2022-2023 Federal Budget Update on Tax Measures

In its first Federal Budget in almost 10 years, the Labor Government has sought to honour its election promises and stick to its pre-Budget spin by splashing out on cheaper childcare, funding schools to provide a wellbeing boost for students, targeting 1 million new homes by 2030 (including some affordable housing) and lowering the cost of (and increasing the range of) PBS prescriptions.  These measures should all be welcomed by the Labor heartland (as well as Scott Morrison's "quiet Australians").  

This spending is partly funded by new tax measures but mostly it is focussed on squeezing every cent out of the usual list of suspects who Labor (and the ATO) consider do not pay their fair share of taxes – such as foreign multinationals and operators in the shadow economy.  

So the Budget's emphasis is on increasing funding for the ATO to combat non-compliance under existing laws and introducing a handful of far stronger integrity rules aimed at curbing what are seen as risks to the corporate tax base (ie, "excessive" interest deductions and offshore payments related to intangible property).  Further, a number of unlegislated measures previously announced by the Coalition over the past decade have also been scrapped.  One significant (and not foreshadowed) change that will affect corporate capital management is a new measure that will effectively prevent listed companies paying fully franked dividends as part of off-market share buybacks.

The Government is hoping (probably correctly) that these measures will not upset too many Australian voters whilst still demonstrating that a bona fide effort is being made to improve the budget bottom line.  So all in all the Budget did not contain any real surprises (other than effectively eliminating off-market share buybacks by listed companies) and should not give the Coalition too much ammunition to return fire.

The key tax proposals in the Budget are summarised below.

BUSINESS TAX MEASURES

Ending franking of off-market share buy-backs for listed companies

The Government has announced that off-market share buy-backs by listed companies will be given the same tax treatment as on-market share buy-backs.  This means that no part of an off-market buy-back undertaken by a listed company will be treated as a dividend for tax purposes and no franking credit benefits can therefore be delivered by a listed company to its shareholders as part of a share buy-back.  Currently, in an on-market share buy-back, a shareholder makes a taxable gain or loss based on the buy-back price in a similar way as an ordinary disposal of the share.  However, for the listed company undertaking the buy-back, a franking debit arises in respect of the dividend component of the buy-back based on the company's benchmark franking percentage for that franking period.

This measure will apply from 7:30pm AEDT, 25 October 2022 but it is not clear if the measure will apply to buy-backs that have already been announced on this date.

As a result of this measure, it is expected that buy-backs will no longer be a favoured capital management tool for most listed Australian companies as any form of buy-back could result in a wastage of franking credits.  Other forms of returns to shareholders (eg, special or ordinary dividends) are unaffected by this measure.  Off-market buy-backs undertaken by companies that are not listed are also unaffected by this measure and they can continue to treat part of the buy-back as a frankable dividend.

Amendments to Australia's thin capitalisation rules

The Government has provided greater detail on the thin capitalisation changes proposed in Treasury's Consultation Paper "Government election committees: Multinational tax integrity and enhanced tax transparency" (Consultation Paper) released in August 2022.  

By way of background, the current "maximum allowable debt" (before debt deductions are denied) for what are referred to as "general" entities (which excludes certain financial entities and authorised deposit-taking institutions), is the greatest of:

1. The safe-harbour debt amount, which is (broadly) 60% of the average value of the entity's Australian assets less its non-debt liabilities;
2. The arm's-length debt amount, which is the amount that would and could have been borrowed by and lent by an independent third party in the same or similar situation (without any external credit support arrangements); and
3. The worldwide gearing debt amount, which allows certain entities to gear their Australian operations up to 100% of the gearing level of the worldwide group to which it belongs. 

