Tax Brief 9 May 2006 Budget 2006 Every year there is frenzied speculation about the likely content of the upcoming Budget. And, as is usually the case, some of the speculation proved to be close to the mark; other guesses proved to be misinformed. The headline items in the 2006 Budget focused on personal income tax rates and superannuation. The superannuation measures to be introduced from 1 July 2007 represent a significant shift in the taxation of retirement incomes. Business tax matters were not forgotten, but these were mostly housekeeping measures and not the structural tax reform that has been repeatedly called for. Nonetheless, there are a few surprises. Personal Tax and Fringe Benefits Tax Personal Income Tax The Government continued its practice of adjusting personal income tax rates. Just as in the 2004 and 2005 Budget, one of the most significant items in the Budget is the reduction in individual income tax. The Government announced personal income tax rate cuts and a substantial broadening of income tax thresholds effective from 1 July 2006. More specifically, the reforms include: A reduction of the highest marginal tax rate from 47 percent to 45 percent. The threshold at which the top rate applies will increase from $95,001 to $150,001. A reduction in the second highest marginal tax rate from 42 percent to 40 percent. The threshold at which this tax rate applies will increase from $63,001 to $75,001. An increase in the 30 percent threshold from $21,601 to $25,001. Consequential changes will be made to some specific tax rates intended to reflect the top marginal rate, such as the rate of tax on trust income not taxed to a beneficiary, and the fringe benefits tax rate. Similarly certain low income and seniors rebates will be increased.
The Tables below show the income tax rates and the applicable income ranges that are currently in operation for the 2005-06 year (Table 1), the rates and ranges that were announced in the 2005 Budget to commence from 1 July 2006 (Table 2), and the 2006 Budget announcement that will instead apply from 1 July 2006 (Table 3). Table 1. Current Tax Rates and Income Ranges 2005-06 Tax Rate (%) Income Level ($) 0 0 6,000 15 6,001 21,600 30 21,601 63,000 42 63,001 95,000 47 95,001 and above Table 2. Tax Rates and Income Ranges Under Budget 2005 Proposed for 2006-07 [Note these rates have been superseded by Budget 2006] Tax Rate (%) Income Level ($) 0 0 6,000 15 6,001 21,600 30 21,601 70,000 42 70,001 125,000 47 125,001 and above 2 Budget 2006
Table 3. Tax Rates and Income Ranges Announced in Budget 2006 for 2006-07 Tax Rate (%) Income Level ($) 0 0 6,000 15 6,001 25,000 30 25,001 75,000 42 75,001 150,000 47 150,001 and above Fringe Benefits Tax Amendments effective 1 April 2006: Fringe benefits tax rate reduced from 48.5% to 46.5% to align with the new maximum personal income tax rate (including Medicare levy). The income tax rates change from 1 July 2006, thus creating a 2% difference over a two month period. Although the FBT rate will be reduced to 46.5% the increase in the personal income tax rate thresholds means that salary packaging arrangements may become less attractive to many employees, especially those on middle level incomes. Salary packaging arrangements may need to be reviewed in light of these changes. Amendments effective 1 April 2007: In-house fringe benefits tax-free threshold increased from $500 to $1000. Minor benefits exemption threshold increased from $100 to $300, confirming the measure announced in the Treasurer s press release of 7 April 2006. Reportable fringe benefits exclusion threshold increased from $1000 to $2000, confirming the measure announced in the Treasurer s press release of 7 April 2006. Definition of remote to be amended (applicable to remote area concessions, eg housing related fringe benefits). 3 Budget 2006
Superannuation Taxation of Benefit Payments Currently superannuation benefits paid from a taxed source (such as a complying superannuation fund) are taxed in a particular fashion depending upon whether the benefit is paid in a lump sum or pension form. A lump sum payment from a superannuation fund is classified as an ETP and is divided into various ETP components e.g. concessional component, CGT exempt component, pre July 83 component etc. For many, benefits may be received as a post June 83 component and would be subject to a maximum rate of tax of 15% plus Medicare levy. Pensions (less the deductible amount) are assessable to the pensioner with a rebate of up to 15% being available. From 1 July 2007 the Government proposes wholesale changes to the taxation of superannuation benefits. As part of the measures the Government proposes to abolish the reasonable benefit limit measures which currently limit the amount of concessionally taxed retirement benefits an individual can receive over their lifetime. Lump Sums Over 60 The government proposes that for persons 60 and over there will be no tax on lump sum benefits paid from a taxed source. At this stage they