Income Tax Part IVA Tax Policy

Unfortunate facts for those who want more tax from multinationals

I once worked for one of these multinationals. It was a US Company with a direct investment in Australia. The US company charged the Australian subsidiary management fees for head office costs, legal, finance…

We were subject to a transfer pricing review by the ATO and at the same time the IRS in the US subjected the US parent to a transfer pricing review. The ATO initially indicated they were of the opinion the management fees were too high for the services provided and so would consider denying deductions. Two months later the IRS indicated the management fees were too low and they would be considering substantially increasing the taxable income of the US entity.

In the end we had to get the ATO and the IRS officials on the same phone call and remind them that in their desire to collect taxes they had to remember that in international transactions, every additional dollar of tax one country collects, due to the various international tax agreements, is one less dollar collected in the other country. Both finally agreed that the management fess were appropriate (months and months and months later…).

With our wonderful politicians and media outlet screaming for more tax from multinationals they need to learn the same lesson.

The US Treasury’s top international tax official, Robert Stack, is also concerned about Australia forming an alliance with Britain and lining up US digital companies to be slugged with a so-called Google tax. The mooted changes would divert to Australia money that was potentially in line for US government coffers, triggering a cross-country fight over taxing rights… “We understand that governments are under enormous pressure to raise revenue and it must be tempting to target non-residents,” Mr Stack said in an interview with The Australian Financial Review in his Washington office. “However, we hope and expect that all companies, including US companies, will be treated fairly and in accordance with international norms of taxation.”

Let me explain it by looking at a multinational’s presence in Australia, my favourite example company, Banana IT.

The IP in the Banana products is owned by Banana US. It licences the right to use this to Banana Singapore (Owned by Banana US) with the rights to sell the product in South East Asia. Banana Singapore pay Banana US a fee for this right. Banana Singapore makes the products (by contracting third parties in China) and sells them to Banana Australia (Owned indirectly by Banana US) at an arms length wholesaler price (as required by international tax agreements). Banana Australia sells the product and makes a retailers profit.

The reason they chose Singapore for the South East Asia hub is the low company tax rate.

Now the Australian Government wants to get more tax in Australia on this supply chain. This is done by increasing the profit in Australia, thereby decreasing the profit in Singapore, meaning less tax in Singapore and more in Australia (Singapore not happy).

But remember, when Banana US is in a bit of financial trouble or wants to make a big acquisition it calls in all of its profits in subsidiaries and dividends get paid back to the US. Banana US has to pay tax on these dividends less the tax already paid in Australia, Singapore… So for every additional dollar of tax paid in Australia is a dollar less tax paid in the US in the future.

If I was the US Treasury, with a $17 Trillion deficit, I would not be happy with Australia claiming taking my future tax revenues from US companies…

Income Tax Rulings

The Commissioner believes in drinking in moderation?

In Taxation Determination TD 2015/9 the Commissioner provides amounts that he will accept as estimates of the value of goods taken from trading stock for private use by taxpayers in named industries.

This helps certain businesses estimate what trading stock has been “sold” outside the normal course of business (like eaten by the owners).

So if you are advising a licensed restaurant or cafe let them know the Commissioner expects them to drink $1,030 of alcohol each year… why? here are the two estimates from the determination

Restaurant/cafe (licensed) $4,490
Restaurant/cafe (unlicensed) $3,460

I can have imported beer now!

Planning Idea Super


Do you have clients who want their money now? “I wont live long enough to get my super!” They want the whole 100% in their hand, not just 91.53% ($91.53 + (9.25% of $91.53) = $100)…

Well maybe you can legally help them…

In ATO interpretative decision ATOID 2015/9 the Commissioner considers whether there are SG obligations when the personal services income rules apply. He asks whether attributed personal services income is ordinary time earnings (as is required before SG obligations apply).

The answer he comes to is, if the attributed income is not actually paid to the individual service provider in the year of income it is attributed to the taxpayer, then there are no SG obligations. As it is not “paid” he says it can’t be ordinary time earnings.

So if you really wanted to keep the 9.25% out of super, set up a personal services entity, get your personal service income paid into the entity, and don’t take it out in the year you earn it… 

You will be taxed on it at your individual rates as the income in the entity will be attributed to the individual and included in the individual’s tax return (rather than the 15% rate that the super fund pays… Maybe everyone earning less than $37,000 should do this once the low income super contributions ends on 30 June 2017????).

