With cost-of-living pressures as a major policy driver and inflation the major handbrake, Budget 2023 perhaps was never likely to be an opportunity for the Federal Government to impose significant new revenue-raising measures. It has instead chosen relatively modest tax measures and clarified or strengthened existing ones where additional revenue could be had, which nonetheless (in combination with many other factors) are projected to deliver a budget surplus.
These measures in themselves are mostly unexciting – with one exception. We have been observing a gradual rethink of managed investment trust (MIT) rules, which cumulatively appear to be a loosening to encourage greater foreign investment. Could this be a harbinger of more to come? Perhaps. The Treasurer got tired of exhorting domestic superannuation funds to invest in rental accommodation and now is inviting foreign capital in and for good measure added some green building concessions.
For now, in the increasingly uncertain economic climate, we see some limited opportunities for growth opened by this Budget, and a need for caution.
Opening up Australia to foreign capital (again)
The Government has announced measures that will broaden the availability of the MIT regime to new build-to-rent projects as well as data centres and warehouses that meet relevant energy efficiency standards.
Firstly, the Government will extend the clean building MIT withholding tax concession to data centres and warehouses. This measure will also raise the minimum energy efficiency requirements for existing and new clean buildings to a 6-star rating from the Green Building Council Australia or a 6-star rating under the National Australian Built Environment Rating System (NABERS).
In relation to the build-to-rent sector, the Government is encouraging the expansion of Australia's housing supply through the following measures:
- increase the rate for the capital works tax deduction (depreciation) from 2.5% to 4% per year (same as hotels); and
- reduce the final withholding tax rate on eligible fund payments from MIT investments from 30% to 15%.
These measures were originally announced on 28 April 2023. The Federal Budget provided further detail in relation to the requirements to be eligible for these concessions. Broadly, it is currently proposed that the measures will apply to build-to-rent projects consisting of 50 or more apartments or dwellings made available for rent to the general public. The dwellings must be retained under single ownership for at least 10 years before they can be sold, and landlords must offer a lease term of at least 3 years for each dwelling.
Further consultation will be undertaken in relation to specific implementation details, including any minimum proportion of dwellings being offered as affordable tenancies.
The above measures will apply where the construction of new build-to-rent projects or data centres and warehouses commences after 7:30pm (AEST) on 9 May 2023 (Budget night). The reduced withholding rate will apply from 1 July 2024 for build-to-rent projects and from 1 July 2025 for data centres and warehouses.
What this means for you: This appears to be a reversal of the trend from previous Governments that continued to tighten and restrict the availability of the MIT regime. These measures, together with other recent State-based concessions for build to rent projects (including land tax and stamp duty surcharge exemptions), will continue to make the build-to-rent asset class more appealing for foreign investment and bring the level of taxation to a similar level to local superannuation funds. If local superannuation funds have previously been unwilling to invest in the build-to-rent sector, they will now have more competition from foreign investors.
Perhaps the additional $2bn given to NHIFC to provide additional cheap loans to affordable and social housing will further stimulate new buildings for the rental market.
However, one of the biggest impediments to build-to-rent projects is the inability to recover input tax credits on construction costs, which has not been changed with these rules. Therefore, while these changes will improve the economics for these projects, it will be interesting to see whether it is material enough to generate substantial investment in this sector.
Tax integrity: the expansion of Part IVA
An unexpected part of its budget measures with unquantifiable impacts, the Government will expand Australia's general anti-avoidance rule (Part IVA) to capture schemes that:
- reduce tax paid in Australia by accessing a lower withholding tax rate on income paid to foreign residents; and
- achieve an Australian income tax benefit, but have the dominant purpose of reducing foreign (not Australian) income tax.
Both measures will apply to income years commencing on or after 1 July 2024, regardless of whether the scheme was entered into before that date. Accordingly, there is a retrospective element to these amendments, and taxpayers should carefully assess their risk.
The lower rate of withholding tax
While the current definition of "tax benefit" for Part IVA purposes explicitly captures schemes designed to avoid liability to withholding tax altogether, it does not currently capture schemes merely designed to access a lower rate of withholding tax. The Government aims to rectify this.
It is important to remember that Part IVA will only apply to cancel tax benefits where the dominant purpose of the taxpayer is to obtain a tax benefit. Accordingly, while the withholding rate for interest payments is 10% and the withholding rate for unfranked dividends is 30%, significant commercial factors are likely to drive taxpayers' choices between equity and debt, which may serve to reduce the likelihood of the dominant purpose test being met.
A more likely angle might be "schemes" designed to access the MIT concessions and lower income tax amounts withheld when making certain payments to non-resident members. We understand the ATO recently flagged its concern that some trusts are not eligible for MIT status, and this targeted amendment may give the ATO a legislative fallback for schemes that – while ticking all the eligibility boxes – are artificial or contrived in nature. Time will tell.
