Taxation of Corporate Finance in Australia - Coursework Example

Name Institution Course Professor Date Table of Contents Abstract...................…………………………………………………………..03 Overview...........................................................................................................04 Introduction………………………………………………………………….04 Reasons for the Review of Australian Tax System.….…………………….05 Need for Tax Reform.......................…………………………………….......06 Taxation in Australia………………………………………………………...06 Corporate Financing in Australia.……………………………………….....08 Tax on Financing………………………………………………………….....09 Lower Income Tax Rate………………………………………......................09 Management of Foreign Savings....................................................................11 Treatment and Taxation of Business Entities................................................13 Company Tax and Foreign Investment..........................................................14 Impact of Investment Taxes.............................................................................16 Conclusion.........................................................................................................16 Appendices.........................................................................................................18 Work Cited.........................................................................................................20 Abstract The approach that was used by Henry Tax Review was to move to four tax bases that are robust and efficient as opposed to several taxes. These include comprehensive personal income, business income, simple private consumption tax and taxation of economic rents from land and natural resources. This report has identified and discussed those recommendations relating to taxation of corporate finance. The underlying drivers of tax reform are continuing to push for changes to the taxation system so that it can reflect on the current situation. The increase demand of public goods, provision of services by the government and wider economic challenges such as changes in technology and globalisation would continue to affect the taxation system. This means that fundamental changes to the taxation system must be carried out to deal with all these challenges. Henry Review of Taxation Overview In any country, an effective tax system is very important. The Australian tax system is fundamental in raising revenue for financing government activities at all levels of government. The important activities that government must provide funds for include education, health, infrastructure and national defence sectors. A good tax system has the ability of achieving this function without necessarily imposing costs on the country’s economy. In this case, reform of the taxation system entails how much the government raises and how it raised it. It includes some kind of balancing revolving around the principles of equity, simplicity, efficiency, and fairness. Australia relies heavily on taxes levied on corporations as well as individuals (Henry et al., 2010). The statistics shows that income tax levied on individuals and corporations in Australia comprised a high percentage of the total revenue that most of the regional competitors (Appendix 2). Indeed, the Australian overall tax mix has not significantly changed and has been favouring individuals and corporate income taxes. Specifically, although the Australian corporate income tax has been high in comparison with other OECD countries, the country’s tax system had not been effective enough to raise the maximum amount of tax from corporations. Introduction In 2008, the Australian government set up a commission popularly known as “The Henry Review” to streamline the tax system. Indeed, the Australian taxation system has undergone a lot of changes in the last three decades (Enright & Petty 05). There have been many reasons given for the need to reform the tax system in a regular manner. The Australian taxation system has been widely viewed as inefficient and burdensome. Moreover, it is a widely expressed view that the country’s taxation system detracts it from its competitiveness and a change to it is paramount in achievement of some micro and macro-economic goals (Australian Industry Group 2011). For example, an effective Australian tax system could result in improved level of savings, increase in the number of workforce participants and a greater level of investments by the business community. Prior to setting up of Henry Review and its various recommendations, the tax arrangements that were in place were regarded as being unstable and need to be reformed as it will not survive in their current form anymore. Therefore, several reasons prompted the setting up of the Henry Review taskforce to review ways in which the tax system could be reformed. Reasons for the Review of Australian Tax System Before Henry Review of taxation was set up, several reasons prompted the need to change how taxation was being conducted in Australia. 1. The tax burden. There have been several concerns by many business leaders that the Australian tax burden is high. The mix of taxes has also been labelled as wrong by these business leaders. The Australian Industry Group, Business Council of Australia and Australia’s Future Fund are among business organisations that pushed for review of the tax system. 2. Costly and Complex Compliance. The complex nature of Australia’s taxation system ensures that the compliance costs by companies become too high. The Australian Chamber of Commerce and Industry pushed for these costs to be reduced. 