In the subsequent years, when it is paid to the individual out of the entity it will be exempt income (86-35 of the ITAA97).

But it does seem like a lot of effort to avoid some of your salary going into a low taxed super fund.

Legislation Rulings

Earnouts – the wait is over

A long, long time ago in a Tax Office far, far away…

After waiting 6 and a half years the Treasury has finally drafted some legislation to fix up how capital gains tax concessions apply to earnouts.

But just a quick reminder on the history of this issue…

In October 2007 the then Commissioner of Taxation released a draft ruling (Draft Taxation Ruling TR 2007/D10) that stated the small business CGT concessions could NOT apply to payments under earnout arrangements. As this outcome was ridiculous, the Commissioner never finalised the draft ruling waiting for the Treasury to fix the legislation. And the clock started ticking…

In 2010 the then Assistant Treasurer announced they would make a legislative changes to overcome some some consequences of the Commissioner’s position in the draft ruling (3 years to get a press release).

In 2013 the then Assistant Treasurer confirmed they would continue with this proposed legislative change (another 3 year to get another press release saying they will do what the first press release said).

During this time the Treasury was working hard to come up with the obvious solution that everyone knew. They released a discussion paper saying what we all thought, and had consultation in 2010 and 2011 where we told them we agree with what they want to do. It was so obvious what was going to happen that the Commissioner has allowed taxpayers to apply the law in expectation of what it will be under these changes all the way back to 2007 …

And now on to what the Treasury has done in the last 6 and a half years…

The draft law does four things:

  • Capital gains and losses in respect of a look-through earnout right are disregarded;
  • Financial benefits under or in respect of a ‘look-through’ earnout right are included when determining the capital proceeds or cost base of the underlying business asset to which the arrangement relates;
  • A taxpayer’s assessment for a tax related liability that can be affected by financial benefits provided or received under a ‘look-through’ earnout right may be amended for up to four years after the earnout arrangement expires.
  • Capital losses arising from a CGT event related to an earnout right may not be taken into account in determining tax liabilities until such time as they cannot be reduced by future financial benefits received under a relevant look-through earnout right.

So the draft law means that where there is an earnout, the only CGT event is the sale of the business and any future payments under the arrangement is just a change in consideration for that sale. Therefore, the small business CGT concession can apply to all the consideration for the sale of the business. Exactly what we always thought.

Just a few quick notes:

  1. This only applies to active assets;
  2. This only applies to real earnouts, and not to just deferred payment plans – the financial benefits provided must also be not able to be reasonably ascertained at the time the right is created;
  3. All the payments under the earnest have to be paid within four years;
  4. All look-through earnout rights must be created as part of arrangements entered into on an arm’s-length basis.

An 18 page bill, a 33 page EM and a two page issue register in 78 months since the issue arose, and remember there was a pretty obvious answer in October 2007 – so obvious we just kept lodging returns as if the law was as this draft law is.

But at least the Commissioner has learnt a lesson. Releasing a draft Ruling with a ridiculous outcome (but correct at law) is not an effective way to encourage the Treasury to quickly fix the law…

Income Tax Tax Policy

How would I change negative gearing?

Simply I wouldn’t. 

But having worked in an office at Parliament House and in the Federal Treasury, sometimes you have to do things you don’t agree with. And it looks like someone is going to be told yo do this 

