Ahead of the federal election on 18 May, we compare the policies impacting small business owners, as announced by the two major parties.
Fast tracking of reduction in corporate tax rate
The Liberal party have fast-tracked the reduction in the corporate tax rate for small and medium-sized businesses.
The corporate tax rate was reduced to 28.5% for small business entities in the 2017 year with a further reduction to 27.5% in the 2018 year. Corporate taxpayers must now meet a complicated base rate entity and base rate entity passive income criteria in order to access the lower corporate tax rate. The base rate entity passive income criteria is overly complicated resulting in increased compliance costs for many taxpayers. Similarly, the legislation requires complex calculations by the taxpayer or their advisers in order to determine the level of franking of dividends. Confusion prevails as the corporate tax rate adopts a look forward approach whereas the franking rate takes a look back approach.
Many small business owners have been left out of pocket by the fast-tracking of the corporate tax rate as the Government did not include a mechanism for taxpayers with prior year retained profits to access the franking credit gap created between profits taxed at 30% and the maximum franking rate, currently 27.5%. This has resulted in a windfall for the Government with some shareholders having to pay top-up tax on income already taxed at company level. Assistant treasurer Stuart Robert indicated at the Tax Institute National Conference in March the Government was aware some shareholders would be left out of pocket by the measure but had no intention of allowing refunds of the surplus franking credits.
The ALP supported the fast-tracking of the corporate tax rate, however, they have on previous occasions indicated they will reverse the changes to reduce the corporate tax rate for entities other than small business.
The introduction and reversal of tax policy is not helpful to taxpayers and adds a significant burden to compliance costs.
Changes to the taxation of Trust distributions
The Liberal party have not announced any policy changes in respect of the taxation of trust distributions.
The ALP proposes to introduce a minimum tax rate of 30% on distributions made by discretionary trusts to adult beneficiaries.
The ALP policy will have a significant impact on small business owners who operate their business via a trust particularly where beneficiaries work in the business and take business profits as trust distributions as opposed to salary and wages. Taxing trust distributions at a flat rate of 30% will not only effectively remove the entitlement to the tax-free threshold for beneficiaries who do not have income from other sources but will also mean business profits will be taxed starting a minimum rate equal to the tax rate imposed on large corporate taxpayers.
The ALP policy is lacking in detail so it is unclear how the proposed change to the taxing of trust distributions would interact with the base rate entity rules. If a discretionary trust is operating a business and distributes non-passive income to a corporate beneficiary how would this then be taxed in the company? If the trust distribution was required to be taxed at 30%, but the base rate entity rules allow the company to tax profits at the lower corporate tax rate (currently 27.5%), which tax rate would prevail?
The ALP have indicated their proposed policy would not apply to farming trusts, however, they do not provide any detail on what they would consider to be a farming trust. In my view, small business who operate via a discretionary trust structure should not ultimately be taxed on business profits at a rate equal to or greater than that paid by a large corporate taxpayer. There should be no discrimination between a farming business or any other business (which may include the local plumber, electrician, bricklayer, café owner, newsagent, etc). This is poorly thought out policy that has the potential to impact on thousands of small business owners, many of whom earn low to middle incomes but use trust structures for asset protection and succession planning purposes.
The ALP have stated “Under a Shorten Labor Government, 99 percent of businesses will receive a tax cut, no business will have their tax rate increased...” however with a significant number of small business taxpayers operating their business via a discretionary trust structure, this policy will not only result in a significant increase in tax paid by small business owners but also add another layer of complexity to tax compliance.
This is very poorly thought out policy that will increase the tax rate of thousands of small business taxpayers. If the ALP is concerned with high-income earners distributing wealth to adult beneficiaries (who do not earn income from salary and wages), any change in tax policy should be targeted to impact on those taxpayers, not small business owners.
Franking credit policy
The Liberal party have indicated they do not support the proposed removal of refundable franking credits.
This is despite introducing legislation that has a similar impact for some taxpayers. The fast-tracking of the reduction in the corporate tax rate had a negative impact for small business owners who may have used historical business profits taxed at 30% to fund growth and are now limited to a 27.5% franking credit on those profits taxed at 30% and above. The excess 2.5% tax paid to the Government is not refundable and as a result, some taxpayers may be out of pocket.
A proposed removal of refundable franking credits is a key ALP policy and is being touted as the gift that will fund billions of dollars of ALP policies including increases in childcare rebates, dental funding for seniors among others. What the ALP have failed to tell voters is that the ‘gift’ as they call it will have a significant negative impact on low-income earners and small business owners who operate their business via a corporate structure. Small business owners who may be impacted by the change will include farmers and many tradies. The ALP have issued misleading and incorrect statements regarding the impact of the policy, with Chris Bowen having to provide clarification on his example of a nurse who earnt $67,000 per year and a retired shareholder who earned the same. What Mr. Bowen was attempting to compare was a salary and wage earner and a self-managed superannuation fund which is a trust. If Mr. Bowen compared two individual taxpayers with a taxable income of $67,000, say a nurse who had salary and wage income and a tradie who operated his plumbing business through a company and took company profits as dividends rather than salary and wages, the tradie would be $3763 worse off after tax than the nurse. Same income, only the nurse can access the tax-free threshold the tradie can’t. The end result is the nurse pays tax of $14,662 and the tradie who receives dividends pays tax of $18,425. Both earn the same taxable income, both taxed at different rates.
It is also important for voters to understand that all taxpayers pay income tax in advance whether they are salary and wage earners or companies. A salary and wage earner will be entitled to a refund of any excess PAYG withholding, however under the ALP policy the individual shareholder (who is the owner of the company and ultimately the taxpayer who is taxed on the company profits) will not be entitled to a refund of excess income tax paid on their behalf.
