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Reform of the Australian Taxation System - Ministerial statement by the Treasurer (Mr Keating), dated September 1985, together with attachments


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The Parliament o f the Commonwealth of Australia

REFORM OF TH E AUSTRALIAN TAXATION SYSTEM

Statement by the Treasurer The Hon. Paul Keating, M .P.

September 1985

Presented 8 October 1985 Ordered to be printed 17 October 1985

Parliamentary Paper No. 315/1985

REFORM OF THE AUSTRALIAN TAXATION SYSTEM

Statem ent by the Treasurer

The Hon. Paul Keating, M.R

Septem ber 1985

REFORM OF THE AUSTRALIAN TAXATION SYSTEM

Statement by the Treasurer

The Hon. Paul Keating, M.P.

September 1985

Australian Government Publishing Service Canberra 1985

© Commonwealth of Australia 1985

ISBN 0 644 04438 1 ISBN 0 644 04439 X (Statement to House of Representatives)

Printed by C.J, Thompson, Commonwealth Government Printer, Canberra

CONTENTS

PAGE

Reform of the Australian Taxation System Statement by the Treasurer, the Hon Paul Keating, MP 1

Attachment A: Estimates of Net Revenue 23

Attachment B: Details of Measures 27

1 Australia card 28

2 Non-cash fringe benefits 32

3 Living-away-from-home allowances 36

4 Entertainment expenses 37

5 Substantiation 39

6 Capital gains tax 41

7 Rationalisation of 49

wholesale sales tax

8 Tax-free threshold 54

9 Prescribed payments system 55

10 Quarterly provisional tax 57

11 Quarantining of farm losses 60

and improved averaging provisions

12 Deductibility of expenditure 62

on soil conservation and on conserving or conveying water

13 Tax concessions for 63

the Australian film industry

14 Capital subscribed to 64

petroleum and afforestation companies

15 Income tax on certain public unit trusts 65

16 Foreign tax credit system 66

17 Petroleum and general mining: 68

Group loss transfer provisions and diesel rebate

18 Imputation system of company tax 69

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19 Poverty traps 72

20 Concessional expenditure rebate 74

21 Negative gearing of rental 75

property investments

22 Depreciation on residential 76

income-producing buildings

Attachment C: Income Tax Rate Scale and Distributional 77

Impact

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REFORM OF THE AUSTRALIAN TAXATION SYSTEM

STATEMENT BY THE TREASURER THE HON PAUL KEATING, M.P.

Mr Speaker,

Since its election in 1983, the Hawke Government has consistently pursued policies directed towards restoring strong economic growth and creating a fairer Australian society.

By any measure our strategy has been an outstanding success.

For the past two financial years this nation has recorded growth rates that are the envy of the Western world.

Under this Government over 430,000 more Australians have found jobs, inflation has been cut significantly from the double digit legacy of our predecessors and we have arrested and turned around the blow-out that we inherited in the Commonwealth

budget deficit.

We now confidently anticipate a third year of strong growth.

And despite the protestations of the doomsayers after I brought down the Budget last month that prospect is being confirmed repeatedly by a series of positive economic indicators.

Mr Speaker, the achievement of sustained high growth rates remains the over-riding economic objective of this Government.

We have policies set for growth.

Not because that is an end in itself.

But because it is only through economic growth that we can cut unemployment.

It is only through growth that we can increase assistance to the needy.

And it is only through growth that we can generate the higher living standards that the whole community desires.

If we are to maintain the momentum of growth it is essential that we act now.

We must be prepared to tackle head-on the issues that in the past have been consigned to the too hard basket.

We must be prepared to debunk the myths and overturn the barriers that stand in the way of our goal.

This Government is prepared to do that.

Today we are taking the hard decisions, confronting the issues and embarking upon a very substantial reform to the Australian national economy.

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Mr Speaker,

For the first time in Australia's recent history a Government has been willing to place tax reform on the political agenda.

But much more than that, for the first time a Government has been willing to act.

We have invited debate, we have asked the people of Australia to express their views and we have listened carefully to what they have said.

The tax reform measures I am announcing today are the outcome of that unprecedented process of consultation.

While they do not include a broad based consumption tax of the kind proposed by the Government at the July Tax Summit, they do represent the most far reaching reform of the Australian tax system to be undertaken by a Government in living memory.

Today we are addressing a crisis in our national taxation system that has been left by a succession of Governments to compound year upon year.

There was a time when Australia had a reasonably sane and credible taxation system.

But that time is long gone.

The system has been broken and beaten by an avalanche of avoidance, evasion and minimisation.

And more so than in any other period in Australia's history, the taxation system deteriorated during the stewardship of the previous Government.

During those seven years tax avoidance became the norm for hundreds of thousands of Australians.

Taxpayers were allowed the indulgence of moving into contrived artificial paper avoidance and evasion schemes - including those of the criminal variety.

The Government of the day was tardy in acting to stem the blatant abuses that were occurring before its very eyes.

More than that, it failed to act at all to tackle the underlying problems.

It is the deterioration and decay that occurred during the late 1970s and early 1980s that has now made substantial reform so essential.

For years Australians have gained satisfaction from believing that their tax system was progressive.

That those who could afford to shoulder a greater share of the burden did so.

Today, that is a fiction.

The system no longer works that way.

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The top marginal tax rate - the 60 cents in the dollar rate - has been paid by barely a few of those whose income should place them in that bracket.

Tens of thousands of these people have walked away from the system.

In their place middle income Australians have been forced to take up the load.

These are the people who have not been in the position to arrange their affairs to take advantage of the tax shelters, the schemes and the concessions.

They have not joined in what had for higher income earners become the socially acceptable business of avoidance and evasion.

But it is they who have sustained the system during the past decade.

What we have seen is a dramatic compression in the application of the marginal tax rates, so that where at the beginning of the 1970s the top rate came in at the current equivalent of $110,000, today it comes in at $35,000.

In the early 1970s the top rate applied at five times average weekly earnings.

Today it applies at 11/2 times.

Mr Speaker, it is for these reasons that from the outset a major objective of tax reform has been to substantially lighten the heavy hand of high marginal tax rates on honest taxpayers in this country.

It would be stupid not to recognise the lesson of recent history; taxpayers just will not pay ridiculously high marginal tax rates.

The system invites abuse if it attempts to impose such a burden.

The time has come when the facts must be faced.

Change is needed.

And if this nation is to continue to progress, it is needed now.

Lower marginal rates will enhance our economic performance by better rewarding initiative.

They will help generate growth by increasing rewards for work relative to those from tax avoidance and evasion.

And they will make for a better nation by reducing distortions in the savings and investment decisions of ordinary Australians.

Mr Speaker,

A fundamental and major reform which this Government will undertake is to reduce the top rate of income tax from 60 cents in the dollar to 49 cents in the dollar.

Further, we will cut the intermediate rate of personal income tax from 46 cents in the dollar to 40 cents.

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This slashing of marginal tax rates represents a dramatic and permanent reform to the Australian tax system.

It will mean that in the future no Australian will be required to pay more than half his or her income in taxation.

It is this action along with the abolition of shelters and the introduction of stronger penalties which will act to end the rorts and abuse of the system.

Combined with our expensive reform a year ago to drop the bottom personal income tax rate from 30 to 25 cents in the dollar, today's measures will restore the system's effective progression.

They also make possible the vital innovation of aligning the top personal income tax rate with the company tax rate.

In a stroke this will make a whole host of tax avoidance devices futile.

Further, in this package for the first time a Government in this country will have recognised the call from shareholders of Australian companies to remove the double taxation of dividends.

This is a reform which was denied in 30 years of Coalition Government.

From today the Government will also have ended the debate which has persisted in Australia for decades as to whether income taken as capital ought to be exempt from tax.

We will establish a capital gains tax so that in the future taxpayers who take their income in the normal manner will not be disadvantaged as against taxpayers who choose to take their income as capital.

Mr Speaker, the benefits of tax reform will be shared among all Australians.

A number of measures are to be taken to relieve poverty traps in our social security system.

These changes will involve easing the income tests applied to pensioners and beneficiaries and will increase the incentive available to these people to earn extra income.

This whole group of reforms - reductions in marginal rates, the alignment of the top personal rate with the company tax rate, the full imputation system for relief of dividend tax, the capital gains tax and the action to relieve poverty traps - makes this statement of reform the most comprehensive in the modern era.

Mr Speaker,

This reform package launches an attack on tax shelters and sectional practices.

Measures that even-up the taxation treatment of different industries will attract resources to where they earn the greatest real profits, rather than to where they attract the greatest concessions or generate the largest tax deductible losses.

It is true that tax shelters and other minimisation devices may, on occasions, stimulate particular industries or activities.

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But it must be understood that whenever such a subsidy is conceded it involves a real - and largely hidden - cost to the rest of the community.

Ultimately, every tax concession, minimisation scheme or evasion rort means that all of those who do not benefit must shoulder a greater burden.

More often than not it is the higher income earners who benefit from exploitation of these practices.

Again, it is the middle income earners - ordinary tax paying Australians - who must shoulder the difference.

By broadening the income tax base and closing loopholes, today's measures will achieve a return to fairness in the Australian tax system not seen for decades.

Australian society will be much the stronger for it.

These measures, and this reform package, are not about raising revenue for the , Government.

The total yield of this package will be returned to taxpayers.

Not only that, it incorporates tax cuts to be delivered in satisfaction of the Government's commitment to continued wage restraint.

. In all, significant cuts will be delivered to everyone in the community save those taxpayers who have made a feast of tax avoidance and evasion.

Next financial year tax cuts totalling $2 billion will be delivered to all taxpayers.

Of this $2 billion, $800 million will be netted in that year from the tax reform measures.

In the following financial year the cost of the tax cuts will be about $4^2 billion, of which the growing yield from the tax reform measures will account for about $ 1 ^ 2 billion.

In other words, the cost to revenue of the cuts will far outweigh the proceeds from the new tax measures.

Putting these figures in individual terms will mean that in the first year the average income earner will receive an income tax cut of $9 per week.

In the second year, a further reduction in the tax scales in July 1987 will bring the total tax cut for the average income earner to $15.20 a week.

None of these tax cuts will be financed by adding to the Government's deficit.

They will be achieved by the most rigorous restraint on public sector outlays.

This Government has already demonstrated its economic credentials.

We are committed to responsible and prudent fiscal policy.

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We have more than halved the deficit as a proportion of Gross Domestic Product in three years.

We have curtailed outlays growth to its lowest rate in six years.

The Government entered the discussions with the trade union movement on wage restraint with a total commitment that the budgetary scope to finance these cuts would be found through expenditure restraint.

The tax package is part of our overall strategy designed to promote growth.

This Government knows that responsible and appropriate fiscal policies are an essential element of macro-economic management.

We will not put sustained economic growth at risk by relaxing fiscal discipline.

Details of the proposed measures are provided in Attachments to my printed speech, which I shall table on conclusion.

I shall now outline the main features of the Government's reforms.

FRINGE BENEFITS

There has been an accelerating shift in recent years toward the payment by employers of remuneration in the form of fringe benefits.

While not readily admitted as such, this shift often has all the hallmarks of outright tax evasion.

High marginal income tax rates have played a major part in providing the incentive for this trend - and we will rectify that problem in this package.

However, the growing shift to fringe benefits has been a major factor in reducing the tax liabilities of predominantly higher income taxpayers.

An increasing awareness of these 'perks' has highlighted the unfairness of the tax system and has contributed to undermining taxpayer morale.

As a consequence, the Government will be proceeding with the taxation of fringe benefits broadly along the lines described in the draft White Paper on Reform of the Australian Taxation System.

That will mean taxing all of the major fringe benefits, whether received in cash or otherwise.

Non-Cash Fringe B enefits

In the case of non-cash fringe benefits, the tax will be payable on the assessed value of the benefits provided to employees and will be levied on the employer at the prevailing company tax rate.

Initially that will be 46 cents in the dollar, changing later in line with the alterations to the company tax regime.

The type of benefits to be taxed include employer-provided motor vehicles, free or

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low interest loans, residential accommodation, goods and services sold at below cost or provided free by an employer and expenses paid on behalf of an employee.

The valuation rules to apply in each case are detailed in the Attachments.

In the case of motor vehicles where no records of costs or business use are maintained, a proportion of the purchase price of the car will be subject to the tax at the relevant company tax rate.

Under these rules, the maximum tax payable on each car will be around 11 per cent of the purchase cost. Lower levels of tax apply where the total distance travelled by the vehicle during the year exceeds specified threshold levels.

If a higher proportion of business use can be substantiated there will be the option of maintaining cost records and log books detailing the breakdown between private and company use.

The fringe benefits tax will not apply to benefits associated with employer contributions to superannuation funds and employee share acquisition schemes, which are already subject to specific taxation provisions.

The tax will be designed to have little or no effect on the many small, traditional employer-provided benefits such as most staff discounts.

A complete exemption applies to staff canteens, free commuter transport fares, the home to work use of taxis and commercial vehicles and child care facilities on employers' premises.

Special concessions will apply to housing and travel benefits provided to employees in specified remote areas.

All employers, with the exception of religious bodies, will be liable for the tax, including the Commonwealth, State and local governments.

Clearly, government bodies other than the Commonwealth will incur a direct liability if they choose to provide such fringe benefits.

In the case of the Commonwealth any payment of the tax will be shown in the Budget papers and will be subject to the Government's own on-going expenditure restraint guidelines and to Parliamentary scrutiny.

In addition, measures are to be taken to equate more closely the treatment of non-cash fringe benefits for Commonwealth public servants with that which is likely to apply to their counterparts in the private sector.

For example, the same rules that the Tax Office applies to private sector employees will be applied to public servants when apportioning the cost of Government provided home telephone services.

Commonwealth financed provision of credit cards to senior public servants is to cease forthwith and existing cards will not be renewed.

The private use of Commonwealth-owned cars provided to employees will be stringently controlled.

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With the introduction of this tax it is expected that some employers and employees may see advantage in replacing fringe benefits with cash payments.

As this would bring currently non-taxable benefits to book, such a development would be consistent with the Government's objectives in taxing these benefits.

The Government will consult with employers and the ACTU about possible adjustments to the wage fixing principles to provide for such "cashing-out" of benefits under appropriate conditions.

The Government does not expect, and would not wish to see, any further build-up in the provision of fringe benefits. The Government will review these arrangements, with a view to tightening their application, should any significant increases occur.

The tax will commence on 1 July 1986 and be paid quarterly, with the first payment due in October 1986.

The amount of tax revenue to be recouped is estimated at $320 million in 1986-87 and $515 million in 1987-88.

Living-Away-From -Hom e Allowances

While most living-away-from-home allowances are not paid at excessive rates to avoid tax, there has been growing abuse in this area. ·

The Government has decided to tax the remuneration component of

living-away-from-home allowances at the employer level in the same way as for non-cash fringe benefits, with effect from 1 July 1986.

The taxable value for this purpose will be equal to the amount of the allowance in excess of the proportion which represents reasonable compensation for additional expenditures on accommodation and on food.

The revenue gain is estimated at $10 million in 1986-87 and $15 million in subsequent years.

Entertainm ent Expenses

One of the greatest difficulties in recent years in determining legitimate expense claims has been in the area of entertainment.

A good deal of so-called 'business' entertainment tends to be done on a reciprocal basis and is often undertaken for predominantly social or personal benefit rather than business purposes.

In practice it is almost impossible for the Tax Office to separate those social activities from genuine commercial activities but it appears that the major part of expenses claimed have little or no genuine relevance to business activity.

It is the Government's view that the general public should not have to subsidise through the tax system the social activities of higher income earners who seek tax deductions for entertainment expenses.

Accordingly it has been decided to deny deductions for all entertainment expenses incurred after today.

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Reflecting the lagged nature of business tax payments, this measure will produce $310 million in revenue in 1986-87 and $330 million in 1987-88.

The disallowance of deductions for entertainment will apply across-the-board and will include business meals, drinks, cocktail parties, tickets or boxes at sporting or theatrical events, sightseeing and hostess allowances.

It will include entertainment claimed to be associated with an advertising or promotional purpose, and it will cover the entertainment expenses of all taxpayers.

However, the measure cannot be directly applied to a tax exempt organisation which pays entertainment expenses which confer a personal benefit on its employees or associates or reimburses them for such expenses.

In such cases, it is intended that entertainment expenses be subject to the tax on non-cash fringe benefits.

Substantiation o f expense claim s

A deficiency of the existing law is that it does not specify the proof required to substantiate employment-related expenditure claims.

This results in successful claims for which there is no proof of expenditure.

To rectify this deficiency the Government has decided to amend the law to provide that deductions will not be allowable for expense claims unless the claimant is able to substantiate the amount and purpose of the claim by receipts or other

documentary evidence.

All allowances above a certain limit, including independently arbitrated allowances, such as parliamentarians' electorate allowances, will be subject to substantiation.

More detailed substantiation requirements than for other expenses will generally apply in relation to car and travel expenses.

Moreover, deductions will not be allowed for the travelling expenses of a spouse on a business trip.

For self-employed people the new requirements will apply only to travel and vehicle expenses.

However, the rules will not apply to claims within the limits of employment-related travelling and accommodation allowances, provided that the travel is undertaken in Australia and the allowance is reasonable in amount.

Similarly, reasonable overtime meal allowances will be excluded.

Nor will the rules apply where total eligible expenses do not exceed $300.

With a 1 July 1986 commencement date, the estimated revenue in 1987-88 is $105 million, building to $200 million after about four years.

CAPITAL GAINS TAX

There has been a long debate in this country about the role of capital gains taxation - a debate which unfortunately has too often been characterised by misinformation and hysteria rather than rational discussion.

