the way work related expenses are allowed to happen a conduit to force changes in behaviour in and of itself?
Mr Brown : Certainly the way that people are able to claim, the rules around it and the system itself create incentives, so what we have got will already have a behavioural consequence. People have modified their behaviour to fit the rules, so, if the rules change, you can expect that that will result in a change in behaviour. People do react.
The issue that is raised by this is what the role of deductions is. Some deductions are put there, in fact, to induce a change in behaviour. The superannuation concessions are there to encourage people to save for superannuation, and the deductibility of superannuation contributions by individuals are there to cover people who do not have employer sponsored superannuation and to encourage them to save. That is something which was introduced to change people's behaviour.
In the case of things like work related expenses, that is part of the income tax system, which recognises that, in calculating income, you should allow people to claim deductions for things that are outgoings incurred necessarily to earn assessable income. Those deductions are allowed except to the extent that they relate to things of a personal capital et cetera nature. But that in itself is compensation for an expense a person incurs in earning assessable income, and that has consequences as well because it encourages people to undertake those expenses relative to what would be the case if the deduction were not available. Their behaviour will be different with and without a deduction. What its role in the system is and whether or not it is right is a policy decision that people will have to make, but, if you are saying we are trying to tax income, does income include expenses incurred in earning assessable income? That is a question about your income definition.
Mr CRAIG KELLY: On the first slide you had up, you had total income less deductions equals taxable income. Shouldn't we from the outset be looking at this as not total income that comes first but deductions which are expenses which actually create the income first? We have the creation of the income by the deductions first rather than the income first less the deductions?
Mr Brown : I suppose what I put up there was the algebra for calculating the amount of tax that somebody has to pay.
Mr CRAIG KELLY: Yes. From a theoretical point of view, shouldn't it be that there are the deductions that create the income to start with rather than the income existing and having the deductions left off?
Mr Brown : Yes. You are going to the nexus of the deductible expense and the earning of income. Certainly in the system the presumption is that those expenses are incurred in order to generate the income that is being earnt. That is why they are deductible in the first place.
Mr CRAIG KELLY: Okay.
CHAIR: To throw it open to the room: as a big believer that individuals rather than government are the best deciders of how they spend their income and therefore one trying to keep taxes as low as possible, I know this topic, which is in your briefing packs, has been tossed around from Ken Henry days to our days. I have no doubts that a lot of you around the room have been involved in these discussions over the last seven or eight years. If as a general rule of thumb it is true to say that, the greater the amount of deductions you have in a system, the higher the marginal tax rates have to be by default, why do you think government has not done anything at the back end of all these inquiries? I know it is a very open ended question, but I thought I would start with a soft half-volley outside off stump.
Mr Johnston : I think the issue is that, wherever we sit around the room and whoever we represent, be they individuals or businesses, unfortunately, government has got itself into a position where everybody is seeking a rent out of these deductions. We are all virtually relying on government to subsidise what we do, whether it is as an employer or an employee. Until we get to the point where we no longer expect almost as a right that government will subsidise what we do, underwrite our interest or implicitly pay for our work expenses, we will not be able to substantially reform the tax system. I guess my addition to that is: the one thing I would like to see here, from the get-go, is the question of bracket creep, because I think, if we can address bracket creep, a lot of the people at the lower end of the tax system who seem to rely on expenditures or deductions will be compensated by the bracket creep and, from there, the rest of us can simplify the tax system.
CHAIR: Before I come there, I just want to follow up. If you feel like jumping in and asking questions, please do. This is once again an open-ended question to the room. The reality of how tax deductions for work related expenses work in this country is that you do not get the whole amount back. You get, as you move through the tax system, a proportion based on your marginal tax rate, as you move through to whatever your end number is. Do you think the Australian public understand that? Following on your point there, do they think that, by claiming the expense, they get it back? My perception of the public is that there is a lack of understanding of the tax system, that they think they actually get the whole lot back, when in fact, for example, if you assume the top marginal tax rate of 49c in the dollar, with your Medicare benefit, they are getting half of it back. Do you think the public understand that?
Mr Johnston : No, I do not think they understand that to anywhere near that level of detail. I think part of the evidence for that is that more and more people are finding the tax system far too complex, which is why more and more people are using tax agents. So we need to go back to basics and explain to people exactly how the deductions work. I think one way we can do that is to look to the UK and the New Zealand examples and say: 'We can bring down your tax rate substantially if we simplify what we're doing. This will mean you have differences in the deductions or the claims you can have, but you can have a lower headline rate of tax.' I think that is something worth going after and could be sold to the broad Australian people.
Mr Drum : Mr Chairman, you rightly point out that, looking at deductibility of expenses for employees has become a bit of a hoary issue over the decades. To your two questions: the first question, as to why governments have not been able to address this in a satisfactory, acceptable way, if you like, points to the fact that a fundamental tenet of our tax system is that, if you incur an expense in the derivation of your income, unless it is private or expressly forbidden, as pointed out by the Parliamentary Budget Office, then it is deductible. That rule applies whether you are an employee, whether you are a contractor, whether you are self-employed, whether you are a business. The rules about deductibility for individuals—there are a raft of equity issues in it. I think governments have recognised that and struggled to address that. In our submission, we point out examples, as others have rightly pointed out—that for someone who does not have any work related expenses to go down the path of a standard deduction for them, to give a free kick if you like, or for them to be a beneficiary of a lower overall income tax rate, whether they are an employee or not, versus someone who is definitively committed to providing their own tools of trade; they do not work for a large employer who is going to subsidise their tools, whether they be tools used in the office or tools out on the job, on the construction site, these types of things. Not everyone has the luxury of having the employer subsidising and providing all the tools for their work. So it is a recognition that employees will invariably incur some expenses in the derivation of their income.
You mentioned Ken Henry, Mr Chair. In his review and in the Intergenerational report, going back a number of Intergenerational reports over the last decade, Ken introduced, amongst other things, the concept of the three 'P's: population, participation and productivity. One of our concerns is: what does it do? This is the second-round effects, if you like. Again, perhaps it is what Mr Brown from the Parliamentary Budget Office was referring to before. What are the second-round effects of capping the deduction or saying, 'You are not entitled to a deduction in the context of investment of people doing self-education, of people incurring the expenses to be productive in the workforce'? These are threshold issues. I do not have a silver-bullet answer myself. That is to your first question.
Your second question was: do people understand that they are not getting back dollar for dollar? I would say absolutely not. Most of the public—quite educated people, people with multiple degrees, although perhaps not in the business, accounting or legal fields—think they are getting dollar for dollar back. They do not realise it depends on their marginal rate. I will leave it there. I have been composing my thoughts for some time, and have a lot to say. Thanks for the opportunity.
CHAIR: Thanks. Jump back in whenever you like.
Mr Greco : Going back to one of your questions on why we have not been able to reform deductions, I think it is to do with the fairness and equity issue. A cap approach does not tick those boxes. It does for simplicity—and we all would like lower personal tax rates—but, given some of the statistics that Colin alluded to, we have a significant number of the population on low incomes making workplace deductions. It is because of what Paul alluded to: the fact that some employers do not reimburse. A cap is a very blunt instrument. It cannot handle the vast variety of circumstances in the system. Going back to the premise that if you earn income you should have a legitimate right to claim a deductible expense against that income, because of the diversity of where you are and who you work for, there is a lot of disproportionate activity happening in the market place. To impose a cap would give a free kick to all those who do not have any deductible expenses. A cap, in essence, is a very blunt instrument. You should always have the opportunity, under our tax system, to claim legitimate expenses. There should be no caps on that, so long as you prove the nexus required. Maybe there could be an exercise of strengthening that nexus to reduce the scope, because the scope seems to be getting wider and wider and you have to ask yourself how wide you want it to be and how complex you want that nexus to be.
But going back to a cap, we just feel it is a blunt instrument. Again, this has behavioural change implications that we cannot ignore. If we are doing it for a cost saving the behavioural implications are real, as Colin alluded to. You are dealing with potentially eight or nine million taxpayers and they will vote with behavioural changes. If you are looking at savings, you have to be careful of the shift of some of the expenses to employers. You also have to think about consequences from the FBT point of view, in that there have to be changes there. And regarding allowances, allowances are there to simplify administration for the recipient and the payer, so there are lots of consequences going down the path. Going back to your first question, essentially, one size does not fit all when we are dealing with workplace deductions, and any method of trying to do that will short-change someone. In this case, it will short-change quite a number of people.
Mr Davidson : I think that a fundamental problem here is how we define a work related expense, or an expense entailed in earning income, and then draw the connection between expenses and income. It is far from a precise science, and this is where the rent seeking comes in. This is where people are able to push the envelope. For example, with rental property investment people can claim deductions at their current marginal rate now when the income stream is off in the future and taxed at half the rate—so there is a disconnect between deduction and income. In the case of self-education expenses, well, what is a self-education expense? Is it the skills you need for the job you have now, in which case it is essentially a fringe benefit for professional people? That raises equity issues and also workplace mobility issues. Or is it about skills enhancement more widely? In which case you have opened the Pandora's box of funding education and training through the tax system—far less efficiently, I would argue, than something like a learning account or something similar on the direct expenditure side where you have some control.
So things like standard deductions, caps and apportionment rules may appear to be blunt instruments, but I do not think there is any precision in the status quo. The status quo is inequitable; it allows rent seeking. The people who are actually accruing costs in earning their income are not necessarily being rewarded in proportion to those costs and the proximity to a stream of income. So there is no doubt the system is broken. The problem, if we adopt blunt instruments like standard deductions and caps, is whether people will go elsewhere to claim the expense—for instance, independent contractor status and private trusts, and then there are the FBT implications. So the thing has to be considered as a whole. It is not just the personal income tax system per se; it is a broader problem.
Mr Morrison : To go back to your original question, Mr Chairman, there are two fundamental things. One is, as others have commented, that this is actually an intrinsic and fundamental part of the tax system and has been for as long as we have had a federal tax system. The ability to claim legitimate expenses against your income is as old as the tax act, which is going to turn 101 years old this year. So it is in the fundamental nature of what our federal income tax arrangements have always been.
The second thing—and my comments here do not relate to workplace related expenses, for which we are not a commentator—is, if you are looking at buying a capital intensive asset like property, for the majority of individuals purchasing an investment property or for businesses investing in commercial properties, it is most likely going to involve some access to debt to be able to fund that. That is a fundamental part of allowing an individual or a business to invest in a capital-rich product like property. That is an inherently fundamental expense in dealing with that investment.
Once you put those two things together, I think that is why those principles have remained, and I think they are often forgotten when people comment on the impacts of the current policy. Without the current policy, you would make investing in capital-rich products like property more expensive and, therefore, you would get less of it. At a time when we need that investment, whether it is to provide rental accommodation for people who need it or for commercial property to underpin business and the economy, that is not what we should be doing.
Mr BUCHHOLZ: With reference to some of the taxation regimes and the way that they handle their returns, with the equity and the capping thing, does ACOSS think there would be an appetite in the Australian public if we were to offer a more simplistic system without having this blunt instrument, as such, where, rather than referring to it as a blunt instrument, it is referred to as an option? If you are a truck driver and you are currently spending a couple of hundred bucks to get your tax done every year, the system could be made easier, where you go in, you hit the button that says 'Truck driver' and it is automatically sent through. There could be an industry set of deductions that are linked to that truck-driving industry. His tax return, linked with his group certificate, could be done with the press of a button. Do you see that as possibility, whereby if you are a truck driver with a real estate portfolio of a couple of million dollars you choose not to take the easy route because your personal circumstances are quite complex and you will take that investment with a tax agent to go and maximise an opportunity? Do you see that as a possibility?
Mr Davidson : I do. I think an approximate or rough average for different groups is probably fairer than the system we have now, where people with the best access to advice can do very well and a lot of people do very poorly. At the extreme end of that spectrum is the Henry proposal for a standard deduction. But with any of those proposals, where you have a default option which is standardised and then the alternative—to go through and claim it individually—there would be revenue implications for government if you give people those options without tightening up on the individual route. Whether it is through caps or stricter definitions, as in the UK, which dramatically reduces the scope for individual claims, you would have consider those kinds of options. There is the quid pro quo to giving people the easy route, if you like. I think that is sellable, but the devil is in the detail.
Mr Highfield : Perhaps to answer a few of the questions that have been raised already—in particular the last question in terms of a simpler set of arrangements—there are precedents. There are systems of this nature already operating in overseas regimes. Quite a number of OECD countries, for example, have simplified withholding regimes, where the onus is put on the employer to do more of the computation so that at the end of the year the employee more or less has met their full tax liability and there is no formalised return assessment process. The UK and New Zealand are examples of countries that have such arrangements.
If you look at the Nordic countries, such as Denmark in particular, which is perhaps the most advanced, they do have the equivalent of an annual return, but it is prepared by the revenue body, not by the taxpayer. It operates on the basis of prefilling, where information is gathered from third parties and assembled for individual taxpayers; entitlements are determined at an individual level; there is a legislative regime that governs the whole operation of that system; and there are various caps et cetera that apply to particular types of deductions. In the case of Denmark, for 80 per cent of their citizens they can prepare a fully completed tax return which is sent to them electronically, or they can get a paper version if they do not have access to online facilities.
There are these sorts of examples around the world where simpler arrangements exist and they work effectively. I think in the Australian context there are a few issues that have not been raised this morning which I think are worthy of consideration. One is the sheer compliance burden associated with Australia's current regime. We currently have around nine million taxpayers making claims for work-related deductions. On average, those claims rise with income. It was in that context that the Henry review made a recommendation around a standard deduction with a threshold and with provision for exceptions—for people to opt out if they did not meet that particular form or prescription of a deduction.
The Henry review also recommended tightening of the rules around deductibility. If the committee were to look it would find that our rules around deductibility of work-related expenses are relatively generous and liberal to the point where there is an incidence of overclaiming deductions. That is another consideration for this committee. From my experience—and I have given evidence on this particular point—I believe that work-related deductions are probably overclaimed, in aggregate, by around 15 per cent. That is based on my experience in the Australian tax system, my observations of Canadian research and generally what happens when people get involved with the tax system.
The other issue that needs to be assessed in this context is the issue of refund churn. Australia's personal tax system is characterised by a heavy incidence of refund churn. By that I mean that you collect a lot during the year and at the end of the year, in the following 12 to 18 months the ATO has to refund large amounts. To give you some figures, in the 2013 statistics almost one million refunds were processed that had an individual value in excess of $6,000. The issue that this creates for the ATO in particular concerns the detection of refund fraud. You will have seen recent publicity concerning issues around identity theft associated with refund fraud. It is not yet a huge issue here in Australia, but it is an enormous issue in the United States. I think that is another particular issue we need to bear in mind. If you have a simpler tax system with fewer deductions, your withholdings can be more precise and your take-home pay can be increased substantially. That is worthy of consideration in terms of selling a more innovative and futuristic package.
CHAIR: I like the word 'liberal'. I want to follow straight on from Mr Highfield and go to the Taxation Office. Given that in this morning's paper there is a story about a gentleman claiming his son as a $5,000 tax deduction, and given what Mr Highfield has just said, how are you placed on the compliance regime, with work-related expenses sitting as they have for 101 years today, as Mr Morrison said? How are you placed to adequately enforce, once again as Mr Highfield said, the generous side of work-related expenses?
Ms Lendon : We have always maintained a strong focus on work-related expenses, because of the very fact that there are so many of them—high numbers of claims and high value. We know too that it is a complex issue for people, which is why we have a very strong focus on help and education. We put out lots of advice and guidance, particularly around tax time when people are thinking about their tax issues, but also through to some quite strong compliance activities that we do. We try to help people as much as possible to get it right, and we want to make that investment as well as we can, and a leveraged investment, which is where tax agents are a key player in the system for us.
