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THE INSTITUTE OF CHARTERED ACCOUNTANTS IN AUSTRALIA
BUSINESS FORUM 2002
6 - 10 MAY 2002

TAX REFORM OVERVIEW

PRESENTATION BY MR DICK WARBURTON
CHAIRMAN OF THE BOARD OF TAXATION
2pm WEDNESDAY 8 MAY 2002

Introduction

Thank you.

Good afternoon everybody. I would like to thank the Institute of Chartered Accountants in Australia for inviting me to talk to you today.

I last spoke to the Institute at its Business Forum 2001, on 8 May last year, exactly 12 months ago to the day. On this occasion, though, I have been moved from the morning to the much more demanding time of immediately after lunch.

If the wines served were Southcorp products, then I know that I am definitely in trouble!

Of course, the Institute has actively engaged with the Board of Taxation over the intervening 12 months.

The Board met with representatives from the Institute in January, and we have had ongoing dealings throughout our work on the Tax Value Method.

The Institute, particularly through its representative, Ken Traill, has made a good contribution to the development and evaluation of the Tax Value Method. Of course, the Institute has also played a very significant role in testing the conceptual and practical implications of the Tax Value Method over the last month or so.

The Institute is also to be congratulated for more generally engaging with the Government on its tax reform agenda. I hope that the Institute's recent loss of Margaret MacDonald, who is now senior tax adviser to Senator Coonan, will not affect its capacity to continue in this work.

I have been asked to provide an overview of tax reform to date. With the Federal budget being handed down next week, I am sure you will appreciate that it would not be appropriate for me to speculate about what, if any, tax measures, might be announced in that context, even if I knew!

Instead, I would like to reflect briefly on the current state of the Government's tax reform agenda, and to discuss where I see the future for tax reform. I would also like to take this opportunity to provide an update of the Board's work on tax consultation arrangements, the Tax Value Method and some other areas of specific focus.

Business Tax Reform

Turning to the state of the agenda, it is almost cliché now to observe that we have witnessed an enormous amount to tax reform over the last three years. I think it is always useful, though, to remind ourselves of the importance of the achievements to date.

In addition to implementing the GST, we have seen major reform of business taxation flowing from the recommendations of the Ralph Review, including:

• the lowering of the company tax rate to 30 per cent;
• changes to the capital gains tax regime;
• the simplified tax system for small business;
• the unified capital allowances system;
• new debt/equity measures and thin capitalisation arrangements; and
• introduction of the Pay As You Go Withholding System (PAYG).

And, of course, there is still more in the immediate pipeline, most notably the introduction of the company tax consolidations regime due to commence from 1 July.

By any stretch of the imagination, the past three years has been a period major and intensive reform - and one that has placed an enormous strain on taxpayers, tax practitioners and tax law administrators.

Understandably, this has led to calls by some for a pause in the reform process - to allow time for all these major reforms to properly bed down before contemplating further initiatives.

While I have some sympathy with this idea, I don't believe we can afford the luxury just yet. In a competitive world, Australia has to increasingly strive for best practice in all key policy areas if we are to match it with other countries.

Put simply, I believe there are still too many important areas of unfinished business on tax reform to rest on our laurels - even for a short time.

As mentioned, we have still to legislate the all-important consolidated companies tax regime.

The question of what constitutes the appropriate taxation treatment of trusts remains unresolved.

The Government's announced review of Australia's international taxing arrangements needs to be progressed.

There is also a more generic issue, shared I might add with many other developed countries, of a need to address the enormous complexity of our tax laws.

Finally, there is also the need to implement the Government's election commitment to establish a new office of Inspector-General of Taxation.

No doubt, many of you here could identify other issues of some priority. I think there would be a large measure of agreement, however, that the ones I have just mentioned rank among the most important at the present time. Not surprisingly, they are also all matters in which the Board has played, is playing or expects to play an important role.

For the remainder of my talk, therefore, I would like to elaborate on the current status of, or some of the key issues I see with, each of these matters.

Consolidations Regime

Starting with the Companies Consolidation regime, many here may recall that, partly on the advice we were given by the Institute, the Board recommended to the Treasurer in February last year that he defer implementation of this measure by 12 months. The Treasurer agreed.