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The Government believes that in inviting discussion about capital gains taxation in the draft White Paper the Australian community was finally offered an opportunity to consider the question of capital gains taxation in a more reasoned atmosphere.

The Government has decided to introduce a capital gains tax but, in the light of the public debate, to incorporate several major modifications to the proposal outlined in the White Paper in June.

These changes address the concerns which have been expressed and will substantially reduce the impact of the tax and allow the community a lengthy period in which to adjust to its application.

In particular, it has been decided that the tax will in every sense be prospective.

That means it will apply only to gains on assets purchased or acquired after today.

All assets already owned by taxpayers will be exempt from the tax when sold by them, both in respect of gains accrued until now and all future gains.

The Government has decided that the deemed realisation at death proposal, outlined in the draft White Paper, will not apply.

Liability for tax in the case of death will be rolled over to successors, and will only be assessed on any subsequent disposal.

Therefore the capital gains tax will not apply in the case of death.

Other main features of the tax include;

- it will apply only when the asset is sold or transferred by gift;

- it will apply only to real capital gains calculated by fully indexing the cost of the asset for inflation;

- a complete exemption will apply to gains on the taxpayer's principal residence and reasonable curtilage, on all motor vehicles, on other personal-use items such as furniture up to a sale value of $5000, and on gains with respect to superannuation and the proceeds of life insurance policies;

- there will be provision for nominal losses to be offset against gains;

- the tax will be levied, on real gains, at ordinary rates of personal and company income tax.

The existing capital gains section 25A of the income tax law will not apply in respect of assets acquired after today, but will continue to apply for assets acquired before midnight tonight.

The existing section 26AAA will continue to apply for all relevant assets.

Because of the wholly prospective nature of the tax, revenue is expected to build up gradually over a lengthy period, as newly-acquired assets are disposed of.

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As an illustration of the fact that this tax will affect only a tiny section of the population, its expected revenue yield, in the fifth year of operation is estimated to be only $25 million.

The tax will mean that for assets acquired after midnight tonight, taxpayers will simply need to keep their records of purchase price, spending on improvements and sale price.

Valuation of assets already held will not be necessary as all are exempt from the new provisions.

To cite an example, suppose an asset such as an office was purchased tomorrow for $100,000 and assume it is sold five years later for $130,000.

If during that five year period inflation totalled 25 per cent, the gain would only be assessed as the difference between $130,000 and $125,000.

The gain of $5,000 would be taxed at the taxpayer's marginal rate - which in the case of a 40 cents in the dollar taxpayer would amount to only $2,000 in tax.

I repeat, however, that every asset already owned by taxpayers will be exempt from the tax.

WHOLESALE SALES TAX

I announced on 13 August 1985 that the Government had decided against any major extension of the indirect tax base but would carry out a rationalisation of the existing wholesale sales tax schedules and rate structure.

As a result of this rationalisation, the rate structure is to be simplified to reduce the existing four step scale to three.

These steps will be 10, 20 and 30 per cent, in lieu of the existing 7 I / 2 , 10, 20 and 32 1 / 2 per cent schedules.

The rationalisation will include the incorporation of the current 7 V 2 Per cent category into the 10 per cent category.

The rate for chocolates and other confectionery will be reduced from the current 20 per cent to 10 per cent, while the tax at that rate will be extended to close

substitutes of the existing taxable items including snack foods, ice cream and biscuits.

Also to be taxed at 10 per cent will be non-oil-burning domestic space heaters, domestic cooking stoves, domestic water heating systems, and wrapping materials for household use.

Each of those items is currently excluded from the sales tax base, a treatment inconsistent with that accorded almost every product of a similar kind.

The rate of tax on items currently subject to 32^2 per cent is to be reduced to 30 per cent in the case of TVs, radios, videos and other electronic equipment, jewellery, furs, cameras, watches and clocks, cosmetics and perfumes and poker and amusement machines.

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Other items currently taxed at 32 I / 2 per cent will fall to only 20 per cent including pens, most brushes and shaving utensils, sound and video tapes and records.

A number of other anomalies and inconsistencies in the wholesale sales tax are being addressed, and details of all the changes are included in the Attachment.

These changes will apply to goods passing the taxing point after midnight tonight.

Safeguarding measures will protect the revenue against any last minute transactions that attempt to avoid tax liabilities arising from the changes. These measures are estimated to result in a net revenue gain of about $75 million in 1985-86 and about $110 million in a full year.

The estimated net effect of these changes in the CPI is very small at around 0.1 percentage points.

AUSTRALIA CARD

In order to combat tax evasion and reduce health and welfare fraud, the Government has decided to implement a national identification system involving the issue to individuals of a card - to be known as the Australia Card.

A companion system for entities such as companies and partnerships is also being developed.

Planning and development for the system will be completed over the next 18 months, and Australia Cards will be issued from March 1987.

The aim is to create an accurate register of all Australians which will contain only the most basic information, such as full name, address and date of birth.

It will assist the Government to verify records and payments - but it will do no more than that.

The privacy of every individual will be maintained.

People will need their Australia Card in only three situations - in connection with employment, conducting specified financial dealings and other matters with tax implications and when claiming Commonwealth benefits.

The Australia Card will help to ensure that everybody in the community contributes a fair share towards the costs of providing government services, and that no individual or group takes from the community more than their fair and equitable entitlements.

It is estimated that taxation revenue gains will amount to about $100 million in the first year of full operation of the system, expected to be 1989-90.

Revenue will rise to around $540 million per annum after the third full year of operation.

TAX-FREE THRESHOLD

The tax-free threshold is primarily intended to recognise the limited capacity to pay tax of low income earners who are required to support themselves for the whole of

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the year on that income.

In its present form the threshold provides an overly generous concession to part-year workers who are not wholly reliant for the full year on the taxable income returned.

The Government has decided that from 1 July 1986 the tax-free threshold will apply only on a pro-rata basis in the case of those taxpayers joining the Australian workforce on a full-time basis for the first time and to those leaving Australia permanently.

The full threshold will continue to apply to other taxpayers.

This measure is expected to yield around $90 million per annum from 1987-88.

PRESCRIBED PAYMENTS SYSTEM

Contrary to the alarmist claims made at the time of its introduction in 1983, the Prescribed Payments System has proved extremely successful in combating tax evasion by contractors and sub-contractors in the building, transport, motor vehicle repair and cleaning and other industries.

On the scheme's introduction, the 10 per cent deduction rate that currently applies to payments by the relevant industries was set on a conservative basis in order to facilitate its implementation.

Having reviewed the arrangements, the Government has decided to increase the deduction rate from 10 per cent to 15 per cent from 1 July 1986.

As at present, those with a responsible tax record may apply to have this rate lowered where appropriate.

This measure will assist in countering evasion by applying a higher withholding rate to those payees who provide false information on deduction forms.

Also from 1 July 1986, owner-builders are to comply with full prescribed payments system requirements by making deductions from payments in connection with construction projects in excess of $10,000 that begin after that date.

The Government proposes to further review the operation of the prescribed payments system, including the desirability of extension to other industries.

The net revenue gain from these changes is estimated at $105 million in 1986-87 and $45 million in subsequent years.

QUARTERLY PROVISIONAL TAX

The existing system for the collection of provisional tax places stress on the money markets due to the substantial seasonal withdrawal of liquidity from the financial system in each June quarter.

To overcome this problem the Government has decided to introduce an instalment system for the payment of provisional tax by individuals, to commence in 1987-88.

When fully implemented, four instalments will be payable.

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I emphasise that taxpayers will not be called upon to pay, in any financial year, a greater amount of tax than under the current system.

Self-assessment procedures will continue to ensure that taxpayers will not be required to pay an amount which exceeds their estimated net tax payable for the year.

The new system will not apply to taxpayers whose provisional tax liability does not exceed $2000 - such taxpayers will continue to pay provisional tax on an annual basis.

This will exclude about three quarters of a million provisional taxpayers, about half of the total.

An alternative pattern of instalment payments with later due dates will be available to taxpayers, such as some primary producers, whose income flow is concentrated in the second half of the financial year.

The reduction in sales of Government securities that will result from this measure is estimated to generate interest savings of the order of $55 million annually from 1987-88.

QUARANTINING OF FARM LOSSES

One of the most heavily used tax shelters set out in the draft White Paper is the write-off of farm losses against income from another source.

The manner in which the tax system is currently structured allows other than genuine farmers to generate significant tax gains by directing investment to what otherwise would often be considered unprofitable ventures.

The proposed measure is along the lines of that canvassed in the draft White Paper, but with significantly more generous treatm ent of non-farm income.

The new rules will commence in the 1986-87 income year.

There will be two approaches.

The first will allow farm losses to be fully written off against non-farm income of up to $15,000 with a dollar for dollar shade-out for non-farm incomes between $15,000 and $30,000.

These thresholds will be subject to indexation.

The second approach will allow farm losses to be written off against non-farm income up to the aggregate of the previous five years net farm income if this provides a greater write off.

This profitability test will cater appropriately for those cases where farm losses are caused by downturns and disasters, rather than tax sheltering activity.

Both approaches are designed to ensure that a genuine farmer who needs to take outside work to supplement farm income will in general not be adversely affected.

Revenue gains are estimated at $125 million in 1987-88 and $95 million annually thereafter.

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Partly offsetting these revenue gains will be a significant improvement in the primary production averaging provisions.

An additional $20 million per annum benefit to farmers will arise from a complementary increase in the notional farm income limit for primary production averaging purposes, from the current level of $5000 to the new level of $15,000.

This represents a significant increase in the amount of non-farm income which may benefit from the averaging provisions.

WATER CONSERVATION

The Government has decided to replace the immediate deduction currently allowed for expenditure by primary producers on conserving or conveying water with a write-off in equal instalments over 5 years.

The change will apply to expenditure incurred under contracts entered into after today.

Having regard to concerns expressed about land degradation problems, the Government has decided not to change the immediate 100 per cent deduction currently allowed for expenditure on soil conservation.

The revenue savings are estimated at $25 million in 1986-87 and $20 million in 1987-88.

FILMS

The very generous tax treatm ent granted to the Australian film industry has in recent years led to a burgeoning cost to the revenue and to accompanying doubts about whether this subsidy is returning value for money.

The cost has grown from $13 million in 1981-82 to $135 million anticipated this financial year.

Consequently the Government has decided that the concessional treatm ent currently provided for film investments will be reduced to a 120 per cent tax deduction and 20 per cent income tax exemption for income.

This will apply to investments made under contracts entered into after today.

The grant to the Special Production Fund administered by the Australian Film Commission is to be increased from $4 million to $6 million in 1985-86, and to $7 million in 1986-87.

The estimated net saving to revenue of the changes are around $35 million in both 1986-87 and 1987-88.

PETROLEUM AND AFFORESTATION COMPANIES

As canvassed in the draft White Paper, the Government has decided to withdraw from midnight tonight the special rebate and deduction available for certain capital subscribed to petroleum and afforestation companies.

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Revenue savings from these changes are estimated at $10 million for 1986-87 and $15 million for 1987-88.

INCOME TAX ON PUBLIC UNIT TRUSTS

The draft White Paper drew attention to the increasing use of trusts to avoid company tax.

Although the reforms to the company tax arrangements, which I shall mention shortly, will reduce the incentive to use trusts, there would still be advantages for tax-exempt institutional investors in the trust form.

The Government has therefore decided to extend company tax arrangements to public unit trusts but only those which operate a trade or business, as distinct from the great majority which are vehicles for investing in property, equities, or securities.

These latter public unit trusts, and all private trusts, will be unaffected by this measure.

The new arrangements will apply to trusts established after today to operate a trade or business.

There will be reasonable transitional arrangements to phase in the new treatment" for existing trusts of that kind, with first company tax payments not required before 1988-89.

FOREIGN TAX CREDIT SYSTEM

Under current arrangements the income of Australian residents from foreign sources is generally exempt from income tax if it has been subject to tax overseas.

That exemption applies, however, regardless of how little that foreign tax may be.

As a consequence the Government has decided to replace the existing arrangements with a general foreign tax credit system along the lines set out in the draft White Paper.

Under the proposed system the foreign source income of Australian residents will be taxed in Australia and a credit for foreign tax paid will be allowed against Australian tax payable on that income.

Salaries and wages will generally remain exempt in Australia if taxable in the source country.

The new system, which is similar to systems operated by the United States, the United Kingdom and West Germany, will apply to income derived from the beginning of the 1987-88 income year.

I stress that, in proceeding with this measure, the Government will, through appropriate measures, give recognition to the position of regional countries that provide tax incentives to attract legitimate investment from Australia and elsewhere as a means of fulfilling their development aspirations.

The direct gain to revenue is estimated at about $45 million per annum at 1984-85 levels of income, with the first revenue gains accruing in 1988-89.

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GOLD MINING

The draft White Paper proposal to tax income from gold mining has not been adopted.

An independent inquiry has been established to examine the impact of the White Paper proposal on the gold mining industry.

That inquiry will report to the Government during the first half of 1986.

TAXATION RELIEF

The measures I have announced will raise about $1.0 billion in 1986-87 and $1.7 billion in 1987-88.

As I stressed earlier the Government is engaged in a tax reform exercise, not a tax raising exercise.

Consequently, every dollar raised by these measures - and more - will be returned to taxpayers and social security beneficiaries by reform of the income tax rate scale and the company tax regime and by reductions in poverty traps.

I turn now to these proposals.

MINING

At present, excess deductions for exploration and development expenditure cannot be transferred to another company, even where the companies satisfy the 100 per cent common ownership test.

Mining companies therefore cannot take full advantage of the group loss provisions available to other companies.

As canvassed in the draft White Paper, the Government has decided to extend that opportunity to petroleum and general mining companies.

This will apply to excess deductions from exploration and development expenditures incurred in 1985-86 and subsequent income years.

The estimated revenue costs of this measure are $70 million in 1986-87 and $65 million in 1987-88.

The Government also proposes to freeze, until the 1986-87 Budget, the difference between the diesel fuel excise and the diesel fuel rebate for diesel fuel used in mining operations.

The rebate will be further reviewed in the context of the 1986-87 Budget.

IMPUTATION SYSTEM OF COMPANY TAX

It has long been a complaint of taxpayers that dividend income is effectively taxed twice - once as company profits and once as personal income.

A further problem has been that the company tax rate is less than the maximum personal marginal tax rate.

17

This has provided an advantage for some higher income earners who can avoid the higher marginal tax rate by establishing companies for tax sheltering.

While the existing tax system provides a positive incentive for some people to channel income through companies, it effectively discourages most investors from buying shares altogether.

For decades the pattern of investment by Australians has been distorted away from productive enterprise owing to the double taxation of dividends.

The Government believes the raising of equity for our continuing national development should be encouraged.

Accordingly, the Government has decided to proceed with a system of full imputation on company income distributed to resident individual shareholders.

To help defray the cost of this measure, the company tax rate will be increased from 46 per cent to 49 per cent.

However, there will still remain a significant net cost of about $250 million per year to Commonwealth revenue.

People receiving dividends will receive a credit when they determine their own personal tax liability.

Thus, for each $51 of dividends received, $100 will be included in the shareholder's assessable income, and a credit of $49 allowed against the taxpayer's assessed income tax bill.

For a taxpayer with a marginal tax rate of 49 per cent, this will effectively free the dividend from any tax.

Individuals facing lower marginal tax rates will be able to apply the excess credit to reduce their tax liability on non-dividend income.

The credit will not give rise to cash refunds where it exceeds tax otherwise payable.

Imputation credits will not extend to non-resident shareholders.

Because of the changes, some re-negotiation of Australia's double taxation treaties could be involved.

It is intended that the 49 per cent company tax rate first apply to company tax collections in 1987-88 - that is, relevant to company incomes for the 1986-87 income year - and that imputation credits first apply to dividends paid in 1987-88.

On the basis indicated, the annual cost to revenue of these measures could be approximately $250 million from 1988-89.

POVERTY TRAPS

As part of the reform package, the Government has recognised that certain social security arrangements presently provide little incentive for pensioners and beneficiaries to earn extra income.

18

Accordingly, the Government will take a number of steps to alleviate the problems caused by these poverty traps.

First, from 1 November 1986, the amount of private income that a pensioner may earn before his or her pension is reduced under the income test will be increased by $10 per week for single pensioners and by $20 per week for pensioner couples.

This increases the amount single pensioners can earn each week without affecting the pension from $30 to $40, and for couples, from $50 to $70.

As a result the pension payment received by all of the 450,000 recipients who currently receive a part-rate pension will increase by up to $5 per week.

Those pensioners earning in the range $30 to $40 per week may continue to face a small tax liability, but will no longer be subject to the 50 cents in the dollar income test as well.

Secondly, the Government will abolish the separate income test on rent assistance.

This test at the moment leads to the withdrawal of 50 cents in rent assistance for the first and each subsequent $1 of income earned.

The inclusion of rent assistance in the general income test will reduce the marginal rate of income withdrawal faced by some 700,000 pensioners and beneficiaries receiving rent assistance, in most cases from 50 per cent to zero.

A benefit of up to $15 per week will flow to some 300,000 pensioners with non-pension income in private rental accomodation.

Thirdly, the Government proposes to further assist pensioners with children.

At present, the weekly income a pensioner may earn without reduction of pension is increased by $6 for each child.

This allowance is to rise to $12 per child.

The measure will increase the pension of all part-rate pensioners with children by up to $3 per week for each child.

All three measures will be introduced from the first pension and benefit payday in November 1986 as the tax reform measures begin to take effect.

The effects of the three measures I have announced may be illustrated by the case of a supporting parent or pensioner with 2 children living in rental accommodation.

At present, if such a pensioner earned $100 a week of private income, the social security pension plus rent assistance is reduced by $44.

