Pitcher Partners Federal Budget 2022-23 | October: Full report

Federal Budget 2022–23 October

Business hit by cuts despite heavy economic lifting

Overview

The first Labor Budget, and second for Australia in 2022, is focused on direct support for Australians living through challenging times. Nearly all the announced initiatives are focused on support for families, through childcare and parental leave, affordable housing, education and improving aged care.

In doing so, the government has arguably failed to recognise the central role that business plays in providing employment, generating profits to fund government spending and driving innovation for longterm structural benefits in its Federal Budget. At best, it could be said that this Budget stays out of the way of business. But there is little in the Budget for the businesses that have weathered financial storms across the last two years, and face surviving a significantly slowing economy in the coming 18 months.

The Budget was light on structural change for the Australian economy or the tax and compliance regimes. Previous programs that targeted the modernisation and transformation of middle market business have been aborted or wound back. This includes a third round of the Manufacturing Modernisation Fund, while nearly $200 million of uncommitted funding has also been taken from the Entrepreneurs’ Program, which was targeted at businesses with an annual turnover of $1.5 million to $100 million. While not yet enacted, another business policy to be impacted relates to IP and other intangible assets, with the Federal Government reversing a policy that would have allowed faster taxwrite offs for patents, copyright and in-house software. These are key incentives in a knowledge economy, a transformation that Australia is still pursuing.

While the above represent loss of initiatives yet to be enacted, Australian-based international businesses (both inbound and outbound) will be subject to more stringent rules regarding the deductibility of interest on debt under the thin capitalisation rules. The new measures will, in some cases, result in a higher cost of doing business due to reduced debt deductions, also reducing the competitiveness of Australian businesses on the international stage.

Investors in ASX-listed companies are impacted with new tax rules to be passed to deny the common corporate capital management practice of conducting off-market share buy-backs in a form that allows buyback proceeds to be split into its components of capital and franked dividend. This will remove the ability to access refundable franking credits and will increase the tax burden of such receipts in the shareholder’s hands.

While government will claim this measure is targeted at the large superannuation funds, it will equally impact all investors, including self-funded retirees with selfmanaged super funds.

One bright light for business is the announcement of a $15 billion National Reconstruction Fund, which will seek targeted co-investments in resources; agriculture, forestry and fisheries; transport; medical science; renewables and low emission technologies; defence capability; and enabling capabilities.

In a sign of economic expectations for the next 18 months, $15 million over two years will be used to extend the Small Business Debt Helpline and the New Access for Small Business Owners programs to support the financial and mental wellbeing of small business owners as they struggle through the slowing world economy.

The expectations for the Australian (and world) economy within the Budget papers should be heeded by all businesses and preventative actions taken to weather the storm that is, in all likelihood, approaching. The Budget papers identify inflation peaking at 7.75% in late 2022, taking two years to recede. Economic growth will be significantly curtailed, from 3.25% in the current financial year to 1.5% in 2023-24, accompanied by unemployment rising to 4.5%. The Budget papers flag that these expectations may be more dire subject to the events in the world economy, domestic consumption being further constrained by inflation and rising interest rates and weather events such as recent floods.

At the same time, business will face a heavier burden of compliance, with increased funding for regulators across the board. As in most Budgets, funding for ATO compliance activity has increased; this time through various programs costing around $1.9 billion over the next four years and expected to increase receipts by approximately $5.3 billion in the same period.

The lack of any structural changes leads us to expect that this Budget points to the likelihood of more substantial changes in the next Budget. We would hope and expect that in May 2023 there is some clearer support for Australian business, international investment and a continued focus on growth and employment.

Business investment

Personal income tax

As expected, the Federal Government is proceeding with the previous government’s personal income tax changes, which include the Stage 3 tax cuts and cessation of the Low and Middle Income Tax Offset.

Medicare Levy, Medicare Levy Surcharge and Personal Tax Rates

There have been no changes announced to the Medicare levy and surcharge thresholds. Further, there have been no changes to the personal income tax rates for the 2022-23 income year or for subsequent years. This means that:

• The 2021–22 income year will be the last year that the Low and Middle Income Tax Offset (LMITO) is available.

• Personal income tax rate reductions will be applied for income years commencing 1 July 2024 and onwards.

The proposed tax rates for resident individuals from previous budgets are contained in the following tables (excluding Medicare levy).

