John Watson (Tasmania, Liberal Party) Share this | Hansard source

The Tax Laws Amendment (2007 Measures No. 3) Bill 2007 is an omnibus bill dealing with 10 issues. However, given the limited time of this debate, I have only the time to discuss three matters about which I have had a close, continuing interest. The first is an amendment to the anti-avoidance measures under division 7A of the Income Tax Assessment Act, an amendment which overcomes some quite punitive provisions which date from 1996. It is indeed very pleasing that the government has recognised the problems faced by a lot of small businesses in often unavoidable situations where there may have been an honest mistake but at the same time with no loss to the revenue, no mischief and no benefit to an individual or to a group of individuals, who were, however, severely penalised.

I therefore wish to take this opportunity, Minister at the table, to express my thanks to the Treasurer, the Treasury, the tax commissioner and the government, because I have been working to rectify these problems for perhaps to 12 to 18 months. The overriding problem with division 7A was often referred to in the profession as the ‘drop dead’ provisions, because there was no commissioner discretion. Therefore, the retrospective amendments dating to 2001-02 are indeed good for many people. In the main, the changes take effect from 1 July 2006. However, the commissioner’s discretion is retrospective and can be utilised in respect of 2001-02 and later years. The fringe benefits tax amendments are from 1 April 2007. The retrospective nature of the amendments is indeed unusual but gratefully received.

Difficulties and issues surrounding division 7A have been numerous, with many accountants facing litigation from their clients arising from the 1996 legislation. Allow me the opportunity of explaining some of those difficulties that previously faced the profession and why they were so keen to get these amendments through. One example is the automatic debiting of a company’s franking credit account where a deemed dividend arises under division 7A. The amendments we are debating today now provide the Commissioner of Taxation with the discretion of disregarding the deemed dividend that has arisen in circumstances of an honest mistake or omission by a taxpayer, providing a greater flexibility in the administration of the process.

Innocent transgressions also often involved intragroup transfers or transactions where there was no economic benefit to the shareholders or associated persons, such as a country bookkeeper drawing from a wrong account or drawing a cheque on advice from a banker to purchase a tractor from what may have been deemed the incorrect account. Quite often such transactions were not detected until the books went to a more sophisticated tax accountant after the year of income when preparing the annual return. There were problems of refinancing shareholders through paying a deemed dividend. For example, a loan from a solicitor being refinanced by a bank could have got caught. In addition, certain shareholder loans could be refinanced without triggering the deemed dividend.

The drafters of the legislation therefore had to navigate some very difficult legal precedents. For example, loans made by private companies to shareholders or associated were caught by division 7A if that loan was not repaid before 30 June of the relevant year or was not the subject of a complying loan agreement entered into before the loan was made. A general principle of taxation is that only economic gains are taxed. However, division 7A imposed the harshest possible tax impact on transactions that had no long-term economic impact—for example, a loan made from a private company to another related entity in June 2003 and repaid in July 2003 in the absence, for example, of a recent loan agreement would suffer an income tax of effectively 48.5 per cent plus a loss of franking credits, which carries a further tax penalty.

An identical transaction undertaken in June 2005, ironically, would have attracted no such tax. Hence the importance of this amendment. Taxpayers without the slightest intention of obtaining a taxation advantage were being levied with substantial taxation imposts without the opportunity or mechanism to undo or correct their situation. Division 7A’s original intent was to ensure that private companies would no longer be able to make tax-free distributions of profits to shareholders in the form of repayment of loans. While this intent was understood and respected, the legislation was interpreted, unfortunately, far wider than its original intent. Here is a warning for future tax legislation.

The second measure that I wish to address tonight in this omnibus bill includes the requirement that investors in forestry plantation schemes meet a 70 per cent direct forestry expenditure test—an initiative strongly supported by the forestry industry, which I am a little bit surprised about. The 70 per cent test will have to be read in relation to a number of other measures, some of which are included in the bill.

There is also another piece of legislation which I refer to as the ‘tax promoters legislation’ that one has to be careful of in navigating this scenario. The schedule also provides for the establishment of a secondary market, which I believe will give original investors the opportunity of selling before harvesting, providing the investment was for at least four years. This measure, I believe, will add a new level of transparency that will ensure costs are contained rather than inflated, which is an important part of this test.

