House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Small Business, the Hon Bruce Billson MP)

Chapter 1 - Accelerated depreciation for small business entities

Outline of chapter

1.1 Schedule 1 to this Bill amends the accelerated depreciation rules for small businesses (businesses with an aggregate annual turnover of less than $2 million) by temporarily increasing the threshold under which certain depreciating assets, costs incurred in relation to depreciating assets and general small business pools can be written off.

1.2 The increased threshold of $20,000 applies from 7.30 pm, by legal time in the Australian Capital Territory, on 12 May 2015 until 30 June 2017. From 1 July 2017, the threshold is $1,000.

1.3 The increased threshold is available to small business entities (including those who previously opted out of the accelerated depreciation rules).

1.4 All legislative references in this chapter are to the Income Tax Assessment Act 1997, unless otherwise stated.

Context of amendments

1.5 In the 2015-16 Budget, the Government announced a number of measures as part of a jobs and small business package, including expanding accelerated depreciation for small businesses. Increasing the immediate deduction for capital expenditures improves small businesses' cash flow. Small businesses tend to be more vulnerable to cash flow problems than larger businesses because their profitability tends to be more volatile and they have lower levels of retained earnings. The impact is expected to be bigger for new small businesses, as large capital expenditures often occur early in a business' life. The measure will also encourage additional capital investment by small businesses through lowering the pre-tax rate of return required to justify new investments.

Summary of new law

1.6 Schedule 1 to this Bill amends the accelerated depreciation rules for eligible small businesses (businesses with an aggregate annual turnover of less than $2 million) by temporarily increasing the threshold under which certain depreciating assets, costs incurred in relation to depreciating assets and general small business pools can be written off from $1,000 to $20,000.

1.7 The increased threshold applies from 7.30 pm, by legal time in the Australian Capital Territory, on 12 May 2015 until 30 June 2017. From 1 July 2017, the threshold is $1,000.

Comparison of key features of new law and current law

Detailed explanation of new law

1.8 The $1,000 threshold for the cost of depreciating assets, costs incurred in relation to depreciating assets, and the low pool value deduction under the small business entity capital allowance provisions is temporarily increased to $20,000.

1.9 This increase applies from 7.30 pm, by legal time in the Australian Capital Territory, on 12 May 2015, and ceases on 30 June 2017. The threshold returns to $1,000 from 1 July 2017.

Deductions for depreciating assets

1.10 Under the existing arrangements, a small business entity (businesses with an aggregate annual turnover of less than $2 million) may elect to use the capital allowance rules to deduct or 'write off' the taxable purpose proportion of the cost of an asset acquired for less than $1,000.

1.11 The 'taxable purpose proportion' of a depreciating asset is defined in subsection 328-205(3) and in general terms represents the proportion of an asset's use in an income year that is for the purposes of producing assessable income. The deduction for assets that cost less than $1,000 is claimed in the income year in which the asset was first used or installed ready for use.

1.12 The amendments temporarily increase the threshold for writing off depreciating assets from $1,000 to $20,000. The taxable purpose proportion of an asset with a cost of less than $20,000 can be deducted for the income year in which the asset was first used or installed ready for use. [Schedule 1, item 9, subsection 328-180(4) of the Income Tax (Transitional Provisions) Act 1997]

1.13 As a result of the increased threshold for writing off assets, depreciating assets that cost $20,000 or more are allocated to a small business entity's general small business pool. The taxable purpose proportion of the cost of such an asset is deducted at a rate of 15 per cent in the income year in which it is first used or installed ready for use, with the remainder deducted in subsequent income years under the pooling rules at an ongoing rate of 30 per cent.

1.14 The increased threshold applies only to assets that were first acquired at or after 7.30 pm, legal time in the Australian Capital Territory on 12 May 2015, and first used or installed ready for use on or before 30 June 2017. Assets that do not satisfy these timing requirements continue to be subject to the $1,000 threshold. [Schedule 1, item 9, paragraphs°328 180(4)(a) and (b) of the Income Tax (Transitional Provisions) Act°1997]

1.15 The requirement that an asset be 'first acquired' at a particular time is not a feature of Subdivision 328-D and is an additional requirement for the increased threshold to apply. This additional requirement limits access to the increased threshold to a small business entity's 'new' assets. Requiring a depreciating asset to have been 'first' acquired by the small business entity ensures that assets cannot satisfy the acquisition requirement if they were previously acquired at an earlier time, temporarily disposed of, and then reacquired at or after the 7.30 pm start time.

1.16 Depreciating assets that are first acquired prior to the 7.30 pm start time continue to be subject to the existing threshold, irrespective of when they are first used or installed ready for use. The existing threshold also applies to depreciating assets that are first acquired from the 7.30 pm start time but were not first used or installed ready for use on or before 30 June 2017.