are not proposing any transitional provisions. Pensions Over 60 Likewise, if a pension is paid from a taxed source where the individual is 60 or over it will be free of tax. Benefits Under 60 The government proposes that those aged less than 60 will pay tax on their benefits. In respect of lump sums it is proposed that they be divided into two components an exempt component and a taxable component. the exempt component would be tax free. The exempt component would consist of the CGT exempt component, the post June 1994 invalidity component, concessional component, undeducted contributions and pre July 83 component (this amount determined at a particular date and becoming a fixed component). the taxed component would essentially be treated like a post June 83 component i.e. if over 55 tax free on the first $129,751 and 15% on the balance. If under 55, 20% on this component. 4 Budget 2006
For pensions the rules are different. If the pension commenced before 1 July 2007 the current rules concerning the calculation of deductible amount would remain. For pensions which commence from 1 July 2007 new more generous deductible amount rules will be introduced. The pensions will be eligible for the full 15% rebate. Death Benefits Special rules are proposed in respect of death benefits which are beyond the scope of this overview. Taxation of Annuity Payments The paper contains no detail about the taxation treatment of annuities purchased with rolled over ETPs which currently, for taxation purposes at least, are essentially treated on a similar basis to superannuation pensions. There is also no mention of the taxation treatment of non ETP annuities. Those are significant omissions which no doubt will be addressed in the future. Employer ETPs The Government proposes to alter the rules concerning the taxation treatment of employer ETPs. Broadly it is proposed that employer ETPs be comprised of two components exempt and taxable. The exempt components would consist of pre July 83 and post June 1994 invalidity components. The taxable amount would be the balance. Where the recipient is under 55 the taxable amount would be taxable at 30% on the first $140,000 and the top marginal rate thereafter. For individuals 55 and over they would be taxed at 15% on the first $140,000 and top marginal rate thereafter. This amounts to a significantly less favourable taxation treatment of these types of benefits. There is no clear commentary concerning whether these benefits can be rolled over and if so the effect of the rollover. Deductable Contributions Limits Under the current rules age-based limits are imposed to limit the contributions in respect of which a deduction can be claimed. For employer contributions the current limits are: Age in Years Deduction limit under 35 $14,603 35 to 49 $40,560 50 and over $100,587 5 Budget 2006
Under the arrangements proposed from 1 July 2007, employers would be able to claim a full deduction for all superannuation contribution made on behalf of employees under the age of 75 (the Superannuation Guarantee would continue to apply only to employees up to the age of 70). The first $50,000 per person per annum would be taxed at the current concessional rate of 15% (within the superannuation fund). The limit would apply per person, regardless of the number of employers contributing on behalf of the person. When the ATO identifies that a person s deductible contributions have exceeded $50,000 in a financial year, the amount in excess of $50,000 would be taxed at the top marginal tax rate, with the tax to be levied on the superannuation fund. A transitional period would apply to persons aged 50 and above to enable them to make larger contributions. In relation to funded defined benefit schemes, notional taxable contributions (that is, superannuation benefits accruing to an employee during a year in a funded defined benefit scheme) would be added to other deductible contribution to accumulation scheme in assessing the $50,000 cap. This measure is subject to consultation. The current arrangement of treating taxable contributions as income of the superannuation fund and the reduction of contributions tax by applying imputation and other credits would remain unchanged. Any additional liability for members of the superannuation fund who have exceeded the $50,000 cap would be determined in respect of an individual but would be levied on the superannuation fund. Superannuation funds would be subject to reporting requirements to provide the ATO with sufficient information to assess contribution tax liabilities. Where taxable contributions (including notional taxable contributions) for an individual exceed $50,000 and are made to more than one superannuation fund, it would be necessary to identify the most practical fund or funds on which to levy the tax. It is anticipated that there would be few instances where this would be necessary. Further administrative arrangement are to be determined in consultation with the superannuation industry. Undeducted Contribution Limits Personal undeducted contributions, which are made out of an individual s aftertax income, would remain tax free when contributed to, and withdrawn from, superannuation. They would also continue to be eligible for the Government cocontribution. Undeducted contributions would be limited to $150,000 per annum. The Government is to consider whether the cap should be averaged over three years to allow people to accommodate larger one-off payments. If the superannuation proposals are adopted, the limit would apply from 9 May 2006. Undeducted contributions in excess of the $150,000 cap would be returned to the individual. 6 Budget 2006