3. Different Levels of Tax and Inefficiency. The inefficiency in taxes collection is as a result of levying of taxes by the three levels of government means that taxes are inefficient. Moreover, the taxation system does not give enough taxing powers to the government in order to meet their target and expenditure responsibilities. Need for Tax Reform In the last three decades, the tax system in Australia has been constantly undergoing process of reform. This has been driven by the changes in the economy and globalisation. The budgetary stress has always been experience since the Great Recession by many governments. Due to this reason and the need for tax increases as well as disparities in wealth and income distribution have led to the need for progressive tax reforms (Godar, Paetz & Truger 95). The reforms that have been conducted have enabled the Australian economy to adjust to the changing circumstances that strengthens the economy. This has led to increase in the economic growth which subsequently provides a secure basis for the creation of secure jobs for people of Australia. The per capita income has been increasing and income distribution has been equitable. However, new challenges have emerged over the last decade. It therefore need initiation of new policies to deal with- hence new tax results. Globalisation is one of these challenges (Ganghof, Steffen and Eccleston 522). For example, Asia had re-emerged as production and finance centre and the capital mobility had been increasing implying that the tax system should undergo some fundamental changes so that it helps in positioning Australia as a regional investment hub. Moreover, it will assist in positioning Australia so that it can take advantage of these regional developments and ensures that it achieves future prosperity. The global financial crisis in 2008 led to the realisation of high current account deficits in the governments all over the world and in Australia. There was need for a stronger effort regarding national savings. In this case, the various tax mixes and the taxation system contribute significantly in encouraging savings. The citizen’s expectations and community needs must be met by the government. The tax system should be able to creatively respond to these demands as well as encourage robust business activity. Prior to the creation of Henry Review of Taxation, tax arrangements in place were unstable and its survival could not be guaranteed for a long time. Taxation by all levels of governments has been criticised for its inefficiencies. Furthermore, the mix of all taxes has a big concern as it hinders economic efficiency. Indeed, the Review found state taxes as one of the most inefficient. It recommended for its abolishment as part of moving to four more efficient tax bases. These are personal income, business income, private consumption and economic rent. In total, Henry Review made a total of 138 recommendations canvassing various aspects of tax issues that include taxation of corporate finance. This report concentrates on the impact that Henry Review recommendations will have on corporate financing, investments and companies in general. Taxation in Australia In comparison with the OECD nations, Australia is not taxed excessively (Enright & Petty 07). Nonetheless, when compared to these nations, the burden of taxation seems to fall disproportionately on businesses and individuals having high income. Further, the tax burden is significantly high than in many other economies in the Asia-Pacific region. The combination of this taxation burden and complexity of the overall tax system as well as several individual taxes has led to poor ranking of Australia in terms of taxation. Several issues in the taxation system brought out this poor ranking hence making Australia to be less disadvantaged in potential investors with some of its key competitors. In this regard, the business community call for the significant reduction of a number of taxes, rebalancing the system, improvement of the tax relationship across all the levels of government, and simplification of the tax administration. Corporate Financing in Australia Taxation is an important factor that affects decisions regarding investments and corporate financing particularly to the taxable investors. The taxation of corporate dividends is carried out in different ways by different countries. The emphasis here will be on Australia, its taxation methods, Henry Review Recommendations and the impact on corporate financing. The Henry Review made 138 recommendations (Enright & Petty 07). These recommendations were well received by the corporate sector because it recommended for abolishment of several taxes. The taxes related to business income, private income, private consumption, and economic rents were not to be eliminated. It recommended that the raising of Australia’s revenue should be concentrated on the following four areas of broad-based taxes: 1. Personal income was recommended to be assessed in a way that is more comprehensive and inclusive. 2. Business income. The dependency of business income as a way to raise revenue was meant to support economic growth. 3. Rents on natural resources and land 4. Private consumption Besides these, other taxes may be introduced only if they improved market efficiency or social outcomes. In the future tax system, Henry Review recommends that other existing taxes should be abolished in the long run. This will result in an efficient tax system that eliminates all the loopholes in the current tax system. Furthermore, there will be clear sources of revenue for the government and the total amount of taxes that can be raised can be projected with ease. As a result, planning of the government expenditure will be easier and development priorities can be identified. Tax on Financing Globalisation has serious implications for the taxation system in Australia. In particular, globalisation affects investment taxation. There is an increase mobility of capital in the world and as such, company income tax as well as other investment taxes have major impact on the business decisions (Godar, Paetz and Truger 95). There has been a relative success in attracting of foreign capital in Australia over recent decades. The growth and development of Asia-pacific region as a favourite foreign investment destination for many investors ensures that Australia get stronger terms of trade. Moreover, this leads to strong investment in the Australian resource sector. In the future, systems should be put in place that ensures that Australia is still an attractive business investment