House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)

Chapter 2 Regulation impact statement

The problem

2.1 There are over 3 million small businesses in Australia. These small businesses contribute in many ways to the Australian economy, including to national growth and competitiveness. Small businesses are also adaptable and flexible and they can respond quickly to changing circumstances. According to the Australian Bureau of Statistics, small businesses added around $390 billion to the Australian economy in 2016-17.

2.2 Small businesses face a unique set of operational challenges, and as a consequence typically have higher failure rates than those for larger companies. A key reason for these higher rates of failure is the challenge small businesses face in managing their cash flow. This is exacerbated by the proportionately higher regulatory costs that small businesses bear relative to larger companies, largely due to their inability to take advantage of economies of scale in understanding and complying with regulation.

2.3 Small businesses currently have access to a range of tax concessions - in particular, they are able to fully and immediately deduct each eligible depreciating business asset they purchase costing less than $20,000 ("the immediate deductibility threshold").

2.4 These reasons remain relevant to the operating environment for small businesses today. Small businesses tend to be more vulnerable to cash flow problems than their larger counterparts because their profitability tends to be more volatile and they have lower levels of retained earnings. It is also not unusual for small businesses to have to manage a disproportionately higher compliance burden, per unit of turnover, than larger businesses.

2.5 The $20,000 threshold has been in place since 12 May 2015 and expires on 30 June 2019. Small businesses with an aggregated annual turnover of less than $10 million ($2 million before 1 July 2016) are able to access the concessional depreciation arrangements for eligible assets.

2.6 As noted in the 2015 regulation impact statement prepared for that measure, the threshold was increased to assist small businesses during a period of economic transition and to help counter the risk that the period of economic adjustment would be a protracted one and would result in a reluctance for businesses to invest and take on new workers absent stronger, sustainable demand. ^[1] During 2015, small businesses were responding by scaling back the level of their capital spending ^[2] , and had revised downwards their longer term capital expenditure plans in the non-mining sector, notwithstanding solid growth that year.

2.7 In addition to helping counteract these behaviours during periods of economic downturn or structural adjustment, accelerated depreciation measures such as the immediate deductibility measure provide enhanced cash flow for small businesses. This can help businesses overcome cash flow pressures arising from other parts of their operations (for example, payment times). ^[3]

2.8 Immediate deductibility is beneficial irrespective of economic conditions given the associated cash flow benefits to business.

2.9 The immediate deductibility threshold will revert back to $1,000 on 1 July 2019, unless there is government intervention. Under a $1,000 threshold, while small businesses with annual turnover less than $10 million could still take advantage of simplified depreciation rules, the cash flow benefits would be reduced and the red-tape costs greater. Small businesses that use these rules are required to track assets they depreciate to ensure all relevant adjustments are made to the small business pool and the appropriate tax deductions are claimed in their tax returns. Records are required to be kept to substantiate these claims. Further background on these costs is provided in the cost benefit analysis section below.

2.10 It is the extra cash flow upfront and less red-tape that the instant asset write-off provides that makes the difference for small businesses, especially new businesses with start-up costs. Small businesses can use this extra cash flow to re-invest in their business, such as buying new assets, paying down existing debt, and it may also give them the flexibility to hire more staff.

Case for government action/objective of reform

2.11 There is a clear role for government to create the right policy settings for Australian small businesses. The Government's objective is to continue to stimulate small business investment and growth, by providing cash flow benefits and reducing red tape for small businesses.

2.12 Australian small businesses contributed around $390 billion in 2016-17 to the economy. A strong small business sector means more jobs for Australians and more opportunities to build vibrant local communities across the country.

2.13 The immediate deductibility threshold is normally $1,000 and since 12 May 2015 has temporarily been lifted to $20,000. The Government has also expanded access to the write off to small businesses with an aggregated annual turnover of less than $10 million from 1 July 2016 (previously $2 million). While the higher threshold has been welcomed by small business, which are keen to see it continued or increased for at least one more year (or potentially permanently), any extension needs to be considered alongside the Government's broader strategic and fiscal priorities.

2.14 A temporary, rather than permanent, threshold induces a behavioural response, which encourages some small businesses to bring forward capital investment before the threshold reverts to $1,000. If the higher threshold was made permanent, this is likely to have a greater red tape reduction effect (because it is ongoing), however the behavioural response would be lost. This is because businesses would have no greater incentive to invest in the current year, compared to future years (i.e. they have certainty as to the availability of concessional tax treatment). There are limits to the data available, as the taxation statistics from 2013-14 to 2015-16 cover multiple changes to the immediate deductibility threshold. However, a higher ($20,000) immediate deductibility threshold is associated with more businesses accessing the concession in the years of the higher threshold, in addition to businesses claiming larger amounts on average (see table under impact analysis of Option 2 below). Noting that a range of factors impact on the timing of business investment decisions, this increase in the number of businesses accessing the concession may represent businesses bringing forward their investment to take advantage of the higher threshold before it expires.