We also know that there are higher-risk areas and occupations, so we work on activities around that. They can be things from prompting letters through to full audits. In areas that we have concerns about we may send people a letter saying, 'We know you have claimed this in the past—have a good look before you claim this year.' That is trying to help them in their forward compliance approach. Of course full audits are the more expensive option, and we use those on the highest-risk cases.
Our approach is that we run our risk tools across all of the tax returns that come in. We are looking for cases that have abnormal claims or are outside the norm for occupations. Talking about that case that you mentioned specifically, they are the types of things that we will pick up. They are more unusual than usual, but our processes certainly do pick those up, and in the more detailed cases we do the audit. We have been doing that for a long time. We know that it is a challenging area for people, but we have been managing that over many years.
CHAIR: Following on with Mr Highfield's figures, if there are a million people claiming greater than 6K as a tax deduction—let's assume 6K for the sake of simple maths. Am I right in saying—
Mr Highfield : No, I did not say that, sorry. With respect, I said there was a million turns processed where the average value of the refund was over $6,000. That is quite separate from the area that Ms Lendon said about that.
CHAIR: If there are a million people with a refund of 6K or more, and we assume 6K for the sake of simple maths, am I right in saying that is $6 billion? Okay. So with that $6 billion going out by way of refund for a million, are you adequately set up to oversee the complexity of monitoring rorts within that environment?
Ms Lendon : As I mentioned, we have our analytics, our risk engines, run over all that data. So we are well placed.
CHAIR: Is it exception reporting? Would that bring up the red flags?
Ms Lendon : Yes—and Adam might jump in with a bit more detail. So that will draw things to our attention. Those risk engines get better and more intelligent with the more work that we do, so that we can identify the cases that we think need to be looked at. That is the approach that we take. On the refunds that Richard has mentioned, that is sometimes about the mismatch of the withholding that has come out, not necessarily a work-related expenses issue. So we need to be careful as to how we use that figure. But that certainly is the approach that we take. We do not have a limitless supply of resources—that is true. So we do take a risk approach. That is where we will put our investment: on those cases that we think need that attention.
The other issue is with tax practitioners. Of course, if we can work with tax practitioners where we may see some trends there then we will do that because is a leveraged approach and we can get to more indirect effects across the rest of the clients as well. So we have approaches of that nature to deal with the complexity in the system.
Mr Drum : I want to get back to a point made by Mr Buchholz before about perhaps a tax nirvana for individuals, that with a simple press of a button it is all done and they do not have to do anything further. I do not want the committee to be misled. This is something that could be done so easily and it is all about work-related expenses. For example, if you look at the individual tax return at the minute, there is a whole raft of reasons why people will still need to lodge a return, even if you took the worst possible case of work related expenses being abolished completely and everyone being given a lower individual tax rate. You still need to lodge because of Medicare. You still need to lodge because of your private health insurance. You still need to lodge because of your rebates for nonworking spouses for family tax benefit or to claim your charitable donations. There is a raft of other things—for your trust distributions, for your distributions received from partnerships.
CHAIR: Mr Highfield mentioned other OECD countries that have—what was the term? Was it 'prefill'?
Mr Highfield : Fully prefilled tax returns.
CHAIR: You are right: each individual has their own individual set of circumstances. But if there is a relationship between a system that allows that person to prefill and add nuance, is that something that could overcome the problems you are alluding to?
Mr Drum : Yes. We are progressing down a path of prefilling already—for example, the tax office with e-tax. It can capture your dividends. It can capture your bank interest. It knows your PAYG details. If you go through myGov and want to self-lodge, it will say, 'Is this information correct about yourself?' and you can validate it or you have the opportunity to correct it. But you still have to fill out the additional things.
My point is that we are in the digital age, processing down a path of making it simple for self-preparers and lodgers. Notwithstanding that, some of these same lodgers who at the moment are claiming a work related expense are going to have a charitable deduction, a distribution from a family trust or a distribution from a partnership that will not be captured by the tax office or by 'big data', if you like. It is information that is specific to family units and family groups, so we are now talking about a compliance issue that is potentially moving from an agency to employers, as Richard was talking about in his example; we can get the employers to capture more data and finetune and withhold better at source. Certainly we can do that, but we are now actually talking about a discussion where some of that compliance burden, even if overall it is less, has just been moved from the government agency to the employer. And what does that mean?
CHAIR: Paul, I am guessing you are an accountant.
Mr Drum : Certainly.
CHAIR: So, on the chart that Mr Brown mentioned earlier, and picking up on Mr Highfield's point of a UK-style model, I guess—
Mr Highfield : I did not advocate a UK-style model. I mentioned the UK model.
CHAIR: Sorry—Scotty mentioned the UK. For example, on the slide we saw, in the percentage composition of WERs, 40.6 per cent, I think it was, came from motor vehicles. That may mean different things to different people, i.e., Scott is a truck driver, so it is a truck. For most of us, the vast majority, it will be a motor car. As the system sits today, as an accountant, if you can get from A to B in a Commodore, and if you drive a car, they are worth 40,000 bucks if you go to Sutton's motors at Homebush, on Parramatta Road—there is a good special on at the moment, in my electorate; Craig Sutton, you can send me the cheque later! But if you can buy a $40,000 Commodore and then lease it—and I am interested in the rules around motor vehicle deductions, I guess—and any executive in Australia can do that job with a Commodore, should the government be footing the marginal tax rate of an individual's proportion of expenses if they choose to drive a Mercedes sports?
Mr Drum : That is really a question for government, about how they want to set policy.
CHAIR: But what I am asking is, are there rules? If you go down a simplified system—and that is what I am asking this government—if we were to come up with a system that said, 'If you drive a car, this is the amount we assume you can do it at', and I guess we are coming back to a standardised system—is that something that you think could be implemented?
Mr Drum : There will be others in the room who can answer this better than me, but that is kind of what already happens now.
CHAIR: That is what I want to know.
Mr Drum : There is a cap already. If you drive your $200,000 Lamborghini, there is a cap on the extent to which—
CHAIR: That is what I am interested in. Do you know that off the top of your head?
Mr Drum : That is $60,000-odd.
CHAIR: Where the luxury car tax sits in?
Mr Drum : Yes.
Mr Gandolfo : That system is already in place.
CHAIR: Good; I am genuinely interested to understand the nuances of it.
Mr Drum : So, if you cut it back to a Commodore a little earlier, and then perhaps we still might have Commodores made in Australia—but they are on the way out; that is a bigger threshold issue, not for this committee. So, I think it is fertile ground, and that is why we are here today—to explore the extent to which a deduction is allowable. I note that Richard is not proposing the UK system, but the rules about the extent to which something is necessarily incurred I think is fertile ground, whereas at the moment it is quite broad—the deductibility of expenses. But certainly we would be interested, as I am sure everyone else is, in what the savings are and where that money would go. At this discussion here it is an issue that has been pulled out, and the terms of reference talk about a report by 29 February that might inform the government in its decision making for the federal budget. It is something that now actually seems to have come out of the broader tax reform agenda, so certainly before we have all voted with our hands to say, 'Yes, let's go down this path, Mr Chair', we need to understand the full picture. But certainly I think this is fertile ground for discussion and exploration.
Mrs Bordonaro : I think it is very important to remember that Australia is a very diverse country. So, we are talking about the example of the truck driver, and we are talking about the example of the Commodore. As somebody who lives in regional Australia, I cannot drive my Commodore where I need to go, so my motor vehicle expenses would be very different to those of somebody living in a CBD environment. That diversity needs to be reflected in business accounting and in employee accounting.
CHAIR: That is a very good point.
Mr Heferen : Just to continue the discussion about the UK, obviously the Treasury would advise the government on policies made by ministers recommending to the parliament, so I do not want to be in the position of advocating a particular path forwards. But I will just note what was said in the PBO's submission and in our submission, and others have raised the issue about the system in the United Kingdom, where the nexus between the expenditure and the income earned is tighter. I think there is a question of what that would mean in practice for the people of the United Kingdom. But you made an observation at the start, Mr Chair, when you asked people whether or not they thought when they claimed a deduction that they were actually receiving the tax value or the entire amount. I also think there is a question—and I am sure there is no-one in this room it would apply to, but I suspect there may be some people—that people go to their tax agent or their accountant and say, 'Here's my tax return', and the tax agent says, 'You can claim this as a deduction', and they are a little surprised. I think what drives that is that they do not actually think of that expenditure necessarily driving their earning of their income. It is as if it were expenditure that would have been incurred anyway, and 'Look, there's a bit of a bonus here,' because you can claim a tax deduction.
I think the observation has been made, both in the Henry report and in work previous to that and work subsequent to that, that Australia's system of claiming work related expenses, compared with a range of other countries, is relatively generous. But the nexus, if you like, between income earned and the expenditure outlaid is maybe a little looser than in other areas, other countries. And whilst New Zealand has gone the whole hog and eliminated it completely in return for lower rates—and obviously there are comments around the room about, 'Well, that's quite tricky, given the difference in expenditure', not only a range of professions but a range of people in different areas in particular professions—nonetheless the United Kingdom one I think does pose an interesting counterbalance—
CHAIR: Are you talking about—regarding the definition, I think, if I am not wrong, they use the words, with respect to WREs, 'wholly, exclusively and necessarily'?
Mr Heferen : That is right. Ours is 'necessarily incurred', but the question is whether it is wholly and exclusively. And I think there will be some times where there is a proportion done, or it could be argued, well, that expenditure is not wholly and exclusively in relation to earning assessable income. For people who have gone over to the UK system—and I am sure Richard is one—the complexity that arises in people making judgements about what particular expenditure is deductible and what is not deductible in that respect. In one sense our system has a boundary. The United Kingdom system would simply shift that boundary. So, there would still be uncertainty and debate either side of that line about whether something is in or out. But it does represent an alternative frame to view the issue through. Of course, which frame is correct or which frame best suits Australia is a policy question and not a sort of objective matter. But I would just like to draw that to the committee's attention.
CHAIR: Does anyone have any thoughts about the UK's definition of a WRE versus—someone used the term 'generous', I think it was, earlier, with regard to how view those in Australia.
Mr HUSIC: But there is another aspect to the UK definition, I recall—that if you go to claim a deduction in a particular employment classification it has to be something that could be applied across the entire classification as opposed to an individual one as well. Is that right?
Mr Heferen : Yes.
CHAIR: But you can argue the toss if you have the relevant documentation to go beyond what is the classification.
Mr Heferen : I am sure there would be situations where people might say, 'Well, actually, the category of employment needs to be adjusted, because I'm doing this sort of job', and the category might be quite broad and it is really time to narrow down that category. And I am sure there will be debate either side about where those categories rest.
Mr Highfield : Just to add some context to Rob's observations, in the United Kingdom two-thirds of employees do not have to file a return. They are outside the categorisation or the area of deduction that Rob just mentioned. The particular category he is referring to would be people who have to self-assess; they do have to file a return. So, what I am saying is that in the broader design of their system they have managed to exclude a requirement for annual filing for two-thirds of their employee population. Now, the two-thirds do actually now get an end-of-year statement from HMRC, which is a new development, which defines how much tax they have paid over the course of the year, what their income was from various sources of employment. It is a means of making the system more transparent to those employees who do not file a traditional type of tax return.
CHAIR: Once again—a half-trucker outside off stump, I guess: Paul and Tony have already said, 'We'd need to see what the saves are.' And going back to my opening comment, do you think one of the reasons the discussions in this space have fallen over historically is that there is a feeling that government is trying to make more out of the taxpayer rather than simplify and give back to the taxpayer? For example, say I am not interested in making any saving, other than through compliance and ease of lodgement for the actual taxpayer—so, having those I guess oversight savings. But say you were to net out as a government—to wipe out—expenses and give back completely by way of, as Adam originally said, so that there is no outside agenda, other than the premise that the individual Australian is the best decider of how to use their money. If you had that as the centrepiece of anything we did in this space—has it historically been that it has not been that as a centrepiece that has caused this to fail? And, if it was, do you think that we would get more goodwill in this space and a better outcome, a better result?
Mr Johnston : Perhaps I could just jump in there. I think you have just made the sales pitch yourself, and I do not think that has ever really been the debate, because the moment somebody talks about tax the shift is immediately to, 'Oh, where are the deductions' or 'Where is the compensation?' whereas if you said, 'No, it just isn't about a bit here being compensated by a bit there, it is about your money coming back to you and you having more choices globally about how your spend what you have earned, and by the way, most of you will not have to file a mountain of documents or go to a tax agent, because we're going to do that ourselves', I do not think that would be overly difficult to sell, particularly if you put it in the context of—and I am relying on a paper that is in the parliamentary library, apparently, by Dr Anne Holmes, about tax expenditures, and on recent figures that is $115 billion. That is the amount of money that the government could have, but basically you are losing. I really think that needs to be put there in the global context of, yes, there are budgetary constraints, but with giving these deductions back or underwriting other behaviours, be it rental property or other, the government is losing not millions but billions.
Mr Heferen : I feel I need to jump in on that. The Tax Expenditures Statement does not measure revenue that the government could otherwise get. All the Tax Expenditure Statement does is, given hypothetical benchmarks that are inevitably a matter of judgement, measure the difference between the benchmark and the tax rate that might apply for a particular organisation, industry or activity, and then measure the utilisation of that. Indeed, the issues we are talking about in relation to work-related expenses—that is not a tax expenditure. By definition, that cannot be a tax expenditure because it is trying to get at what taxable income is. Other things, like net rental losses, are not tax expenditures. They are getting at what the correct amount of tax paid might be given the taxable income being the subject of taxation. That is something that is often put into public domain; 'Here is this amount of money that the government could have.' It is not a measure of that, it is not meant to do that and it is not designed to do that, but unfortunately it is sometimes reported as such.
Mr HUSIC: In the briefing papers that the committee had a number of things stood out. There were references to other jurisdictions' use of standard deductions as a simple and effective way of trying to sidestep the whole need for a shoebox collection of receipts—to just provide the standard deduction—and that that will speed up the process. But then there is the argument that that just encourages people to apply for a deduction that they may not have actually triggered. Then there is another argument that instead of providing the standard deduction we should actually do what New Zealand did, which is to wipe the deductions out and make it flow through on an income tax cut, particularly for lower income people. But there is still this thing about people on much higher incomes—as has been demonstrated in the PBO demonstration—that are making fairly sizeable claims. It leads me to the example that was provided, I think, by KPMG—and I do not know if they are still on the line—which is to provide a threshold under which no work-related expenses are claimed, to cap that amount, to fix that cap and to have the threshold indexed. I guess what I am putting out there is: of these types of scenarios, what do people see as aiding simplicity, fairness and efficiency within the system? If the KPMG people are on the line and can talk to their example it would be helpful as well.
Mr Wardell-Johnson : The motivation behind the proposal which you have just outlined is really based on simplicity. It is very hard to delineate between what might be called 'good' and 'bad' work-related expenses.
Can I also make a point in relation to the earlier comments, and maybe about 'necessary'. The woman on the Woden omnibus would think that her child care expenses are necessary for her working. She probably would not think that a psychiatrist going to Venice for a conference would be necessary. We and the UK and the US have drawn certain lines that exclude types of expenditure like childcare. I am not saying that that is inappropriate, but there is a mismatch between the language in our tax legislation and how tax lawyers use that and what the common person understands would be appropriate. That is the second point I would like to make.
The third one is that I think there is a very significant variation in aggressiveness—for want of a better word—in claiming work-related expenses. I think there are strong differences between those that are taking a view right at the edge and those that are being conservative. I note that the Parliamentary Budget Office put some statistics—which I could not see—in relation to gender. I did some work on this about three or four years ago, and there is quite a big difference in the way in which women and men claim deductions. I think about 80 per cent of that is due to income inequality but 20 per cent is not and it is unexplained. It might be because men and women tend to focus on different professions. But it might be the degree of aggressiveness, as in males are more likely to be aggressive in claiming deductions than women are. I do not know whether they are helpful as comments, but they are the comments I would make.