It was, in particular, abundantly clear at the time that most businesses, especially smaller to medium sized businesses, were simply not prepared for the change.

Reflecting this involvement, the Board subsequently has been concerned to do all it possibly can to ensure that the legislation is enacted from 1 July this year.

To this end, at the request of the Australian Tax Office - but also, I would have to say, in light of some unease among Board members about progress being made at the time - the Board in October last year appointed a private sector representative to the high level steering group oversighting the company consolidations project.

The person was Mr Ken Spence of the Melbourne tax advising firm, Shaddick and Spence. I am sure many here will know and recognise Ken as an expert in corporate tax matters. I believe this initiative proved to be enormously successful in assisting with the development of the draft legislative package released in February.

The feedback the Board received was that Ken played an extremely valuable role in contributing his technical and commercial expertise to the shaping of this package, and in successfully alerting to the pitfalls of some key elements or approaches that otherwise might have been pursued.

The appointment of Ken in this role potentially provides a model for future exercises of this type.

The Board, obviously, is continuing to monitor closely developments with the consolidations legislation and to provide input and assistance where appropriate.

Entity taxation

In conjunction with its recommendation to defer the consolidations legislation, the Board also recommended that the impending Entities Taxation legislation similarly be deferred and re - evaluated in light of the strong community concern at its potential impacts.

In the event, the Treasurer announced that the Government had abandoned the legislation, and that it would commence a new round of consultations on the issue of the appropriate tax treatment of trusts.

The Treasurer also announced that the Board would be involved in this further process.

In taking up the matter, the Board has gone back to a "clean sheet" of paper to identify if there are any specific tax abuses in the area of trusts. The Board has initially been assisted in this task by a Working Party comprising representatives from Treasury, the ATO and a number of external experts and advisers in the field.

The objective has been to identify issues that may require a policy response and, to the extent issues are identified, to provide advice on what the potential options might be. The Board has gone some way in the development of its thinking in these respects, but I would stress that it has not drawn any definite conclusions at this point.

The issues are extremely complex and problematic. People can rest assured, however, that any recommendations the Board makes will protect legitimate small business and farming arrangements involving trusts.

Once its initial position has been settled, the Board intends to advise the Treasurer with a view to canvassing the issues more broadly with stakeholders.

International Taxation

The taxation treatment of company groups and trusts are obviously both important issues. But in my view, issues of even greater importance to Australia's economic future are the way in which, and the extent to which, we tax foreign investment in Australia and the foreign earnings of Australian companies.

Put simply, Australia must have an internationally competitive taxation system.

The reduction in the corporate tax rate, revised tax treaty arrangements with the United States and other recent tax reforms have obviously helped to make us tax competitive with most other industrialised countries.

There seems to be little argument, however, that still more reform is needed if we are to maintain and enhance our position. This is especially so in an environment where other countries also continue to make their tax systems more internationally orientated.

Our tax system must, in particular, continually respond to emerging global trends, important among which are:

• the continuing integration of national economies and the increasing mobility of capital and skilled labour;
• the increasing importance to Australian companies of both foreign shareholders and foreign source income;
• the aging populations in Western economies; and
• the increasing awareness of the need to address the environmental consequences of economic activity.

Responding to these sorts of challenges, the Treasurer last Thursday confirmed and elaborated on the Government's election commitment to consult widely with key stakeholders in reviewing Australia's international taxation arrangements. Importantly, he has also asked the Board of Taxation to undertake the public consultation process over the second half of this year and to report to the Government on outcomes by the end of the year.

As announced by the Treasurer, the review will concentrate on at least four principal areas:

• the dividend imputation system's treatment of foreign source income;
• the foreign source income rules;
• the treatment of "conduit income," that is foreign source income that flows through an Australian entity to a non-resident investor; and
• the high level policy aspects and processes of our Double Tax Agreements.

The intention is that the consultations on these and any other matters will be based on a discussion paper now being prepared by the Treasury and due for release publicly around the middle of this year.

The Board has not yet decided the full details of the processes it will employ in conducting the consultations. Obviously we would welcome thoughts people may have in that regard, and the Board more generally will be looking to engaging at an early stage with key stakeholders, of which the Institute is clearly one.

