The lead-up to the 2017-18 Federal Budget has been dominated by a number of key tax-related topics:
- most prominently, housing affordability. In particular, the role of investors in driving up property values, emboldened by negative gearing and capital gains tax (CGT) discount tax concessions, is something which has divided the two major parties and much of the population;
- taxation of multinationals; and
- the future direction for the taxation of stapled structures (structures which warehouse a very significant percentage of Australian economic activity).
Key challenges and opportunities in the Federal Budget
While infrastructure taxation reform has been deferred, among other things, the Budget addresses the question of housing affordability but without seeking to disturb negative gearing or the CGT discount concession. With a combination of carrot and stick, the Government is hoping it can allay concerns that it is not doing enough for first home owners and, more broadly, those looking for affordable accommodation. The approach to housing affordability in the Budget has created new opportunities for Fund managers and investors looking to establish investment structures based on affordable housing ‒ the new Managed Investment Trust (MIT) measures and increased CGT discount concession for qualifying affordable housing are examples of these opportunities.
Multinationals and foreign investors also remain in focus for the Government with various policies aimed at strengthening the multinational anti-avoidance law (MAAL), OECD hybrid mismatch rules and non-resident CGT rules. In relation to the MAAL measure in particular, taxpayers potentially affected may have already been in discussions with the Australian Taxation Office (ATO) regarding structures which are deemed "offensive" but, nonetheless, this Budget measure means that multinationals will need to consider the change in light of any existing or proposed inbound investment structures.
The proposed changes to the taxable Australian real property (TARP) "principal asset" test is also a subtle but important change ‒ the details of this proposed measure are limited but taxpayers should maintain a watching brief on this proposed change, particularly if they are considering divesting interests in entities (foreign or Australian) which directly or indirectly hold Australian land.
The big news in the Budget is also the new tax on banks, a tax which one might expect will result in increased funding costs for borrowers, particularly investors.
Strengthening of the multinational anti-avoidance law (MAAL)
The MAAL is an anti-avoidance rule which targets schemes designed to avoid or reduce the attribution of income to an Australian branch where the principal purpose (or one of the principal purposes) of the scheme is to obtain an Australian tax benefit or an Australian tax benefit and a reduction in a foreign tax liability.
The Government is now amending the law to ensure that the MAAL is not compromised through the use of foreign trusts and partnerships in corporate structures. With effect from 1 January 2016, the MAAL will apply to corporate structures that involve the interposition of partnerships that have any foreign resident partners, trusts that have any foreign resident trustees, and foreign trusts that temporarily have their central management and control in Australia.
It would seem that this is a response to various arrangements which the ATO has already highlighted in previous taxpayer alerts, involving the use of foreign tax transparent entities.
The Government remains committed to reducing the company tax rate to 25%
The Government has confirmed in the Budget that it remains committed to its 10 year Enterprise Tax Plan to reduce the company tax rate to 25%.
Introduction of a major bank levy
The Government has announced certain measures intended to ensure greater competition and accountability in Australia's banking system. As part of these proposals, a new six-basis point levy on the major bank's liabilities will be introduced, starting on 1 July 2017.
The levy will only affect Australia's five largest banks with assessed liabilities of $100 billion or more. It will not apply to superannuation funds or insurance companies. Customer deposits of less than $250,000 and additional capital requirements imposed on banks by regulators will be excluded from assessed liabilities.
Changes to Capital Gains Tax rules for foreign investors
The Government has announced the following CGT changes for foreign investors:
- The main residence CGT exemption for foreign and temporary tax residents that own Australian real estate will be removed from 7:30pm (AEST) on 9 May 2017. Existing properties will be grandfathered until 30 June 2019.
- The CGT withholding rate for foreign tax residents will be increased from 10% to 12.5%. In addition, the CGT withholding threshold for foreign tax residents will be reduced from $2 million to $750,000. These changes will apply from 1 July 2017.
Measures designed to reduce pressure on housing affordability
Deductions will be disallowed for travel related to inspecting, maintaining or collecting rent for residential rental property.
From 1 July 2018, first home buyers will be able to withdraw voluntary superannuation contributions, and associated deemed earnings, that are made after 1 July 2017 for a first home deposit. Contributions and earnings will be taxed at 15%, and withdrawals will be taxed at marginal rates less a 30% offset. Contributions are capped at $15,000 per year, and $30,000 in total, within existing caps.
Plant and equipment depreciation deductions will be limited to outlays actually incurred by investors of residential real estate properties. Investors who purchase plant and equipment for their residential investment property after 9 May 2017 will be able to claim a deduction over the effective life of the asset. Plant and equipment forming part of residential investment properties as of 9 May 2017 will be grandfathered, continuing to give rise to deductions for depreciation until either the investor no longer owns the asset, or the asset reaches the end of its effective life.
However, property investors will be unable to claim deductions for plant and equipment purchased by a previous owner. Subsequent investors will have the existing plant and equipment items reflected in their cost base for capital gains tax purposes.
An annual foreign investment levy of at least $5,000 will apply to all future foreign investors who fail to occupy or lease their residential property for at least six months of the year.
CGT discount increased by 10% for individuals investing in qualifying affordable housing
Beginning 1 January 2018, resident individuals who elect to invest in qualifying affordable housing will receive an additional ten percentage points capital gain discount, increasing the discount from 50% to 60% for qualifying investments. Importantly, this discount will also flow through to those resident individuals investing through qualifying affordable housing MITs.