From November next year, this pensioner would lose only $18 in reduced benefits for a total gain of $26 a week.

The full year effect on outlays of the measures is estimated at about $215 million.

Net full year costs will be around $185 million as some part of the outlays will be clawed back in personal income tax in later years.

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THE INCOME TAX RATE SCALE

Mr Speaker, as I said at the outset, our major objective has been to substantially lighten the heavy weight of high marginal tax rates on honest taxpayers and to restore fairness to the operation of the taxation system.

That is what we set out to do.

With this reform package, that is what we will achieve.

The new tax schedules I will announce shortly have been framed with a number of factors in mind.

First, they represent the fulfilment of the Government's commitment to provide tax cuts from September 1986, equivalent to a 2 per cent wage increase, as part of its agreement with the Australian Council of Trade Unions for continued wage restraint.

In addition, the tax cuts take account of the distributional impact of the reform measures that I have outlined.

These impact most heavily upon higher income earners; that is, the reform measures are highly progressive.

While that, of itself, does not establish a case for providing greater relief at such income levels, I come back to the point that reductions in the higher marginal rates have been, and remain, a prime objective of tax reform.

It is the high rates of personal income tax that have provided a major incentive for people to avoid and evade their tax and which involve the most severe disincentive to work, save and invest.

But few of the people in the top bracket have paid the 60 cents in the dollar asked of them.

They have arranged their affairs to evade, avoid or minimise that liability.

Instead their share of the burden has been carried by ordinary middle income Australians.

It must clearly be understood that the measures I have announced today will impact most heavily upon high income avoiders and evaders - those people will very definitely be worse off because of the Government's actions.

At the same time, when this package is implemented the Government of the Commonwealth of Australia will no longer be seeking to collect in income tax more than half the income of any citizen.

Mr Speaker, the tax cuts that I will now detail have been timed to take effect as the extra revenue from our tax reform measures comes on stream.

On top of that, the Government fully recognises that the making of these tax cuts imposes very substantial constraints on future government spending proposals.

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The following changes will be made to the personal income tax rate scale from 1 September 1986:

. the tax free threshold will be increased from $4595 to $5100, and the $12,500 threshold will be increased to $12,600;

. the 25 per cent marginal rate will be reduced to 24 per cent;

. the 30 per cent marginal rate will be reduced to 29 per cent;

. the 46 per cent rate will be reduced to 43 per cent;

. the 48 per cent rate will be reduced to 46 per cent; and

. the 60 per cent rate will be reduced to 55 per cent.

From 1 July 1987, by which time the revenue yield of the income tax base broadening measures will have built up significantly, the Government will complete the reform of the scales by making further reductions in the higher marginal rates.

Specifically:

. the 43 and 46 per cent rates will be reduced to 40 per cent; and

. the 55 per cent rate will be reduced to 49 per cent.

With the alignment of the top personal tax rate and the company tax rate at 49 per cent from 1987-88, the special tax on excess profit retentions by private companies - the so-called Division 7 tax - will be unnecessary and will be removed.

Further details of these tax cuts, and their impact on various categories of taxpayers, are included in the Attachments.

CONCLUSION

Mr Speaker what I have announced today are far-reaching genuine, and substantial tax reforms.

They achieve the fundamental objectives we set ourselves at the outset of this ambitious endeavour, namely:

. to significantly reduce marginal tax rates;

. to curtail tax avoidance and evasion and restore fairness to the tax system; and

. to gear our tax system for economic growth by providing greater rewards for initiative, removing distorting shelters and ending the double taxation of dividends.

The Government's tax reform exercise is completed.

We will, however, continue to act where necessary to stamp out any avoidance and evasion practices that develop.

Furthermore, the package I have announced today commits the Government to unprecedented fiscal responsibility over the years ahead.

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Mr Speaker, in bringing down this package the Government has confronted the issue of tax reform.

We have been willing to consult with the people of Australia.

We have been willing to seriously and responsibly consider the issues involved.

And we have been willing to take hard decisions.

These decisions are essential to secure the future economic well-being of the Nation. They are essential if we are to recover respect and integrity for the taxation system. They are essential if all Australians are to be treated with fairness and with equity.

The Government is confident the people of Australia will recognise that these significant measures are taken in the best interests of the Nation and for the greater good of every individual Australian.

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ATTACHMENT A

ESTIMATES OF NET REVENUE

23

ESTIMATES OF NET REVENUE

The table attached provides estimates of net revenue in 1985-86 prices for each measure in 1986-87 and 1987-88. (Some measures involve changes to outlays rather than receipts, or a combination of both.) The estimates allow for collection lags and have been calculated on the basis of the new individual income tax rate scales to apply from 1 September 1986 and 1 July 1987 respectively, and allow for an increase

in the company tax rate to 49 per cent from 1 July 1986 (which will first affect collections in 1987-88).

The measures have been costed individually and cover tax payable by both individuals and companies. Implementing all measures in combination would boost the estimates for many of the individual income tax revenue components because a

significant proportion of taxpayers will be affected by more than one measure and this lifts them into higher marginal rate brackets. In aggregate the revenue from individuals could be about 20 per cent higher, boosting total net revenue in 1986-87 to $0.8 billion and $1.4 billion in 1987-88.

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NET REVENUE ESTIMATES (1985-86 PRICES) (a)

Measure Commencement

date

1986-87 $ million

1987-88 $ millioi

1. Australia card 1.7.89 -128 -83

2. Non-cash fringe benefits 3. Living-away-from-home

1.7.86 320 515

allowances 1.7.86 10 15

4. Entertainment expenses 20.9.85 310 330

5. Substantiation requirements 1.7.86 - 105

6. Capital gains tax 7. Rationalisation of wholesale 20.9.85 5

sales tax 20.9.85 110 110

8. Tax-free threshold 1.7.86 - 90

9. Prescribed payments system 1.7.86 105 45

10. Quarterly provisional tax 1.7.87 - 140

11. Quarantining of farm losses 12. Deductions for expenditure on conserving or conveying

1.7.86 105

water 20.9.85 25 20

13. Concessions for film industry 14. Petroleum and afforestation 20.9.85 35 35

rebates 20.9.85 10 15

15. Public unit trusts 20.9.85 5 5

16. Foreign tax credit system 17. Loss transfer for

1.7.87

petroleum expenditure 1.7.85 -70 -65

18. Imputation system 1.7.87 - -

19. Poverty traps 20. Concessional expenditure

1.11.86 -140 -195

rebate

21. Negative gearing of rental 1.7.85 60 63

properties

22. Depreciation on rented

18.7.85 55 100

residential accommodation T otal comprising: Increased revenue

Increased outlays

18.7.85 -2

705

976 271

“7

1348

1599 251

(a) Some measures involve changes to outlays rather than receipts, or combination of both. The follows: components for the relevant measures are

Measure 1986-87 1987-88

Revenue Outlays Revenue Outlays $m $m $m $m

Australia card 128 - 83

Quarterly provisional tax - - 90 -50

Films 38 3 38 3

Poverty traps - 140 20 215

Total 38 271 148 251

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·.

ATTACHMENTB

DETAILS OF MEASURES

27

1. AUSTRALIA CARD

The Government has decided to implement a national identification system involving the issue of a card (the Australia Card) to individuals as broadly outlined in the draft White Paper and other related material presented to the Taxation Summit. A companion numbering system for entities other than individuals, closely related to

the individual system, is also to be developed.

COMMENTARY

The proposed system utilising an Australia Card will be administered by the Health Insurance Commission making use of the network of Medicare offices. The Card will utilise a unique number and the holder's signature but will not include a photograph. The Commission will hold a central register of identification details for

individuals, eg full name, age, address. The integrity of the information held on the central register will be heavily dependent upon information currently held on State and Territory Registries of Births, Deaths and Marriages and the Prime Minister will therefore be writing to State Premiers and the Chief Minister of the Northern Territory to seek their co-operation in making available to the Commonwealth details held by the respective Registries.

A companion, yet separate, system will be introduced for the wide range of entities and other non-individuals liable to tax. These include corporations, trusts, partnerships, various clubs, associations, etc. This companion system is designed to prevent the leakage of revenue gains from individuals to entities and other

non-individuals.

Planning for and development of the system will be completed over the next 18 months and Australia Cards will be issued during the two years from March 1987. The issue of cards will be done in such a way as to involve a minimum of

inconvenience to all concerned. Because of the time necessary for the

establishment of the system and the issue of the Cards, taxation benefits will not commence until the 1989-90 financial year.

The March 1987 date is nine months later than originally envisaged. The delay arises mainly because the level of integrity of the original system, on which earlier estimates were based, is no longer considered adequate, especially for social welfare purposes. Achievement of the required level of integrity and safeguards for the system will result in some additional costs being incurred, but are essential if the

prospective revenue gains and other benefits are to be realised.

To guard against improper use of the Australia Card, legislation will be introduced to confine the use of the Card to the functions proposed at the Taxation Summit; that is, to assist in combatting tax evasion, to reduce the scope for abuse of the social security system and other government allowance and benefit programs, and to assist in identifying illegal immigrants and others in jobs that Australians are entitled to occupy. In the longer term the Card could be used to rationalise other government identification systems. No other uses will be permitted by law.

Except as precisely defined in the enabling legislation, the use of the Australia Card or number within the private sector, by Commonwealth agencies or by State authorities will be prohibited. In addition, the system will be subject to stringent safeguards to protect and maintain the civil liberties and privacy of individuals.

SUMMARY

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In particular, specific safeguards covering privacy and civil rights will be incorporated into the enabling legislation which will also be made subject to the Freedom of Information Act and the Government's forthcoming privacy legislation.

The Australia Card and its number will be used to aid in the identification of -(a) participants in certain financial transactions (eg opening and operating bank accounts and the like, payments of interest, distributions by unit trusts, disbursement of rent collected by estate agents, etc) and other specified

matters for taxation purposes;

(b) persons lawfully entitled to undertake work in Australia (for tax linkage purposes);

(c) persons entitled to Government allowances, benefits, pensions and other income support payments; and

(d) persons entitled to Medicare benefits.

Non-production of the Card or number for the purposes specified in the legislation will not alter a person's rights or entitlements to Commonwealth benefits or payments, subject only to that person being able to demonstrate sufficient proof of identity as would confer eligibility for the issue of the Card. However, failure to provide the Card for certain specified transactions, etc will attract economic sanctions. Depending on the specific transaction an appropriate sanction might be the application of a withholding tax at a very high rate or the forfeiting of

eligibility for a tax deduction. There may, however, be occasions where there is no appropriate economic sanction (examples could be the transfer of funds out of the country or the opening of a non-income producing bank account), and it may therefore be necessary to prohibit the conduct of some matters in the absence of

production of a Card.

The primary legislation governing the system will be introduced as a single package in the 1986 Autumn Sittings of Parliament. This legislation will provide the uses to which the Card can be put, with other relevant legislation such as the Income Tax Assessment Act, Social Services Act, etc being used as the vehicle to provide such

individual sanctions and/or prohibition as may be appropriate to the various transactions, etc involved. In this way, each proposed transaction, etc sanction and prohibition will be subjected to full Parliamentary scrutiny.

The Australia Card is designed to provide a substantially effective and long overdue means of ensuring that everybody in the community contributes a fair share towards the costs of providing Government services to the community. At the same time it will help ensure that no individual or group within the community takes from the community more than their fair and equitable entitlement.

In this context, increased taxation revenue arising out of a reduction in evasion is the major benefit to be derived from the system. The reduction in fraud against and abuse of other government programs, particularly those in the social security area, is also considered to be important, but it is not possible at this stage to estimate

with any degree of precision the savings involved.

The taxation benefits will flow from information reported to the Taxation Office making use of the Australia Card number. A requirement for Australia Card numbers to be recorded in respect of employees would ensure that those with 'second jobs' would be notified to the Taxation Office in a manner that could be

29

matched with their taxation record. The inclusion of the Card number with information reported to the Taxation Office in connection with interest payments will permit effective matching of reported information with taxpayer records.

In the case of business taxpayers, better audit case selection is expected to achieve an increase of 12 percentage points in productive cases over three years when the revenue yield would be around $20 million per annum. Time taken on audit cases could be reduced by about 12 per cent, while non-lodgers of tax returns liable to pay tax would be more readily detected and traced. There would be a greater likelihood of errant taxpayers being detected, thus convincing some of them to file more accurate returns. This deterrent effect is estimated to provide revenue gains of $105 million in 1989-90. An additional field of audit cases not disclosed by present case selection methods is expected to emerge. The increased revenue yield is conservatively estimated at about $200 million after three years and would recur annually. There would be some beneficial impact on evasion in the corporate sector,

with an additional revenue yield of perhaps $25 million annually.

These possibilities produce the following prospective revenue gains:

1989-90 $m

1990-91 $m

1991-92 $m

1992-93 $m

Salary and Wages 35 50 50 50

Dividends and Interest 35 100 160 160

Business Taxpayers . Better audit case selection 5 10 20

. Reduction in time per case 5 10 20

. Non-lodgers 35 70 70 70

. Increased range of cases _ 65 130 195

. Corporations - 15 25 25

— -------- — ------------ —

Total 105 310 455 540

The expected revenue gains are lower than the $800 million originally envisaged as a result of the non-inclusion of a photograph on the Card and also because the estimated gains are now based on the proposed new rate scales.

The implementation of information reporting arrangements using the Australian Card will be synchronised with the already approved increase in audit coverage to 2 per cent of non-salary and wage taxpayers by 1992. That 2 per cent coverage target is based on annual increases of 0.25 per cent in the rate of coverage. For 1985-86, the rate of coverage has been set at 0.75 per cent, leaving a further coverage of

1.25 per cent to be achieved by 1992. A large part of the staff resources needed to achieve these increases in coverage will be released for compliance work by the introduction of a self-assessment system for processing income tax returns in the Taxation Office, the first stage of which is to commence in the 1986-87 year.

The information reporting arrangements associated with the system will require employers, financial institutions and others to adjust records and relevant computer programs and systems to show the Card number on documents such as group certificates and interest lists provided to the Taxation Office. It is not expected that this will impose an undue burden on the business sector particularly when

30

compared to that which would be involved under alternative approaches to deal with evasion, such as an extension of withholding arrangements. Moreover, to the extent that tax evasion is reduced, the great bulk of honest taxpayers in the business sector and the community generally will benefit through a reduction in their overall tax

burden.

It should be emphasised that if the Australia Card proposal were not to be implemented, other control measures would have to be designed and introduced to counter tax evasion, although they would be less effective than the proposed identity system.

Extension of withholding tax source arrangements is not considered to be a practical alternative to introduction of the Australia Card because such arrangements could only apply to a limited range of transactions. For example, any attem pt to apply such a system to business income (excluding that which is of a kind which can be

made subject to the prescribed payments system) would, from a practical and administrative point of view, be unworkable. There would also be severe practical constraints standing in the way of extending withholding arrangements to rental income - because rents are usually subject to substantial but variable offsetting

costs (such as interest, repairs, rates, management and collection expenses), no single withholding tax rate could be selected that would be appropriate for most cases. Accordingly, since withholding tax could only effectively operate in relation to certain unearned income, it would not achieve the substantial revenue benefits

estimated for the proposed system.

As noted earlier, the use of withholding arrangements may in some situations provide an appropriate sanction for non-use of the Australia Card.

REVENUE

It is expected that revenue gains in the taxation area would be $105 million in the first year (1989-90) of full operation of the system rising to around $540 million per annum after the third year of operation. Total establishment costs for the system are expected to be $127 million; annual operating costs are expected to average

around $86 million per annum for the seven years up to 1992-93 stabilising at around something under $100 million per annum thereafter.

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2. NON-CASH FRINGE BENEFITS

A separate tax is to be imposed on employers in respect of the total taxable value of non-cash fringe benefits provided to employees (or associates). All employers (with the exception of religious institutions) will be liable for the tax, including those not subject to income tax such as Commonwealth and State governments and their agencies, local government bodies and charitable institutions. The rate of tax to be charged will be the prevailing company tax rate (initially 46 per cent) and tax paid

will not be allowed as a deductible expense to the employer. The tax will commence on 1 July 1986 and a quarterly basis of payment will be adopted with the first payment due and payable in October 1986.

Measures are to be taken to equate, as closely as possible, the treatment of non-cash fringe benefits for Commonwealth public servants with that which is likely to apply to their counterparts in the private sector. In addition, the Government has decided that Commonwealth financed provision of credit cards to senior public servants is to cease forthwith; existing cards will not be renewed. The private use of Commonwealth-owned cars by employees is to be stringently controlled. Rentals and call charges associated with telephones of employees of the Commonwealth and

its statutory authorities presently funded wholly or partly by the Commonwealth will be apportioned between the Commonwealth and the employees in a similar manner to that allowed by the Taxation Office for the purpose of determining the - business element of such expenses paid by private sector employers.

DESCRIPTION

The types of benefits to be taxed include: employer-provided cars; free or low interest loans; free or subsidised residential accommodation; free or subsidised board; goods and services sold at a discount or provided free by an employer; and expenses paid on behalf of an employee. The tax will not apply to benefits associated with employer contributions to superannuation funds and employee share acquisition schemes, which are already subject to specific taxation provisions.

COMMENTARY

While the precise details of the range of benefits to be taxed and the valuation rules will be enunciated when the enabling legislation is presented, the proposed valuation rules for the major kinds of non-cash fringe benefits will be broadly as follows.

