Australian small businesses would pay zero company tax but forfeit a range of tax concessions under one of the proposals flagged in the federal government’s tax discussion paper.
The discussion paper, released on Sunday by the Department of Treasury, is the first step in the federal government’s review of the Australian tax system. A green paper will be developed by the end of the year, followed by a white paper – which will outline the Coalition’s policies – ahead of the 2016 election.
The paper acknowledges “compliance costs associated with regulation are felt most by small business” and a chapter dedicated to small businesses presents a number of options for taxation reform.
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Peter Strong, executive director of the Council of Small Business of Australia, welcomed the paper, which he told SmartCompany is comprehensive and covers a broad cross-section of the issues in the tax system. He welcomed the section dedicated to small business.
“Good on them for putting this out,” Strong says.
“We know the tax system is complex, but until now, no one has done anything about it. Big changes will be needed and so it is quite right to engage everyone in this process.”
Slashing company tax for SMEs
Drawing on the experience of countries that have significantly reduced the rate of company tax for small enterprises, including Canada, China, the US and the UK, Treasury said in the paper “it may be possible to introduce a lower or zero tax rate on small companies”.
But eliminating company tax for small businesses would come with a trade-off: forgoing “specific, small business concessions”, including industry-specific tax breaks and broader concessions such as capital gains tax.
Treasury said the tax system is over-reliant on company and personal income tax, with 70% of the revenue generated by the federal government coming from these two tax measures.
Small Business Minister Bruce Billson has also confirmed all small businesses will receive some form of tax relief in this year’s budget, even those not incorporated.
“A lower rate that replaced multiple specific concessions could encourage small businesses to spend their resources expanding their business, rather than managing their tax affairs,” said Treasury.
“Reduced tax rates on small corporations may also provide an easy source of finance to businesses by allowing them to retain more of their earnings and expand business activity.”
Treasury said another option could be to provide immediate refund for tax losses for small businesses.
“Many start-up small businesses make taxable losses in their first years of operation,” said Treasury.
Strong welcomed any reduction in company tax rates and says there will be “give and takes throughout this whole thing”.
Theo Sakell, partner and executive director of tax consulting at Pitcher Partners, also welcomed the option, telling SmartCompany this morning “any reduction in the corporate tax rate would translate into an increase in working capital in those companies and allow them to expand and grow their business”.
Sakell says access to funding is “a lot harder” for SMEs and so any extra cash can only be a good thing.
“It can only be good for the Australian economy,” Sakell says.
“More money means more jobs as small business is a large employer in Australia.”
However, Sakell says any potential changes to specific tax concessions for small businesses need to be thought out carefully as for many small business owners, their companies represent their “retirement nest egg”.
An Australian S-Corporation
The number of Australian small businesses that operate through trusts has grown strongly since the early 2000s, according the tax discussion paper. Trusts are just one option for structuring small enterprises and each type of business structure is treated differently under tax law, making the choice of structure a costly and confusing exercise.
Given the complexity of the Australian tax system, Treasury said another option for small business is to adopt an Australian equivalent of the “S-Corporation”, a single tax structure that operates in the US. In the US model, S-Corporations can pass corporate income, losses, deductions and credit through to shareholders for tax purposes. The company itself is not taxed, with all taxation done at the individual income level.
While Strong says this may be “one way to go” in Australia, and indicated COSBOA would be open to the idea, Sakell warns against introducing yet another legal structure into the tax system.
“In the US, the S-Corporation is quite popular but they have so many different structures over there, they are used to it,” Sakell says.
But in Australia, giving business owners the option of another operating structure could add further complexity to the system, Sakell says.
“There are other non-tax considerations too,” he says.
“In the US, only an individual can own an S-Corporation. It can put the individual at risk.”
Division 7A implications
Sakell says the tax discussion paper also highlights the pressure that could be placed on the complex Division 7A tax regulations, as any reduction in the corporate tax rate would “exacerbate” the gap between company and individual tax rates.
The anti-avoidance regulations of Division 7A are designed to discourage businesses from distributing loans to shareholders or their associates for personal use and enjoyment.
The provisions were introduced in the 1990s but since then the regulations have become increasingly complex and now capture all sorts of transactions, adding to compliance costs for businesses.
The definition of small business
The options for small business taxation contained in the discussion paper will depend on how the government chooses to define small business, says Sakell.
“We will be keenly monitoring how small business is defined,” he says.
“It has to be simple as we don’t want small businesses to get bogged down in compliance, but it also has to be fair.”