The ATO would collect information to determine when a person has exceeded the annual cap. Rules would be developed to determine which contributions are refunded in cases of multiple contributions and funds. There would be scope for exemptions to the cap (for example, the CGT exempt component from the sale of a small business). Special rules may need to be developed for defined benefit funds. Transfers from Overseas Superannuation Funds Where an individual elects to treat a transfer from an eligible overseas superannuation fund as a taxable contribution, the taxable amount will remain taxed at the 15% rate. The announcement did not suggest that this concession would be subject to any limit as to quantum. Contributions by Self-employed Persons Full Deductibility The self-employed (and other persons able to claim deductions for personal contributions to superannuation) would be able to claim a full deduction for contributions to superannuation until age 75. The announcement did not suggest a relaxation of the general criteria determining who is eligible to claim a deduction in respect of a personal superannuation contribution. Co-contribution Entitlement The Government co-contribution scheme will be extended to the self-employed with effect from 1 July 2007. Persons will need to meet certain criteria in relation to the source of their income, and their income must be under the Government co-contribution upper threshold. They must not be a temporary resident and be less than 71 years of age at the end of the income year. The co-contribution would only be payable on undeducted contributions. Eligible self-employed persons will need to give consideration to how much of their contributions is treated as deducted and how much is treated as undeducted. Contributions to Untaxed Funds Contributions to untaxed superannuation funds will continue to be exempt from contributions tax. Transfers from Untaxed Funds Transfers of untaxed benefits would generally continue to be subject to contributions tax. The untaxed (transferring) fund would be required to withhold tax at the top marginal tax rate for amount above $700,000. The first $700,000 will be treated as a taxable contribution by the receiving fund and the remainder 7 Budget 2006
will form part of the exempt component of the receiving fund and will not be subject to further tax. Lump Sum and Pension Payment from Untaxed Funds Lump sum payments arising from untaxed funds to an individual over the age of 60 would be taxed more concessionally than is currently the case. A rate of 15% would apply up to $700,000 and the top marginal tax rate above that amount. For those aged 55 to 59, a rate of 15% will apply up to the low-rate ETP threshold (currently $129,751), 30% will apply above this amount up to $700,000 and the top marginal tax rate will apply above that amount. For those aged under 55, a rate of 30% will apply up to $700,000 and the top marginal tax rate above that amount. Pension payments will be taxed at marginal tax rates. Individuals over the age of 60 would be entitled to a 10% offset. Flexibility for Payment of Benefits The Government has announced proposed measures which should simplify the rules surrounding the payment of benefits, and in particular, improve the flexibility of how and when a person can take their superannuation benefits. The most significant change in this regard is the abolition of the work test. Under current measures, funds are require to pay benefits to members who have reached 65 years of age and have not worked more than 240 hours in the most recent financial year. Under the proposed measures, there will be no work test and members can choose (where the preservation conditions have been satisfied) whether to draw on their superannuation or not. This will provide flexibility for retirees on when and how they use their superannuation. In addition to the abolition of the work test, funds will not be required to pay benefits to a person who reaches 75 years of age. Members in this category may choose to keep their benefits in a fund indefinitely. There will be no changes to the preservation age, as the preservation age is already legislated to increase from 55 to 60 years between the years 2015 and 2025. Accordingly, members would still be able to take their superannuation benefits once they have reached preservative age and have retired from the workforce, or have reached age 65. We should note that the Government proposes certain minimum drawdown standards if a fund is to take advantage of the exemption for pension earnings. 8 Budget 2006
