The report of the Henry Review of the Australian taxation and transfer system released on 2 May 2010, entitled 'Australia's Future Tax System' (the Report) is the 'root and branch' review into the taxation and transfer system proposed by the Australian Labor Party at the election in 2007. It contains some 138 recommendations for long-term reform of the tax and transfer system. It found that there are currently 125 taxes in aggregate imposed by all levels of Government in Australia. However, 90% of the tax collected in Australia is raised by only 10 of those taxes. This has led to the half-serious suggestion in taxation circles that the simplest and most efficient form of taxation reform in this country would be to raise those 10 taxes by about 10% and eliminate the other 115!

Also on 2 May 2010 the Government released its 'Stronger Fairer Simpler – A tax plan for our future' response to the Report.

Some commentators have criticised the Government for only adopting a few of the Report's recommendations about tax. However, some 56 of the recommendations in the Report relate to reform of the transfer payment system, governance and administration of the taxation system, local Government and monitoring and reporting on the tax and transfer system.

A discussion of the transfer payment system is outside the scope of this article, which deals with the taxation issues. Also this article does not discuss the recommendations in relation to personal savings, personal taxation and taxation of retirement income.

Based on modelling presented to the Review, there is a potential overall gain of 2% to 3% of GDP from the implementation of its major tax recommendations.

The Henry Report

The fundamental recommendation of the Report is that the taxation system should raise revenue from four efficient tax bases, namely:

1. personal income tax 
   
2. business income
   
3. private consumption, and
   
4. economic rents.

Other taxes should only be maintained if they address efficiently social issues such as the 'sin taxes' on alcohol, tobacco and gambling and environmental charges or economic issues such as taxes for road use.

Taxes which should go

The following taxes should be abolished:

• insurance taxes
  
• payroll tax
  
• property transfer taxes (stamp duty)
  
• stamp duties on the purchase of motor vehicles
  
• resource royalties replaced by the rent tax
  
• luxury car tax
  
• the tax on superannuation contributions in the fund
  
• income taxes on all Government pensions, allowances and benefits, and
  
• fuel and vehicle registration taxes, if replaced by more efficient road user charges.

Business income

Recommended improvements in business taxation arrangements include:

• reduce the company tax rate to 25% over the medium term
  
• consider a business expenditure tax, for example, with an allowance for corporate equity
  
• dividend imputation should be removed over the medium term
  
• reduce the compliance cost for small business
  
• enhance the capital allowance allowed for write-off of income producing assets, and in particular small businesses should be encouraged with a low value asset write-off with a high threshold for small business, and more streamlined small business capital gains tax (CGT) rules.

The taxation rules concerning trusts should be updated and re-written.

The small business CGT rules should be revised to:

• remove the active asset 50% reduction and 15 year exemption concessions
  
• increase the lifetime limit of the retirement exemption by permanently aligning it with the CGT cap for contributions to a superannuation fund, and
  
• allow taxpayers who sell a share in a company or an interest in a trust to access the concessions through the turnover test.

Other CGT proposals are:

• remove current grandfathering provisions relating to pre-CGT assets with a market value cost base provided for those assets when the exemption is removed (or before the end of the previous indexation arrangements), allowing a relatively long lead time, and
  
• re-write the CGT legislation using a 'principles-based' approach to integrate it better with the rest of the income tax system.

Consumption taxes

While the terms of reference of the Henry Review excluded a consideration of goods and services tax (GST) the Report contains a number of recommendations which would impact upon the operation of the GST if adopted:

• replacing all State consumption and payroll taxes with a low rate broad based cash flow tax that exempts business exports sales, and
  
• replacing the GST input taxation of financial services with a more efficient and simpler financial services tax.

Land and resource taxes

Perhaps the most radical changes to Australia's taxation system would be brought about if the Government adopted the Report's recommendations in relation to land tax and economic rent taxes in relation to natural resources.

Land tax

Land tax should apply equally to all land users and aggregate holdings. Thresholds and rates of the land tax should be set at differing levels based on the land value per square metre. Accordingly, lower value use land, such as agricultural land, would face no or limited land tax and moderate rates would apply to other types of land due to the broad base. A long transition period would be necessary to slow the valuation effects of this change in the system.

Resource rent rax (RRT)

The recommendation of the Henry Report which has achieved the most notoriety to date, is the proposal for introduction of an RRT. The Report proposes replacing all current resource charging arrangements at both Federal and State Government level with a uniform RRT imposed and administered by the Federal Government on the following basis:

• a 40% rate which, with the company tax rate at 25% would achieve an effective rate of 55% on mining profits
  
• applies to non-renewable resources (oil, gas and minerals) projects except for lower value minerals
  
• measures rents as net income less an allowance for corporate capital at the long term Australian Government bond rate
  
• allows losses to be carried forward with interest or transferred to other commonly owned projects with the tax value of residual losses refunded when a project is closed
  
• is allowed as a deductible expense in the calculation of income tax with loss refunds treated as assessable income
  
• applies to existing projects with an adjustment for the invested capital starting base.