Mr COLEMAN: Just a few comments. I guess one of the things that for me comes of out of this discussion is that this is a discussion that is really about compliance and simplicity as opposed to, purely, work related deductions. To Paul's point, if you can simplify the work related deduction space but you still maintain a relatively complex system which requires millions of taxpayers to, effectively, have professional help to put in tax returns, you have not achieved a great deal from the perspective of compliance. So it seems to me that the overarching goal, here, really should be to create a system in which far fewer people are required to go through the complex process of submitting tax returns with professional help. That, obviously, has a compliance benefit for individuals and it probably has a benefit in the sense of lower deductions for the cost of managing tax affairs.
Having said that, I think the other question we have to consider—as a number of people have raised—is this fundamental question of is it appropriate that people can claim work related expenses against work related income, because that is quite a fundamental tenet. I am interested in people's views, but it probably is. If it is very directly related to work it would seem fair that it can be claimed. It seems to me that the idea of some sort of simple averaging, which I suspect the vast majority of taxpayers would just happily accept, coupled with a capacity for people to put in more detailed tax returns, if they need to do so, would be sensible.
To the point that was made—I think it was by Richard—that that could have an increased cost of deductions, that obviously goes to what the average level is set at. So you would probably have to set it at a reasonably modest level. Also in this process you have to look at everything that requires people to go through a complex process to submit a tax return, not just work related deductions—you could simplify work related deductions but still be left with a system which is, overall, still complex.
Mr Mullins : There have been a couple of references to self-education expenses and I think they are, in some ways, a good example of the complexity of some of the issues that are raised here. In terms of variation between individuals, it really goes back to the extent to which individuals are required to be educated and trained for the role that they perform and the extent to which they are expected to fund that continuing education and training for themselves, and that varies enormously from one industry to another—from a construction worker to someone, for example, working in health and medical research.
It also raises this whole issue of what is necessary and how you relate that to current income. Again, to take the example of a health medical researcher, we see enormous scientific advances all the time in health and medical research and those advances are based on new technologies, new ideas and new concepts. There is a huge emphasis on the individuals themselves keeping up-to-date with those changes and maintaining their own knowledge and skills. That is essential, perhaps, not so much to earning their income this year but, certainly, to their ability to earn that income next year and the year after. I think this whole question of what is necessary becomes quite difficult in that context, and there are other considerations in that.
The example was raised of a conference in Venice. If you are a medical researcher in Australia, today, you are probably working in a field where there might be one or two other people who are working in your speciality in Australia. Most of the expertise and most of the knowledge is going to be overseas. Necessarily, you are going to be travelling overseas to meet with other colleagues and to attend conferences and symposiums, because that is the way that knowledge is transferred in this sector. It is essential to the way that people maintain their skills and maintain their knowledge. That is not only in their own interest, I would suggest, but also in the interest of the Australian community, particularly with the focus on innovation and the need that that drives for lifelong learning.
Mr Davidson : If it so essential to the work of these people, why isn't the employer paying? And if the employer is not paying, what does that say about the funding of and investment in research and development in Australia? I think there is a more fundamental problem, here, that we cannot paper over through the personal tax system.
CHAIR: Greg ended on that point, but what I think the body of his point was going towards was the complexity of the category: what is self-education and what is essential for maintenance of employment? It was that complexity side. Would that be fair to say, Greg?
Mr Mullins : Yes, that certainly is one of the key points. I think the other point—again, taking up this point about differences across the economy— is the extent to which individuals are responsible for their own education and training and keeping up to date with their field or profession. This varies enormously across the economy and across different occupations—from someone who is a process worker where, if the company they are working for introduces a new production line or a new approach, they are going to be trained by their company in the way that is done. If you have someone who is a lawyer or an accountant working in a profession there may be some provision for that, but they may also be expected, for example, to fund their own higher education—to be paying for a masters or something like that.
In the scientific research professions there certainly is an issue, here, about the way it is funded. I do not think the solution to that is, simply, to shift that responsibility to the employer. In most cases, in scientific research, a large proportion is funded by the Australian government. What you are effectively doing is shifting some of that cost back to the Australian government where, in fact, you have a whole profession, here, a range of researchers, who are more than happy to personally subsidise the cost of their own self-education, and are doing that now because, as we noted, claiming a deduction does not go anywhere near covering the costs. These individuals are the ones who are best placed to determine what sort of training and further education they need.
Mr Varrasso : Thanks, Mr Chair. I did put my hand up a while ago so the conversation has shifted.
CHAIR: I apologise.
Mr Varrasso : I am a tax lawyer. When I go to parties and people ask me what I do, I tell them I am a tax lawyer. There is usually a long silence. After that, they ask me a question about what they can claim. That is not all I wanted to say, but I thought it was appropriate.
CHAIR: It is a hell of a start though, Adrian!
Mr Varrasso : There are two points to that. One is that there is an expectation, I think, in the community that they have a right to claim amounts they incur, in relation to deriving their income. As Mr Morrison said, that has been in our system since 1915 and that is going to be a difficult thing for government to deal with. It comes back to the point before, I think, that was referred to as the 'sales pitch' a government has to be able to get a community to buy into this.
The second point to my story is that I am sure, given the silence, most taxpayers do not want to have to speak to their tax agents, tax lawyers and tax advisers. The system is very complex and any steps that we take to work towards simplicity should be considered. The difficulty in doing that is that, with simplicity, there is often the trade-off with equity.
There have been so many examples talked about over the morning so far, and, to use one, Mrs Bordonaro raised the point about her travel as compared to somebody else who might be in the exact same profession. If we deny the expenses related to vehicles and put a standard amount on that, Mrs Bordonaro loses out as compared to somebody else in her profession who lives a lot closer to where they need to be. There are these trade-offs in everything that we can work through today, and we have to be careful about balancing simplicity and equity. There are obviously policy decisions in all of this. Going back to the example of vehicles, it might be a question for government of, in a sense, subsidising the fact that we have these geographical differences with other jurisdictions. I know we can compare to other jurisdictions, but we have to take into account a variety of differences that we have here. Motor vehicles are expensive here, far more than in other jurisdictions. So there are government policy points on all of these.
One other point: we do need to be careful about the talk of pushing costs onto business, particularly in the current environment. It is very difficult to say that these should all be pushed onto employers and employers should bear the burden.
Part of the issue with the difficulties around work related expenses—it is only part of the problem—is that, with any work related expense, it is often the case that there are private benefits. To use an example of a carpenter who buys some tools obviously related to his or her employment, at the same time they can use those tools to build a cubbyhouse at home, whereas a lawyer cannot.
Mr Drum : You can wear your gown for fancy dress-up!
Mr Varrasso : No, I cannot build a cubbyhouse to save my life! My point is that shifting costs onto business in that respect causes difficulties where a business is, in a sense, funding some private benefits. I could go on. The conversation has moved to a variety of places.
CHAIR: You raise a very good point. Take the example that was given of the four-wheel-drive requirement versus the town car. In the simplification, I guess what you are saying is that you would need to be sensitive. You may determine a definition of 'regional'. It might be that you are more than 100 kilometres from a capital city in Australia and you would click on this spot for your expenses versus this spot. You are saying, if we do go down the simplification route, which, as a tax lawyer, it sounds like you are not afraid of, it needs to understand the nuances of geography—I guess that is the example here.
Mr Varrasso : Yes, there are a lot of things we can do to help simplify the system to deal with the complexity and, as a result, I think frivolous claims for work related expenses will be addressed. When we talk about over-claiming, we have to be careful to distinguish between fraudulent claims, which are just not within the law, and those that are at the edge where there is some complexity and uncertainty around the law. So we can deal with the second; the first is always going to be a matter for the regulator to address.
Mr Gandolfo : If I could expand on a couple of points that Mr Varrasso made and respond to one by Mr Davidson, we in financial services are in an industry which is highly regulated. In order for, perhaps, me and for Mrs Bordonaro and others in our industry to maintain our licences and our accreditations with funders, we need to do 20 hours of CPD every year. We also need to keep abreast of any legislative change that comes in, and the most recent example would be changes to anti-money-laundering legislation, which came into effect in January. We each of us had to do a course, which incurred a cost. And it is common to financial planners, accountants and all those sorts of professions. To respond to the ACOSS point, the reason that quite often employers do not pay that is that the education and the benefit rest with the employee.
CHAIR: And they are free to leave.
Mr Gandolfo : That is right—exactly. The employee is the one who holds the licence or the qualification, and those types of workforces or professions are inherently mobile, so you could be training someone to achieve a qualification that the next employer gets the benefit from.
Mr Greco : On the point Greg raised of putting a cap on work related deductions—to state the obvious, self-education is a component of work related expenses. We had this conversation not too long ago as far as putting the cap on that component. It did not make any economic sense to put any restrictions on investment on human capital. We had that conversation. If we were to remove a cap, and we are not opposed to a cap—I think David mentioned a modest cap and going back to Scott's arguments—we are one step closer to not having to lodge a return if we have an option for a standard deduction. It has to be modest so it does not cost revenue a lot of money, but having a cap on self-education does not make any sense. It is a component of work related expenses. As an accounting body we are not opposed to simplification. I think there should be an option as part of the raft of changes that we get closer to some of these other jurisdictions where a large chunk of the population, because of pre-fill, have that option, but we do not want to take a one-size-fits-all approach and eliminate because of the diversity of scenarios in the workplace. We go back to the fundamental principle of being able to claim a legitimate deduction against your revenue, and that option should not be taken away.
To further the point, self-education expenses are already very restrictive and obviously professional people have to do it as part of their ongoing requirement. For example, if a vet nurse wants to go to university to become a vet, those expenses are not deductible. They are already restricted. There is a case for making it less restrictive to enhance our human capital and for productivity reasons. But you want to be mindful of the fact that it was not too long ago that we had the discussion about having a cap for self-education.
Mr Hicks : Firstly, I want to echo David's point that there are good reasons many employers do not pay for employee expenses. Those expenses provide personal benefits which can be taken on to an employee's next employer—whether that is through education or through the purchase of a home office or something like that. Secondly, it is important to realise that there are reasons for funding expenses through a deductions based approach. Our tax system is based on the idea that people's tax liability should be based on their capacity to pay and the amount that they pay should increase as a proportion of each dollar of additional income as they earn more money. The flipside is that, if we say that someone's capacity to pay is reduced by an expense, that reduction has a bigger effect on their capacity to pay for higher-income earners. There are reasons to fund things through a deduction system rather than through direct appropriations or something like that. Ultimately, there are pros and cons to making changes in this area, and there are always going to be, and it is just a case of weighing them up. There are definitely benefits from simplifying the system, and we could perhaps reduce some over-claiming as well. It is not just fairness concerns that mitigate against that; it is also about efficiency. If we make it more difficult to claim work related expenses, then professions with higher work related expenses become less attractive and so we are distorting behaviour by doing that. The point is that it should not be an either/or thing. We should not adopt a simplistic rule for all types of expenses; we should look at what we think people should not be claiming and we should be specific about that; then we should look at ways of adjusting the system so that those claims cannot be made, rather than taking a top-down approach.
Mr COLEMAN: I have a question mainly for the ATO people. Just back to the earlier point: if we assume for a moment that it is possible to simplify the work related expenses area—which is a significant assumption, but let us make it for now—if the overall system remains complex nonetheless, and substantially the same number of people still have to use a tax agent to put in their tax returns at the same level of expense and so on, not a huge amount has actually been achieved from the perspective of simplicity and making compliance easier. As I said before, it needs to be holistic; it cannot just be this deductibility area. What are the other areas in the ATO that you would see as things that would need to also be simplified if we are seeking a goal like the UK's of, say, substantially reducing the number of people who need to go through a complex process for a tax return?
Ms Lendon : One of the things that has really helped simplify processes for people has been the prefilling and the amount of data that we get so that we can prepopulate a return and people then just need to tick it. The more that we can get to a position where data can be prefilled—at the moment we get a lot of income data, we get information around shares and dividends and so forth. That certainly simplifies the issue. On the deductions side, of course, we do not get the third-party data; it is similar with gifts and donations. I think it is probably how far you can go, so the more things that can be prefilled the easier, and then a larger part of the population have very little to do. That is the assumption there and that is where we are certainly headed.
A point on deductions, we have released an app called myDeductions to help people document during the year, because we know one of the issues around deductions that are complex for people is keeping their records. People can miss out on things because they do not keep good records. We are looking at all those ways to simplify within the current system, but there is no doubt that if we can get more data to prefill, that makes the overall experience for people faster and helps them get it right.
Mr COLEMAN: Looking at the figures on the cost of managing tax affairs, that is actually going up—not going down or flat—on these most recent numbers, which suggests that there has not been a notable compliance benefit for the average taxpayer. Is there a specific and detailed plan in place to try to make that happen?
Ms Lendon : I guess it is a question about why do people go to a tax practitioner? Some would say they go to a tax practitioner because they do not trust the ATO to tell them all the things that they might be eligible to claim. But we also know people do not have faith in themselves and their own understanding to be able to do that and get the most that they are eligible for. I think it does come down to understanding behaviour and why people use a tax agent as to why that figure is going up. It would be interesting to get some views from the associations on that too.
Mr Drum : We agree with Alison's comments from the ATO regarding human behaviour and their lack of trust in themselves about getting it right, the levels of confidence and, certainly, mistrust of the agency. Australia is a sophisticated economy. We have high-powered jobs, dual-income families and a complicated system, but we are also an economy that uses services. We get our dogs down to the pedicare get their toenails trimmed, we pay for our haircuts, we take our stuff to the drycleaner on the weekends and we get our cars washed. We do not do everything ourselves. We are happy to pay for a service if we think we are getting good service, so they do not want to be embroiled in thinking about this 24/7 for the whole year. And at the relevant time they collect the papers and they go along and they get the service that they are seeking.
Mr Brown : Chair, I have just a couple of observations. The discussion around self-education expenses brought something to the fore in my mind, which is that, when you are looking at what you are trying to achieve and at what policy is trying to encourage, if you have a standard deduction system that covers those kinds of deductions, one of the things that you remove is the marginal incentive for people to undertake that expenditure, because you get the value of the deduction regardless of whether you actually spend the money. So, in the case of self-education expenses, if you wish to encourage something like that, you still need to have something that may provide a person with an incentive, if that is what the government's objective is actually to do. So, in designing the system, you probably need to give careful consideration to what is in and what is out, depending on those incentives that you want to provide in the system.
Another related factor is that many things already receive a substantial level of public subsidy. If you have something which is heavily subsidised out of the public purse already, that raises a question about whether it should be deductible, even if it is directly related to earning assessable income. The one that came to mind there— which is actually regarded as a private expense, so it is not a good example—is child care. There is a fairly large level of public subsidy already to child care. So the question about whether it should be deductible as well is a moot one, and it goes to what level of support you want to give something which is subsidised out of the public purse already. If it were not subsidised at all then there would be a better case for saying that that is something that should be deductible if you think there is that nexus to earning assessable income.
The third point that comes out of this—it goes back to revenue neutrality—is that, if you are going to have revenue-neutral reform, given that there is in fact an uneven distribution of deductions between taxpayers, then that uneven distribution means you are going to have winners and losers. So, with any reform in this area, you are going to have to also determine what the level of winners and losers is that you are prepared to bear.
CHAIR: Thank you. I am going to come to Mr Johnston, but before I do, Mr Brown raises an excellent point. It has been interesting to watch this morning. I have tried to push the argument of revenue neutrality as the tool by which we achieve simplicity and ease of maintenance by the ATO. A lot of you have been at these inquiries over the last seven years, and I keep saying it: everyone reverts back to the marginal tax rates exactly as they are today and looks at the impact it would have. It has been fascinating to watch. Mr Hicks, you were the latest—I am sorry, I do not mean to embarrass you in any way—to say that the system is 101 years old. Mr Morrison, you started off in this vein. We as a government are looking at a system that is 101 years old. Are there things we can do that are revenue neutral? But, you are right, Mr Brown: there are winners and losers in that. We are looking at a mass total, but each individual has their own individual set of circumstances. That is something that we as government and policymakers definitely need to take into consideration. Mr Johnston?
