Budget Tax Alert. Australia s Federal Budget. At a glance

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1 Budget Tax Alert Australia s Federal Budget At a glance R&D changes require action for larger companies Digitisation tax reforms discussion paper to be released soon - prepare for consultation Thin capitalisation integrity changes require start date clarification Focus on tax integrity rules and black economy rules will feed into business systems over time Personal tax rate reductions over time. The EY Budget Brief Federal Budget 2018 punting on growth outlined the economic and policy issues in the Australian Federal Budget delivered on 8 May 2018 by the Federal Treasurer Scott Morrison. Accelerating growth has seen tax revenues above forecasts while spending has maintained a steady path. Cautious growth forecasts underpin future reform plans and the path to surplus. This Tax Alert focuses on the key tax measures announced and foreshadowed. Key business tax measures announced were: Changes to the tax treatment of R&D expenditure will see winners and losers. An intensity test introduced for larger companies will see improved incentives of up to 12.5% for R&D-intensive companies, but reduced to 4% for the least R&D-intensive companies. These compare with the current 8.5% and (previously) 10% incentives for larger companies A consultation paper is to be released in the next few weeks covering Australia s participation in the G20 countries review of digitisation of business and changes required to tax systems. Numerous integrity measures to be introduced will impact businesses and forward planning for financing and tax compliance processes. These include: Thin capitalisation integrity measures to align the valuation of intangible and internallygenerated assets for tax and financial reporting purposes Removing the ability of Managed Investment Trusts (MITs) and Attribution MITs to apply capital gains discounts at the trust level Transparency initiatives expanding significant global entity definitions and requiring tax disclosures by companies bidding for government contracts Numerous future black economy measures will include denial of deductions for some payments where there has not been compliance with PAYG rules Directors penalties for corporate tax non-compliance will be broadened Major funding of ATO big data compliance initiatives will see greater ATO data analytics which will require corporate readiness. Indirect tax and customs duty measures saw changes also. Personal tax reform will see reductions limited to lower income taxpayers. A path to substantial personal tax reform was outlined, effective in future years. We believe there is a need for broader tax reform to underpin fiscal stability and create a more efficient and productive tax regime. Hopefully the future will bring sufficient opportunity for proper research, consultation and deliberation at a community level to develop broad acceptance politically to enable such reforms to emerge.

2 Tax changes announced in the Budget This Tax Alert outlines the key tax changes, categorised into changes affecting: Businesses including international businesses Financial services and real estate Indirect taxes Personal taxes Superannuation for members and employers Business tax measures R&D offset significant changes with winners and losers The Government response to the 2016 Review of the R&D Tax Incentive sees significant changes to the R&D offsets (incentives) creating winners and losers. The changes will apply for income years starting on or after 1 July For companies with over $20m aggregated turnover (eligible for non-refundable offsets): A sliding rate offset, to replace the current fixed offset, will vary with the claimant s R&D Intensity. The R&D intensity will be a ratio of R&D expenditure divided by total expenditure for the year, though further details are to be released (EY has opened discussions with Treasury) The final offset benefit will be tiered with the potential for an effective benefit rate between 34% and 42.5% (assuming a 30% corporate tax rate) R&D Intensity tier Marginal R&D Premium Added to claimant tax rate (at30%) gives 0-2% 4.0% 34.0% 2-5% 6.5% 36.5% 5-10% 9.0% 39.0% >10% 12.5% 42.5% Increase in the R&D expenditure cap from $100m to $150m. Many large global and domestic based companies will now only receive 4 % support for every $1 of R&D expenditure. Only 18 months ago this same level of R&D expenditure by these companies received 10% support. This is not competitive with other local foreign jurisdictions to encourage R&D investment in Australia. For companies with under $20m aggregated turnover (receiving refundable offsets): Offset rate will be a premium of 13.5% above the company tax rate (from a fixed 43.5% offset) Cash refunds will be capped at $4m p.a. with the balance carried forward to future income years as nonrefundable tax offsets. Clinical trials will not be counted towards this cap Other general R&D changes include: Increased integrity measures including increased funding for ATO and regulators, improved guidance material, a public findings register and R&D Tax administrative and technical changes. New transparency measures, including publication of company names and amounts of R&D expenditure claimed. Businesses will need