First, can we be clear there is no such part of the tax law that allows “negative gearing”. Like almost every other tax system in the world, our tax laws allow people to claim a tax deduction for expenses – like interest on a mortgage – that relate to gaining income – like rent from an investment property.
Second, can we be clear that people claiming “negative gearing” deductions are claiming the deduction on actual cash they have paid out. They are spending real money on their rental property and are getting tax deductions for it.
And thirdly, “negative gearing” can apply to anything you buy using borrowed money to make income from, not just property. I could borrow to buy shares and if the interest on the loan I pay is greater than the dividends I get in a year the shares were negatively geared. I could borrow to buy a piece of software I want to licence to others in Australia and if the interest on the loan is greater than the licence fees I get the software is negatively geared.
And after reading these three point “negative gearing” now sounds a whole lot less scary and evil than when it is described in the media.
So lets get to making the changes to negative gearing. But first we need to know why we are doing this. To take property investors out of the market? Lets be honest and say we are doing this so we don’t have to cut expenditure. We are just doing it to raise money. And if this is the reason we need to ensure we understand flow on effects. For example, if all we do is drive investors to buy low yield shares that might have high potentially capital gains we will raise no income tax, and reduce stamp duty collected.
So to avoid these flow on effects we have to either “cover the field” by closing negative gearing on all asset classes (property, shares, …) or only cut negative gearing deduction on property to a point where no one will change their investing practices.
“Wont people just move to super?” Super fund can’t borrow (limited recourse borrowing are dead – trust me). And you can only get a deduction for $30k into super each year.
Lets start with covering the field. We need to limit interest deduction (or equivalent to interest) on purchasing any asset where the asset is used to make passive income (rent, licence, royalty, …). I would actually like this to the definition of “active asset” in Division 152 of the ITAA1997.
So how much of the interest deduction do we limit? Either the amount above the passive income or just a percentage of the interest based on the equity invested. These two options already exist in the tax laws.
In Division 35, if you run a business on the side and it makes losses (called non commercial losses) you cannot offset it against your other income. In Division 820, we have the Thin Capitalisation rules which only allow deductions on a part of any interest expenses base on a debt to equity ratio.
I would love to use a thin cap model. If you borrow more than 70% of the value of the asset to gain passive income (“to acquire an asset that is not an active asset”) you cannot claim the deduction for interest or interest equivalents on the amount borrowed above the 70%. Each year the taxpayer can, at their election, revalue the asset to see if the initial loan is now less than 70% of the current value of the asset.
I am not sold on 70%, and would leave it to the actuaries to work out a percentage.
But this would slow investors who would wait till they have 30% equity before they buy.
The reason I prefer the thin capitalisation model is there are just to many problems with the non commercial losses model. For example:
I buy a rental property on a mortgage, incur interest but can’t find a tenant. This goes on for a year. I then sell the property. Under the non commercial losses rule equivalent I never get to claim the interest as a deduction. Now I had no idea my property would be negatively geared when I bought it. So I had no idea that interest would be non deductible.
With the Thin Capitalisation model you know what you will be able to claim as an interest deduction.
Now lets look at option two – Change negative gearing enough to raise some tax but not too much so that people change their practices. But isn’t this the model I recommended above but just with a higher percentage – 80%.
If interest is only on 70% or 80% then the interest expenses will be less, and the rent is set by the market so there is no change in income.
This only applies for new non active assets.
So we have raised some money… I think. And the chattering class can pat the government on the back (and ACOSS WILL HAVE TO FIND A NEW BOOGYMAN). But this is a great reason to change taxes and to change the fundamental proposition that you can claim a tax deduction for expenditure incurred in gaining income.
Super Tax Policy

Tax announcement everywhere…

I hope Chris Bowen is Prime Minister one day. Yes big call but he is measured and thoughtful and never ever in a rush.

And he has now released a super tax policy. It is a good start…

For those who will scream “wont we have thousands of more people on the pension if we increase tax on super?” The percentage of people over retirement age receiving the pension is the same as it was in 1992 when super was introduced so end of arguement

Labor will add 15% tax on earnings from super accounts in pension phase where the earnings are above $75,000 a year. They chose this number as to get $75,000 you need to have about $1.5 million in assests in super.

Wayne Swan announced this before but, like mist of his announcements, never got any legislation ready.

There will be transistions for Capital Gains. If it is like the Swanny rules the Capital Gain in any new assets will be covered by the 15% and the tax will apply to all Capital Gains that occur after a date in ten years time.

This is still amazingly concessional, as is you have two retirees and their super fund in pension phase earns $200k a year, each retiree gets $100k each and has to pay $4,500 tax each (15% of $30,000). But it is a start… And I doubt anyone will change the tax planning advice they give to high wealth individuals.

The second change is another no brainer. The Division 293 tax is the extra 15% tax that high income earners (greater than $300,000 a year) pay on their super fund contributions. This tax means those who earn under $300,000 pay 15% on concessional contributions and those above pay 30%.

