Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 14 - Regulation impact statement
Policy objective
14.1 The consolidation measure in this bill, which deals with the consolidated income tax treatment of wholly-owned groups as single entities, is part of the Governments broad ranging reforms which will give Australia a New Business Tax System. The reforms are based on the recommendations of the Review of Business Taxation, instituted by the Government to consider reform of Australias business tax system.
14.2 Currently, the income tax system treats each company in a wholly-owned group as a separate entity (subject to certain grouping provisions). Taxing member entities separately means that each entity must separately account for all intra-group transactions as well as debt and equity interests. For business, this imposes extra compliance costs and sometimes stands in the way of the most efficient business structures. From the communitys perspective, the existing grouping provisions for wholly-owned groups provide opportunities for tax avoidance through artificial arrangements.
14.3 This bill is part of the legislative program implementing the New Business Tax System. Other bills have been introduced and passed already.
14.4 Broadly, the New Business Tax System will enhance Australias competitiveness through lower company and capital gains tax rates, and reduced compliance costs.
14.5 Consolidation is expected to address both efficiency and integrity problems existing in the taxation of wholly-owned entity groups, many of which arise from this inconsistent treatment. These include:
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- compliance and general tax costs;
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- double taxation where gains are taxed when realised and then taxed again on the disposal of equity;
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- tax avoidance through intra-group dealings;
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- loss cascading by the creation of multiple tax losses from the one economic loss; and
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- value shifting to create artificial losses where there is no actual economic loss.
The objectives of measures in this bill
14.6 The object of consolidation is to improve efficiency and reduce compliance costs by providing a business environment in which some highly complex business structures are no longer seen as necessary.
14.7 The consolidation regime is expected to:
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- assist in the simplification of the tax system;
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- reduce both compliance costs and ATO administration costs associated with the existing tax treatment of company groups;
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- improve the efficiency of business restructuring; and
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- strengthen the integrity of the income tax system.
Implementation options
14.8 These problems will be addressed by ceasing to recognise multiple layers of ownership within a wholly-owned group and by treating the group as a single entity for income tax purposes.
14.9 It is intended that the benefits to be achieved by consolidation as described above should therefore encourage wholly-owned groups to adopt the new regime. Wholly-owned groups that choose to remain outside consolidation will lose entitlement to the existing grouping rules which currently provide some of the benefits intended to be replaced by consolidation.
14.10 The major measures in this bill arise directly from recommendations of the Review of Business Taxation. Those recommendations were the subject of extensive consultation. The implementation options for these measures can be found in A Platform for Consultation and A Tax System Redesigned . Table 14.1 shows where the measures (or the principles underlying them) are discussed in those publications.
| Measure | A Platform for Consultation | A Tax System Redesigned |
|---|---|---|
| Consolidation | Chapters 25 to 27, pp. 529-590. | Recommendations 15.1 to 15.5, pp. 517-529. |
14.11 These implementation options discussed in A Platform for Consultation and A Tax System Redesigned have only been subsequently modified where required to reflect changed circumstances. Table 14.2 lists variations from the recommendations of the original review. Most of these variations were exposed in the December 2000 and February 2002 exposure drafts.