to consider the impact. They will want to provide feedback to us or to Government of the impacts of the proposed changes in the consultation process. Significant global entity companies The definition of significant global entities (SGEs) is to be broadened for income years commencing on or after 1 July SGEs will then include (in addition to the current groups headed by a company required to provide consolidated financial statements) members of large groups headed by private companies, trusts, partnerships and also by investment entities (e.g. private equity funds). This broader range of companies will be subject to SGE higher tax penalties, obligations for general purpose financial statements and county by country reporting, and will need to adjust compliance and reporting processes. Transparency, black economy and ATO Big Data The full Government response to the Black Economy Taskforce Report is expected to bring in $5.3 billion over the next four years. From broadly, 1 July 2019 key measures include: Business deductions Businesses will not be able to claim deductions for employee payments without withholding PAYG Deductions will also be disallowed for payments to contractors without any PAYG withheld and where the contractor does not provide an ABN Cash payments made to businesses will be limited to $10,000 maximum. Transparency measures Businesses seeking to tender for Australian Government procurement contracts over $4 million (including GST) must provide an ATO statement indicating that they are "generally compliant with their tax obligations". Illegal phoenixing Measures to combat illegal phoenixing of companies include: Expanded ATO powers to retain tax refunds where there are outstanding tax lodgements Extending the director penalty provisions to make directors personally liable for some GST, luxury car tax and wine equalisation tax debts These measures are to be supported by the introduction of specific offences and Corporations Law changes to limit directors ability to resign to avoid liability and related creditors rights to vote on the appointment of external administrators. No express start date announced. Taxable payments reporting Security and investigation services, road freight transport and computer system design services will fall under the taxable payments reporting system (TPRS) requiring payers to report payments to contractors to ATO. Budget tax overview: Australian Federal Budget May 2018 Page 2

3 Other Designing a new regulatory framework for the Australian Business Numbers (ABN) system in ; developing options for improving how businesses interact with government to be considered in the Budget; New funding to support small businesses with fewer than 20 employees during the transition to Single Touch Payroll Reporting from 1 July 2019 New funding to the Tax Practitioners Board (TPB). The ATO receives significant funding under the black economy, R&D, superannuation and other initiatives, including $318.5 million over the next four years for new ATO mobile strike teams, increased audit presence, black economy hotline, improved data analytics and educational activities. Businesses can expect significantly increased ATO activities including data analytics and systems reviews, and prepare for efficient response management. Small business instant asset write-off for assets under $20,000 extended The instant asset write-off for assets under $20,000 for small businesses with aggregated annual turnover of less than $10m will be extended yet again, for assets first used or installed ready or use by 30 June The write off was due to expire 30 June Eligible entities will welcome the further time to access this concession. Retailers and suppliers of assets to small businesses will also benefit. Private group integrity measures Tax integrity announcements aimed at private groups include: Unpaid present entitlements (UPE) of companies - From 1 July 2019, UPEs to trust income conferred on a private company beneficiary without then being paid will be treated as loans for tax purposes under the Division 7A private company tax integrity regime. This will codify existing ATO administrative treatment of such UPEs. The Division 7A concessional changes announced in the 2017 Budget have been deferred until 1 July Income to individuals from image rights - From 1 July 2019, individuals (typically high profile persons) will no longer be able to alienate income from image or brand rights that are disposed of or licensed to a related entity. Such income will be assessable to the relevant individual. Testamentary trusts - From 1 July 2019, an integrity measure will be introduced to ensure income and gains derived from non-estate assets is not subject to concessional taxation where distributed to minors. In such cases, the income will be subject to the existing higher tax regime applying to minors deriving investment income. Circular trust distributions - From 1 July 2019, an anti-avoidance measure will apply to family trusts using a circular trust distribution strategy to reduce or avoid tax. Such distributions will be taxed at the highest marginal tax rate plus Medicare levy. Partnership Everett assignment changes - From Budget night (8 May 2018), the small business CGT concessions will no longer be available to partners who derive