BILLS DIGEST NO. 116, 2014–15              10 June 2015

Tax Laws Amendment (Small Business Measures No. 1) Bill 2015

Kai Swoboda
Economics Section 

Date introduced: 28 May 2015

House:  House of Representatives

Portfolio: Treasury

Commencement:  Royal Assent; except for Division 2 of Part 2 in Schedule 1 which commences immediately after the commencement of Division 1 of Part 2 in Schedule 1 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Act 2015.

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website.

Purpose of the Bill

The purpose of the Tax Laws Amendment (Small Business Measures No. 1) Bill 2015 (the Bill) is to amend various income tax laws to reduce the tax rate for incorporated businesses with an aggregate turnover of less than $2 million from 30 per cent to 28.5 per cent. The Bill also makes changes to maintain the franking credit passed to owners of these businesses at 30 per cent and consequential changes to reflect the 28.5 per cent tax rate.

Background

Policy announcement and related measures

On 1 February 2015, the Prime Minister, Mr Abbott, announced that a small company tax cut from 1 July 2015 ‘at least as big as the 1.5 per cent already flagged’ would be part of a small business jobs package.[1]

The proposal as announced in the 2015–16 Budget on 12 May 2015 was for a reduction in the company tax rate to 28.5 per cent for small businesses from 1 July 2015.[2] This was part of a broader ‘Growing Jobs and Small Business’ package that was announced as part of the 2015–16 Budget.[3] Other elements of this package included:

•       a five per cent tax discount (capped at $1,000) from 1 July 2015 for unincorporated small businesses with an annual turnover of less than $2 million

•       small businesses with turnover below $2 million will be able to fully and immediately deduct every asset they acquire that is valued up to $20,000 for tax purposes—an increase from the current $1,000 threshold[4]

•       changes to the Fringe Benefits Tax (FBT) system will expand the FBT exemption for work related portable electronic devices

•       reforms to Capital Gains Tax (CGT) rollover will enable small businesses to change the legal structure of their business without incurring a CGT liability and

•       start-ups will be able to immediately deduct professional expenses incurred when they begin a business, such as legal expenses on establishing a company, trust or partnership, rather than writing them off over five years.[5]

This Bill implements one of the measures included in the Government’s 2015–16 Budget package of measures ‘Growing Jobs and Small Business’.[6]

Small business definitions

There are a number of definitions used to describe a ‘small business’.

Australian Bureau of Statistics

The key definition of small business used by the Australian Bureau of Statistics (ABS) is largely based on the number of employees, with a small business defined as an ‘actively trading business with 0-19 employees’.[7] Based on this definition, there were around two million small businesses as at 30 June 2014, accounting for 97 per cent of businesses in Australia.[8] Of these small businesses, around 62 per cent were non-employing businesses, 28 per cent had one to four employees and ten per cent had five to 19 employees.[9]

Other Commonwealth usage

There are a number of other definitions that are used in other Commonwealth laws and programs. These include:

•       Privacy Act 1988—defines a small business as one whose annual turnover for the previous financial year is $3 million or less[10]

•       Australian Securities and Investments Commission Act 2001—defines a small business as a business employing less than 100 people if the business is, or includes, the manufacture of goods, or a business employing less than 20 people otherwise[11] and

•       Fair Work Act 2009—defines a small business employer as an employer with fewer than 15 employees.[12]

Income tax law

However, the proposal to lower the company tax rate for small business which is put into effect by this Bill relies on the definition in the Income Tax Assessment Act 1997 (ITAA 1997) of a small business entity.

A business will be a small business entity in the current financial year if:

•       it is carrying on a business in the current year; and

•       one or both of the following applies:

–      in the previous year before the current year the aggregated turnover of the business was less than $2 million

–      the aggregated turnover for the current year is likely to be less than $2 million.

This definition, which is used as the basis for a number of existing tax concessions, including capital gains tax concessions and simplified depreciation arrangements.[13]

In 2012–13, there were 298,225 taxable entities meeting this definition, of which 288,810 were profitable.[14] These are the entities most likely to be directly impacted by the changed tax arrangements. Of these entities, over half operated in three industries being financial and insurance services, rental hiring and real estate services and professional, scientific and technical services (Table 1). On average, the most profitable industries in which these entities operated were financial and insurance services, mining and agriculture, forestry and fishing.

Table 1 Taxable and profitable small business entities summary financial performance, 2012–13

Industry

No. of taxable and profitable small business entities

Share of total taxable profitable small business entities (%)

Average profit ($)

Average net tax ($)

Average assets ($)