| Approach reflected in this bill | Reason for the approach |
|---|---|
| Discretionary trusts and hybrid trusts are allowed to be members of a consolidated group if they are effectively wholly-owned by the head company. | This new test avoids introducing unnecessary complexity into the regime. |
| The rate at which transferred losses can be used by a group is restricted to approximate the rate at which the losses would have been used had the entity transferring the losses not joined the group. The new method by which this is achieved departs from Recommendation 15.3 of A Tax System Redesigned . | This new method was developed in consultation with interested taxpayers and their advisers after earlier consultations concluded that the method contained in Recommendation 15.3 of A Tax System Redesigned would be inequitable in certain circumstances. |
| A concessional method for the use of transferred losses has been developed to apply to certain losses transferred to a group that consolidates during the transitional period. | This change was necessary in recognition of the departure from Recommendation 15.3 of A Tax System Redesigned . |
| Group income tax liability is to be borne initially by the head company. Where the head company fails to satisfy the liability on time, The Commissioner can recover the liability directly from the subsidiary members of the group as allocated under a tax sharing agreement. This is a departure from Recommendation 15.1 of A Tax System Redesigned. | The ability of the Commissioner to recover an unpaid amount in accordance with an allocation under a tax sharing agreement was developed in response to concerns raised by interested taxpayers and their advisers regarding the significant impact an imposition of joint and several liability would have on typical commercial practices. |
Assessment of impacts
14.12 The potential compliance, administrative and economic impacts of the measure in this bill has been carefully considered, both by the Review of Business Taxation and by the business sector. The Review of Business Taxation focused on the economy as a whole in assessing the impacts of its recommendations and concluded that there would be net gains to business, government and the community generally from business tax reform.
14.13 The measure in this bill specifically impacts on those taxpayers identified in Table 14.3.
| Measure | Affected taxpayers |
|---|---|
| Consolidated groups to be taxed as a single entity. | Estimates based on ASIC and ATO data indicated that there may be between 11,300 and 33,472 head companies and up to 101,870 subsidiaries eligible to be members of consolidated groups. These figures do not include trusts which can also be subsidiary members. Businesses in all sectors of the economy will be affected but the greatest impact is expected to be on large corporate groups. |
| Repeal of grouping provisions. | Companies in wholly-owned groups that choose not to be taxed as a consolidated group. |
14.14 As is standard with new measures, groups affected will need to incur up-front costs in determining whether entry into the consolidation regime is in their best interest and, if so, either familiarising themselves with the new law or having advisers familiarise themselves with the new law. Costs will also be incurred in updating reporting software and intra-group accounting systems as well as in notifying the ATO of the decision to consolidate.
14.15 Due to the magnitude of the consolidation measure, for large corporate groups, especially head companies, the start-up costs may be significant. For example, upon consolidation the market values of all assets held by group members needs to be determined, resulting in some new cost bases assigned (to each asset). However, these costs are alleviated by a transitional measure under which the group can elect, prior to 1 July 2003, to bring assets into the group at their existing cost bases.
14.16 However, overall the measure in this bill is expected to result in significantly reduced ongoing compliance costs for wholly-owned groups because the consolidation regime will improve the equity and integrity of the current business tax system.
14.17 Currently, each legal entity in a wholly-owned group is treated as a separate entity for tax purposes. However, AASB Accounting Standard 1024 requires financial reporting on an economic entity where a parent entity controls a subsidiary. By treating a wholly-owned group of entities as a single taxpayer, the taxation treatment of such groups is more consistent with their accounting treatment, resulting in cost savings. For example, transactions such as the sale of stock and payments of interest between group members are at present recognised for taxation purposes. Under the consolidation measure, these intra-group transactions will be ignored for taxation purposes, thereby more closely aligning the taxation and accounting treatment of entities.
14.18 As each legal entity in the group is currently treated as a separate entity for tax purposes, each must lodge a separate tax return resulting in an assessment, prepare a BAS for income tax, pay a separate PAYG instalment and separately comply with other administrative requirements. In a consolidated group only the head entity is recognised for income tax purposes, and is the only entity which must comply with the above requirements. This will result in compliance cost savings, especially for groups comprising numerous entities. There will also be cash flow benefits accruing to the group as a result of the aggregation of PAYG obligations.
14.19 Within a consolidated group, tax attributes such as losses, franking credits and foreign tax credits will be pooled by the head entity. The need for the head company to operate a single record for each attribute, rather than separate records for each attribute of each entity, will result in compliance cost savings for groups that choose to consolidate.
14.20 Company groups must currently deal with a large amount of complex legislation aimed at preventing loss duplication, value shifting, the avoidance or deferral of capital gains and other practices involving transactions within groups. The consolidation measure will result in significant compliance cost savings because existing integrity measures will not apply to intra-group transactions, which are ignored within a consolidated group.