Business Tax Changes Depreciation Rate Currently, a taxpayer can choose to use either the diminishing value or prime cost method to calculate the annual depreciation deduction of depreciating assets. The diminishing value method uses a fixed proportion (determined by using the diminishing value rate ( DVR ) and the effective life of the asset) of the asset s written down value to calculate its annual depreciation deduction. The DVR is currently at 150 percent. The Government has announced that the DVR for all eligible assets (new and secondhand) acquired on or after 10 May 2006 will be increased to 200 percent. The announced increase in the DVR will allow a quicker write off (i.e with higher deductions being available in the early part of an asset s effective life) for a taxpayer using the diminishing value method. The increase in the DVR will not, however, change the asset s effective life or the total amount that is written off over the asset s effective life. Nonetheless the Government proposes to alter some depreciation rules around mining, petroleum and quarrying rights. Employee Share Schemes Extension to Cover Stapled Securities The employee share scheme provisions currently provide a regime for the concessional taxation of employee share schemes. The provisions currently only apply in respect of eligible shares or rights to acquire shares and do not extend to cover other forms of securities, such as units in a unit trust. Subject to the satisfaction of certain conditions, the employee may choose to be taxed on a deferred basis or on an up-front concessional basis on any discount associated with the acquisition of the eligible shares or rights. The employee share scheme provisions currently do not apply fully to stapled security structures. The Government has announced that the employee share scheme and related capital gains tax provisions will be extended to cover stapled securities that include an ordinary share and are listed on the Australian Stock Exchange. This measure will have effect from 1 July 2006. This measure will provide greater flexibility for employers with stapled securities to offer employee share schemes that provide appropriate incentives to staff without the complexity of the historic arrangements that have been implemented by many stapled entities. Distributions of Net Income by Australian Managed Funds and Custodians to Non-residents All Australian managed funds and custodians will be required to withhold tax from distributions of income (other than dividends, interest or royalties) to nonresidents at the company tax rate, irrespective of the identity of the non-resident. A single tax collection regime with a single rate should simplify the tax collection 9 Budget 2006
process for the managed funds industry. The current withholding tax rules for distributions of dividends, interest or royalties remain unchanged. This measure will apply from 1 July following the date of Royal Assent. The design of the legislation will be subject to consultation with the business community. Trust Distributions to Non-resident Trustees Currently, a resident trustee is liable to pay tax on distributions to non-resident individuals and companies, but not on distributions to non-resident trustees. From 1 July 2006, resident trustees will be required to also pay tax on distributions to non-resident trustee beneficiaries. This will ensure that the tax treatment of trust distributions to non-resident trustees is consistent with distributions to other nonresident beneficiaries. International Tax Ensuring Consistent Tax Treatment of Foreign Dividends Currently, non-portfolio dividends paid by a non-resident company are excluded from the assessable income of an Australian resident company under s.23aj. The three cumulative requirements for a dividend to be a non-portfolio dividend are that it must be: a dividend (other than an eligible finance share dividend or a widely distributed finance share dividend ); paid to a company; where that company has a voting interest amounting to at least 10% of the voting power in the company paying the dividend (a non-portfolio interest ). Two changes are proposed to apply from the date of Royal Assent of the enabling legislation: Although there is insufficient detail on this proposal at this stage, it appears intended that the test for determining whether an interest is a portfolio interest will depend on the extent of the economic interest in the nonresident company, rather than its voting interest. It would be expected that economic interest will reflect all of voting, dividend and capital rights. An inconsistency identified in Budget Paper No. 2 is that, in certain circumstances, the 10% voting interest threshold could be achieved by holding a portfolio interest in a foreign company via a controlled foreign company (a CFC ). At this stage, there is insufficient detail on this proposal. However, it appears intended that the inconsistency will be fixed by ensuring that dividends paid between companies resident in section 404 countries are no longer excluded from the recipient company s attributable income for CFC purposes. It follows that these dividends may be taxed under the CFC provisions. 10 Budget 2006
