Chris Evans|Knowledge@ASB

Who would be the winners and losers if Australia simplified its tax system? As tax time looms, many Australians with relatively simple tax affairs are once again preparing to file a return in the hope of receiving at least a small sum back. And accountants and tax agents also are bracing for the annual onerous round of compliance activity on their behalf. But it doesn’t have to be like this! In the UK and New Zealand, the personal tax system has been simplified, so most “wage slaves” who are taxed at source no longer need to fill in a return. While taxpayers are spared the obligation for frequently negligible returns, accountants are able to focus on the more interesting activities of adding value and creating greater wealth for clients. In an interview with Julian Lorkin of Knowledge@Australian School of Business, Chris Evans, professor of taxation, outlines why the case for simplified tax adds up.

An edited transcript of the interview follows.

Knowledge@Australian School of Business: Many people loathe tax time, having to fill in a tax return every year and go along to an accountant. Is there an easier system?

Chris Evans: In many countries in the world you don’t fill in a tax return. Take the UK or New Zealand, for example, very few taxpayers in those countries have to fill in returns. It’s only taxpayers with more complicated tax affairs that have to complete and submit an annual return. Otherwise the tax system takes the right amount of tax at the right time during the year. At the end of the year, you neither owe money to the taxman, nor are you owed money.

In Australia, we could look at changing our system away from what we call comprehensive filing, in which everybody has to file a return, into one where there’s much more selective filing – only those with more complicated affairs need to submit a return. Those of us who are straightforward “wage slaves”, that is, people who have only employment income and have had the right amount of tax taken at the right time during the year would have nothing more to worry about.

Knowledge@Australian School of Business: I’ve been talking to Michael D’Ascenzo, the commissioner of the Australian Taxation Office, and he was saying that people enjoy filling in a tax return simply because they get money back as a result. They consider it almost like Christmas when they get the cheque in the post.

Chris Evans: That’s a rather strange way of looking at it. I don’t prepay my electricity so that I can enjoy getting money back at the end of the year. Why would I enjoy prepaying my tax, paying it before I need to and then getting a nice cheque back at the end of the year? It used to be a tradition in Australia that those cheques, the tax refunds, paid for the annual holiday, or the fridge, or something big. From the commissioner’s point of view, he’s obviously interested in getting everybody to submit a return because it’s sort of command and control and it means you know what’s going on. But the point is the tax office already knows most of that information anyway because the employers have sent in the amount of tax that they have deducted. If they wanted to, the tax office could find the information from the banks about the amount of interest that’s been paid to taxpayers, or from companies the amount of dividends that have been paid. So, a lot of the information is already there in the tax office. It seems very strange that they want us to then send in an annual return and confirm most of what they already know. It would be much simpler just to wash us out of the system.

Knowledge@Australian School of Business: Tax professionals argue that not only would thousands of them be out of work if we adopted the UK system, but also that people love finding ways of claiming back just a little bit of extra tax – and, effectively, that fun would go out of the system.

Chris Evans: That’s interesting because tax agents would be concerned about the loss of work. But we did this national survey with accountants about four years ago, and a lot of them said: “Yes, get this trivia out of our lives and let us get on with what we’re supposed to be doing, which is adding value to the businesses’ and to personal taxpayers’ wealth, rather than having to deal with everyone’s little refund each year.” The tax agents who do nothing else may well be losers and we would no longer have this same tax agent dependency that we have currently in Australia, but a lot of other tax agents and accountants would be able to get on with some serious value-adding work, rather than wasting time on petty compliance.

Knowledge@Australian School of Business: Can we assume that if we scrap the annual tax return, then the cost for individuals will go down? While people may not be claiming so much back, they would actually be paying less tax upfront?

Chris Evans: We’d be paying less to external advisors, and if we cleaned out and simplified the system we’d probably be paying less tax – so there could be a win-win all around.

Knowledge@Australian School of Business: I’m sure many people are crossing their fingers hoping that we will change the system

Professor Robert Deutsch

If ever there was any doubt as to the status of Australia’s reputation as the lucky country all doubt appears to have been removed by the recent debate regarding a 1% company tax rate cut for the very narrow sector of small business which is fortunate enough to operate through the medium of a company.

