Appendix 2: Tax summary
The Inquiry has identified a number of taxes that distort the allocation of funding and risk in the economy. The Funding chapter explores these issues in detail. The Inquiry has also identified other tax issues that may adversely affect outcomes in the financial system. The tax issues listed below should be considered as part of the Tax White Paper process unless they are already under active Government consideration.
|Differentiated tax treatment of savings vehicles||The tax system treats the returns from some savings vehicles more favourably than others. Interest income from bank deposits and fixed-income securities are taxed at individuals’ marginal tax rates. In contrast, salary-sacrificed superannuation is taxed concessionally. The unequal tax treatment of savings vehicles distorts the asset composition of household balance sheets and the broader flow of funds in the economy.
The relatively unfavourable tax treatment of deposits and fixed-income securities lowers their attractiveness as savings vehicles and increases the cost of this type of funding.
|Negative gearing and capital gains tax||The asymmetric tax treatment of interest costs and other expenses (which are fully tax deductable) and capital gains (which are taxed concessionally) encourages leveraged and speculative investment — particularly in housing. Since the Wallis Inquiry, higher housing debt has been accompanied by a greater exposure to mortgages by lenders. The housing market has become a significant source of risk for the financial system and the economy.|
|Dividend imputation||The case for retaining dividend imputation is less clear than it was in the past. By removing the double taxation of corporate earnings, the introduction of dividend imputation reduced the cost of equity, and so contributed to the general decline in leverage among non-financial corporates. However, the benefits of dividend imputation, particularly in lowering the cost of capital, have arguably declined as Australia’s economy has become more open.
The dividend imputation system creates a bias for individuals and institutional investors, including superannuation funds, to invest in domestic equities. As such, dividend imputation may be affecting the development of the domestic corporate bond market.
Mutuals cannot distribute franking credits, unlike institutions with more traditional company structures, which could be affecting competition in banking.
|Tax treatment of Venture Capital Limited Partnerships||Venture Capital Limited Partnerships are taxed concessionally, but the complex tax rules may be a barrier to fund raising. A recent Board of Taxation review (Review of Taxation Arrangements under the Venture Capital Limited Partnerships Regime) made recommendations to simplify the regime.|
|Tax treatment of superannuation funds||Although the same tax settings apply to all superannuation funds, different tax outcomes between self-managed superannuation funds (SMSFs) and APRA-regulated funds may encourage individuals to establish SMSFs.|
|Tax treatment of legacy products||Legacy products are financial products that are outdated and closed. These include life insurance policies and interests in managed investment schemes. Legacy products are a drag on the efficiency of product providers, which may ultimately lead to higher costs for consumers. In 2009, Treasury proposed a framework for rationalising legacy products, however, this has not yet led to a solution that has been implemented. One significant issue was the tax treatment of underlying assets upon the conversion or consolidation of legacy products into products with equivalent features or benefits.|
|Interest withholding tax (IWT)||IWT may distort the funding decisions of financial institutions and place Australia at a competitive disadvantage internationally.
Deductions for interest paid by a bank branch of a foreign-owned bank and located in Australia to its parent are capped at the LIBOR rate. This can prevent the Australian branch from claiming the full interest cost of borrowing.
Australia is one of the few countries to apply IWT to central clearing parties. This may be placing Australia at a competitive disadvantage when trading derivatives globally.
|Goods and Services Tax (GST)||GST is not levied on most financial services. This may contribute to the financial system being larger than it might otherwise be. Financial service providers that do not charge GST still must pay GST on inputs, but cannot claim input tax credits. Providers pass this cost on to consumers in the form of higher prices.
As a result, households could be over-consuming financial services compared to what they otherwise would if GST was applied to these services. Because the GST is embedded in prices charged to businesses but not charged explicitly, businesses cannot claim input tax credits and therefore pay a higher price for financial services, which would lead them to consume less financial services than they otherwise would.
|The Research and Development (R&D) Tax Incentive||The R&D Tax Incentive provides businesses with tax credits for eligible R&D costs. The tax credits are available to businesses on an annual basis. Particularly for new ventures, access to quarterly R&D tax credits would help alleviate cash flow constraints.|
|Tax treatment of social impact bonds||Social impact bonds pay returns based on associated investments achieving agreed social outcomes. Concessional tax treatment of social impact bonds could increase investor demand.|
|Tax treatment of managed funds||The Johnson review recommended changes to the tax system to address uncertainty and scope issues with regard to funds management. Some proposed changes have been partially implemented, such as the investment management regime and the new tax system for managed investment trusts. Other changes are being considered by Government, such as the tax treatment of collective investment vehicles.|
|Tax treatment of offshore banking units (OBUs)||Submissions seek Government support for OBUs and clarification of associated tax rules.|
|Tax treatment of Islamic financing||Submissions seek clarification of the tax treatment of Islamic finance products and services.|