Agriculture, Forestry and Fishing

4,855

2%

$113,814

$31,427

$1,174,373

Mining

920

0%

$127,103

$37,922

$1,155,115

Manufacturing

10,315

4%

$82,448

$24,266

$643,629

Electricity, Gas, Water and Waste Services

750

0%

$86,842

$24,835

$497,557

Construction

34,725

12%

$70,452

$19,871

$758,583

Wholesale Trade

10,675

4%

$74,260

$21,012

$607,256

Retail Trade

13,150

5%

$59,532

$16,980

$15,915,974

Accommodation and Food Services

7,245

3%

$55,783

$16,323

$610,164

Transport, Postal and Warehousing

11,165

4%

$49,515

$13,718

$357,968

Information Media and Telecommunications

2,590

1%

$78,611

$22,763

$439,758

Financial and Insurance Services

56,400

20%

$178,498

$43,625

$1,563,184

Rental Hiring and Real Estate Services

54,000

19%

$56,958

$16,565

$736,307

Professional, Scientific and Technical Services

41,270

14%

$80,703

$23,440

$371,508

Administrative and Support Services

9,355

3%

$67,439

$19,082

$344,281

Education and Training

3,035

1%

$65,849

$19,265

$265,965

Health Care and Social Assistance

13,260

5%

$96,396

$28,578

$388,683

Arts and Recreation Services

2,250

1%

$83,716

$23,876

$446,828

Other Services

10,540

4%

$57,192

$16,623

$361,588

Other

2,310

1%

$105,676

$29,766

$343,696

Total

288,810

100%

$91,360

$24,793

$1,466,364

Source: Australian Taxation Office (ATO), ‘Table 5 Selected items and financial ratios, by company size, taxable status, profit status and broad industry, 2012–13 income year’, ATO website, accessed 9 June 2015. The ATO taxation statistics define businesses with a turnover of less than $2 million as 'micro’ businesses.

These 288,810 taxable and profitable small business entities comprise part of almost 782,000 incorporated entities with a turnover of less than $2 million in 2012–13.[15] In 2011-12, a total of 2.3 million small business entities had a turnover of less than $2 million, putting the number of unincorporated small business entities at around 1.7 million of this total.[16]

Arguments for ‘special’ tax measures for small business

There are a number of arguments in favour of concessional tax treatment for small business. A 2009 review of such policies by the OECD noted that the main arguments in favour of such treatment were based on positive externalities where small businesses generate benefits greater than those accruing to private investors; and to overcome capital market imperfections resulting from information asymmetries.[17] The OECD summarised these in the following terms for small and medium enterprises (SMEs):

Positive externalities (‘spill-over’ benefits)

A main argument for SME investment incentives is that SMEs generate benefits over and above those accruing privately to investors. The benefits may include innovation (e.g. process innovation) that can be applied elsewhere and positively affect economic growth in the economy. Other potential benefits include labour training and the upgrading of skills that can be applied subsequently, in other businesses. In deciding the amount of investment to undertake, SME investors can be expected to consider only private benefits and costs of investment. By ignoring social benefits that spill-over into the economy at large, the expected outcome would be under-investment in SMEs, relative to a socially optimally [sic] level based on social benefits and costs. Tax incentives targeted at SMEs, at the company and/or shareholder-level, may encourage investment closer to a social optimum.

Capital market imperfections

Another main line of argument for tax incentives for SMEs considers capital market imperfections resulting from information asymmetries. Perhaps the most commonly cited example is where the profitability of a business, in particular an early-stage business with highly uncertain (risky) returns, is better understood by managers of firms than by outside creditors. Asymmetric information may result in the extension of credit to firms with “quality” investments but at excessive interest rates (in excess of what would be charged with symmetric information), or no funding (at market rates), or costly signalling, implying in each case under-investment. Another example of information asymmetry arises where outside equity investors are unable to monitor activities of managers who may engage in consumption activities inconsistent with the maximisation of firm value. In such cases, asymmetric information, leading to significant monitoring costs or demands for increased rates of return by outside investors, may lead to under-investment relative to an efficient outcome based on symmetric information.[18]

Some of the other arguments in favour of preferential tax treatment for small business are related to impediments to small business creation and growth created by ‘normal’ tax arrangements that apply to small businesses irrespective of size such as relatively high compliance burden, tax on sale or inheritance of a small business and limited loss offset discouraging risk taking.[19]

Arguments against ‘special’ tax measures for small business

The arguments against preferential tax treatment for small businesses include uncertainties of the extent that positive spill-over benefits are particularly associated with small businesses and whether asymmetric information may in some cases result in overinvestment, rather than underinvestment.[20] Arguments against also consider the practical implementation of such measures, which may lead to efficiency losses (through inadequate targeting) or whether a tax intervention is the best way to achieve a certain outcome.[21]

That the Australian income tax system includes a range of measures that provide concessional taxation arrangements to small business (through the $2 million annual aggregate turnover definition) suggests that policy makers have previously generally accepted that arguments for such measures have been convincing.

However the fact that such arguments have been accepted in the past should not necessarily be used to support the extension of existing measures, nor the creation of new measures. British tax academic Judith Freedman noted that such proposals can introduce additional complexity and have efficiency implications:

Small businesses are often seen as having special tax needs. There are frequently demands made on their behalf by pressure groups and politicians for special concessions, incentives and reliefs. Small business representatives are vociferous and the cause is a popular one for politicians. The result is far from simplification. Often layer upon layer of regulation adds elections and decisions for the smallest businesses to cope with. There is also consequent frequent change, which is inevitably burdensome and costly. It does not follow from the small size of a business that the affairs of that firm or the law applying to it are, or can be, simple. Small business affairs interact with those of the family and other personal relationships and they offer a way of life as well as a financial venture. They are inherently complex. Even if complete simplicity is unattainable, however, general stability and good tax structures will benefit all businesses, including small businesses for whom learning about and understanding change is particularly burdensome. It may sometimes be the case that a reform that is argued to be needed for small businesses may be desirable for all. If that is the case then there are good grounds based on equity and allocation, as well as simplicity and definitional arguments, for not imposing restrictions by way of size. The arguments against this will often relate to costs in terms of reducing revenue raised rather than any objection by way of principle. If provisions are to be limited to small businesses only, the reason for this limitation needs to be made clear.[22]

