House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 1 PAYG instalment reduction for small businesses

Outline of chapter

2.1 Schedule 1 to this Bill amends section 45-400 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) (which provides how the Commissioner of Taxation (Commissioner) works out the amount of the pay as you go (PAYG) quarterly instalments on the basis of GDP-adjusted notional tax) to provide for:

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a 20 per cent reduction of the amount of the PAYG instalment worked out under the section for the quarter that includes 31 December 2008 for certain small business taxpayers; and

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a regulation-making power to allow the amount of the PAYG instalment worked out under the section to be reduced in the future in circumstances specified by regulations.

Context of amendments

2.2 Under the PAYG instalments system, taxpayers earning business or investment income pay instalments during the year towards their final tax liability for that income year. Taxpayers may pay their PAYG instalments on the basis of GDP-adjusted notional tax (GDP-adjustment method) or on the basis of instalment income.

2.3 The GDP-adjustment method is available to the classes of taxpayers listed in section 45-130 of Schedule 1 to the TAA 1953. These taxpayers are individuals, multi-rate trustees and full self-assessment taxpayers with $2 million or less of instalment income for the previous income year or more than $2 million of instalment income for the previous income year and are eligible to pay an annual PAYG instalment but have chosen not to. For the 2009-10 income year or later income years, 'small business entities' (as defined by section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997)) will be automatically eligible to use the GDP-adjusted method.

2.4 Taxpayers who pay PAYG instalments on the basis of the GDP-adjusted method are generally quarterly payers who pay four instalments annually. However, section 45-134 of Schedule 1 to the TAA 1953 allows primary production businesses and special professionals to pay two instalments a year under the GDP-adjustment method.

2.5 Under the GDP-adjustment method, the Commissioner works out the amount of the instalments taxpayers pay in accordance with Subdivision 45-L of Schedule 1 to the TAA 1953.

2.6 The amount of the instalments payable depends on the taxpayer's GDP-adjusted notional tax which is worked out under section 45-405 of Schedule 1 to the TAA 1953. Broadly, the GDP-adjusted notional tax is worked out by 'uplifting' the taxpayer's income in the previous year by that year's rate of nominal GDP growth (the GDP uplift factor).

2.7 The GDP uplift factor can be unrepresentative of expected profit growth in income years where economic and business conditions change quickly and the expected income of taxpayers changes accordingly. This can cause taxpayers to be required to pay PAYG instalments that are too high compared with their actual income, with the overpaid tax being refunded to them at the conclusion of the income year when their final tax liability is assessed. For example, for the 2008-09 income year, due to the global financial crisis, the profit growth for small businesses as forecasted in the Mid-year Economic and Fiscal Outlook 2008-09 is significantly lower than the GDP uplift factor of 8 per cent.

2.8 While taxpayers may vary their instalment amounts calculated and notified by the Commissioner themselves, many are reluctant to do so, as underpayments can trigger the general interest charge. As such, it is desirable to build more flexibility in the law to allow the instalment amounts calculated on the basis of GDP-adjusted notional tax to be reduced to more accurately reflect changing economic circumstances.

Summary of new law

2.9 The PAYG instalment amount for the quarter that includes 31 December 2008 for certain small business taxpayers who are quarterly payers paying four instalments annually on the basis of the GDP-adjustment method as worked out under section 45-400 of Schedule 1 to the TAA 1953 will be reduced by 20 per cent. This reduction will not affect the instalment amounts as worked out under the section for the following quarters in the same income year.

2.10 In addition, the PAYG instalment amounts as worked out under section 45-400 of Schedule 1 to the TAA 1953 may be reduced in the future in certain circumstances as prescribed by regulations. Any prescribed reduction will not affect the instalment amounts as worked out under the section for the quarters following the prescribed quarter(s) in the same income year.