The proposal for those who missed it, is that one of the carrots to compensate for the stick that is the Minerals Resource Rent Tax (the technical name for the mining tax) would be a reduction in the company tax rate from 30% to 29% for incorporated small businesses. The planned start date is 1 July 2012. Small business in this context as currently planned will be defined broadly as any business carried on through a company where the annual turnover is no more than $2 million. According to some estimates this will deliver tax cuts for 720,000 incorporated small businesses out of a total of small businesses conducted through sole tradership’s companies partnerships etc of 2.4 million. The cost to government revenue in the first year is expected to be in the order of $200 million which would in part be funded by a $1.4 billion revenue take from the proposed mining tax based on current estimates.

Let us for a moment look at it from the micro perspective of an incorporated small business rather than from the macro perspective of the government. A business with an annual turnover of $2 million (which is the current proposed upper threshold to qualify as a small business) might reasonably have taxable income of $1 million assuming deductible costs against turnover of $1 million. Tax currently would therefore amount to $300,000 which after the proposed corporate tax reduction would be reduced to $290,000.

Of course all this assumes that the incorporated small business in question is profitable. If it is not, it is unlikely to be paying any tax and accordingly a 1% tax reduction even for such an entity would be meaningless.

Even when looking at profitable incorporated small businesses, most would be lucky to have the numbers suggested in the previous paragraph. More likely the numbers would be half that suggested and thus give rise to net annual savings of only $5000.

Without wishing to belittle the savings that might be achieved, one would have thought that at a micro level they are so marginal as to make almost no difference to the ongoing viability and profitability of most incorporated small businesses.

At a macro level $200 million in costs is a very small hit to a government budget which runs into many many billions. In any event one would think that if the government is to expend some of the yet to be proven revenue from the mining tax, there are far better ways to utilise those funds for the benefit of small business. Perhaps an upfront grant of $5000 to any newly established small business (in whatever form) which employs at least 2 unrelated individuals would be of far more benefit to the individual enterprise and to the economy as a whole, than a miniscule tax cut to existing profitable incorporated small businesses. Based on those numbers this could aid in the establishment of 40,000 new small businesses.

How we can spend so much time and energy arguing about so little is quite remarkable. We are undoubtedly the lucky country if this 1% tax reduction for such a small group occupies our headlines so extensively.

Professor Robert Deutsch is from the School of Taxation and Business Law, Australian School of Business UNSW. This opinion piece first appeared in The Australian on 16 March 2012.

Dale Boccabella

At the October Tax forum, to be held on October 4^th and 5^th 2011 in Canberra, experts and academics are to sit down and discuss taxation in Australia. Alas, with all the noise ahead of the Tax Forum, little attention has been focused on trusts.

I want to see them resolving the treatment of discretionary trusts.

Discretionary trusts (DTs) have become pervasive and they will grow in number. In addition to DTs being set up by living persons (principals), it has become common practice for many assets passing on death to be housed within a DT (testamentary trusts/discretionary will trusts). And, wealth that will pass to future generations in Australia over the next 20-years or so will be unprecedented.

So what makes DTs popular? To answer this we need some understanding of this “entity”. It is a trust. But unlike many other trusts (e.g. listed property trusts, listed share trusts), the [potential] beneficiaries do not have fixed entitlements to capital or income. Whether a beneficiary gets a distribution of capital or income is at the discretion of the trustee (legal owner of trust property) and/or those behind the trust. Accordingly, a beneficiary does not legally own anything until the trustee decides to make them a distribution.

The trustee is the legal owner of trust property, but trust property does not belong [beneficially] to the trustee. The trustee is often a “$2 company”. Often, trust property will have been transferred to the trust for no money by the people behind the trust (usually Mum and Dad). These people are likely to be potential beneficiaries along with the children, and a family company.

As well as being the only shareholders in the $2 trustee company, Mum and Dad may also be the appointers of the trust. Appointers have power to remove a trustee if they are not satisfied with the way the trustee is exercising his/her/its discretion.

What flows from all this? First, assets held within a DT are generally beyond the reach of creditors of the beneficiaries, and creditors of the principals who set up and transferred assets to the DT. This also means the trustee in bankruptcy of a beneficiary or the principals usually cannot access those DT assets. Further, the principle that creditors of a trust (e.g. suppliers of goods to trust) can, in certain circumstances, access the assets of beneficiaries of the trust, does not apply to a DT.

In terms of “divisible property” for the purpose of a family law proceeding (relationship breakdown), the Family Court can take into account assets held in a DT, but this is less likely where the DT’s assets existed before the failed relationship commenced.