Example 1.1

Patrick's Plumbing Pty Ltd (Patrick's Plumbing) is a small business entity and satisfies the conditions to make the choice to apply the small business capital allowance provisions in the income year that runs from 1 July 2015 to 30 June 2016.

Patrick's Plumbing purchases a truck on 15 July 2015 for $19,000. The truck is used 100 per cent for business purposes and therefore has a taxable purpose proportion of 100 per cent.

Patrick's Plumbing chooses to apply the small business capital allowance provisions and writes off the asset by claiming a $19,000 deduction for the truck in its tax return for the 2015­16 income year.

Example 1.2

Daryl's Electrical Pty Ltd (Daryl's Electrical) is a small business entity and satisfies the conditions to make the choice to apply the small business capital allowance provisions in the income year that runs from 1 July 2015 to 30 June 2016.

Daryl's Electrical acquires a ute for $40,000 on 28 July 2015. Daryl's Electrical estimates that the ute has a taxable purpose proportion of 40 per cent for the 2015-16 income year. As the ute cost more than $20,000, Daryl's Electrical is unable to immediately deduct the cost of the ute and the ute is instead added to Daryl's Electrical's general small business pool.

Daryl's Electrical's general small business pool has an opening balance of $10,000 on 1 July 2015 from assets added to the pool in previous income years. Assuming the ute was the only asset allocated to Daryl's Electrical's general small business pool in the 2015­16 income year, the deduction that Daryl's Electrical can claim in the 2015-16 income year under the pooling rules is 15 per cent of the taxable purpose proportion of the ute, and 30 per cent of the opening balance of the pool. As the taxable purpose of the proportion of the ute is $16,000 (being 40 per cent of $40,000), the deduction allowable is $2,400 (being 15 per cent of $16,000) for the ute and $3,000 for the opening balance of the general small business pool.

1.17 Consistent with the objective of the increased threshold applying to newly acquired assets, it is not intended that assets acquired under artificial or contrived arrangements have access to the increased threshold, or indeed to the existing arrangements. An example of an arrangement of this kind would be where a number of related small business entities that earned income from similar income sources sold their assets to one another in order to satisfy the 'first acquired' requirement and write off the full value of those assets under the increased threshold.

1.18 While a specific provision has not been included under these amendments in relation to artificial or contrived arrangements, the general anti avoidance provisions are intended to be applied to arrangements of that kind. In the event of evidence that small business entities systematically engaged in artificial or contrived arrangements designed to take advantage of the increased threshold and the general anti-avoidance provisions became too administratively difficult to apply, retrospective amendments to explicitly prohibit such behaviour would be considered to ensure that the integrity of the small business capital allowance provisions is maintained.

Deductions for amounts included in the second element of the cost of depreciating assets

1.19 Under the existing arrangements, a small business entity can also deduct an amount included in the second element of a depreciating asset's cost (for example, an amount spent on improving or transporting a depreciating asset), provided the amount is under $1,000, the amount is the first such amount to be deducted in respect of the asset, and the asset was written off in a previous income year.

1.20 Consistent with the changes to the threshold for writing off depreciating assets, the amendments temporarily increase the threshold for writing off amounts included in the second element of a depreciating asset's cost from $1,000 to $20,000. [Schedule 1, item 9, subsection 328-180(5) of the Income Tax (Transitional Provisions) Act 1997]

1.21 As a result of these amendments, if a small business entity incurs a cost of $20,000 or more that is included in the second element of a depreciating asset's cost, and the depreciating asset has been written off in a previous income year, the asset in relation to which the cost was incurred is treated as having a value equal to the amount that is included in the second element of its cost. The asset is then allocated to the small business entity's general small business pool, deducted at a rate of 15 per cent in the income year in which the amount was incurred, and then deducted at a rate of 30 per cent in subsequent income years as part of the general small business pool.

1.22 The increased threshold applies only to costs that are included in the second element of the depreciating assets cost during the period commencing at 7.30 pm, by legal time in the Australian Capital Territory, on 12 May 2015 and ending on 30 June 2017. Costs that are in incurred outside of this period continue to be subject to the $1,000 threshold. [Schedule 1, item 9, paragraphs 328-180(5)(a) and (b) of the Income Tax (Transitional Provisions) Act 1997]

Example 1.3

Taylor's Tailoring Pty Ltd (Taylor's Tailoring) is a small business entity and satisfies the conditions to make the choice to apply the small business capital allowance provisions in the 2014-15 and 2015­16 income years. Taylor's Tailoring's income year runs from 1 July to 30 June.

On 1 June 2015, Taylor's Tailoring purchases an industrial sewing machine for $5,000 for use in its tailoring business. The taxable purpose proportion of the sewing machine is 100 per cent.

Taylor's Tailoring chooses to apply the small business capital allowance provisions and writes off the asset by claiming a $5,000 deduction in its income tax return in the 2014-15 income year.

On 30 November 2015, an overlocking function is added to the machine to improve its functionality and for use in the tailoring business. The cost of this improvement is $2,000.