Employer-provided Cars

The motor vehicle valuation rules will apply to any employer-provided motor vehicle (ie a passenger car, station wagon, mini-bus, panel van, utility or other commercial vehicle with a designed load capacity of less than 1 tonne or 9 passengers) that is used by an employee for private purposes. An exemption will, however, be granted

for taxis, panel vans, utilities and other commercial vehicles (but not normal passenger cars, station wagons or mini-buses) where private use of such a vehicle is restricted to home to work travel and other private use which is incidental to the business use of the vehicle.

Employers will be given a choice of two methods for calculating the taxable value of the benefit from private use of a vehicle. The first method will value the benefit as the private usage proportion of the costs incurred by the employer in operating the vehicle while the second method will value the benefit by reference to a statutory formula.

SUMMARY

32

Where an employer chooses to use the first method, the taxable value of the benefit will be equal to the private usage proportion of total annual vehicle costs, less any amount paid by the employee for his or her private use of the vehicle. Total vehicle costs will include registration, insurance and running costs plus, for a leased vehicle,

the cost of leasing the vehicle or, in the case of an employer-owned vehicle, the equivalent cost (ie depreciation and imputed interest representing the opportunity cost of investment in the vehicle). The private usage proportion will be equal to the ratio of kilometres driven for private purposes (including travel to and from work) to

total kilometres driven. Log books will need to be maintained for the vehicle to substantiate business usage of the vehicle.

Under the second method, no substantiation records of business and private use need be maintained. The annual taxable value of a vehicle will be a specified percentage of the original purchase cost of the vehicle to the employer (or, in the case of a leased vehicle, its market value at the time the lease commenced), the percentage depending on total kilometres (private plus business) travelled in the tax year.

The following table sets out the percentages that will apply:

Total Kilometres Taxable Value as %

of Original Cost to Employer

Tax Payable as % of Original Cost to Employer

Less than 25,000 24 11.0

25,000 to 40,000 16 7.4

More than 40,000 8 3.7

For example, if a car costing $10,000 travelled 35,000 kilometres in the 1986-87 year, the tax in respect of that year would be 46 per cent^jpf $1,600 = $736. The taxable value will be reduced by any contribution the employee makes to either standing or running costs, including both reimbursements to the employer, such as

payment of a lease fee, and actual costs (eg petrol) borne directly by the employee.

Free or Low Interest Loans

The taxable value of a free or low interest loan will generally be equal to the difference between interest accruing at a prescribed interest rate and interest accruing at the actual interest rate, if any, charged. A single prescribed rate will apply to all types of loans and will be set annually prior to the commencement of

the tax year to which it applies. The prescribed rate will be based on the lowest rate charged for arm's length housing loans by the Commonwealth Savings Bank. For fixed interest loans granted prior to the date of introduction of the tax on non-cash fringe benefits, the taxable value of the benefit will be set at the

difference between interest accruing at the Commonwealth Savings Bank housing loan rate prevailing when the loan was granted, and interest accruing at the actual interest rate charged, if this is to the advantage of the taxpayer.

R esidential Accom m odation

The taxable value of employer-provided residential accommodation will generally be equal to the market rental value of the accommodation less any rent or charge paid by the employee. Where there is insufficient evidence of market rental value, the benefit will be valued at such amount as the Commissioner of Taxation determines

is fair and reasonable. That is, the Commissioner would be required to determine an amount that approximates as closely as possible a fair market value.

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For employer-provided housing that qualifies for the existing remote area housing concession, the taxable value will be based on two-thirds of market rental value (less any rent paid by the employee).

The accommodation valuation rule will apply to houses, flats and other forms of residential accommodation.

The market rental value or the value set by the Commissioner will generally be ascertained for the first period to which the tax applies and be indexed annually in line with movements in the rent component of the consumer price index.

Where residential accommodation is provided to an employee who is living away from his or her usual place of abode, the benefit will be exempt. The same treatment will apply to a benefit provided in similar circumstances by way of a cash living-away-from-home allowance.

Existing provisions of the income tax law dealing with subsidised housing (sections 26AAAA and 26AAAB) will be repealed.

Board

The taxable value of board provided to an employee (and/or family) will be equal to a fixed amount per meal per person less any contribution by the employee.

Goods and Services Sold or Provided by an Employer as Part o f his or her Business

In many industries, goods and services sold or provided by an employer as part of his or her business are provided to an employee free or at a discount. As canvassed in the draft White Paper, generous valuation rules will apply to these benefits. The proposed valuation rules will mean that most traditional staff discounts will not

attract tax.

Where the good provided free or at a discount to an employee was purchased by the employer, the taxable value will be equal to the amount, if any, by which the cost to the employer exceeds the price charged to the employee. Where the good was

manufactured, produced or processed by the employer, the taxable value will be equal to the amount, if any, by which the lowest price charged by the employer to purchasers at arm's length (whether to wholesalers, retailers or the public) exceeds

the price charged to the employee.

The taxable value of services will be the amount, if any, by which 75 per cent of the price charged by the employer for providing equivalent services in an arm's length transaction exceeds the price charged to the employee.

There will be exemptions for:

- free or discounted commuter transportation services provided by transport bodies for their staff;

- free or discounted goods provided and enjoyed on the employer's premises (eg, free drinks to brewery workers); and

- the first $200 per annum of the aggregate taxable value of free or discounted goods and services provided to an employee.

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Other Goods and Services

Any good or service not covered by one of the previous categories may potentially be provided by an employer to an employee as a fringe benefit. Such benefits may occur, for example, where a company credit card or charge account is used to pay for goods and services provided to an employee in respect of holidays or private

travelling expenses. Another form of benefit occurs where an employer purchases goods or pays for services which are provided to employees by way of gifts or prizes.

Where, as in the above examples, the good or service is purchased or paid for by the employer, the taxable value will generally be set equal to the amount paid by the employer for the good or service less any contribution by the employee. The taxable value will be reduced to the extent that a deduction would have been allowable to

the employee for income tax purposes if he or she had paid for the good or service (eg protective clothing).

To the extent that the cost of a good or service is not deductible to the employer (eg fees paid to social and sporting clubs are non-deductible under existing legislation and entertainment costs will become non-deductible under another measure proposed in the tax reform package), it will be exempted from fringe

benefits tax except in the case of public sector and other bodies exempt from income tax.

Where free or subsidised travel is provided to employees in remote areas under the terms of an award or employment agreement, the taxable value will generally be equal to 50 per cent of the cost of the travel less any contribution by the employee.

Some employers perform or supply services for employees of a kind that are not supplied to customers in the normal course of business. Further consideration will be given to the appropriate treatm ent of such services. However, the provision of in-house child care facilities for the dependants of employees will not be taxed.

Meals provided on work premises - through canteens, cafeterias, dining rooms and the like - will also be exempted. However, should there be a significant move towards the provision of this form of benefit, the Government will consider taking action to bring the benefit to tax.

Expenses Paid on Behalf o f an Em ployee

Instead of providing an employee with goods or services, an employer may pay for expenditure incurred by an employee in respect of the purchase of goods or services. In some cases, the employer makes the payment directly to the payee. In other cases, the employee pays the account in the first instance and is reimbursed

by the employer. A common example of this form of benefit is the payment of an employee's telephone account. Other examples are the payment of an employee’s accounts in respect of rent, electricity, etc, rates, medical services, health fund contributions and school fees for the employee's children.

The taxable value will be set equal to the amount of the payment (or

reimbursement) by the employer but be reduced to the extent that the payment would have been deductible to the employee for income tax purposes if he or she had made it.

To the extent that the payment is not deductible to the employer (eg entertainment costs and social and sporting club fees), it will be exempted, except in the case of public sector and other bodies exempt from income tax.

REVENUE

With a commencement date of 1 July 1986 and a quarterly basis of payment, the revenue gain is estimated at $320 million for 1986-87 and $515 million in 1987-88. 35

3. LIVING-AWAY-FROM-HOME ALLOWANCES

The Government has decided to tax certain living-away-from-home allowances at the employer level in the same way as non-cash fringe benefits, with effect from 1 July 1986. The taxable value for this purpose will be equal to the amount of the allowance less that proportion which represents reasonable compensation for additional expenditure on accommodation and net additional expenditure on food.

COMMENTARY

The background to the current special deduction available to any employee in receipt of a living-away-from-home allowance, and its shortcomings, were described in the draft White Paper. There the suggestion was also made that additional living

expenses associated usually with difficult and remote locations should be borne by the employer who derives the direct benefit from employees' services, rather than by the community as a whole through the tax system.

The proposed measure will mean that an employer who pays a living-away from-home allowance will only be liable for tax on that part (if any) of the allowance that does not represent reasonable compensation for additional expenditure on accommodation and net additional expenditure on food. That is, a

tax liability will arise where the allowance compensates for other living expenses or is set at a level in excess of reasonable compensation.

In some cases, an employer provides an employee living away from home with non-cash benefits (for example, free board and quarters) rather than a cash allowance. Such benefits fall within the scope of the tax on non-cash fringe benefits and the valuation rules for these benefits will be consistent with the taxation arrangements for cash living-away-from- home allowances.

With regard to accommodation, the employer will be exempt on any non-cash benefit provided to an employee living away from home that takes the form of either the provision of residential, accommodation or the payment or reimbursement of an expense incurred by the employee by way of rent or other consideration for

the right to occupy residential accommodation.

Where free board is provided to an employee, the taxable value of the non-cash benefit will be equal to the probable saving in food expenses because of his or her absence from home.

REVENUE

The revenue gain is estimated at $10 million in 1986-87 and $15 million in subsequent years.

SUMM ARY

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4. ENTERTAINMENT EXPENSES

The Government has decided, as foreshadowed in the draft White Paper, to amend the income tax law to deny deductions for all entertainment expenses incurred after 19 September 1985.

COMMENTARY

There has been understandable public criticism of the availability of tax deductions for business executives and others which effectively subsidise their entertainment costs. A good deal of claimed business entertainment is done on a reciprocal basis and as much for social and personal benefit as for business purposes. The so-called

business lunch has lowered public confidence in the fairness of the tax system.

The Government can no longer allow the general body of taxpayers to subsidise the largely social activities of people - usually well-off people - through deductions for entertainment expenses. The only effective way of preventing tax deductions for essentially private entertainment that is claimed to have a business purpose is to

disallow deductions for entertainment altogether. It is recognised that this will mean that, in a number of cases, deductions will be denied for genuine business expenses. There is, however, no practical alternative to disallowance across the board if effective action is to be taken to stop abuse in this area.

Legislation will be introduced to disallow deductions for all entertainment expenses incurred after 19 September 1985. Disallowance will apply to entertainment provided to such persons as customers, clients, suppliers, employees and business or work associates. By way of illustration, some common forms of entertainment are

business meals, drinks, dinners, cocktail parties, staff social functions, and so on. Disallowance will extend also to expenses incurred in providing entertainment, such as tickets or boxes to sporting or theatrical events and sightseeing, and to the payment of hostess allowances to spouses of executives. It will also extend to

entertainment having some advertising element such as refreshments provided to persons invited to attend such events as film premieres or product launches.

The cost of a person's own meals while travelling on business away from home is not, of course, regarded as an entertainment expense.

The deduction for business entertainment will be denied to the person who meets the cost of the entertainment. In most cases this will mean disallowing deductions to employers and self-employed persons; disallowance will extend both to entertainment which a firm pays for directly and to expenditure which is incurred on

behalf of the firm by a director or employee and then reimbursed.

Where the cost of entertainment is borne by a director, officeholder or employee, the expenditure will be disallowed as a deduction in computing his or her taxable income. Where an entertainment allowance, expenses of office allowance or similar allowance is paid by an employer to an employee, the amount of that allowance will

continue to be included in the employee's assessable income but the employee will not be entitled to claim a deduction for any entertainment expenses paid for from the allowance. The employer will remain entitled to claim a deduction for the amount of the allowance paid to the employee.

While the measure will cover entertainment expenses of all taxpayers, whether self-employed, a private or public sector employee or a taxable private or public

SUMMARY

37

sector employer, it cannot have application to a tax-exempt employer. Where such an employer pays entertainment expenses which confer a personal benefit on its employees or reimburses employees for such expenses, the entertainment expenses will be subject to the tax on non-cash fringe benefits.

REVENUE

Revenue gains are estimated at $310 million in 1986-87 and $330 million in 1987-88.

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5. SUBSTANTIATION

The Government has decided to amend the income tax law to provide that, with certain exceptions, deductions will not be allowable for employment-related expense claims by employees unless the claimant is able to substantiate the quantum and purpose of the expenditure by receipts or other documentary evidence. Claims for

car and travel expenses by non-employees will also be subject to substantiation requirements. The rules will apply to expenses incurred on or after 1 July 1986.

COMMENTARY

A deficiency in the existing law is that it does not specify what proof is required to substantiate employment-related expenditure claims. This has resulted in taxpayers making claims that cannot be proved by documentary evidence. Excessive claims for employment-related expenses is a signficant area of tax evasion. To rectify this

situation, legislative substantiation requirements will be introduced.

Expenses Subject to Substantiation Rules

If legislative substantiation requirements were applied to all employment-related expenditure claims, the compliance costs imposed on taxpayers might be regarded as being unnecessarily high. Reflecting this consideration, the draft White Paper canvassed the suggestion that, in relation to independently arbitrated allowances,

substantiation rules apply only for claims for expenses in excess of such an allowance. However, the Government has concluded that such an exclusion would afford employees too much latitude to benefit from such allowances and would encourage their proliferation. Accordingly, virtually all independently arbitrated

allowances - including parliamentarians' electorate allowances - will be subject to the general substantiation requirements.

The substantiation requirements applicable to employees will, however, be subject to two exclusions.

The first exclusion relates to certain types of specific purpose allowances. The general substantiation rules will not apply to claims within the limits of allowances that are made specifically for the purpose of enabling an employee (or officeholder) to meet the costs of accommodation and meals whilst travelling away from home in

carrying out duties for the employer, provided that the travel is undertaken in Australia and the allowance is reasonable in amount. Similarly, reasonable overtime meal allowances will be excluded from the substantiation requirements.

The second exclusion will provide a threshold below which substantiation rules will not apply. Where annual claims for aggregate employment-related expenses (other than expenses relating to domestic travelling allowances and overtime meal allowances) do not exceed $300 the substantiation rules will not apply. That is, such

claims could be established under the terms of the present law by means other than documentary evidence. However, aggregate claims over $300 will only be allowable if the full amount of the claim can be substantiated by documentary evidence.

Substantiation Rules

The general rule will be that an expense will be regarded as substantiated only where a taxpayer is able to produce a receipt, invoice or other documentary evidence that shows the amount, date and essential character of the expense.

SUMMAR Y

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More detailed substantiation requirements will generally apply in relation to car and travel expenses to assist in restricting deductions to the business element of such expenses.

For car expenses, taxpayers will normally be required to substantiate the extent to which the car is used for business purposes by maintaining daily log books or similar records in which details of business trips are recorded. However, individuals will be relieved from substantiation requirements if, having regard to the occupation or business of the taxpayer and other relevant circumstances, the Commissioner of Taxation is satisfied that their annual business mileage is generally in excess of

5,000 kilometres per annum. In these circumstances, the taxpayer may claim a deduction equal to one-third of the annual vehicle costs or, alternatively, a deduction equal to 12 per cent of the purchase price of the motor vehicle (subject to

the limits on the cost of cars for depreciation purposes). Where claimed business mileage does not exceed 5,000 kilometres and is based on detailed and reasonable estimates of business use, deductions based on standard mileage rates will be allowable in the absence of substantiation. These rules will provide some limited scope for claiming deductions without substantiation but are designed so as not to open up an avenue for abuse.

For travel expenses, taxpayers will be required to substantiate the business purpose of overseas travel and extended domestic travel by maintaining adequate contemporaneous records (eg a diary) of the business activities conducted during the trip.

Deductions will not be allowed for travelling expenses in respect of a spouse who accompanies an employee or self-employed person on a business trip. Where a public sector or other tax-exempt employer meets the costs of a spouse

accompanying an employee or officeholder on an official trip, it is intended that the expense be subject to the tax on non-cash fringe benefits.

REVENUE

Revenue gains from this measure are expected to build up to $200 million after about four years. With a 1 July 1986 commencement date, the estimated revenue in 1987-88 is $105 million.

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6. CAPITAL GAINS TAX

Real capital gains represent an increase in an asset-owner's purchasing power that should be included in a comprehensive definition of income for tax purposes. The current system of taxing capital gains violates horizontal equity, since it favours those who receive income in the form of capital gains, and undermines the

progressivity of the tax system since the distribution of the ownership of capital is skewed in favour of higher income groups. Other defects identified in the draft White Paper were the distortion of investment decisions in favour of assets yielding capital gains and the scope for tax avoidance by conversion of income into capital

gains.

The Government proposes to introduce a capital gains tax along the lines of the draft White Paper proposal but modified in several substantial respects to take account of community concerns. The main design features of the proposed capital gains tax are that it will:

. apply only to real gains made on assets acquired after midnight tonight; and

. apply upon realisation of assets;

. apply to gains calculated by indexing the asset cost base. This means that an asset which increases in value at no more than the rate of inflation bears no capital gains tax, while assets whose value increases at greater than the rate of inflation are only taxed on that part of the gain which is in excess of the

inflation rate (see examples below);

. be levied at ordinary rates of personal and company income tax;

. allow realised nominal losses to be offset against capital gains realised in the current year or be carried forward and offset against gains in subsequent years but, except for specified items, not allow a deduction for losses on personal-use items. Losses on those specified personal-use items which are allowable would

be deductible only against realised gains on other specified personal-use items;

. treat disposal of assets by gift as realisation, with the recipient being taken to receive the gift at its fair market value;

. not treat the death of the asset-holder as giving rise to a deemed realisation of his or her assets. Capital gains tax will not be levied following the death of a taxpayer unless his or her assets are actually realised by the administrator of the deceased estate or disposed of by a beneficiary of the estate. In the case of assets acquired by the deceased on or before 19 September, the administrator

or the beneficiary will be taken to have received the asset at fair market value. In the case of assets acquired by the deceased after 19 September, a rollover will apply - that is, as a general rule, the administrator or the

beneficiary will be taken to have acquired the asset at a value equal to the deceased's asset cost base at the time of death.