Schemes that reduce a foreign tax liability
Further, Part IVA has not generally applied to a "scheme" that reduces Australian tax where the dominant purposes was directed at reducing a foreign tax liability. It has always been a high-risk argument for taxpayers to run because in succeeding in Australia, the taxpayer may invite significant exposure in another jurisdiction.
The effect of this change is that Australian tax benefits associated with schemes designed to obtain a foreign tax benefit can be cancelled by the ATO. Given the tightening of the rules, the need for taxpayers to present compelling, objective evidence of local and global commercial drivers for transactions is heightened. A strong foreign tax driver will not be enough to escape the operation of Part IVA in Australia. Further, relief is not available under Australia's tax treaties where Part IVA applies, raising the stakes significantly.
Tax integrity – growth in tax and superannuation liabilities and late lodgements
The Government will provide $82.1 million funding over four years to the ATO to target the growth of tax and superannuation debts and overdue lodgements, targeting high-value debts over $100,000 and aged debts older than two years, for public and multinational groups with an aggregated turnover over $10 million, and private groups or individuals controlling over $5 million net wealth.
A small business lodgement penalty amnesty has been announced for small businesses with an aggregate turnover of less than $10 million, for outstanding lodgements lodged 1 June 2023 to 31 December 2023, that were originally due during the period 1 December 2019 and 29 February 2022 (largely aligning with the COVID-19 pandemic).
Pillar II: implementing the 15% global minimum tax
As with all international tax changes, both the announcement and the resulting law are complicated. The following tries to distil the key measures. Following the 8 October 2021 endorsement of the OECD Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitisation of the Economy, the 2023-2024 Federal Budget announced Australia's implementation of Pillar II. Of particular note, in addition to the Income Inclusion Rule (IIR) and Undertaxed Profits Rule (UTPR), Australia will also implement a domestic 15% minimum tax for certain entities.
In short the rules seek to ensure that regardless of the location in which the income is derived, it should be subject to a rate of tax at least 15%. This counters multinationals taking advantage of low tax, or tax concessions in particular jurisdictions. The tax is implemented in a top-up manner to ensure that the global group will have an effective tax rate of at least 15%.
Australia will implement the 15% global minimum tax in the following manner:
- From income years beginning on or after 1 January 2024, the IIR will apply to top up Australian headquartered multinationals, or foreign multinationals located in jurisdictions that have not implemented an IIR where there is income within the group that has not been subject to tax at 15%.
- To supplement this rule, from income years beginning on or after 1 January 2025, the UTPR will apply where no IIR applies to the group and will deny deductions in Australia to ensure that the Australian income is subject to tax at least at 15%.
To ensure that Australia does not lose out on revenue as Pillar II is implemented around the world, Australia has followed the lead of others such as the United Kingdom, the European Union, Singapore and Hong Kong( to name a few), and is implementing a domestic 15% tax rate. Without such a rule, income adjustments for lower taxed Australian income could have been subject to the IIR in other jurisdictions, thus foregoing the opportunity for additional revenue.
Consistent with the model approach, the measures will apply to multinational groups with annual global revenue of EUR 750 million. While we do not have specific details on how these will be implemented, it is intended that certain sectors to which the measures will have particular adverse application will be carved out. Those include investment funds, pension funds, government entities, international organisations and not-for-profits. Industry will be keenly awaiting the definitions of those particular groups to determine whether they are in or out of the measures.
The Government has announced a mixed approach when it comes to the interaction with franking credits. The domestic minimum tax gives rise to franking credits. However, consistent with OECD guidance, the IIR will not give rise to franking credits. At this stage no announcement has been made on how the foreign income tax offset rules will interact with the measures.
What this means for you: At this stage, there is no draft legislation or an indication as to when it will be released. These are complex measures, not just from a domestic implementation perspective, but also regarding their interaction with other foreign tax systems. It will be essential that those affected are given enough time to consult on the rules to assist to identify any inadvertent consequences, and then to have sufficient time to prepare for implementation of the complex rules.
The interaction of Pillar 2 measures with other foreign tax systems will be complex.
Superannuation: payday super
On 2 May, the Government announced that employers will be required to pay superannuation guarantee (SG) contributions on employees' payday from 1 July 2026.
Currently, to avoid the imposition of the superannuation guarantee charge (SGC), employers are required to pay superannuation to the employee's fund on or before the quarterly due date. However, some employers choose to make payments more frequently, such as monthly or fortnightly.
The new requirement will align the payment of SG with the payment of salary and wages. The Government expects the measure will make it easier for employees to monitor their payments. In 2019-20, the ATO estimates the net SG gap to be $3.4 billion, or around 4.9% of theoretical SG contributions.