Mr Johnston : Just a few quick points. Going back to the point of professional or educational expenses, I would like to point out again, as a lawyer, there are certain professional things that I have to do, but equally there are conferences and there are conferences. The educational value you get out of one may be very different to the educational value you get out of another. I think there is still an active question as to whether, on a wider policy point, government and the taxpayer should be subsidising that. The last speaker made the point about whether we should be giving deductions for things like child care, when that industry gets subsidy from other areas. Again, from the perspective of certain professions, they also have regulatory powers; they also have certain monopolies they can exercise. So, regardless of whether it is subsidised or deducted or not, persons who wish to keep accreditation or certificates under certain professions will have to do a certain amount of education anyway. That should happen regardless of the deduction.
Finally, on the point of simplifying the tax return—the question raised by the CPA that, while you might simplify deductions, there might be an issue with travel deductions and spouses and things like that—at least in relation to travel deductions what tends to be happening more and more is that not only do people claim deductions for donations but government gives donations to charitable bodies itself. So the government is reducing the amount it receives doubly by allowing the deduction and then giving a direct grant anyway.
CHAIR: That is a very good point.
Mr Davidson : I think the discussion around self-education neatly expresses the difficulty in distinguishing between individual benefits, public interest—for which expenditure programs like education and health care are in place—and what employers should be paying for. The lines between those three are very difficult to draw. I think that is a huge challenge for us.
CHAIR: That is a fair point.
Mr ALEXANDER: My question is to Mr Highfield. I do not know whether or not you are an expert on the Danish system, but in their no-touch tax returns, is there consideration for child care?
Mr Highfield : I think there may be some sort of allowance or deduction for that. Harking back to an observation Alison made earlier: part of the Danish tax system's third party reporting does extend to areas of deductions. For example, in relation to charitable donations, I understand the Danes do get third party reporting from charities. I do not know if there are caps or limits on that, but I do believe there is some provision—I cannot be 100 per cent sure, but I would not be surprised—for child care. Again, I would not be surprised if it were not supported by third party reporting by the childcare provider. That means that the Danish tax authority can still automate the assembly of information and the preparation of an annual statement of your income, deductions, entitlements and tax payable.
Mr ALEXANDER: If not, there is no reason it could not be done—noting that we need to improve female work participation. We lag behind a number of countries we compete with in this regard and it is a driver of productivity. It often seems very unfair that the female bears the burden of having to pay after-tax dollars for their child care. Sometimes it is more expensive to go to work than to stay at home. In regard to Mrs Bordonaro and the question of regional areas and increased distances—by the way, you get better knowledge when you drive longer distances.
Mrs Bordonaro : It depends on the quality of the road.
Mr ALEXANDER: Yes, you are right. A professional person is going to be paid more. There is therefore consideration in their wages for the degrees they have already obtained and are expected to maintain. Given that in regional areas you may have to drive further—are your wages commensurate with the cost of living in a regional area as opposed to the very high cost of living and housing in Sydney and Melbourne?
Mrs Bordonaro : I can connect a lot of dots in this conversation. As a working parent, I can probably cite a day where I have driven long distances to attend a continuing professional development course that is mandated by ASIC which I must do to earn an income—and there has been a considerable increase in those mandates from ASIC across many industries over the last five years. That might be a reason for an increase in self-education expense. While I am busy driving, my children are in child care. I am time poor and that is why I would take my tax to a professional to have it done, because it is easier. I would just like to link all those conversations up. That is the reality of our lives; we all live busy lives; and in producing an income we all make different decisions. I might decide to sit down of a night and trawl through the ATO's website and do my own tax returns versus making a decision to pay someone to do it for me. I would not like that choice to be taken away from me.
Mr ALEXANDER: Would it be a simpler and better system if, when you have a deduction and you are in a 50 per cent tax bracket, you get a larger amount back than if you were in a 30 per cent bracket? Would there ever be consideration given to a tax credit for work related expenses, in this case child care? In other words, what if we did away with subsidies?
Mrs Bordonaro : My eldest child is 21, and I have worked her entire life. She was six days old when I returned to work. I have been an employee and, over the last few years, I have had my own business and I can see it from all perspectives. There are many times when I have decided not to apply for the various subsidies and so forth because it is so complex; I would rather spend the time with my child than sit at night filling out paperwork. Simplifying that process would improve efficiency and improve the ability of women to working and managing children.
Dr Zirnsak : I wanted to weigh into the discussion around the notion of simply shifting all education expenses onto the employee. Picking up on Peter's point, there are wider concerns. To give an example, in Victoria the government introduced the requirement for employees in pubs and clubs with electronic gaming machines to have a responsible service of gaming certificate. Some employers took the view that they wanted to take it seriously—
CHAIR: I think I am the only parliamentarian with one of those, by the way.
Dr Zirnsak : Then you would know that some employers who took this very seriously paid for their employees to do high-quality courses that involve role-play and that gave them the skills to actually to do this properly. On the other hand, there were a bunch of employers who said, 'All I care about is having someone who has the certificate.' That generated an incentive for RTOs to be set up which ran two-hour courses all on paperwork with minimal testing of skills. As long as you have the bit of paper, you are in the pub or club and are able to claim for being an employee. Then there is a community cost to that in terms of harm caused in those venues—a lack of protection for people gambling in those venues. There are often public interests in ensuring that employees across the board have a certain level of skill. If you want to say, 'Well, that could come back to a regulator enforcing that level of skill,' then that requires a revenue to ensure regulators can function properly—which we see all too little of across many areas in our society.
Mr Highfield : I would just like to comment on the issue of winners and losers, which you raised earlier on. When you or whoever comes to that position when that has to be done has to take a broader perspective. You should not just be looking at the specific area of change. For example, if you were to radically simplify work related deductions, there is obviously a compliance burden-saving for the individual involved. There is also, I would suspect, a significant change in the incidence of people who use tax professionals, because I would suspect that the majority of the employee-type taxpayers largely use a tax professional in the context of providing advice on work related deductions. The number of deduction labels in their return simply explain that situation. Most of the income is prefilled by the tax office, so it simply gets down to the deduction items where the advice is being sought. The sheer volumes simply say that the major areas of deductions are work related deductions, gifts and donations and then, in the other realm, you get into more complexity where people have investments and negatively geared properties and all that sort of thing. So I just think the winners and losers argument or approach should take account of that bigger perspective. The overall design should be one that makes it simpler for the broad masses while recognising there are exceptions that have to be dealt with fairly within the overall legislative framework.
CHAIR: Mr Highfield, following on from that—and we have heard a lot of discussion this morning about self-education, so let's use that as an example—if we go back to the point of revenue neutrality as a mindset from government in looking at simplifying the system and if we take that subset, following on from what Mr Brown said about there being winners losers—and if we were to come up with a profile of the median person in that category, we know full well through the ATO what that subset costs us in terms of the dollar figure of deductions. If we took that approach there would obviously be winners and losers but we pick the median point—and we would probably take median over average because of the skew of income and the nature of it—is that a possible way for government to look at these things: take a subset of expenses and then apply that? Let's say you earn $100,000 in the top marginal tax rate—49c in the dollar; let's put it at 50c in the dollar for the sake of simplicity—and you incur $2,000 worth of personal education expenses, if we reduce it then the reality is that government pays for half and you pay for half. If we reduce your marginal tax rate to compensate for that then you are not out of pocket whether or not you incur the expense. I know that is what New Zealand did, for example, in its absolute form. But is that a way for government to proceed, do you feel, given your experience?
Mr Highfield : With self-education there may well be justification for taking a slightly different course.
CHAIR: I just chose that, by the way.
Mr Highfield : Okay. There has been lot of discussion and contribution on self-education and obviously it is an important area. I think from my recollection there are about 600,000 claims for self-education deductions, so they are nowhere near a majority. The broad masses are around uniform and motor vehicle expenses et cetera. It may be that the broader simplification approach that is embarked upon recognises that self-education expenses or some deduction items need separate treatment. You have not even mentioned gift deductions. There are something like five million gift deductions; one-third of these are less than $50. Can you imagine the amount of record keeping and effort that goes into claiming these mickey mouse amounts in tax returns? You would not want to get to a situation where people simply had to add to a prefill tax return the fact that they claimed a $10 gift deduction. Again, the Henry review recommended that the threshold for gifts should be raised, I think from $2 to $30 or $50—something like that, Rob?
Mr Heferen : It's $50 or something like that.
Mr Highfield : I think there is a whole lot of separate thinking that needs to be given to these different areas in the context of a broader principle about simplification for the masses.
Mr Heferen : The point you make, though, about when people think about deductions, work related expenses or the like, the comparison is always with the particular marginal rate they are on. Then the observation is, as Colin quite rightly said, that any analysis from the committee has to then think about what recommendations might mean for—
CHAIR: Different marginal tax rates.
Mr Heferen : different marginal tax rates. A necessary precondition is knowing what the marginal tax rates are. If there were an exercise where a government was just looking at this issue, it is hard practically but conceptually straightforward. In a process which this is feeding into, in the broader discussion, it then becomes a far more difficult issue to determine, to try to even have a stab at winners and losers, because the point about what the marginal rate might mean and the threshold of cuts and that sort of thing will be one of the issues under discussion in the broader debate. Obviously, by the reporting date, a lot of that material is still is being considered. It may be that a more principles based approach is one way of looking at this and saying that, clearly, the result of what will happen to people's outgoings or people's income will be highly relevant and maybe even possibly a determinative issue. But it cannot be known until such time as the question about minimum marginal rates and thresholds is finalised.
CHAIR: Yes, but you are assuming that it is analysed in isolation. If analysed together, one feeds into the other.
Mr Heferen : Exactly. There is co-dependency, which of course is very difficult for a committee to work through when dealing with only part of the issue that is co-dependency.
CHAIR: Which is why I would suggest there is probably someone in the Treasurer's office watching what we are saying right now.
Mr Heferen : I am sure they are watching very closely.
CHAIR: Mr Hayes?
Mr Hayes : I was just going to reflect on the discussion and say that there seem to be, in my mind, three possible models. The first model that seems to come out of this might be picking up what Richard was saying, which is doing very little, but you would focus on the over-claiming. The paper itself suggests that the claim could be around $1.5 billion. So all you would do is focus on those which clearly should not be claimed. That is one model, but it achieves nothing as far as simplicity goes. It is just focused on the revenue and getting that revenue and ploughing it back into a reduction rate.
The next model seems to be a standard deduction but a choice. Once you get above the standard deduction, you have the ability to claim the extra amount, presumably with a quid pro quo that it comes with substantiation. I will leave it to Treasury and others to comment, but I suspect there is not a significant dollar saving in that type of model that you could plough back into a reduction in rates. With that second model—that is equity; that is fine— but I am not sure that there is that much money to be had out of that particular change.
The third one might be described as what KPMG has put forward. You go right to the very end, and it just focuses entirely on 'simplicity wins out'. Roughly, the KPMG model would be a no-deduction model. You can have variations of that. For example, rather than no deduction, you could have tighter nexus. It seems to me that, at one end, the equity is winning out. At the other end, if you truly want to dramatically take complexity out, then simplicity wins out. There are no good or bad expenses at that end. For each expense, whether it be child care or self-education, you can justify those deductions; that is not the point. Simplicity wins out. But, at the end of the spectrum, you clearly have heaps and heaps of winners and losers. And that is the challenge for the committee.
So—I am just putting my thoughts out—there seem to be three possible models that you could consider and, obviously, down the far end it is the more dramatic as far as the potential in this was.
CHAIR: I should have let you close the session, because that is an excellent summary of what we have discussed this morning.
Mr Hicks : I will be very brief. Apart from supporting Matthew Hayes's summary of the situation, I wanted to comment on the idea that employers could take on more of the reporting responsibilities. I think it makes sense where the information is already collected by the employer as part of their normal business processes, absent some costs of transitioning to digital systems, but it does not make sense where the employer is having to collect additional information from the employee. All you are doing there is putting an extra middleman in the process, and it does not really add to compliance; it just adds an extra administrative cost.
Mr Davidson : Very quickly: this is a standard deduction form of a tax cut for many people, so I think there are different ways of skinning the cat, if that is the way that you want to go.
CHAIR: Very fair.
Mr Ward : We are focused a lot more on the corporate side of tax affairs.
CHAIR: You are important after lunch!
Mr Ward : I just wanted to make one comment in relation to a person that has not really been part of this discussion. I think that, if we are looking at revenue implications, you have to look at perhaps a cap on the tax deductibility or the tax benefits of superannuation contributions above a certain income threshold, or ask: once you have made a certain dollar-value contribution into a superannuation fund, does it need a tax benefit?
CHAIR: That is part of the bigger discussion, obviously, that Rob Heferen referred to.
Mr Drum : The point has moved on a bit, so I will raise a new one. We have not really discussed the New Zealand experience that much. I know that some of the submissions talked to that—not ours—but, as part of this discussion, I think it would be appropriate and worthwhile if someone did talk to that. My limited understanding of their experience was that they had very high individual rates, around 66 per cent, and, when they got rid of WREs, they had the highest marginal rate at the time. So it was quite a seismic chop. They are down to 33 per cent for individuals now, some decades later. But there was a lot on the table for them to simplify the system at the time, and their forms and that type of thing did not have all this Medicare and other encumbrances in the back of it either. That experience is quite different, rather than us just looking again to New Zealand—I know it is part of the terms of reference—or the UK as providing that panacea.
CHAIR: Richard, were you bouncing around bureaucracy when New Zealand did what they did?
Mr Highfield : No—
Mr Drum : Well, you were around!
Mr Highfield : I was around, but I think I was in another country. Sorry, did you have a general question? In my work with the OECD, I had some fair association with the New Zealand—
CHAIR: Just the experience, post the changes they made.
Mr Highfield : I think it is generally recognised that in New Zealand only about one-third of personal taxpayers have to file a return. I understand that in recent years there has been a slight growth in the number of people who were previously in that population of non-filers now coming back into the system to try and claim refunds of tax—for whatever reason, or whether their particular circumstances dictated it. But it still, broadly, has a similar characteristic to the United Kingdom: you have one-third who file and two-thirds who do not. My understanding is that New Zealand they have a withholding tax on interest at source, which we do not have in Australia. The British also have a withholding tax on interest, so they are collecting a lot of their tax through the withholding mechanisms, which, in a lot of cases, reduces the obligation to have the income reported by the individuals concerned.
So I think, by and large, New Zealand does have lower personal rates of tax than Australia, but it also has a very broad goods and services tax and has the broadest base in the world of any tax. It raises three times the amount of revenue from its indirect taxes that Australia does, so it has a different tax mix.
Mr ALEXANDER: Going back to Mr Morrison's earlier comment that it has been this way for 101 years, I would come back to say: that is an argument for change—otherwise we would still be having to take with our transport a bucket and a shovel to clean up. That is no longer necessary. We have, I think, an evolved complexity. I really agree with your comments, and I think we often get a great fear of the pain of change. I think we are really agreeing that there is a need for change, but it is the art of transition. How do we get to where we all know we need to go—to have this reduction of compliance and the simplification but do it in a just and equitable way? It does seem to me, if I understand this argument correctly, that it is a mix of compensation that you are duly paid for your job, and that is in consideration of the education you have had, or the costs of your trade; and, when that is coupled with tax reductions, you really reduce the need for work related claims. I think that is where we need to move towards. We have a certain point that we are at now, but I think we all agree that we need to have those two—
CHAIR: We will take that as a comment.
