Australian Federal Budget 2021-2022

The Treasurer has handed down a big spending budget in the Government's ongoing fight against the economic turmoil wrought by COVID-19 and with an eye to the upcoming Federal election. Despite the better than expected performance of the Australian economy, the expected deficit for this year is estimated to be an eye watering $161 billion, although that deficit is more than $50 billion lower than was expected in last year's Budget handed down just over six months ago.

Big spending initiatives are directed at essential services, including job training, childcare, disability services, aged care and mental health.

Winners include the Australian business sector with the extension of temporary full expensing of assets and loss carry back measures at an estimated cost of more than $20 billion over the forward estimates period. Low and middle income earners also benefit from the extension of the low and middle income tax offset for a further year. There is also a focus on seeking to ensure Australia remains competitive in attracting globally mobile employees, with changes to the employee share scheme rules and the individual residency rules. A number of measures are also directed at encouraging the development of innovation businesses in Australia.

The key tax proposals in the Budget are summarised below.

Business tax measures

Employee Share Schemes

Under current law, under a deferred tax employee share scheme (ESS), a taxing point will occur when an employee ceases to be employed by the employer company (or a subsidiary or parent). This taxing point can be problematic if at that time there is limited or no liquidity in the ESS interest, the ESS interest is still subject to vesting conditions or the employee is under restrictions that prevent the employee from selling their ESS interests at that time (eg under a shareholders' agreement). Even if the employee is able to sell the ESS interest, it may be commercially undesirable to do so at that time (eg the company may still be in a start-up phase). This aspect is particularly acute for start-up companies.

To address this issue the Government will remove the cessation of employment deferred taxing point. As a result, the deferred taxing point will now be the earlier of:

• in the case of shares, the time that there is no real risk of forfeiture and no genuine restrictions on disposal of the shares;
• in the case of options, the time that there is no real risk of forfeiture and no genuine restrictions on disposal of the options or, if the options have been exercised, there is no real risk of forfeiture and no restrictions on disposal of the shares; or
• 15 years from the time the ESS interest was acquired.

The change will apply to ESS interests issued from the first income year after the date the amending legislation receives Royal Assent.

In addition, the Government will remove certain regulatory requirements for issuing ESS interests where employers do not charge or lend to the employees to whom they offer the ESS interests and streamline requirements for unlisted companies making ESS offers that are valued at up to $30,000 per employee per year where employers do charge or lend.

Full expensing of assets

The Government will extend the temporary full expensing of assets measure for a further 12 months until 30 June 2023. Under this measure, businesses with an aggregated annual turnover (broadly, aggregated annual turnover is assessed by reference to the turnover of the relevant entity together with certain related entities) of less than $5 billion will be eligible to immediately deduct the full cost of eligible capital assets acquired from 7.30pm AEDT on 6 October 2020 and first used or installed ready for use by 30 June 2023. Normal depreciation arrangements will apply from 1 July 2023.

Temporary loss carry-back

The Government has announced that it will extend the temporary loss carry back measure to allow eligible companies to carry back losses from the 2022-23 income year to offset previously taxed profits in the 2018-19 or later income years. The loss carry back rules enable eligible companies to apply tax losses (revenue losses not capital losses) against previously taxed profits, generating a refundable tax offset in the year in which the loss is made. Eligible companies are corporate tax entities with an aggregated annual turnover of less than $5 billion. This measure is designed to work in tandem with the full expensing of assets measure (see above) by providing eligible companies access to the tax value of losses generated by the full expensing deductions, and hence encourage investment in assets eligible for full expensing.

The amount of the tax refund is limited by requiring that the amount carried back is no more than earlier taxed profits and does not also result in a franking account deficit (ie the carry back amount cannot be greater than the amount of the company's franking credits at the end of the relevant income year). Companies who do not elect to take advantage of this measure can continue to carry forward their tax losses under the existing tax loss rules.

TOFA hedging and foreign exchange amendments

For transactions entered into on or after 1 July 2022, the TOFA rules will be amended to facilitate the use of the hedging election in Subdivision 230-E on a portfolio hedging basis. These changes may remove the current impediments to accessing the hedging elections where the commercial approach to hedging financial positions does not match the tax requirements to access the elections. The amendments will also reduce compliance costs and unintended outcomes associated with the taxation of unrealised foreign exchange gains and losses.

New ATO early engagement service for new foreign investment into Australia

From 1 July 2021, eligible investors will be able to access a new early engagement service provided by the ATO to give investors upfront confidence on how Australia's federal tax laws apply to the investment. This service is intended to be tailored to the needs of each investor, offers access to expedited binding advice and advanced pricing agreements and is to be integrated with the FIRB approval processes (if applicable).

Innovation measures

Patent box

For income years starting on or after 1 July 2022, a patent box tax regime will be introduced for companies deriving income from certain patents at a concessional corporate tax rate of 17%. Patents covered will be new patents applied for after the Budget announcement and will include Australian medical and biotechnology patents with the possibility of clean energy related patents being added, subject to consultation.

Australia's patent box regime will follow the OECD's guidance on patent boxes to meet internationally accepted standards. There are currently 20 countries with patent box regimes, including the UK and France.