What this means for you: Employers must comply with SG requirements and do so by the payment deadline to avoid the imposition of penalties and non-deducibility of contributions under the SGC regime. The deferred start date of payday super allows for employers, superannuation funds and payroll providers to update their process and systems prior to the change, and, importantly, to allow systems and software providers the time to make necessary changes to supporting products. We expect that given the possible increase in processing fees (such as software subscriptions or superannuation clearing house fees) and to enable compliance by the due dates, this measure may result in some employers moving some employees to a less frequent pay cycle.
The measure follows an increased focus on employer compliance and greater visibility over employees' pay in recent years. For example, Single Touch Payroll introduced the disaggregation of pay components to improve reporting of income for means-tested government payments through Services Australia.
This Budget has seen a renewed focus on the enforcement of employers' superannuation guarantee obligations by the ATO.
The Government will provide $40.2 million to the ATO in 2023-24 to improve the ATO's data-matching capabilities to find and act on superannuation guarantee underpayment. We expect an increased data-matching capability will see an increase in initial letters from the ATO to employers who may have been flagged for potential non-compliance. The Government has also announced it will set public targets for the ATO's recovery of unpaid superannuation, to be reported annually.
Superannuation: No change to the statutory Superannuation Guarantee rate increases
As expected, the Government did not announce any changes to the scheduled increase in the statutory SG rates. We note the SG rate changes as presently scheduled are:
- 1 July 2023 – 11%
- 1 July 2024 – 11.5%
- 1 July 2025 onwards – 12%.
Most immediately, the rate of SG increases to 11% from 1 July 2023.
What this means for you: Employers should ensure that they are prepared for this increase and aware of the difference for employees on total fixed remuneration packages as compared with those on remuneration plus packages.
Non-arm's length income rules
Following the release of the 24 January 2023 consultation paper, the Federal Government has announced the following changes to the operation of the non-arm's length income rules.
- For self-managed superannuation funds and small APRA-regulated funds (funds with 6 or few members):
- the amount of income that will be taxable as non-arm's length income (NALI) will be limited to twice the amount of a general expense subject to the rules;
- contributions will be carved out of income that can be subject to the NALI rules;
- exempting large APRA-regulated funds from the NALI provisions for both general and specific expenses; and
- exempting expenses that were incurred prior to the 2018-2019 income year.
What this means for you: These changes will be welcomed by the superannuation sector following the uncertainty on the potential broad application of the measures following the ATO's expansive view on the operation of the provisions in Law Companion Ruling 2021/2. These are sensible changes to limit what should be very targeted integrity measures to schemes that are implemented with the intention of subverting the non-concessional and concessional contributions caps.
For large APRA=regulated funds this change will eliminate the additional compliance burden associated with seeking to ensure that rules, which from a policy perspective should never have any application to them given their regulatory environment, do not inadvertently apply.
For self-managed superannuation funds and small APRA-regulated funds, these changes limit the potentially wide impact of the application of the general expenses, which could have resulted in the whole income of the fund being subject to tax at the higher non arm's length income rate. The sector will also welcome the sensible carve-out for contribution income from the provisions, given that inherently in their nature, such income could not be the subject of any non-arm's length arrangement.
Superannuation: income tax rates
As announced on 28 February 2023, from income years beginning 1 July 2025, income on superannuation balances exceeding $3 million will be subject to tax at 30%, rather than 15% for income in accumulation phase or 0% for pension phase.
The tax will be imposed on the individual, with the option for taking the tax out of the superannuation fund.
What this means for you: No additional details regarding the proposed measures were announced during the Budget, so at this stage the following key open questions remain:
- The 31 March 2023 consultation paper announced that the 30% tax would apply to the growth in the balance of the superannuation fund in the year, consequently taxing the unrealised growth in the fund. From a design perspective, this is a feature that has been heavily criticised and is a departure from the typical manner in which tax is levied on flows of income. Industry has criticised the liquidity concerns that such a measure will have on the sector. Will the Government reconsider this approach and design a mechanism where the tax is on realised gains?
- The Government intended for the measure to apply equally to accumulation and defined benefit funds. However, given the formulaic nature of defined benefits funds, taxing, there will be considerable complexity to navigate and a potential mismatch in approaches between accumulation and defined benefits as it comes to the manner in which the tax be paid out of the superannuation fund. How will the Government navigate the complexities of the defined benefit market, a market that is likely to have quite a few affected participants?
- The big question regarding indexation. The Government has announced that it is not intending for the $3 million cap to be indexed. However with increases in superannuation guarantee and rising inflation, the amount of Australians with a $3 million balance might start to rise considerably. Will this approach be reconsidered?
We have a few more budgets and an election before this measure will be implemented. In that time, Treasury will need to work on implementing what appears to be a simple change, in a very complex system.