Comparison of key features of new law and current law

Detailed explanation of new law

Amount of instalments reduced as specified by regulation

2.11 The amendments insert a regulation-making power to allow for PAYG instalment amounts for quarterly payers who pay four instalments annually on the basis of GDP-adjusted notional tax to be reduced in certain specified circumstances to more accurately reflect prevailing economic conditions and actual income of certain taxpayers for a particular income year. Section 18 of the TAA 1953 provides that the Governor-General may make regulations prescribing matters required or permitted by the Act to be prescribed, or necessary or convenient to be prescribed for carrying out or giving effect to the TAA 1953. [Schedule 1, item 3, subsection 45-400(3 ) of Schedule 1 to the TAA 1953]

2.12 The PAYG instalment amounts payable under the GDP-adjustment method for quarterly payers who pay four instalments annually are worked out in accordance with the table in subsection 45-400(2) of Schedule 1 to the TAA 1953.

2.13 The regulations may specify the instalment quarter(s) to which a reduction applies or the taxpayers eligible for the reduction. [Schedule 1, item 3, subsection 45-400(4 ) of Schedule 1 to the TAA 1953]

2.14 A prescribed reduction of the instalment amount for a quarter in an income year will not affect the working out of instalment amounts for the later quarters of that income year. The amounts worked out for quarters following the prescribed quarter will be determined as if no reduction had occurred. [Schedule 1, item 3, subsection 45-400(5 ) of Schedule 1 to the TAA 1953]

2.15 An instalment amount for a quarter in an income year as worked out in accordance with the table in subsection 45-400(2) of Schedule 1 to the TAA 1953 is a set percentage of a taxpayer's GDP-adjusted notional tax reduced by the instalment amounts for the earlier quarters in that income year. As such, the reduction of one quarter's amount would ordinarily be clawed back in the next quarter's instalment amount, effectively reversing the cash flow benefit of reducing one quarter's PAYG instalment amount. By ignoring the reduction for the quarters following the quarter(s) to which the reduction applies, the amount reduced is not clawed back through the subsequent quarter's instalment amount.

December 2008 quarter PAYG instalment reduction

2.16 The quarterly PAYG instalment amount for the quarter that includes 31 December 2008 for certain small business taxpayers who are quarterly payers paying four instalments annually on the basis of GDP-adjusted notional tax will be reduced by 20 per cent. [Schedule 1, item 3, subsection 45-400(6 ) of Schedule 1 to the TAA 1953]

2.17 The 20 per cent reduction for the quarter that includes 31 December 2008 broadly represents the annual reduction in instalments necessary to reflect the expected slowing in small business profit growth for the 2008-09 income year in a single quarterly instalment.

2.18 Small business taxpayers who will be eligible for the reduction are small business entities (see below), a partner of a partnership that is a small business entity, or a beneficiary of a trust that is a small business entity, for either the 2007-08 or 2008-09 income years. [Schedule 1, item 3, paragraphs 45-400(6 )( a ) to ( c ) of Schedule 1 to the TAA 1953]

Example 2.1

Alice is a partner of a partnership that is a small business entity for the 2007-08 income year. Alice is required to pay quarterly PAYG instalments on investment and business income she derives (including her share of the partnership income) on the basis of GDP-adjusted notional tax.

While Alice is not a small business entity herself she is eligible to receive the 20 per cent reduction to her quarterly PAYG instalment amount for the December 2008 quarter as she is a partner of a partnership that is a small business entity. The 20 per cent reduction applies to all the income accounted for in working out Alice's GDP-adjusted notional tax which includes both her income from the partnership and business and investment income from other sources.

2.19 'Small business entity' is defined in section 328-110 of the ITAA 1997. Broadly, an entity is a small business entity for an income year if they are carrying on a business for the income year and their aggregated turnover is less than $2 million for the previous income year or is likely to be less than $2 million for the current income year (calculated on the first day of the current income year for the entity).

Example 2.2

In the 2007-08 income year, James carried on an IT consultancy business. His aggregated turnover for that income year was $1.9 million.

For the 2008-09 income year, James is a small business entity because his aggregated turnover for 2007-08 was less than $2 million. This is irrespective of his likely or actual turnover in the 2008-09 income year.