Taxable income

$0 – $18,200

Nil

Tax on this income

19 cents for each $1 over $18,200 $45,001 – $120,000 $5,092 plus 32.5 cents for each $1 over $45,000 $120,001 – $180,000 $29,467 plus 37 cents for each $1 over $120,000 $180,001 and over $51,667 plus 45 cents for each $1 over $180,000

$18,201 – $45,000

$0 – $18,200

Proposed changes for 2024–25

Taxable income Tax on this income

Nil

19 cents for each $1 over $18,200 $45,001 – $200,000

$18,201 – $45,000

$5,092 plus 30 cents for each $1 over $45,000 $200,001 and over $51,592 plus 45 cents for each $1 over $200,000

2022–23 and 2023–24

Tax integrity and compliance

The Federal Government continues its focus on tax integrity and compliance programs by committing significant additional funding aimed at raising further revenue from audit and review activity.

Personal Income Tax Compliance Program

The Budget provides the ATO with an additional $80.3 million to extend its Personal Income Tax Compliance Program for a further two years from 1 July 2023. It is expected to increase tax receipts by $674.4 million.

The additional funding will aim to modernise the ATO’s guidance products, engage earlier with taxpayers and tax agents and target compliance activities in key areas of non-compliance, including the over claiming of deductions and incorrect reporting of income.

Tax Avoidance Taskforce

In the March Budget, the previous government had already extended the operation of the ATO’s Tax Avoidance Taskforce to 30 June 2025 by announcing an additional $652.6 million in funding. The current government doubles down on this measure by extending the program for another year to 30 June 2026 committing a total of $1.1 billion to the program in the process. This measure is expected to result in increased tax receipts of $2.8 billion in total over the forward estimates period.

The Federal Government anticipates that the additional funding will enable the ATO to pursue new priority areas of observed business tax risks, complementing its ongoing focus on multinational enterprises and large public and private businesses.

With the ATO’s recent activity in several key areas for private groups, including Division 7A and section 100A, we anticipate that the ATO’s increased scrutiny on the middle market will continue into the foreseeable future.

Shadow Economy Program

The Federal Government will extend the ATO’s Shadow Economy Program for a further three years from 1 July 2023, providing an additional $685.2 million to both the ATO and Treasury which is expected to generate an increase in tax receipts of $2.1 billion. The Shadow Economy Program is targeted at activities such as cash transactions that take place outside the tax and regulatory system.

Tax Practitioners Board Compliance Program

The Budget commits $30.4 million to the Tax Practitioners Board (TPB) over four years from 1 July 2023 to increase compliance investigations into high-risk tax practitioners and unregistered preparers. This measure is expected to increase tax receipts by $81.9 million.

It is anticipated that the TPB will use new risk engines to better identify tax practitioners who engage in poor and unlawful tax advice, thus improving tax compliance and raising industry standards.

Taxable Payments Annual Reports (TPARs)

The Government has announced it will defer the requirement to report transactions relating to the sharing economy as part of the TPAR regime.

Reporting of transactions relating to the supply of ride sourcing and short-term accommodation will now commence on 1 July 2023, and the reporting of other sharing economy transactions (including but not limited to asset sharing, food delivery and tasking-based services) will now commence on 1 July 2024.

Corporate measures

The Federal Government announced proposed changes to the income tax treatment of off-market share buy-backs, which will align the tax treatment with on-market share buy-backs. Targeted towards superannuation fund investors, this measure effectively removes access to refundable franking credits on these transactions.

Change in treatment of off-market share buy-backs

In a somewhat surprising move, given the political sensitivity of refundable franking credits, the Federal Government will target investors of listed companies who undertake off-market share buy-backs in a measure that is anticipated to save $550 million over the next four years.

Presently, the tax law distinguishes between a share buy-back made in the ordinary course of trading on an official exchange (on-market buy-backs), and all other share buy-backs (off-market buy-backs).

Under the current rules, a company that undertakes an off-market share buy-back is required to allocate the buy-back proceeds received by the shareholder between two components, a dividend component (which can be franked), and a capital component. This split is often based on the relative composition of the company’s retained earnings and paid-up share capital. However, where a buy-back occurs on-market, no part of the purchase price is taken to be a dividend. Instead, the company is required to debit its franking account.