With effect from income years commencing on or after 1 July 2023, the Government will repeal the safe harbour debt amount for general entities, replacing it with a limit of debt-related deductions set at 30% of EBITDA.  In addition, and this was not directly proposed in the Consultation Paper, the Government will repeal the worldwide gearing debt amount, replacing it with a group ratio rule, which will allow an entity in a group to claim debt-related deductions up to the level of the worldwide group's net interest expense as a share of EBITDA (which may exceed the 30% rule).  Furthermore, the arm's length debt amount will be retained, although it will only apply to external third party debt, disallowing deductions for related party debt under this test.

In contrast to the Consultation Paper, the Budget included an announcement that disallowed deductions under the new earnings-based test (i.e., where debt-related deductions exceed 30% of EBITDA), but not those deductions disallowed under the arm's length debt amount or the group ratio rule, will be able to be carried forward and claimed in a subsequent income year, for a period of up to 15 years.  It is not yet clear whether the capacity to utilise those denied deductions will be subject to the continuity of ownership test (or 50% stake test for certain trusts), the continuity of business tests, or will generally be available.

The capacity to carry forward debt deductions denied under the new earnings-based test, but not under the alternative measures, means that taxpayers will need to carefully consider which measure they wish to use to determine their maximum allowable debt (assuming, as at present, that a choice remains).  It may be preferable to adopt the earnings-based test even where the arm's length debt amount may have permitted additional deductions (but not all deductions), as the earnings-based test may (over time) provide a greater level of deductions.

In addition, there remains considerable uncertainty over key elements of the regime.  How non-consolidated entities will calculate their earnings-based amount is not clear, and it is similarly unclear how a group will be determined for the purposes of the group ratio rule (noting certain deficiencies in the previous group concept used for the purposes of determining the worldwide gearing debt amount).  Moreover, it is not clear whether limiting the arm's length debt amount to only external third party debt could impact the use of financing vehicles which on-lend to other entities within the group, which is a common structure in the property and infrastructure sectors (among others).  

Note that the measures will not apply to entities that are financial entities for thin capitalisation purposes.  Although the Budget announcement is not clear, the expectation is that it will also not apply to authorised deposit-taking institutions.

The measures will take effect for income years commencing on or after 1 July 2023.  Accordingly, taxpayers who are general entities that are subject to the thin capitalisation regime should, as a matter of urgency, consider how these rules may apply to them.

Payments relating to intangibles held in low- or no-tax jurisdictions

The Government will introduce a new anti-avoidance rule to prevent significant global entities (entities with a global revenue of at least $1 billion) from claiming deductions for payments made directly or indirectly to related parties in low- or no-tax jurisdictions.  This measure was part of Labor's commitments taken to the Federal Election and has been the subject of Treasury consultation.

Tonight's announcement clarifies some aspects of the scope of the new rule:

1. The measure only applies to payments made to related parties.  This was unclear in the Treasury Consultation Paper, and provides welcome clarification.
2. A low or no-tax jurisdiction is a jurisdiction with a tax rate of less than 15% or a tax preferential patent box regime without sufficient economic substance.
3. The measure will apply to both direct and indirect payments to related parties.  An example of an indirect payment given in the Treasury Consultation Paper involved a royalty that is incurred outside Australia and higher up the intra-group value chain but then charged to Australia as part of the purchase price of tangible goods and/or services.

A number of elements of the new rule remain unclear; in particular, it is unclear how an "indirect" payment will be identified, what the scope of "related parties" will be and how this rule will interact with the proposed implementation of the OECD "two-pillar solution" to address the tax challenges of the digitalisation of the economy.

One can expect the rules to be complex and difficult to apply (this is the case in relation to the hybrid mismatch rules which provide a precedent) and the design of the rules will be critical to ensure that there is not an excessive denial of deductions in Australia.

The measure will apply to payments made on or after 1 July 2023.