2.20 Small business taxpayers who are quarterly payers who pay two instalments annually are not eligible for the reduction. Under section 45-134 of Schedule 1 to the TAA 1953, primary production businesses and certain professionals, such as professional sports persons, may pay two instalments annually under the GDP-adjusted method. The amount of instalment for quarterly payers who pay two instalments annually is worked out under section 45-402 of Schedule 1 to TAA 1953. These taxpayers are required to pay their two instalments at the third and fourth quarters in an income year, as such, the period between the time that they are required to pay instalments and the time they are required to pay their final annual income tax liability is shorter than a taxpayer who pays four quarterly instalments throughout the income year. Accordingly, applying the PAYG instalment reduction will not provide much cash flow relief for these taxpayers as the timing difference between the payment of their instalments and receiving a possible refund on their final annual income tax liability is small.

Example 2.3

Michael is a primary producer and pays two instalments annually on the basis of GDP-adjusted notional tax. Michael is not eligible for the 20 per cent reduction applicable to the PAYG instalment for the instalment quarter including 31 December 2008.

2.21 Similarly, small business entities who have voluntarily varied their PAYG instalment amount for the instalment quarter that includes 31 December 2008 to better reflect their individual circumstances under section 45-112 of Schedule 1 to the TAA 1953 are not eligible for the 20 per cent reduction. The 20 per cent reduction is intended as an alternative to voluntary variation where taxpayers are uncertain about varying their PAYG instalment.

2.22 Depending on a taxpayer's accounting period, the instalment quarter that includes 31 December 2008 may be an entity's first, second, third or fourth instalment quarter. The meaning of instalment quarter is provided in section 45-60 of TAA 1953.

Example 2.4

Constantine Cleaning Services Pty Ltd, with the Commissioner's permission, adopts a substituted accounting period and is a quarterly payer who pays four instalments annually on the basis of GDP-adjusted notional tax. Constantine Cleaning Services Pty Ltd is an 'early balancer' and its 2008-09 income year covers the period from 1 May 2008 to 30 April 2009.

As a company with an aggregated turnover of less than $2 million in the 2007-08 income year, Constantine Cleaning Services Pty Ltd is eligible for the 20 per cent PAYG instalment reduction. The quarter including 31 December 2008 will be the third quarter for Constantine Cleaning Services Pty Ltd. The 20 per cent reduction will apply to Constantine Cleaning Services Pty Ltd's third quarter PAYG instalment.

2.23 The reduction for the quarter that includes 31 December 2008 will not affect the instalment amounts worked out under section 45-400 of Schedule 1 to the TAA 1953 for the later quarters in the same income year. The amounts worked out for quarters following the quarter that includes 31 December 2008 will be worked out as if no reduction had occurred. [Schedule 1, item 3, subsection 45-400(7 ) of Schedule 1 to the TAA 1953]

2.24 Ignoring the 20 per cent reduction for the quarter that includes 31 December 2008 will make sure the reduction is not clawed back through the subsequent instalment amounts in the same income year.

2.25 In order to avoid inoperative provisions in the tax laws, the provisions that give effect to the reduction for the quarter that includes the 31 December 2008 will be automatically repealed on 1 July 2013. [Schedule 1, item 4 .

2.26 Given the insertion of new provisions in section 45-400 of Schedule 1 to the TAA 1953, two headings will be inserted in the section to make clearer the matters that are dealt with by each of the subsections. [Schedule 1, items 1 and 2]

Application provisions

2.27 The amendments in Part 1 of this Schedule commence on the day the Bill receives Royal Assent and apply in relation to instalment quarters in the 2007-08 income year and later income years. The application to instalment quarters in the 2007-08 income year is required in order to account for small business taxpayers who adopted a substituted accounting period with a late December balancing date in lieu of 30 June 2008 (late December balancers). The quarter that includes 31 December 2008 for late December balancers will be the fourth quarter of the 2007-08 income year for these taxpayers. [Schedule 1, item 5]