Rationale for the small business company tax cut

The case for cutting the tax rate for small companies is included in the Government’s regulation impact statement that forms part of the Explanatory Memorandum to the Bill.[23] The regulation impact statement notes that there are around 780,000 incorporated businesses with a turnover of less than $2 million that may benefit from a reduction in the tax rate.[24] The ‘problem’ identified is that the small business sector has the potential to ‘contribute strongly to national growth and competitiveness’ but that weak conditions, regulatory costs and access to finance are impeding this growth by the sector.[25]

The regulation impact statement identifies the key benefit of a reduction in the small business company tax rate as being that the reduction would allow more of these businesses to retain these earnings, allowing them to invest more and expand their activity:

Investment is important as it leads to existing output being produced at a lower cost (capital deepening) and new and improved ways of doing business (innovation), which improves the amount of output produced for each unit of input, including labour (productivity). As a result, higher investment can lead to higher employment and wages over time. However, given the small size of these companies, the overall macroeconomic impact is unlikely to be as significant compared to a broader tax cut to all companies.[26]

The engine room of the economy?

The Government’s 2015–16 ‘Growing Jobs and Small Business’ package (which includes the measure to which the Bill relates) makes the claim that ‘the hard working women and men of Australian small businesses are the engine room of our economy’ and that ‘[t]here is no doubt small business is at the forefront of Australia’s jobs and growth’.[27] In support of this claim was information that in 2013–14 Australians started over 280,000 businesses.[28]

Claims that small businesses are an ‘engine room’ have been made in the Parliament over many years.[29] The term has also been used as a mantra by some industry groups.[30] However, this may be overstated.

Innovation

A recent report by the Productivity Commission on business set up and transfer noted that small businesses (defined for the purposes of its study as being those with fewer than 20 employees) are far less likely to engage in innovative activity than larger businesses, with an estimated one per cent of small businesses introducing an innovative product or service that was ‘new to Australia’ in 2012–13, compared with 14 per cent of large businesses.[31] The Productivity Commission noted:

The vast majority (over 90 per cent) of new businesses are micro-businesses with few (less than four) or no employees. Most business owners are male, but female owners are becoming more prevalent in new businesses set-up. The median age of business owners (at 47 years) is older than the general workforce and is increasing faster. Many businesses are started to provide employment for the owner or their family, to satisfy lifestyle choices, to provide services to a community sector or to raise funds for a specified purpose. Such businesses are not necessarily innovative, nor is rapid growth necessarily sought.[32]

The ABS’s regular innovation survey publication, Innovation in Australian Business, 2012–13, found that overall the likelihood that a business engages in innovative activity increases as the size of the business (measured for the purposes of the ABS publication by employment size) (Table 2).

Table 2 Innovation by business size, 2012–13

Employment size

Estimated number of businesses (‘000)

Businesses with introduced or implemented innovation (innovating businesses) (%)

Businesses with innovative activity that was still in development (%)

Businesses with innovative activity that was abandoned (%)

Businesses with any innovative activity (innovation-active businesses) (%)

0–4 persons

466

28.9

18.3

5.3

34.7

5–19 persons

243

45.8

27.8

6.9

51.0

20–199 persons

58

58.3

35.6

6.3

63.4

200 or more persons

4

66.8

51.4

4.4

74.3

Source: Australian Bureau of Statistics (ABS), Innovation in Australian business, 2012–13, Key measures of innovation, cat. no. 8158.0, ABS, Canberra, 21 August 2014, accessed 2 June 2015.

Employment, value added and wages growth

The key data in relation to employment, value added and wages by business size (measured in terms of number of employees) is from the ABS’s publication Australian Industry 2012–13.[33] Unfortunately these data are only available for the period since 2007–08, limiting analysis to a relatively short period.[34]

Based on these data, in 2012–13 small business accounted for:

•       43 per cent of total employment

•       26 per cent of total wages and salaries and

•       33 per cent of industry value added.

Over the period since 2006–07—a period which takes in any effects of the global financial crisis in late 2008— small business employment has declined in some years and increased in others, sitting at a level at 30 June 2013 that was 519,000 fewer than at 30 June 2007 (Figure 1). However, employment in medium sized businesses continued to grow, suggesting that some of the loss in employment in the small business sector was taken up by larger businesses.

Figure 1 Employment by business size, selected industries, 2007–08 to 2012–13 (‘000)

Source: Australian Bureau of Statistics (ABS), Australian industry 2012–13, cat. no. 8155.0, ABS, Canberra, 28 May 2014, accessed 2 June 2015, and previous years.

Trends in employment, wages and salaries and industry value added for small business over the period 2007–08 to 2012–13 show that while employment declined over the period, industry value added by small business increased by more than ten per cent (Figure 2).

Figure 2 Changes in small business indicators, selected industries, 2007–08 to 2012–13 (2007–08 = 100)

Source: Australian Bureau of Statistics (ABS), Australian industry 2012–13, cat. no. 8155.0, ABS, Canberra, 28 May 2014, accessed 2 June 2015, and previous years.