. exempt gains on a taxpayer's principal residence and reasonable curtilage;

. exempt gains with respect to superannuation and the proceeds of life insurance policies, gains on the disposal of motor vehicles and gains on other personal-use assets (such as furniture) whose disposal value in the year is below $5,000;

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. allow rollovers (ie deferral of capital gains tax liability) in cases of

compensation for compulsory acquisition of assets and stolen or destroyed property, provided replacement assets are acquired within a stipulated period, and for asset ownership changes associated with certain types of business re-organisations;

. permit income losses (except those subject to quarantining provisions) to be offset against realised capital gains, either in the year in which the loss occurs or to be carried forward (unindexed and subject to the usual seven year limitation) for offset against future realised capital gains. Negative gearing losses and primary production losses subject to quarantining provisions (which

are not subject to the seven year limitation on carry forward) will be allowed as an offset against any realised capital gain from relevant rental or farm properties;

. an existing provision taxing certain gains as ordinary income, section 25A, is to be abolished in respect of assets acquired after midnight tonight; and

. bodies currently exempt from tax on their income are to be exempt from tax on their capital gains;

In general, any capital expenditures associated with the purchase, improvement or disposal of an asset subject to capital gains tax may be included in the cost base of that asset. More specifically, the following types of expenditure may be included in the asset cost base:

. expenditure on capital assets such as plant and equipment and associated capital improvements which attract income tax deductions together with balancing adjustments at the time of sale;

. expenditure on income-producing buildings and other capital expenditures such as soil conservation and water conservation, which attract income tax deductions but no balancing adjustment on sale. (The implications of such expenditures on the allowance of capital losses in respect of the associated composite asset are yet to be resolved.);

. capital expenditure which attracts no income tax deductions (for example, the c'earing of land for primary production purposes);

. valuation costs and costs of acquisition and disposal such as legal costs, stamp duty and agent's commission, to the extent that these are not deductible for income tax purposes; and

. the purchase price of shares in licensed management and investment companies (MICs).

As a general rule, annual expenses such as repairs and interest payments whether for business or non-business purposes will be excluded from the asset cost base for capital gains purposes.

For capital assets and associated improvements, nominal losses on which are already allowed for income tax purposes through the operation of balancing adjustments on disposal, nominal losses will not also be allowed for capital gains purposes. Losses on the sale of MIC shares will not be allowed for capital gains purposes. The existing "claw-back" arrangements applicable to MIC shares under the income tax law will continue to apply.

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The "coupon" depreciation provisions for income-producing buildings will be retained, but further consideration is to be given to the treatm ent of nominal capital losses in respect of such buildings.

The indexation provisions of the capital gains tax will apply, not only to the original cost of the asset, but also to other allowable expenditures taken into account in the calculation of the asset cost base.

The restriction of the tax to assets acquired after today, the decision not to deem realisation at death, the exemption for the principal residence and reasonable curtilage, the concessional treatment of personal-use assets including motor vehicles and the taxation of only real capital gains mean that, for most taxpayers,

the capital gains tax will have little or no impact. The restriction of the tax to real gains only will ensure that only increases in the taxpayer's real ability to purchase goods and services will be taxed.

Taxpayers such as farmers and small businessmen who have traditionally expressed concern that a capital gains tax would be unduly harsh and lead to the break-up or sale of the family farm or business upon their death have no cause for concern. The combination of a very generous provision limiting the tax to assets acquired after

today, the tax-free transfer of assets upon the death of a taxpayer, and indexing fully for inflation means that there will be no tax liability for existing farmers and small businessmen in respect of their existing asset holdings, while the vast majority of those who acquire farms or small businesses after the introduction of the tax are

unlikely to face a substantial liability were they to either sell or give away their assets. The exemption of reasonable curtilage associated with the principal residence will further assist those farmers who acquire their assets after today. Together these design features will minimize any unfair impact of the capital gains

tax upon farmers, small businessmen or any other sections of the community.

REVENUE

Since the tax will apply only to capital gains on assets acquired after today, revenue in the early years will be small and build up only gradually. It is estimated that the capital gains tax could generate tax liabilities of around $25 million in the fifth year of operation.

DETAILS OF THE TAX'S OPERATION

Further details of the proposed operation of the tax follow. The Government proposes to provide additional information concerning some design details that remain to be settled. These include, in addition to those referred to in other parts of this attachment, the application of the tax to gains on Australian assets held by

non-residents; the taxation treatm ent of gains on foreign assets held by Australian residents; the treatm ent of foreign exchange gains and losses; the scope of the asset roll-overs allowed in respect of certain types of business reorganisations; the treatm ent of leases; and the nature of anti-avoidance provisions.

COMMENCEMENT

The capital gains tax will apply only to gains on assets acquired after midnight on 19 September 1985. Acquisition includes purchase, construction and transfer by way of gift or inheritance.

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Buildings, the construction of which commenced on or before today, will be exempt from the capital gains tax. Where construction of a building commences after today any gain related to the associated land will be exempt from capital gains tax if the land was acquired on or before today. Any real gain relating to the building will be subject to capital gains tax.

Application of the tax to major capital improvements effected after today, to assets acquired on or before today, will be subject to further consideration.

Principal Residence Exemption

The broad purpose of the exemption for owner-occupied principal residences is to free from capital gains tax a housing unit which is owned by the taxpayer and ordinarily inhabited by him as his principal residence. Where a family ordinarily inhabit a common housing unit, it is not intended to allow each of those individual family members to claim exemption for a principal residence (eg the spouse will not be able to claim a family holiday home as a principal residence).

The Principal Residence

In order for a taxpayer to claim that a housing unit qualifies for exemption, it must be owned by the taxpayer and the taxpayer must designate it as his principal residence.

A 'housing unit' is proposed to include a house, apartment in a duplex or apartment building, a strata title, a cottage, a mobile home, caravan or houseboat. It could also include a share of the capital stock of a housing cooperative.

A housing unit owned by a taxpayer will generally qualify as the principal residence provided it is "ordinarily inhabited" by the taxpayer. The term "ordinarily inhabited" will be defined to ensure that, generally, at any one time a taxpayer can ordinarily inhabit only one principal residence. The intention is to permit absences such as vacations and temporary employment in other locations.

Special rules will be developed to cover the situations of individuals transferred for lengthy periods to some other locality as a result of their employment (eg defence personnel, teachers, diplomats, politicians), and for those who live in holiday houses for varying periods of time. It is proposed that a taxpayer may elect that a housing

unit, notwithstanding that it is not ordinarily inhabited by the taxpayer or his family, may continue to be treated as his principal residence, up to some maximum period. This would cater for those who vacated their principal residence to pursue employment or studies in another locality for several years.

Included in the principal residence exemption will be a basic exemption for a reasonable curtilage associated with the principal residence.

Mixed Use

Property used partly as a principal residence and partly for some other purpose (eg a small business with the owners living in the Hat above or a house with several rooms given over to a doctor's surgery) presents an administrative problem of determining the appropriate proportion of the gain on sale of the property eligible for exemption as a principal residence.

It is proposed to apportion values to both the residence component and the total property to determine the exempt portion of any gain.

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Treatm ent o f Breaks in Principal R esidence Status

Where the taxpayer sells a home that has qualified as a principal residence during the taxpayer's ownership, the whole gain over that period would be exempt from tax. If the home were designated as the principal residence for only part of the

period, the taxpayer would be required to apportion the gain between the periods where the residence had exempt status and when it did not. The exempt portion of the gain would be determined by applying the ratio of the period for which the housing unit was designated as the principal residence to the total period that the

taxpayer owned the property. Provision will be made to preserve the exemption where, for a short period at the time of changing homes, two residences are owned.

It is proposed that the period of ownership of a block of land on which a principal residence is subsequently constructed be recognised for purposes of the principal residence exemption in certain circumstances, subject to appropriate anti-avoidance safeguards.

Ownership through Trusts or Companies

Where a family trust or private company owns a housing unit lived in by a beneficiary or trustee of the trust or a shareholder of the private company, the Government has decided not to allow an exemption. Trusts and private companies are entities separate from their shareholders, trustees or beneficiaries and such

ownership arrangements may be motivated by tax avoidance considerations. It would, however, be open to affected taxpayers to rearrange their affairs to qualify for the exemption. The principal residence exemption will be available, however, in the case of a trustee of a deceased estate where the spouse of the deceased is

entitled to, and is occupying, the principal residence of the deceased.

D efinition o f 'Fam ily Unit'

To avoid a family claiming more than one principal residence at any one time, it is proposed that only one principal residence exemption will be available for each family. A "family" for this purpose will be defined as the taxpayer, his legal or de facto spouse (excluding a spouse who is ordinarily living apart from the taxpayer and

is separated according to a judicial separation or written separation agreement) and dependent children.

Future o f Existing Provisions

As proposed in the draft White Paper, where a realised capital gain would already be subject to tax under an existing provision of the Income Tax Assessment Act and could also become subject to tax under the general capital gains tax, the existing provision is to take precedence. The draft White Paper left the future of the

existing sections 25A and 26AAA to be determined in the light of the design features decided upon for the proposed capital gains tax.

Section 25A operates to tax as ordinary income gains arising from the sale of property acquired for the purpose of profit-making by sale or from the carrying on or carrying out of any profit-making undertaking or scheme. Section 26AAA applies to tax, as ordinary income, certain gains derived within a 12 month period from

property sales. Some $30 million of tax revenue was raised from individuals taxed under either section 26(a) (now section 25A) or section 26AAA in 1982-83.

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In the Light of its decision to restrict the capital gains tax to assets acquired after today, the Government has decided to abolish section 25A for assets acquired after midnight tonight.

The Government has decided to retain section 26AAA in its present form. The provision deals with short-term gains that can be viewed as similar to other forms of income and does not involve any problem of uncertainty of application.

The Government has also decided that assets disposed of within 12 months of acquisition which are not subject to section 26AAA and fall for treatment under the capital gains tax will not be eligible for an indexation adjustment in computing capital gains tax liability. If an asset is held for less than 12 months, there is less need to provide inflation protection.

T reatm ent of Gains on Financial Securities

The question of the treatment of exchange rate gains and losses is to be given further consideration. That question aside, the Government does not propose to change the current taxation treatment of gains associated with financial securities. On 16 December, 1984, the Treasurer announced new rules providing for the full

taxation on accrual of nominal gains on discounted and deferred interest securities, including DINGO bonds and capital-indexed securities. These rules provide uniformity of tax treatm ent of the yield of different types of fixed interest investment whether in the form of interest or capital gains. To apply the proposed

indexed capital gains tax on a realisations basis to the capital component of discounted and deferred interest securities would re-create differences between the tax treatment of different securities and consequent undesirable distortions in the

financial markets.

Assets Sold on an Instalm ent Payment Basis

Where payment of the sale price of an asset is spread over a number of years, the gain will be taxed in the year in which ownership of the asset legally changes hands. For example, an asset with an indexed cost base of $30,000 is sold for $50,000, payable $10,000 now and a further $10,000 per annum for four years, with market

interest rates charged on the deferred payments. The real gain 'is $20,000 ($50,000 less $30,000), which would be included in the vendor's income in the year of sale.

A ssets o f Which Only Part is Sold

In the case of sale of part of an asset (eg a 20 per cent interest in a property), capital gains tax will be levied on the asset portion sold, as illustrated in the example below. The underlying principle is that the indexed cost base for the total asset is to be calculated at the date of sale of the asset portion. This amount is

then pro-rated according to the proportion of the asset sold to determine the indexed cost base attaching to the asset portion sold. This latter amount is netted from the asset portion sale price to determine the taxable gain or loss.

For example, assume a 20 per cent interest in a property is sold for $20,000 and the indexed cost base of the total asset at the date of sale is $75,000. The indexed cost base for the sale of the asset share is therefore 0.20 x $75,000 = $15,000, implying a taxable real gain of $20,000 - $15,000 = $5,000.

Treatm ent o f Bodies Currently Exempt from Income Tax

Various bodies, such as Commonwealth and State governments and some of their

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agencies, local government bodies, religious and charitable institutions, life offices in respect of their superannuation business, approved deposit funds and most classes of superannuation fund, are exempt from tax on their income. As the rationale for taxing capital gains derives from the view that gains are analogous to income, it is

consistent that bodies exempt from income tax also be exempt from capital gains tax.

Index for Adjusting the A sset C ost Base

To be consistent with the concept of income as an increase in command over goods and services (which underlies the rationale for including capital gains in the income tax base), the appropriate index to be applied to convert nominal capital gains into real capital gains should measure the increase in the overall cost of goods and

services over the period that the nominal gain accrued. That is, a real gain or increase in purchasing power occurs only if the nominal value of an asset has increased relative to the price level of goods and services generally.

The CPI has been chosen on the grounds that it is not subject to revision, is available more quickly than alternative indices and is much better understood publicly. The use of the CPI in calculating real capital gains is consistent with its use in all other indexation arrangements - rates of excise duty, social security payments, indexed

Treasury bonds, wage indexation, etc. It is therefore proposed to use the all groups, eight capital cities CPI.

The CPI is available quarterly and the purchase or sale date of an asset is to be associated with the CPI index number corresponding to the quarter in which the transaction occurs. For example, all asset transactions falling within the June quarter 1986 would be associated with the June quarter 1986 CPI index number.

EXAMPLE 1

A taxpayer acquires an asset for $10,000 on 1 July 1986 and sells that asset for $20,000 on 1 July 1996. The CPI index at the time of purchase was 100, and 200 at the time of sale. The taxable real capital gain will be calculated as follows:

Proceeds of disposal $20,000

less original cost increased for $10,000 x 200 = 20,000

inflation between date of 100

purchase and date of sale --------

Taxable gain 0

Tax payable 0

EXAMPLE 2

A taxpayer acquires an asset for $10,000 on 1 July 1986 and sells it for $22,500 on 1 July 1996. Again, the CPI number at purchase was 100 and at sale was 200.

Proceeds of disposal $22,500

less original cost increased for $10,000 x 200 = 20,000

inflation between date of 100

purchase and date of sale Taxable gain 2,500

Tax payable (a) 1,225

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(a) For a taxpayer already on the top marginal personal income tax rate of 49 per cent.

EXAMPLE 3

A taxpayer acquires an asset for $10,000 on 1 July 1986, carries out improvements costing $3,000 on 1 July 1991, and sells the asset for $25,000 on 1 July 1996. The CPI index at purchase was 100, at the time of improvement was 150 and at time of sale was 200.

Proceeds of disposal $25,000

less original cost increased for $10,000 x 200 = 20,000

inflation between date of 100

purchase and date of sale less cost of improvements 3,000 x 200 = 4,000

increased for inflation 150

between date expenditure was incurred and date of sale Taxable gain 1,000

Tax payable (a) 490

(a) For a taxpayer already on the top marginal personal income tax rate of 49 per cent.

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7. RATIONALISATION OF WHOLESALE SALES TAX

SUMMARY

The Treasurer announced on 13 August 1985 that the Government was not proceeding with either a tax on selected services or an extension of the wholesale sales tax (WST) to major new categories of goods. Instead, it would be embarking upon a rationalisation of the existing WST goods categories and tax rate structure designed to reduce distortions, anomalies and inconsistencies in the WST system.

The rationalisation detailed below will take effect for goods passing the taxing point after midnight tonight (ie 19 September 1985).

COMMENTARY

R ate Class R ationalisation

The rate structure is to be simplified to include an exempt category (as at present) but to reduce the number of rate categories from four to three (10, 20 and 30 per cent) by absorbing the 7.5 per cent rate category into the 10 per cent rate

category. Items currently taxed at 32.5 per cent will be shifted to either the new 30 per cent rate category or the 20 per cent rate category.

The items to be taxed at 30 per cent (formerly 32.5 per cent) are:

. Jewellery and imitation jewellery;

. Goods made wholly or principally of precious metal or plated with precious metals other than silver;

. Clothing accessories such as studs, tie clips and collar pins;

. Field, marine and opera glasses;

. Watches and clocks;

. Cosmetics, perfumery and bath salts;

. Cameras, photographic films, photographs and other photographic equipment;

. Radio and television receivers;

. Record, tape and disc players;

. Tape and video recorders;

. Furs and fur garments; and

. Poker machines and other amusement machines.

It is intended that earth stations designed to receive the Household and Community Broadcasting Satellite Service and purchased for domestic use to receive such service will be exempt.

All other items formerly taxed at 32.5 per cent will be included in the 20 per cent rate category. These include:

. Serviette rings; book ends and book marks; boxes/cases for jewellery, clothing accessories; paper weights and paper knives; tooth picks; and cigarette lighters and cases; 49

. Fancy goods;

. Ornaments;

. Artificial flowers and fruits;

. Fountain, ball-point and felt-tipped pens, and propelling pencils;

. Shaving equipment;

. Toilet/dressing cases and sets;

. Musical boxes;

. Sound records, tapes and discs, and video tapes and discs; and

. Totalizator equipment.

These changes will go some way towards reducing the effective dispersion in the rate structure and the distorting effects of the tax on the relative prices of goods.