The measure is intended to encourage Australian owned and developed patents. The Government will consult with industry in the detailed design of the patent box. It is unclear at this stage how the regime will interact with the Australian imputation/franking credit regime and whether the benefit of the concession will be effectively unwound at the Australian shareholder level upon dividends being received, such that it may create differential outcomes for Australian-owned and foreign-owned Australian patent box companies.

Digital games tax offset

In an effort to encourage greater Australian participation in the $250 billion global games development industry, the Government will introduce a Digital Games Tax Offset for expenditure on qualifying Australian games expenditure of at least $500,000. The Government will consult with industry on the criteria and definition of qualifying expenditure, but games with gambling elements or that cannot obtain a classification rating will not be eligible. The refundable offset of 30% will be available from 1 July 2022 to Australian resident companies and foreign resident companies with a permanent establishment in Australia, and the maximum claim per year is $20 million.

Review of venture capital tax concessions

The Government will undertake a review of the venture capital tax concessions to ensure current arrangements are fit for purpose and support genuine early stage Australian start-ups. As the venture capital tax concessions were introduced about 20 years ago, it is an opportune time for the concessions to be reviewed and improved.

Allowing taxpayers to self-assess the effective life of depreciating intangible assets

The Government will amend the capital allowance rules to allow taxpayers to self-assess the effective life of depreciating intangible assets, rather than being required to use the effective life prescribed in the tax legislation. The amendments will apply to patents, registered designs, copyright and in-house software and will apply to assets acquired from 1 July 2023. As taxpayers can generally self-assess the effective life of tangible depreciating assets, this measure will align the tax treatment of tangible and intangible depreciating assets. The measure should also allow taxpayers to adopt a more useful effective life, which may allow faster depreciation where appropriate.

Financial services

Offshore banking unit transparency

Currently, "offshore banking units" (OBUs) benefit from the following tax concessions:

• effective interest rate of 10% on eligible OB activities (as defined), rather than the usual corporate tax rate of 30% (achieved by only bringing to account the "eligible fraction" of income from OB activities and associated expenses); and

• interest (and gold fees) paid on eligible foreign borrowings by an OBU is exempt from interest withholding tax.

These concessions will be removed from the start of the 2023-24 income year in respect of the income tax exemption and from 1 January 2024 for the interest withholding tax exemption. Legislation effecting these changes was introduced on 17 March 2021 in the form of Treasury Laws Amendment (2021 Measures No. 2) Bill 2021 (the OBU Bill).

The concessional tax treatment of OBUs was originally introduced to encourage offshore transactions and lending to non-residents. However, in October 2018, the OBU regime was held to be a harmful preferential tax regime by the OECD Forum for Harmful Tax Practices. Accordingly, the Government has determined to remove the concessional treatment, in the timeframe required by the OECD.

The OBU Bill also removes the ability of the Minister to make a declaration or determination that a person or company is an OBU. While this change applies from the day after the amendments receive Royal Assent, the Minister has not been approving new applications since the announcement of the changes in October 2018. Any applications made after this time will lapse once this ability is removed.

Corporate Collective Investment Vehicle

In the 2016–17 Budget, the Government announced it would introduce a tax and regulatory framework for a new corporate collective investment vehicle (CCIV), with an intention for this to be introduced by 1 July 2017. The regime is intended to provide flow through treatment for a corporate vehicle, as a means to enhance the international competitiveness of the Australian managed funds industry. The 2021-22 Budget has delayed the introduction of this regime to 1 July 2022.

The intended tax framework for the CCIV regime is that it would broadly align with the tax regime for attribution managed investment trusts (eg provide for flow through tax treatment), with similar requirements including with respect to widely held requirements, closely held restrictions, and engaging only in passive investment activities (among others).

Exchange of information countries

The Government has announced an update to the list of Exchange of Information Countries. Tax residents in the Exchange of Information Countries are entitled to access the reduced Managed Investment Trust (MIT) withholding tax rate of 15% on fund payment from withholding MITs rather than the rate of 30% which applies to residents of countries which are not Exchange of Information Countries. In order to be included on the list, jurisdictions must have entered into an Exchange of Information Agreement with Australia, either on a bilateral or multilateral basis. The updated list will now include a total of 136 jurisdictions, once the announced additions of Armenia, Cabo Verde, Kenya, Mongolia, Montenegro, and Oman are included.

Tax residency rules

Individual residency

The Government will replace the current individual tax residency rules with an ostensibly simpler regime. The new rules will implement a primary test which applies so that any person physically present in Australia for 183 days in an income year is an Australian tax resident (subject to the application of applicable double tax agreements (DTA)). Where the primary domestic test does not apply, secondary tests will be applicable (again subject to any relevant DTA). The Budget Paper indicates that the secondary tests will operate by reference to physical presence and other "measurable, objective" criteria.