destination. Additionally, investment should be primarily directed towards areas that are most productive. If this is carried out, an expansive and more productive capital stock will lead to attainment of higher growth rate and probably higher wages for Australians in the future. However, the tax system should be reformed. The Henry Review of Taxation made numerous recommendations that touch on corporate financing. Lower Income Tax Rate In comparison with OECD countries, the company income rate in Australia is high (Ganghof, Steffen and Eccleston 519). For example, in 2009, the company tax rate was 30 per cent. This was 5 percentage points higher as compared to other OECD economies with small to medium economies. Indeed, this tax rate was the third highest as shown in appendix (1). The Henry Review recommended a reduction of this tax rate to 25 per cent. A high company tax rate does not attract investors and they would rather prefer to invest in other OECD countries which have lower rates or are significantly reducing their company tax rate. The company tax rate should be reduced in light of these developments if Australia is to remain a regional attractive investment hub. In regard to the company income tax, the tax meted to the company profits also acts the company income tax (Nam 70). The Henry Review recommended the introduction of an improved charging to non-renewable resources taxes and the broad-based resource rent tax. This will ensure that Australians exploits their natural resources in a more effective way. A high investment tax discourages investment activities. Investors or entrepreneurs with brilliant ideas are reluctant to invest because their profits are significantly reduced due to high investment taxes. The reduction of investment taxes will therefore encourage a lot of entrepreneurial and innovation activities. This kind of tax reform increases the income for Australian people through creation of a large and productive capital stock. Furthermore, this is achieved through technology generation that boosts the productivity of Australian businesses. Taxes affect corporate decision making as well as the value of the firm (Graham 574). It affects corporate structure decisions. The firms that are tax highly are likely to pursue policies that will provide them with tax benefits. It is therefore beneficial for the company and the people who are affected by their decisions that company tax should not be high. The recommendation of Henry Review that company tax to be reduced will have far reaching positive effects if implemented. The reduction of company income tax rate has various positive impacts. There are many multinational companies that operate in Australia. A decrease in incentives for foreign multinational companies to move their business profits out of Australia is reduced with a lower income tax rate. The Henry Review Report on the taxation system made a total of 138 recommendations. However, the government only focused on implementing one recommendation; a proposal to levy a comprehensive new tax on the mining industry (Fenna & Anderson 409). This proposal was referred to as ‘Resource Super Profits Tax’ (RSPT) by the government. The revenue that RSPT generates would fund a decrease in the income tax of companies that the report recommends to be reduced. It will also increase infrastructure development and superannuation benefits (Fenna & Anderson 409). The mining industry was against this proposal and conducted campaigns to oppose its implementation. The political debate centred on the tax itself and the impact it will have on the mining industry. The Henry Review had recommended resource rent tax to replace all existing Commonwealth and state resources taxes. However, RSPT was not seen by the industry players as the solution or an alternative to existence of the high corporate tax. The company tax is one of the important tax mix element in Australia. Indeed, the revenue generated from company tax is substantially more than in many countries. Specifically, the company tax accounts for around 5 per cent of the GDP (Stewart et al., 10). It represents 17 per cent of all tax revenues in Australia. Since the company tax constitutes a significant portion of the government revenue, it may seem a logical move to disregard Henry Review recommendation and maintain the tax rate at 30 per cent. However, this will raise other potential problems such as driving away investors. Lack of investment leads to slow economic growth and lack of jobs. It may therefore be prudent to adopt this recommendation and find other ways of raising the tax deficit brought by this reduction. In general, a lower company tax rate result in increased individual’s living standards hence national wellbeing. Management of Foreign Savings The Henry Review recommended for improvement of how Australian managed funds are taxed. This will ensure that conduit income is not part of the overall Australian tax. The taxation arrangements that have been in place for many tears concerning Australia managed funds have created uncertainty around the treatment of conduit income. This reduces Australian managers’ global savings competitiveness. The treatment of cross-border dealings is uncertain due to the presence of ambiguous words in the law. For example, the meaning of ‘Australian source’ is ambiguous and must be specifically defined. Australian managed funds are treated on a flow-through basis which consequently means that the taxation system should be neutral. This should be the case in regard to how savings that are invested in an Australian managed fund should be treated. Nonetheless, the manner in which Australian managed funds are taxed is a complex activity in practice (Robinson, Painter and Solomon 49). It relies on both statutory rules and case law in its administration. Moreover, its governance is through a mixture of trust law and concepts of tax law. These factors are complicated and have thus resulted in uncertainty to the tax outcomes. These difficulties require improvement of how managed funds are treatment for taxation purposes. This