Base Broadening

The coverage of the WST will be extended in a number of areas, principally with the - intention of reducing anomalies. The major change relates to confectionery, snack foods, biscuits and ice cream. The present WST system taxes confectionery at 20 per cent while exempting close substitute products such as snack food, biscuits and

ice cream. For example, popcorn is taxable while potato crisps are exempt. Chocolate-coated biscuits are taxable if marketed as confectionery but exempt otherwise. This demarcation leads to both administrative complexities in deciding the appropriate rate to apply and obvious inequities in taxation treatment between goods which compete closely in the market place. To ameliorate these problems, the 20 per cent rate applying to confectionery is to be reduced to 10 per cent while a 10 per cent WST will be applied to the following close-substitute products.

. Snack foods including:

- potato crisps, chips, and straws (hot potato chips will remain exempt along with other hot foods);

- other savoury food products such as corn chips, prawn chips and pork crackling; and

- nuts and seeds that have been salted, spiced, smoked or roasted.

. Biscuits (including cookies, crackers, cones and wafers but not biscuits manufactured on retailers' premises and crispbreads) and commercial mixes for use in manufacturing these products.

. Ice-cream, ice-cream cakes, ice-cream substitutes, frozen confectionery (other than frozen yoghurt), flavoured ice-blocks and similar frozen products (other than those products manufactured on retailers' premises) and commercial mixes for use in manufacturing these products.

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Neither ice-cream nor biscuits manufactured on retailers' premises are to be subject directly to tax because of the inherent difficulties in taxing goods produced at the retail level under a wholesale sales tax. In order to avoid conferring an undue taxation advantage upon these products compared to other ice-cream or biscuits,

machines for the manufacture of biscuits, cones or wafers on retail premises will be subject to a 20 per cent rate. Machines for the manufacture of ice-cream products on retail premises are already subject to a 20 per cent rate. These measures, together with the taxation of the commercial mixes for use with these machines,

will ensure that these competitive retail activities bear some measure of indirect tax. The higher tax rate on the machines (20 per cent) compared to the products themselves (10 per cent) will partly compensate for the narrower tax base involved in taxing only the machines and the mixes rather than the total value of the

products.

Most major household appliances including furniture, refrigerators, freezers, washing machines, clothes dryers, and vacuum cleaners are presently subject to a 7.5 per cent WST rate, which will be increased to 10 per cent under the rate class rationalisation proposals. Certain household appliances or similar items are

currently exempt. In order to remove these anomalies and spread the indirect tax burden more evenly across commodities, the following items will be taxed at 10 per cent.

Non-oil-burning domestic space heating appliances, fire grates and fireplaces. Oil-burning domestic space heaters are currently taxable at 7.5 per cent, (now to be 10 per cent) while brick and similar in-built fireplaces which form an integral part of a building will remain exempt.

. All domestic cooking stoves, ovens (including microwave ovens), ranges and grillers. Portable stoves, including camping stoves, portable grillers and toasters are currently taxable at 7.5 per cent (now to be 10 per cent) while commercial-type stoves and microwave ovens will continue to be taxable at 20

per cent.

. Domestic water heating systems (electric, gas, solar, etc) and water softening, filtering, desalting and sterilising equipment. (Commercial-type water heating systems are already taxable at 20 per cent.)

. Oven and freezer bags are currently subject to a 20 per cent rate while other wrapping materials (eg aluminium foil, plastic wraps), bags and fastening materials marketed exclusively or principally for household use are exempt. A consistent treatment is to be provided by taxing all these items at 10 per cent.

S p ecific A nom alies and Inconsistencies

A number of specific anomalies and inconsistencies are to be remedied through the following measures.

. Tax at 10 per cent books consisting wholly or principally of maps (currently exempt) in line with maps which are already taxed.

. Tax at 20 per cent ships and vessels used as a residence or for private transport purposes (currently exempt) to bring the treatment generally into line with ships used for pleasure, sport or recreation and caravans which are already taxed at this rate.

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Tax at 20 per cent all water treatm ent appliances and equipment for swimming pools and spa baths, spa pools and hot tubs (such equipment, other than water filtering equipment which is currently taxable at 20 per cent, is currently exempt).

Tax at 20 per cent domestically (ie Australian) produced foods for birds (currently exempt) to bring the treatment into line with food for other domestic pets and imported food for birds.

Tax at 20 per cent imported overseas literature and other printed matter relating to overseas travel (currently taxable at 7.5 per cent) to achieve consistency with equivalent domestically produced materials.

Tax at 20 per cent rolls for player-pianos (currently exempt) to achieve a consistent treatment with pianos, player-pianos themselves, and the proposed treatment for similar home entertainment items such as records and tapes.

Tax all firelighters at 10 per cent - at present Australian-made

briquette-shaped firelighters are exempt, over-sized matches will be taxable at 10 per cent and firelighters in granular form and all imported firelighters are taxable at 20 per cent.

Reduce the rate of tax on compost bins from 20 per cent to 10 per cent to achieve consistency with incinerators, garbage bins and garbage stands.

Exempt goods containing not less than 95 per cent of milk products and whey powder and whey paste (currently taxable at 20 per cent) to remove an inconsistency relative to goods containing not less than 95 per cent of milk or

milk powder.

Exempt herbal teas, fruit teas, ginseng tea and other similar beverages currently taxable at 20 per cent to achieve consistency with traditional teas.

Exempt attachments for log forwarders for use in the timber-getting industry (currently taxable at 20 per cent) to remove an inconsistency between the attachments vis-a-vis the equipment itself or parts for the equipment which are both exempt.

Exempt imported bullion (currently taxable at 20 per cent) to achieve consistency with domestically produced bullion.

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REVENUE

The estimated revenue yield of these measures is as follows:

$m pa

Raise 7.5 per cent rate to 10 per cent 170

Reduce 32.5 per cent rate to 30 per cent for certain goods -66

Reduce 32.5 per cent rate to 20 per cent for all other items -91

Reduce the 20 per cent rate on confectionery to 10 per cent but extend the tax to snack foods, packaged biscuits, ice cream, cones and wafers; tax at 20 per cent

machines used to manufacture cones, wafers or biscuits on retail premises 30

Tax non-oil burning space heating equipment, fire grates and fire-places at 10 per cent 8

Tax domestic cooking stoves, ovens (including microwave ovens), ranges and grillers at 10 per cent 30

Tax domestic water heating systems and water softening, filtering, desalting and sterilizing equipment at 10 per cent 12

Tax at 10 per cent all wrapping material, bags and fastening material for household purposes 11

Other measures 6

Total 110

The estimated net revenue gain is $75 million in 1985-86 and $110 million in a full year. If all of the changes were passed through fully into prices, the estimated direct impact would result in an increase of around 0.1 percentage points in the consumer price index.

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8.TAX-FREE THRESHOLD

The Government has decided that in future the tax-free threshold (currently $4,595 per annum) will be available only on a pro rata basis in the case of those taxpayers joining the Australian workforce on a full-time basis for the first time and those leaving Australia permanently.

In situations where a taxpayer leaves Australia to reside permanently in another country part-way through a financial year, say 1 January, he or she would only be able to take advantage of the tax free threshold on a pro rata basis - in this case, one-half of the threshold would be available. A similar situation would be faced by a school leaver or immigrant entering the workforce on a full-time basis for the

first time; if he or she commenced full-time employment on 1 February, only 5/12 of the threshold would be available.

This measure will only affect taxpayers in relation to the assessment of their first (full-time) or last income tax assessment. Other part-year workers and casual employees will continue to benefit from the full threshold.

The threshold will be increased from $4,595 to $5,100 on 1 September 1986.

COMMENTARY

In its present form the tax-free threshold provides an overly generous concession to many taxpayers with low taxable incomes, in particular to persons first entering the full-time workforce and those leaving Australia permanently. The threshold is intended to benefit low income earners who are required to support themselves for the whole of the year on their income. Part-year workers are not necessarily wholly reliant for the full year on the level of taxable income returned.

REVENUE

This measure is estimated to result in a gain to revenue of around $90 million per year. The measure is to first apply for the 1986-87 income year, and the bulk of the revenue gain will first occur in 1987-88.

SUMM ARY

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9. PRESCRIBED PAYMENTS SYSTEM

The Government has decided to increase the basic single rate of deduction under the Prescribed Payments System (PPS) from 10 per cent to 15 per cent and to require owner-builders to make PPS deductions. The Government will further review the operation of the PPS, including the industry coverage.

COMMENTARY

The basic rate of tax deduction under the PPS is to be increased to 15 per cent in respect of all prescribed payments made on or after 1 July 1986.

The 10 per cent deduction rate and other features of the PPS were set originally on a conservative basis to facilitate implementation of the scheme in 1983 with the minimum administrative burden on all concerned. Experience with the PPS has confirmed that the existing deduction rate is too low for many PPS payees and that

a higher rate would more closely reflect the tax that will be ultimately payable by these payees on assessment.

The higher rate will also ensure that the major enforcement benefits of the system are maintained. In this regard, the Commisioner of Taxation has indicated that there is still a core of people in the community who, rather than not provide their payers with a deduction form at all and thereby incur a 25 per cent deduction from

their PPS payments (a 15 per cent penalty rate added to the present single rate), give their payers a form with a false name, address and file number on it so that only a 10 per cent deduction is made. The payees concerned are generally those who have not lodged income tax returns and, until they are detected by the Taxation

Office, the 10 per cent deduction effectively represents their final liability. The proposed increase in the basic rate of deduction will significantly reduce evasion in this area. For payees who do not provide a deduction form at all, the rate of deduction will become 30 per cent (the 15 per cent penalty rate added to the new

single rate).

Application of the increased deduction rate is likely to lead to an increase in the number of applications for deduction variation certificates, and it will remain possible for payees to apply to the Taxation Office for a lower rate of deduction where that is appropriate. As in the past, the Taxation Office will adopt practices

that impose the least possible inconvenience on the taxpayers concerned.

Under existing PPS arrangements, a householder who makes payments in connection with a building project valued at $10,000 or more is required to report such payments to the Taxation Office. In many cases, however, householders are entering into "owner-builder" type arrangements under which a licence or other

permit to build, alter or make additions to a building is taken out in the name of the householder or in the name of a tradesman and, in either case, the householder then organises various aspects of the building project himself, rather than engage a building contractor to carry out the work. It has been argued that householders

entering into these type of arrangements generally assume the responsibilities and obligations of professional builders, and should also have to comply with full PPS requirements, ie. the making of PPS deductions. The Government has accepted the logic of this view and has decided, therefore, that householders who enter into these

owner-builder arrangements should be required to make deductions from payments made on or after 1 July 1986 in connection with construction projects in excess of $10,000 that are commenced after that date.

SUMMARY

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A further review of the operation of the PPS, including the desirability of extending it to other industries, is to be undertaken.

REVENUE

The proposed changes to the PPS are estimated to produce a net revenue gain of $105 million in 1986-87 and $45 million in each succeeding year.

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10. QUARTERLY PROVISIONAL TAX

The Government has decided to introduce a compulsory instalment system for the payment of provisional tax by individuals, commencing in 1987-88.

COMMENTARY

The system will generally require provisional taxpayers whose provisional tax exceeds $2,000 to pay quarterly instalments of tax during the year in which the income is derived (ie the same year in which it is presently payable). As at present, instalments paid in respect of any year will be credited against the actual tax payable calculated on assessment after the end of that year. Any shortfall will be

due for payment by the taxpayer within 30 days of an assessment being issued by the Taxation Office, or 1 February of the following income year, whichever is the later. Any excess will be refunded. The system will, in broad effect, bring taxpayers who derive non-salary and wage income more into line with those salary and wage

earners whose incomes are now subject to deductions of tax at the time of receipt.

The new system will be designed so that taxpayers are not called upon to pay, in any financial year, any amount of tax greater than that payable under the present provisional tax system - only the timing of payments will be altered. When the system is fully implemented, four instalments will be payable and the earliest due

dates will be 1 September, 1 December, 1 March and 1 June each year. In the 1987-88 year, however, the earliest due date will be 1 December 1987 (when two quarterly instalments will be combined into one payment); the remaining instalments will be due on 1 March and 1 June 1988. Using 1987-88 as an example, each of the

first three quarterly instalments will be one-quarter of the provisional tax payable in respect of the 1986-87 income year (adjusted, as at present, to reflect subsequent income movements) as notified to the taxpayer by the Taxation Office. The final instalment will be calculated as the balance required to make up the full payment of

provisional tax for the 1987-88 year, calculated in the same way as at present and based on income in the 1986-87 year, and adjusted to reflect income movements in the intervening year. In subsequent years quarterly instalments will be calculated in the same fashion.

Although it is proposed that the law will specify the earliest due date in respect of each instalment, to ensure the efficient use of the manpower and equipment resources available to process receipt of instalment payments, actual due dates for payment will be spread over a period of time from the earliest due date (as at

present).

A taxpayer who receives an instalment notice calling for an instalment which exceeds the appropriate percentage of the estimated net tax payable for the year will be entitled to apply to the Commissioner of Taxation, before the due date for payment of the instalment, to have the instalment recalculated on the basis of his or

her estimate. Once a taxpayer has a tax instalment recalculated in this way, that estimate will be used as a basis for future instalments in that income year.

To allow flexibility to taxpayers with fluctuating incomes, while maintaining administrative simplicity, a taxpayer will be permitted to lodge up to two estimates varying the provisional tax payable in a particular year. However, these variations must be reasonably based. As a safeguard against abuse, penalty tax will become

SUMMAR Y

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payable, on a similar basis as applies under the existing provisional tax system, where a taxpayer underestimates either instalments of provisional tax or the amount of provisional tax liability for the year.

The quarterly provisional tax system will apply to anyone who is currently caught by the criteria for payment of provisional tax: namely, persons whose taxable income for a year is sufficient to attract tax and whose non-salary and wage component of income is $1,000 or more. However, instalments will not be sought from taxpayers

whose provisional tax liability does not exceed $2000 - such taxpayers will continue to pay provisional tax on an annual basis. This will mean that about one-half of the 1.6 million taxpayers who are subject to provisional tax will not be subject to the quarterly payment requirement.

Some taxpayers (particularly primary producers) do not receive income evenly throughout the year. For example, a farmer may receive the initial wheat pool payment in the second half of the income year. To meet such special circumstances it is proposed that an alternative, later, pattern of instalment payments be available to any taxpayer who, having regard to the nature of his business, can satisfy the

Commissioner of Taxation that he will derive more than three-quarters of his gross income after the earliest due date for the second instalment of provisional tax (1 December). The alternative basis is:

(i) one-half of the provisional tax for the year due on 1 February; (ii) the balance of the provisional tax for the year due on 1 June.

Where the tax scales affecting individuals in an income year are changed during the year, the Taxation Office will take those changes into account when calculating the final instalment.

There is a strong case on equity grounds for introducing an instalment system for the payment of tax on income other than salary and wages more closely matching the PAYE tax instalment deduction system.

For example, if a salary or wage earner is paid on a weekly, fortnightly, or monthly basis then he or she will normally pay tax on those earnings on the same basis. After nine.months, his cumulative tax instalment deductions from his gross pay will approximate three-quarters of his total tax liability for the current year. In contrast, a provisional taxpayer at present generally has available, for the first nine

months of the year, the full amount of his income, undiminished by the tax payable on it. The benefit to the provisional taxpayer from the availability of these funds will normally far outweigh the cost of the financing, in advance, the tax payment on income for part of the last quarter of the financial year.

There are also wider economic and monetary policy advantages in the spreading of provisional tax payments. At present about 90 per cent of provisional tax payments is concentrated from the last days of March through the June quarter in each

financial year. This contributes very significantly to the large seasonal fluctuations in liquidity that are reflected in disruptive and avoidable volatility in domestic short-term interest rates and the exchange rate. Such volatility imposes unnecessary costs on the private sector and hinders effective monetary management.

REVENUE

The measure is revenue neutral in on-going terms, although it is expected that collections of up to $90 million associated with late payments under the current

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system will be brought forward to 1987-88. Interest savings as a result of the need to sell fewer Government securities will be around $55 million annually from 1987-88; there will be additional administrative costs for the Taxation Office of $1.5 million in 1986-87, $7 million in 1987-88 and $9 million in subsequent years.

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11. QUARANTINING OF FARM LOSSES AND IMPROVED AVERAGING PROVISIONS

SUMMARY

The Government has decided to limit the immediate write-off of losses from primary production to farm income and a specified amount of non-farm income. Losses not written off in the year of income will be carried forward indefinitely for write-off against future income. The measure - designed to counter the widespread use of farm losses to shelter from tax income from other sources - is along the lines of that canvassed in the draft White Paper but with considerably more generous

treatment in respect of the amount of non-farm income against which losses can be offset. In addition, a significant number of farmers will benefit from an increase in the amount of non-farm income which will be able to be taken into account for primary production averaging purposes.

COMMENTARY

Deductions for losses for the 1986-87 and subsequent income years from a taxpayer's primary production activities are to be limited to the amount of non-farm income deemed to be 'notional' annual farm income and specified as the greater of:

. $15,000 shading out dollar for dollar for non-farm incomes between $15,000 and $30,000, with these thresholds subject to indexation in subsequent years; and

. the aggregate of the previous 5 years of net farm income.

Any excess primary production loss is to be carried forward indefinitely for deduction in later years against the taxpayer's farm income, the annual notional farm income specified above and any taxable gain on disposal of primary production

property. Quarantined primary production losses carried forward will be deducted in later years ahead of any losses carried forward under the existing loss provisions of the income tax law.

The measure will apply to all individuals, companies, partnerships and trusts carrying on a business of primary production. Many farms are operated as husband and wife partnerships and the notional farm income provisions could benefit both partners if they each earned non-farm income.

The specified 'notional' farm income limit of $15,000 and associated shade-out provisions, together with the indexing of these, will also extend to the current income tax averaging arrangements under which a maximum of $5000 of 'notional'

farm income is allowed for averaging purposes. This will provide a significant tax benefit to many genuine primary producers, unrelated to the proposed quarantining measure.