As the sewing machine was written off in the 2014-15 income year and the amount of the improvement is less than $20,000, Taylor's Tailoring claims a $2,000 deduction in its income tax return for the 2015-16 income year.

Deductions for low pool values

1.23 Under the existing arrangements, a small business entity can also deduct the balance of its general small business pool at the end of an income year if the balance of the pool at the end of the year is less than $1,000. The balance of the pool is determined prior to calculating any deductions in respect of the pool.

1.24 The amendments temporarily increase the 'low pool value' threshold to $20,000, meaning that a small business entity can deduct the entire balance of its general small business pool if the balance of the pool at the end of an income year is less than $20,000. [Schedule 1, item 9, subsection 328-180(6) of the Income Tax (Transitional Provisions) Act 1997]

1.25 Because the rules for writing off low pool values apply at the end of an income year, the increased threshold for low pool values applies to income years that end during the period commencing at 7.30 pm legal time in the Australian Capital Territory on 12 May 2015 and ending on 30 June 2017. [Schedule 1, item 9, subsection 328-180(6) of the Income Tax (Transitional Provisions) Act 1997]

1.26 For small business entities that have accounting periods that align with the financial year (that is, accounting periods that commence on 1 July and end on 30 June), the amendments mean that general small business pools that have a balance of less than $20,000 on the final day of the 2014-15, 2015-16, and 2016-17 income years can be written off. Although the majority of the 2014-15 financial year does not fall within the period covered by the amendments, a general small business pool with a balance of less than $20,000 can still be written off at the end of a standard 2014-15 income year because that year ends during the period covered by the amendments.

Example 1.4

Levi's Pet Washing Pty Ltd (Levi's Pet Washing) is a small business entity and satisfies the conditions to make the choice to apply the small business capital allowance provisions in the 2013-14 and 2014-15 income years. Levi's Pet Washing's income year runs from 1 July to 30 June.

In the 2013 14 income year, Levi's Pet Washing purchased a fitted out van for the mobile pet washing business for $20,000. The van was purchased 100 per cent for a taxable purpose. The business did not have any other assets in its general small business pool

In its 2013 14 income tax return, as the cost of the van was over the $1,000 threshold that applied for the income year, the business claimed a deduction for 15 per cent of the cost ($3,000), with the remaining cost ($17,000) being deductible in later income years under the pooling rules.

The business did not make any further purchases during the 2014­15 income year and the balance of the pool at the end of the 2014-15 income year remained at $17,000.

In its 2014-15 income tax return, Levi's Pet Washing claimed a deduction of $17,000 for the balance of the general small business pool, as the balance of the pool at the end of the year is below the $20,000 threshold that applies for that year.

Deductions for low pool values in substituted accounting periods

1.27 For a small business entity that has a substituted accounting period (that is, an income year that does not commence on 1 July and end on 30 June), the final day of the period covered by the amendments will not be the final day of one of its accounting periods. This means that in the final year in which the small business entity can write off assets under the increased thresholds, the small business entity's general small business pool will be subject to the $1,000 threshold rather than the $20,000 threshold.

1.28 If a small business entity has a late balancing substituted accounting period, for example, 1 October to 30 September, the part of its 2016­17 income year to 30 June 2017 is covered by the amendments. However, because its 2016-17 income year ends after 30 June 2017, the small business entity will not be able to access the $20,000 low pool value threshold for that income year.

1.29 Alternatively, if a small business entity has an early balancing substituted accounting period, for example, 1 April to 31 March, its entire 2016­17 income year and the first 3 months of its 2017-18 income year will be covered by the amendments. The small business entity will be able to access the $20,000 threshold in relation to its general small business pool for the 2016-17 income year, but not for the 2017-18 income year (because that income year ends after 30 June 2017).

Five year 'lock out' rule

1.30 Under the existing arrangements, a small business entity that elects to apply the small business capital allowance provisions in an income year, and then does not choose to apply the provisions for a later income year in which they satisfy the conditions to make this choice (that is, the entity 'opted out'), is not able to apply the small business capital allowance provisions for a period of five income years, commencing from the first later year for which the entity could have made the choice to apply the provisions. This rule is contained in subsection 328-175(10), and is commonly referred to as the 'lock out' rule.

1.31 The amendments alter the way the lock out rule applies in particular income years.

1.32 Small business entities are not required to apply the lock out rule to income years that end on or after 12 May 2015 but on or before 30 June 2017. These income years are referred to as 'increased access years'. [Schedule 1, item 9, subsections 328-180(1) and (2) of the Income Tax (Transitional Provisions) Act 1997]

1.33 For small business entities that have accounting periods that align with the financial year (that is, accounting periods that commence on 1 July and end on 30 June), the increased access years will be the 2014­15, 2015-16 and 2016-17 income years. During these income years, small business entities can opt back into applying the small business capital allowance provisions to access the higher threshold.

