The role of revenue measures (ie. taxation) as a tool to shape the economy yet not creating excessive inflationary pressure requires a delicate balancing act and we have seen how, in the case of the UK, financial markets have punished economies (and politicians) for proposing taxation measures which it considers undesirable.
It’s in the light of these factors that this Budget, which forecasts an underlying cash deficit of $36.9bn, must be seen: the Government is looking to send a message that it is capable of dealing with the challenges before it. It is clear that the Government continues the thematic of recent years of increasing the tax take from multinationals (the thin capitalisation and intangible tax reforms) as well as looking to reduce perceived integrity concerns about franking credits (the changes to the off-market buy back rules). On the other hand, the Government seems intent on accelerating the transition to clean energy, with tax measures designed to drive a significant take-up of electric cars.
What seems clear is that this is the start of a conversation and we expect that the May budget is likely to focus on tax revenue with numerous effective tax increases expected.
The upshot for many corporates is that a number of these measures – such as the changes to thin capitalisation rules and off-market share buy-backs – will require reconsideration of capital management and funding strategies. Our tax experts at Clayton Utz explore the implications of these and other key tax-related measures for the 2022-23 Budget.
Multinational tax integrity and transparency
Thin capitalisation changes
Following the August consultation paper on the measures, the Government announced that it would:
- limit an entity’s debt related deductions to 30% of EBITDA – which replaces the previous safe harbour test;
- allow an entity in a group to claim debt related deductions up to the level of the worldwide group’s net interest expense as a share of earnings (which may exceed the 30% EBITDA ratio) – which replaces the previous worldwide gearing test; and
- retain the arm’s length debt test as a substitute test which will apply only to an entity’s external (third party) debt, disallowing deductions for related party debt under this test. However, no further details have been released as to how the limited application of this test would interact with the other tests.
The announced measures also introduce a mechanism whereby interest deductions denied can be carried forward for 15 years. No details have been announced yet on whether this would be subject to a change of ownership limitation similar to the tax losses.
The changes will apply to income years commencing on or after 1 July 2023 and apply to MNEs operating in Australia and any inward or outward investor, in line with the existing thin capitalisation regime. Financial entities will continue to be subject to the existing rules.
Given the changes are expected to apply from 1 July next year, MNEs can commence modelling of the potential impact of the changes as well as the level of debt that can be supported under the alternative thin capitalisation methods. Sectors which typically may be highly leveraged, such as real estate, construction and private equity, would be expected to be most immediately impacted by the changes, but, not all industries should be adversely affected, in particular those entities that have high profitability and are less capital intensive such as service and some technology-based companies.
Enhanced tax transparency by MNEs with new reporting requirements
The Government will introduce the following reporting requirements for relevant companies to enhance the tax information they disclose to the public:
- significant global entities (entities with global revenue of at least $1 billion) will need to publicly release certain tax information on a country-by-country (CbC) basis and a statement on their approach to taxation, for disclosure by the ATO;
- Australian public companies (listed and unlisted) will need to disclose information on the number of subsidiaries and their country of tax domicile; and
- tenderers for Australian Government contracts worth more than $200,000 will need to disclose their country of tax domicile (by supplying their ultimate head entity’s country of tax residence).
The changes will apply to income years commencing on or after 1 July 2023. It remains to be seen whether the concept of tax domicile introduces a new definition and test that differs from tax residency, noting that clarification of Australian tax residency definitions remains subject to legislative reform.
Businesses that are impacted should take the following action:
- significant global entities that already voluntarily disclose CbC information should continue to do so and those that don’t should prepare to provide the high-level data that is required, for example on the amounts of tax paid in jurisdictions they operate in and the number of employees in these jurisdictions;
- Australian public companies should be prepared for establishment of a public registry of ultimate beneficial ownership that shows who ultimately owns, controls and receives profits from a company; and
- tenderers for Australian Government contracts should ask themselves whether they are likely to be domiciled offshore for the purposes of this disclosure and whether representations made for these purposes have a bearing on their tax profile vis-à-vis the ATO and other tax authorities.