Multinational Tax Integrity Package – Tax Transparency

The Government has announced the introduction of reporting requirements for specified types of companies to enhance the tax information they disclose to the public. The following new measures will apply for income years commencing from 1 July 2023:

• large multinationals that are "significant global entities" will be required to prepare for public release certain tax information on a country by country (CbC) basis and a statement on their approach to taxation, to be disclosed by the ATO;
• listed and unlisted Australian public companies will be required to disclose information on the number of their subsidiaries and their country of tax domicile; and
• tenderers for Australian government contracts worth more than $200,000 will be required to disclose their country of tax domicile (by disclosing their ultimate head entity's country of tax residence).

This measure reflects some of the items proposed in the Consultation Paper dated August 2022.
The first requirement above would appear to extend requirements to collect CbC information to a broader range of entities, as the concept of a "significant global entity" is (generally speaking) broader than the concept of a "country by country reporting entity". In addition, the requirement to provide a statement on the multinational's "approach to tax" appears to correspond with the Global Reporting Initiative tax Standard (GRI 207) which requires reporting on "Management approach to disclosures", including the approach to tax, tax governance, control, risk management, as well as stakeholder engagement and management of concerns related to tax. 

Increased funding for compliance measures

The Government will provide the ATO with a significant boost in funding, with the Budget announcing an extra $1.5 billion in ATO funding across various market sectors.

The Budget measures focus on funding the ATO for increased compliance activity in personal income taxation, cracking down on "shadow economy" activity and boosting the ATO Tax Avoidance Taskforce to support business tax compliance, complementing the ongoing focus on multinational enterprises and large public and private business.

This investment in increased compliance is expected to deliver an extra $5 billion in additional revenue to the Budget over four years.

Digital currencies

The Government will introduce legislation to clarify that digital currencies/cryptocurrencies continue to be excluded from the Australian income tax treatment of foreign currency. This maintains the current treatment of digital currencies, including capital gains tax treatment where they are held as an investment. This measure will not apply to digital currencies issued by or under the authority of a government agency, which continue to be taxed as foreign currency. The start date of the measure will be backdated to income years that include 1 July 2021.

This follows the release of the draft Treasury Laws Amendment (Measures for Consultation) Bill 2022 by the Treasury earlier this year for comment.  The draft legislation relies on amending the existing definition of digital currency in the A New Tax System (Goods and Services Tax) Act 1999 to exclude government-issued digital currencies and include digital currencies that are not government-issued but have been adopted as a legal tender, before adopting the amended definition as an exclusion from the definition of foreign currency in the Income Tax Assessment Act 1997 (Cth).

Electric car tax measures

As previously announced, the Government will exempt zero or low emissions vehicles from fringe benefits tax (FBT).  The FBT exemption will apply if:

• the car is a zero or low emissions vehicle (eg, battery EV, hydrogen fuel cell EV or plug-in hybrid EV);
• the value of the car at the first retail sale was below the luxury car tax threshold for fuel efficient vehicles (currently $84,916); and
• the car is first held and used on or after 1 July 2022.

This measure is included in the Treasury Laws Amendment (Electric Car Discount) Bill 2022, which has been passed by the House of Representatives and is currently before the Senate.

These vehicles will also qualify for an exemption from import tariffs.  The legislative drafting for this measure has not yet been released.  

These measures will be reviewed after 3 years.

Australia/Iceland Tax Treaty

As previously announced on 13 October 2022, Australia and Iceland have signed a new tax treaty, the first tax treaty between the two countries.  The new treaty includes many features common to Australia's more recently enacted tax treaties including reduced rates of withholding on dividends, interest and royalties.  

In respect of dividends, a number of different limitations apply.  For example, a maximum 5% rate is applicable to dividends paid to a corporate shareholder that holds a direct interest of at least 10% of the voting power of the company paying the dividend throughout a one year period that includes the date on which the dividend is paid.  A nil rate applies to certain entities (eg listed entities) that hold at least 80% of the voting power of the company paying the dividend throughout a one year period that includes the date on which the dividend is paid.

