House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 1 - An overview of the Simplified Tax System

Outline of chapter

1.1 This chapter provides a general overview of the STS. It briefly explains each component of the STS and refers readers to the relevant chapters for more detailed explanation of the rules.

1.2 Diagram 10 shows how the STS rules relate to each other. [Schedule 1, item 1, Subdivision 328-A]

Diagram 1.1: STS for business

1.3 This chapter also provides a general overview of the new prepayments arrangements resulting from the STS changes contained in this Bill.

Context of reform

1.4 The STS modifies the method of determining taxable income for certain businesses with straightforward, uncomplicated tax affairs. Eligible businesses that choose to use the STS will have access to simpler depreciation, trading stock and accounting arrangements (although the remaining tax rules apply outside these areas).

1.5 The Review of Business Taxations report A Tax System Redesigned recommended the STS and the Government supported that recommendation (Treasurers Press Release Nos. 58 and 59 of 21 September 1999). The Review of Business Taxation estimated that around 95% of all businesses, and 99% of farming businesses, would be eligible for the STS.

1.6 Consistent with the Governments approach to business tax reform, the detailed design of the STS has benefited from extensive consultation with business representatives and professional bodies.

1.7 The object of the STS is to provide the following benefits to those businesses eligible to enter the STS:

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a reduction in effective tax burden; and

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simplified record keeping and reporting requirements.

The STS also contains integrity measures to ensure that ineligible businesses cannot structure or restructure their affairs to take advantage of these benefits. These measures reinforce that the STS is designed for small businesses with straightforward and uncomplicated affairs. [Schedule 1, item 1, section 328-50]

1.8 This Bill also contains amendments that complete the Governments announced changes to the prepayments provisions in the taxation law. For more detail on the context of this reform, see Chapter 7.

Overview of new law

Main elements of the STS

1.9 There are 3 main elements of the STS. These are:

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new accounting arrangements for STS taxpayers which recognise business income and deductions only when they are received and paid [Schedule 1, item 1, Subdivision 328-C] ;

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a simplified depreciation regime under which depreciating assets costing less than $1,000 each are written off immediately. Most other depreciating assets are pooled and enjoy an accelerated rate of depreciation [Schedule 1, item 1, Subdivision 328-D] ; and

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a simplified trading stock regime where STS taxpayers do not have to account for changes in trading stock or do stocktakes at the end of the income year in certain circumstances [Schedule 1, item 1, Subdivision 328-E] .

Can you enter the STS - Chapter 2

1.10 A business must meet certain criteria to be eligible for the STS.

1.11 A business is eligible to enter the STS for a year of income if:

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it carries on a business in that year;

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the STS average turnover of the business and related businesses for that year is less than $1 million; and

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the business and related businesses have depreciating assets of less than $3 million at the end of that year.

Entering and leaving the STS - Chapter 3

1.12 Eligible taxpayers may choose to enter the STS. STS taxpayers remain in the system unless:

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they choose to leave; or

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they no longer meet the eligibility rules:

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STS taxpayers who choose to leave the STS must wait at least 5 years before they can re-enter; and

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STS taxpayers who are required to leave the STS because they are no longer eligible may re-enter in the year they again become eligible.

Accounting method for STS taxpayers - Chapter 4

1.13 Ordinary income is recognised when received . Broadly, ordinary income of a business includes ongoing business or trade income.

1.14 General deductions and deductions for tax-related expenses and repairs are deductible when paid . Broadly, general deductions of a business include ongoing operating expenses such as wages, rent and purchase of stock.

1.15 Entry adjustment rules ensure that when a business enters the STS and uses the new accounting arrangements for STS taxpayers, business income and expenses affected by the new accounting arrangements, are not recognised twice or omitted.

1.16 Exit adjustment rules ensure that when a business leaves the STS and stops using the new accounting arrangements for STS taxpayers, business income and expenses previously affected by the new accounting arrangements, are not omitted.

1.17 These adjustments are also designed to prevent any double counting or omission of business income and deductions affected by the new accounting arrangements for STS taxpayers.

Capital allowances for STS taxpayers - Chapter 5

1.18 The capital allowances are:

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depreciating assets that cost $1,000 or less are written off immediately;

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depreciating assets with an effective life of less than 25 years are pooled - the pool is treated as a single depreciating asset with an accelerated rate of depreciation of 30% on a declining value basis;

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depreciating assets (excluding buildings, which will retain their current treatment) with an effective life of 25 years or more are pooled in a long life pool and are depreciated at the rate of 5% on a declining value basis;

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simplified treatment of private use assets; and

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simplified treatment on disposals of depreciating assets.

Simplified trading stock regime - Chapter 6

1.19 Where the difference between the value of trading stock on hand at the start of an income year and the reasonably estimated value at the end of the year is $5,000 or less, an STS taxpayer does not have to:

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value each item of trading stock on hand at the end of the income year; and

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account for any change in the value of trading stock on hand.

1.20 Where the difference between the value of trading stock on hand at the start and at the end of the year is greater than $5,000, an STS taxpayer must value each item of trading stock on hand at the end of the year and account for the change in value in accordance with the current law.

Prepayments of deductible expenses - Chapter 7

1.21 Under the new 12-month prepayments rule, an advance payment made by an STS taxpayer or an individual incurring deductible non-business expenditure will be immediately deductible where:

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it is incurred in respect of a period of service not exceeding 12 months; and

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the period of service ends no later than the last day of the income year following the date on which the payment is made.

1.22 Small business taxpayers not entering the STS and non-individual taxpayers who are incurring deductible non-business expenditure will move to the general scheme of the prepayments provisions; that is, their deductions for incurred deductible prepayments expenditure will be apportioned over the service period.

Regulation impact statement - Chapter 8

1.23 The objectives of the STS are to provide certain benefits to eligible businesses through the provisions of an alternative method of calculating taxable income. Specific details of the impacts are contained in Chapter 8.

Application and transitional provisions

1.24 The STS will apply to assessments for income years commencing after 30 June 2001. [Schedule 1, item 2]

Consequential amendments

1.25 Schedule 2 to this Bill contains amendments to the ITAA 1997 resulting from the introduction of the STS.

1.26 A new item is inserted in the table in subsection 4-15(2) to show that, for STS taxpayers, taxable income is worked out in a special way. [Schedule 2, item 1]

1.27 The dictionary in the ITAA 1997 is amended to insert the meaning of an STS taxpayer. [Schedule 2, item 22]

1.28 Consequential amendments apply to amendments for income years commencing after 30 June 2001. [Schedule 2, item 24]