The increase in the specified monetary limit from the $10,000 in the draft White Paper to an indexed $15,000 significantly increases the amount of non-farm income able to be earned by farmers without being affected by the quarantining measure. In increasing this monetary limit and indexing it the Government was particularly

mindful of the fact that many genuine farmers can earn significant amounts of non-farm income, especially during hard times.

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Taxpayers will also be able to attract higher notional farm income for quarantining purposes in particular years by demonstrating a proven record of farm profitability, regardless of the level of their non-farm income in those years. This profitability test will address more completely those cases where farm losses are caused by

downturns or disasters, rather than by tax sheltering activity. Losses of up to the aggregate of the previous 5 years' net farm income may be offset against other income.

The quarantining of taxpayers' primary production losses to, broadly, their income from primary production is aimed at taxpayers who undertake farm activities to exploit weaknesses in our tax system: particularly, the up-front deductions for full nominal interest payments and rapid write-off provisions, coupled with the later

realisation of capital gains which are either not taxed or, as proposed, taxed on a preferential basis. Sheltering non-farm income from tax in loss-making years is an essential part of this exploitation.

For similar reasons the Government announced on 17 July 1985 the quarantining of excess interest from "negatively geared" rental property investments to the income and taxable gains from those investments. Similar quarantining measures will be applied to other areas should that prove necessary to protect the revenue from tax sheltering activities.

The notional farm income concept to be applied with the quarantining of farm losses is designed to minimise adverse effects of the measure on genuine farmers or other taxpayers undertaking primary production purely for commercial reasons. Such a concept avoids the disadvantages of qualitative and quantitative tests that would

otherwise be required and which invariably would be complex, would involve very heavy administrative workloads and could introduce uncertainties as to the outcome in particular cases.

The measure will inevitably have some effect on some existing investments, particularly those with longer lead times. Nevertheless, the measure does not apply to losses until the 1986-87 income year and losses incurred before then will remain deductible against either farm or non-farm income of future years. Both the delay

in the start-up of the measure and the more generous treatment in relation to non-farm income will ameliorate the effects of the measure on existing investments.

Offsetting the revenue gains from the quarantining measure will be the effect of the significant improvement in the primary production averaging provisions. An additional $20 million per annum benefit to farmers will arise from the

complementary increase in the notional farm income limit for primary production averaging purposes, from the current level of $5,000 to the new level of $15,000. This represents a significant increase in the amount of non-farm income which may benefit from the averaging provisions.

REVENUE

Revenue gains from the measures are estimated at $105 million in 1987-88 and $75 million per annum thereafter.

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12. DEDUCTIBILITY OF EXPENDITURE ON SOIL CONSERVATION AND ON CONSERVING OR CONVEYING WATER

SUMMARY

The Government has decided to replace the immediate deduction currently allowed for capital expenditure by primary producers on conserving or conveying water with write-off over 5 years. Taking into account concerns with land degradation

problems, the Government has decided not to change the immediate deduction currently allowed for expenditure on soil conservation.

COMMENTARY

Eligible capital expenditure for the purpose of conserving or conveying water - which presently qualifies for immediate write-off- where incurred under a contract entered into after 19 September 1985, will be deductible over 5 years. A 20 per cent deduction will be allowed in the year in which the expenditure is incurred and

in each of the subsequent 4 years.

The move to 5-year write-off does not imply reduced Government priorities in relation to water conservation. The Commonwealth's funding under the recently established Federal Water Resources Assistance Program, which includes assistance for rural water conservation, will be $67.3 million in 1985-86, an increase of $4.6

million on the equivalent 1984-85 expenditure.

Providing 5-year write-off for expenditure on conserving or conveying water will significantly reduce the incentive to tax shelterers and is consistent with the concessional treatm ent more generally accorded assets of primary producers and other businesses.

REVENUE

The revenue savings are estimated at $25 million in 1986-87 and $20 million in 1987-88.

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13. TAX CONCESSIONS FOR THE AUSTRALIAN FILM INDUSTRY

SUMMARY

The concessional treatm ent currently provided eligible film investments, by way of 133 per cent income tax deduction and 33 per cent income tax exemption, is to be reduced to 120 per cent deduction and 20 per cent exemption. Additional funding of $2 million in 1985-86 and $3 million in the following two years is to be provided to

the Special Production Fund (SPF) administered by the Australian Film Commission.

COMMENTARY

Eligible investments in qualifying Australian feature films, mini-series, telemovies and documentaries, made under contracts entered into after 19 September 1985 will attract a deduction of 120 per cent of eligible expenditure. The investor's net earnings from qualifying productions, up to a maximum of 20 per cent of the eligible

investment, will be exempt from income tax.

The current 133 per cent deduction and 33 per cent exemption will continue to apply to contributions towards the production of a film that are made after 19 September 1985 in lieu of contributions underwritten under an agreement in force at that date. This will avoid any unforeseen burdens being placed on underwriters who had underwritten contributions before the announcement.

The Government is committed to the maintenance of a viable Australian film production industry. However, the level of generosity of the taxation treatment of investment in film productions has been such that investors have often not been interested in the underlying commercial potential of the productions but primarily in

the tax sheltering potential of these investments. Despite the reduction in the generosity of the tax treatm ent from 150 per cent deduction and 50 per cent exemption in the 1983-84 Budget, the cost of the concession rose from $13 million in 1981-82 to $95 million in 1984-85. The cost in 1985-86 is estimated at $135 million.

The difficult task facing the Government was to select an assistance regime which balanced the needs of reversing the burgeoning drain on the budget while avoiding too sharp a reduction in the level of investment in the industry. The form of the assistance was also an important consideration.

The Government was assisted in its consideration of these issues by discussions with industry representatives and by many written representations and submissions from the industry. After taking the various views into account the Government settled on reducing the current level of indirect assistance and agreeing to provide some additional direct assistance through the SPF.

The Government expects that the proposed reduction in the level of indirect assistance to the film industry will result in an appropriate reduction in the level of investment in the industry and in so doing reduce the associated cost to revenue while at the same time increasing investors' interest in the quality and commercial

viability of film production.

REVENUE

The estimated net savings to revenue of the changes are $35 million in 1986-87 and subsequent years.

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14. CAPITAL SUBSCRIBED TO PETROLEUM AND AFFORESTATION COMPANIES

SUMMARY

As canvassed in the draft White Paper, the Government has decided to withdraw the rebate and deduction available for certain capital subscribed to petroleum and afforestation companies.

COMMENTARY

The following income tax concessions are to be withdrawn:

. the rebate of 27 cents for each dollar of share capital subscribed to a petroleum prospecting or mining company, or to an interposed company investing in such a company, where the company forgoes the deductions for prospecting or mining expenditure; and

. the deduction allowable for one-third of the calls paid by companies, certain trustees and non-resident individuals to an afforestation company. (The concession applicable to resident individuals and other trustees was withdrawn with effect from 1 July 1985 with the termination of the concessional

expenditure rebate.)

These changes will apply to moneys paid after 19 September 1985 other than payments in respect of calls made on or before that date, being payments by a person who owned or beneficially owned the relevant shares on or before that date.

These measures, together with the effective extension of the group loss provisions to excess petroleum exploration and development expenditure, will mean that the taxation treatment of petroleum and afforestation companies will be more in line with that of companies generally.

Removal of the afforestation concession will eliminate the situation where both the company and its shareholders obtained tax benefits for, in effect, the same item of expenditure. Withdrawal of the petroleum rebate will remove the special treatment of capital subscriptions which was provided for reasons which have much less relevance today.

REVENUE

Revenue savings from these changes are estimated at $10 million for 1986-87 and $15 million for 1987-88.

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15. INCOME TAX ON CERTAIN PUBLIC UNIT TRUSTS

SUMMARY

The draft White Paper drew attention to the increasing use of trusts to avoid the company tax arrangements. While recognising that a possible approach would be to tax trusts as companies, it pointed to the complexities involved and the need for further study.

Although the decision to introduce a full imputation system for companies will reduce the incentive to use trusts, there would still be advantage for tax-exempt institutional investors in the trust form because it is not proposed that imputation

credits be refundable.

To ameliorate that bias, it has been decided to extend company tax arrangements to those public unit trusts which operate a trade or business. Private trusts, and public unit trusts of the more traditional kind which invest in property, equities or securities will not be affected. The measure will apply to relevant existing trusts

from 1988-89, and to any relevant new public unit trust formed after today.

COMMENTARY

The measure will extend the present corporate unit trust provisions in certain respects and apply them to an additional category of trusts. The present provisions of Division 6B of the Income Tax Assessment Act apply to public unit trusts established as a result of a company reorganisation; such trusts are taxed as

companies and distributions to unit-holders are taxed as dividends.

The corporate unit trust provisions will in future apply also to business ventures set up initially as public unit trusts which actively operate a trade or business. The extension will not apply to trusts which are no more than vehicles for investment in

property or securities.

In order to ensure that exempt institutional investors cannot by-pass the provisions, eg by limiting the number of unit-holders to less than 50, the "public unit trusts" tests in Division 6B will be changed in some respects. A trading unit trust will be a public unit trust under that Division if, though its units are held by less than 50 persons, 20 per cent or more of the units are beneficially owned, directly or

indirectly, by persons or bodies exempt from tax.

As a further safeguard in situations where an investment trust is interposed between a trading trust and an exempt institution, tracing rules will enable the status of the trading trust to be established by reference to the tax status of the ultimate beneficial owners of the units.

The new rules will apply as from the 1985-86 income year to public unit trusts established after today which operate a trade or business. It will apply as from the 1988-89 income year to trusts of that kind which are already established.

REVENUE

The measure will save $5 million in 1986-87 and 1987-88. Although only a small number of existing businesses are already established as public unit trusts, a trend has been developing which would have significant revenue consequences in the absence of corrective action.

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16. FOREIGN TAX CREDIT SYSTEM

The Government has decided to replace the present double taxation relief arrangements with a general foreign tax credit system along the lines applied by some of our major trade competitors and as set out in Chapter 20 of the draft White Paper.

COMMENTARY

Under the new system:

(i) paragraph 23 (q) of the Income Tax Assessment Act, which exempts much foreign source income if it has borne tax in the foreign country, will be withdrawn. Section 46 will also be withdrawn in respect of foreign source dividends derived by resident companies;

(ii) the foreign source income derived by Australian resident individuals and by Australian resident companies will then be subjected to Australian income tax (apart from certain salary and wages as set out below);

(iii) credit will be allowed against the Australian tax payable for analogous foreign tax that is paid by the Australian resident on the foreign income. The credit will not exceed the amount of the Australian income tax payable in respect of the relevant foreign income;

(iv) subject to the Australian 'parent' having at least a 10 per cent shareholding for a continuous period of 12 months in a foreign subsidiary or sub-subsidiary, the Australian company will be allowed a credit both for withholding tax on dividends it receives from the foreign company and for underlying foreign company tax on that portion of the profits from which the dividends are paid;

(v) generally, and subject to retention of existing provisions for consultants working overseas on approved projects, salary or wages earned overseas that is subject to tax in the country of source will be fully exempt from Australian income tax where derived by the Australian taxpayer in performing the relevant duties overseas for a continuous period of at least 12 months - a proportionate exemption applying where the period is from 3 to 12 months - with the exempted salary or wages earned overseas (including by consultants on approved projects) being taken into account in calculating the appropriate rate of Australian tax on other income so that exemption of the salary or

wages will not also reduce the tax payable on the other income; and

(vi) no general provision will be made to preserve the tax incentives (in the form of lower taxes) that may be offered by developing countries to foster investment in those countries; such concessions need to be considered on a case-by-case basis in respect of particular kinds of income earned in particular countries, and one obvious context for that kind of consideration is

the negotiation of comprehensive double taxation agreements with the countries concerned.

Other more technical aspects - such as rules for determining the source of income and foreign income tax that will be creditable (eg state taxes, unitary taxes) - are currently being developed. It has been decided, however, that credit will apply on a country-by-country basis.

SUMMARY

66

The system will apply to income derived from the beginning of the 1987-88 income year.

The issues associated with the introduction of a foreign tax credit system were canvassed in the draft White Paper. Briefly, the present manner of treating foreign source income of Australian residents is not consistent with the general equity, neutrality and efficiency objectives of a sound taxation system. As well, the

present treatm ent encourages Australians to avoid tax by arranging to give their income an artificial overseas source.

Many of Australia's trade competitors - including the United States, the United Kingdom and West Germany - operate foreign tax credit systems without suffering dire consequences. Concerns about such consequences would have substance only if, after allowance of a credit for foreign tax paid, substantial Australian company tax

was still payable. In fact, the Australian company tax rate is comparable with, and in some cases lower than, that of the major developed countries, so that in the majority of cases little, if any, Australian tax would be payable after credit is allowed for foreign income tax paid on the relevant income. Elements of such a system are in fact already reflected in certain double taxation relief provisions of

Australian domestic law.

Australian companies that could be most adversely affected by the introduction of a foreign tax credit system are those which conduct operations in tax haven (low tax) countries. There is no reason why the Australian tax system should effectively

subsidise and encourage such operations.

It is stressed, however, that, in proceeding with this measure, the Government will through appropriate measures give recognition to the position of regional countries that provide tax incentives to attract legitimate investment from Australia and elsewhere as a means of fulfilling their development aspirations.

REVENUE

The direct gain to revenue is estimated at about $45 million per annum at 1984-85 levels of income, with the first revenue gains accruing in 1988-89. In the longer run the revenue gains could be substantially greater if followed-up with the adoption of appropriate anti-tax-haven measures.

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17. PETROLEUM AND GENERAL MINING: GROUP LOSS TRANSFER PROVISIONS AND DIESEL REBATE

SUMMARY

As canvassed in the draft White Paper, the Government has decided to allow petroleum and general mining companies an annual election to have excess exploration and development expenditure deductions treated as losses under section 80 of the Income Tax Assesment Act so that they may attract the group loss

transfer provisions.

Changes are also proposed to diesel excise rebate arrangements.

COMMENTARY

Currently, any excess deductions for exploration and development expenditure over the taxpayer's net assessable income for the income year may be carried forward indefinitely, but cannot create a section 80 loss and thus be transferred to another company where the companies satisfy the 100 per cent common ownership test. Mining companies therefore cannot take full advantage of the group loss provisions available to other companies.

To bring the treatment of such companies more into line with that of other companies, general mining and petroleum companies will be allowed an annual election to have excess deductions from exploration and development expenditures actually incurred in 1985-86 and subsequent income years taken into account in determining section 80 losses.

Rebates of excise for diesel fuel used in mining operations (not including diesel fuel used in mining towns) will be increased to offset any further increases in excise resulting from excise indexation arrangements between now and the 1986-87 Budget. The rebate will be further reviewed in the context of the 1986-87 Budget.

REVENUE

The estimated revenue costs of the group loss measure are $70 million in 1986-87 and $65 million in 1987-88.

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18. IMPUTATION SYSTEM OF COMPANY TAX

In the draft White Paper the Government set out options for an imputation system for company dividends. Such a system would remove the current problem whereby company income is taxed twice - first at the company level and then in the hands of shareholders when distributed as dividends.

The Government has now decided to proceed with a system of full imputation for resident individual shareholders commencing in 1987-88. This will markedly reduce distortions in the present arrangements affecting the decisions Australians take about investment of their savings.

As indicated in the draft White Paper, there will be an increase in the company tax rate to help defray the cost, but not to the point of achieving a revenue neutral result. There will be a net cost which it has been necessary to take into account in

designing the imputation arrangements.

COMMENTARY

The company tax rate will be increased from its present level of 46 per cent to 49 per cent, at which level it will equate with the maximum personal marginal income tax rate.

An imputation credit applied to a dividend will have been matched by a payment of a corresponding amount by the company. To achieve this result, a special compensatory tax arrangement will apply. When a resident company distributes

profits by way of dividends it will at the same time pay a compensatory tax at a rate equivalent to $49 for every $51 distributed to shareholders.

An amount equal to the compensatory tax so paid will be set against the income tax calculated by reference to the profits of the company so as to discharge a corresponding amount of that liability. Where there is no such company tax liability, the compensatory tax therefore remains effective.

A resident individual receiving eligible dividends (those in relation to which compensatory tax has been paid by the company) will be entitled to a tax credit, equal to the amount of the compensatory tax, in calculating the tax he or she has to pay on the total of those dividends plus the amount of the credit.

Thus, for each $51 of eligible dividends received, a resident individual would be assessed on an amount of $100 and a credit of $49 would be allowed against income tax so assessed.

The credit could be offset against income tax on the shareholder's income, whether from dividends or other sources, but not against the Medicare levy. The credit will not give rise to cash refunds where it exceeds tax otherwise payable or where the shareholder is a tax-exempt body. In line with the intent of the new system a tax

credit will not be extended to non-resident shareholders. Because of the changes, there may be a need for renegotiation of certain double tax treaties, as appropriate.

With the company tax rate and the maximum personal marginal income tax rate aligned at 49 per cent, no income tax on the dividend would be payable by the shareholder on eligible dividends. Shareholders whose dividends plus credit were all

SUMM ARY

69

assessed at the maximum marginal rate would be eligible for a credit equal to the income tax assessed on that total amount. The credit would exceed the income tax assessed on the dividends plus credit where shareholders were on lower marginal tax rates, and the excess could be offset against income tax on their non-dividend

income.

Suppose a dividend of $51 is received by a taxpayer on a 40 per cent marginal tax rate. The calculation would be:

$

Dividend 51

Assessable (dividend plus credit) 100

Tax on $100 40

less credit 49

Net credit 9

In effect, no personal tax is collected from the taxpayer on the dividend, and a net credit of $9 can be set against tax on other income.

