What’s new in the better tax paper?

With the release of the Better Tax discussion paper in March, some would be forgiven for feeling a sense of déjà vu. Haven't these issues already been discussed and decided?

After all, it is less than five years since the final report from the Future Tax System Review (the Henry Tax Review) was released.

This review, however, should be different. The scope of the review is much broader — for example, the ability to recommend changes to the scope and rate of the goods and services tax (GST) is within scope, and possible recommendations to change the taxation of super for people over the age of 60 has not been ruled out.

In addition to this, it is also important to put this review into context, given other recent discussion papers and reform proposals that have either concluded or are nearing conclusion, including:

• The Financial System Inquiry;
• The McClure review of the social security system;
• The recent 2015 Intergenerational Report; and
• The Trowbridge Report into retail life insurance advice.

While it has felt to many that we have recently been going through consultation overload, the emergence of these range of reviews in a short space of time provides the opportunity to ensure that the Better Tax review can be conducted in a broader environment rather than being conducted in isolation.

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It is also important to remember that it will be some time before we see any significant changes as a result of this review.

Indeed, the Government has indicated that while submissions to the review will close on 1 June 2015, it will then release a follow up discussion paper on reform options, and will release its plan for tax reform before the next Federal election (expected in the second half of 2016).

It would not be surprising for the Government's plan to form one of its key election policy platforms, thereby seeking a mandate to implement its proposed changes.

Areas for potential change

The Government is actively seeking consultation around the changes that could be made to the tax system in Australia. They are seeking formal submissions and asking people to be involved in a conversation.

Here are just some of the areas for consideration from a financial planning perspective that could have an impact on the strategies recommended for clients.

Importantly though, while the comments below may relate to one specific area, any broad tax changes may mean that while there are changes to one area of taxation there may be offsetting changes in another.

GST reform

To encourage submissions in this area, the Better Tax paper includes some comparisons between Australia's rate of GST and various consumption taxes from around the world. It notes that the rate of GST is the joint fourth lowest of the comparable taxes in the Organisation for Economic Co-operation and Development (OECD) and is approximately half of the OECD average.

The discussion paper also contains an analysis of the GST base (47 per cent of consumption of all goods and services) and notes that while it is similar to the OECD average (55 per cent), the GST base as a percentage of all goods and services has been consistently decreasing since it reached its peak in 2005/2006 of 56 per cent.

Changes to the rate and base of the GST is not something that can be easily done. Indeed, it actually requires the unanimous support of the State and Territory Governments, as well as passage of relevant legislation by the Australian Parliament.

With revenue generated from the GST having historically been passed back to the states and territories as compensation for changes or relinquishment of various state taxes in the past, and much discussion at state levels as to whether that compensation has been adequate, you can imagine unanimous support may be difficult to achieve.

Of most note in discussion here has not been around the rate of GST, but around the base — even from the Government. This approach is interesting given that the paper clearly calls out the low rate of GST in Australia.

The largest area of debate has focussed on the imposition of GST on goods purchased online from overseas. With these purchases largely not attracting GST, the Government sees this as a clear area of lost revenue.

However, if the Government was able to find a way to levy GST on these purchases, the question is, what impact would it have on your client's behaviour?

For example, are they only purchasing these items because they seem comparatively cheap? Are the items being purchased a need or a want?

If they became more expensive, would they still buy them, and would they continue to buy online and from overseas, or would they be purchased from an Australian shop front?

Would your clients instead choose to save those monies, and therefore what wealth creation opportunities does that present to your clients?

Personal income tax reform

The discussion paper recognises that individual income tax is "the single most important source of government revenue and has consistently raised around half of the Australian Government's tax receipts since the 1970s."

Leading up to the release of the paper, there has been a lot of discussion around "bracket creep", which occurs when inflation pushes individuals to a higher average tax rate as more of their income is subject to the higher marginal tax rates. If left unchecked, this process has the ability to significantly increase the tax payable by each taxpayer.

While the obvious solution to this is to automatically index the thresholds, governments generally prefer to index them manually as it gives the appearance of giving a tax cut.

And over recent decades governments have lowered rates and raised the thresholds to address bracket creep, and maintain the rewards for effort. It is expected that this process will continue but when addressing bracket creep manually, it allows the government of the day to target specific areas and the discussion paper has sought views on what areas should have priority.

Other areas discussed in the paper are the possibility of using a standard "work-related expenses" deduction, thereby reducing the complexity of completing returns for many Australians. Interestingly, this option was canvassed by the previous Government, but ultimately was a reform option that the current Government has not decided to pursue.

The Better Tax paper has also expressed concern at the variability of tax treatment of different types of income depending on the source, as illustrated in Chart 1 from the Better Tax discussion paper.