While the increase in industry value added shows that the value of activity has increased despite the fall in employment, medium and large businesses continue to contribute greater industry value added per employee than small businesses (Figure 3). In the case of large businesses, this value added per employee in 2012–13 of $131,259 per employee is 80 per cent higher than the $72,780 per employee in small business.[35]

Figure 3 Industry value added per employee for selected industries, 2007–08 to 2012–13 ($)

Source: Australian Bureau of Statistics, Australian industry 2012–13, cat. no. 8155.0, ABS, Canberra, 28 May 2014, accessed 2 June 2015, and previous years.

Policy development

The proposal for a lower company tax rate for small business has not been recommended by any government commissioned tax reviews. Rather, it has evolved from an initial proposal by the Rudd and Gillard Governments to bring forward by one year for small business a general cut in the company tax rate. The Coalition’s pre-2013 election commitments then built on this proposal with separate policies on lower company taxation and for a paid parental leave scheme. The proposal is consistent with the Australian Greens’ 2013 election policy. This is discussed below in more detail.

Major tax reviews

In March 2015, the Government published a discussion paper as part of the current tax review that raises some specific tax issues relating to small businesses. These include compliance costs, choice of business structure and complexity.[36] In relation to a single lower tax rate for small businesses the discussion paper included a proposition that a lower single rate (or zero tax rate) could be put in place to replace multiple tax concessions:

Instead of multiple concessions across the tax system, an alternative option that could be considered is to apply a lower or zero tax rate for small businesses. A lower rate that replaced multiple specific concessions could encourage small businesses to spend their resources expanding their business, rather than managing their tax affairs.[37]

This issue may be raised through the tax review, with the Government posing the following specific questions in the discussion paper:

How effective is the current range of tax concessions (such as CGT and industry specific concessions) at supporting small business engagement with the tax system? To what extent do the benefits they provide outweigh the compliance, complexity and revenue costs they introduce?

What other mechanisms (such as a single lower tax rate, improved technology deployment or other non-tax mechanisms) could assist small businesses to engage with the tax system while decreasing compliance and complexity costs?[38]

2008–2009

The most recently completed tax review, entitled Australia’s Future Tax System (known as the Henry Tax Review) did not include any specific recommendations relating to a reduced company tax rate for small business. Rather, the Henry Review did recommended increasing the turnover threshold from $2 million to $5 million for access to the existing small business tax concessions as well as a general reduction in the company tax rate to 25 per cent.[39]

1998–1999

Earlier, the Review of Business Taxation (known as the Ralph review) concentrated on the compliance cost impact on small business and recommended simplified taxation arrangements for small business (with an annual turnover of less than $1 million).[40] Also included in the report of the Ralph review were recommendations relating to changed capital gains tax arrangements and a simplified depreciation regime.[41]

1973–1975

The earliest of the reviews is known as the Asprey review. It was conducted just after changes to a single company tax rate from a system that imposed a lower rate on the first $10,000 of company income and a higher rate on amounts above this. The review noted that the previous arrangements ‘may be seen as a very crude way of providing some relief from the burden of over-taxation to shareholders in small enterprise’.[42] Members of the review did not favour a return to such a policy, and with reference to policies in Canada and the United Kingdom at the time providing for lower tax to eligible small businesses, noted that:

If special provisions are to be made for small enterprises, the Committee would prefer the Canadian or United Kingdom model rather than a return to what used to be the Australian law. However, the Committee takes the view that one should not lightly introduce a new element of non-neutrality into the company tax system.[43]

Rudd and Gillard Government proposals

On 2 May 2010, as part of its response to the Henry Tax Review, the Rudd Government announced that it would cut the company tax rate to 28 per cent, with the reduction being phased in from 2012–13 for small businesses, one year earlier than for other companies.[44] This announcement also included plans for the Resource Super Profits Tax and an increase in the instant write‐off threshold from $1,000 to $5,000.[45]

On 2 July 2010, the Gillard Government altered the company tax cut proposal as part of an amended mining tax—the Minerals Resource Rent Tax (MRRT). The alteration was necessary due to reduced revenue. That being the case, the Government announced that:

… the company tax rate will continue to be cut to 29 per cent from 2013–14 but will not be further reduced under current fiscal conditions. Small companies will benefit from an early cut to the company tax rate to 29 per cent from 2012–13.[46]

Legislation to implement this proposal was, however, never introduced into the Parliament. Although the legislation to implement the MRRT passed through both Houses of the Parliament in early 2012, by the time of the 2012–13 Budget in May 2012 the proposal for a company tax cut was abandoned.[47]

One of the reasons for this was that support for an across-the-board company tax rate reduction was not supported by the Australian Greens (the Greens). Their support was limited to a company tax rate cut for incorporated small businesses only.[48]

2013 election policies

In the run-up to the 2013 Federal election, each of the parties included proposals to enhance business in their policies.