I believe the forestry plantation arrangements that seek to make use of the 70 per cent direct forest expenditure fundraising mechanism—and the emphasis is on ‘direct’—should only be used by those corporations with long experience in forestry and staffed by people with great qualifications, including actuarial qualifications. I issue this warning because I can see many potholes along the life of a project, starting from the initial investment to the harvesting of the plantation, its marketing and final distribution.

Honourable senators would be aware of the 1964 precedent in the Cecil Brothers High Court decision that was decided against the Australian Taxation Office by denying the office the right to substitute a different price to the one actually charged. Cecil Brothers was a shoe retailer which purchased certain stock from a related company at a price higher than the market price charged by the usual suppliers. Legislation therefore had to overcome the possibility of a like situation in the forestry industry, whereby, for example, a box of seedlings that cost $3 by one arm of the promoting company could be sold to another within the corporate structure for a price of $25, or the employment of contractors by an associate company and charged back to the forestry operation at a price grossly exceeding the market price—a mechanism to inflate the value of direct forest expenditure. How did the drafters overcome that? They inserted what was known as an arms-length market price test to overcome the precedent in the Cecil Brothers case.

I believe that the 70 per cent direct forest expenditure is available only for forestry plantations where it is for the long term, for experienced operators and, I also add, the brave. Records have to be kept for the life of the plan plus five years. The problems will occur when the forest company falls short of an ATO audit in four or five years time. Not only do all of the forest corporations incur severe penalties should they breach the 70 per cent test, but the investors will have the indignity of their tax returns being amended by denying the initial deduction for the investment. The mind boggles, Senator Brandis, the minister at the table, at the potential legal ramification for such an event. I ask honourable senators to remember that we are dealing with projected future costs with a seven- or 12-year life, and these costs must be discounted to present values and the records have to be kept for the life of the plan.

Discounting recognises that a dollar today is not the same as a dollar in the future because, even in the absence of inflation, today’s dollar can be invested. Not only does the plantation company have to work out very carefully its direct—not its overhead, not its indirect, but its direct—forestry expenditure, but there are a number of what I call contestable fringe costs that may be subject to challenge in an audit. The company must be familiar with this counter cash flow technique, thus the potential for error could be high for those who are not prepared, those who do not fully understand the costs and ramifications of legislation. Otherwise, they may fall below the 70 per cent limit with all of the dire consequences that I referred to. So I also issue a caution to financial planners therefore to treat such projects with high caution as they may also get caught up in the future legal consequences or ramifications.

I wish to spend the remainder of my available time addressing scheduled 10 of the bill, which concerns the new withholding arrangements for managed fund distributions for foreign residents. The legislation effectively puts into legislative form the Australian tax office’s administrative arrangements, which currently carry different rates from 29 per cent to 47.5 per cent. For example, there is a 30 per cent corporate rate, an individual 29 per cent rate and a 47.5 per cent superannuation noncomplying rate. The measure before us tonight removes the uncertainty and reduces the compliance burden by having to address different types of income and different types of recipients of that income. To put it quite simply: this measure does provide for a high degree of certainty.

Currently, managed investment trusts and their intermediaries have to clarify the nature of the foreign investor as an individual, a company, a trustee or a foreign superannuation fund. So the focus on these amendments is on the foreign residents with Australian sourced income. The Australian sourced income comprises rents, capital gains and some foreign exchange gains, but not interest or dividends because these classes of income are already subject to a separate withholding rule. So trustees will withhold a common 30 per cent from all distributions to foreign residents. However, this is the nub that the Labor Party have not realised: these foreign investors do have the opportunity of lodging an Australian tax return to get a credit for the 30 per cent tax against their tax liability of their net income—that is, the distribution less deductions such as sums borrowed to invest in the property trust. This is in contrast to the ALP’s proposed amendment as a 15 per cent final tax without deductions.