Deductions denied for payments relating to intangible assets held in low or no tax jurisdictions
As foreshadowed in the same consultation paper as the thin capitalisation measures, the Government will introduce a new anti-avoidance rule is aimed at preventing SGEs from being able to deduct payments made directly or indirectly to related parties where intangibles are held in low tax or no tax jurisdictions. For this purpose low or no tax jurisdictions are considered to be jurisdictions where either:
- the corporate tax rate is less than 15%;
- there is a preferential patent box regime in place without economic substance.
This will apply to payments made on or after 1 July 2023. SGE taxpayers are encouraged to consider whether their related party transactions may attract this new anti-avoidance measure.
Designing the rules to apply at 15% is of no particular surprise as this aligns with the key rate that will apply under the OECD Pillar II measures. However, the introduction of the patent box measure with the economic substance qualifier will be one to closely monitor once draft legislation has been released, especially for European headquartered multinational groups where patent box regimes are quite common.
OCED Pillar 1 & 2
The Budget made no reference to the introduction of the OECD Pillar 1 and Pillar II measures that Australia agreed to implementing on 8 October 2021. With consultation still underway, we may need to wait until the next Budget in May for further details as to how these measures will be crafted.
Changes to share buybacks
In another measure impacting the access to franking credits, the Federal Government announced that from Budget night off-market share buybacks would be treated in the same way as on-market share buybacks. Accordingly, the share buyback amount will be considered to be capital proceeds in relation to a capital gain, as opposed to a portion being considered a franked dividend. This comes into effect from Budget night.
This is the second measure announced by the Government in recent months impacting the ability of shareholders to access franking credits. The impact of this measure will be felt hardest by superannuation funds who while typically would be able to access a 10% rate on the capital gain associated with an on-market share buyback, access to the franking credits that came with an off-market share generally resulted in refundable franking credits. These refundable franking credits boosted the post-tax returns of the investment. For those members in the pension phase where their income is exempt, the access to the refundable franking credit was especially beneficial.
Following the release of Taxpayer Alert 2020/5, superannuation funds’ access to franking credits in a range of situations was under close scrutiny of the ATO as part of regular pre-compliance review processes and more targeted reviews where it perceived that a particular superannuation fund was manipulating the rules to access a franking credit. However, for the majority of the industry which has significant stakes in the ASX200 that have undertaken considerable off-market share buy backs in recent years, the measure will have a cost to their Australian equities portfolio.
Ushering in a new era of salary packaging
In a subtle effort to demonstrate Australia’s resolve to reduce greenhouse gas emissions and achieve its emissions reduction target, the Albanese Government is backing the electric car industry by exempting battery, hydrogen fuel cell and plug-in hybrid electric vehicles (with a first retail price below the LCT threshold for fuel efficient vehicles) from fringe benefits tax (FBT) and import tariffs. This is also one of only a few tax relieving measures detailed in the Budget.
The key takeaway from this announcement is the significant impact the FBT exemption will have on employee salary packaging incentives. The ability to make car repayments out of an employee’s pre-tax salary (via salary sacrifice arrangements), that is now even more tax efficient in the absence of FBT, should be enticing for any employee given recent cost of living pressures.
Meanwhile, the elimination of import tariffs may not have a significant impact on the price of electric vehicles manufactured in countries with which Australia already has a free trade agreement (a zero import tariff already applies to more than half of the electric cars currently on sale in Australia). Although, some popular models may see price reductions.
Don’t wait too long however to buy that electric vehicle! The Government aims to review the measure after three years, so this tax incentive may not be around for too long.
Certain COVID-19 business grants made non-assessable non-exempt (NANE) income
Certain business grants made by State and Territory Governments prior to 30 June 2022 may be eligible for NANE treatment, thereby exempting recipients from paying tax on these grants, subject to certain eligibility criteria being met. The confirmation of NANE treatment resolves the uncertainty faced by businesses who had received these grants during the COVID-19 pandemic, many of whom had been holding off lodging tax returns pending clarification of the treatment. If eligible, the grants will not be taxed in the hands of the recipients, ensuring greater value of the grants in the hands of the businesses.
