Sometimes less is more.
The temptation for a government is to feel that they need to announce a whole series of new tax measures every year. But rarely is this the best way to develop a strong and efficient tax system.
Thankfully the 2019-20 federal budget hasn’t gone down this path. Rather, the focus has been on targeting specific areas of tax avoidance, in particular through funding the ATO and other regulators.
The black ‘cash’ economy is a recognised issue and one that’s being systematically addressed. The federal government’s continued support for addressing this issue would be welcomed by the vast majority of taxpayers who are doing the right thing.
Funding the ATO’s Tax Avoidance Taskforce is another effective way for the government to ensure compliance with the tax system and raise tax revenue. The taskforce targets the highest value and highest risk taxpayers in the system: multinationals, large corporate, large private groups, trusts and high-wealth individuals. The taskforce is merely improving the way the ATO can apply existing tax laws.
And it has been very effective.
Since 2016, the taskforce has raised $7 billion from large corporates and $2.8 billion from private groups and wealthy individuals. It’s expected to raise more than $3.6 billion over the forward estimates.
What’s really positive about these two measures is they target taxpayers that are not complying with the tax laws, but they really don’t impact significantly on taxpayers that are complying.
This is where aspects of Labor’s proposed tax policies risk missing the mark. The proposed changes to negative gearing, the taxation of trusts and deductions for tax advice apply to all taxpayers — not just the subset that is avoiding tax or engaging in aggressive tax planning. It’s important to remember Labor’s policies are high-level and more detailed policies will be developed if they win the upcoming election. But the high-level policies present a real issue for SME businesses — an issue that is largely unnecessary if the focus was instead on supporting the ATO to better apply the existing tax laws.
The government — whether coalition or Labor — should be very conscious of how their policies may affect SME businesses. Clamping down on perceived tax avoidance is admirable, but the measures should hit the offenders, and the ‘collateral damage’ should be minimised.
Tax issues will be identified by the ATO that need legislative fixes. When this happens, the government needs to act and act promptly.
There are two glaring issues in our tax system that neither the current government nor the opposition seems to have the willingness to resolve: the taxation of trusts and anti-avoidance measure Division 7A applying to private groups.
Taxation of trusts
Taxation of trusts has been a pollical football for too long and genuine, comprehensive reform is required in this area. Labor’s announcement to put a minimum tax on trust distributions, is only a band-aid solution.
Really, the whole tax law applying to trusts needs to be re-thought and re-written.
The reality is many SME businesses operate through a trust structure for valid commercial reasons. However, the tax treatment for trusts is becoming increasingly complex. This increases the cost of complying with tax obligations and increases the risk of non-intentional non-compliance conscious — or in other words, business owners making mistakes with their tax not because they are trying to avoid tax but because the tax system is too complex for them to understand. A complex tax system is also much more expensive for the ATO to administer.
Currently, companies are able to access the ‘small-business’ tax rate of 27.5%, reducing to 25% in the coming years. Imposing a higher 30% minimum tax on trust distributions will disadvantage SME businesses operating through trusts, relative to those operating in companies. SME businesses should have the 27.5% (and in the future, the 25% rate) irrespective of what structure the small businesses are operating through. This would create a level playing field. This would give the same tax outcome for SME businesses, regardless of whether they are operated by a company or a trust, while also creating fairness in the system.
Division 7A rules applying to private groups
Access to finance and cashflow are the two major headaches for SME business. Accessing bank debt is increasingly difficult. Many business owners will borrow against their house to finance their business (a practice that may become problematic under Labor’s negative gearing changes) and others look to get finance from family and friends.
Where a private company lends funds to an associate, Division 7A can treat the loan as a dividend even where the loan is used to finance a business.
A set of provisions such as Division 7A are a necessary feature of our tax system. They act to prevent shareholders (or associates) of private companies from accessing profits in a company (taxed at 30% or less) without paying the appropriate personal tax (taking the tax rate up to as high as 47%).
While an anti-avoidance measure is necessary, at the same time, the government needs to support SME businesses who have aspirations for growth, who are beginning to employ more people and overall just want to do the right thing.
There’s no doubt in its current form Division 7A is prohibitive and expensive and impacts the needs of SME business. The government, the ATO, the Board of Taxation and taxpayers alike have recognised for years that Division 7A is unnecessarily complex and does not achieve its policy objectives. Yet, despite two sets of budget announcements, a Board of Taxation report and a Treasury consultation paper later, and we are still no closer to addressing these problems.
This means Division 7A is one of the key tax provision that the incoming government should seek to reform if they really have SME businesses’ interests at heart. A good policy would see a simplification of the existing rules. A reasonable balance should be struck between preventing shareholders inappropriately accessing company profits and enabling SME business to borrow from related private companies, so they can fund investment in their business and business assets.
Proper tax reform is hard. It takes time, impartiality and commitment.
Hopefully the incoming government, whatever their political persuasion, will be prepared to tackle these difficult issues.
And hopefully, they won’t just announce a whole series of new tax measures that don’t contribute to building a strong and efficient tax system.