a capital gain on disposing part of their partnership interest to a related party (commonly referred to as an Everett Assignment). Whilst the general CGT discount will still be available, such assignments are likely to be less tax effective. International tax Thin capitalisation rules integrity changes Valuation of assets - to align the value of assets for thin capitalisation purposes with the value included in their financial statements. The Government will tighten Australia s thin capitalisation rules by requiring entities to align the value of their assets for thin capitalisation purposes with the value included in their financial statements. Companies will no longer be able to revalue assets for the purpose of the safe harbour thin capitalisation test if the asset value is not contained in their financial statements This places the onus on those preparing financial statements and their auditors to ensure that valuations adopted are appropriate and in accordance with accounting standards This measure applies to income years commencing on or after 1 July 2019 and suggests that valuations before the Budget will be accepted. However valuations undertaken after Budget Night cannot be included in this intervening period unless adopted in the entity s financial statements. These measures may adversely impact entities that hold assets which have an accounting value that is significantly less than market value, and also where there is reluctance to revalue assets on its accounting balance sheet. Asset valuations for thin capitalisation purposes have recently been contentious, with several ATO Tax Alerts and a number of significant ATO audit processes and disputes. The acceptance of valuations before the Budget will be welcome in management of outstanding matters. This change will impact many sectors including not only services groups but also infrastructure and resources. Mining and exploration companies will need to consider the impact of the above in conjunction with soon to be released ATO guidance on the classification of mining, quarrying and prospecting right assets. The thin capitalisation arm s length debt test remains available and may be a potential option for some. Inbound investors closing access to thin capitalisation tests intended only for outbound investors Foreign controlled Australian consolidated entities and MEC groups that control a foreign entity will be treated as both outward and inward investment vehicles. This measure will ensure that inbound investors cannot access tests (such the worldwide gearing test for outward investors) that were only intended for outward investors. This change is applicable for income years commencing on or after 1 July Budget tax overview: Australian Federal Budget May 2018 Page 3

4 Income tax base for international digital companies The Treasurer stated in the Budget speech that the next big challenge is to ensure big multinational digital and tech companies pay their fair share of tax and he has been working with the G20 to bring the digital economy into the global tax net. In a few weeks he will release a discussion paper that will explore options for taxing digital business in Australia. EY supports the issue of a paper to inform and engage the community that: There is now global action by governments to address the perceived problem of cross-border digital business with an OECD and G20 process to develop proposals by 2019 Australia has already introduced measures such as the Multinational Anti Avoidance Law and Diverted Profits Tax to increase digital companies and other MNEs income tax, as well as measures that arose from the global action to counter BEPS There is no need to act in haste and if Australia is to introduce a digital tax, it should be done in consultation with other G20 members the approach of the UK. The European Commission (EC) recent recommendations show the risks of moving out of line with other countries. Digital economy companies need to prepare for consultation. Businesses with a digital presence in Australia need to assess the potential future implications of a broader digital transactions tax. Financial services and real estate Removing the CGT discount for MITS and AMITs Managed Investment Trusts (MITs) and Attribution MITs (AMITs) will no longer be eligible to apply the 50% capital gains tax (CGT) discount at the trust level from 1 July MITs and AMITs will still be able to distribute a capital gain that can be discounted in the hands of the beneficiary, when entitled. Given this measure will only apply to MITs and AMITs it is likely to create significant complexity and system development costs for custodians and administrators to comply with CGT rules as they apply to various types of investment entities. Further in relation to beneficiaries that have investments in non MIT trusts, MITs and AMITs, this will increase the complexity of their tax affairs. The proposed changes align to the treatment of capital gains in the proposed Corporate Collective Investment Vehicle rules and for Listed Investment Companies. These further proposals, impacting the funds and asset management industry, will warrant careful review and involvement in consultation as they develop, given the significant complexity and systems issues for participants. Updated list of Information Exchange Countries/Regions Effective from 1 January 2019, the Information Exchange (EOI) countries/regions will be expanded. 