ALP

The 2013 election policies of the Australian Labor Party’s (ALP) did not include any proposals to change the general company tax rate.[49] However, policies directed specifically towards small business included increasing the instant asset write off threshold from $6,500 to $10,000 for eligible assets purchased between 8 September 2013 and 30 June 2015.[50]

Coalition

The Coalition’s 2013 election policies included a proposal to cut the company tax rate to 28.5 per cent from 1 July 2015.[51] However, at the same time the Coalition proposed introducing a paid parental leave scheme. That scheme was to be funded by a 1.5 per cent levy on companies with a taxable income in excess of $5 million. The net effect of the two policies would be that only those companies below this threshold would effectively face a tax cut.[52]

Greens

The Greens were the only major party to advocate a lower company tax rate that would apply only to small business. This policy proposed a reduction in the company tax rate to 28 per cent from 1 July 2014 for companies with a turnover of under $2 million.[53] An objective of the policy was to ‘to promote the vitality of the sector and to encourage more Australians to enter into small businesses’.[54] Part of the policy was also to increase the instant asset write off threshold from $6,500 to $10,000.[55]

Committee consideration

At the time of writing the Bill had not been referred to a Committee. At the time of writing, neither the Senate Standing Committee for the Scrutiny of Bills nor the Parliamentary Joint Committee on Human Rights had commented on the Bill.

Statement of Compatibility with Human Rights

As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible.[56]

Policy position of non-government parties/independents

ALP

In his budget reply speech on 14 May 2015, the Leader of the Opposition, Bill Shorten, indicated that the ALP would support the proposal for a reduction in the company tax rate to 28.5 per cent.[57] He also indicated that the ALP would support a further cut to 25 per cent, to ‘give small businesses the sustainable boost to confidence that they deserve, the confidence to create jobs’.[58]

Greens

The Greens welcomed the proposal for the small business company tax cut following the release of the Budget.[59] As noted earlier, the Greens 2013 election policy proposed a reduction in the company tax rate to 28 per cent from 1 July 2014 for companies with a turnover of under $2 million.[60] This is broadly consistent with the provisions of this Bill.

Minor parties and independents

Of the minor parties and independents that had expressed a view on the proposal:

•       Senator Xenophon was reported as supporting a proposal to cut the company tax rate to 28.5 per cent when it was first announced by Prime Minister in February 2015[61]

•       the Palmer United Party, while not indicating whether it would support the measure in the Parliament, questioned the impact of the reduction in company tax for small business in stimulating the economy[62]

•       Senator Madigan was reported to support a halving of the company tax rate for businesses manufacturing in Australia[63]

•       the Family First party’s Senator Day has advocated for a single rate flat tax, and to move to this by reducing the 30 per cent corporate tax rate[64] and

•       the Liberal Democratic Party’s general taxation policy is to ‘substantially cut taxes’, with the associated savings from reducing expenditures cutting the company tax rate to 20 per cent.[65]

Position of major interest groups

While some business groups have expressed concerns about the potential complexity and distortions that may result from a two-tier company tax rate regime, business groups generally support the policy. The Business Council of Australia noted that:

The small business package provides some welcome relief by assisting start-ups and helping to keep small enterprises to be [sic] competitive.

… While a two-tier company tax rate is not ideal, the impact of these measures is confined to a small part of the economy. It is important for both major parties to remain committed to a lower, more internationally competitive company tax rate for all businesses as fiscal circumstances permit.[66]

These sentiments are similar to those expressed by the Australian Chamber of Commerce and Industry, which supports the 2015–16 Budget small business measures as a package, but has also noted the potential implications of a two-tier company tax rate being a ‘dog’s breakfast’.[67]

In early 2015, the Council of Small Business Organisations of Australia (COSBOA) was advocating for a five per cent company tax rate for smaller businesses with a turnover of up to $5 million.[68] Following the release of the Budget, the CEO of COSBOA welcomed the small business package:

The budget inclusions for small business have been designed to boost confidence, boost cash flow and boost the economy, an economy that has always been based upon the foundation of small business people.[69]

Chartered Accountants Australia and New Zealand noted that the cut for small businesses ‘should apply across the board, and follow with a plan to lower it over successive budgets to 25 per cent’.[70]

Financial implications

The Explanatory Memorandum notes that the financial impact of the measure estimated to be $1,450 million over the four years to 2018–19 (Table 3).[71]

Table 3 Financial impact of lowering company tax rate to 28.5 per cent for small incorporated businesses, 2014–15 to 2018–19 ($ million)

2014–15

2015–16

2016–17

2017–18

2018–19

Total

Financial impact

0

-$250m

-$400m

-$400m

-$400m

-$1,450m

Source: Explanatory Memorandum, Tax Laws Amendment (Small Business Measures No. 1) Bill 2015, p. 3, accessed 9 June 2015.

A costing prepared by the Parliamentary Budget Office for the Australian Greens’ proposal to reduce the company tax rate to 28 per cent for these entities from 1 July 2014 estimated the impact to be -$1,850 million over the four years to 2016–17 (Table 4). This costing was also based on retaining the 30 per cent franking rate.[72] While the PBO costed policy was based on a commencement date one year earlier and an additional 0.5 percentage point reduction, it is interesting to note the different profile for revenue foregone and the magnitude of the impact of an additional 0.5 percentage point reduction.

Table 4 Financial impact of Australian Green’ 2013 election policy to lower the company tax rate to 28 per cent for small incorporated businesses, 2014–15 to 2017–18 ($ million)

2013–14

2014–15

2015–16

2016–17

Total

Financial impact

-$50m

-$100

-$750m

-$950

-$1,850m

Source: Parliamentary Budget Office (PBO), 2013 election: Post-election report of election commitments, ‘Attachment H: costing documentation for Australian Greens' election commitments Part 2: GRN001 - GRN035’, PBO website, p. 296, accessed 3 June 2015.