High-income earners or low-income earners with a gross salary of around $37,000 will not be impacted by the ALP policy if they received franked dividend income as the franking credits will merely offset additional tax payable.
Issues with the proposed policy aside, ‘gifts’ by nature are voluntary which means in order for the ALP to meet the promises of free childcare and dental care for the elderly, the ALP will be relying on taxpayers who receive franking credit refunds not to change the way they take business profits or to change their current investment strategy. If taxpayers impacted by the policy change their investment strategy (which they will), the franking credit ‘gift’ will be no more and the ALP will be left with a $6 billion hole in their budget.
Negative Gearing and Capital Gains Tax changes
The Liberal party have not announced any policy changes in relation to negative gearing or changes to the CGT general discount.
I note the Government has not made any announcements as to whether they intend to proceed with the proposed removal of the CGT main residence exemption for foreign residents. The Bill introducing the contentious change has lapsed however the proposed change is still showing on the ATO website which may indicate the Government will seek to reintroduce the policy if re-elected.
The ALP’s proposed policy on the removal of negative gearing on all new investments other than new residential property and the reduction in the general CGT discount from 50% to 25% has drawn significant opposition from industry groups and tax experts.
Details of the removal of negative gearing from investments other than property appear to have been removed from the ALP website so it is unclear how the policy will apply to investments other than new residential property (e.g. shares). The ALP have indicated all existing investments will be grandfathered, however, detail on how this will work is also missing from the website.
Based on previous information released by the ALP it appears negative gearing losses on existing investments (e.g. rental property and shares) will still be able to be offset against salary and wage income, however negative gearing from all new investments entered into post 1 January 2020 (except for new residential property) will not be able to be offset against salary and wage income and will be required to be carried forward to be utilised against investment income earned in future years.
In the 18 years I’ve worked in public practice, the taxpayers most likely to use negative gearing have been middle-income earners trying to increase wealth, provide a future for their kids and save for retirement. These taxpayers have typically included Government workers including prison officers and police along with small business owners. It is rare for taxpayers at the ‘top end of town’ to use negative gearing as a growth strategy as they generally have the cash available to purchase assets without borrowing. A taxpayer on a high income and significant cash assets would not spend $20,000 cash on interest repayments to obtain a tax benefit of $9,400. The proposition is ludicrous. The ALP policy will not only add unnecessary layers of complexity to annual tax compliance, the staggered start date and grandfathering of investments will make preparing tax returns a nightmare. Tax policy should not add this level of complexity to the preparation of individual tax returns, and considering the ALP is also proposing to cap the annual tax deduction for fees incurred in attending to tax affairs, taxpayers face challenging times ahead.
Similarly, the proposed reduction in the general CGT discount from 50% to 25% will only add more complexity for taxpayers. Taxpayers will have no choice but to seek professional advice in order to track cost base information and determine which assets are grandfathered and which ones aren’t. With the proposed start date to apply to assets purchased from 1 January 2020, the ALP would not see any impact on Government revenue from the proposed measure until January 2021 at the earliest as the CGT general discount only applies where assets have been held a minimum of 12 months.
Instant Asset Write-Off
The current Government has been using the instant asset write off as a ‘carrot’ to entice small business each year since it was introducing in 2015.
In the 2019 year, the instant asset write-off started with a threshold of $20,000, was hastily increased to $25,000 from 29 January 2019 and before the legislation introducing the change had even passed was increased again to $30,000 with the eligibility period for the measure also being extended to 30 June 2020.
The measure, while welcome, is now complicated and has added confusion for taxpayers who are looking to purchase business assets. The measure only applies to eligible business use assets and small business owners can only access the deduction if they elect to use small business simplified depreciation. Medium sized businesses, however, can access now access the measure if their aggregated turnover is less than $50 million and they are carrying on a business (this can include passive investment companies). Medium sized businesses are not required to meet any other additional conditions in order to access the immediate write-off.
Small business would be more likely to benefit from this measure if it was made a permanent part of tax legislation, reducing complexity with tax compliance and providing small business with the opportunity to bring forward the purchase of business assets when the business was ready to grow.
The ALP supported the changes to the instant asset write off and have previously indicated they would make the measure permanent.
On review of the small business policy on the ALP website, the ALP does not make it clear if they will introduce a permanent instant asset write off measure for small business (or all business) for eligible assets costing less than $20,000.
Under the ALP investment guarantee, all businesses will be able to claim an upfront deduction of 20% of the asset purchase price where the asset costs more than $20,000 with the balance to be depreciated consistent with the assets effective life. The upfront deduction will not be available if the taxpayer uses pooling so a small business taxpayer would not be able to access the measure if they used simplified small business depreciation.
If the proposed ALP policy is to allow an instant asset write off for all business for eligible assets costing less than $20,000 and an upfront deduction of 20% of the purchase price for eligible assets costing over $20,000, this would be a welcome measure for businesses. Further clarification is required from the ALP on how the policy is intended to work before taxpayers could draw any real conclusions.
ALP policies are likely to result in increases in tax for small business taxpayers as well as add significant additional layers of complexity to tax compliance.
Add to the additional tax burden, uncertainty around changes in penalty rates and the introduction of a ‘living wage’, the ALP policies have the potential to have a significant negative impact on small business and could lead to business closure and job losses. Analysis of the ALP policies indicate the statement made by the ALP that “99% of small business will receive a tax cut and no small business will have their tax rate increased” is clearly not true.
It is difficult to comment on the impact of proposed Liberal policies on small business as the only policies announced in the Federal Budget have already been implemented. With the failed attempt to introduce a superannuation amnesty and the increase in complexity in tax compliance from the introduction of the base rate entity rules and multiple changes to the instant asset write off, it would be understandable if small business had doubt over future tax changes that may be planned by a Coalition Government but are still to be announced.