TaxRambling.com

When the idea of indexing rates and thresholds in the tax legislation is discussed, it is often discussed in terms of bracket creep that occurs due to the individual income tax thresholds not being indexed. However, while this is a great example of this issue (if the highest threshold had have been indexed for CPI when it was set at $180,000 under the Howard Prime Ministership, it would be over $250,000), there are many other more objectional examples. 

These objections are that, due to the fact that the threshold is not indexed, much of the purpose of the underlying legislation is lost over time. There are examples where unindexed thresholds mean that concessions have been offered to taxpayers for good reasons are now almost irrelevant. There are examples where anti-avoidance provisions have been watered down by unindexed thresholds to be much easier to avoid. Therefore, these unindexed thresholds both increase (limiting concessions) and decrease (limiting anti avoidance measures) the tax collection. 

It must be acknowledged that in almost all these cases this was not a choice of those implementing the policy, but this occurs merely by the fact that the drafters of the legislation did not consider that the value of money changes over time due to inflation.

Therefore, the Government should consider a program of considering all thresholds in the tax laws that are not indexed, and consider indexing them by some appropriate measure.

It may also be worth considering if the thresholds that are currently indexed are indexed using an appropriate measure. Recently the indexation measure for HELP was amended to be more appropriate and other indexations may also need such adjustments. This could be done in conjunction with looking at unindexed thresholds.

Example 1: The Non Commercial Losses rules

The Non Commercial Losses rules in Division 35 were introduced by the New Business Tax System (Integrity Measures) Act 2000 and applied from 1 July 2000. Division 35 arose as a result of the Government’s adoption of Recommendation 7.5 of the Ralph Committee’s report, Review of Business Taxation: A Tax System Redesigned. This recommendation focused on significant revenue leakage from individual taxpayers claiming deductions for unprofitable activities which were ‘often unlikely to ever be profitable’.

In Division 35 there are a series of exemptions such that these rules do not apply if:

• the amount of assessable income derived by the individual from the relevant business activity for an income year is at least $20,000
• The activity has produced a tax profit in 3 out of the past 5 years. 
• The individual uses real property, or an interest in real property, on a continuing basis in the relevant business activity, that has a value of at least $500,000
• The individual uses certain other assets, on a continuing basis in the relevant business activity, that have a total value of at least $100,000

Almost 25 years later the three dollar based thresholds still remain, making avoiding these exception substantially easier to fall within than they were in 2000. These exemptions will apply to more and more taxpayer, making this anti-avoidance provision less useful each year, as these thresholds have not been indexed.

From above we see that this anti-avoidance measure does not apply if there is $500,000 of real property used in the business. Estimates range within types and locations of properties, but estimates of the increase in property prices from 2000 to today are between 300% to 450%.  Taking the mid-range (375% increase in property from 2000 to 2024), in 2000 dollars this $500,000 threshold is now the equivalent of a mere $133,333. For example, in 2000 I was unable to offset the losses from my Alpaca farm against my other income because the land I was using in the farm was only worth $133,333 in value, and well below the $500,000 required. But now in 2024 that same land would be worth over $500,000 and I could offset these losses against my other income.

CPI has increase by 44% over these 25 years so that the $20,000 assessable income threshold of 2000 is effectively just $11,200 in 2000 dollars, and the $100,000 other asset test is also almost halved by inflation.

Every year this anti-avoidance provision become less applicable due to unindexed thresholds

Example 2: Tax rates for eligible income of minors

In the Income Tax Rates Act 1986 a higher tax rate was set to apply to the eligible income of a minor who was a resident for the full income year. It was reduced by this Act so that only the first $416 of eligible income of these minors is taxed at the normal individual rates. Therefore, if the beneficiary has no other income, no tax is payable on the first $416.

This was to acknowledge that minors may have small amounts of passive type income and they should not be penalised for that, but the tax laws should stop parents diverting passive income to their children for tax minimisation purposes.

But as the $416 has not been indexed, it remains at this rate 38 years later.

Given inflation this $416 concession has become effectively smaller and smaller each year. $416 today is the equivalent of $194 in 1986 (214% CPI inflation) so this concession is worth less than 50% of its original amount as it was not indexed. The policy (allowing a small amount of passive income to be derived by minors without an effective penalty tax applying) has not changed by the indexation has substantially effected its operation.