Currently, Australia's domestic tax law contains four separate residency tests for natural persons: an "ordinary concepts" test, a "domicile" test, a "183 day" test and a test applicable to members of certain Commonwealth superannuation schemes (and member's families). The ordinary concepts test operates by reference to the ordinary meaning of "resides". The domicile test and the 183 day test each rely on a two-step process (broadly, if the domicile or 183 day condition is met, the individual is not a tax resident if, respectively, the person's principal place of abode is outside of Australia, or the person's usual place of abode is outside of Australia and the person does not intend to take up residence in Australia).

The current regime is challenging in a number of respects. The current tests are, in their application, largely matters of fact and degree, which can also involve detailed exercises in statutory interpretation. Recent years have seen a spate of Australia court and tribunal decisions, focusing in particular on the ordinary concepts and domicile tests.

The Board of Taxation has previously highlighted these challenges. In their 2017 report the Board considered "that the complexity, lack of certainty, inconsistent outcomes and integrity issues inherent in the residency rules is significant and warrants reconsideration". The 2019 report suggested the rules were no longer appropriate for the 21st century. The brief proposal contained in the Budget, on its face, aligns with the primary recommendation coming out of the reports. The Budget paper notes that the new framework is based on the Board's recommendations, although it remains to be seen how the secondary tests will in fact be implemented.

Residency of entities

In the 2020-21 Budget the Government announced an intention to change the definition of resident company for Australian income tax purposes. Broadly, under the proposed new test, a company that is not incorporated in Australia will only be treated as an Australian tax resident if it has a "significant economic connection to Australia", which will require that the company's core commercial activities are undertaken in Australia and its central management and control is in Australia.

In this year's Budget the Government announced that it will consult on broadening this amendment to trusts and corporate limited partnerships. The Government will seek industry's views on this as part of the consultation on the original corporate residency amendments announced last year.

Personal tax measures

Superannuation

Changes to superannuation which are expected to have effect from 1 July 2022:

1. The $450 per month minimum income threshold for the superannuation guarantee will be removed. This means that employers will have to pay the superannuation guarantee for employees earning below that monthly threshold if that employee would otherwise be eligible for the superannuation guarantee. For affected employees whose employment terms provide that pay is calculated exclusive of super, this may require employers to pay the super guarantee (which will be 10.5% from 1 July 2022) on top of their existing pay. For employees whose pay is inclusive of super, this may result in a decrease in an employee's take-home pay but the amount paid by the employer remains the same.
2. Individuals aged 67 to 74 years will be allowed to make non-concessional contributions or receive salary sacrifice superannuation contributions without meeting the work test, which currently requires that they work at least 40 hours over a 30 day period in the relevant financial year. This does not affect personal deductible contributions where the work test continues to apply.
3. The maximum releasable amount of contributions under the First Home Super Saver Scheme will be increased from $30,000 to $50,000. This scheme allows individuals to release voluntary contributions along with associated earnings for the purpose of buying their first home.
4. The eligibility age to make downsizer contributions to super will be reduced from 65 to 60 years of age. A downsizer contribution allows certain individuals selling their main residence to contribute up to $300,000 from the disposal proceeds into their super.

Personal tax

The low and middle income tax offset will be retained for one more tax year (2021/22). The offset was intended to be an interim measure under stage 1 of the transition of personal tax rates under the "Personal Income Tax Plan", but has been retained despite stage 2 having been brought forward to the 2020/21 income tax year.

In addition, the non-deductibility of the first $250 of self-education expenses for prescribed courses of education will be removed.

Other measures

Junior Minerals Exploration Incentive

On 5 May 2021 the Government announced it will extend the Junior Minerals Exploration Incentive (JMEI) to the end of June 2025. Broadly, the JMEI enables eligible exploration companies to convert their tax losses from greenfields mineral exploration expenditure into tax credits that can then be distributed to investors who purchase newly issued shares in that eligible entity during a certain period. Australian resident shareholders who are issued an exploration credit will be entitled to a refundable tax offset or, if the shareholder is a corporate tax entity, additional franking credits.

Increased powers for the Administrative Appeals Tribunal in relation to small business taxation decisions

Following recent criticism of the ATO's use of its debt recovery powers, the Government has announced that the jurisdiction of the Administrative Appeals Tribunal (AAT) will be extended to allow "small business entities" to challenge ATO action to recover disputed debts where the underlying tax is being challenged in the AAT.

The ATO has broad powers to recover tax debts even while they are being disputed. At present, the only avenue available to taxpayers to challenge ATO debt recovery action is through the court system, which can be costly and the technical grounds of challenge limited. Following Royal Assent of the enabling legislation, small business entities (generally defined as individuals and other entities that carry on a business and have an aggregated turnover of less than $10m per year) may apply to the AAT to pause or modify ATO debt recovery action until the underlying tax dispute has been determined by the AAT. The measure does not seem to apply to individuals and other entities that do not carry on a business.

Not for profits

Many non-charitable not for profits (NFPs) (eg community service, sporting, recreational or agricultural organisations) are able to self-assess their eligibility for an exemption from income tax. From 1 July 2023, the ATO will require income tax exempt not for profits with an active ABN to complete an annual self-review of their eligibility for the income tax exemption and submit this online. This measure is intended to increase transparency in respect of the exemption and ensure that only eligible NFPs are claiming the exemption.