Secondly, the DT allows the trustee flexibility to make income (and capital) allocations to beneficiaries based on their differing needs and capacities. For example, one of the children might currently be unemployed or sick and therefore a greater income allocation can be made to him/her for the current year. The DT also allows the trustee to defer or stagger a particular child’s entitlement because there is concern about the child’s big spending habits (spendthrift). It should be said though that it is rare that the flexibility of the DT is sought to deal with the differing capacities and needs of beneficiaries. Other less sophisticated legal arrangements can more than adequately deal with the differing needs and capacities scenario.

Thirdly, and this is usually the most important advantage sought, the DT allows for tax minimisation; substantial minimisation. The flexibility that has a genuine non-tax basis to it (see above) also provides the means to minimise tax by, for example, allocating a given taxable income across a number of taxpaying units (simple income splitting). In addition, the DT allows income allocations across tax years to take account of beneficiaries’ other tax profile that can change over years. There is also the advantage of streaming different income types to beneficiaries who can make best use of certain items of income, a technique the government has recently re-endorsed.

There are many other tax advantages from a DT including allowing income allocations to children under 18-years of age to be taxed at the adult tax rate schedule where the DT arose under a will (testamentary trust). Normally, under-18s are taxed at a penalty rate of tax on their unearned income.

The advantages of DTs are quite substantial. No other entity comes close to offering all the advantages of the DT; some offer one or two advantages of the DT. And of course, one person’s advantage is another person’s disadvantage. For example, suppliers to DTs may have trouble getting payment for debts, and minimized tax through DTs must be made up by other taxpayers or government services must be reduced.

Are there any disadvantages to those using a DT? The main one is the danger of a “rogue trustee”. That is, the trustee might exercise their discretion in a way contrary to the wishes of the principals who set up the DT. With careful legal drafting, including wise selection of appointers, safeguards against this can be provided.

It is one of life’s twists that DTs can also breed suspicion and “distrust” amongst “beneficiaries” who would otherwise (fixed trust) expect an entitlement. The reason is that entitlements under a DT are contingent on the trustee’s discretion so that a beneficiary may be at the whim of the trustee, and those controlling the trustee.

The cost of financial planners, tax advisors, lawyers, etc, in setting up a DT and properly maintaining it can also become expensive as an effective DT must be kept-up-to date with changes in the circumstances of relevant parties. Indeed, these professionals are doing, and will continue to do, a solid trade in DTs.

By and large though, the disadvantages to those who can avail themselves of a DT are not significant and are overwhelmed by the advantages. And, no other entity (e.g. fixed trust, company) comes close to offering the same or similar tax and non-tax advantages.

As far as tax goes, various government inquiries have endorsed the current tax treatment of DTs. Indeed, the Assistant Treasurer, the Hon Bill Shorten MP told a Tax Institute conference recently: “We don’t believe trusts are any form of tax avoidance. We see trusts as a legitimate feature of how Australians conduct their financial affairs.” The tax advisors listening must have had a quiet chuckle; they need to be quiet because a loud chuckle may prompt the Assistant Treasurer to actually check the basis for that ridiculous statement.

Equally important are the non-tax advantages. To my knowledge, there has not been a systematic and comprehensive inquiry on the asset protection aspects (code for not paying debts), property division aspects, etc, of DTs. However, there has been isolated reform in various areas that has reduced the abusive use of the DT (e.g. pensioners cannot house assets in a DT and avoid having those assets counted for asset and income testing purposes).

The pervasive use of the DT has snuck up on society. The time for a comprehensive review of the advantages and disadvantages of DTs has come. At the moment, many Australians are gorging themselves on the advantages of DTs, and similar advantages are not available to others.

Dale Boccabella is an Associate Professor at the Australian School of Taxation and Business Law.

Gordon Mackenzie

When planning for one’s own death, it isn’t wise to depend on handing over superannuation funds to beneficiaries.

Spouses and children face the prospect of significant tax bills upon the death of a parent or partner following a ruling by the Australian Taxation Office.

The ATO ruling clarifies the manner in which pension assets will be treated following a death, and mean that private pensions are no longer tax-free upon the death of a pensioner and that any beneficiaries will have to pay capital gains and income tax on the assets.

What we are seeing with this ruling is the view that super funds should not be used for estate planning purposes.

If a death benefit is paid to someone other than a spouse or dependent child, the taxes in the fund and when the benefit is paid reverse the tax concessions that the deceased got for using a super fund in the first place.