2.15 Small business measures like immediate deductibility can also help to increase the level of labour productivity by lowering the cost of capital today. This can both encourage new capital investment and bring forward investment that would have occurred in future years, thus increasing the available capital per worker - that is, capital deepening - providing a key source of labour productivity growth.

2.16 In addition, earlier investment in better technologies, machinery and software, can lead to new business models, processes and add-on innovations that can allow labour and capital to be combined and integrated more efficiently - that is, increase the level of multi-factor productivity.

Policy options

Option 1: No policy change (revert to $1,000 immediate deductibility threshold from 1 July 2019)

2.17 Under this option, there would be no new action taken by the Government and current rules regarding the immediate deductibility threshold (for assets costing less than $20,000) would cease on 30 June 2019. That is, small businesses would go back to only being able to claim an immediate tax deduction for asset purchases that cost less than $1,000 from 1 July 2019.

Option 2: Extending the immediate deductibility threshold at the current $20,000 threshold until 30 June 2020.

2.18 This option would extend the $20,000 immediate deductibility threshold for small businesses until 30 June 2020.

2.19 Small businesses would be able to immediately deduct purchases of eligible assets costing less than $20,000 which are first used or installed ready for use by 30 June 2020. Assets valued at $20,000 or more (which cannot be immediately deducted) would continue to be placed into the small business simplified depreciation pool and depreciated at 15 per cent in the first income year and 30 per cent each income year thereafter. The pool could be immediately deducted if the balance is less than $20,000 over this period (including existing pools).

Option 3: Extending the immediate deductibility threshold until 30 June 2020 and increasing it from $20,000 to $25,000 (preferred option).

2.20 This option would introduce a $25,000 immediate deductibility threshold from announcement to 30 June 2020, so that it applies to eligible assets each costing less than $25,000 (not $20,000).

2.21 Eligible assets valued at $25,000 or more (which cannot be immediately deducted) would be placed into the small business simplified depreciation pool and depreciated at the same rates as outlined above under Option 2. The pool could be immediately deducted if the balance is less than $25,000 at the end of the income year (including existing pools).

Cost benefit analysis of each option/impact analysis

Option 1: No policy change (revert to $1,000 immediate deductibility threshold from 1 July 2019)

2.22 Under this option the immediate deductibility threshold would revert back to $1,000 from 1 July 2019.

Benefits

2.23 The benefit of this option is that there would not be a revenue impact over the forward estimates.

Costs

2.24 The cost of this option, however, is that it would not stimulate additional small business investment and growth, given that there would be no additional cash flow benefits and would not reduce red tape for small business.

2.25 Small businesses that use the simplified depreciation rules are required to track assets they depreciate under these provisions to ensure all relevant adjustments are made to the small business pool and the appropriate tax deductions are claimed in their tax returns. Records are required to be kept to substantiate these claims. Under the small business simplified depreciation rules, when assets are added to the small business pool, the small business can claim a deduction for 15 per cent of the asset's cost. The asset is then depreciated at 30 per cent per annum in the pool, until the pool balance falls below $1,000. At this time, the remaining balance of the pool can be written off.

2.26 Small businesses are generally required to track the cost of the asset, the date it was acquired, the date and cost of the asset at the time it is added to the pool, as well as the details and timing of any subsequent improvements made to the asset. Small businesses also need to be mindful of the proceeds and timing of the sale of the asset, as these can result in additional tax liabilities or deductions.

Option 1 - Net outcome

2.27 While there would not be a cost to revenue over the forward estimates, small business would not be able to access the additional cash flow benefits and red tape savings.

2.28 The regulatory burden estimates for the other options presented below represent the change from this status quo.

Option 2: Extending the current immediate deductibility threshold at the current $20,000 threshold until 30 June 2020

2.29 Under this option, the $20,000 immediate deductibility threshold for small businesses would be extended until 30 June 2020.

Benefits

2.30 Extending the immediate deductibility threshold until 30 June 2020 promotes small business investment and growth by providing additional cash flow benefits and reducing red tape for small business. It also provides increased certainty as the threshold remains the same for another year.

2.31 Currently, small businesses are able to immediately deduct the cost of asset purchases that are valued at less than $20,000.

2.32 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. A $20,000 threshold also has a greater cash flow impact for new small businesses, as large capital expenditures often occur early in the lifecycle of a business.

2.33 Immediate deductibility generally improves cash flow for small businesses by allowing an immediate deduction for the entire cost of an asset costing less than $20,000 in the year that cost is incurred, rather than deducting a proportion of the cost over a number of years under the ordinary depreciation rules. In most instances, this reduces the tax bill of small businesses in the current income year, improving cash flow and allowing them to use the extra funds to reinvest in their business.

