Australia: The Ralph Corporate Tax Reforms

In 1999, the Australian government received and basically adopted the Ralph Report which recommended sweeping changes to the basis of business taxation, including the international taxation regime. Although some of the recommended changes finally made their way to the statute book, other important improvements fell by the wayside.

In particular, proposals to instal the 'tax value' method of calculating corporate tax were dropped after an extended period of consultation. Exposure drafts of the first two key pieces of legislation were published before the end of 2000, but raised many difficult questions for business.

The new consolidation regime laid down in the New Business Tax System (Consolidation) Bill 2000 would treat wholly owned Australian entities as a single taxpayer for income tax purposes - groups can choose not to consolidate, but if they don't do so will be unable to transfer losses between companies, defer tax on transfer of assets between wholly owned companies, or obtain rebates on unfranked dividends.

However, distracted by the furore which surrounded the introduction of the controversial GST (Goods and Services Tax), the government withdrew its draft, and didn't re-issue it until the spring of 2002. The new rules came into effect on 1st July 2002.

Among other things, the new legislation:

• set out the complex rules under which the tax losses of group members may be transferred to the head entity when they enter the group, and how those losses may be used by the head entity;
  
• provided for franking credits and other tax attributes of group members to be transferred to the head entity;
  
• set out rules for the treatment of cost bases of assets, spreading the cost of acquiring a joining entity plus its liabilities among the entity's assets to determine their cost base. On a disposal, it is this cost structure that will be used to calculate gains or losses for capital gains tax.
  
• dealt with the timing of the change to consolidation in the context of a company's financial accounting date.

Under the old system, each entity within a wholly owned group was taxed separately, some (but not all) intra-group transactions were ignored, inter-corporate dividend rebate and loss transfer provisions still applied, and although there was the potential for double taxation on gains, there was also the possibility of legitimate tax minimisation by creating multiple tax losses within the group, and value shifting so as to create losses where no actual economic loss had occurred.

The second major issue that was addressed in 2000 was the question of capital allowances.

The adoption of a comprehensive capital allowance regime under the New Business Tax System (Capital Allowances) Bill 2000 was intended to replace the many capital allowance provisions that currently existed, provide consistent treatment for capital expenditure and was supposed to allow write-offs of capital expenditure based on several alternate bases.

• The draft provided consistent meanings to key concepts such as 'depreciating asset', 'taxable purpose', and 'effective life', but crucially did not clearly define the term 'asset'. As a result, businesses continue to have to grapple with three different concepts of an asset in accounting, CGT, and capital allowance terms.
  
• The new rules allowed the write-off of a limited range of 'blackhole' costs such as expenditure on business establishment, converting business structures, and equity raising, which would be deductible under the new regime, until on or after 1 July 2001; but business was disappointed in the limited range of 'blackhole' expenses that were included.
  
• Businesses (and especially mining businesses) needed to review and update their asset registers to reflect the new concepts of 'depreciating asset' and 'hold'; ownership structures would have to be reviewed (especially in non-consolidated groups) to ensure that assets are held so that the most appropriate entity is entitled to the capital allowance deduction; and any asset sale likely to take place in the next year or two needs to be scrutinised carefully to get the timing and structure right - in some cases it may be desirable to accelerate disposals, in other cases to defer them.

The Capital Allowances rules were originally supposed to allow either a traditional (as set out in the Draft) or a 'tax value' approach, but the Tax Value method never reached the statute book.

From the beginning, the Government was leery of some of the more extreme recommendations of the Ralph Report, although this might have been a matter of legislative overload rather than a failure of nerve. In particular, there was at first no sign of any detail on 'Option 2', otherwise known as 'the tax value method'. This was the radical proposal to abolish the traditional distinction between income and capital and to determine taxable income on the basis of cash flows and the changing value of assets.

Finally, in March, 2002, the Board of Taxation, (itself a creature of the Ralph Report) presented a 260-page consultation document. ATO Assistant Commissioner at the time, Andrew England, who helped draft the proposal, said that although the plan aimed to simplify the two existing Income Tax Assessment Acts, and provide a more robust and comprehensive structure for income tax law more consistent with economic and accounting approaches to income measurement, it was still likely to face opposition from the business sector and tax practitioners.

'TVM is not a new tax, it's a new way to draft income tax law and structure income tax law,' Mr England told journalists, pointing to the proposal's revenue neutral properties.