What that means is that benefits paid to non-dependant adult children, say, will be taxed at an effective tax rate of 31.5%, (or 16.5% on capital gains). That rate is, broadly, the tax rate that most Australians would have paid had they not used a super fund on that account balance. So, in that way the tax concessions for using a super fund are recaptured.

Gordon Mackenzie is a Senior Lecturer and Program Convenor at the Australian School of Taxation and Business Law at the Australian School of Business. Gordon Mackenzie has given submissions to Henry Tax Review Panel on Resolving the Tax Inefficiency of Losses, and the Cooper Review on Tax Governance of Superannuation Funds, into the structure and operation of Australia’s superannuation system.

Associate Professor Dale Boccabella

The Federal Government has looked at slashing the tax free threshold for duty free goods, following complaints from retail giants that shoppers now want to buy online overseas. Retailers say they want a tax barrier to drive customers back into their stores, and a report by PwC today says that although Australia lags behind in online shopping, it is catching up fast, with an increase of 13% in sales expected this year.

However this could cost Australia more. The cost of collecting the tax may outweigh what tax revenue could be raised. As the Board of Taxation indicated around a year ago, there are many practical difficulties in collecting GST on goods bought over the web where the online shop is overseas.

The Government has now confirmed that it has examined reducing the threshold to $500, however online retailers such as eBay say that only a very small minority of transactions would be impacted by this, and little additional revenue would go to the government, which puts the cost of implementing the change at $38 million.

There are two alternatives to collecting the tax, both of which would be costly and time consuming, and neither of which would actually raise any significant revenue.

We could get the Australian consumer to collect the GST on the sale made to them and send a remit to the Tax Office. The bottom line here though is that Australian Governments are very reluctant to impose tax collection or reporting obligations on consumers as opposed to businesses. Quite simply, consumers wouldn’t want the hassle, and wouldn’t be thankful for having this burden imposed on them.

The alternative is to ensure that all companies that can trade online with Australian consumers are registered for GST. However, the government is under considerable pressure to keep overseas companies with only a few Australian customers out of our GST system because of the high compliance costs that go with GST registration, which would mean that the compliance costs can outweigh the revenue collected.

Indeed, one could query why the low value threshold was increased so significantly to $1,000 (from $250) in 2005, and why there wasn’t much opposition from retailers at the time. The brick and mortar retailers may have a point that this is placing them at a competitive disadvantage. However Australia’s GST is ‘only’ 10%. Admittedly anecdotal, I have seen price differentials between on-line goods and brick and mortar goods that cannot be explained by the presence or absence of GST, and is more likely to be from the high cost structures of brick and mortar businesses, and possibly from excessive mark-ups.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business, University of New South Wales.

Associate Professor Dale Boccabella

The income tax changes related to the Carbon Tax partly implement recommendations from the Henry Review. That is to be welcomed, however there are some alterations to the tax scheme that have received little publicity.

The government’s carbon tax reform is designed to deliver tax cuts to those below $80,000 of taxable income. This is achieved through raising the tax free threshold, and also increasing marginal tax rates above the new threshold (15% to 19% and 30% to 32.5%) along with the lowering of the low income tax offset.

The increase in the tax free threshold, on its own, would go some way towards implementing the Henry Review indicative recommendation of raising the threshold to $25,000 and then having a flat 35% rate all the way up to $180,000 of taxable income.

However, the increase to the marginal rates that accompanied the threshold increase ensures the Henry Review ‘indicative’ recommendation is not fully implemented.

This is the first time in decades that marginal tax rates have been increased. The 15% rate goes up to 19%, while the 30% rate goes up to 32.5%. The low income tax offset will be reduced, and the tax-free threshold will rise to $18,200 from 1 July 2012 and $19,400 from July 2015.

Indeed, the combination of a higher threshold along with increases in two marginal rate bands ensures that those with taxable income above $80,000 are in the same position as they were in before the carbon tax changes. Accordingly any assertion that tax rates have gone up (which implies some pay more) is calculated to mislead.

The federal government estimates that around an extra one million people will not have to lodge a tax return, both due to the raising of the tax-free threshold, and because the deductions claimed for work-related expenses are proposed to rise from $300 to $500 in 2012 and $1,000 from July 2013.

However the one million figure is inaccurate, and an over-estimation. While this change is welcome, and it makes life easier for those with very simple tax affairs, a lot of people have a small number of shares because of the round of de-mutualisation and de-nationalisations over the decades. Even if they have only a tiny amount of shares, they still have to lodge a tax return.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business, University of New South Wales.