Key provisions

The Income Tax Rates Act 1986 specifies a range of income tax rates, including the company tax rate of 30 per cent.[73]

Item 1 of Part 1 of the Bill repeals existing subsection 23(2) of the Income Tax Rates Act which specifies the 30 per cent rate applying to most companies. Item 1 inserts proposed subsection 23(2) into the Income Tax Rates Act to provide that the rate of tax for a small business entity for a year of income is 28.5 per cent whilst a rate of 30 per cent applies for most other companies. As stated previously, the term small business entity is defined in subdivision 328-C of the ITAA 1997 Act to be an entity that:

•       is carrying on a business in the current year; and

•       one or both of the following applies:

–      in the previous year before the current year the aggregated turnover of the business was less than $2 million

–      the aggregated turnover for the current year is likely to be less than $2 million.[74]

Importantly, the tax rate for companies is not progressive. Companies that are not small business entities will pay the 30 per cent rate on the total of their taxable income.

Non-profit companies pay no tax on the first $416 of their taxable income. Tax is then ‘shaded in’ at a rate of 55 per cent of the excess over $416 until the tax on taxable income is equal to the corporate tax rate ($915 at a 30 per cent company tax rate).[75] Item 2 of Part 1 of the Bill repeals and replaces subsections 23(6) and (7) of the Income Tax Rates Act. Proposed subsection 23(6) modifies the ‘shade in’ rates by retaining the $416 threshold but setting the upper threshold for companies that are a small business entity at $863. The upper threshold of other companies is set at $915.

Credit unions are taxed differently depending on whether they are ‘small’, ‘medium’ or ‘large’.[76] The 45 per cent paid by medium credit unions reflects the 30 per cent corporate tax rate. Proposed subsection 23(7) provides that the amount of tax payable by a company that is a medium sized credit union that is a small business entity is 42.75 per cent. Otherwise the rate is 45 per cent.

Item 3 of Part 1 of the Bill repeals and replaces existing sections 24 and 25 of the Income Tax Rates Act to apply the 28.5 per cent company tax rate to a trustee of corporate unit trusts and a public trading trust that is a small business entity and a 30 per cent rate for the remaining entities.

Key issue—a two-tier company tax rate

The two tier company tax rate regime for small and larger businesses established by the Bill has been criticised on a number of grounds. The key criticism from certain business groups relates to the introduction of a distortion in the tax system that may provide incentives for businesses to restructure their tax liabilities or be a disincentive for growth.[77]

As an example, a small business entity with an aggregate turnover of $1,999,999 (that is, less than $2 million) that makes a taxable profit of $500,000 would be liable to pay tax of $142,500 at a 28.5 per cent tax rate. Were the same profit made by an entity with a turnover of $2,000,010 million—just ten dollars more—the tax liability at the 30 per cent rate would be $150,000. The tax paid on the additional ten dollars of revenue—$7,500 in this case—may provide a strong incentive for a business to remain below the $2 million threshold.

The regulation impact statement in the Explanatory Memorandum notes that this ‘tax cliff’ ‘could be a disincentive to growth and, while it would not be very large in most circumstances, it adds to the existing disincentives within the system to grow above the small business turnover threshold’.[78] However, the statement also considers that such behavioural responses are likely to be uncommon, with around 5,500 companies close to the $2 million threshold.[79]

Another criticism of the emergence of a two tier system is that the use of the turnover threshold reinforces the bias against low margin small businesses, such as high volume retail operations.[80]

That said, there are a number of OECD countries that have adopted an approach to provide preferential income tax treatment for smaller companies. For example, smaller businesses in Canada, France, Japan and Korea benefit from a corporate tax rate that is between 43 per cent and 67 per cent of the standard corporate tax rate.[81]

Other provisions

Consequential amendments including maintaining franking credit at 30 per cent

Under the dividend imputation system, a resident taxpayer receiving a dividend that has had tax applied at the corporate tax rate is entitled to an equivalent ‘franking credit’ for their individual taxable income. This credit reduced the individual’s taxable income by an equivalent amount, thereby avoiding double taxation on this profit.

Part 2 of the Bill makes a number of consequential amendments to various tax laws to retain this 30 percent franking rate for small businesses as well as to provide that a number of rebates and tax offsets are passed through to an entity at the relevant company tax rate.

Concluding comments

There are a number of arguments in favour of concessional tax treatment for small business. These include the ‘spill-over benefits’ associated with intervention for small business, overcoming capital market imperfections and higher compliance costs for these entities.

The introduction of a lower company tax rate for businesses with a turnover of less than $2 million has not evolved from a recommendation of a government-commissioned tax review but rather has emerged from proposals by the ALP and the Coalition to lower the company tax rate generally. That said, such an arrangement is a feature of a number of OECD countries.

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[2].              Australian Government, Budget measures: budget paper no. 2: 2015–16, pp. 19–20, accessed 2 June 2015.

[3].              T Abbott (Prime Minister), J Hockey (Treasurer) and B Billson (Minister for Small Business), Growing jobs and small business package to help small businesses invest more, grow more, and employ more, joint media release, 12 May 2015, accessed 2 June 2015.