will ensure that there is certainty and risk of conduit income being taxed is greatly minimised. The Henry Review recommended that financial institutions operating in Australia should not be part of groups that pays an interest withholding tax on interest payable to non-residents. In Australia, the income tax systems only tax the company’s return on equity. On the other hand, deductions of interest payments are done from the income tax base of the company. In this case, a tax incentive is provided to the companies so that they can finance their investment by using debt rather that use equity capital. This has its negative effects. Indeed, over reliance of debt results in companies being more vulnerable to insolvency (Robinson, Painter and Solomon 48). Furthermore, they are more prone to economic shocks. The way debt and equity are treated for tax purpose is complex. This helps in the creation of opportunities where companies avoid taxation. The increase in innovation of financial products has not helped; instead, it has further complicated this issue. In most cases, financial experts devised these products for purposes of exploiting the difference in how debt and equity are treated in the tax system. The difference between debt and equity is no longer clear enough. The implications that are brought about by how debt and equity are treated in the tax system depend on several financial sources albeit in part. The financing decisions that are tied to tax-induced distortions need to be reduced in order not to encourage firms to rely on debt finance to a large extent. It will also avoid biasing to other business financial decisions made by companies like dividend payouts. In Australia, there are distortions regarding access of foreign debt. This can be significantly reduced if interest withholding tax to interest paid by financial institutions to non-residents that undertakes their operations in Australia is not applied. Treatment and Taxation of Business Entities In Australia, there exist four common forms of business entities. They are corporation, partnership and trust, unincorporated joint venture, and a branch (PricewaterhouseCoopers 32). Corporations are more flexible investment vehicle that is most common in Australia. They are legal entities and are distinct from their shareholders. They are taxed as separate entities. The partnerships and trusts are flow-through entities for purposes of taxation. Unincorporated joint venture is a contractual association between two or more parties. On the other hand, branch refers to an Australian branch of foreign corporation. They are not regarded as separate entities for taxation purposes. However, the recent changes that have been enacted aims to align treatment of branches with how companies are treated for tax purposes. Since shareholders are a distinct entity from the company, the company is taxed as a separate entity. The imputation system is still used in Australia. This ensures that there is no double taxation of profits (PricewaterhouseCoopers 32). The dividend imputation that has been in use provides various benefits that include improvement of neutrality in financing and choices of an entity. Due to these reasons, Henry Review recommended for it to be retained for a period spanning from short to medium. The owners of business entities and the entity itself are sometimes subject to income tax except sole traders. In this case, double taxation can occur easily. The occurrence of double taxation can give rise to high effective tax rates. In cases where double taxation is undesirable, the entity’s income should be attributable to the business owners on an annual basis. In circumstances where tax outcomes are the same, the taxation system should be tailored in such a way that it allows businesses to adopt forms of organisations that are preferable in a commercial sector. The taxes have been found to affect the choice of organisational form through a number of researches that have been conducted. De Mooij and Ederveen 2008 assert that there is evidence supporting the notion that when company income tax rates are reduced, the income is shifted to the corporate sector. The tax system should therefore be devised in such a way that it captures every aspect of entities undertakings. The appropriate tax arrangements should exist and be consistent for different types of entities. Company Tax and Foreign Investment A company is not a real person but a legal fictional character. It therefore cannot bear the economic incidence of company tax. It is rather an intermediary for purposes of taxing others. Shareholders, customers or employees may bear the burden of company tax (Gale and Samwick 01). This is because the economic incidence may shift from capital owners through the effects of wages and prices. There has been always a rationality question as why companies are levied taxes yet they do not bear it. It was acknowledged by the Henry Review that company tax operates to as a fallback to the personal income tax. In this case, it collects taxes from a company as an agent of domestic shareholders. Indeed, a lack of company tax provides incentive to individuals to derive as well as hold business returns and services in an organisation. In terms of administration, company tax is easier than personal income tax. It is collected by form of instalments throughout the year ensuring that the government has an uninterrupted and a steady stream of revenue. Sorenson and Johnson 206 assert that company tax ensures the retained profits in a company or those that have been distributed to non-resident shareholders are subjected to the Australian tax system. There has been a significant debate as to whether the Australian company tax is competitive enough to attract investors. It is often argued that the Australian statutory company tax rate may be having negative impact on its ability to attract international investment in a world that is more globalised than ever before. The revenue statistics shows an effective collection of the company tax in Australia. However, the question that still remains