Treasury provided the Working Group with information on possible business tax savings largely drawn from the Tax Expenditures Statement. In the time available the Working Group has not had the opportunity to fully consider the benefits and risks of one or more or a combination of savings options and the Working Group has not been able to consult widely on the extent of any adverse impacts.
Statutory effective life caps
A substantial expenditure in the business tax system is the provision of statutory effective life caps34 for certain depreciating assets used in certain industries. In particular, statutory caps are available in the oil and gas, petroleum, agricultural and transport industries. The application of the statutory cap on the effective life of depreciating assets means that the effective tax rate applying to each of these industries is kept below the statutory rate. Assets with statutory effective life caps generally have very long effective lives such that even a statutory effective life cap of 15-20 years is a concession in some cases.
Accelerated depreciation arrangements for all other assets were removed as part of the reforms following the Review of Business Taxation.35 Statutory effective life caps were introduced in 2002 to maintain accelerated depreciation for certain depreciating assets amid concerns that the extension of effective lives would have wide-ranging effects on investment decisions.
In consultation sessions the Working Group has discussed the application of statutory caps in the oil and gas industry. Possible savings generated from the removal of statutory caps would be influenced by how the removal was applied. For example, the level of savings would be influenced by the start date and whether the changes applied to assets installed ready for use after the start date or whether the current statutory caps would still be used where contracts for assets had been entered into before the start date despite assets not being installed ready for use.
Immediate deduction for exploration and prospecting
The current tax law allows an immediate deduction for certain expenditure on exploration or prospecting for minerals which allows the expenditure to be deductible outright in the year in which it is incurred.36 Examples of deductible expenditure include transport, materials, labour and administrative costs incurred in carrying out exploration or prospecting activities. The tax law also allows an immediate deduction for the cost of depreciating assets that are first used in exploration or prospecting.37
Treasury has costed the removal of the immediate deduction for exploration and prospecting expenditure, with effect from the announcement of the 2012-13 Budget, as achieving savings of $1200 million over the forward estimates period. Alternatively, the removal of the immediate deduction for the cost of depreciating assets first used in exploration or prospecting from the announcement of the 2012-13 Budget would achieve savings of $900 million over the forward estimates period.
Possible savings generated from the removal of the immediate deductions represent the upper bound for potential savings under those options. Phasing in the removal of either of the immediate deductions would reduce the potential savings achieved. It is also important to note that savings achieved would be influenced by the start date.
The R&D non-refundable tax incentive
The R&D tax incentive replaced the R&D tax concession from 1 July 2011 to provide a targeted tax offset to encourage certain companies to conduct R&D activities that benefit Australia. The R&D tax incentive provides a 40 per cent non-refundable tax offset for eligible entities with a turnover of $20 million or more.
Treasury costings indicate that a reduction in the rate of the non-refundable tax offset from 40 per cent to 37.5 per cent, with effect from 1 July 2013, would achieve savings of $500 million over the forward estimates period.
A second approach could leave the rate unchanged but impose a cut-off turnover threshold. Treasury costings indicate that imposing an upper turnover threshold at a relatively high level of $30 billion would provide savings of around $150 million per year. Introducing such a threshold would be expected to affect a small number of very large companies with very large R&D spends.
A third approach would be to impose a substantial annual cap (for example, at least $100 million) on the amount of R&D expenditure that would attract the 40 per cent non-refundable tax offset. The size of the cap needed to achieve a particular savings target is yet to be costed by Treasury.
Thin capitalisation rules
The current thin capitalisation regime is designed to ensure that multinationals do not allocate an excessive amount of debt to their Australian operations. The regime operates by disallowing a proportion of otherwise deductible borrowing expenses where the debt allocated to Australian operations exceeds certain limits. Without robust thin capitalisation rules, improved loss recoupment arrangements could increase the incentives of multinationals to shift debt and their related deductions to Australia providing them with a competitive advantage over purely domestic firms (or firms with truly independent financing arrangements).
The current thin capitalisation regime consists of a number of debt tests or limits. These limits require Australian entities under the regime to calculate the maximum debt deductions allowed to be claimed on their Australian operations, based on the underlying Australian assets involved. If the Australian operations have debt deductions above the maximum allowed (the debt limit that the entity elects to use for its operations), the excess deductions will be denied. Conversely, where the debt deductions of the entity's Australian operations do not exceed the maximum allowed, none of these deductions will be denied.
The following possible changes to the thin capitalisation rules were used as the basis for consultation:
- removing the arm's length debt test (for general entities and non-bank financial entities) and the arm's length minimum capital amount (for banks) from the domestic law;
- reducing the safe harbour maximum debt limit for general entities from 75 per cent to 60 per cent on a debt-to-total assets basis (or from 3:1 to a 1.5:1 debt to equity basis);
- reducing the worldwide gearing ratio for general entities and non-bank financial entities from 120 per cent to 100 per cent; and
- increasing the worldwide capital ratio for banks from 80 per cent to 100 per cent.
34 That is, the life of the asset for tax depreciation purposes is shorter than the actual economic depreciation of the asset.
35 Review of Business Taxation, 1999, Review of Business Taxation: A tax system redesigned, Canberra.
36 Under section 40-730 of the ITAA 1997.
37 Under subsection 40-80(1) of the ITAA 1997.