56 countries/regions to be added include Austria, Switzerland, the Philippines, Lichtenstein, Luxembourg and China but not Hong Kong. The updated list in the regulations will allow investors to benefit from lower MIT withholdings. Deductions denied for vacant land Deductions for expenses associated with holding vacant land will be denied, to address concerns they are being improperly claimed for expenses, such as interest costs, where the land is not genuinely held for the purpose of earning assessable income. We understand that this measure, applicable from 1 July 2019, is not intended to apply to landholders who carry on a business of property development. Thus it may have limited application. Indirect tax, customs and trade related measures GST - online hotel bookings Following the extension of the GST to digital products and other services provided by offshore suppliers from 1 July 2017 and to low value imported goods from 1 July 2018, the GST will be extended to offshore sellers of hotel accommodation in Australia from 1 July The impact of the measure will be that offshore sellers of Australian hotel accommodation will pay GST on the markup over the wholesale price of the accommodation. It will ensure the same tax treatment of Australian hotel accommodation, whether booked through an offshore company or an Australian company. Alcohol excise refund scheme and concessional excise changes to benefit craft brewers and distillers As previously announced, the alcohol excise refund scheme cap will increase from $30,000 a year to $100,000, for all brewers and distillers, and the concessional draught beer excise rate will be extended to smaller kegs typically used by craft brewers and distillers. This applies from 1 July Illicit tobacco taskforce and tobacco duty measures As previously announced, the Government will further crackdown on the illicit tobacco trade with a new Illicit Tobacco Taskforce, new framework to protect tobacco duty, and further resources to combat illegal domestic production. Importers must have permits and pay all duty and tax liabilities when tobacco enters the country, rather than when it leaves a licensed warehouse and enters the domestic market, from 1 July New levy on sea cargo A new levy is to be imposed on port operators from 1 July 2019 in relation to sea cargo. The levy will be payable on a quarterly basis calculated at $10.02 per twenty foot container (or equivalent) and $1 per tonne for noncontainerised cargo. Relevant costs can be expected to be passed on to importers and should be taken into account in pricing and budgeting decisions. Removal of custom duty related to clinical trials From 1 July 2018 customs duty will no longer be payable on placebos and clinical trial kits imported into Australia simplifying the import process associated with conducting clinical trials in Australia. Extension of benefits for trusted traders Importers accredited under the Australian Trusted Trader Program are set to benefit from the removal of the requirement to produce country of origin documentation under certain free trade agreements. It is unclear when this benefit will commence and which free trade agreements it will impact. Accreditation under the Budget tax overview: Australian Federal Budget May 2018 Page 4

5 Australian Trusted Trader Program is becoming increasingly attractive for importers and exporters. Parties involved in international trade should assess the potential benefits of pursuing accreditation. Personal income tax changes Seven year personal income tax plan A centerpiece of the Budget is staged personal income tax relief: Step one low and middle income tax offset Under an additional non-refundable low and middle income tax offset for the to income years Taxpayers earning up to $37,000 paying 19% marginal tax will have their tax reduced by up to $200 Those earning more than $37,000 paying 32.5% cents in the dollar will have their tax reduced (maximum of $530 per year) For those earning above $90,000 the tax relief reduces to zero at just over $125,000. Step two The top threshold for the 32.5% tax bracket will increase from $87,000 to $90,000 from 1 July 2018 In the $37,000 threshold will be lifted to $41,000, and the $90,000 threshold will be raised to $120,000. The low income tax offset is also increased. Step three In the personal tax system will be simplified by abolishing the 37% tax bracket. The 32.5% bracket will apply from $41,001 up to the top marginal tax rate threshold which will also be adjusted to $200,000. As previously announced, the 2017 Budget decision to increase the Medicare Levy by 0.5% from 1 July 2019 to fund the NDIS will not proceed (nor will corresponding increases to rates linked to the top rate). The Medicare lowincome thresholds will also be adjusted from Table: Personal tax rates and threshold changes: Rate (%) to ($) and ($) onwards ($) , , , ,201-37,000 18,201-41,000 18,201-41, ,001-90,000 41, ,000 41, , , , , ,000 N/A , , ,001+ Visas and immigration The Government will introduce a pathway to permanent residency for holders of Retirement (subclass 410) and Investor Retirement (subclass 405) visas. From , a portion of the planned