1.34 The lock out rule begins to apply again from the first income year that ends after 30 June 2017. However, in determining whether the lock out rule applies from that point, the income years preceding the increased access years are disregarded, as are all of the increased access years except for the last of those years. [Schedule 1, item 9, subsections°328­180(1) and (3) of the Income Tax (Transitional Provisions) Act 1997]

1.35 For small business entities that have accounting periods that align with the financial year, this will mean that although the lock out rule applies from the 2017-18 income year, small business entities are only required to look as far back as the 2016-17 year in determining whether the lock out rule applies.

1.36 If for some reason a small business entity opted out of the small business capital allowance provisions in the 2016-17 income year (being the last of the increased access years), the small business entity would be locked out from the small business capital allowance provisions for at least five years. However, the lock out rule would not apply if the small business entity had instead opted out in the 2015-16 income year, or an earlier income year, but then chose to apply the small business capital allowance provision in the 2016-17 income year.

Example 1.5

Zoe's Café Pty Ltd (Zoe's Café) is a small business entity and satisfies the conditions to make the choice to apply the small business capital allowance provisions in the 2015-16, 2016-17 and 2017-18 income years. The income year for Zoe's Café runs from 1 July to 30 June.

On 20 May 2015, Zoe's Café purchases a new coffee machine for $12,000. The business does well and due to demand, requires a second coffee machine, which is purchased on 15 December 2015 for $13,000.

Zoe's Café elects to apply the small business capital allowance provisions and claims a $12,000 deduction in the 2014-15 income year for the first coffee machine, and a $13,000 deduction in the 2015-16 income year for the second coffee machine. Both coffee machines have a taxable purpose proportion of 100 per cent.

In the 2016-17 income year, Zoe's Café purchases another depreciating asset that costs more than $20,000. Zoe's Café elects not to apply the small business capital allowance provisions because it is able to claim a better deduction for the asset under the uniform capital allowance rules.

In determining whether Zoe's Café is able to apply the small business capital allowance provisions in the 2017-18 income year, only the election in the 2016-17 income year is relevant.

As Zoe's Café did not choose to apply the small business capital allowance provisions in the 2016-17 income year, Zoe's Café is locked out from the 2017-18 income year from applying the small business capital allowance provisions in this year. Assuming Zoe's Café was otherwise eligible to apply the small business capital allowance provisions in its 2017-18 year, Zoe's Café can only begin to apply the small business capital allowance rules again in the 2022-23 income year.

Five year lock out rule for substituted accounting periods

1.37 For a small business entity that has a substituted accounting period (that is, an income year that does not commence on 1 July and end on 30 June), the final day of the period covered by the amendments (being 30 June 2017) will not be the final day of an income year. This means that the increased access years of the small business entity will not necessarily be the 2014-15, 2015-16, and 2016-17 income years.

1.38 For a small business entity that has a late balancing substituted accounting period which ends after 30 June, the 2016-17 income year will not be an increased access year. The small business entity's 2014-15 and 2015-16 income years will be increased access years, and in determining whether the lock out rule applies from the 2016-17 income year, the 2014­15 income year and earlier income years are disregarded. Because the 2015-16 income year is the last of the small business entity's increased access years, that year will continue to be relevant for determining whether the small business entity is subject to the lock out rule for the 2016-17 income year, and later income years. If for some reason the small business entity opted out of the small business capital allowance provisions in its 2015-16 income year, the small business entity will be locked out from the provisions for at least five income years.

Example 1.6

Josh's Jukeboxes Pty Ltd (Josh's Jukeboxes) is a small business entity that has a late balancing substituted accounting period which ends on 31 August. Josh's Jukeboxes increased access years are the 2014-15 and 2015-16 income years because those years both end during the period that goes from 12 May 2015 to 30 June 2017. Josh's Jukeboxes' 2016-17 income year is not an increased access year because it ends after 30 June 2017.

Josh's Jukeboxes did not apply the small business capital allowance provisions in its 2013-14 income year. Despite this, Josh's Jukeboxes can apply the small business capital allowance provisions in its increased access years (being its 2014-15 and 2015-16 income years).

In determining whether Josh's Jukeboxes is able to apply the small business capital allowance provisions in its 2016-17 income year, only the election in the 2015-16 income year is relevant. If Josh's Jukeboxes chose not apply the small business capital allowance provisions in its 2015-16 income year, it will be locked out from applying the rule for at least five years, commencing from its 2016-17 income year.

1.39 Alternatively, for a small business entity that has an early balancing substituted accounting period that ends before 12 May, the 2014-15 income year will not be an increased access year. The small business entity's 2015-16 and 2016-17 income years will be increased access years, and in determining whether the lock out rule applies from the 2017-18 income year, the 2015-16 income year and earlier income years are disregarded. Because the 2016-17 income year is the last of the small business entity's increased access years, that year will continue to be relevant for determining whether the small business entity is subject to the lock out rule for the 2017-18 income year, and later income years. If for some reason the small business entity opted out of the small business capital allowance provisions in its 2016-17 income year, the small business entity will be locked out from the provisions for at least the next five income years.