2.34 It also results in a compliance saving for small business as they are no longer required to track the annual depreciation for these assets or maintain detailed records substantiating their depreciation claims. Generally, a business would retain the invoice for purchase of the asset and use this as evidence to claim the cost of the asset (the immediate deduction) in their tax return.

2.35 By way of comparison, record keeping if the asset is depreciated under Division 40 of the Income Tax Assessment Act 1997 (the general depreciation rules) or using the simplified small business pools is more onerous, and requires depreciation schedules (as well as other information mentioned previously) to be maintained in order to substantiate the depreciation deductions claimed in the tax return.

2.36 Over 300,000 Australian small businesses have taken advantage of the $20,000 instant asset write-off according to 2015-16 tax data. Compared to 2014-15, in 2015-16 the number of claims increased by around 60,000 and the average amount claimed increased by $4,100 to around $9,000.

2.37 Data sourced from ATO Taxation Statistics on the utilisation of the instant asset write-off from the three most recent years of available tax data can be found in the below table. It is not possible to observe the value or type of individual assets that are immediately deducted, just the total deduction for all such assets purchased by a small business in each year.

2.38 That small businesses are benefiting from the $20,000 instant asset write-off has been noted previously. On 13 October 2017, the then Minister for Small Business, the Hon Michael McCormack MP, noted that the policy has led to 'more money in the pockets of small businesses so they can grow their businesses, employ workers and pay them more' ^[4] .

2.39 As discussed above, a further benefit is that immediate deductibility can help to increase the level of labour productivity by lowering the cost of capital today.

Costs

2.40 This option would not increase compliance costs. In fact, compared with the status quo, there would be a decrease in overall compliance costs because it is an existing measure and there are no new requirements associated with the extension to 30 June 2020.

2.41 However, extending the measure to 30 June 2020 is estimated to have a net cost to revenue.

2.42 Relative to Option 1, this option may involve a negligible change in administration costs as the ATO would need to amend its information resources, such as its website, to communicate that the $20,000 threshold would be extended to 30 June 2020.

Option 2 - Net benefit

2.43 The net result is that the significant benefits of improved cash flow (encouraging small businesses to reinvest in and grow their business) and reduced red tape outweigh the revenue costs associated with this option.

2.44 This option would result in an estimated total average annual regulatory saving for businesses of $2.5 million:

Table 2.1: Regulatory burden estimate (RBE) table (Option 2)

*Average impact per year (10 years).

Option 3: Extending the immediate deductibility threshold until 30 June 2020 and increasing it from $20,000 to $25,000 (preferred option)

2.45 This option would introduce a $25,000 immediate deductibility threshold from announcement to 30 June 2020, so that it applies to eligible assets each costing less than $25,000 (not $20,000).

Benefits

2.46 This option would provide small businesses with cash flow benefits as in Option 2 but also in relation to assets costing less than $25,000.

2.47 This option would also reduce compliance costs for small businesses but to a lesser extent than Option 2 (see discussion below).

2.48 Key stakeholders have provided anecdotal evidence of the benefits that the instant asset write-off provides in terms of promoting additional investment in the small business community, or called for a higher threshold to provide even greater benefits:

2.49 The Australian Small Business and Family Enterprise Ombudsman, Kate Carnell welcomed the passage of the legislation extending the instant asset write-off to 30 June 2019 noting... "this gives small businesses and family enterprises more time to invest in their business, and buy the equipment they need to grow and prosper. That might be a new computer, photocopier, cash register, restaurant oven or a second-hand ute, printer or generator - as long as they have been purchased for less than $20,000..." and that "For capital-intensive businesses, $20,000 is too low." (Press release of 12 September 2018).

2.50 The CEO of the Australian Chamber of Commerce and Industry, James Pearson, said... "It's particularly positive that the Bill got such broad support in both the House and the Senate. Small business is the backbone of the country and accelerated depreciation is an extremely important measure in helping business to invest and grow..." (Press release of 12 September 2018).

2.51 The President of the National Farmers' Federation, Fiona Simson said "The instant asset write-off is an effective way to assist farm businesses to build resilience by incentivising investment in farm equipment and machinery"' and noted "At a time when farm business resilience is stretched to the limit managing drought, the measure is a sensible taxation reprieve for farmers". (Press release of 13 September 2018).