All fees and stamp duties on the transfer of interests in a resource project, except those related to administrative costs would be abolished.

Exploration expenses

If exploration expenses are to receive earlier access to tax benefits than other expenses (as they do), then this should take the form of a refundable tax offset at the company level, for exploration expenses incurred by Australian small listed exploration companies, with the offset set at the company income tax rate. The Report did not recommend the adoption of 'flow through' share schemes allowing for exploration companies to pass losses to their shareholders.

Taxation of financial institutions

Assisting Australia to be a regional financial centre:

• financial institutions operating in Australia should generally not be subject to interest withholding tax on interest paid to non-residents
  
• consider negotiating future tax treaties and amendments to tax treaties to reduce interest withholding tax to zero, with appropriate safeguards against tax avoidance, and
  
• tax Australian managed funds and related services so as to provide greater certainty that conduit income will not be subject to Australian tax.

Not-for-profits (NFPs)

The current categories of NFPs qualifying for income tax or GST concessions are appropriate and should remain. NFPs should be permitted to apply their income tax concessions to their commercial activities.

Clubs with large trading activities in the fields of gaming, catering, entertainment and hospitality should be subject to a concessional rate of taxed total net income from those activities above a high threshold, with no tax below the threshold.

The current fringe benefits tax (FBT) concessions for NFPs should be removed over time and replaced with direct Government funding.

Government Response

The Government's initial response to the Henry Review has been:

• to adopt a quite limited number of the recommendations, and
  
• in a press release by the Prime Minister, to identify a significant number of recommendations by the Review and 'some potential misinterpretations of the recommendations' which the Government advises 'it will not implement … at any stage'. These recommendations and misinterpretations are set out in an appendix to that press release.

Notably, they include:

• no changes to negative gearing deductions
  
• no changes to CGT discount arrangements
  
• no application of CGT to pre-CGT assets
  
• no death duty, and
  
• no removal of 'the benefits of' dividend imputation.

Summary of key Government responses

In response to the Report, the Government proposes the following changes in taxation arrangements:

• a reduction in the rate of company tax from 30% to 29% in 2013/14 and a further reduction to 28% from 2013/14 onwards. Small business will obtain the benefit of the new 28% rate from 2012/13
  
• a new resource 'super profits tax' (RSPT) to be introduced for mining project profits at a 40% rate from 1 July 2012 with the RSPT to be deductible against company income tax (resulting in an effective tax rate of 56.8%)
  
• State royalties to apply in parallel to the RSPT but to reduce or offset RSPT
  
• a tax offset for exploration companies where the Australian exploration expenditure results in a tax loss. A flowthrough share scheme will not be implemented. The exploration offset will extend to geothermal exploration
  
• improved and accelerated depreciation arrangements for small businesses with an instant write-off for small business assets worth up to $5,000 and depreciation of all other assets (other than buildings) in a single pool at a rate of 30%
  
• the level of employer contribution to avoid imposition of the superannuation guarantee charge is to rise from 9% to 12% by 2019/20. The rate of contribution will increase by 0.25% in each of the 2014 and 2015 tax years followed by increases of 0.5% up to the 12% rate in the 2020 tax year.

Resources super profits tax (RSPT)

The Government has allowed a period of one year for further consultation and negotiation over the details of the operation and implementation of the RSPT.

The RSPT as announced is not necessarily the same in all respects as the RRT recommended by the Report. In addition, some important matters of detail and some key implications of the RSPT remain uncertain and doubtless will be negotiated, including:

• how is the 'super profit' to be calculated?
  
• is this really a super profits tax or is it a tax on resource profits generally?
  
• will the commodity price cycle effectively allow the RSPT to be passed on to customers?
  
• what is the likely impact on company profits and franking credits available for distribution?
  
• how will the new tax regime address transitional issues for existing projects?
  
• will the tax discriminate against existing projects in favour of new projects?
  
• what implications do existing double tax treaties and other investment treaties have for the introduction of the tax?

2011 Budget

Measures announced in the 2011 Budget which pick up on other Report recommendations include:

• a 50% tax discount on the first $1,000 of interest earned by individuals (from bank, building society and credit union deposits and bonds, debentures and annuity products).
  
• an option for individual taxpayers to claim a standard tax deduction of $500 for work related expenses and costs of managing tax affairs from 1 July 2012 and $1,000 from 1 July 2013.
  
• phasing interest withholding tax paid by financial institutions on most interest paid on off-shore borrowings down from 10% to 5% in two steps by the 2015 tax year, with the aspirational goal of reducing the rate to zero.

Conclusion

Inevitably, not all of the recommendations of the Report will be implemented. Implementation of other recommendations will only occur over the medium to long term. For the first time, there has been a study of the Australian tax system at every level of Government. The Report sets out the principles upon which future tax reform should proceed. The Report considered Australia's position in the context of global markets for labour, goods, services and capital, and having regard to future demographic factors. In that light, the Report is a most significant contribution to the future economic planning of the nation.