He was right about the opposition: in September, then Treasurer Peter Costello announced the demise of the government's Tax Value Method (TVM) plans, much to the delight of the Australian business community. Michael Dirkis, tax director of the Tax Institute of Australia welcomed Mr Costello's announcement:

'We are happy to say that chapter in tax reform has gone away. It is good that the government has seen common sense with this issue,' he commented.

Institute of Chartered Accountants tax counsel, Brian Sheppard echoed this sentiment, explaining that: 'It wasn't going to deliver a simplified tax system, just a different tax system.'

Other Ralph Report Proposals

The taxation of trusts is an example of a Ralph proposal which emerged in bowdlerised form: originally, the plan was to introduce uniform taxation of entities. In fact, the exposure draft which was published in October 2000, amounted to no more than an attack on discretionary trusts, bringing them largely within the existing (and future) corporate taxation regime.

The same exposure draft included revised sets of rules for franking of corporate dividends, a new imputation regime, and new rules for franking credits for foreign withholding tax:

• A franking credit, up to 15% of a gross distribution received by an Australian corporate tax entity, will be available for foreign withholding tax paid on foreign distributions. The credit will be allowed whether the distribution relates to a portfolio interest (less than 10%) or non-portfolio interest in the non-resident entity, and whether or not the distribution is assessable. This would allow a franking credit for withholding tax on non-portfolio dividends received by Australian resident companies from companies in listed (comparable tax) countries;
  
• A further franking credit may be allowed to an Australian corporate tax entity if both of the following apply:
  
  • withholding tax on the distribution the entity receives is less than 15% of the gross distribution; and
    
  • withholding tax was paid by its foreign 100% subsidiaries on foreign distributions those subsidiaries received.

In all cases, to be eligible for the credit, the foreign distributions must be equivalent to frankable distributions. That is, no credit will be allowed for any portion of foreign withholding tax which relates, for example, to a return of capital.

These rules represent an improvement for Australians investing offshore, but they don't help investors in countries such as the UK where there is no withholding tax.

Other, not minor, sets of rules proposed by the Report, only some of which were subsequently addressed included:

• the matter of related-party transactions - the Ralph Report threatened that all such transactions outside a consolidated entity would be subject to 'arms-length' rules (dealt with through transfer-pricing regulations introduced in 2001);
• international taxation (see below), including
  • improvement of conduit taxation rules (partially dealt with in 2004);
  • the introduction of imputation credits for foreign dividend withholding tax;
  • expansion of the thin capitalisation regime;
  • reform of taxation in relation to foreign expatriates;
  • improvement of the double tax agreements.
• a new regime to deal with the taxation of leases and rights to provide consistency of tax treatment among these types of assets.;
• 'significant changes' to the taxation of distributions from an entity and disposals of membership interests;
• new measures affecting the application of capital gains tax including:
  • abolition of averaging;
  • freezing of indexation at 30 September 1999;
  • the exclusion of gains and losses from the disposal of plant from the
    CGT regime;
  • partial CGT exemption for individuals, complying superannuation funds and some trusts;
  • strengthening of the anti-avoidance regime.

The Government was slow in grasping the nettle of the taxation of international businesses, not releasing its proposals until August, 2002. Launching the international taxation arrangements consultation paper, Mr Costello observed that:

'I do not want to see Australian companies leave Australia. I want Australian companies to grow and remain headquartered in Australia.' He continued: 'The net benefit will be if we can encourage regional headquarters and promote Australia as a financial centre.'

Among the suggestions contained within the consultation document were: the reduction of capital gains tax for foreign executives working in the Commonwealth, and the elimination of double taxation on foreign share options.

The Treasury Department was also said to be considering offering tax breaks to foreign multinationals in order to encourage them to establish regional headquarters in Australia.

The planned changes were warmly welcomed by business groups at the time. Chief Executive of the Business Council of Australia (BCA), Katie Lahey commented:

'Australia must grasp this chance to recalibrate its cross-border tax laws to be internationally competitive, to attract and retain people, skills and investment, and at the same time jettison the dead weight holding back the international growth of Australian companies.'

Executive Director of the Corporate Tax Association, Frank Drenth echoed this sentiment, announcing that: 'This will make the system more workable.' He said that the newly released proposals represented a step in the right direction, explaining that:

'In themselves, these measures are not going to make a Singapore funds manager pack up their bags and move to Sydney. But they represent recognition that we don't need to tax every last cent of foreign-sourced income.'