[4].              This measure is being implemented by the Tax Laws Amendment (Small Business Measures No. 2) Bill 2015. When completed, a copy of the Dills Digest will be available on the Bill Homepage for this Bill.

[5].              Ibid.

[6].              Australian Government, Budget 2015: growing jobs and small business, 2015, p. 2, accessed 2 June 2015.

[7].              Australian Bureau of Statistics (ABS), Australian industry 2012–13, cat. no. 8155.0, ABS, Canberra, 28 May 2014, accessed 3 June 2015.

[8].              Australian Bureau of Statistics (ABS), Counts of Australian businesses, including entries and exits, June 2010 to June 2014, cat. no. 8165.0, ABS, Canberra, 2 March 2015, p. 21, accessed 1 June 2015.

[9].              Ibid.

[10].              Privacy Act 1988, section 6D, accessed 3 June 2015.

[11].              Australian Securities and Investments Commission Act 2001, subsection 12BC(2), accessed 3 June 2015.

[12].              Fair Work Act 2009, subsection 23(1), accessed 3 June 2015.

[13].              Income Tax Assessment Act 1997, subdivision 328-C, accessed 1 June 2015.

[14].              Australian Taxation Office (ATO), ‘Table 5 Selected items and financial ratios, by company size, taxable status, profit status and broad industry, 2012–13 income year’, ATO website, accessed 9 June 2015. The ATO taxation statistics define businesses with a turnover of less than $2 million as 'micro’ businesses.

[15].              Australian Taxation Office (ATO), ‘Table 5 Selected items and financial ratios, by company size, taxable status, profit status and broad industry, 2012–13 income year’, ATO website, accessed 9 June 2015.

[16].              Treasury, ‘Small business data card’, Treasury website, 5 December 2014, accessed 3 June 2015. The estimate of 1.7 million unincorporated small business entities in 2011-12 assumes that the number of incorporated small business entities in 2011–12 is around the 782,000 in 2012–13.

[17].              OECD, Taxation of SMEs: key issues and policy considerations, OECD Tax Policy Studies, 18, accessed 1 June 2015.

[18].              Ibid., p. 85.

[19].              Ibid., p. 84.

[20].              Ibid., p. 94.

[21].              Ibid., pp. 94–95.

[22].              J Freedman, ‘Reforming the business tax system: does size matter? Fundamental issues in small business taxation’, in C Evans and R Kever (eds), Australian business tax reform in prospect and retrospect, 2009, pp. 155–156, accessed 9 June 2015.

[23].              Explanatory Memorandum, Tax Laws Amendment (Small Business Measures No. 1) Bill 2015, pp. 13–32, accessed 9 June 2015.

[24].              Ibid., p. 14.

[25].              Ibid., pp. 14–15.

[26].              Ibid., pp. 15–16.

[27].              Australian Government, Budget 2015: growing jobs and small business, op. cit., p. 2.

[28].              Ibid.

[29].              See for example, J Howard (Prime Minister), ‘Ministerial statements: small business deregulation task force report: Government response’, House of Representatives, Hansard, 24 March 1997, p. 2691, accessed 2 June 2015; B Ripoll, ‘Private members’ business: small business’, Federation Chamber, Debates, 3 March 2014, p. 1449, accessed 2 June 2015.

[30].              Australian Chamber of Commerce and Industry (ACCI), Small business welcomes support in budget, media release, 12 May 2015, accessed 2 June 2015.

[31].              Productivity Commission (PC), Business set-up, transfer and closure, PC draft report, May 2015, pp. 4–5, accessed 2 June 2015.

[32].              Ibid., p. 4.

[33].              Australian Bureau of Statistics (ABS), Australian industry 2012–13, op. cit.

[34].              The first time this publication included information on employment by business size was the 2009 release, which related to both 2006–07 and 2007–08 (Australian Bureau of Statistics (ABS), Australian industry 2008–09, cat. no. 8155.0, ABS, Canberra, 28 May 2009, pp. 14–17, accessed 9 June 2015)

[35].              Australian Bureau of Statistics (ABS), Australian Industry 2012–13, op. cit.

[36].              Australian Government, Rethink: tax discussion paper, March 2015, pp. 105–120, accessed 2 June 2015.

[37].              Ibid., p. 119.

[38].              Ibid., p. 120.

[39].              K Henry, Australia’s future tax system: report to the Treasurer, Part Two detailed analysis, volume 1 of 2, December 2009, pp. 167 and 174, accessed 1 June 2015.

[40].              J Ralph AO, A tax system redesigned: more certain, equitable and durable, July 1999; pp. 573–589, accessed 1 June 2015.

[41].              Ibid.

[42].              Taxation Review Committee (K Asprey and R Parsons), Full report, Australian Government Publishing Service, Canberra, 1975, pp. 241–242, accessed 1 June 2015.

[43].              Ibid., paragraph 16.100, p. 242.

[44].              K Rudd (Prime Minister), Stronger, fairer, simpler: a tax plan for our future, media release, 2 May 2010, accessed 1 June 2015.

[45].              Ibid.

[46].              J Gillard (Prime Minister), W Swan (Treasurer) and M Ferguson (Minister for Resources and Energy), Breakthrough agreement with industry on improvements to resources taxation, joint media release, 2 July 2010, accessed 1 June 2015.