These grants are:
- Business Costs Assistance Program Four – Construction (Victoria);
- Licenced Hospitality Venue Fund 2021 – July Extension (Victoria);
- License, Hospitality Venue Fund 2021 – Top Up Payments (Victoria);
- Business Costs Assistance Program Round Two – Top Up (Victoria);
- Business Costs Assistance Program Round Three (Victoria);
- Business Costs Assistance Program Round Four (Victoria);
- Business Costs Assistance Program Round Five (Victoria);
- Impacted Public Events Support Program Round Two (Victoria);
- Live Performance Support Program (Presenters) Round Two (Victoria);
- Live Performance Support Program (Suppliers) Round Two (Victoria);
- Commercial Landlord Hardship Fund 3 (Victoria);
- HOMEFRONT 3 (ACT); and
- Small Business Hardship Scheme (ACT).
Businesses that received any of the abovementioned grants should consider their eligibility to treat these amounts as NANE.
Providing certainty on unlegislated tax and superannuation measures
Measures that will not be proceeding
The Government has reviewed and will not proceed with a number of legacy tax and superannuation measures that were announced in previous Budgets but which had not been legislated, including:
- The 2013-14 Mid Year Economic and Fiscal Outlook measure to limit the scope of the integrity rule in section 974-80 of the debt-equity provisions (which effectively denies deductions, in certain circumstances, on interest payments to the extent that they fund a return on an equity interest). Section 974-80 has created significant uncertainty since the debt-equity provisions were introduced and the existence of proposed law changes (which have been mooted for nearly a decade) together with the existing law, only contributed to this uncertainty.
- The 2016–17 Budget measure that proposed changes to the taxation of financial arrangements (TOFA) rules (in respect of which a delayed start date was subsequently announced in the 2018–19 Budget). The proposed changes had contained four key components:
- a “closer link to accounting”, which was intended to strengthen and simplify the existing link between tax and accounting in the TOFA rules;
- simplified accruals and realisation rules, which were to significantly reduce the number of taxpayers in the TOFA rules, and were intended to reduce the arrangements where spreading of gains and losses is required under TOFA, and which were to result in a simplification of the required calculations;
- a new tax hedging regime which was to be easier to access, encompass more types of risk management arrangements (including risk management of a portfolio of assets), and which would remove the direct link to financial accounting; and
- simplified rules for the taxation of gains and losses on foreign currency which would streamline the legislation, while preserving current tax outcomes.
The 2016–17 Budget measure that proposed changes to the taxation of asset-backed financing arrangements eg. deferred payment arrangements and hire purchase arrangements, so that such arrangements would be treated in the same way as financing arrangements based on interest bearing loans or investments. The proposed measures were intended to improve access to more diverse sources of capital in Australia, and to support infrastructure investment in Australia.
The 2016–17 Budget measure that proposed introducing a new tax and regulatory framework for limited partnership collective investment vehicles (CIV). (The corporate CIV provisions, also announced in the same Budget, were enacted in February of 2022).
Measures that have been deferred
The Government will also defer the start dates of three legacy tax and superannuation measures, to allow sufficient time for policies to be legislated and implemented.
This includes the 2021–22 Budget measure that proposed making technical amendments to the TOFA rules, including amendments to:
- facilitate access to hedging rules on a portfolio hedging basis; and
- reduce compliance costs and correct unintended outcomes, so that taxpayers are not subject to unrealised taxation on foreign exchange gains and losses, unless this is elected.
The proposed start date for the 2021-2022 Budget measures relating to the technical TOFA amendments has been deferred from 1 July 2022 to the income year commencing on or after the date of Royal Assent of the enabling legislation.
ATO resourcing and funding
This Budget will see a continuation of the materially elevated ATO staffing levels, up from around 18,000 in FY17, to approaching 20,000, and an increased departmental budget for the ATO.