Mr ALEXANDER: It is a comment, but it is in thorough agreement with you, and I hope that is not distressing for you!
Mr Greco : In relation to what Ms Lendon said, yes, the tax office has pretty much thrown everything to the public—e-tax, myTax, pre-fill—but it has not done anything with respect to the numbers going to a tax agent, so that provision of a service is still quite strong. I will be honest; I think, with the mentality of a refund, because of work reductions, there is an opportunity to maximise a refund. A survey was done 10 or 15 years ago, I think, regarding the obligation to lodge a return. One would have expected that the public would come back and say, 'It's a pain in the backside; take it away,' but I think what the results clearly showed was that it brought closure to the year. They could do an annual health check with their financial accountant, who might be able to provide services other than tax, but it was also a reflection point on how much tax they actually paid, because, other than that point in time, no-one knows. Money just appears in one's bank statement, so—
CHAIR: You are so right. Earlier I asked the question of all of you: do you think Australians understand that, when they claim deductibilities, they only get their marginal tax rate component of it back? The other thing that happens in the real world is: when you employ someone, they say, 'What am I earning?' and you give them a number and they say, 'No, what do I get in the hand?' That is the conversation that happens between employee and employer, in my experience. I see you all shaking your heads, so I know you agree. A very good point.
Mrs Bordonaro : I wanted to draw attention, on the topic of superannuation contributions as a deductible expense, to the fact that it is important to bear in mind in that discussion that the average woman in Australia earns less and we do take the burden of child care and so forth, so it is important that you do get to a point where you have a window of opportunity where, hopefully, your career or your business has progressed and you can play catch-up. So you do need the ability to make those higher contributions so that you do not become the working poor of the future.
CHAIR: A very fair point. We will break now for lunch. If people want to continue this conversation afterwards in the personal space before we jump to companies, so be it—I am very flexible to let it go, because the conversation has been flowing all over the shop.
Proceedings suspended from 11:46 to 12:25
CHAIR: Technically we are moving into topic 2 after we have a little overlap on topic 1.
Mr Wardell-Johnson : I might withdraw because I think our views are consistent with virtually everyone else's in the room, if you do not mind.
Mr Johnston : We were talking about deductions in terms of simplification. I actually concede that I have forgotten the exact point we got up to so I am happy to move on.
Mr Drum : One of the questions was about possible discussion issues on page 41 of the framing document, which is quite an excellent document so I commend those who put that together for the purposes of this roundtable. But one of the questions was: should there be any changes to substantiation requirements for WREs? To that point, I want to put on the record that our current substantiation system has a $300 deminimus unsubstantiated amount. If your claims are less than $300, you do not have to provide or keep records and receipts. If you go over then you have to keep records and receipts for the whole lot. That is like a 1987 amount. It has never been indexed. It was back when Australian workers' weekly earnings were $460 per week. AWOTE is now about $1,460. So if we are talking about substantiating or not substantiating a 1987 amount, it would be at least triple that. It would be close to $1,000 by way of a simplification measure and stopping people filling shoeboxes with little chits and pieces of paper and receipts.
There is a broader threshold issue about simplification and cutting the costs of compliance for taxpayers if that was raised and indexed prospectively so we do not come back to this in another 20 or 30 years. I also note—not that I am not necessarily suggesting it but as part of this discussion—that as part of the tax reform discussion in the US at the moment, one of the candidates or Congress members has actually proposed a $15,000 standard deduction for every American taxpayer. I just wanted to mention that as well.
CHAIR: We will take those as comments.
Mr Greco : Also in relation to the report, on page 26, someone mentioned the possibility of over claiming. The tax office at the moment has got a project where it is under tax gap. It is basically going to look at taxpayers and what they have claimed and substantiate what they have claimed versus what they should have claimed. So there is some analysis underway that could quantify that level of over claiming. I thought I would bring that to the attention of the committee.
Mr Gandolfo : One question that has not been raised in the discussion and one that Ken and I were discussing outside is: what marginal tax rate change could you apply if you were going to remove tax deductions for work expenses?
CHAIR: That is the sixty-four dollar question.
Mr Gandolfo : But it is half of the whole debate.
CHAIR: I guess the answer is it depends on a couple of factors: (1) political guts; (2) political salesmanship; and (3) the maths that Rob and Richard and I had the to and fro about—what you actually knock out and what it saves the government in revenue and when you find the median point. I guess the science has to come in from government to work out where you go with it and what that gives you the capacity to do. But as Rob said, with the other discussions we have got going on inside government at the same time and not sitting this in a silo, we are looking at tax across the board and how it all interacts with each other.
Mr Johnston : Doesn't that relate to a broader point? We know that about 73 per cent of individual taxpayers end up lodging a tax return but getting about the same back in transfers. So that is really the tilting point at which we then go on to ask: what do the marginal rates of tax need to be? So we concentrate at the end beyond the 73 per cent.
CHAIR: Adam, I will take that as a comment. That is the job—the internal workings of what it actually looks like. This report will be presented to the Treasurer. The Treasurer, working with people in the Treasury and the ATO, will work out what they want it to look like and what the policy becomes moving forward.
Mr Hayes : Speaking about caps, they tend to be an all-or-nothing scenario—you get over that level and you have died. You might want to think about whether in fact you spread deductions after a certain level. A rough rule of thumb is if you are above a certain amount of expenditure then maybe that expenditure is promoting future income for several years. So rather than all or nothing, you might want to think about spreading your deductions over that period of time.
CHAIR: Is there anyone else that wants to talk on what we were talking about before the break, before we jump into post break discussions?
Mr Highfield : I encourage the committee to be bold and imaginative in dealing with this issue. As Mr Alexander said, it has been with us for 101 years. Change is overdue, others have done it and there are other options and other much simpler approaches to reform.
CHAIR: Mr Buchholz just asked if he could get a sense from the room if there is a mood for reform. I guess the one disclaimer to that is there is a saying that I like and unfortunately now I am a politician: the one thing about politics is you can always back self-interest. I know that everyone sitting in the room is representing potentially self-interest.
Mr BUCHHOLZ: Is there consensus that the current system is overcomplicated?
CHAIR: Richard, that is actually a very good concluding sentence. I can assure you as chair of this committee that I did not come to Canberra to watch spiders on the wall so I hope that we do come up with something that is bold and visionary. Mr Morrison, you did a great job of kicking off the theme for the day. We are 101 years old. If we are having a broad discussion as we are having about the future of the taxation system in its entirety, this is the time that we should propose to the Treasurer some ideas that might allow us to look forwards instead of backwards.
We now move to discussion of the second theme, company tax deductions. The committee's focus in relation to the company tax system is on deductibility of interest incurred by businesses in driving their income. The committee is considering whether there is support for various options to broaden the company tax base to fund reductions in the company tax rates.
For those of you that have just joined as, you have probably got a little insight into how this roundtable has worked this morning. I am very keen, as are my committee members, for it to be a genuine discussion, jumping all over the place. This morning we went backwards and forwards on topics. People, even if a topic has changed, just put up their hand and flagged to me that they want to talk and came back in and talked about whatever topic. Even if we have moved on, drag us back to where you want us to be and please do not be shy. I also said to the group before, I am not precious about heading the full distance on this. As I said to the group, some of us have been down here all week having to deal with the Labor Party.
Mr Harnisch : To follow on from Ken Morrison, my focus for the next round of discussion will be on where Australia needs to be for the next 100 years. Yes the tax system, you could argue, has served us well but nevertheless the tax system, as we know, has become complicated. It has a unique architecture, but I think it will not serve business well and the economy well going forward. I know this is not the remit of this particular committee and you could take this as a statement but you need to be mindful when we are looking at tax deductibility that we have to look at it in the broader context, not quite this remit but we need to keep in mind. Australia is a global economy. We are capital short. We are human capital short. We rely on investment from overseas and domestically. We have got to keep confidence in the Australian economy. Not only do we want domestic investors to keep investing in Australia but also overseas investors. So we need to have a globally competitive tax system. That deals with the previous comment about are our marginal tax rates too high? Master Builders Australia's position has always been that the marginal tax rate needs to come down. We have also been arguing that the company tax rate needs to come down. Having said that global statement, we come down now to tax deductibility, in this case interest rates. The reality not only for the construction sector but also for the businesses that operate within it—and it is no different to any business in Australia—is that most of the companies rely on debt for good reason. It allows for gearing, it is part of their cash flow and therefore the interest deductibility for at least the construction sector needs to continue.
CHAIR: It probably is a little bit different, construction, to a lot of other industries that are cash flow sensitive insofar as would I be right in saying a lot of projects in your industry would actually capitalise the interest?
Mr Harnisch : It depends on which part of the sector you are talking about. But certainly for the actual contractors, it is part of their cash flow. It is the only way they can win tenders to carry out a tender. They simply do not have the depth of the balance sheets they need to do those sorts of projects, even property developers. That is because of the scale these days and the complexity of our regulatory environment, where it can take up to 10 years before you can get a project up and running. So you can be carrying a negative cash flow for up to 10 years and carrying a whole lot of risks. We need to be mindful of that. I suspect it is similar for other industry sectors where, for all sorts of regulatory reasons, you simply cannot fund a project and have it start the next day. It can take up to 10 to 15 years by the time you go through environmental reviews et cetera before you can get a project up and running.
This is really the point we are making. The Prime Minister has said that the government wants an entrepreneurial culture. The other point I want to make is that Australia is a First World economy and that reflects the fact that we have massive diversity. Different people are doing things differently. Different businesses are doing things differently. We have to allow that diversity to flourish. That means, in terms of debt and equity financing and different debt instruments, that needs to be allowed to flourish. It needs to be recognised as a proper way of doing business, rather than putting in constraints on debt financing, and allowable deductibility should not be constrained.
Having said that, we are not talking about the extreme. We are not talking about the fact that some people may be abusing the tax system. That is a different matter. That is a matter that obviously should be dealt with by the tax office and the parliament, where necessary. So let's not stray too far to focus on those who are not playing by the rules. That was the debate this morning. Let's not get too focused on those who are abusing the tax deductibility. Let's quarantine them out of where Australia needs to be going forward.
My opening statement is that the Prime Minister has said that he wants an entrepreneurial economy and that he wants young people to be able to start their own businesses. Those businesses will require different debt and other sorts of instruments. The tax system should facilitate it. The tax system should not be an inhibitor. The tax system should be an enabler.
CHAIR: Colin, we might get you to jump in here and give us the Parliamentary Budget Office's overview. Then we will jump back into the discussion.
Mr Brown : Certainly. The overview I am going to give now is just a description of company interest deductions in particular and how they fit into the scheme of the company tax system. In line with the terms of reference, I am focusing only on company interest deductions in this presentation. Interest deductions are, of course, only one type of company expense. Other expenses typically include wages and salaries of employees, depreciation expenses for assets, the cost of trading stock, rent and it goes on. So interest deductions are one type of deduction amongst any. Why are they perhaps a little different to some other deductions, at least in people's minds? Interest deductions are the costs to a company associated with debt that is used to finance the capital and operations of the company. In many cases Australian companies have a choice between financing using debt or financing using equity where debt is deductible to the company as an expense and the cost of servicing equity is not deductible. But in the case of Australian companies and the Australian source income of those companies the income stream is frankable under our imputation system.
The choice between debt and equity finance by Australian companies will be driven by many considerations. That includes the cost of using debt versus the cost of using equity. Quite often equity finance is seen as being a fairly expensive source of finance. If you were looking at the choice between using debt or using equity, debt is a lot more flexible for a company to use and to raise than is equity. Also, considerations of risk come in there. They have differing risk profiles depending on the company, what it is raising the debt for and so on. Finally—dare I say it?—a factor is going to be tax. That is a consideration in how companies finance themselves.
My first table, which is out of our submission, shows company interest expenses by company size based on their annual turnover. It shows that $45.2 billion in interest expenses were claimed in 2012-13, which is the latest year of data that we have. Of that amount, $29 billion or 64 per cent of the expenses were claimed by just 921 very large companies. Those are companies with turnover greater than $250 million.
The final column shows interest expenses as a proportion of total expenses. The thing to note there is that interest expenses accounted for 2.6 per cent of the total expenses claimed by large companies. So out of all expenses they are a relatively small slice. But that probably also reflects that they have a lot of other costs that are deductible. In terms of framing its size, the 2.6 per cent perhaps should be taken back to looking at the company's actual earnings or level of equity capital that is invested rather than the total of expenses.
The figures in the table exclude the finance industry because finance companies are, by their nature, highly leveraged and using those would skew the figures quite considerably. Basically finance companies are in the business of using debt and are quite different as a result. Debt is a little bit like their trading stock.
If I look at the story over time, the blue line in this chart is very large companies, the red line is the average for all companies and this is showing interest deductions by company size as a proportion of the total expenses. Over the period shown, those expenses have been coming down. The green line is the RBA cash rate. A major factor in the decline in interest expenses as a proportion of total expenses is just that interest rates themselves have been coming down. In some respects that is saying that the cost of debt finance has reduced and therefore the total expense has gone down. The amount of debt has not necessarily followed the same path.
Let's look at interest expenses claimed by very large companies by industry type. We are looking at that large-company group—the 921 companies. We look at interest as a percentage of total expenses. In that group, the largest expense claim taken as a proportion of total expenses was in the rental hiring and real estate services industry and in electricity, gas, water and waste services industries, with interest expenses accounting for about 6.6 per cent of reported expenses in those industries. I will note that the data for real estate services is not separately shown because it actually falls into the 'other' category for the purposes of the table. It is actually quite a small sector; it just has a high level of expense on interest as a proportion of total expenses.
In absolute terms, the mining industry and the manufacturing industry had the largest interest expenditure, accounting for 20 per cent and 15 per cent respectively of total reported interest expenses in this group of companies. There are several non-tax-related factors which may influence the level of interest expenses of different industries and companies, including their funding structures and level of risk. The point of the table is to show that interest expenses as a proportion of total expenses vary considerably between industries. Not all industries are the same. The finance and insurance industries are shown at the bottom of the table. For them, interest as a proportion of total expenses is nearly 26 per cent. That goes to the point that they are in the business of borrowing and lending money. As a result, they have very high levels of interest expense because it is, in fact, much more of a working expense for them rather than being a cost of financing in the same way as for other industries.
Finally, one of the areas that are of interest is multinational companies. Much of the attention in terms of the interest deductions has been focused on multinational companies because of the scope for them to use interest deductibility in a high-tax source country such as Australia to shift income to low-tax destination countries. If you can get a deduction in Australia at the 30 per cent company rate but have it assessed in another country at a much lower rate—for instance, maybe 15 per cent if you were to go to Singapore—there is scope to use interest deductions to shift profits. The potential for that has been the subject of an action item for the OECD in their base erosion and profit shifting project. In Australia, we have thin capitalisation rules that are aimed at limiting the scope for interest deductions to be used for profit shifting. So we already recognise this is a problem, and there are rules in place to manage that. The rules limit the amount of debt relative to equity, in relation to which a company can claim interest deductions. It puts a cap on how much you can gear your operations, if you are a multinational company.
The table shows interest expenses of companies that are subject to the thin capitalisation rules, by size of company. The table shows that companies that are subject to thin capitalisation rules in 2012-13 reported relative interest expenses that are higher, on average, than companies not subject to the rules. Interest expenses made up 3.2 per cent of all expenses claimed by companies subject to thin capitalisation compared to 2.3 per cent for all companies in Australia, with 1.6 per cent being the average for companies not subject to the thin capitalisation rules. So, essentially, the thin capitalisation rules apply to a group of companies that have a greater incentive to use interest deductions as a means of managing tax liability, but they put a limit on how much they can do that. As a result, they are a pretty important part of our corporate tax system.