When this came in people whinged and complained and then realised that a 30% tax rate is 19% lower than a 49% tax rates. So no one changed their advice to their high wealth clients.

So what will Labor change regarding Division 293 tax? The $300,000 threshold goes to $250,000. Yawn… But a good start.

(I should mention they will also remove the 10% tax offset for defined benefit income above $75,000).
A good start. And to call it anything else is kidding yourself. We have a public finance structural deficit if $40 billion a year and this will raise $1.4 billion. But politics wins again.
And of course Mr Populist, Bill Shorten destroys the good start by ruling out any other changes to superannuation if Labor wins the next election. 

This demonstrates how Labor will responsibly manage the budget and the economy without stifling economic growth or cutting billions of dollars from pensions, health and education.

I hope he knows where he is going to find the other $38 billion a year (i am kidding myself) without touching any of these. 
Remember, he wont increases taxes in his first term unless he takes the tax change to next years election.

“If Tony Abbott wants to increase taxes – be it petrol, be it GST – he should take it to an election,”…

So Bill will make only minir changes to revenue and wont change any of the big expenses…
Chris Bowen for PM!!!
Tax Policy

The Greens have a tax policy!!!

In the history of the Greens has there ever been a day they have made two tax announcements? Mark down 21 April.

First, they have plans for small business tax. They are proposing:

  • A 2% tax cut for small businesses
  • Restoring and increasing the instant asset write-off threshold to $10,000
  • Restoring the loss carry-back provisions

Of course everyone knows the Coalition will announce a 2% small business tax cut in 21 days time in the budget so it is not a very brave announcement. But, other than there being no announcement on how they are going to fund it, we would all love a $10k instant asset write off. But remember what Government finances were like in 2008/09 when the Henry Review recommended this.

Second, the Greens leader has released a discussion paper of policies to crack down on “tax avoidance by multinational corporations”. Can someone please give her a dictionary… What is tax avoidance…

… “Tax avoidance is the legal usage of the tax regime to one’s own advantage to reduce the amount of tax that is payable by means that are within the law.”

She goes on to say companies that legally use the tax system are “dodging their taxes.”

This is a parliamentarian who doesn’t understand it is good to act according to law…

But lets get to the actual policy.

1. Re-employ the ATO employees who lost their jobs in the last 18 months… Does the Senator realise these “dodgy companies” were acting in the same legal way more than 18 months ago when all these employees were at the ATO?

2. Help whistleblowers at the ATO come forward – sour grapes that after spending a week in a Senate committee find absolutely no unpaid corporate tax?

3. Increase what the ATO publishes. This would include who the ATO settles matters with and “name and shame the worst offenders of profit shifting”. Remember, in the Senate inquiry we leart that the Senator and senator Xenophon think that paying for products from your Overseas parent company that you sell onto customers is profit shifting… Shouldn’t the parent company just give it to the Australian company for free??? If they did it would be illegal profit shifting from thE other country to Australia senator!

Apart from some changes to corporate reporting to ASIC this is it. 

Finally, if there are actually companies “dodging their taxes” as the Senator claims, they wont be worried at all. All the information the Senator wonts public is already in the ATO’s hands. So there will only be extra tax collected if the 20,000 ATO employees are in on the companies scam and ignoring the information they already have – nice conspiracy theory Senators.

Income Tax Tax Policy

What is happening at the Australia Institute?

This morning the head of the Australia Institute, Richard Dennis, tells us there is no other imputation systems in the world and we can save biiillliiioonnss by removing it.

Wrong and wrong… But exactly what Fairfax journalist would love to print so he is a very good lobbyist.

First, I assume he has never heard of New Zealand – Australian residents can actually claim New Zealand imputation credits against their New Zealand sourced income. UPDATE they have changed the heading of the article removing this claim. I assume Fairfax New Zealand put Fairfax Australia straight…

Second, and much more importantly, Richard knows that to avoid double taxation of company profits you need to use one of two things.

1. An imputation system where the company pay a high tax rate but if it pays out a dividend to a shareholderthe shareholder  gets the benefit of the tax already paid.

For example a company makes profit of $100. The company pays tax of $30 (30%). The shareholder get $70. Without an imputation system the shareholder pays another $34 (49% is the highest individual rate) so the shareholder only gets $36, and the tax man gets $64 of the $100. But with an imputation system the shareholder gets a credit for the tax already paid buy the company at 30%, so the shareholder pays a top up tax of 19% (49% – 30%). And the shareholder gets $51 and the taxman gets $49. Perfect.