The Business Council of Australia, of course, is another key player and it already has taken something of a lead in the debate with the release of its December 2001 discussion paper on Removing Tax Barriers to International Growth.

The Productivity Commission has also made a contribution through its report on Offshore Investment by Australian Firms in February this year. Importantly, this report suggests that, in general, investment overseas by Australian companies has a positive, not negative, impact on jobs and investment in Australia and hence, ought not to be discouraged.

Clearly, we all now have a major task ahead of us, and one we must do right.

The Board, I can assure you, will do its utmost in that respect.

Complexity of the Tax System.

A further major area of unfinished business, in my view, relates to the need to redress the enormous complexity of our tax law.

There does not seem to be any serious argument, in particular, with the proposition that our tax law is currently far too complex and voluminous relative to what it is supposed to achieve.

And it is probably an understatement to say that the recent round of tax reform has done little to remedy the problem!

Australia's income tax law has been described as second only to the United States in terms of complexity and I think it is instructive to note that the United States has recently embarked on exploring means of simplifying its tax law.

On 25 February this year the Secretary to the US Treasury, Mr Paul O'Neill, mentioned in an address to the US Chamber of Commerce that the complexity of the US tax code strangles US prosperity. He noted that it is, in particular, a drag on the ability to create new jobs in the USA.

I suspect the same is true for Australia.

It should come as little of a surprise therefore that, since its inception, by far the major focus of the Board has been on two broad issues that go directly to the question of achieving simpler and more efficient tax law in Australia.

Many here will know that when establishing the Board in August 2000, the Treasurer assigned to it an initial task of further developing and evaluating the so called Tax Value Method for calculating taxable income. The TVM, of course, was recommended by the Ralph Review of Business Taxation as a means to achieving, among other things, a simpler more coherent income tax law.

Early in its life, the Board itself also embarked on a major project of identifying best practice arrangements and processes for effective community engagement and input into the development of tax laws. In the Board's view, such engagement and input is essential to achieving good tax law outcomes, including in terms of simplicity and laws more attuned to commercial realities and the individual circumstances taxpayers. Of course, facilitating such input is also an area central to the Board's role.

Community Consultation

The Board completed its work on community consultation arrangements in March, and the Treasurer announced the Government's response to its recommendations also last Thursday.

Thursday was indeed a big day for the Board!

Given its central importance to the Board's on-going role, the Board put a great deal of time and effort into this project.

In particular, we last year commissioned KPMG Consulting to extensively canvass community views and ideas about the current community consultation processes and what might constitute best practice in the future.

Many here will have participated in that exercise, either by completing the survey developed and distributed by KPMG or otherwise through attendance at the various stakeholder meetings KPMG conducted.

In addition to the information garnered through the KPMG exercise, the Board also itself conducted investigations into the issue, including a more detailed assessment of arrangements employed in New Zealand, which are recognised as being at near the forefront of current world best practice.

The upshot was a set of recommendations intended to formalise and strengthen the quality and effectiveness of community consultation processes in tax law design and implementation.

I am very pleased to say that the Treasurer accepted the Board's recommendations virtually in their entirety. In particular, he endorsed and committed the Government to:

• Consulting on all substantive tax legislation initiatives, other than in obvious circumstances of extreme commercial, market or tax avoidance and like sensitivities.
• Seeking early external input in the identification and assessment of high level policy and implementation options.
• Seeking technical and other input from external stakeholders, including the Board , in the development of the policy and legislative detail.
• Thoroughly road testing draft legislation and related products prior to implementation.
• Ensuring the policy intent of each new measure is clearly established and described by public announcement.
• Announcing for each new measure the consultation process to be followed and the roles and responsibilities of those conducting it.

The Treasurer also endorsed the Board's recommendations to release forward work programs of tax legislation and to provide better feedback to external participants in consultation processes.

A further recommendation of the Board, albeit one from which, for obvious reasons, the government members abstained, was that responsibility for the drafting of tax legislation should be transferred from the Tax Office to the Treasury.

The Treasurer has announced that this too will happen, from 1 July this year.