It should be noted that the thin capitalisation rules have recently been tightened—when I say recently, I mean from 1 July 2014—and the data that we have in these tables cover the period prior to that change. As a matter of context, the rules have recently been tightened even more to limit the extent to which companies can profit shift. At this time, we do not have any data to say how effective that has been.
By way of winding up, the key point that I would note here is that probably all companies use debt to some degree. Their circumstances vary quite considerably; they vary by industry, they certainly vary by size of company, and they also vary depending on whether they are domestically focused or multinational. Thank you.
CHAIR: Thanks, Colin. Keeping in mind Wilhelm has already kicked off, do you want to jump in, Craig?
Mr CRAIG KELLY: You made a comment about the importance of the international competitiveness of our taxation system. Would you like to expand on that a little bit in relation to deductions here, as compared to other countries. Also, where do you see us sitting at the moment as far as international competitiveness goes, and where do you see we may be in a couple of years, if policies stay the same as they are?
Mr Harnisch : These are overarching, high-level policy principles that I would like the committee to think about. The Australian economy is a global economy. I have the opportunity and privilege to travel overseas on a regular basis. When you go there, you have countries where the company tax rate is as low as 15 per cent. These are the sorts of countries that we need to compete against, whether we like it or not. Those countries are competitive.
The concern I have is that we have been seeing a trend where overseas investors choose not to invest in Australia. Even worse, you see Australian companies actually moving offshore, not only because of tax but because the tax environment is more favourable to them and their ability to expand is more favourable to them. It is not purely tax; I accept that. There are other reasons why they might do that. And then we have some of our brightest minds as well. They go overseas and they take advantage of the low tax rates and the ability to start off their own businesses without the constraints that might exist in Australia. So my opening comments were really in the context of Australia needing to position itself for the next 100 years. Australia needs to make sure it remains competitive. We are capital short; we need that sort of investment. Therefore, if we are going to be increasingly globally competitive and if we are going to be an economy where we are going to maintain a quality of life and, in fact, improve it, then we need to have a competitive tax system—or a globally competitive tax system—that will facilitate those high-level objectives. Our view is that the company tax rate of 30 per cent is not a competitive tax rate globally.
Mr CRAIG KELLY: If I could perhaps follow up or throw it open to others, obviously the tax rate itself is a factor of how internationally competitive it is, but also, surely, what deductions are available in our system as compared to other systems have to be a component of our international competitiveness. Maybe you could comment there, or if anyone else in the room could make any comments, on the international competitiveness of our current rate of deductions for a company.
CHAIR: At the risk of going back to the well, how this played out this morning, for those who were not here, was that, when we kicked off, Richard Highfield jumped in and gave some comments on his OECD-related experiences. Mate, would you feel like adding your voice? As I say, sorry to put you on the spot, but it worked well this morning.
Mr Highfield : It is a matter of record that even among OECD countries, which tend to be regarded as advanced economies, there is a trend towards lower corporate tax rates. But, as the member just acknowledged, how much tax a company pays is contingent not only on the rate but also the base—the deductions—to which they are entitled. For example, a country like Ireland, which has a well-known very low statutory corporate tax rate of, I think, 12½ per cent, nevertheless collects a sizeable amount of revenue in corporate tax receipts because of the economic growth that that contributes to and, I suspect, possibly a slightly narrower deduction base. There are other countries like the United States where the corporate tax rate is well over 30 per cent but their revenue productivity, in terms of tax to GDP, is well below Ireland's in the comparative sense. So there are different features of their tax system that, at the end of the day, determine how much tax is ultimately payable by the corporation concerned. But the general observation of rates moving downwards for corporate tax is clearly a trend that has been observed by the OECD, and there would be literature around that could inform the committee on that particular aspect.
Mr Heferen : Just following on from Richard, the US has quite a high corporate tax rate, as does Japan. But, if we look at Europe, Germany, I think, still has a relatively high corporate tax rate. But, interestingly, the Nordic countries, which are usually regarded as high tax—in fact, their tax to GDP ratio is quite high, around 40 per cent to 50 per cent compared with ours, which is under 30 per cent—typically have corporate tax rates—putting Norway to one side because of its North Sea oil—of 20 per cent, 23 per cent and that sort of thing. I think the United Kingdom is bringing its down to 18 per cent; it went down to 20 per cent from 30 per cent. We saw, at the time when John Ralph reported with the Ralph review back in 2000, that the Howard government reduced the corporate tax rate. We then had it at 36 per cent, down to 34 per cent and then to 30 per cent. At that point in time that was sort of middling of an OECD average—just average countries, not weighted average, because the US and Japan would blow that out.
Since then, as Richard said, a number of OECD countries have been reducing theirs and Australia has stayed at 30. So compared to the OECD countries, we are obviously still relatively high in our region. I think that is the point that Wilhelm was making, that we are considerably higher. Interestingly, I think New Zealand is at 28. Chile also has a dividend imputation system. We both share a dividend imputation system. We still maintain relatively high rates—not that there is necessarily a connection there. I am sure, as far as domestic investors go, because of the wash-out of the corporate tax, you could afford to have a higher rate. But now the debate moves to the question of foreign investment—whether the corporate tax rate becomes more relevant.
CHAIR: Isn't an important feature of the discussion in this space that it has been somewhat hijacked by the multinationals? Or, if you break it into two, the other difference—when we talk company tax, as opposed to this morning when we talked personal tax—is that those companies, be they publicly listed or privately owned, distribute and, when they do, if you are domestically based, you are subject to top-up tax. So you have got this interrelationship happening between the profit generated at the back-end and then deductions claimed in a company environment. But when they, if they are privately owned, make their way out, be it through a family trust or whatever vehicle is sitting behind it that is forced to distribute on a yearly basis, the trust distributes and there is top-up tax at the top, at the marginal rate of the person that goes to, less the franked dividend. It is the same in terms of public companies. When they distribute by way of dividends, you pay your top-up tax there versus the franked dividend there. But on the multinational side—and Mr Brown made mention of thin capitalisation—there are two very different arguments here, aren't there?
Mr Heferen : That is right. If we think about Australian companies distributing to Australian shareholders, there is an incentive for the shareholder to actually want the distribution to occur, because they value the franking credit. The franking credit is a bit like the deduction; it is not valued one to one. I think the researchers who look at this would say that the franking credit is valued at something greater than zero, and it would depend a lot on the characteristics of the shareholder. We have a country that does not have a franking system. The incentives are different. For a country that operates a full classical system, arguably there is a greater incentive for the company to retain profits and pay the tax at the corporate rate but leave it in the company as a relatively cheap form of finance; whereas in Australia we do not have that. There is debate about the relative merits and Australia seems to be pretty comfortable with its imputation system.
But then when you have the situation of a multinational that may operate a business in Australia but the shareholders remain largely foreign shareholders, obviously the incentive of the franking system no longer operates. Indeed, a lot will depend upon where those profits are taxed. You might think they would be taxed in Australia, if the company was an Australian company, but they are not taxed in Australia or not taxed very much in Australia because the company, through a whole range of mechanisms—and they have been well traversed in other committees and in the public domain—would shift that profit elsewhere. There are some well-known cases of particularly large American IT companies which would sometimes borrow to make distributions to the American shareholders because they do not get access to the cash which is generated through business. So you enter into an extraordinarily complex web of company financing and tax arrangements which, as you probably know better than me, is extraordinarily difficult.
But coming back to the question about the base and the deductibility of interest—and we have examined this a fair bit for the work we have done through the OECD—deductibility of interest is pretty common. Different countries have different approaches to thin capitalisation. The German system is one where they might go the next step and deny deductions that other countries might allow. I stand to be corrected but, given the nature of their economy, they are probably on one extreme or one side, while we tend to occupy the middle a little more. The fact that interest deductibility seems to be a pretty common feature, certainly across developed countries.
CHAIR: This is where you jump in simply by putting your hand up.
Mr Pearson : I wanted to pick up a couple of points on page 57 with the discussion paper, but also to pick up on the points that Mr Brown and Mr Heferen made. The first point is that the deductibility of expenses in determining taxable income is an internationally accepted principle, as we have already discussed. That includes deductibility of interest expenses and which, of course, has to be accompanied by appropriate integrity measures, and both Mr Brown and Mr Heferen talked about that. It is fair to say that there is no global move to limit interest deductibility—yes, there is the OECD BEPS program and that is looking again at tax integrity, if I can put it that way, but there is no global move to limit interest deductibility. If Australia was to go it alone on that front, we would argue that there are risks to our international competitiveness and our attractiveness to foreign investment. I would also pick up the point from Wilhelm that that would be potentially very damaging to growth, prosperity and jobs.
Picking up another point from Mr Brown, banks are fundamentally different in their use of debt. What banks do as financial intermediaries is facilitate flows of credit from people with surplus funds to people who need those funds for consumption or investment. For banks interest on debt is a working expense, just as for the manufacturer the cost of the inputs is a working expense. That is why it is tax deductible. We are pleased that the difference of financing companies has been recognised by the PBO analysis.
Finally on the question of other deductions that might be given up by the company sector in return for a company tax cut, there are not that many deductions available to the finance industry or to banks. You will notice that not only do banks pay a lot of tax but in fact the effective tax rate is very close to the company tax rate. That just illustrates the absence of concessions that could be given up in return for—
CHAIR: The size of the profits!
Mr Pearson : a lower company tax rate. One could look at a return on equity, indeed. What I really want to do is to reinforce some of the points that have been made, and we would certainly concur with all of those points.
Mr Brown : Some of the earlier discussion about the company tax rate highlighted point about the difference between the headline company tax rate and the effective tax rate of companies. That really does depend on what is deductible and what is not deductible and the likes. My colleague Tony is pointing out to me that in fact the cut in the company tax rate in Australia, which we saw probably a decade and a half ago now, went from 36 to 30 per cent and it was achieved by base broadening.
With a broader base and a lower rate, what you do is bring down the headline tax rate but the effective tax rate remains broadly similar. The effect of that is companies are faced with a lower company rate and headline rate but in fact overall pay about the same amount. The importance of some of that is you also need to look at what are the marginal incentives for companies to do things. You could argue that without lower headline cash rate the incentive structure is improved in terms of companies making investment decisions for the future, but that still depends on what deductions are in fact allowed. If you start limiting deductions, what you are actually doing is pushing up that effective tax rate, and you do need to be careful about what that does in terms of how it hits different activities. It could be quite distorting in its own right if you are not careful.
The other thing about it is that Australia is a net capital importer. We borrow a lot of money from overseas, and we are very much dependent on capital inflows for our economic activity.
I think Germany was mentioned as a country which had limited interest deductibility in various ways, or had cut back strongly, but they are a net capital exporter, so they are in quite a different position to us. We do need to be very careful about what we wish for in terms of looking at these proposals and what their effects are and the impact on the effective tax rate is something—the tax rate on marginal investment decisions is very important. Our marginal investors in Australia, so the people who actually influence our level of economic activity, are arguably overseas, so we need to keep that in mind.
CHAIR: Yes, very good point.
Mr Varrasso : Flicking again through our briefing notes I just noticed that in the section on interest deductibilities for corporates there is no mention of the work the Business Tax Working Group did. It is only three years ago that we had a group formed to look at this very issue about what we can do to fund a reduction in the corporate rate. They looked at broadening the base in three areas: depreciation, R&D and interest deductions. It was chaired by a now Commissioner of Taxation. Rob was a member of the Business Tax Working Group. Their report concluded that they could not at that time see that there was a basis for doing that and that they could not see how it would achieve a reduction in the corporate rate at the time—I think it was looking at a two to three per cent reduction. I do not know. Sorry to throw to Rob without notice, but I do not know if you want to talk about the work that was done then?
Mr Heferen : Thank you for that! You are very right. The working group could not come to a consensus. The working group had a reasonably broad range of participants and the point Colin just made that the reductions in 2000 and 2001 from 36 to 34 to 30 were funded by a broadening of the base. It has been examined over the years by various treasurers. Certainly when the business tax working group looked at it it concluded that the base was actually pretty broad. There were some areas where accelerated depreciation still exists, notably in the immediate write-off for exploration activities, accelerated depreciation for the oil and gas, aircraft, a lot of agricultural equipment and R&D, as Adrian says, and finally thin capitalisation.
The working group concluded that in the areas where there were faster write-offs in economic life there was no consensus that changing that would actually lead to overall economic benefit. In other words, with those accelerated write-offs there were good policy reasons for them and there was no consensus to change. Indeed the rate at which such a change would fund was looked at in isolation saying, 'Okay, if the exploration immediate deduction was removed what revenue saving would there be and how much could the corporate rate be reduced by?' My recollection is that the numbers simply did not stack up. That was without any behavioural change. Obviously, taking away a tax deduction would mean some sort of behavioural change. Even ignoring that, which of course would push it in the other direction, it still was not sufficient for a significant cut. The working group concluded that the corporate tax base was probably as broad as it should be.
Mr Capito : Even some of the incentives that had at that stage been identified as ones that could be removed in return for a lower corporate rate were things like thin capitalisation, which had been at three to one but has since been tightened even further, and R&D, which has since been tightened even further by denying it to companies in groups that have more than $20 billion in revenue. So even some of those incentives that were there at the time, which together with other incentives did not add up to making much of a dent in the corporate rate, have already been utilised by government since then—by the Labor government at the time. So there is even less in the cupboard now than there was then. There really is not much room to move.
The only other point I would make is that, if there were to be a reduction in deductions for interest, we would need to think about whom that would favour and whom that would disadvantage. It would obviously disadvantage those companies, including Australian companies, that rely on debt as their primary funding source for new projects. It would disadvantage less those companies, domestic or foreign, that had plenty of excess capital and were therefore not so reliant on debt. It would also advantage non-resident companies that could locate their interest deductions in their home jurisdiction or elsewhere, vis-a-vis Australian companies that would be denied those deductions—where they are competing on bids and projects and so on. Firstly I think you would have an overall increase in the cost of capital, so there would be less invested to start with. Then you would have to try to make that up by reducing the corporate tax rate. But it would disadvantage Australian companies vis-a-vis those other companies, both foreign and domestic, that either had surplus capital and did not rely so much on debt financing or that could get that debt deduction located somewhere else. Most non-resident companies would try to do that anyway.
Dr Zirnsak : On the issue of competition and corporate tax rates, the Tax Justice Network has put out a report refuting a lot of the arguments made about having to reduce corporate tax rates. One point it made, for example, was that if you increase the corporate tax rate you increase the incentives for people at the wealthy end of the personal income tax rate to incorporate themselves and therefore pay the corporate rate. You therefore start eroding your base on the personal tax side as well as on the corporate tax side.
CHAIR: If they do that, they have to distribute outside that company tax environment. They can leave it in there to fund the business or they can take it out to use personally. If they do the latter, they have paid 30c in the dollar up-front and—assuming for the sake of simplicity they are on a tax rate of 47c in the dollar—they pay top-up tax, which is the additional 17c.
Dr Zirnsak : You get a timing advantage from doing that. You get a timing advantage from corporatising your income and doing that.
Using Ireland as an example: the Tax Justice Network goes through an analysis of Ireland. Part of the reason it was successful was its historical and cultural links to America. There was a lot of capital flowing in from America. That raises the question: if people in Ireland spoke Swahili, would they have attracted the same level of capital? The report points out there was an awfully large flow of capital into Ireland from the European Union under the Common Agricultural Policy that was in place at the time. That was a benefit that often gets missed out in these discussions. In addition, Ireland did a whole lot of dirty secret deals that it did not reveal to other countries—deals where it was ripping them off. From memory, they did a two per cent deal with Apple. That is an example of where routing profits through Ireland was a way for Apple to reduce its tax bill. I do not think that is the way you would want a responsible country to go to attract capital—by doing secret deals to cheat other countries out of their tax rights.