2. The second model is a low rate or exemption model.

This is where you exempt company to company dividends (or you can approach 100% tax rates through a chain of companies if there is no imputation system).

But to stop the double taxation that occurs when the dividend is paid to the final individual/trust/super fund shareholder like in the example above, every developed country has introduced a much lower company tax rate or/and a lower tax rate for dividends.

If you don’t do this dividends stop being paid by companies as it is much better from a tax persepective to keep the money in the company and make capital gains where there is no double tax.

So due to taxpayer response,  less tax is collected if you don’t bring in an intercorporate exemption and a lower company tax rate or dividend rate.

Stop pretending we could save $5 billion a year by removing imputation, unless you have the guts to say you want to keep the 30% company rate as well as getting rid of imputation. Also, you need to say no company will notice and change their practices because they are all pretty stupid. Go on, say it! I dare you…

Finally, if the Australia Institute want to remove imputation and reduce the company tax rate (which is the only reasonable change on the table), I expect they will get lots of funding from Apple and Google. You see, a company with Australian shareholders love the imputation system as any tax they pay are passed to their shareholders as a credit. But that is not the case for non resident shareholders, including most of the shareholders of Apple and Google. These multi nationals, which Richard slammed at a recent Senate hearing for not paying enough tax, would love to pay even less tax in Australia because they can’t pass the credit for the company tax they pay on to their shareholders in other countries.

Richard, do you want the current system (no according to todays rant), a system where there is double taxation that can approach 100% and stops dividend payments (I hope not) or a system with a lower company tax rate that is better than the current system for only one group of people – those evil multi nationals you tell us some much about?

The Australia Institute is just doing the oldest Magician trick – distraction. If we are thinking about the imputation system, or capital gains taxation, or super concessions, or multinational tax payments, or whatever tax, we wont allow our politicians to think about reducing spending because there may be all this extra tax we can raise… But it is a very effective lobbying tool…

Look at my right hand over here…

Tax Policy

I give up… Media and tax reform

To the Fairfax and ABC media screaming that corporates dont pay enough tax, here is a lesson that is pitched for those with limited desire to investigate – i.e. Journalists.

Bill Pty Ltd runs a petrol station. He buys 2 million litres of fuel each year. He buys it at $1.50 and sells it at $1.53 (10 years ago when I last had a fuel station client markups were 2%). His turnover is $3 million dollars. His electricty and repairs and… is $10,000.

So how much tax does the ABC and Fairfax think he should pay. 30% of his turnover – being $900,000.

Well that is what they want Apple to pay. “How can Apple Australia only pay  $80 million in tax on $6 billion turnover?” They ask… The answer is you dont pay tax on turnover!!!!

Poor Bill has a turnover of $3 million but after he pays for the fuel to sell, and his costs he only has $50,000 to pay the owner who had to work every day as he could not afford staff. And what tax does this evil tax dodger pay on its $3 million turnover? A mere $15,000. That is a rate (tax to turnover) of 0.5% (Barry Cassidy has just had a heart attach and Michael West is in a fit!).

If the PROFIT is only $50,000 then $15,000 tax is appropriate.

Apple Australia is merely a reseller of Apple products, deigned by Apple US and made by Apple Singapore. Its mark up (profit % on coat of goods) is almost identical to other resellers like JB HiFi.

So having a turnover of $6 billion is irrelevant. What is the profit? About the same as JB HiFi (as a percentage of sales)…

Grow up and inform us journalist.

Tax Policy

Swings and tax roundabouts…

“Google should pay more tax in Australia. If their customers are in Australia, that is where they should pay tax…” So I was told today. My response…

One of Australia’s biggest tax payer, Rio Tinto, sells 35% of its products to China but pays all its tax (almost all) in Australia. If you believe in “customer location” taxation, then you believe in bankrupting Australia…

“No. Australian companies still return their income in Australia but multinationals have to pay more”… I can’t even begin to start to answer this response…

It would be nice if people complaining about what tax multinationals pay understood there are other countries in the world that also have tax systems to pay for their schools, hospitals…