Small business deductions – for a limited time only
From 1 July 2023 to 30 June 2024, small businesses with aggregated annual turnover (ie. total ordinary income of the business and that of any associated businesses) of less than $10 million will be able to immediately deduct the full cost of eligible assets valued at less than $20,000. The $20,000 threshold will apply on a per asset basis, so multiple assets can instantly be written off. Ineligible assets valued over the $20,000 threshold can continue to be placed into the small business simplified depreciation pool, and the provisions preventing small businesses from re-entering the simplified depreciation regime for 5 years if they opt out will continue to be suspended until 30 June 2024.
Further, as part of the Small Business Energy Incentive, small and medium businesses with aggregated annual turnover of less than $50 million will be able to deduct an additional 20% of the cost of eligible depreciating assets, including upgrades to existing assets, that support electrification and more efficient use of energy, up to a maximum bonus deduction of $20,000. Examples include energy-efficient fridges, electric heating or cooling systems, or demand management assets such as batteries or thermal energy storage. However assets such as electric vehicles and assets that are not connected to the electricity grid and use fossil fuels will be excluded from the incentive.
When this comes into effect: To be eligible, the abovementioned assets must also be first used, installed ready to use, or upgraded, for a taxable purpose between 1 July 2023 to 30 June 2024.
What this means for you: The instant asset write-off is a small win for small businesses to reduce compliance costs and increase cash flow. The additional depreciation deductions for eligible depreciable assets are expected to incentivise small businesses to invest in energy efficient assets at a time when energy prices are expected to increase substantially over the coming years. With interest rates also at near term highs, businesses will need to determine whether the additional capital costs make sense in the short- and long-term.
Petroleum Resources Rent Tax (PRRT) and Australia's energy transition
As foreshadowed by the Treasurer as part of pre-budget announcements, the Government will introduce a number of technical changes to the PRRT regime.
The bulk of these changes are in direct response to the Treasury Gas Transfer Pricing Review released on 7 May 2023 (GTP Review) as well as an earlier PRRT review conducted by Michael Callaghan AM PSM.
Broadly, the PRRT is a tax on profits generated from the sale of certain petroleum commodities (such as liquified natural gas) related to oil and gas projects located offshore in Australian waters. While the taxing mechanics under the PRRT regime are inherently complex, a key component is the gas transfer pricing (GTP) rules which broadly determine a price to calculate the PRRT revenue from a relevant LNG project. The operation of the GTP rules was a core focus of the aforementioned reviews.
As part of the PRRT budget measures, the Treasurer has stated that the Government will proceed with 8 of 11 recommendations of the GTP Review and 8 recommendations of the Callaghan Review.
While the specific detail of any corresponding legislative changes is limited at this stage, the Treasurer has indicated that a key reform will be focused on the deductions regime for LNG producing projects (ie. "LNG Projects"). Importantly, under the current PRRT regime, taxpayers can generally offset 100% of their exploration and development costs before being required to pay any PRRT on profits generated. As per the Budget papers, this means that most LNG Projects are not expected to be subject to any significant amount of PRRT being payable until the 2030s.
In order to address this perceived issue for LNG Projects, a deductions cap will be introduced such that the annual allowable expenditure deductions under the PRRT regime for LNG Projects will be broadly limited to 90% of each taxpayer’s PRRT assessable receipts (with a corresponding carry forward mechanic for amounts unable to be deducted due to the deductions cap). Further, LNG Projects would not be subject to the deductions cap until 7 years after the year of first production or from 1 July 2023, whichever is later. Certain expenditure such as closing-down expenditure, starting base expenditure and resource tax expenditure will not fall within the deductions cap.
In the words of the Treasurer this measure is intended to result in "more tax, sooner". In this respect, the Government has indicated that the PRRT measures will result in a further $2.4b of PRRT payable over the five years from 2022-23.
The Treasurer has stated that the Government will consult on the final design and implementation details for the deductions cap and GTP rule changes later in 2023 with consultation on other policy changes, such as the recommendations from the Callaghan Review and an update to the PRRT general anti-avoidance rules in early 2024.
Separate to the aforementioned changes related to the GTP Review / Callaghan Review, the Budget papers also flagged certain other targeted amendments, including that the PRRT legislation will be amended to clarify that, for any expenditure incurred from 21 August 2013, the term "exploration for petroleum" is limited to the "discovery and identification of the existence, extent and nature of the petroleum resource" and does not extend to "activities and feasibility studies directed at evaluating whether the resource is commercially recoverable".
Overall while some of the changes flagged are significant, they do not (as currently announced) represent the widescale overhaul of the PRRT regime that many within the industry had speculated when the PRRT regime was first canvassed by the Government as being a focal point of this year's Budget. However it will be interesting to see the full scope of the changes once the relevant amending legislation is publicly released down the track.