The compensatory tax, which will be broadly along the lines of the advance corporation tax operated in the United Kingdom, will ensure that the credit allowed to the shareholder has been matched by a payment of a corresponding amount by a company.

Dividends received by resident individuals from resident companies other than co-operatives after the commencement of the measures will be eligible for a tax credit. Dividends paid by co-operatives are deductible from assessable income of the co-operative and are already only taxed in the shareholders' hands. The credit will not apply to dividends received by Australian shareholders from non-resident companies, whether or not they have Australian branches. Nor will it apply to distributions of income in the form of bonus shares or other arrangements involving "captive" distributions.

If a dividend were paid by one resident company to another, the recipient company would not itself receive an imputation credit, but could pass on to its own resident individual shareholders an entitlement to a credit on dividends which it paid to them out of that income. Compensatory tax which it paid in respect of its own

distribution would be reduced by the amount of the imputation credit attaching to the dividends it had received. Thus, when profits pass through the corporate chain, the credit will attach to the ultimate distribution to resident individual shareholders.

Some details of the measure, including transitional arrangements relating to its commencement, are under examination and will be announced subsequently. The broad intention on timing is that the 49 per cent company tax rate will first apply to company tax collections in 1987-88 (on company incomes of the 1986-87 income year) and that the compensatory tax and imputation credits will also apply to

dividends paid in 1987-88; further work on the precise details is being undertaken.

With the maximum personal marginal income tax rate in 1987-88 set equal to the company tax rate of 49 per cent, Division 7 tax on excess retentions by private companies will no longer be necessary and will be removed.

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REVENUE

It is expected that there will be no net cost to revenue from the measure until 1988-89. From 1988-89 the annual cost is estimated to be approximately $250 million.

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19. POVERTY TRAPS

The Government has decided to make certain changes to social security arrangements from November 1986, in the overall tax reform context, to alleviate some of the problems caused by poverty traps. The measures include:

. increasing the pension free area by $10 per week, to $40 per week for single pensioners and $70 per week for a couple;

. removing the separate income test on rent assistance; and

. increasing the income disregard for each child of a pensioner from $6 to $12 per week.

Pensioners and beneficiaries with non-pension income will also benefit from the increase in the income tax threshold and the reduction in marginal tax rates.

COMMENTARY

Increase in the Pension Free Areas

Just as the zero rate scale threshold protects low income taxpayers from actually paying tax, the pension free areas (currently $30 per week for single pensioners and $50 per week (combined) for couples) protect pensioners from a loss of pension when they have only modest amounts of private income. The free areas have been

increased only once since 1972. The increases in the pension free areas to $40 per week for single pensioners and $70 per week (combined) for pensioner couples will protect about 140,000 social security and repatriation pensioners from any loss of pension. In addition, those pensioners with private incomes in the range over which the free areas will be increased will experience a significant reduction in their effective rates of income withdrawal - from 68.75 per cent to 36.5 per cent. Further, all 450,000 current part-rate pensioners will receive an increase in their pension of up to $5 per week each.

Rem oval of Separate Income Test on Rent A ssistance

Pensioners and beneficiaries renting in the private market receive a special payment (rent assistance) of up to $15 per week. Eligibility for this payment is subject to an income test which commences to reduce rent assistance from the first dollar of non-pension/benefit income. The proposed measure will remove this income test and rent assistance, like other special needs supplements to basic pensions and

benefits, will be withdrawn under the normal pension/benefit income tests. This will have the effect of reducing the effective marginal rates of withdrawal faced by nearly 700,000 social security pensioners and beneficiaries and repatriation service and widow pensioners, in most cases from 50 per cent to zero. Close to 300,000 will receive an increased payment of up to $15 per week.

Increase in Income Disregard for Children

At present, an amount of $6 per week per child is "disregarded" in applying the pensions income tests. The proposed measure will increase that amount to $12 per week. This measure will mean an increase in pension of up to $3 per week for each child for all of the 50,000 part-rate pensioners with children. The "income

SUMMARY

72

disregard" has not been increased since 1972 and its real value has, as a consequence of movements in the general level of prices and incomes since then, been greatly reduced. This measure will also reduce the marginal withdrawal rates faced by some 10,000 pensioners with small non-pension income.

The effect of these measures is illustrated in the following table:

ILLUSTRATIVE TABLE OF BENEFITS UNDER POVERTY TRAP MEASURES

Private Income $100pw Current Pension Reduct­ ion

Pension Reduct­ ion from Nov 1986

Gain Current

Rent Assist­ ance

Rent Assist­ ance

from Nov 1986

Total Gain

Single pensioner: $pw $pw $pw $pw $pw $pw

- No children . not renting 35 30 5 - 5

. renting 35 30 5 - 15 20

- Two children . not renting 29 18 11 - - 11

. renting 29 18 11 ~ 15 26

Pensioner couple (combined):

- No children . not renting 25 15 10 - - 10

. renting 25 15 10 15 25

- Two children . not renting 19 3 16 - - 16

. renting 19 3 1.6 - 15 31

REVENUE

As the measures are intended to apply from the first pension and benefit paydays in November 1986, the gross outlays cost is estimated at about $140 million in 1986-87 and about $215 million in 1987-88; net ongoing full year costs will be around $185 million as some part of the outlays will be returned in personal income tax in

financial years following the year in which the measures are implemented.

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20. CONCESSIONAL EXPENDITURE REBATE

The Treasurer announced on 17 July 1985 that the concessional expenditure rebate was to be replaced with a medical expenses rebate with effect from the 1985-86 income year.

The medical expenses rebate will apply at the standard rate of tax (currently 30 cents in the dollar) to the excess of net medical expenditures over $1,000 in the year of income. The rebate will apply to the same range of medical expenses covered by the former concessional expenditure rebate. These include doctor, hospital, and chemist expenses in respect of illness or operations, and dentist and optometrist expenses.

COMMENTARY

This measure will simplify the personal income tax. It will also make it fairer as only a small proportion of taxpayers (6 per cent), mainly those with higher incomes, had been eligible for any benefit under the former rebate.

Moreover, it was difficult to justify the concessional treatment afforded to most of the items covered by the concessional expenditure rebate because they already receive substantial government assistance in other ways (eg education and superannuation).

However, the Government acknowledged a need to provide assistance, through the introduction of a medical expenses rebate, to taxpayers who incur high unreimbursed medical (including hospital, dental and optical) expenses which are not fully covered

by government health programs.

REVENUE

Removal of the concessional expenditure rebate is expected to produce savings of $15 million in 1985-86 and $85 million in a full year. The introduction of the medical expenses rebate is estimated to have a negligible cost to revenue in 1985-86 and cost $22 million in a full year. The net effect of these two measures is a gain to revenue of $15 million in 1985-86, $60 million in 1986-87 and $63 million in 1987-88 and each subsequent year.

SUMMARY

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21. NEGATIVE GEARING OF RENTAL PROPERTY INVESTMENTS

SUMMARY

The Government announced on 17 July 1985 its decision to reduce the income tax advantage associated with the negative gearing of rental property investments.

COMMENTARY

Broadly, the measures will apply to rental property investments made after 17 July 1985. Interest relating to such investments in real property held for rent-producing purposes will be deductible only from the sum of relevant rental income, net of other allowable deductions (other than any building depreciation deductions) and any

taxable profit or capital gain on disposal of relevant rental property. Where other allowable deductions (such as maintenance, rates or management expenses) exceed gross rental income, they will remain deductible against assessable income from

other sources. The interest not allowed as a deduction in any year will be

quarantined - that is, carried forward and allowed as a deduction against relevant rental income or any taxable profit or capital gain on disposal of relevant rental property in later years.

Full details of the measure were provided in the 17 July 1985 press release.

REVENUE

The revenue gain from this measure is estimated at $55 million in 1986-87 and $100 million in 1987-88.

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22. DEPRECIATION ON RESIDENTIAL INCOME-PRODUCING BUILDINGS

SUMMARY

The Treasurer announced on 17 July 1985, in association with measures dealing with negative gearing of rental property investments, that depreciation at the rate of 4 per cent per annum would apply to residential income-producing buildings (as well as to extensions, alterations or improvements to existing buildings) on which

construction commenced after that date.

REVENUE

The revenue cost of this measure is estimated at $2 million in 1986-87 and $7 million in 1987-88.

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ATTACHMENTC

INCOME TAX RATE SCALE AND DISTRIBUTIONAL IMPACT

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THE INCOME TAX RATE SCALE AND DISTRIBUTIONAL IMPACT

In considering options for restructuring the personal income tax rate scale, the Government placed particular emphasis on the following factors:

. the basic objective of reducing high marginal tax rates;

. the amount and timing of the additional revenue from the income tax base broadening measures;

. the distributional impact of those measures, which bear almost entirely on taxpayers in the higher tax brackets;

. the commitment to provide a reduction in rates, with effect from 1 September 1986, sufficient to compensate workers for the 2 per cent wage increase that they will forgo in the April 1986 wage case; and

. the desirability of aligning the company tax rate with the top marginal rate of personal income tax.

It is estimated that the package will boost net revenue by $0.8 billion in 1986-87 and by $1.4 billion in 1987-88. These estimates are net of increases in Government spending, including expenditure to fund relief of poverty traps and the establishment costs for the national identification system. Detailed estimates are presented in

Attachment A of this document.

The distributional impact of the base-broadening measures is discussed in the draft White Paper, in particular in Chapter 22 and the Appendices thereto.

That discussion shows that the impact of the base-broadening measures will be concentrated at higher income levels and, therefore, that the measures will have a progressive impact on the distribution of the tax burden. The distributional pattern of the extensions to the base reflects the greater incentive that high marginal rates provide for taxpayers to avoid tax by taking advantage of the present narrow base of

the income tax.

The incentive to avoid or minimise tax has become increasingly widespread in line with the growth in the number of taxpayers facing marginal tax rates of 46 per cent or higher.

The number of taxpayers subject to the current 46 per cent or higher marginal rates is estimated to increase by around 20 per cent to about 2.5 million taxpayers in 1985-86 and, in the absence of rate scale changes, to approach 3 million (or over half the full-time workforce) in 1986-87. Similarly, the proportion of taxpayers in the top marginal rate bracket has been growing rapidly.

The past practice in Australia of allowing high marginal tax rates to fall on increasing numbers of taxpayers has not been matched by a commensurate increase in tax revenues or, therefore, in the actual progressivity of the income tax arrangements. In 1954-55, the top marginal rate began at an income level approximately 18 times average yearly earnings. Today the top marginal rate begins

at $35,000, only 1.5 times average yearly earnings. This trend has been accompanied by a sharp contraction in the relative contribution of income tax from the upper income ranges. For 1984-85, it was estimated that income tax assessed to individuals earning more than 1.6 times average earnings accounted for approximately 21 per cent of total net tax assessed. In 1954-55, the comparable

figure was approximately 54 per cent.

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These trends are consistent with the fact that the effective progress!vity of the income tax system is significantly less than its apparent progressivity. To a significant extent, the progressivity of the present rate scale is more apparent than real.

The strategy of broadening the income tax base and reducing high marginal rates of personal tax is being pursued in a number of OECD countries. President Reagan's proposals for tax reform, released on 28 May 1985, would replace the current 14 personal marginal tax rates, ranging from 11 to 50 per cent, with three tax rates of

15, 25 and 35 per cent. New Zealand's tax reform proposals, announced on 20 August 1985, provide for replacement of the current income tax rate scale, which includes a top marginal rate of 66 per cent, with a three step scale with marginal

rates of 15, 30 and 48 per cent.

Given the need to reduce marginal rates around average earnings and to support the thrust of the base-broadening measures by reducing incentives to avoid tax, particular emphasis was placed on providing the most substantial reductions in marginal rates to apply at average and higher incomes. Consideration was also

given to the fact that the alignment of the top marginal rate of personal income tax with the company tax rate under a system of full imputation would remove a significant distortion between incorporated and unincorporated businesses.

Finally, given the limited revenue available from base-broadening and the cost of the tax cut to compensate for the 2 per cent discounting of the April 1986 award wage increase, together with the cost of measures to alleviate poverty traps, it was not possible to finance additional reductions in marginal tax rates across the board.

In light of these considerations, and the timing of the additional revenue flowing from the reform package, the Government has decided to progressively reduce marginal rates with changes effective from 1 September 1986 and 1 July 1987. The proposed rate scales are compared with the present scale below.

Present Scale Proposed Scales

Income Marginal Income 1.9.1986 1.7.1987

$pa Rate $pa Marginal rates

(cents per $) (cents per $)

0- 4595 0 0- 5100 0 0

4595-12500 25 5101-12600 24 24

12501-19500 30 12601-19500 29 29

19501-28000 46 19501-28000 43 40

28001-35000 48 28001-35000 46 40

35000 & over 60 35000 dc over 55 49

The scale to be introduced on 1 September 1986 will apply with effect from date for purposes of PAYE instalments, with a composite scale applying on assessment for 1986-87 incomes. The composite scale will consist of 2/12 of the present scale and 10/12 of the scale to apply from 1 September 1986.

The increase in the tax free threshold will relieve an additional 130,000 taxpayers from any final liability to tax in 1986-87.

The scale to apply from 1 July 1987 will apply for the full year.

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D I S T RI B U T I ON AL I M P A C T OF THE O V E R A L L P A C K A G E

The distributional impact of the reform package will depend on the combined effect of the base-broadening measures and the restructuring of the rate scale. The analysis below (which follows that developed in the draft White Paper) illustrates

how the burden of measures borne directly by individuals offset substantially the savings flowing from the cut in marginal rates at higher incomes.

Table 1 summarises the estimated distributional implications of replacing the present rate scale by that proposed for 1 July 1987, in association with the introduction of the various base broadening measures. The income figures are 'comprehensive' incomes. Roughly, for present purposes this can be thought of as presently taxable income plus income that will become taxable under the proposed

measures. The figures in columns two and three relate to taxpayers who would not be affected by the base-broadening measures. These are the taxpayers who have been shouldering the additional burdens imposed by the avoidance practices of others. As discussed more fully in the draft White Paper, the proportion of

taxpayers who could reasonably be expected not to be affected by the

base-broadening measures falls as income increases. At incomes above $30,000 per annum, it is unlikely that there are very many taxpayers who are not avoiding at least some income tax. Clearly, these 'no avoidance' figures are not (particularly above $30,000 per annum) rep resen tative.

TABLE 1: NET GAINS AND CHANGES IN DISPOSABLE INCOME FOR SINGLE INCOME EARNER

Comprehensive Income (a) ($pa)

Taxpayer Not Affected by base-broadening measures Representative Taxpayer

Net Gain ($/week)

Change in Disposable Income (%)

Net Gain ($/week)

Change in Disposable Income (%)

10,000 3.40 2.0 3.40 2.0

12,500 3.80 1.9 3.70 1.8

17,500 4.90 1.8 4.40 1.6

19,500 5.30 1.8 4.70 1.6

22,500 8.70 2.7 5.80 1.7

27,500 14.50 3.8 9.50 2.4

32,500 22.00 (b) 5.1(b) 13.20 3.0

37,500 31.10 (b) 6.6(b) 13.60 2.7

45,000 46.90 (b) 8.8(b) 11.60 2.0

75,000 110.20 (b) 14.5(b) 15.60 1.7

100,000 162.90 (b) 17.1(b) -20.70 -1.6

(a) Present taxable income plus income that will become taxable under the proposed base-broadening measures. (b) There are virtually no taxpayers at these income levels who would not be affected by the base-broadening measures.

Figures which are more representative of the likely experience of taxpayers at different income levels are shown in columns four and five. These numbers were generated using data provided by the Tax Office on the value of various avoidance practices by income level. In order to model the experience of a representative

taxpayer it has been necessary to describe the concentration of avoidance practices

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among taxpayers a t different income levels. Concentration was effected implicitly by sharing a pool of avoidance (estimated from data supplied by the Tax Office) among a sub-set of taxpayers.

The representative figures generally show a progressive pattern of net gains above $32,500 per annum. The levels of avoidance assumed for these taxpayers cannot be described as ex trem e, however. This can be illustrated by noting (for example) that for a taxpayer with comprehensive income of $100,000 per annum, and who is

avoiding paying taxes on one-half of his income, the net 'gain' would be

approximately minus $400 per week. For a taxpayer with comprehensive income of $50,000, also avoiding tax on one-half of his income, net 'gain' would be minus $200 per week. These are much larger losses of disposable incomes than the

representative figures presented in the table (the figures in the table for a taxpayer on an income of $100,000 per year are consistent with only 24 per cent of income presently avoiding tax) but because income is defined to include non-taxable non-cash fringe benefits like company cars and low-interest loans, they are not

unrealistic. There is evidence of taxpayers with these incomes presently avoiding paying taxes on a t lea st one-half of their comprehensive incomes. Evidence on the avoidance practised by even higher income taxpayers is presented on page 43 of the draft White Paper.

The analysis summarised in Table 1 is, for the most part, confined to the impact of base-broadening measures that are borne directly by individual taxpayers, ie, it takes incomplete account of the burden initially borne by companies, which may contribute about half of the total revenue from base-broadening. Ultimately, of

course, the corporate burden will be shifted to individuals - in a competitive environment the burden is likely to be borne by corporate shareholders via reduced dividends and/or slower growth in the value of shares reflecting lower retained earnings. A significant portion might be borne indirectly by domestic residents

through their investments in life offices and superannuation funds. In general, it is to be expected that the bulk of domestic shareholders and investors in life offices and superannuation funds will have average or higher incomes. This implies that the package is even more progressive than is illustrated in Table 1.

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