Example 1.7

Caroline's Language Centre Pty Ltd (Caroline's Language Centre) is a small business entity that has an early balancing substituted accounting period which ends on 31 March. Caroline's Language Centre increased access years are the 2015-16 and 2016-17 income years because those years both end during the period that goes from 12 May 2015 to 30 June 2017. Caroline's Language Centre's 2014-15 income year is not an increased access year because it ends before 31 March 2015.

Caroline's Language Centre did not apply the small business capital allowance provisions in its 2013-14 income year. Despite this, Caroline's Language Centre can apply the small business capital allowance provisions in its increased access years (being its 2015-16 and 2016-17 income years).

In determining whether Caroline's Language Centre is able to apply the small business capital allowance provisions in its 2017-18 income year, only the election in the 2016-17 income year is relevant. If Caroline's Language Centre chose not apply the small business capital allowance provisions in its 2016-17 income year, it will be locked out from applying the rule for at least five years, commencing from its 2017-18 income year.

Consequential amendments

1.40 Consequential amendments are made to Subdivision 328-D to insert notes indicating that the $1,000 threshold in that Subdivision is increased to $20,000 between 12 May 2015 and 30 June 2017. [Schedule 1, items 1 to 8, note 3 at the end of subsection 328-175(10), notes at the end of subsections°328-180(1) to (3), note at the end of subsection 328-210(1), notes at the end of subsections 328-250(1) and (4), and note at the end of subsection 328-253(4)]

1.41 The consequential amendments to Subdivision 328-D commence on the day this Bill receives Royal Assent. Because the changes to the threshold are temporary, most of the consequential amendments will be repealed on 1 July 2019 (being two years after the threshold returns to $1,000). The consequential amendment relating to the five year lock out rule will be repealed on 1 July 2022 (being five years after the last increased access year). [Schedule 1, items 10 to 14, note 3 at the end of subsection 328-175(10), notes at the end of subsections 328-180(1) to (3), note at the end of subsection 328-210(1), notes at the end of subsections 328-250(1) and (4), and note at the end of subsection 328-253(4)]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

1.42 Schedule 1 to this Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

1.43 Schedule 1 to this Bill amends the accelerated depreciation rules for small businesses (businesses with an aggregate annual turnover of less than $2 million) by temporarily increasing the threshold under which certain depreciating assets, costs incurred in relation to depreciating assets and general small business pools can be written off.

1.44 The increased threshold of $20,000 applies from 7.30 pm, by legal time in the Australian Capital Territory on 12 May 2015 until 30 June 2017. From 1 July 2017, the threshold is $1,000.

1.45 The increased threshold is available to all small businesses (including those who previously opted out of the simplified depreciation rules).

Human rights implications

1.46 Schedule 1 to this Bill does not engage any of the applicable rights or freedoms.

Conclusion

1.47 Schedule 1 to this Bill is compatible with human rights as it does not raise any human rights issues.

REGULATION IMPACT STATEMENT

Expanding accelerated depreciation for small businesses

Background

1.48 The Australian economy is in transition and faces significant structural challenges due to both domestic and international factors. Mining investment is now detracting from GDP growth. The switch to broader-based growth driven by activity in non-resource sectors is occurring, but perhaps more slowly than is desirable.

1.49 Below trend economic growth is leading to spare capacity in the labour market and increasing unemployment, particularly youth unemployment. Economic growth has been below its long run average in 5 of the past 6 financial years, weighing on job creation and contributing to a gradual upward drift in unemployment.

1.50 Low interest rates, a falling Australian dollar and real wage adjustment over time are expected to support employment and encourage business growth over the longer term.

1.51 There have been some positive signs the required adjustment is underway, including job advertisements showing a slight upward trend in recent months ^[1] .

1.52 However there is a risk of the adjustment being a protracted one, particularly given businesses remain reluctant to invest and take on new workers absent stronger, sustainable demand. ^[2] Investment in the non-mining sectors continues to be subdued, ^[3] and small businesses have responded by scaling back the level of their capital spending. ^[4] Longer term capital expenditure plans have also been revised down significantly in the non-mining sector, notwithstanding solid growth this year.

1.53 The Government committed to expanding accelerated depreciation for small businesses (both incorporated and unincorporated businesses with aggregated turnover less than $2 million). In the 2015-16 Budget, the Treasurer announced small businesses could fully and immediately deduct depreciating assets costing less than $20,000 (increased from the current level of $1,000) from 7:30 pm May 12, 2015 until 30 June 2017.

The problem

1.54 Small businesses make an important contribution to the Australian economy. They account for the vast majority of the active private businesses in the country and represent large shares of its employment and value added.