The government took further steps towards improving the international taxation regime for businesses in December, 2003, introducing measures which took effect from July, 2004, relaxing Controlled Foreign Company (CFC) rules as they apply to countries possessing broadly similar taxation regimes (BELCs), such as the US, the UK, Germany, France, Canada, Japan and New Zealand, in effect exempting income derived from outside such countries but passing through them (and therefore taxed in them).

"Once the package is complete", said Ernst and Young, "Australian multinationals doing business in these major commercial centres will no longer need to be overly concerned with measures that are aimed at tax haven operations. The Government has clearly recognised the fact that business takes place in these countries for commercial rather than tax related reasons."

However, CFC rules continued to apply to income derived through a trust or arising under the Foreign Investment Fund (FIF) measures, even if derived through CFCs resident in such comparable tax countries."

The new legislation also allowed fund managers to invest up to 10% of their fund in foreign passive investments before FIF rules apply, and also relieves complying superannuation funds from the FIF measures.

In April, 2004, the government introduced legislation to the Australian parliament that it said would simplify the taxation system for companies with offshore earnings by ensuring that they only pay a single layer of tax.

Commenting on the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004, parliamentary secretary to the Treasurer, Ross Cameron, noted: "The measures in this bill will directly assist Australian companies with foreign subsidiaries or branch operations by generally ensuring that they only pay one layer of (foreign) tax on the profits of those offshore operations as well as reducing compliance costs in many cases."

However, he added that “any passive or highly mobile income shifted to those offshore investments will continue to be taxed in Australia on an accrual basis."

The government is hoping that the changes in the tax law will make Australian firms more competitive overseas, and Mr Cameron explained that they are designed to help small, as well as large firms.

"The changes are not just relevant to big business with extensive offshore operations," he observed. “They will also assist those emerging Australian businesses looking to expand offshore to take advantage of global opportunities."

Additionally, the new law would allow firms to ignore capital gains from the sale of shares in a foreign subsidiary, and would also expand the application of foreign dividend exemption to all nations.

Although the government had made some improvements to the tax position of international companies in 2003 and early 2004, they did not go far enough for the taste of business, which continued fierce lobbying throughout 2004 for further changes.

In September 2004, then Treasurer Peter Costello responded, indicating that he wanted to overhaul the country’s international taxation system to ease the tax burden on firms operating overseas. Costello revealed that one of his top priorities is to help firms that derive much of their income overseas and pay tax on it but do not benefit from a domestic tax credit.

"I would like to improve Australia's international taxation arrangements so that Australian companies can expand in foreign jurisdictions, while remaining domiciled in Australia," Costello said. "We want to promote Australia as a place for regional headquarters - for Australian companies but also for foreign companies," he added.

Costello spoke as News Corp, the largest firm listed on the Australian Stock Exchange, prepared to move its domicile and primary listing to the United States. During the election process in 2005 little progress was made in the business taxation arena; but Costello returned to the fray in January, 2006, promising yet further reappraisals of business taxation in an international context.

In February 2006, a study was launched to measure the country's international competitiveness, and despite a change of government in 2008, scrutiny of this area is ongoing.

In August 2008, the Australia’s Future Tax System (AFTS) Discussion Paper was launched by Treasury Secretary Dr Ken Henry - claimed to be the most comprehensive review of the country's tax system in fifty years.

The wide ranging review encompassed many aspects of the federal and state/territorial tax system, and considered: the balance of taxes on work, investment and consumption and the role for environmental taxes; enhancements to the tax and transfer system facing individuals, families and retirees; the taxation of savings, assets and investments, including the role and structure of company taxation; the taxation of consumption and property and other state taxes; simplification of the tax system, including the interactions between federal, state and local government taxes; and the proposed emission trading system.

The review did not, however, consider the rate and base of the GST, and interactions with the transfer system.

"Long-term reform of our tax and welfare systems is a key way to secure our economic foundations for the future, create wealth, spread opportunity and reward working Australians," announced a statement issued by Treasurer Wayne Swan.

Legislation to modernize the CFC regime was due to come into effect in 2010 but delays in implementation led to a postponement with a further draft amendment to the CFC regulations published in February, 2011. It is widely expected that the new rules will apply from July, 2012.