ATO resourcing is expected to grow further in the coming years, noting the Government's commitment to the extension of tax compliance programs and tax revenue targets under these programs.
These increases, and the extended funding for compliance programs, are unsurprising in the current climate. Taxpayers and their advisers can also expect the ATO’s current focus on debt recovery to continue.
Extended ATO compliance programs
Existing ATO compliance programs are to be extended with additional funding and noteworthy revenue targets. Taxpayers should anticipate that by virtue of these programs, the ATO will have increased resourcing, including, improved data matching capability, which will see increased audit and review activity.
Personal Income Tax Compliance Program
This program is focused on individual non-compliance, such as incorrect reporting of income and overclaiming of deductions. An additional $80.3 million of funding will be provided to boost the program for an additional two years from 2 July 2023 which is expected to increase tax revenue by $674.4 million between now and 2026. The ATO is likely to utilise this funding to improve existing compliance integrity products, as well as engage earlier with taxpayers and tax agents to target compliance activity (for instance, through early engagement). Taxpayers and tax agents should therefore expect increased ATO activity in the personal income tax space.
Shadow Economy Program
This program represents a co-ordinated regulatory response to target dishonest and criminal activities that occur outside of tax and regulatory systems, which result in a significant economic tax gap. The program is expected to receive $685 million of funding over the next three years and is projected to increase tax revenues of $2.1 billion over the next four years.
Removal of $10,000 cash payment limit under Shadow Economy Taskforce
The 2018-19 Budget measure to introduce a limit of $10,000 for cash payments made to businesses for goods and services (whether by individuals or other businesses) has been removed. This measure was aimed at reducing money laundering and tax evasion as part of the recommendations under the Shadow Economy Taskforce.
Tax Practitioner's Board (TPB) funding boost
The TPB will receive $30.4 million of funding to increase compliance investigations into unregistered and high-risk tax practitioners over four years from 1 July 2023. The TPB intends to utilise new risk tools to identify practitioners or unregistered practitioners who engage in poor or unlawful tax advice in an aim to improve tax compliance and standards across the industry. Taxpayers should remain vigilant and ensure that their choice of tax agent is registered and appropriately qualified. In the event of TPB inquiry, tax professionals should seek legal advice.
Continued funding for the ATO’s Tax Avoidance Taskforce
The ATO has been allocated a further $1.1bn of funding for its Tax Avoidance Taskforce over the next four years. This consists of an extra $200m above existing funding for the next three years, and the extension of the taskforce for an additional year (FY26, $500m spend). The funding will bolster the ATO’s already significant Taskforce resources.
The Tax Avoidance Taskforce seeks to ensure that multinationals and large public and private groups pay the right amount of tax in Australia by detecting tax avoidance, protecting revenue and maintaining integrity in the tax system.
The Taskforce administers numerous ATO compliance programs, including the implementation of measures under the OECD’s Base Erosion and Profit Shifting initiatives, Australia’s diverted profits tax and the ATO’s assurance reviews (first called the Justified Trust reviews, then Streamlined Assurance Reviews, and now Combined Assurance Reviews which cover both income tax and GST).
The Taskforce has been well funded and highly successful since it was introduced in 2016, with the tax collected as a consequence of its efforts far exceeding initial estimates. This time around, the estimated revenue from the Government’s $1.1bn spend over the next four years is $2.8bn.
The Budget Papers make reference to this measure supporting the ATO to pursue what is referred to as “new priority areas of observed business tax risks”. It remains to be seen precisely what those tax risks are which the ATO might target. The denial of deductions for payments to related parties in low tax jurisdictions for the use of intangibles also announced in the Budget is likely to be in the frame, along with others. Whatever the focus, the ATO’s compliance activities over the last decade since the Taskforce was introduced have shown it to be very active and assertive about its views. Corporates and large private groups need to be prepared for scrutiny from one of the most well-resourced revenue authorities globally.