All of this, clearly, represents an exceptionally good outcome. A win-win, I believe, for all concerned.

The Government should benefit enormously from the greater surety these arrangements will provide that its policy proposals can be effectively and efficiently implemented. Taxpayers and their advisers should also benefit greatly from the greater opportunity the arrangements will provide for ensuring that our tax laws are more attuned to commercial practice and realities, and to taxpayer's individual circumstances.

The transfer of the legislative function will also, I believe, assist greatly in clarifying responsibilities and accountabilities throughout the legislative development process.

I should add here that, in making this recommendation, we were not seeking to condemn or criticise the Australian Tax Office for its work in the area. Rather, the intention is to address what we saw as a fundamental structural flaw in current arrangements, one which impeded outcomes notwithstanding the best of efforts and motives of all involved.

Consistent with its Charter, the Board will continue closely to monitor and advise on the implementation and on-going operation of the new arrangements.

Tax Value Method

In contrast with the Community Consultations project, the Board's work in evaluating the Tax Value Method is still progressing. However, we are now well into the final phase in formulating our recommendation to the Government on the future of this proposal, which we are due to submit by around end-June.

By any stretch of the imagination, this too has been a major task.

As I mentioned earlier, the TVM has its origin in the Ralph Review of Business Taxation, when it was known as "Option 2". The Ralph Review sparked off an extensive public debate on the TVM, which ultimately led to its being referred to the Board.

The thrust of the debate was between those who believed the TVM had conceptual merit, and those who doubted that it would be feasible to introduce it.

I have always likened the Board's work on the TVM to an R&D project typically undertaken by a large corporate. Most R & D projects, of course, begin with a good idea, before the discussion turns to whether it can be implemented. Along the way, there will also always be people who believe the investment involved could be better made elsewhere, to address needs perceived to be of a higher, more immediate priority.

I think that has truly been the experience of the TVM exercise.

The majority view early last year was clearly that there was insufficient information available to judge the practicalities of going down the TVM path.

Against that background, the Board determined a strategy for its further development and evaluation of the TVM which:

• First, focussed on developing further the facts about the TVM; and
• Second, promoted or sponsored the progressive testing and evaluation of the concept, with an emphasis on road testing in partnership with companies and tax practitioners.

The Board also determined that its processes for developing and evaluating the TVM should be both open and inclusive of all stakeholders.

When the Board embarked on this exercise, it established two groups to assist it.

The first is a small TVM Legislative Group charged with developing the TVM demonstration legislation and associated explanatory material. Led by Andrew England of the ATO, and advised by Paul Abbey of Shaddick & Spence, its other members were drawn from the ATO and Treasury.

The second is a larger TVM Working Group, whose membership includes the key members of the Legislative Group plus some 19 non-government sector tax experts drawn from the accounting, tax advising, corporate and academic spheres. This Group has been responsible for assisting with the development of the draft legislation and also in assisting with the evaluation of the TVM.

As mentioned earlier, the Institute has been well represented on this Group by Ken Trail.

The members of the Working Group have throughout the exercise been free to liaise more generally with others in the community, and all information generated from the process has been exposed publicly on the Board's web site as and when it has become available.

Four prototypes of TVM demonstration legislation were in fact produced and made available through the Board's web site: each new prototype refining and adding to the former.

The Board also set itself a timeframe of broadly some eighteen months in which to complete its work, targeting around the middle of this year as the time by which it would present its findings and recommendations to the Treasurer.

Needless to say, we have since adhered faithfully to this strategy and timeframe.

The culmination of most of the Board's TVM development work was the package of material it released publicly in March this year. In particular, at the Board's March Consultative Briefing, it released four key publications:

• A TVM overview document, providing what I would term an "executive summary" of the concept and what it seeks to achieve;
• A more detailed TVM Information Paper that provides very comprehensive information about what the TVM is, the rationale for considering the idea, and what the key benefits of adopting it might be;
• The fourth prototype of draft TVM legislation, intended to demonstrate and assist in assessing the practical application of the TVM; and
• Explanatory Material to the prototype legislation, which also gives guidance as to how some important but as yet undrafted parts of the current law would be encapsulated in a TVM framework.