Investors who may obtain a refund of excess franking credits, such as superannuation funds, retirees and charitable organisations, may have a preference to participate in an off-market share buy-back. Where the buy-back price is largely made up of the dividend component, the current rules also allow taxpayers to recognise a capital loss due to the reduced capital proceeds for capital gains tax purposes. As they are typically selective, investors that choose to participate in off-market buy-backs will generally obtain the greatest tax benefits.

Under the proposed measure, the tax treatment of off-market buy-backs by listed companies will align with on-market buy-backs. In other words, no part of the consideration for the off-market share buy-back will be taken to be a dividend and the company will be required to debit its franking account.

Whilst the effective tax rate for an individual on the top marginal tax rate deriving a discount capital gain is similar to that when receiving a fully franked dividend (depending on the cost base of the shares), the changes would be expected to impact the investment returns of superannuation funds.

This is the second recently announced measure targeting franking credits derived by superannuation funds that invest in Australian listed companies. These measures appear to be contrary to the election promise of the Federal Government that stated they would not pursue the removal of refundable franking credits derived by superannuation funds.

If enacted, the measures will apply from 7:30pm on Budget Night (25 October 2022) and may result in the discontinuation of a number of off-market share buybacks currently being contemplated by listed companies.

Financing and investment

The Federal Government has announced that it will pursue its reform of the thin capitalisation rules to limit interest deductions based on an earnings test rather than a balance sheet test. Commencing on 1 July 2023 these measures are expected to have a significant impact on deductions available to inbound and outbound groups.

Reform of the thin capitalisation rules

Consistent with their pre-election commitments, the Federal Government will proceed with significant reforms to the thin capitalisation rules for non-financial entities from 1 July 2023. The measures will adopt OECD recommendations and apply to entities that are members of multinational groups (both inward and outward entities).

The proposed earnings-based test will limit debt deductions for an income year to 30% of an entity’s Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA). This will replace the current asset-based safe harbour test which denies deductions where an entity’s average debt exceeds 60% of the average value of its assets for the year.

The alternative arm’s length debt test will be retained but will be limited so that it can only be relied on to support debt deductions on external (unrelated party) debt.

The proposal will also adopt an alternative group ratio rule allowing an entity to claim debt deductions above the 30% EBITDA ratio based on its worldwide group’s net interest expense ratio (as a share of earnings). This will replace the existing asset-based worldwide gearing test.

Unlike the current thin capitalisation rules which operate to permanently deny excessive debt deductions, the earnings-based rule will allow denied deductions to be carried forward up to 15 years. This is an important feature which recognises the potential negative impact on taxpayers that experience long lead times between expenditure and earnings (such as startup entities, property developers, taxpayers conducting infrastructure projects and those suffering temporary downturns and falls in earnings).

It is presently unknown whether subsequent utilisation of excess debt deductions will be subject to continuity of ownership testing. Further, it does not appear that the measure will allow the carry-forward of excess debt capacity as has been adopted in other jurisdictions that have implemented the equivalent OECD recommendation.

Impact on SMEs

While the measures are targeted at large multinational groups, the thin capitalisation rules apply to many entities in the middle market which are majority foreignowned or have foreign operations. The main carveout is the $2 million de minimis which appears will not be uplifted, despite many calls for a higher de minimis in a higher interest rate environment.

The earnings-based test will particularly affect property developers and property funds which may incur debt deductions in the early years prior to generating income. In these projects, any change to the debt/ equity mix may affect investor returns on equity and performance fees earned by fund managers.

No transitional rules

The Federal Government is silent on any grandfathering or transitional relief such that the measures will apply from 1 July 2023 to entities with pre-existing arrangements. Such entities may therefore be significantly affected where long-term borrowings have been committed and may not be easily renegotiated. Entities who were funded to ensure that they complied with the current 60% safe harbour may now find that a significant portion of their interest costs will become non-deductible affecting projected returns.

Further clarity is required

The devil will be in the detail as many aspects of the measures are still unknown including what adjustments are required to the EBITDA (such as for tax losses and intra-group distributions), whether the measures will apply to net interest expenses (as per BEPS Action 4) or gross interest expenses, whether capital gains will form part of EBITDA (including the impact of the capital gains tax discount) and if and how the excess debt capacity of related entities will be factored into the calculations.

Pitcher Partners made a comprehensive submission on the proposed thin capitalisation reforms in the recent Treasury consultation paper and will continue to closely scrutinise any further consultation documents and exposure draft legislation to advocate for middle market taxpayers who will be unfairly impacted by these proposals.