Picking up on the argument that Australia should not move first: the primary recommendation the OECD came up with out of the BEPS process was to move to an interest-profit ratio rather than use a debt-equity ratio. Under the current regime there are two ways that we see that you can cheat. One is you cheat on rates. You artificially inflate the rate you can claim back to yourself. This is particularly when you are making loans to yourself from overseas. I make myself a loan and I then say that the loan is unsecured. I will lend to myself in a way that is unsecured, so that when I do an arm's-length test I can claim I am entitled to a higher rate of interest than if it was two arm's-length parties doing a secured loan—but in fact it is a loan to myself. It is my choice whether I claim it is secured or unsecured, as an example. Certainly, the internal documents from the ATO identified cheating on rate as one area. The other areas you can cheat are on the debt-equity ratio. You can cheat on the equity side by inflating the amount of equity you load up or have over-inflated values. Again the FOI documents we obtained through the ATO indicated internal concerns that that was happening. An interest-to-profit ratio deals with a bit of that. There are still ways you can cheat around that, but you limit the amount of cheating that take place. Other countries have already done it, so the notion that Australia would be moving on its own is just not true. I will leave it at that point at this stage.
CHAIR: Are you talking mainly about offshore profit shifting?
Dr Zirnsak : That is primarily what we see. The other one I should mention is Australia should move on the hybrid issue. The OECD recommendation was pretty simple. It was about the substance of what goes on. It says: if in this jurisdiction I am able to claim a deduction but at the other end it is not counted as income for tax purposes, then I should not be allowed the deduction. Or even worse, where you claim a deduction here and, because you have played off the international laws of countries against each other, you get a deduction at both ends.
CHAIR: Given that top-up tax and Division 7A tax action would handle those things domestically. I might throw it to you Kathryn in response—sorry to put you on the spot—in terms of some of the suggestions that have been made, what are your thoughts and where are we up to? I notice there were some recommendations loosely around where we are going. I know we have some legislation in the Senate that we are attempting to get through. I thought you might want to jump in.
Ms Davy : You are right to point to these issues in the corporate tax arena. Australia has very strong thin capitalisation rules, which have recently been tightened. I think Colin pointed out that from 1 July 2014, the allowable ratio of debt to equity has been reduced, so that the level of debt that inbound and outbound companies can have has been reduced, to limit the level of deductibility. We have also been working on our transfer pricing rules alongside the OECD recommendations and obviously we will continue to do so. The treatment of hybrids is part of the OECD program. Treasury and the government are tracking that and will cooperate with the OECD on those measures.
Mr Heferen : Can I just add on the hybrid issue that Mark pointed out, in the budget last year there was announced a package which was the first step of implementing the recommendations that the G20 have agreed to out of base erosion and profit shifting. The hybrids was one that we moved on early. As Mark says, it seems pretty obvious that if you have a deduction over here you have to pay tax over here. If you do not have to pay tax you should not get a deduction. But there a lot of tricky issues working it through. The government is taking it forward through the Board of Taxation—which is a sort of a private sector advisory body that includes the Commissioner of Taxation, the First Parliamentary Counsel and the Secretary of the Treasury—for it to work up a 'here is the plan to take forward and how to put it in place'. That is proceeding. A country by country report is in to deal with more information to assist with transfer pricing is proceeding, as Kathryn said. The action items dealing with that have been finalised, so that is proceeding.
The other one is the interest deductions. The G20 agreed to adopt the OECD's recommendations on limiting interest deductions. But that is really targeted at the egregious stuff, so it is not actually going and saying that you should deny deductions; it is making sure that the deductions are legitimate. There is scope still there—if there is genuine arms-length price on the debt then the interest can be deductible. So that is all progressing.
CHAIR: Kathryn and Robert, am I right in assuming that the legislation that currently sits in the Senate, which has passed the House, is attacking—historically our focus has been tax havens, but obviously information is the key, and this came through the G20, of jurisdictions working with each other for companies that might base their operations in one country and their back end in another. It is obviously information flow between these economies—the regulators in these economies—that is ultimately going to allow you to highlight the inconsistencies that Mark was talking about.
Mr Heferen : Chair, do you mean the legislation that has been passed by the Senate?
CHAIR: Yes, sorry.
Mr Heferen : The multinational anti-avoidance law, the increased penalties and the country-by-country reporting have passed the Senate. The country-by-country reporting in particular—and obviously that will be a matter for the tax office, because what will happen is that companies doing business anywhere will have to provide the tax authorities with what is going on in this country and the global thing. It is saying, if you have got a tiny bit of tax paid here but a huge amount of employment activity going on here, then the tax authorities of the different countries will be able to have a look and say, 'Hang on; how does that all match up? They have actually got substantial operations here. They've got plenty of people. There's plenty of activity. Why is the profit somewhere else?' That will be one of the key things that will assist the tax office.
CHAIR: Do you want to jump in, Jeremy?
Mr Hirschhorn : I am happy to talk on a few points, perhaps responding in part to some of Mr Zirnzak's points. Maybe I will focus on the debt piece first before the multinational anti-avoidance law bit. They are both very important. Around the world, pretty much every developed country has got rules to deny deductions for where there is, colloquially, debt dumping. But different countries choose different mechanisms. We have the debt equity based approach. Others have an earnings-stripping based approach. That is the German-type approach. In a sense, your choice of technique is one of policy, but there is also always a policy tension, which I think has come up in some of the discussions, which is that, to the extent it goes to cost of capital, it goes to investment and economic returns. In a sense, the level in which the integrity rule kicks in is also a policy question. We have spoken about how it applies in Australia, but Australia implicitly has a restriction, where our rules focus on related party debt. It is implicit, rather than explicit, because we have things like the arms-length test. If you borrow arms-length, external debt, in a sense, is almost by definition arms-length debt. But I think it is also important that, when we talk about debt deductibility, we also should talk about interest-withholding tax regimes, because that is the flip side of how we tax interest going offshore.
What I would say is that, within that, we have many strong integrity rules to enforce that policy choice. The policy settings that we are given, as the tax office—we think we have many strong rules to enforce that policy setting. We spoke about rate of debt and we have used indeed the old transfer pricing rules, which have recently also been strengthened. Reference should be had to the recent decision in Chevron, which involved borrowing externally on lending at a higher rate within the Chevron group, about debt creation—in a sense, artificial debt creation. Reference should be had to the recent decision in Orica, where part IVA applied, the general anti-avoidance rule applied, to artificial creation of deductible debt in the Australian group.
We have stated publicly our concern around derivatives—use of related party derivatives—to convert interest, subject to interest-withholding tax, into deductible swap payments, which are not subject to interest-withholding tax. We have stated that we are going to issue a taxpayer alert shortly, and I do not think it should surprise the committee if in the future you see some litigation on that.
Dr Zirnsak also referred to thin-cap safe-harbour exploitation. Again, sometimes it is worth going back in history. We have had a debt-equity base test for a long time, but then accounting changed. Debt equity is premised on accounting laws and accounting rules changed under the adoption of international financial standards, and certain large intangibles which were legitimately on people's balance sheets had to come off the balance sheets. It is sometimes referred to colloquially as 'the masthead provision', because the intellectual property of mastheads had to come off the balance sheets under IFRS.
That said, we have an active compliance program around people who we would consider are exploiting, or inappropriately trying to fall within, that particular concession. Again, I do not think it should surprise the committee if action is seen around that in the future. There were comments around the anti-hybrid rule. Again, that is a very hard rule. It is easy in principle, as Mr Heferen said, but hard in practice. What we would say is that an effective anti-hybrid rule reduces the motivation for excessive allocations of debt to Australia. So we would expect that if an effective anti-hybrid rule can be introduced in Australia and globally some of this tension might also fall away.
Indeed, there are also elements of action item 3, which relates to controlled foreign companies out of the OECD, which also bolster that anti-hybrid rule. At the moment, if capital is coming from a high-tax jurisdiction to a low-tax jurisdiction then obviously it could come directly, in which case anti-hybrid would really address that because why would you try to get a deduction in Australia at 30 per cent if you are going to be taxed somewhere else at 35 per cent? In a sense, if you could dogleg that through a low-tax jurisdiction you might still have a motivation but if, under the OECD action point around control of foreign corporations, there was a home-country top-up tax—you put it in within a 10 per cent jurisdiction and the home country says, 'Good try, but we'll top up your tax'—again, that would reduce the motivation.
What I would summarise around debt is that implicitly there is an integrity thing. Every jurisdiction has this integrity challenge, and then there is the nuanced policy-setting point as to the cost of capital and economic activity trade-off. We would feel that we have the tools to enforce the policy settings which are in place.
Mr COLEMAN: Within this debt-to-equity ratio issue, one thing that occurs to me is that I think the argument in relation to operational expenses and interest costs associated with operational expenses in a business is very strong—it should be. And I think there is an argument about the further away you get from operational expenses of a business the more that is a nuanced conversation. Have you ever done any analysis or work on what proportion of claimed interest expenses in Australia relates to operational activities of those businesses within Australia? Do you know what I mean? I could finance an acquisition and effectively, through private equity type transactions, people can put debt associated with the cost of that acquisition into the business itself, which is not in fact associated with the operations of that business.
Mr Hirschhorn : I will take on notice whether we have done that analysis. I suspect that we have not. It is a feature of our system that if you buy a capital asset, in a sense, you can get a deduction against that. Where our corporate tax system has worked is that because of the interaction of tax consolidation and our normal rules, it means that in most offshore acquisitions of Australian entities it is possible to get the acquisition debt effectively deductible against the Australian operations. So, it is a combination of our settings that is colloquially referred to as a debt push-down. That is a feature of our system.
Mr COLEMAN: In previous reviews you have not considered that question of the proportion of deductions that relate to operational activities as opposed to, say, financing of acquisitions.
Mr Heferen : Certainly, from our perspective when this has been examined over the years I do not recall—and in conjunction with the tax office, before Jeremy's time—that being an issue. Debt is Debt. Tony is suggesting we may have done in the past.
Mr McDonald : I am just briefly putting a previous hat on. I believe there might have been some analysis previously in relation to concerns that, when companies were claiming interest deductions under section 25-90, they may disproportionately be through capital restructures or other things like that. So I think there was some analysis done at that point. But I suspect that debate moved on, and I had left the ATO by the time the debate had moved on. I think there was analysis that was done. It might have been in a discussion paper at the time of the 2013 budget.
Mr Heferen : The 2013-14 budget.
Mr McDonald : I do not know that there is anything more than that.
Mr Heferen : That was in the context of overseas acquisitions.
Mr McDonald : To be clear, it is in the context—because that section only applies in the context—of the multinational part, rather than the broader part. But, as our submission goes through, a relatively high proportion of interest deductions for companies in Australia are already subject to the thin capitalisation rules.
Mr Heferen : In the context of Australian companies and when they raise debt, and what that is used for—their ongoing operations versus a sort of passive asset they might hold—I do not recall any analysis that has that differentiation.
Dr Zirnsak : Just responding to a few of the points raised, I think it is a strawman in this context to keep having this discussion about companies not being allowed to claim any interest repayments as a tax deduction. I think to keep raising it in this room does not make any sense. I do not think anyone in this room other than the ACCI floated it as a possibility. I think every other submitter in the room accepted that there were legitimate reasons for legitimate interest repayments to be claimed. Certainly, our focus is on gaming the system and those who effectively cheat or find ways around rules—
CHAIR: I think the discussion was always going to head there, so I am with you—
Dr Zirnsak : I think if people keep raising it it wastes our time. Unless the ACCI want to push that really hard in the room, I suspect they are going to be on their own having that argument. Responding to what was raised by Treasury on this, on the rate issue an example of that is the Chevron case study we gave. There was analysis done by Neil Chenoweth from the Australian Financial Review. He points out that when we look at all the numbers—we have done our own checking of this, as well—Chevron was raising money there at 1.0, 1.2 or 2.0 per cent interest rate in Delaware on loaning to Australia. The case was at a nine per cent rate on average—it did vary across years. But the internal document seems to suggest that an arm's-length rate that the ATO would have accepted was five per cent, based on the basis that Chevron decided the loan from Delaware to Australia would be an unsecured loan and therefore it could claim an arm's-length rate of five per cent. So your real cost is 1.2 or 2.0 per cent, but you get away with a five per cent under the arm's-length rule in the way you choose to loan yourself the money. That is gaming the rate.
CHAIR: Stop there. Jeremy is going to respond to that.
Mr Hirschhorn: We cannot comment on individual taxpayers, but this is in the public domain. I think the reason for the difference between the one per cent and five per cent, which would come out in the hearing, was not the unsecured nature of the debt but the currency of the debt. So it was the denomination. So the assessment was on the basis of a five per cent Australian dollar loan, which was on a similar credit rating to a 1.2 per cent US dollar loan—
Dr Zirnsak: We and other commentators would question why Chevron chose to denominate the loan and use that currency difference in that particular case. There are still questions there about opportunities to game within the arm's-length rule. The OECD report on the debt issue looked at a fixed rate debt-to-equity ratio—what we have—versus a fixed rate interest-to-profit ratio, and came down on the side of saying an interest-to-profit ratio was less open to abuse, if you can have a fixed rate. That is where they fell. I would be interested as to why perhaps Treasury and the ATO disagree with that OECD assessment—
CHAIR: Rob will answer that one.
Mr Heferen: The OECD report on action item 4 said that the preference was the net interest expense of the 10 to 30 per cent of EBITDA or profit. But it was quite clear in saying that countries, for their own specific reasons, may decide to continue with a debt-to-asset treatment, which Australia has, and indeed also an arm's-length. The majority of the OECD members are European. The secretariat is heavily European based. So they look at it through a German and French perspective, because the British come in and go out and ignore it anyway, and the Americans do not participate. In our situation, with relatively high corporate rates internationally, high infrastructure investment needs, resource rich, and pretty reliant on foreign capital to turn potentially productive assets into productive assets, we felt we were in a situation where we needed to make sure that the arm's-length test was retained, and the OECD accepted that. Whilst they say in general it should be this, it is pretty clear on the face of it that where countries have a specific need for slight variances, that is fine. We still have to go through the process of making sure that our rules do not allow companies to have quite a departure from the base of the 30 per cent EBITDA under reasonable assumptions. That is a process the government needs to go through. Obviously we will work through that with the ATO and provide advice on that. In fact when the G20 endorsed the final report the Treasurer flagged it. So there is still that work to be done so that the government can be assured that what it is doing is actually in line with what the OECD is recommending. But I just want to make it clear that the report did allow for the circumstances that Australia finds itself in, and recognises that as being something that countries could be able to take into account.
Dr Zirnsak: On the hybrid issue the OECD has given the recommendation as to how to implement it. There is further detail. The committee might want to read this 425 pages. It is great bedtime reading! I can assure you of that. It outlines what the OECD found on how to implement a hybrid rule at the domestic level. I do have some concerns. I appreciate there are some complexities around this, but I do worry about the length of time the board of taxation might be taking to look at this—getting bogged down in detail.
Mr Gandolfo: I acknowledge your comments that the general consensus in the room is that there is not going to be a change in the tax deductibility of interest. But I want to put some comments on the record. Of the 694,000-odd companies that are listed in the table on page 44 of the briefing paper, only 2,000 of them come into the category of large or very large corporations, or come into the discussion we have been having up to this point on global tax shifting. The majority of those businesses, by far, are small to medium-sized businesses, and almost all of those businesses are debt funded. Debt is an enabler. It comes at a cost and it provides a benefit. If you make changes to those things, you will change the way businesses operate. Every incentive that has been offered to small to medium-sized businesses to increase, or to go and invest in new plant, machinery, capital equipment and that sort of thing, has been matched with a tax-driven incentive such as investment allowance or instant asset write-off. So tax-deductibility and interest are linked, and the behaviour of business owners is driven by those things.