1.55 There are currently around 2.3 million small businesses in Australia (defined as having less than $2 million turnover). According to the Australian Bureau of Statistics, small businesses provide around 43 per cent of non-financial private sector jobs in Australia and around one third of non-financial output in 2012-13. ^[5] The small business sector has the potential to contribute strongly to national growth and competitiveness, including providing greater employment opportunities. Small businesses have the advantage of being adaptable and flexible, able to respond profitably to changing circumstances. Studies indicate that it is small businesses that are often the entities that test and pioneer innovative ideas and business practices, which are critical to future economic growth, job prospects and improved living standards.

1.56 However, while small businesses play a significant role in the Australian economy, they also face a unique set of operational challenges, and as a consequence typically have higher failure rates than those for larger companies. A comparison of the outcomes of the NAB survey of large companies, with the Sensis survey of small businesses undertaken by the Reserve Bank suggests that conditions for small business have been weaker than for larger businesses since the global financial crisis in 2008-09. ^[6]

1.57 One issue is regulatory costs; incorporated small businesses face higher proportional regulatory costs than larger companies due to their inability to take advantage of economies of scale in understanding and complying with regulation.

1.58 The other main issue for small companies is access to finance. Funding for small businesses is essential to facilitate productivity growth and job creation. Improving small business's access to finance was a Government election commitment. ^[7]

1.59 Allowing small businesses to immediately deduct most business assets they purchase under $20,000 would encourage small businesses to invest in new assets or replace old, out-dated equipment. This will support small businesses to invest in the assets they need to grow their business and prosper in the future.

Case for government action / Objective of reform

1.60 While it is businesses that create jobs, there is a clear role for Government to address impediments and create the right conditions for Australian small businesses to grow and become more productive. With the economy facing below-trend growth, the Government's objective is to stimulate small business investment, growth and employment.

1.61 The Australian economy is in transition. The declining terms of trade and the ageing of the population are placing downward pressure on income growth. Small business is a key driver of Australia's economy, underpinning growth and innovation and providing jobs for millions of Australians.

1.62 Small businesses are typically more vulnerable to shocks and changes in economic conditions than larger businesses. This makes it particularly important that, during this period of economic transition, the policy settings support small business growth and innovation. This proposal will encourage small businesses to invest in the assets they need to grow and service their customers.

1.63 Providing small businesses with a $20,000 threshold for immediate deduction encourages investment. Investment is important as it leads to existing output being produced at a lower cost and new and improved ways of doing business (innovation), which improves the amount of output produced for each unit of input, including labour (productivity). As a result, higher investment can lead to both higher employment and wages over time.

Policy options

Option 1: No policy change.

1.64 Under this option, no new actions would be taken by the Government and existing policy settings would be relied upon. The existing simplified depreciation rules allow small businesses to immediately deduct most assets that cost less than $1,000. Assets that are purchased for $1,000 or more can be added to the general small business pool (the pool) in the second year after they have been depreciated at a starting rate of 15 per cent in the first year. The pool is always depreciated at a rate of 30 per cent each year. Thus, the effective depreciation schedule for assets purchased by small business and placed in the pool is 15 per cent in the first year and 30 per cent for each year after. If the pool reaches a value below $1,000, the entire pool can be immediately deducted. The pool reduces the requirement to track the tax value of assets over multiple years because once an asset is in the pool, it is no longer depreciated individually, but as part of the pool at one constant rate.

1.65 Businesses which opt-out of the simplified depreciation rules are prevented from re-entering for five years.

Option 2: Expanded accelerated depreciation ($20,000) for small businesses:

1.66 Under this option, the simplified depreciation rules would be changed to allow small business to receive an immediate tax deduction for most individual assets they purchase costing less the $20,000 (up from the current threshold of $1,000).

1.67 This $20,000 threshold applies to each individual asset purchase. Small businesses can apply this $20,000 rule to as many individual items as they wish. Assets costing above this amount could be placed in the pool and depreciated at the rates mentioned in option 1.

1.68 This option exempts businesses which have opted-out out of the simplified depreciation rules from the lock-out rules.

1.69 These arrangements start at 7:30 pm 12 May 2015 (Budget night) and continue until 30 June 2017.

Option 3: Expanded accelerated depreciation ($15,000) for small businesses:

1.70 This option is the same as option 2; however, the threshold would be $15,000 instead of $20,000.

Cost benefit analysis of each option / Impact analysis

Option 1: No policy change.

1.71 This option involves no new actions by the Government and relies on existing policy settings. Consequently, it would introduce no new impacts on businesses, community organisations or individuals. At the same time, it would not address the issues identified in the problem section.

1.72 As noted in the background, low interest rates, a falling Australian dollar and real wage adjustment over time can be expected to support employment and encourage business growth over the longer term, along with increasing infrastructure investment and already announced measures to reduce regulation and red tape burden to make it easier to do business. However, a long, drawn out adjustment process would have substantial social costs, as identified in the Problem section.