[47].              Minerals Resource Rent Tax Act 2012, accessed 1 June 2015, Australian Government, Budget measures: budget paper no. 2: 2012–13, p. 22, accessed 1 June 2015.

[48].              P Coorey, ‘Eyes on Wilkie over company tax cuts’, The Sydney Morning Herald, 2 May 2012, p. 6, accessed 1 June 2015; M Grattan, ‘No hope of tax cut for big business: Milne’, The Age, 16 April 2012, p. 3, accessed 1 June 2015.

[49].              Prime Minister Rudd did however announce a proposal for the creation of a ‘Northern Special Economic Zone’ for which tax incentives would apply ‘with the objective of reducing the company tax rate for Northern Territory-based companies in five years’ (K Rudd (Prime Minister of Australia), Growing the north: a plan for Northern Australia, media release, 15 August 2013, accessed 1 June 2015).

[50].              Australian Labor Party, Boosting investment by small business, Australian Labor Party policy document, Election 2013, p. 2, accessed 1 June 2015.

[51].              Liberal National Coalition, The Coalition’s policy to lower company tax, Coalition policy document, Election 2013, p. 2, accessed 1 June 2015.

[52].              Liberal National Coalition, The Coalition’s policy for paid parental leave, Coalition policy document, Election 2013, pp. 6–7, accessed 1 June 2015.

[53].              Australian Greens, Standing up for small business: lower taxes, Australian Greens policy document, August 2013, accessed 1 June 2015.

[54].              Ibid.

[55].              Australian Greens, Greens focus on small business, media release, 8 August 2013, accessed 1 June 2015.

[56].              The Statement of Compatibility with Human Rights can be found at page 11 of the Explanatory Memorandum to the Bill.

[57].              B Shorten, ‘Second reading speech: Appropriation Bill (No. 1) 2015-2016’, House of Representatives Debates, 14 May 2015, p. 95, accessed 3 June 2015.

[58].              Ibid., p. 95.

[59].              P Whish-Wilson, Small business package puts back what the Government took away, media release, 13 May 2015, accessed 1 June 2015.

[60].              Australian Greens, Standing up for small business: lower taxes, op. cit.

[61].              C Heaney, ‘Senator backs tax breaks’, The Herald Sun, p. 48, accessed 1 June 2015.

[62].              C Palmer, Budget 2015: Clive Palmer’s response to the 2015 Federal Budget, 15 May 2015, accessed 1 June 2015.

[63].              L Bourke, ‘Crossbencher to launch his own party’, The Sydney Morning Herald, 9 April 2015, p. 7, accessed 3 June 2015.

[64].              B Day, ‘Statements by Senators: taxation’, Senate, Hansard, 25 March 2015, p. 2330, accessed 3 June 2015.

[65].              Liberal Democratic Party (LDP), ‘Policies: taxation’, LDP website, accessed 3 June 2015.

[66].              Business Council of Australia, Statement on the 2015–16 Federal Budget, media release, 12 May 2015, accessed 3 June 2015.

[67].              Australian Chamber of Commerce and Industry, Small business welcomes support in budget, media release, 12 May 2015, accessed 3 June 2015; J Mather, ‘Two-tier business tax concerns ACCI’, The Australian Financial Review, 14 April 2015, p. 3, accessed 2 June 2015.

[68].              Council of Small Business Organisations of Australia, Grow and be healthy, remove FBT on child care and health, make small business company tax 5%, media release, 10 February 2015, accessed 3 June 2015.

[69].              Council of Small Business Organisations of Australia, Budget extraordinaire shows respect for people in business, 12 May 2015, accessed 3 June 2015.

[70].              Chartered Accountants Australia and New Zealand, Healthy housekeeping but few plans for success, media release, 12 May 2015, accessed 3 June 2015.

[71].              Explanatory Memorandum, Tax Laws Amendment (Small Business Measures No. 1) Bill 2015, op. cit., p. 3.

[72].              Parliamentary Budget Office (PBO), 2013 election: Post-election report of election commitments, ‘Attachment H: costing documentation for Australian Greens' election commitments Part 2: GRN001 - GRN035’, PBO website, p. 294, accessed 3 June 2015.

[73].              Income Tax Rates Act 1986, section 23, accessed 2 June 2015.

[74].              Income Tax Assessment Act 1997, subdivision 328-C, accessed 1 June 2015.

[75].              Income Tax Rates Act 1986, subsection 23(6).

[76].              Thresholds for defining credit unions by size are defined in section 6H of the Income Tax Assessment Act 1936.

[77].              P Coorey, ‘Rethink call for two-tier tax’, The Australian Financial Review, 11 February 2015, p. 7, accessed 2 June 2015; J Mather, ‘Two-tier business tax concerns ACCI’, op. cit., p. 3.

[78].              Explanatory Memorandum, Tax Laws Amendment (Small Business Measures No. 1) Bill 2015, op. cit., p. 19.

[79].              Ibid.

[80].              Taxpayers Alliance, ‘Preliminary #2015 budget thoughts: more tax, more spending more deficits’, Taxpayers Alliance website, accessed 2 June 2015.

[81].              OECD, ‘Tax database: Table II.2. Targeted corporate income tax rates’, OECD website, accessed 3 June 2015; OECD, ‘Tax database: Table II.1. Corporate income tax rate’, OECD website, accessed 3 June 2015.