You would create a shift in behaviour if you ceased to be able to have a tax deduction on interest. You would move people. In our space—we are in the asset finance business, and asset finance receivables in this country are about $100 billion at any given time—there is a lot of money out there on which interest is being paid. If that ceased to be deductible, you would shift behaviour to operating lease and, under new operating lease accounting standards, you would encourage people to move into a regime where they are going into a service-based cost where you have a lot of blind costs and you are still going to have a tax deduction anyway, or you are going to move smaller businesses and microbusinesses into fee-based lending arrangements where there is no interest but there are fees. If you extrapolate those fees out and equate them to interest rates, the rates on those are very high, but they are still deductible. They come at a cost, so no-one actually benefits from any of that.
I have a couple of other quick points, if I may. If you remove company tax deductions for interest, that does not provide any benefit; it actually comes at a cost to people who are in a trust arrangement or a partnership arrangement. The deduction at one end is removed, but the tax cost at the other end is still there, because once it is distributed the normal tax rate would apply. You also have situations where some companies and businesses—agribusinesses in particular—only make profits seasonally, or every five to seven years sometimes, or cyclically. There would be a cost to those businesses as well. So our view—and we made it pretty clear in our submission—is that it would be an absolute killer for business.
CHAIR: We will take that as a comment, David.
Mr Gandolfo : Well, it is a comment. I am sorry, but I just wanted to put it on the record.
CHAIR: We will take it as a comment. My favourite tax lawyer!
Mr Varrasso : You are one of the few that say that! I will just try to capture a few things. I had some thoughts from earlier. I have one comment regarding the question around whether work has been done to assist the difference in levels of interest deductions or at least interest claimed for either working capital—being ordinary operations—or restructure/acquisitions. I just want to make a comment on that. I do not see the need to make that distinction where ultimately for both there is still a nexus required, generally, that the costs incurred in deriving income are assessed, so to get the deduction there has to be that nexus.
The second point is to just talk about effectively endorsing the comments that Jeremy has raised about our laws being appropriate for our current policy settings. There has been a bit of talk about whether taxpayers are able to work outside of our laws. This comes back to a comment from our earlier session around dealing effectively with those that operate within the law and those that clearly operate outside of the laws. We can only address the issues that we have with the current laws.
CHAIR: Those comments, for those of you who were not here, was over claim versus fraudulent claim.
Mr Varrasso : Yes, sorry. What I am talking about in the context of our current discussion is that I think our current laws, as Jeremy has flagged, are appropriate for our current policy settings. We have a very robust regime of integrity measures. We have transfer pricing laws, multinational avoidance, part IVA and thin capitalisation, and within each of these there are specific integrity measures as well. To the extent that taxpayers operate outside of those laws, the administrator will address that, and they are doing that. There was discussion just now about the Chevron decision. I do not know that it was actually said that the court found in favour of the tax office. I do not know what more there is to say on that point, but I just wanted to capture that.
CHAIR: Thank you. Mr Morrison, do you want to make a comment?
Mr Morrison : Yes, thank you. I want to make a couple of comments building on what Wilhelm said a bit earlier on in relation to housing and what is commonly referred to as negative gearing. I think Wilhelm made the case very strongly that interest deductibility is important for those organisations which are constructing or developing housing. There is also a demand side, which bleeds into the personal income tax focus of the discussion before lunch. Something that is not commonly recognised is that that 27 per cent of new housing construction is actually bought by investors. So income deductibility and negative gearing is an important underpinning of more than a quarter of new housing supply in this country.
From both ends of the spectrum, as others around the table have talked about, if you are a business in a capital-intensive industry, like property obviously is, interest deductibility is very important. I would note that commercial property institutional investment is primarily held in real estate investment trusts where there is a tax flow-through status. So, effectively, there is no negative gearing available. Tax is paid in the hands of the beneficiary, which is a common international perspective. For those active companies that are creating the product, there are the deductibility impacts on dealing with a capital-intensive business. But then there is the demand side, which is also very important. When we have policymakers focusing on the need to ensure we have adequate housing supply to address affordability issues there is a real danger in messing around with interest deductibility and the impact that could have on housing supply.
Mr Hicks : I just need to correct the record. We are not proposing the removal of interest reductions. Just on how the issue was translated into the briefing paper, we said that removing interest reductions would solve the debt equity distortion but would also create a whole host of other problems. We are certainly not saying that it would be appropriate.
Speaking more broadly, the reality is that capital is becoming more mobile. We are becoming more and more capital-reliant. It is becoming harder and harder to determine where a business activity actually takes place. So it is good that we are doing work through the OECD and the G20 to make sure that people are doing the right thing and to make sure that the policy framework makes sense. But ultimately we are trying to defy gravity here. The rest of the world is becoming less and less reliant on company profits as a source of taxation revenue. We are going to have to follow them. Whether that is next year or 10 years down the line, we are going to have to go there eventually. Just taking deductions away and broadening the base is not going to allow us to do that.
Mr Sorahan : I want to follow on from some of the comments that were made earlier and go back to the question of whether removing interest deductibility is an appropriate trade-off for a lower corporate tax rate. It is important to note that that would have a very severe impact on capital-intensive industries, including mining. It would increase the effective tax rate on mining investment in Australia. We rely a lot on debt for very large, long-term capital investments in the order of billions of dollars. So it would increase our effective tax rate. There would not be a trade-off for us. It would be an increase. There would perhaps be a cut for other industries but there would be an increase for an industry which comprises almost 50 per cent of Australia's exports.
The second point to make on that is that, for Australia, which is a medium-size capital importer, that is exactly the kind of tax system we do not need.
Mr Johnston : Coming from the perspective of a micro-business, which I admit would never be operating on the level of looking for that level of debt financing, my concern would be that this entire discussion has had underlying it the fact of long-term debt. For large projects—buildings, mines and things like that—that is understandable. But again, relating to comments I made earlier today, what the government is in effect doing is subsidising activity. That may be good economic activity in a policy sense, but ultimately it is potential taxes that the government is forgoing. So it may be worth considering putting some sort of time limit on how long that deduction can last, if the broad agreement is about 10 years, but then saying, 'We have given you that reduction for that many years. We the government representing the taxpayer now expect some back taxes because we are assuming that we are dealing with businesses that are ultimately designed to make profits.' I think that profit motive in the end is the part of the debate that is missing. You do not go into business to make a loss; you go into business to make a profit.
Mr Morrison : Just to build on that comment—and this is in relation to the property industry—if you look at the broader tax take from property, it is $72 billion within the Australian taxation system. If you look at just real estate specific taxes they account for—and these are Treasury numbers—it is around nine per cent of our total tax take. That is compared to an OECD average of five per cent. I know you were not making a comment specific to real estate or to property, but, if you are looking at how that logic might apply to property, I think there is already plenty of tax being paid by any measure.
Mr Brown : There are probably two things just to note. In some ways, the distinction being drawn about debt is that debt might be a substitute for equity, perhaps. But, in fact, a lot of debt run by companies is actually financing their ongoing operations, working capital, trading stock and a whole lot of things like that where it is just an ordinary part of doing business. I think it would actually be very difficult to draw a distinction between debt incurred for that purpose and debt that is incurred as underlying capital finance of a company. Money is fungible. Basically, money is money. That is one observation just on that bit of the discussion.
The other observation just goes back to the OECD action item No. 4 where the recommendation is to have a limit on interest deductions as a proportion of EBITDA or a measure of earnings. That is somewhat equivalent to what we do in Australia where we have a debt-to-equity ratio and we have an arms-length set of rules and transfer pricing rules. If you have the two things together, as we have in Australia, you end up with something which looks very much the same. You limit the amount of debt and you also limit the price of the debt. That is what the OECD recommendation does.
The thing about the OECD recommendation is that it puts it into a single cap which is fixed. The effect of having two separate caps is that you have a debt-to-equity ratio which is fixed but the price can vary, depending on interest rates, which gives you a little bit more flexibility in terms of what would happen if global interest rates were to suddenly start going up. Debt deductions would also go up. But if you have the OECD recommendation of a fixed amount, you would start denying people what are in fact legitimate deductions. So there are pros and cons both ways.
Mr Wolfe : Just looking outside of the company structure for a moment, the housing industry, for example, is made up of about 85 per cent small businesses. Those small businesses, in the great majority, are sole traders and partners that would not benefit from a reduction in debt interest but might be disadvantaged by any changes to the deductibility provisions that might apply to members of those companies. I think it is important to take that into account. Do not presume that everybody is going to benefit.
The other point I would make is that on pages 41 and 57 there is a presumption or hypothesis that any deductibility benefits in personal income tax or company income tax is quarantined to advantage an income tax rate personally or company tax rates. I am not sure if that was the intention when we were talking about winners and losers before. If there is going to be any change to either one of those, is it the intention that those revenue benefits might offset in a hypothecated or quarantined way?
CHAIR: I cannot remember if you were here this morning.
Mr Wolfe : I was.
CHAIR: This is a personal view. The committee will meet post this and talk about it and then make a report to the Treasurer. The view is that the aim of this exercise was to look at what you could do to lower tax rates, not where the savings were generated from and what you could spend the money on.
Mr Wolfe : The two questions in the discussion paper on page 41 tend to give the impression that if you generate some tax revenue benefits from personal income tax changes that would then offset personal income tax rate thresholds. The question on page 57 has the same sort of view that if you do anything to company tax—
CHAIR: As in the lowering of them?
Mr Wolfe : As in the lowering of them, yes. Therefore, I am seeing a presumption that you quarantine any benefits in personal tax to personal tax thresholds and company tax to company tax payment thresholds. I do not know if the government is committing to that sort of an arrangement or whether or not there is room for winners and losers—
CHAIR: The government is not. This is a joint committee. This committee will meet—Labor and Liberal—and make recommendations out of it. The government is not.
Mr Wolfe : The discussion around the table here may have presumed that any changes to deductions, and the benefits in company rate or company deductions, might then derive into benefits in the company tax rate and they might not.
CHAIR: Listening to it intently, I think the consensus around this table in relation to companies—and I think after we meet this would flow through the committee into the report—is there is not a lot of room to move on the company side of the fence. I do not think the two are correlated.
Mr Davidson : We are about to conclude, so I will make a broad comment. We think the case for a lower corporate tax rate on economic efficiency growth grounds is a lot stronger than the case for lower personal income taxes. Having said that, it is not yet obvious to us that there are not any hollow logs in the business tax system, and certainly quite a few have been unearthed in that other inquiry into transfer pricing and international cost shifting. If even a fraction of the amounts involved were clawed back that is a lot of money. That would be a form of base broadening and rate lowering that, I think, would work well.
I am wary of the statement that there is a consensus in the room, or there was consensus in the tax working party or elsewhere, because when I look around this room there is a whole bunch of people who are representing the larger taxpayer interest and not that many who are standing up for the fisc beyond our able friends in Treasury. Many of these discussions, including the one on self-education and childcare deductions, would go very differently with a different group of people in the room. It raises a question for me: was the composition of this group determined purely on the basis of submissions? Over many years of working in tax policy I have always been astounded by the limited diversity of people in the room. We struggle to make a difference to that or involve our members in serious tax policy work. There are always very few, what we call, community voices. That is not to say that we will always be at odds with everybody else in the room. We ginger things up a bit. But I think it would help if, in tax policy discussions of this kind, there was more of a diversity of voices—
CHAIR: Just going directly to that: firstly, I would absolutely consider myself a community voice, and, secondly, this process has run the way that all committee processes run in parliament: you advertise and call for submissions, and the committee is composed off the back of those. But it is open to anyone to submit and, therefore, to anyone to come. So congratulations to you and to everyone here, because you have seen fit to be involved.
Mr Davidson : I think this one caught a lot of us on the hoof, it is fair to say; we had a rather short—
CHAIR: I probably take personal responsibility for that. I was made chair of this committee at the end of September, and we had a very tight time frame, as a government. So to put my government cap on: I knew what we were contemplating and looking at. To put my committee hat on: I did not think that there was enough discussion about what we particularly have discussed this morning in the mix. I can tell you, personally, as a community representative—my third hat—what I am interested in: as I said this morning, as a rule of thumb, I believe that every individual in Australia is the person best placed to spend the money that is in their pocket, not the government. So I thought it was a conversation we needed to have. Hence, I worked with the secretariat and Ed and said, 'How do we do it?' realising that, if anything meaningful were to come out of it, it had to fit a very tight time frame, due to circumstances beyond my control. So I do apologise.
Mr Davidson : I understand that. This is a good format, I think.
CHAIR: It has been very productive. I think we might have the lucky last.
Mr Wolfe : I would not underestimate the impact of regulation on cash flow and businesses also. The regulations quite often affect the way in which businesses have to manage their cash flow, and that, therefore, drives debt financing and interest arising from that. So, in a lot of instances—particularly in our industry, where there are significant state consumer protection legislative regimes that control what businesses can and cannot do in terms of work completed and claiming payment from their clients and so on—that means that, in an industry which is dominated by small business and has to finance that cash flow by borrowings, that interest is a very real part of their business, because of the regulations that exist across the states and territories.
CHAIR: It is a perfect demonstration of the fact that taxation is a complicated thing and that, at every level of government, we get ourselves involved and make life ever more complicated. I think that is a nice way to finish, unless there is anyone—Mark?
Dr Zirnsak : I just wanted to follow up the comment from PBO and to get it on the record as to what the OECD actually did say as the recommendation. To quote from their executive summary:
Recognising that some groups are highly leveraged with third party debt for non-tax reasons, the recommended approach—
proposes a group ratio rule alongside the fixed ratio rule. So they actually have talked about a two-sided test anyway, and they have, as I said, recommended an interest—a beta fixed ratio. So that is just to be clear about exactly what they did recommend. It was not just the one fixed ratio.
Mr Ward : I will just make a brief comment. I do think that there is significant ability and room to improve the thin capitalisation rules. It has been suggested that the ATO has everything that they need, and I commend the ATO on the fantastic case and the victory with Chevron. But again, Chevron is appealing that decision. It took the ATO $10 million and years to get to the point to get that decision, and we now know that there is the ATO has an ongoing audit with Chevron for another lending scheme. The case was around a loan of $2.5 billion. Chevron now has a $35 billion loan at a highly inflated interest rate—not as grossly inflated as the last one, but clearly the lower margin on a higher volume. Even Chevron admitted that that could produce $15 billion worth of tax deductions in Australia over the life of that loan. I would estimate that that deduction is probably significantly higher than that. This to me is an issue of national importance. This is the largest single project in Australia's history and it is not clear when or what tax revenues will flow from it, either from the corporate side or from the PRRT side.
CHAIR: Thank you for that comment.
Mr Johnston : Mr Chairman, if you might indulge me for a second. You might remember that when we started back I had an incident of failing memory. The one point I did want to raise from the last session was the point that was also raised about superannuation. Another thing I think the committee should consider in terms of income and deductions in terms of superannuation is that that system tends to assume that a person or persons will have regular, stable work for about 40 years of their life and therefore have income. However, for increasing numbers of us this is not true—we are temporary contractors or a lot of us are doing part-time work or are having to set up our own arrangements—therefore, contributions to superannuation become highly irregular, if at all, and at the end of our functional working lives we have much less. I draw your attention to the Re:Think tax discussion paper. It did raise certain European models of a base tax that might supplement retirement incomes which might be needed to supplement superannuation for all of those who do not have for a variety of reasons regular work that pays into super.
CHAIR: That is a very fair point, and it is noted. Thank you for your participation today. If you have been asked to provide additional material, would you please forward it to the secretariat. You will be sent a copy of the transcript of your evidence, to which you can make corrections of grammar and fact. On behalf of the committee and personally I would like to thank you for taking some time out of your busy schedules to join us in lovely Canberra. I really felt the conversation this afternoon was more in unison than this morning's, which made this morning interesting at times. I really thought it was productive and you have given us a lot to go away and think about.
Resolved that these proceedings be published.
CHAIR: I declare this roundtable public hearing closed. I hope those who have travelled travel home safely. Thank you.
Committee adjourned at 14:13