Option 2: Expanded accelerated depreciation ($20,000) for small businesses (preferred option):

1.73 This option involves expanding accelerated depreciation for small businesses from 7:30 pm 12 May 2015 until 30 June 2017. The threshold for immediate deduction would be raised to $20,000 for this period. After these two income years, the threshold would revert to $1,000.

1.74 A simple example of how small business benefits from this proposal is to look at the cash flow that results from the expansion of accelerated depreciation:

•

A company that purchases an asset for $19,999 with the current policy settings would be able to depreciate the asset by $3,000 (15 per cent of $19,999) in the first year and $5,100 (30 per cent of $16,999) in the second year, by using the pool. The cash flow the company would receive from these depreciation amounts are $855 for the first year (assuming a 28.5 per cent small company tax rate) and $1454 in the second year. The company would continue to depreciate the pool at 30 per cent until the pool was under $1,000, at which point the entire pool could be written off.

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Under the $20,000 option, the company would be able to immediately deduct the entire $19,999 in the first year. The cash flow the company would receive from this change is $5,700 in the first year. In the second year, there is no further depreciation of this asset as it has been written off completely. This means that the company is paying more tax in the second year relative to the scenario for the existing arrangements.

1.75 While the cash flow under both scenarios is close to being the same after ten or fifteen years, it can be this extra cash flow upfront that makes the difference between a small business surviving or not. With the extra $4,845 in cash flow that the company in the scenario above would receive under the $20,000 option, it may reinvest that money into more equipment or employ more staff. Alternatively, it may choose to pay down some of its borrowing and reduce interest payments. Both of these benefits may have a further cash flow benefit.

Option 3: Expanded accelerated depreciation ($15,000) for small businesses:

1.76 This option involves expanding accelerated depreciation for small businesses for 7:30 pm 12 May 2015 until 30 June 2017. The threshold for immediate deduction would be raised to $15,000 for this period. After these two income years, the threshold would revert to $1,000.

1.77 The same analysis applies for this option as the $20,000 option, above. However, as the threshold for immediate deductibility is lower, the cash flow benefits are lower. The overall cost to government revenue for this proposal would be lower than option 2, but the benefit to small business would also be lower. In addition, option 2 presents a larger compliance saving than this option.

Benefits

1.78 Expanding accelerated depreciation for small businesses will benefit small business taxpayers who use the simplified small business depreciation arrangements under section 328-D of the Income Tax Assessment Act 1997.

1.79 The proposal does not change the total quantum of deductions available to businesses. Instead it allows businesses to deduct the cost of more assets immediately rather than over a period of time.

1.80 Increasing the rate at which small businesses can depreciate capital expenditures would improve small business's cash flow by releasing funds that would otherwise be tied up in depreciating assets. Small businesses tend to be more vulnerable to cash flow problems than larger businesses because their profitability tends to be more volatile and they have lower levels of retained earnings. The impact is expected to be bigger for new small businesses, as large capital expenditures often occur early in a business's life.

1.81 The measure will also encourage additional capital investment by small businesses through lowering the pre-tax rate of return required to justify new investments.

1.82 A temporary threshold would see some business bring forward capital purchases from future years. The costings incorporate this behaviour, but the magnitude of this is not anticipated to have anything beyond a negligible impact on the economy.

1.83 The proposal also extends the higher threshold for immediate deductibility to the small business depreciation pool. This will further benefit small businesses cash flow and reduce compliance costs through allowing businesses to depreciate the assets included in the general small business depreciation pool more quickly.

1.84 There will be a compliance cost saving for small businesses through not needing to maintain a depreciation schedule for assets costing less than the proposed threshold of $20,000. The current threshold is $1,000. There will also be less complexity in filling out tax return forms for small business entities as depreciation amounts for assets below $20,000 will no longer need to be calculated. The gross compliance cost saving is estimated to be $6.1 million per year for option 2 (table 1) and $4.0 million for option 3 (table 2).

Costs

1.85 Option 2 will result in an estimated revenue cost to the Budget of $1.8 billion over the forward estimates and the equivalent number for option three is $1.2 billion.

1.86 There will be some transitional compliance costs to small business entities associated with the proposal, largely relating to understanding the change, but these are expected to be small compared to the ongoing compliance saving associated with the measure. This is because the change builds on existing depreciation pooling arrangements which are well understood by taxpayers - with the only change being to the asset value threshold to which these arrangements apply.

1.87 Limiting the increase to two years would have a smaller reduction in regulatory costs than an ongoing option. This is primarily because of the short timeframe necessarily limiting the period small businesses would benefit from simplified record keeping. In addition, some businesses would be expected to engage in evaluating the timing of their acquisitions to maximise their tax benefit in the two years, further reducing the net regulatory savings from the proposal. Options 2 and 3 are likely to lead to a small increase in compliance costs for small businesses in year 3, when the threshold reverts to $1000. At this point, for assets greater than $1000, small businesses will be required to establish or add to a pooling arrangement.