14.21 Further, the consolidation measure will improve the integrity of the taxation system by removing the potential for taxpayers to receive unwarranted benefits in the form of duplicated losses. The tax system will also become more equitable as the consolidation regime will prevent gains being subject to double taxation - where the gain is taxed when realised and then taxed again on the disposal of the equity. To an extent, the consolidation measure will affect the amount of tax paid by entities that choose to consolidate as opposed to those that do not.
14.22 Although there will be initial administrative costs associated with the introduction of the consolidation measure, it is expected to produce administrative savings on an ongoing basis. For example, the ATO will expend less because it will be dealing with far fewer income tax entities than was previously the case.
14.23 The consolidation measure is expected to cost approximately $1 billion over the forward estimate period. This cost largely relates to the transitional concessions that will allow groups to use their losses faster than is allowed under the current law.
Strengthen integrity of the tax system
14.24 The consolidation measure will address integrity problems in the current taxation of wholly-owned groups, including:
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- double taxation;
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- loss cascading;
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- value shifting; and
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- tax avoidance through intra-group dealings.
14.25 The consolidation measure, as part of the New Business Tax System, will provide Australia with an internationally competitive business tax system that will create an environment for achieving higher economic growth, more jobs and improved savings. Further economic benefits of this measure is explained in more detail in the publications of the Review of Business Taxation, particularly A Platform for Consultation and A Tax System Redesigned.
14.26 The consolidation measure in particular will provide economic benefits in the form of a simplified income tax system and a significant reduction in compliance and administrative costs associated with the current tax treatment of corporate groups. The consolidation regime will also have a positive effect on the Australian economy because it will improve the integrity, equity and efficiency of the Australian income tax system.
14.27 The consultation process began with the release of the Governments Tax Reform Document: Tax Reform: not a new tax, a new tax system in August 1998. The Government established the Review of Business Taxation in that month. Since then, the Review of Business Taxation has published 4 documents about business tax reform, a subject of which was consolidation. In particular, A Platform for Consultation and A Tax System Redesigned canvassed options, discussed issues and sought public input.
14.28 In December 2000 an exposure draft was released which contained the general principles of consolidation. In February 2002 a further streamlined exposure draft was released taking into account submissions on the earlier exposure draft. The accompanying explanatory material to the February 2002 exposure draft provided a comprehensive overview of the regime as a whole. It discussed proposed legislative amendments not included in the exposure draft at that time.
14.29 The Government has consulted extensively in implementing this measure. Significant contribution was made to the regimes development via submissions and workshops and by ongoing consultative groups. For example, the consolidation measure has been the subject of ongoing discussion with a focus group comprised of large corporate group representatives and tax advisers. The measure has also been presented to the Commissioners Small Business Advisory Group.
14.30 The number of submissions received in response to the exposure drafts was 36 for the December 2000 exposure draft and 34 for the February 2002 exposure draft. Issues raised have been published on the ATOs Tax Reform website and are updated as developments occur. Whilst the majority of submission comments have been adopted, a small minority could not be accommodated. This was either because the submission did not accord with the underlying policy intent of the consolidation regime or was not a practically viable option for the regime.
14.31 For example, the suggestion that 5%, rather than 1%, of all membership interests be allowed to be held by employees ran contrary to the principle that the consolidation regime would only apply to entities that are substantively wholly-owned by the head company of the consolidated group. Another example is the suggestion that a wholly-owned group of entities be able to enter and exit the consolidation regime on an annual basis. Such a proposal would negate the intended ongoing compliance cost savings of the regime, and would be extremely difficult for the ATO to administer.
Conclusion and recommended option
14.32 The measure contained in this bill is expected to support a more efficient, innovative and internationally competitive Australian business sector, to reduce compliance costs and to establish a simpler and more structurally sound business tax system.
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