Venture Capital Early Stage Venture Capital Limited Partnerships The Government has announced a progressive replacement of the Pooled Development Funds ( PDF ) program with new investment vehicle known as an early stage venture capital limited partnership ( ESVCLP ). This vehicle appears to be principally based on the existing venture capital limited partnership ( VCLP ) regime. Similar to the VCLP program, a registered ESVCLP will not be subject to the deemed corporate tax status which generally applies to limited partnerships. Rather, investors in ESVCLPs will be taxed on a flow through basis. Resident and non-resident investors will be exempt on any revenue and capital gains made upon the disposal of eligible investments by the ESVCLP. Losses on eligible investments will not be deductible. An ESVCLP will be required to meet certain regulatory and reporting requirements. It is expected that these will parallel the requirements which must be satisfied by VCLPs. Other requirements for a ESVCLP will include: a maximum fund size of $100m; the investment made in any one company cannot exceed 30% of the ESVCLP s committed capital; and the ESVCLP must divest its assets in the company if the total assets of the portfolio company exceed $250m. Following the introduction of the VCLP regime, amendments were required to the various State and Territory partnership laws to address perceived structural inadequacies of the limited partnership as an investment vehicle. Conforming changes may need to be made to deal with ESVCLPs. It is not clear how this existing PDFs will be affected. Changes to Existing Venture Capital Limited Partnership Regime The Government has announced that it will relax some of the requirements applicable to the existing VCLP regime. This regime provides a tax exemption for certain non-resident investors for profits and capital gains made by certain eligible venture capital limited partnerships from specified investments. 11 Budget 2006
These changes are summarised below: Current Requirement Proposed Changes An investor must be an eligible venture capital partner. This means that the investor must be: a tax-exempt non-resident of, or a foreign fund of funds established in, Canada, France, Germany, Japan, the UK, or the US; or an entity resident in Canada, Finland, France, Germany, Italy, Japan, the Netherlands, New Zealand, Norway, Sweden, Taiwan, the UK or the US that holds less than 10% of the partnership s capital The residency requirements will be simplified. Accordingly, an eligible venture capital partner will be either: a tax-exempt nonresident or a foreign venture capital fund of funds ; or a non-resident entity that holds less than 10% of the partnership capital At the time the initial investment is made, and for the following 12 months, more than 50% of the individuals who provide services to the company must perform them primarily in Australia and more than 50% of the company s assets by value must be in Australia. This requirement will be relaxed. No further information is available at this stage. Only investments in shares or options over shares in a company are eligible for the exemption. The exemption will be extended to units in unit trusts and convertible notes. The committed capital of the VCLP must be at least $20 million. Minimum committed capital is to be reduced to $10 million. Investee companies must have a registered auditor. The appointment of an auditor may occur at the end of the financial year of the investment. 12 Budget 2006
Despite submissions to the contrary, there will be no increase in the $250 million maximum threshold for the assets of investee companies. For further information, please contact Sydney Melbourne Michael Moschner Michael.Moschner@gf.com.au +61 2 9225 5969 Adrian O Shannessy Adrian.O Shannessy@gf.com.au +61 3 9288 1723 G&F document ID 510039501_15.docx These notes are in summary form designed to alert clients to tax developments of general interest. They are not comprehensive, they are not offered as advice and should not be used to formulate business or other fiscal decisions. Liability limited by a scheme approved under Professional Standards Legislation Greenwoods & Freehills Pty Limited (ABN 60 003 146 852) www.gf.com.au Sydney ANZ Tower, 161 Castlereagh Street, Sydney NSW 2000 Australia Ph +61 2 9225 5955, Fax +61 2 9221 6516 Melbourne 101 Collins Street, Melbourne VIC 3000, Australia Ph +61 3 9288 1881 Fax +61 3 9288 1828 Perth QV.1 Building, 250 St Georges Terrace, Perth WA 6000, Australia Ph +61 8 9211 7770 Fax +61 8 9211 7755 13 Budget 2006