1.88 Implementation costs are also expected to be slightly higher than under an ongoing option due to the additional learning costs associated with the threshold reverting back to $1,000 after two years. These increased compliance costs are incorporated in the compliance tables above.

Net Benefit

1.89 Options 2 and 3 will deliver a reduction in compliance costs for small businesses, particularly those that are capital intensive, through simplifying their tax arrangements and the record keeping required from 12 May 2015 through to 30 June 2017.

1.90 By allowing small businesses to write off more assets early, the increase in the threshold will boost small businesses cash flow, particularly for new businesses, reducing their vulnerability. The measure will also encourage additional capital investment by small businesses through lowering the pre-tax rate of return required to justify investments.

1.91 Data are not yet available to accurately assess a previous version of this policy. Even when they are, this kind of analysis can be difficult.

Consultation

1.92 The tax proposals have been informed by targeted consultation with tax specialists outside government, including the Board of Taxation (the Board), on a confidential basis. Options were discussed with the Board on a couple of occasions, to give particular Board members an opportunity to provide feedback and to ask follow-up questions. This included the incorporated and unincorporated tax cuts. The Board's positive feedback was a factor in deciding on particular parameters in the final policy design.

1.93 The Treasury also consulted with the Australian Tax Office in order to identify any implementation issues, integrity concerns with the proposals, as well as any potential flow-on impacts they might have within the broader tax framework.

1.94 The limited consultation on the proposals reflects the cabinet-in-confidence nature of the decision making process. However, it should be noted that the proposed tax options have already been the subject of, and informed by, extensive consultations undertaken as part of previous policy processes. Specifically, the Australia's Future Tax System (the Henry Review) report included a recommendation to increase the threshold for immediate deductibility to $10,000 (Recommendation 29), alongside simplified depreciation rules to reduce complexity and compliance costs for small businesses.

1.95 Several stakeholders also have argued for an increase to the threshold, including the Australian Chamber of Commerce and Industry in its pre-Budget submission. ACCI supported the Henry Review's earlier recommendation to increase the threshold for immediate asset write-off to $10,000 in the income year the asset is first used or installed. The Australian Industry (Ai) Group similarly supported a period of accelerated depreciation for investments in plant and equipment and a lift in the small business instant asset write-off to $6,000.

1.96 Announcement of $20,000 instant asset write-off for small businesses in the Budget received a generally positive response from stakeholders. The Council of Small Businesses of Australia (COSBOA) released a media statement 12 May 2015 welcoming the changes to accelerated depreciation, stating they would work to assist small businesses to start up, operate and if desired, grow. Kate Carnell, CEO of the ACCI, stated the measures announced in the Budget would "turbocharge small businesses" and help restore plunging small business confidence (May 18, 2015), while the Australian Dental Industry Association (ADIA) described the increased threshold as an "exciting initiative for small business...in the dental industry and economy overall".

1.97 As the implementing legislation is to be introduced as a 2015 Winter T Bill, there will not be time for the release of exposure draft legislation. This is not considered an issue since the legislation is expected to be relatively straightforward as it is essentially a rate change.

Option selection / Conclusion

1.98 The preferred option is to expand accelerated depreciation for small businesses by providing a $20,000 threshold for immediate deductibility (option 2) from 7:30 pm 12 May 2015 until 30 June 2017.

1.99 This option strikes a balance between encouraging investment and economic growth and ongoing budget repair.

Implementation and evaluation / review

1.100 Legislation is required to implement the proposal. As the Government has set the start date as 7:30 pm 12 May 2015, accelerated depreciation is scheduled with the small business company tax cut because it needs to be a Winter T Bill and enacted by 30 June 2015 (so taxpayers can claim their deductions for the 2014 15 income year).

1.101 The design of the legislation is expected to be relatively straightforward largely relying on current models in the tax system.

1.102 The ATO would be responsible for administering the tax rules applying to small businesses. The ATO and Treasury are experienced in implementing this type of reform.

1.103 For options 2 and 3, the rules around asset eligibility do not change. That is, if an asset was eligible for immediate deductibility under the current $1,000 threshold it will continue to be deductible under the new $20,000 threshold.

1.104 However, to ensure the proposal operates as intended, the ATO will engage with small businesses based on their behaviour and choices. This will include providing clear guidance so that businesses intending to utilise the provisions find it as easy as possible to do so.

1.105 If small businesses exhibit behaviours that indicate a high level of risk, they can expect a higher level of interaction with the ATO. The ATO has a risk-based program to identify taxpayers that are not meeting their obligations and will take measured approaches to influence taxpayer behaviour.

1.106 The benefit of this measure should not be assessed in isolation but considered as part of the small business package.