As a result of measures announced in the 2006-07 Budget, the Government will reduce taxes on business by $4.2 billion over four years. The changes will improve the incentives for businesses to invest in plant and equipment, provide additional incentives to invest in the venture capital industry and significantly reduce the complexity of the tax system for small business.
The Government will encourage additional and more efficient investment in new plant and equipment by increasing the diminishing value rate for determining depreciation deductions from 150 per cent to 200 per cent (referred to as 'double declining balance') for all eligible assets acquired on or after 10 May 2006.
The Government will simplify the tax system for small business by aligning eligibility thresholds for a range of small business tax arrangements, increasing fringe benefits tax thresholds and widening access to the small business capital gains tax concessions for the owners of small businesses.
The Government will also introduce a suite of new measures to encourage venture capital investment.
Business tax reform
A key objective of the Government's approach to business taxation reform has been to create an environment for achieving higher economic growth and a sustainable revenue base through an efficient, competitive and fair business tax regime.
The Review of Business Taxation undertaken in 1998 and 1999 resulted in significant improvements to Australia's business tax system. Most of the reforms following the review have centred on broadening the tax base, reducing tax rates and reducing tax system complexity. The reforms included:
- substantial reductions in the corporate tax rate from 36 per cent to 30 per cent over two years;
- introduction of the consolidation regime, enabling wholly-owned groups to be treated as a single entity with effect from 1 July 2002;
- reducing the tax compliance burden on small business and extending tax relief to these taxpayers through the Simplified Tax System (STS);
- tax relief for demergers;
- the simplified imputation system;
- the entrepreneur's tax offset;
- ensuring the deductibility of business 'blackhole' expenditure;
- advancing work on the taxation of financial arrangements; and
- reforming international taxation arrangements.
Following the Review of Business Taxation the Government also removed accelerated depreciation and aligned tax depreciation rates to an asset's effective life. This met two broad policy objectives: to fund substantially a reduction in the company tax rate and to remove tax-induced distortions to investment decisions. The measure builds on this reform ensuring tax depreciation more closely aligns with the way assets actually decline in value.
Improving Australia's depreciation arrangements
The Government will increase the diminishing value rate from 150 per cent to 200 per cent for depreciating assets. The new rate will apply to eligible assets acquired on or after 10 May 2006, regardless of the asset's effective life.
This measure provides a direct benefit to Australian businesses of $3.7 billion over the next four years. Importantly, it ensures that Australian businesses have the right incentive to undertake investment in new plant and equipment that is necessary for them to keep pace with new technology and remain competitive. It will also improve resource allocation by aligning depreciation deductions for tax purposes more closely with the actual decline in the economic value of assets.
Depreciation and the tax system
Depreciating assets are assets that can reasonably be expected to decline in value over time. The tax system recognises this decline in value by allowing deductions for the cost of assets used in the production of assessable income. The current effective life depreciation arrangements are directed at allowing the taxpayer to deduct an estimate of the actual decline in the value of the asset each year.
There are assets that wear out more rapidly in the early years of use. For these assets, taxpayers can use the diminishing value method to determine deductibility, and concentrate deductions in the initial years in which an asset is held. The prime cost (straight-line) method of depreciation is available for assets that wear out evenly over time. Generally, taxpayers have a choice between the diminishing value and prime cost methods.
The diminishing value rate was 150 per cent of the prime cost for all applicable assets. As noted in the report International Comparison of Australia's Taxes, approaches to depreciation differ across countries. However, of the 10 OECD comparator countries studied, Australia had the equal lowest present value of depreciation allowances for an eight-year asset.
Several of the comparator countries have a diminishing value rate of 200 per cent. Academic studies suggest that a diminishing value rate of 200 per cent may more closely approximate the actual decline in the economic value for assets generally.
To ensure that depreciation rates are competitive in a world of rapidly advancing technology, the diminishing value rate has been increased to 200 per cent.
Chart 9: Present value of depreciation as a proportion of initial purchase price(a)
Eight-year asset — selected countries
- The present value figures do not include the value of investment allowances.
Source: Devereux, MP, Griffith, R and Klemm, A. (2002) 'Corporate income tax reforms and international tax competition' Economic Policy, 35, 451-495, Institute of Fiscal Studies http://www.ifs.org.uk/publications.php?publication_id=3210 and Treasury estimates.
As shown in Chart 9, this measure will bring Australia more into line with other comparable countries, enhancing the international competitiveness of Australian business.
This reform is not a reintroduction of accelerated depreciation, available in some countries, which can distort resource allocation. Instead, it builds on the reforms of the Review of Business Taxation, which focused on the key issue of aligning depreciation with the effective life of an asset. This reform will provide a more neutral arrangement across depreciating assets by bringing the rate of depreciation for tax purposes more closely into line with economic depreciation.
Improving incentives to invest
Increasing the diminishing value rate from 150 per cent to 200 per cent for depreciating assets will allow businesses to write off the cost of new plant and equipment more rapidly for tax purposes, reducing the cost of investing in eligible assets over their effective lives (see Box 3). This will directly reduce the cost of investment, particularly for start-ups and new enterprises in the crucial early phase of a business venture.