The proposal for a 15 per cent withholding tax has the effect of creating a tax concession to a group of people but which are not available to those who make direct investments. So it is the same income, but if it is made by a person who makes a direct investment they do not get this final 15 per cent. So you have got a situation where there is a breach of a principle of taxation—that is, that taxpayers on the same incomes from the same source should pay the same tax. The ALP amendment does not achieve this outcome. You have got that disparity. We have got enough of these problems that we are trying to correct, and yet the Labor Party wants to perpetuate these sorts of problems. So if a tax rate does result in a greater foreign investment, I believe this is likely to flow to an already mature Australian property market. These are the consequences.

This may have the effect of creating Australian investors out of the Australian property market. Therefore, the ALP’s property owners proposal has potential to further overheat the Australian property market at this time at the expense of ordinary Australian investments and, indirectly—here is the problem—to ordinary homeowners by jacking up the price. Originally, I had some sympathy with a 15 per cent rate. It has simplicity, and this would have had the effect of matching Australia’s withholding tax rate with those of a number of other countries. On the other hand, it would have created an environment of income being taxed differently to direct investment, and I think that is indeed unfortunate. We also have to consider the affordability issue for Australian investors and individuals, because the crowding effect would assist foreign investors to the detriment of Australians.

Questions have been asked about the competitiveness of the Australian property trusts industry. It is one of the most sophisticated in the world and has done very well and is very well managed. But headline rates do not seem to have affected the growth in the Australian listed public trust in recent years. Nor do I believe this legislation will make any change. Evidence suggests that, in recent years, these foreign resident investors in Australian property trusts, which are known in the industry as REITs, have not lodged many tax returns, as they are entitled to do, despite Australia property income having been taxed by withholding the corporate rate of 30 per cent. So the sky is not going to fall in as a result not passing the Labor Party amendments.

The Australian property trust industry is, I believe, one of the world’s largest property trust markets, representing something like 15 per cent of global real estate property trust market capitalisation, and there has been no evidence of a flight in capital, and nor do I believe there will be as a result of this legislation. I know the financial services industry has lobbied strongly in support of the Labor Party amendment, but I have to point out that the industry is a very sophisticated one. It has a very good growth record; it has strong management and strong leadership; and it puts Australia at the forefront in financial services and contributes to Australia being a regional financial centre, particularly in this part of this world and in this time zone, which includes countries like Singapore, Hong Kong and Japan.

In fact, in 2005, 70 per cent of all funds raised were invested offshore and foreign investment in property trusts has also increased to about 15 per cent of the total equity in property trusts—a very good and commendable record. It also must be remembered—and this is the important point—that Australia does not tax the foreign income, only the income derived by the trust in Australia, which is merely a portion of the total. Therefore, this measure is only concerned with Australian sourced income paid to foreign residents. That is the limitation of the bill before us. For example—and I think this will clarify the position—if an Australian property trust invests in both Australian property and New Zealand property and distributes the income to a UK investor, there is no tax on the income from the New Zealand property because Australia only taxes foreign residents on the Australian sourced income.

The government decided not to support the Labor Party amendment to introduce a final flat rate of tax on non-royalty, non-dividend, non-interest overseas payments—I gave the list earlier—because the government regarded this as a measure to protect the revenue. Everybody wants tax concessions for some group or other, but there has to be a limit and a degree of responsibility in managing the budget, and that is why the Howard-Costello team has been so successful in leading Australia through some fairly difficult decisions to the prosperity we now enjoy. The government’s first responsibility is to protect the revenue—and Labor’s amendment would have cost a lot of revenue.

My final comment is associated with accessing financial advice. I support the government’s measure to assist investors to get access to appropriate financial advice—and some very good measures are included in the bill. But there is still some way to go. For example, for some time I have supported the notion of an up-front deduction for fees paid to a financial planner for financial advice. But the irony of the situation is that, while these up-front amounts paid to a financial planner for investment advice are not tax deductible, the trail commissions, many of which not only apply to the initial investment but can trail on for years and years, are tax deductible. So again you have this unequal playing field. I have spent a lot of my time in tax over many years in trying to make sure that we have tax equity. I think this is one area where we can not only create tax equity but help to encourage the concept of paying up-front fees rather than trail commissions, which I know some members of the superannuation committee had some problems with some years ago. I commend the bill to the Senate.