This clearly was a very comprehensive package of demonstration and explanatory materials.

Indeed, for a policy matter that has not yet been decided by a government, it probably represents the most comprehensive package of its type ever assembled in Australia.

The Board asked for public submissions to be lodged with it by the end of April, and copies of all submissions so far received will shortly be available on the Board's web site.

The Board, of course, is now in the process of evaluating those submissions.

I think it is fair to say that the tenor of the public commentary coming from the practitioner organisations and others over the past several weeks has generally been negative towards the TVM. In its evaluation of the issue, however, I think it is fundamentally important that the Board focuses carefully on the reasons underpinning peoples concerns.

In an environment where we have all had to cope with a great deal of tax reform, and in many cases are still trying to cope, it is quite understandable that there will be a good deal of emotion and scepticism pervading about the prospects of such a major and fundamental reform that the TVM would represent.

What the Board is seeking to do, however, is to move beyond this - to objectively assess all of the issues on their respective merits.

To that end, the testing which the ICAA conducted under the Board's sponsorship has been very important in identifying many of the specific areas of concern, and the extent of the concerns.

The Board is now carefully evaluating all of the information derived from the ICAA's testing and will be assimilating it with that coming from submissions and other research work the Board has commissioned, and which is now coming to fruition.

The latter includes work the Board has commissioned from Associate Professor Chris Evans, Director of the Australian Taxation Studies Program at the University of New South Wales intended to provide an independent and indicative evaluation of the potential transitional and on-going compliance costs in adopting the TVM.

The Board also has commissioned Professor Graeme Cooper of Melbourne University and Dr Michael Wenzel of the Australian National University to evaluate the extent to which the TVM based law might reduce uncertainty about potential tax outcomes. For example, would the TVM methodology lead to fewer disputes about the correct tax treatment of some transactions?

As well, the Board has sponsored some work on a potential alternative model for restructuring the income tax law, the so called "Option 3" approach, to give it a potential additional benchmark by which to evaluate the TVM.

Implicit from the foregoing is that the Board is not going to be rushed to a judgement on the TVM.

As I see it, the critical issue that we need to determine is not whether there should be a fundamental restructuring and reform of our current income tax law, but, rather, whether the TVM is the most appropriate platform or vehicle for effecting this reform.

If the consensus is that the TVM, or at least the TVM in its entirety, is not the way to go, then obviously, the question becomes what is?

I think the tragedy would be that if, in the determination of some to simply kill off the TVM idea, we were inadvertently to also kill off any prospect of needed fundamental reform to our tax laws for perhaps the next 10 or 20 years.

That certainly was the experience we had with the GST, for example.

So I think that it is of fundamental importance that debate over the TVM, even from this late stage, continues in a rational and objective manner.

Inspector-General of Taxation

Before concluding, I would like to briefly touch also on the Government's proposal to establish an Inspector-General of Taxation.

The Minister for Revenue and Assistant Treasurer, Senator Coonan, has indicated that she will be asking the Board of Taxation to consult on the Government's proposal for this office, and will also be seeking the Board's own views on the matter.

When the Government releases its proposal, expected to be in the form of a discussion paper, the Board will be publishing its own consultation plan for its work on this topic. The Board will be making the Consultation Plan and further material about the Government's proposal available through its web site.

I encourage you to take the opportunity to make your views known to the Board on this important issue.

Concluding Remarks

I have covered a lot of territory so far this afternoon and I would conclude by thanking you for your attention.

Evident is that the Government still has a very active tax reform agenda and that the Board of Taxation also continues to be very active in pursuing its charter to enhance community input in the processes for developing and implementing taxation legislation.

The Board faces a major challenge over the next couple of months as it puts together its recommendation on the Tax Value Method.

Apart from the Tax Value Method, the Board's agenda over the remainder of the year will include its consideration of the taxation of trusts and the proposal to establish an Inspector-General of Taxation.

I am confident also that the Board will play a significant role in the Government's foreshadowed review of international taxation arrangements.

I continue to look forward to your support, both individually and through the Institute, as we strive to improve our taxation system.

Thank you again for your time this afternoon.