While Australia's interest withholding tax rate will remain at 10%, this rate will now apply in respect of Icelandic interest withholding tax, rather than 12% as is currently the case.  The tax treaty will include an exemption from interest withholding tax for interest paid to Contracting States and related bodies, central banks, certain recognised pension funds and financial institutions provided that certain conditions are met.

Lower withholding rates, not exceeding 10% of the gross amount, on royalties will also apply under the tax treaty. This is a substantial reduction from Australia's 30% rate and will reduce the rate in Iceland by at least 10%.

Withholding tax measures will come into force in respect of income derived by a non-resident on or after 1 January next following the date on which the Convention enters into force.  The commencement dates for other tax measures vary.

COVID-19

The Government has further extended the measure pursuant to which payments from certain state and territory COVID-19 business support programs are made non-assessable non-exempt (NANE) income to a number of new programs.  This is in addition to a number of existing programs that have previously been designated by the Government as eligible for this treatment.

STATUS OF LEGACY TAX AND SUPERANNUATION MEASURES

The Government has also sought to provide certainty on the status of certain "legacy" measures announced, but not legislated, by the previous Government. The Government has indicated that certain of these measures will no longer be proceeding, while for certain other measures the start date will be deferred.

Legacy measures that will not be proceeding include:

• Self-assessment of the effective life of intangible depreciating assets, for which legislation was introduced but was never passed (2021-2022 Budget measure);
• Amendments to the debt/equity tax rules to ensure that an integrity provision (section 974-80) that deems certain interests to be equity interests would only apply where both the purpose and effect of the arrangement was that the ultimate investor has, in substance, an equity interest (the budget paper refers to the rules as being a 2013-14 MYEFO Measure, however, we believe this measure was from the 2011-12 MYEFO);
• Amendments to the taxation of financial arrangements (TOFA) rules to reduce the scope, decrease compliance costs and increase certainty through a redesign of the TOFA framework by (among other things) establishing a closer link to accounting and introducing a new hedging regime (2016-17 Budget measure);
• Removal of key barriers to the use of asset-backed financing arrangements, which are supported by assets, such as deferred payment arrangements and hire purchase arrangements (2016-17 Budget measure).  It is understood one of the key benefits of this reform was to facilitate Islamic finance arrangements as financial arrangements for tax purposes; 
• Introduction of a new tax and regulatory framework for limited partnership corporate collective investment vehicles (2016–17 Budget measure); and
• Establishing a general category of deductible gift recipient (DGR) for providers of pastoral care and analogous well-being services in primary and secondary schools, which would have allowed taxpayers to make tax deductible donations to such service providers (2021–22 MYEFO measure).

Legacy measures for which the start date will be deferred include:

• Introduction of a sharing economy reporting regime under which sharing economy online platforms will be required to report identification and income information regarding participating sellers to the ATO for data matching purposes (2019–20 MYEFO measure). This measure has been deferred from 1 July 2022 to 1 July 2023 (ride sourcing and short-term accommodation transactions) and from 1 July 2023 to 1 July 2024 (transactions such as asset sharing, food delivery and tasking-based services); and
• Amendments to the TOFA rules to facilitate the use of the hedging election in Subdivision 230-E on a portfolio hedging basis, to remove impediments to accessing the hedging elections where the commercial approach to hedging financial positions does not match the tax requirements to access the elections (2021–22 Budget measure). This measure has been deferred from 1 July 2022 to the income year commencing on or after the date of Royal Assent of the enabling legislation.

The Government has not provided information in the Budget about why they have determined to defer or not to proceed with these measures. There are also certain measures announced, but not legislated, by the previous Government about which the Budget Paper remains silent (such as the patent box regime announced in the 2021-22 Budget for corporate income associated with Australian patented inventions in the medical and biotech sectors, and changes to the corporate tax residency rules). It remains to be seen whether the new Government will ultimately proceed with such measures.

Authors: Vivian Chang, Partner; Sanjay Wavde, Partner; Steve Whittington, Partner; Ian Kellock, Partner; and Costa Koutsis, Partner.