parent permanent migration places will be quarantined for retirement visa holders each year. As part of the establishment of the pathway, the Government will close the subclass 405 visa to new applicants. The subclass 410 visa is already closed to new applicants. The Government will expand the refund provisions for the Skilling Australians Fund levy. From 1 January 2019, the Government will set a planning target of around 2,100 overseas trained doctors per annum to contribute to the continued growth in overall doctor numbers. Superannuation for members and employers Better integrity over deductions for personal contributions Individuals claiming deductions for personal superannuation contributions will be investigated to ensure notice of intent forms have been filed with their super fund. Increasing the maximum number of allowable members in self-managed superannuation funds (SMSF) and small APRA funds The maximum number of SMSF and small APRA fund members will increase from four to six members from 1 July Three-yearly audit cycle for some self-managed superannuation funds SMSF trustees with a history of good record-keeping and compliance may elect to have their fund audited every three years rather than annually from 1 July More choices for a longer life work test exemption for recent retirees With effect from 1 July 2019 people aged 65-74, with superannuation balances below $300,000, can make voluntary contributions to superannuation without meeting the work test (minimum 40 hours in any 30 day period). This concession is only available in the first year that the work test requirement is not met. Employer issues Preventing inadvertent concessional cap breaches by certain employees - From 1 July 2018 individuals with multiple employers and income in excess of $263,157 can request for a certain employer not to contribute the superannuation guarantee. This is to ensure the $25,000 concessional contribution cap is not inadvertently breached and to avoid the flow on impost of excess contributions tax and shortfall interest charges applying. This should be particularly helpful for non-executive directors who sit on multiple boards. Changes to insurance in superannuation - From 1 July 2019, insurance within superannuation will change from a default requirement to an opt-in approach for certain categories of employees, including those under 25, those with balances under $6,000 and some inactive accounts. This has the potential to create increased administration for employers as they may effectively have to manage this change, particularly where the insurance is provided under group life policies. Budget tax overview: Australian Federal Budget May 2018 Page 5

6 For more information please contact: Tax Policy Services Alf Capito Tel: alf.capito@au.ey.com Government & Public Sector Peter Sanders Tel: peter.sanders@au.ey.com Mining & Metals Rachel G Charles Tel: rachel.charles@au.ey.com Technology, Media & Entertainment and Telecommunications Mark Chan Tel: mark.chan@au.ey.com Energy Oil Gas Chad Dixon Tel: chad.dixon@au.ey.com Energy Power Utilities Infrastructure Richard Lambkin Tel: richard.lambkin@au.ey.com Real Estate George Stamoulos Tel: george.stamoulos@au.ey.com Consumer & Industrial Products Peter Janetzki Tel: peter.janetzki@au.ey.com Australian Diversified Business Justin Howse Tel: justin.howse@au.ey.com Health and Life Sciences Denise Brotherton Tel: denise.brotherton@au.ey.com Financial Services Grant Peters Tel: grant.c.peters@au.ey.com Business Tax Services Todd Wills Tel: todd.wills@au.ey.com Global Compliance & Reporting Andrew van Dinter Tel: andrew.van.dinter@au.ey.com People Advisory Services Anne Giugni Tel: anne.giugni@au.ey.com Indirect Tax Brad Miller Tel: brad.miller@au.ey.com International Tax Services Sean Monahan Tel: sean.monahan@au.ey.com Law Kirsty Keating Tel: kirsty.keating@nz.ey.com Transfer Pricing Services Anthony Seve Tel: anthony.seve@au.ey.com Transaction Tax Reid Zulpo Tel: reid.zulpo@au.ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY s Tax services Your business will only succeed if you build it on a strong foundation and grow it in a sustainable way. At EY, we believe that managing your tax obligations responsibly and proactively can make a critical difference. Our global teams of talented people bring you technical knowledge, business experience and consistency, all built on our unwavering commitment to quality service wherever you are and whatever tax services you need. We create highly networked teams that can advise on planning, compliance and reporting and help you maintain constructive tax authority relationships wherever you operate. Our technical networks across the globe can work with you to reduce inefficiencies, mitigate risk and improve opportunity. Our 50,000 tax professionals, in more than 150 countries, are committed to giving you the quality, consistency and customization you need to support your tax function. For more information, please visit Ernst & Young, Australia. All Rights Reserved. SCORE NO: AUNZ This communication provides general information which is current at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk. Liability limited by a scheme approved under Professional Standards Legislation. Budget tax overview: Australian Federal Budget May 2018 Page 6