International tax

The Federal Government has focused on integrity measures to restrict deductions, increase penalties and enhance tax transparency for large multinationals, but refrained from providing certainty on key outstanding tax residency measures. These measures are aimed at collecting substantially more revenue from this taxpayer group.

Restricting royalty deductions for Significant Global Entities

In keeping with the commitment to multinational tax integrity, the Federal Government announced that it will introduce an anti-avoidance rule to prevent Significant Global Entities (SGEs) from claiming tax deductions for payments made directly or indirectly to related parties concerning intangibles held in tax havens (i.e. jurisdictions with a tax rate of less than 15% or a tax preferential patent box regime without sufficient economic substance). This measure complements the ATO’s recent focus on the treatment of payments relating to intangibles and royalties.

The proposed integrity rule will apply to payments made on or after 1 July 2023, which is consistent with other proposed multinational integrity changes. As with the proposed changes to thin capitalisation, this is an ambitious start date and a lot of work will be required to draft the legislation and any transitional provisions.

The measure was part of the Federal Government’s election commitments, with broad details released for consultation in August 2022. While this provided some clarity around the entities and types of payments that will be subject to the provision, there are still some uncertainties. Of particular interest will be what is included within the definition of ‘intangibles’. There is also no mention of a purpose test, unlike many other anti-avoidance provisions in the tax law. This may result in many more payments being caught by the new antiavoidance rule.

Tax Treaty between Australia and Iceland

The Government signed the Convention between Australia and Iceland for the Elimination of Double Taxation with respect to Taxes on Income and the Prevention of Tax Evasion and Avoidance on 12 October 2022. The treaty will increase tax certainty for taxpayers in both countries, lower withholding tax rates and limit double taxation risks. The new treaty is expected to enter into force once Australia’s domestic implementation requirements have been completed.

Residency measures

The Budget confirms that the measure previously announced in the 2021-22 Budget to relax residency requirements for self-managed superannuation funds (SMSFs) and small APRA-regulated funds (SAFs) by extending the safe harbour for the central control and management test from two to five years for SMSFs and removing the active member test for both fund types is still proposed. Failing the ‘residency’ requirement can render SMSFs and SAFs non-complying, which can have serious financial consequences.

These changes will make it easier for members to retain and contribute to such funds whilst they are temporarily overseas for work or education. The measure is now expected to come into effect in the first financial year after the proposed budget receives Royal Assent.

Unfortunately, the Budget was silent on proposed changes to Australia’s individual tax residency rules, and the proposed modernisation of Australia’s residency tests for companies, corporate limited partnerships and certain trusts. We presume that the Government remains committed to these measures.

Public reporting requirements for Significant Global Entities

The Budget has extended current tax transparency requirements to now include new public tax disclosure requirements. Specifically, for income years commencing from 1 July 2023:

1. SGEs will be required to publicly release certain tax information as well as a statement on their approach to taxation;

2. Australian public companies (both listed and unlisted) will be required to disclose information on the number of subsidiaries and their country of tax domicile; and

3. Entities which tender for Australian Government contracts worth more than $200,000 will be required to disclose their country of tax domicile (by supplying their ultimate head entity’s country of tax residence).

The details concerning what information will require disclosure and how the information will be disclosed (i.e. through ATO publications or within existing financial accounts) is unclear. However, it is our expectation that these measures will further increase compliance costs and present new challenges as taxpayers look to present and explain tax information in a simple and meaningful way.

Increase in penalty unit amount

The Federal Government will increase the amount of the Commonwealth penalty unit from $222 to $275, from 1 January 2023. These penalty units generally apply to offences ranging from making false or misleading statements to late lodgements.

SGEs will be most impacted as their administrative penalties are calculated based on double penalty units while late lodgements are multiplied by 500. This means that the current maximum failure to lodge penalty for any missed statement will increase from $555,000 to $687,500 for SGEs.

Fuel tax credits and transport

The Federal Government has announced an increase to the Road User Charge that will impact operators of heavy vehicles travelling on public roads.

Increase in road user charge

The Heavy Vehicle Road User Charge will increase from 26.4 cents per litre to 27.2 cents per litre for diesel fuel. The charge is collected by reducing the Fuel Tax Credit amount that can be claimed for fuel used by operators of heavy vehicles travelling on public roads.

This increase compounds on a previous increase in the Road User Charge from 25.8 cents per litre that commenced from 1 July 2022. The Road User Charge contributes to road maintenance and repair.

