The Rudd Government today announces important new measures to improve the integrity of the tax system and protect Commonwealth revenues needed to support jobs and invest in nation-building in the face of the global recession.
The new measures will save around $880 million in extra revenue over the forward estimates and will help ensure everyone pays their fair share of tax.
Firstly, the Rudd Government will close a tax loophole that allows a relatively small number -around 11,000 - of mostly high wealth individuals to exploit parts of the tax system to unfairly minimise or avoid their tax obligations.
Specifically, the Government will remove the ability for high income individuals to deduct losses from unprofitable business activities against their own income.
The Government will do this by tightening the rules in the income tax law applying to the use of non-commercial losses.
In certain circumstances, where expenses exceed income earned from non-commercial business activities, salaried employees can reduce their salary income with these excess expenses. Many of these activities do not have a commercial purpose or character and are no more than hobbies or lifestyle choices.
This can mean that unfair personal income tax deductions can be claimed against salary, wage and other income for activities like running hobby farms that don't have a commercial purpose and may not ever make a profit.
To address this loophole, from 1 July 2009, taxpayers with adjusted taxable incomes of over $250,000 will only be able to deduct those expenses against the income from the non‑commercial business activity.
The Government will also tighten the rules relating to the taxation of benefits provided by a private company to its shareholders or their associates. The measure removes the scope for private companies to allow company assets – such as real estate, cars and boats – to be used for free, or at less than their arm's length value without paying tax.
By contrast, the same use of the asset by an employee – rather than a shareholder – would attract fringe benefits tax.
However from 1 July 2009 the Government will remove this inconsistent treatment, helping to ensure that shareholders pay their fair share of tax.
Both of these measures will apply from the beginning of the 2009-10 income year.
The Government will also take steps to prevent taxpayers from avoiding paying tax on distributions from closely-held trusts – which are trusts that generally have fewer than 20 beneficiaries.
From 1 July 2010, closely-held trusts will need to withhold amounts from trust distributions at the top marginal tax rate where taxpayers have not provided a tax file number to the trustee. Such arrangements are already widely applied elsewhere in the tax law, including to bank accounts and other trust distributions.
This will ensure that taxable distributions to a beneficiary of a closely-held trust, including a family trust, are included in the beneficiary's tax return.
Full details of the changes are contained in the Attachments.
The Government is closing a tax loophole that allows a relatively small number (around 11,000) of predominantly high wealth individuals to exploit parts of the tax system to unfairly minimise or avoid tax.
The loophole effectively allows individuals to claim tax deductions for non-commercial business activities against their other income. It operates as follows:
The measure will ensure excess deductions from unprofitable business activities cannot be used to reduce salary, wage and other income of high income earners by tightening the application of the non‑commercial losses rules. Taxpayers with an adjusted taxable income of over $250,000 will instead have excess deductions quarantined to the business activity. The existing rules will continue to apply to taxpayers with an adjusted taxable income of $250,000 or less.
Taxpayers will still have the ability to apply to the Commissioner of Taxation for relief from the rules if there are exceptional circumstances or because the nature of the activities means that a taxpayer is temporarily carrying on an uncommercial business but the activities they are undertaking are nonetheless independently assessed as commercially viable.
Ted is an executive in a large multinational company. Ted's salary is $290,000 for the 2009‑10 income year. Ted also has a hobby farm, which runs at a loss each year. In the 2009-10 year, the hobby farm makes a loss of $40,000.
Under the current law, Ted passes the non-commercial losses real property test and therefore can claim his business losses.
Ted's taxable income has therefore been reduced to $250,000 [$290,000 – $40,000] from $290,000. This provides an unfair tax saving of $18,600.
Under the proposed changes, Ted's adjusted taxable income (ignoring his business losses) is $290,000.
Ted does not lose the deductions – but he can only use them to offset future income from the hobby farm.
The Government will extend the operation of the non-commercial loan rules in Division 7A of the Income Tax Assessment Act 1936 to cover circumstances where a shareholder (or their associates) is permitted to use a company asset such as real estate, a car or boat for free or at a discounted rate. While fringe benefits tax would apply to the use of such assets by employees, the same use of the assets by shareholders would be tax free.
This measure will remove this inconsistent treatment by deeming a 'payment' made to a shareholder through the free use of a company asset to be a dividend and taxable accordingly. In doing so, it will ensure that shareholders pay their fair share of tax.
Ben is a shareholder of private company which manufactures luxury yachts. It owns a luxury yacht for sales demonstration purposes. On weekends, the company allows Ben to use the yacht for free.
Ben is not an employee of the company so Ben's use of the luxury yacht is not be subject to fringe benefits tax. Under the proposed amendments, Ben will be required to pay for his weekend use of the yacht (at market value rates), otherwise the use will result in the company being treated as making a deemed dividend that Ben has to pay tax on.
The non-commercial loan rules will also be further strengthened to ensure that corporate limited partnerships cannot be used to circumvent Division 7A. Other technical amendments to Division 7A will also be made to strengthen its operation. The Government will consult on the form of the intended changes.
With effect from 1 July 2010, the Government will also extend the current TFN withholding arrangements to closely-held trusts, including family trusts, to ensure that the assessable distributions to beneficiaries of these trusts align with the amounts included by these beneficiaries in their tax returns.
It operates as follows:
Michael is a beneficiary of a closely held trust who is entitled to a distribution of $100 of trust income. Michael is assessable on the distribution and has not provided his TFN to the trustee of the trust.
Under the current law Michael will receive the full $100 distribution from the trust when it makes the distribution.
Under the proposed changes to the law, for Michael to receive the full $100 distribution from the trust he will need to quote his TFN to the trustee before they make the distribution.
If Michael fails to provide his TFN to the trustee of the trust, the trustee will be required to withhold $46.50 from the $100 distribution and remit the withheld amount to the ATO.
Michael may then claim a credit for the tax withheld in his annual tax return. For example, if Michael's marginal tax rate is 31.5 per cent (including Medicare levy), he would get a refund of $15 after he lodges his return.
The measure will also help to improve the efficiency and effectiveness of the Tax Office's income matching system as a means of ensuring that closely-held trusts and their beneficiaries comply with the taxation law. TFN withholding arrangements already apply, broadly, to salary and wage income, dividends, interest and unit trust distribution entitlements.
12 May 2009