Productivity Commission proposes material reform to Australia’s corporate tax system

The Productivity Commission (PC) has, in the lead up to this month’s Economic Reform Roundtable, issued its interim report on ‘Creating a more dynamic and resilient economy’. Headlining the interim report are draft recommendations to reform Australia’s corporate tax system to encourage investment and improve productivity growth.

Draft Recommendations

The PC proposes to lower the company income tax rate to 20% for companies with annual turnover below $1b, and separately introduce a new net cashflow tax  (NCT) of 5% for all companies, regardless of turnover. 

The first draft recommendation will broadly align the company tax rate that applies to nearly all Australian companies to the OECD average statutory company tax rate of 21.1%, and seeks to:

• Encourage capital investment by lowering the before-tax return on capital expenditure that companies require to meet their capital expenditure hurdle rates and increasing retained earnings available for reinvestment;
• Encourage established foreign companies to enter Australian markets, challenge incumbents, increase competition and bolster dynamism and productivity, which will ultimately increase employment and real wages; and
• Enable emerging companies to more effectively compete with larger incumbents.

The second draft recommendation, which will operate in conjunction with the corporate income tax system, will apply to all companies regardless of annual turnover, and seeks to allow companies to deduct the value of their capital expenditure in the year it is made, rather than incrementally through depreciation. Key design features of the proposed NCT are:

• Recognition of all receipts from goods and services as turnover, in contrast to company income tax, which is calculated having regard to the capital versus revenue distinction;
• Recognition of all purchases as expenses in the year of purchase, removing the need to separately account for depreciation or a capital account;
• Exclusion of financial transactions from both sales and expenses, meaning both interest earnings and payments are disregarded; and
• The ability of companies to offset losses under the NCT against company income tax liability down to zero, with unused losses carried forward with an uplift to compensate companies for the delayed recoupment of tax losses. 

The following two tables illustrate the operation of the two proposed recommendations:

Table 1

Table 2

Impact

Modelling conducted by the PC forecasts the two draft recommendations will increase investment by $7.4 b (1.6% of investment), GDP by $14.6b (0.5%), and labour productivity by 0.4%, all in a revenue neutral manner. The measures would be revenue neutral due to companies above the $1b threshold likely facing an overall tax increase, depending on their investments in Australia.

RSM View

RSM welcomes the PC’s draft recommendations, which have been described as a ‘first step’ towards the overarching goal of reorienting Australia corporate tax system towards one that better supports a dynamic and resilient economy, although RSM respectfully requests that the PC consider whether the $1b turnover cap for the reduced company income tax rate should be higher from  the outset, noting, inter alia, the potential impact on high volume, low margin businesses, and the PC’s own admission that increasing the cap to $3b or $5b would cause a productivity gain. 

RSM also invites the PC to release specific detail regarding its draft recommendations, such as the impact of the tow-tier system on franking credits and any transitional rules, and encourages the PC to ensure that the NCT is designed such that associated compliance costs are minimised. 

There are also a number of planning points for in-scope companies to consider, such as:

• The drafting of transitional rules, noting that past investment incentives have typically used the concept of a previous ‘commitment’ (already ordered from the supplier, subject a purchase/construction contract, or approved by the board) as to what is not eligible for the new concessions.  Therefore, some planning may be required around when and how future capital projects are approved and committed to, so as to not prematurely enter commitments and be excluded from the new investment incentives; and
• If implemented, careful planning around both capital realisation and capital investment will be required. Noting, that capital realisation would be included as a cash inflow and capital investment as a cash outflow for calculating the NCT. 

RSM will continue to monitor relevant developments and provide updates as appropriate. 
 

FOR MORE INFORMATION

If you would like to learn more about the topics discussed in this article, please contact your local RSM office.