What this chart shows is that the rate of tax paid in savings held in cash deposits is higher than if those funds had been invested in property or shares.

This difference in tax treatment is an issue as it discourages investment in bank accounts in favour of shares and property.

Property and share investments both benefit from the 50 per cent general discount on capital gains tax (CGT) and shares also benefit from imputation credits.

This has the potential to encourage your clients to invest in those assets, rather than the "safer" bank deposits, and also reduces potential revenue from the tax system for the Government.

Of particular note, the Better Tax paper questions the level of distortion the general CGT discount has created in the housing market.

This discount means that capital gains are taxed more concessionally than other income, which is the mechanism by which negatively geared properties can be worthwhile investments.

They also noted that the "deductions claimed for investment properties as a proportion of gross rental income have increased over the last 15 years and are now greater than gross rental income."

It was in this light that the authors canvassed the idea of Norway's Dual Income Tax System, which was introduced in 1992 to address perceptions that the investment allocation was distorted and characterised by excessive borrowing for "socially unprofitable investment".

That system uses a progressive labour income tax schedule, with a base rate of 32.1 per cent and top marginal rate of 47.2 per cent, and a 27 per cent flat capital income tax rate for interest, rental income, royalties and capital gains.

The review committee has sought opinions on how this or a similar system might work in Australia.

If a system of taxation was introduced that resulted in a more equitable taxation of investments, irrespective of their class, would this impact on the way your clients chose to invest? And would such a change have a bigger impact on clients on higher incomes who may be more focussed on investment strategies designed to generate tax efficiencies, as opposed to lower income clients who may be more focussed on overall wealth creation?

Finally, with potential changes being recommended to reduce the level of the corporate tax rate, how will this impact on dividend imputation rules, and will this impact on decisions by clients to invest into the Australian share market?

Superannuation reform

The discussion paper gives little away regarding what should be changed in the taxation of superannuation. It notes that the flat rate of contributions tax provides a greater benefit to higher income earners and amounts to a penalty for individuals on the lowest level of income.

As mentioned previously, this review will go further than the Henry Tax Review due to all of superannuation falling within its remit. Therefore, it is to be expected that superannuation will be thoroughly reviewed and any associated recommendations will be wide ranging.

If you think just about super, we have had a "simpler super system" announced in the 2006 Federal Budget that was soon renamed to be a 'better super' system. After the Cooper review of superannuation, we ended up with 'stronger super'.

To date, there are a number of areas that have already been raised for discussion around the taxation of super, some of which were discussed in the Henry Tax Review, but not enacted. Consider how any of the following changes would impact on the behaviour and strategies employed by your clients if they were enacted:

• What if we have a return to the previous "Reasonable Benefit Limit" (RBL) style of taxation of superannuation benefits? Comments have been made that concessional treatment of superannuation savings should be capped at a certain limit (e.g. $2.5 million). This is different to the previous RBL system where individuals were taxed at a higher rate for exceeding a certain level of savings. Under this model, the concessions within super may be removed.
• Should there be a move to a lifetime contribution cap, rather than the current annualised system? Would this better allow people to contribute when they can, rather than be limited by an amount at a particular time?
• Should there be a greater level of taxation concessions afforded to those who choose to access their superannuation savings via some form of non-commutable income stream? This sounds like the previous versions of a complying income stream, but will it also provide benefits from a reduced reliance on social security in the future? Given that it is tax revenue that ultimately finances the social security system, the overlap between the two is a clear consideration in this process.
• Should there be a change to the age at which superannuation can be accessed tax- free? It would not be a surprise to see some form of change in this area. Currently, under legislation super can be accessed tax-free from age 60 — and it is the specific age that is mentioned. With preservation ages starting to increase from 1 July this year (moving from current age 55 to age 56), and proposals to increase the age at which age pension can be accessed to be lifted to age 70, would it be surprising if tax-free access to super was changed to be five years before age pension age (which would align to current treatment) or even potentially be raised to age pension age itself? How would this impact the future savings and work plans of your clients?

The need for reform

With the conflux of discussion papers on different areas affecting the saving and welfare system for all Australians, the time for a discussion on the reform of Australia's taxation system has never been more appropriate or important.

If you think just about super, we have had a "simpler super system" announced in the 2006 Federal Budget that was soon renamed to be a "better super" system. After the Cooper review of superannuation, we ended up with "stronger super."

Bryan Ashenden is the senior manager, advice strategies and knowledge at BT Financial Group.

Footnote

1. While the chart looks at nominal effective marginal tax rates the same relativities would apply for real effective marginal tax rates, albeit with higher rates. Real effective tax rates incorporate the effects of inflation.