With the removal of the excise reduction in September and fuel prices remaining high, operators of heavy transport vehicles will no doubt be dissatisfied with this measure.

Superannuation

The Government has left the superannuation system broadly unchanged with no new announcements made.

Eligibility for downsizer superannuation contributions

The Government confirmed its intention to reduce the eligibility age for downsizer superannuation contributions from 60 to 55 years of age. Legislation for the measure has been introduced into Parliament which will allow the change to commence from the start of the first quarter after the amending legislation receives Royal Assent, which will occur 1 January 2023 at the earliest.

Unlegislated superannuation measures announced by the previous government

The Government provided limited commentary on previously announced superannuation changes that have not yet been finalised.

Audit

The Government confirmed it will not proceed with the proposal to permit some self-managed superannuation funds to have audits completed every three years as announced in the 2018-19 Budget. This is unfortunate as the measure would have reduced compliance costs for self-managed funds.

NALE

The Government has disappointingly not commented on previously announced reforms to the Non-Arm’s Length Expense (NALE) rules which would have ensured that they operate as envisaged following changes from 1 July 2018. The rules are designed to prevent superannuation funds from circumventing contributions caps and increasing earnings through non-arm’s length dealings. However, significant concerns were raised following the ATO’s broad interpretation of the rules in LCR 2021/2 which could see all the income of a superannuation fund taxed at 45% (including large retail and industrial funds) as a result of immaterial discounts on services provided to the fund. Pitcher Partners will continue to advocate for sensible reforms to ensure NALE rules do not result in significantly disproportionate adverse outcomes for super funds.

Announced but unenacted measures

Leading into the most recent Budget there were approximately 70 previously announced measures that had not yet been enacted. The Federal Government has provided clarity in respect to only 12 of these measures, leaving taxpayers in the middle market uncertain as to the Federal Government’s position on the remaining measures.

Taxation of financial arrangements

The Federal Government will not proceed with previously announced measures to amend the Taxation of Financial Arrangements (TOFA) rules. The original announcement primarily concerned the re-write of the TOFA provisions to allow financial institutions to better align with accounting principles, and to provide simplified rules for non-financial institutions. However, that announcement also contained measures on the foreign currency rules dating back to 2004.

While not proceeding with the general re-write of the TOFA provisions is not overly concerning, the failure to follow through on amendments to the foreign currency rules will leave a number of provisions unworkable. Given the detail of the required amendments contained in the 2004 press release, it is surprising that they have not been progressed.

On the other hand, the Federal Government has confirmed that it intends to proceed with minor technical amendments to facilitate access to hedging on a portfolio basis. This measure was set to commence from 1 July 2022 but has been deferred to commence in the income year after the legislation introducing the measure receives Royal Assent.

The integrity rule on back-to-back equity and debt financing

The Federal Government announced that it does not intend to proceed with reforms to the integrity rule (section 974-80) that seeks to recharacterise debt interests in a company as equity interests where debt is funded by related party equity. The operation of this provision can result in a non-deductible interest.

The ATO has historically taken a very broad view of this integrity provision, which led to an announcement in the 2011-12 Budget that the law would be amended to remove unintended consequences. While the proposal was welcome, the Treasury released Exposure Draft legislation which differed significantly from the proposed amendments.

By not proceeding with the measure, there is a risk that the ATO may return to their original views expressed on section 974-80. It will therefore be critical for the ATO to clarify how they will seek to apply this integrity rule going forward.

Limited partnership collective investment vehicles

The Federal Government has chosen not to proceed with previous announcements to introduce a Limited Partnership Collective Investment Vehicle (LPCIV).

LPCIVs are a globally recognised investment vehicle and, in addition to Collective Investment Vehicles (CIVs) that were introduced from 1 July 2022, would have completed a suite of collective investment vehicle structures available in Australia.

Depreciation

The Federal Government has stated that it will not proceed with the proposal to allow taxpayers to selfassess the effective life of intangible depreciating assets. This means that effective lives of intangible depreciating assets (such as in-house software, copyrights and patents) will continue to be set by statute.

Other measures not confirmed in the Budget

There are a significant number of other measures that were previously announced but not yet legislated, including proposed changes to Division 7A, corporate and individual tax residency measures. It is disappointing that the Federal Government has not confirmed its position with respect to these measures, which leaves taxpayers in the middle market uncertain of the government’s position going forward.

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