Thursday, 28 July 2011

Tax reform in two days? Tell 'em they're dreaming

Now that the long-awaited discussion paper for the Government's tax forum has been released, shouldn't we expect more clarity around goals and more detail about the format?

While it is good to see that the forum will be broken down into sessions around key areas of the taxation system, tax reform is too important to be rushed over a two-day discussion.

At The Tax Institute, we have long called for a measured and structured approach to tax reform. We need a timeline for reform and a process for taking the debate forward beyond the October forum.

What’s missing in the Government’s discussion paper is detail about the format of the forum and the ultimate objectives of the whole exercise. How are 150 different people with at least 300 different points of view on varying aspects of the tax system going to produce a strategic tax reform roadmap for the future?

The discussion paper is a blueprint of some of the key issues already widely canvassed in the Henry Tax Review, which was billed as a ‘once in a generation opportunity for reform’.

The biggest fear for tax professionals is that once the two days of discussions are over, the only tangible output will be a warm glow and a communiqué calling for more discussion.

The Tax Institute is holding its own tax reform event in Sydney on 31 August called ‘The Great Tax Debate’ (www.taxinstitute.com.au/greattaxdebate).  While not in competition with the Government’s tax forum, the Great Tax Debate will provide a platform for real tax reform discussion and undertake some preparatory work that is crucial ahead of the October forum.

What do you think?

Robert Jeremenko 
Senior Tax Counsel

Tuesday, 26 July 2011

How does the carbon price fit within the Tax Act?

There has been a lot of talk about the Government’s carbon pricing mechanism (CPM), including how this new scheme fits within the broader tax agenda. Reform aside, what are the real tax consequences of Australia’s adoption of a CPM?

The first step in understanding the impact of the CPM is to appreciate the mechanics of the proposed system. This is set out in the Government’s plan. I’m not going to provide a detailed description here (many other commentators have already done so, see useful links below). But if you just want the very basics, here is my attempt to explain it in a nutshell.

From 1 July 2012, major polluters will be required to purchase “carbon permits” for every tonne of emissions they produce. In the initial phase, the carbon permits will have a fixed price that is set by the government; after three years, there will be an emissions trading system, where the price of carbon permits will (generally) be determined by market forces. Certain industries are exempt. Some heavy polluters will receive assistance by receiving a number of free permits. In the emissions trading scheme, participants can buy and trade permits. At the end of each period, emitters are required to surrender permits equal to the emissions they produce.  If an emitter does not have sufficient carbon permits, a shortfall emissions charge will apply (which is effectively an inflated charge for carbon permits). 

I must stress, this is a very short form of the mechanics, and it is worthwhile reading the Government’s materials to completely understand the scheme.  Keen observers will note that the CPM is not terribly different to the former Carbon Pollution Reduction Scheme (CPRS), though the politicians will certainly tell you otherwise.

It is worthwhile noting that whilst many, including the Government itself, describe the CPM as a “carbon tax” or “like a tax”, it is not, in the legal sense, a tax. Carbon permits are a form of assignable personal property that will be created under a statute. It is useful to think of them like a license.

The holding, trading and surrendering of carbon permits will have tax consequences. The Government has given some high level guidance on the tax treatment of permits (refer to the Government’s  factsheet and page 109 of the Government’s plan).

I have set out below the Government’s intended tax treatment of carbon permits, as well as The Tax Institute’s initial reactions.

Overall design:  specific provisions will be enacted in the tax legislation to deal with the treatment of carbon permits. This is a good approach, as it should avoid uncertainties (provided the law is drafted clearly!). This is a similar approach to what was adopted under the CPRS – you can check out the ill-fated CPRS tax legislation to get an idea of what the CPM tax legislation might look like (refer to Schedule 2 of the Bill).

Tax treatment of permits: broadly, carbon permits will be treated like an item of trading stock under a rolling balance method, with gains/losses on revenue account. The approach is sound because it removes the complex capital/revenue characterisation issues.

Tax treatment of penalties: the Government proposes that penalties will not be tax deductible.  Though not set out in the announcement, this presumably extends to the emissions charge (which is charged when an entity does not have sufficient permits on hand to meet its emissions liability). We consider that the emissions charge should be deductible, as it is akin to the acquisition of additional permits.

Tax treatment of freely allocated permits: the Government proposes that freely allocated permits will be assessable (that is, to take the view that they are akin to a non-cash benefit, which would usually be assessable). Our view is that freely allocated permits are like a form of compensation; by applying TR 95/35 principles, they should not be included in assessable as income.

Supplies of carbon permits under GST provisions: in a welcome move, the Government has announced that the supply of carbon permits will be GST-free (this is contrast to the position under the former CPRS, where buying and selling a permit would have been a taxable supply). Making the supply of carbon permits GST-free will ensure that significant GST costs (including financing costs and compliance costs) are not incurred by taxpayers.