2.52 The Council of Small Business Australia (COSBOA), the national peak body representing the views of Australian small business associations was pleased "to see the instant tax write off extended to 30 June 2019 as per the budget" and said "COSBOA knows that value of cash flow and agility to a small business and this tax measure is a key positive contributor to our sector." CEO of COSBOA, Peter Strong, said "it is important that this measure is continued...this provision is well used by the small business community. It provides the opportunity for businesses to plan better for their future and access needed assets much more quickly, when needed, including equipment that will help our businesses thrive and help employ more people." (Press release of 12 September 2018).

2.53 In addition, the higher threshold of $25,000 may induce an additional behavioural response to bring forward capital investment when compared to an extension of the existing $20,000 threshold. This is because planned purchases of assets less than $20,000 may have already been brought forward as a result of the existing threshold. Assets costing between $20,000 and $25,000 will not have been previously eligible for immediate deductibility prior to this measure, and will not be eligible after 1 July 2020. Thus, there may be a strong incentive to bring forward planned purchase of these assets.

2.54 As discussed above, a further benefit is that immediate deductibility can help to increase the level of labour productivity by lowering the cost of capital today.

Costs

2.55 This option would result in a small decrease in compliance costs, resulting in an estimated total average annual regulatory saving for businesses (see Table 2.2 below). Small businesses would need to understand and adjust to the change in the immediate deductibility threshold, which adds to the compliance burden of this option.

2.56 Small businesses would be able to access the benefits of immediate deductibility for assets costing up to $25,000.

2.57 A $25,000 immediate deductibility threshold would have a higher estimated cost to revenue than a $20,000 threshold over the forward estimates period.

2.58 Relative to Option 2, this option may also involve a small increase in administration costs as the ATO would need to amend its information resources, such as its website, to communicate to small businesses that the threshold is increasing to $25,000.

Option 3 - Net benefit

2.59 The net result is that the higher benefits of improved cash flow (providing a greater incentive for small businesses to reinvest in and grow their business) and reduced red tape outweigh the costs associated with this option, but to a lesser extent than in Option 2.

2.60 This option would result in an estimated total average annual regulatory saving for businesses of $0.2 million if the threshold is $25,000, as set out in the table below:

Table 2.2 : Regulatory burden estimate (RBE) table (Option 3)

*Average annual impact (calculated over 10 years).

Consultation plan

2.61 The $20,000 immediate deductibility threshold was introduced in the 2015-16 Budget, following extensive stakeholder consultation, which included the Board of Taxation, the ATO, small business stakeholder groups and professional tax and accounting bodies. It was subsequently extended in the 2017-18 Budget by 12 months to 30 June 2018 and then for an additional 12 months in the 2018-19 Budget to 30 June 2019.

2.62 Stakeholders have provided regular feedback on the effectiveness of the measure, including in response to the request for Pre-Budget Submissions and following the passage of legislation to give effect to this measure. There is strong stakeholder support for the instant asset write-off, including from stakeholders such as the Australian Chamber of Commerce and Industry, and the Council of Small Business Australia.

2.63 Stakeholders are expected to welcome the more generous $25,000 instant asset write-off and the added incentive it provides for small businesses to invest and grow. The measure involves a change to the date of application and depreciation write-off threshold only and is similar to some previous measures and therefore it was not considered necessary for consultation to be undertaken. In addition, public consultation on a future increase in the threshold could have resulted in some small businesses postponing asset purchases until after the date of application of the $25,000 threshold.

Option selection/conclusion

2.64 Taking into account the various benefits associated with this proposal, the preferred policy option is to increase the instant asset write-off threshold to $25,000 for small business from announcement until 30 June 2020 (Option 3). This option improves cash flow for small businesses, and induces a stronger behavioural response in comparison to the other options. These benefits outweigh the lower regulatory saving resulting from Option 2.

Implementation and evaluation/review

2.65 Legislation is required to implement this proposal and will be administered by the ATO. Implementation is expected to be straight-forward, as it is a continuation of an existing measure with a higher threshold of $25,000.

2.66 A quantitative analysis of the policy is complicated by the long time periods between the announcement of the policy and the finalisation of taxation statistics. Further, the effect of this policy would be difficult to disaggregate from the effect of other Government policies to support small businesses. As timely quantitative analysis is not practical, the Treasury has focussed on stakeholder feedback on the effectiveness of the $20,000 immediate deductibility threshold to guide evaluation. Examples of this feedback are included as part of the impact analysis for Option 3.

2.67 Following the passage of the legislation, Treasury will continue to build into its broader small business consultation processes opportunities to seek views from small businesses about their practical experiences with the higher $25,000 instant asset write-off. Treasury will also, rather than conducting a survey, consider feedback from stakeholders as part of annual pre-budget submissions.

2.68 Feedback from the ATO's engagement with small businesses in implementing the initiative, together with a further data, would also be used to assess the benefits of this initiative and to inform the evaluation of the initiative, which would underpin any subsequent decision by government on the appropriate level of the threshold for the instant asset write-off.