The higher CGT discount comes with the following qualifications:
- the housing must be provided to low to moderate income tenants;
- rent must be at a discount to the private rental market rate;
- the housing must be managed though a registered community housing provider; and
- a minimum investment term of three years.
Ironically, much of the talk prior to the Budget revolved around a paring back of CGT discount concessions to assist in making housing more affordable. This measure involves an increase in CGT discount concessions for the purpose of making housing more affordable (though it would seem more affordable for renters rather than first home buyers).
Affordable housing through MITs ‒ MIT concessions for trusts investing in affordable housing for at least 10 years
Part of the Government's plan for reducing pressure on housing affordability, MITs will now be able to acquire, construct or redevelop property for the purposes of affordable housing. However, in order for an investor to be eligible to receive the concession through an MIT, the MIT must:
- derive at least 80% of its assessable income from affordable housing;
- derive only up to 20% of its assessable income from other eligible investment activities currently permitted under the existing MIT rules; and
- keep the affordable housing available for rent for at least 10 years.
In the event of a breach of these restrictions, non-resident investors investing through such MITs will be subject to a 30% withholding tax rate (an increase on the 15% under the MIT withholding regime) on:
- investment returns for that income year where the income derived from affordable housing is less than 80% or income derived from other eligible activities is greater than 20%; and
- the net capital gain arising from the disposal of those assets that are held as affordable housing for less than 10 years.
MIT concessions have represented a major attraction for foreign investors since introduced. While perceived abuses of MIT rules have been of concern to Treasury and the ATO in the context of various transactions (for example, those described in Taxpayer Alert TA 2017/1), on this occasion, it would seem that the MIT rules are being used by Government to entice foreign investment into affordable housing.
Improving small business concessions
Immediate deductibility of assets less than $20,000
Small businesses will be able to claim an immediate tax deduction for eligible assets that cost less than $20,000 and are installed and ready for use by 30 June 2018 (extending the existing concession by a further 12 months). Assets that cost $20,000 or more can be added to the small business simplified depreciation pool and deprecated at 15% in the first income year and then 30% for each subsequent income year. The balance of the pool can be immediately deducted if it is less than $20,000 before 30 June 2018.
The immediate deduction will now end on 30 June 2018 and will apply to businesses that have a turnover of less than $10 million (previously it was $2 million).
Tightening the small business CGT concessions
From 1 July 2017 the access to the small business CGT concessions will be tightened. The concessions will only apply to those assets that are used in a small business or ownership interests in a small business. Treasury is concerned that the concessions are being applied to assets that are unrelated to the small business being carried on. No further information has been provided as to how the concessions will be tightened.
The concessions will continue to be available to those with a turnover of less than $2 million or business assets of less than $6 million.
Principal asset test now calculated on an associate inclusive basis
Changes will be made to the way that foreign tax residents calculate their CGT liability on indirect interests in TARP. Currently a foreign tax resident will only have a CGT liability on disposal of an interest in an entity that holds TARP if it passes the principal asset test. The principal asset test requires the market value of the TARP assets held by the Australian entity to be more than 50% of the total market value of the assets of that entity. The test is conducted on an entity standalone basis (subject to the operation of tracing rules through multi-tiered structures).
From 7:30pm (AEST) on 9 May 2017 the TARP principal asset test in Division 855 of the Income Tax Assessment Act 1997 will be calculated on an associate inclusive basis to ensure that foreign tax residents are not separating the indirect interests in Australian land in order to ensure that the principal asset test is not passed. There is some uncertainty regarding how the associate inclusive test will be applied and Treasury is yet to provide further guidance.
OECD hybrid mismatch rules
The Government continues to focus on hybrid mismatch issues ‒ this time, the focus is on structures used by banks and financial institutions, by eliminating mismatches that occur in cross border transactions relating to Additional Tier 1 (AT1) regulatory capital (it would seem that the proposals primarily affect banks with foreign branch structures). Under proposed changes:
- AT1 returns are not frankable to the extent they are also deductible in a foreign jurisdiction; and
- where the AT1 capital is not wholly deployed in the issuer's foreign operations, the franking account of the issuer is to be debited as if the returns were to be franked.
The proposed changes will apply to returns on AT1 instruments paid from the later of 1 January 2018 or six months after Royal Assent, though transitional arrangements will apply to AT1 instruments issued prior to 8 May 2017 so that the measure will not apply to returns paid before the next call date of instrument occurring after 8 May 2017.
It would seem that this measure will serve to increase the cost of funds to banks and ultimately, borrowers.
Increase in Medicare levy and increasing the Medicare low income thresholds
Starting from 1 July 2019, the Medicare levy on taxable income will increase half a percentage point from 2.0 to 2.5%. Low-income earning singles, families, seniors and pensioners will continue to receive relief from the Medicare levy with an increase to the low-income Medicare levy threshold. Effective from the 2016-17 income year, the thresholds will be increased to $21,655 for singles, and $36,541 for families (plus an additional $3,356 for each dependent child or student).
This measure is estimated to have a gain to tax revenue of $8.2 billion over the forward estimates period of 1 July 2019 to 30 June 2021.