Supplies of carbon permit derivatives: the Government has announced that he normal GST rules will apply to transactions in financial derivatives of carbon permits.  We are continuing our analysis of the impact of this planned treatment, particularly in light of the existing treatment of derivatives.

The Government’s climate change policy contains a range of programs to encourage emissions abatement, including grants to support the development of clean energy.  It is interesting that the Government has not tinkered with the existing R&D tax concessions in order to offer more support for innovative clean energy projects. We have made a number of suggestions to the Government on how the tax system can be used to support investment in clean energy technology, and we look forward to exploring these possibilities with them. 

The Tax Institute’s Climate Change Committee is standing by to review the draft legislation, which is due to be released by 31 July 2011. Although the interaction with the tax system is not the primary policy driver, it is still crucial that the CPM does not create unnecessary compliance costs, which would ultimately reduce the scheme’s efficiency.
I’m interested to hear your thoughts on the CPM – are there any areas of tax uncertainty that you think the Government should address?

I have listed a few helpful resources and sources of analysis on the CPM. If you have any suggested reading materials, please note them in your comments. 

Useful links
Parliamentary Library’s comparison of the CPRS and the CPM
KPMG's guide
Allens Arthur Robinson’s Climate Change Blog and tax consequences analysis
Freehills’ Brief and a tailored brief for the mining industry
Greenwoods & Freehills' Tax Brief

POST SCRIPT: the draft legislation was released on 28 July 2011 for public comment. You will find the tax amendments in Schedule 2 of the Clean Energy (Consequential Amendments) Bill 2011. Ready, set, review!

Tamera LangTax Counsel, The Tax Institute

Thursday, 21 July 2011

We're big enough to debate a congestion tax

Excluding petrol from the carbon tax package doesn’t mean Australian motorists will be any happier with what governments tax them at the bowser and the disconnection with what's spent on the roads.

Federal fuel excise currently amounts to 38 cents in the litre. The Government receives more than $13 billion from this, yet spends only a fraction of this on roads. The Productivity Commission has been asked by the Government to conduct an inquiry into fuel excise arrangements, including an examination of the merits of a regime based explicitly on the carbon and energy content of fuels. Reports suggest it will also examine whether road-user charges are needed to reduce congestion and discourage driving.

In economic terms, road-user charges (or congestion taxes) impose a surcharge on users of a road transport network in periods of peak demand. The Henry Tax Review suggested this was a way to directly fund transport improvements and new infrastructure projects, as well as enable tax cuts in other areas. Motor vehicle stamp duties could be abolished and compulsory third party insurance could become more fairly priced.

So let’s have this discussion and much more at the Government’s Tax Forum later this year. What are your thoughts?

Robert Jeremenko
Senior Tax Counsel

Wednesday, 13 July 2011

Is this real tax reform?

One of life’s certainties, other than death and taxes, is that all Governments indulge in spin. The challenge is working out where facts taper off and at what point the art of persuasion begins.

Accepting the inevitability that the Gillard Government’s proposed Carbon Tax will pass into law later this year, advocates for a simpler, fairer taxation system have a responsibility to argue for policy outcomes that match rhetoric.

That’s why we have to make it clear that the one thing this policy is not is major tax reform.

It is more like a re-working of parts of the tax system that amounts to a series of adjustments around the edges.

Increasing the tax-free threshold to $18,201 from July 1 next year is the headline-grabber. This equates to an effective tax free threshold of $20,542 – an increase of not much more than 25 percent over the current $16,000 threshold – which is hardly the tripling that some are claiming.

There’s something to be said for the changes removing about a million Australians from the tax system and it was a direction laid out in the Henry Review. It’s a good thing to remove the need for these people to file a tax return. Under the Henry plan, however, the low income tax offset was to be abolished in an effort to make the system simpler.

We still have four income tax thresholds rather than the simple two preferred by Henry. The point at which people move between the thresholds, and hence the tax rates, is what causes distortions in the effective tax rate. This is compounded by any withdrawal of government assistance as people return to the workforce.

These changes have been billed by the Government as delivering “a simpler, more transparent personal tax system.”

In reality, little has changed. The changes are neither simple nor transparent and the package relies heavily on the tax transfer system to compensate low income earners.

That’s why it’s essential the Government seize the moment and lay-out the scope for its planned October Tax Forum. Expand it from a two-day interlude to make it a centrepiece of a true tax reform agenda.

Focus on carbon tax implementation but cast the policy net wider. Give teams of policy experts well-defined briefs in advance, to come up with reform proposals that benefit the whole system.