is whether it has a a negative effect to international financing or it is for the good of the nation. The empirical evidence that is available from other countries and from economic modelling suggests the need for tax reform. The company tax rates appear to be decreasing all over the world. Although this clear, the best direction that Australia should follow is not apparent. The Henry Review found strong evidence linking company tax as a significant factor in making decisions of the business. Moreover, the choice of where to invest and the size of the investment are affected by the company tax rates in different countries. Henry et al., (2010, 39) concluded that the Australian tax system makes it difficult to attract foreign investment in other sectors of the economy apart from resource industry. This is because sectors such as manufacturing and services have fewer location-specific advantages in comparison with the resource sector. Impact of Investment Taxes The impact of different taxation levels on economic growth remains a controversial issue with no consensus as to whether it affects a country economic growth. However, there is substantial evidence asserting that the way a country’s taxes are composed do have an effect on economic growth (Gale and Samwick 02). Specifically, there is increasing evidence that a shift away from reliance on the company income tax to relying heavily on the production and consumption taxes has a greater potential of increasing growth and GDP. The income taxes levied on investment may lead to decrease in domestic productivity as it increases the required cost of capital. Furthermore, it also reduces incentive to invest. A smaller domestic capital stock can be achieved which in most cases leads to low wages and productivity. In general, the company income tax affects productivity as it discourages foreign direct investment. It therefore means that investment taxes can significantly affect technological transfers. Conclusion The Henry review is the first comprehensive tax system review in Australia. As such, the government should consider implementing all or majority of these recommendations to ensure that there is future prosperity and new business and investment opportunities are seized. This is because regardless of what the government considers as more pressing issues or what they undertake or not do in the short term, there will always be pressures for fundamental tax reform. The Henry Review recommendation on the reduction of company tax was aimed at improving Australia’s attractiveness as an investment destination and to reduce the overall tax burden on investment. It will also promote higher national incomes as a result of an efficient corporate tax system fully supporting improved productivity as well as capital investment. The five key reform directions for the Australian corporate tax system recommended by Henry Review reflect on these objectives. It includes reduction of burden of company taxation. The investment biases should be reduced through introduction of simpler and uniform capital allowance rules by favouring particular assets and industries. Innovation and corporation risk should be supported by treating taxation of gains in a more symmetrical way. It means taxation of gains as they are being realised. A loss carry back arrangement should be introduced to allow immediate realisation of excess losses. Another key reform direction that was recommended to be introduced by Henry Review is levying of a broad-based rent tax by the Commonwealth government. These reform directions were aimed at enhancing efficiency of the taxation system. It should be noted that the majority of these reforms have not been implemented. Appendices Appendix 1 Appendix 2 Work Cited Australian Industry Group. Tax Reform Priorities: A Position Statement for the Tax Forum, Australian Industry Group, 2011. Canberra. De Mooij, Ruud A., and Sjef Ederveen. "Corporate tax elasticities: a reader's guide to empirical findings." Oxford Review of Economic Policy 24.4 (2008): 680-697. Enright, Michael J, and Richard Petty. Australia's Competitiveness: From Lucky Country to Competitive Country. Hoboken: Wiley, 2013. Print. Fenna, L & Anderson, G, The Rudd Reforms and the Future of Australian Federalism, in Appleby, Gabrielle, Nicholas Aroney, and Thomas John. The Future of Australian Federalism: Comparative and Interdisciplinary Perspectives. Cambridge, UK: Cambridge University Press, 2012. Print. Gale, William G., and Andrew A. Samwick. "Effects of income tax changes on economic growth." Economic Studies at Brookings, 2014. Brookings. Ganghof, Steffen, and Richard Eccleston. "Globalisation and the dilemmas of income taxation in Australia." Australian Journal of Political Science 39.3 (2004): 519-534. Godar, Sarah, Christoph Paetz, and Achim Truger. "Progressive tax reform in OECD countries: Opportunities and obstacles." International Journal of Labour Research 6.1 (2014): 95-125. Graham, John R. "Taxes and corporate finance: A review." Foundations and Trends in Finance, 1.7 (2003):573-691. Henry, K. R. et al, Australia’s Future Tax System: Report to the Treasurer, Part One, Overview, Commonwealth of Australia, 2010. Canberra. Nam, Chang Woon. "Corporate Tax Incentives for R&D Investment in OECD Countries." International Economic Journal 26.1 (2012): 69-84. PricewaterhouseCoopers. Mergers and Acquisitions: A Global Tax Guide. Hoboken, N.J: J. Wiley & Sons, 2006. Print. Robinson, Allens, Warwick Painter and Zeke Solomon. Australia. In Stephen Ball (ed), Hedge Funds: Jurisdictional Comparisons. London: Sweet & Maxwell, 2011. Print. Sorenson, B. and Johnson S.M. Taxing Capital Income: Options for Reform in Australia’ in Melbourne Institute of Applied Economic and and Social Research Australia’s Future Tax and Transfer Policy Conference—Proceedings of a Conference, Commonwealth of Australia, 2010. Canberra. Stewart, M, Andre Moore, Peter Whiteford and Quentin Grafton. A Stocktake of the Tax System and Directions for Reform: Five Years after the Henry Review, Tax and Transfer Policy Institute, 2015. Online. Read More