The measure is equivalent to a 33 per cent increase in the allowable depreciation rate for all eligible assets. For example, for an asset with a ten-year effective life, the annual rate of depreciation will increase from the current rate of 15 per cent to 20 per cent.
Box 3: How the increased diminishing value rate will benefit business
The following examples illustrate how the increase in the diminishing value rate will affect the depreciation deductions that a business can claim. The increase in the diminishing value rate increases the deductions available to a business early in the asset's effective life, when assets typically decline most in value.
As shown in the examples below, the increase in the diminishing value factor does not change the effective life over which the assets are depreciated or the total dollar amount written off over the asset's effective life (assuming assets are scrapped at the end). However, the depreciation deductions in the early part of the asset's effective life are higher, increasing their net present value and reducing a business's financial cost of holding the asset.
Table 3: Depreciation on a new $4,000 computer — effective life of 4 years
Table 4: Depreciation on a new $20,000 forklift — effective life of 11 years
Improving resource allocation
Taxation is only one of a number of factors that are taken into account when making investment decisions. However, the favourability or otherwise of the tax treatment of an investment can have a significant impact on investment decisions.
The diminishing value method is intended to approximate the actual decline in value of an asset and the true cost to taxpayers of the asset as an input cost. Where depreciation deductions are less than this actual cost, taxpayers may hold assets longer than necessary to maximise the tax benefit from their investment. As a consequence, the rate of change of the increase in capital stock will be lower than it would otherwise be without the tax-induced distortion. This has a negative impact on productivity and economic growth.
Where possible, all forms of investment should be taxed neutrally so that the tax system does not divert investment away from the most productive assets. If the tax system biases investment decisions, this will lead to an inefficient allocation of resources and impede productivity and economic growth.
Ensuring, as far as possible, that depreciation for tax purposes aligns with the way assets actually decline in value ensures the tax system is neutral with respect to investment incentives.
The measure will provide a substantial benefit to both individuals and businesses. It will encourage additional and more efficient investment in all eligible plant and equipment, which will strengthen prospects for economic and employment growth through capital deepening and improved resource allocation.
The 200 per cent diminishing value rate will apply to eligible assets (new and second hand) acquired on or after 10 May 2006, including assets with statutory caps. It will also apply to project pool expenditure for new projects.
The simplified depreciation arrangements for small businesses under the STS, low-value pools and special arrangements for horticultural plants will not be changed.
Reducing complexity for small business
The Government will introduce a number of reforms to simplify the tax system for small business. These reforms will reduce taxes on small business by $435 million over four years and deliver $40 million worth of changes to simplify fringe benefits tax. These measures reduce compliance costs for small business and allow more taxpayers to be eligible for the small business tax arrangements.
In recognition of the potentially significant economic and social costs of complexity, the Government established the Taskforce on Reducing Regulatory Burdens on Business (the Taskforce) in October 2005.
In April 2006, the Government issued an interim response to some of the Taskforce's recommendations, including reforms to fringe benefits tax, that the Taskforce had identified as a priority for reducing tax complexity for business. This budget builds on those announcements, with a range of measures directed at further reducing the complexity faced by small business. In aggregate, the simplification measures included in this budget:
- address concerns about the complexity associated with the range of small business definitions in the tax law by:
- aligning a range of small business measures set at turnover levels of between $1 million and $2 million;
- aligning certain methodologies by which turnover is calculated under the STS and goods and services tax;
- increasing the STS annual turnover threshold from $1 million to $2 million;
- removing the $3 million depreciating assets test from the STS eligibility requirements altogether; and
- increasing the net assets threshold for the capital gains tax (CGT) small business concessions from $5 million to $6 million;
- allow STS taxpayers to be eligible for the CGT small business concessions without having to satisfy the net assets threshold and to pay quarterly pay as you go instalments on the basis of GDP‑adjusted notional tax;
- introduce a number of measures that will simplify and extend small business access to CGT concessions in response to the Board of Taxation's post implementation review of small business CGT arrangements;
- In addition to responding to the Board of Taxation's review, the measure also improves access to the small business capital gains tax concessions for the owners of small businesses by replacing the current 50 per cent controlling individual test with a 20 per cent significant individual test.
- extend depreciating asset roll-over relief under the uniform capital allowance regime to situations where a sole trader, trustee or partnership in the STS disposes of all the assets in an STS pool to a wholly‑owned company;
- increase the fringe benefits tax reporting and minor benefits thresholds in response to the report of the Taskforce; and
- increase the in-house fringe benefits tax-free threshold from $500 to $1,000.
Encouraging investment in venture capital
The Government will introduce a suite of new measures to encourage venture capital investment. The Government will introduce an early stage venture capital limited partnership investment vehicle to provide investors with flow-through tax treatment and a complete tax exemption on capital and revenue gains. The existing venture capital limited partnership vehicle will be enhanced by easing a number of restrictions.
The Government will also provide $200 million to support a third round of the Innovation Investment Fund programme. This will increase the number of fund managers with expertise in the venture capital sector and provide more start-up capital to new companies, particularly those with a technology focus.