On 25 October 2022, Federal Treasurer Jim Chalmers introduced his – and the new Labor Government’s – inaugural budget. While it may feel unusual to be talking about a Federal Budget outside of the ordinary May cycle, this timing provided an opportunity for fiscal recalibration given the volatile (and inflationary) macroeconomic environment which has set in since the election.
Although the general electorate was loud in its calls for general cost-of-living concessions, the Government was restrained insomuch as it did not offer anything new in the way of upfront cash-flow relief for households, other than those measures already announced as part of the election cycle.
Key taxation measures introduced in this Budget mean prudent corporates will need to revisit their existing financing arrangements, particularly to consider the debt and equity mix, while the expenditure measures should pique the interest of both the affordable housing and infrastructure sectors.
Tax – stage-three tax cuts remain, but ‘thin-cap’ rules set to change
The focus in the lead up to the Budget was fixed on whether the stage-three tax cuts for individuals legislated under the previous Government would be repealed (that did not occur, meaning that middle and high income taxpayers and their employers alike may rejoice for now). However, corporate clients will need to consider their current financing arrangements, particularly the debt and equity mix, together with their capital management strategies, following substantial changes to the ‘thin-cap’ rules to limit interest deductions and the removal of tax concessions for off-market buy-backs undertaken by listed public companies.
Specifically, multinationals and investors subject to the thin capitalisation regime may need to tweak their levels and location of debt financing following the replacement of the safe harbour ‘debt to asset ratio’ test and the worldwide gearing ‘debt to equity ratio’ with new earnings-based tests. Such new earnings-based tests will limit debt deductions to 30% of an entity’s earnings before interest, taxes, depreciation and amortisation (EBITDA) or in proportion to the worldwide group’s net interest expense as a share of earnings, respectively. These new measures were a critical plank of the Labor tax agenda announced before the recent election to implement key Organisation for Economic Co-operation and Development (OECD) recommendations for reform of the international business tax system and will apply to taxpayers from their first income year commencing on or after 1 July 2023. We have previously discussed the Labor Government’s tax reform agenda, in an earlier Insight here.
Additionally, and of immediate note, from 7.30 pm AEDT on 25 October 2022 the tax treatment of off-market share buy-backs undertaken by listed public companies will be aligned with the treatment of on-market share buy-backs. Historically, off-market buybacks were used as a means of clearing out residual franking credits resting in a company’s franking account. Listed public companies will now have to turn their minds to how to best make their excess franking credits available to their shareholders. Retail investors facing a cost-of-living squeeze will no doubt be hoping for increased dividend distributions as a result. Institutional investors such as superannuation funds will also be interested in this measure as it is likely to change the capital and dividend mix of returns from their investments.
A number of tax measures previously announced by the former government were put on hold or reversed. Arguably the most notable instance of this is that the Government will not proceed with allowing taxpayers to self-assess the effective life of intangible depreciating assets. We anticipate those in technology and R&D heavy spaces to be most affected by this measure, however, any impact should be manageable given that this essentially amounts to a maintaining of the status quo.
Whilst not explicitly stated, the corporate tax changes (particularly those characterising low tax jurisdictions as countries with a tax rate of less than 15%) are consistent with Labor’s commitment to taxing multinationals in Australia at rates that ensure an effective tax rate of at least 15% on global profits. This is in line with the second limb of the strategy outlined in the OECD’s Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (2021).
Finally, the recent and material changes announced by the Government relating to franked distributions funded by capital raisings, that would have retrospective effect, may be further called into question. Hopefully, with the change to off-market buy-backs described above, the Government will allow reason to prevail and drop these measures given their limited impact or at least make the commencement date prospective.
Invigorating affordable housing
The Budget contained a number of measures which can be expected to fuel a marked increase in the size of the affordable housing industry in Australia. Specifically, the Budget contained the following relevant measures:
- the announcement of a $10 billion investment to establish the Housing Australia Fund. It is intended that returns from the Fund will be used to build 30,000 new social and affordable housing dwellings over five years;
- an expansion of the remit of the National Housing Infrastructure Facility to allow greater flexibility in the use of existing funds; and
- the establishment of a national ‘Housing Accord’ in collaboration with the states and territories, delivered over five years, commencing from mid-2024. Under this program the Federal Government would provide $450 million, with “ongoing availability payments” also accessible over the longer term.
Our early sense is that the industry has been receptive to these measures. In particular, the ‘Housing Accord’ is being viewed as a novel and appreciated attempt to enlist and marshal the resources, not only of the Federal Government but also the state and territory governments (which would invariably have input, and possibly counterproductive overlap, on such projects anyway).
Although we do not anticipate an immediate or even short-term alleviation of Australia’s housing shortage as a result of these policies, the staggered implementation of these projects should hopefully go some way towards helping the affordable housing industry grow, while still managing the inflationary concerns which currently plague the residential construction industry.
That being said, we do query whether this delayed implementation will have the unintended consequence of pushing some projects down the pipeline to when the proposed funding is readily available (although this may also be an intentional way of alleviating current demand-side inflation in the construction sector more broadly).
Commitments to infrastructure
Infrastructure is invariably an area of the Budget which attracts headlines and this time around was no different with a number of contentious projects receiving funding commitments, most notably Victoria’s Suburban Rail Loop and high-speed rail in New South Wales.
However, the infrastructure spend was not all glamourous and a number of projects which obtained funding commitments should, once online, go some way to improving in particular the efficiency of Australia’s logistics and distribution network, in turn minimising input costs and reducing supply-side inflationary pressure across most, if not all, sectors.
Some specific financing commitments include:
- $757.7 million over five years to improve mobile and broadband connectivity in rural and regional Australia, including significant investment in the roll-out of mobile base stations;
- $2.6 billion to projects in Victoria, including $2.2 billion for the controversial Suburban Rail Loop East;
- $2.1 billion to projects in Queensland, including $866.4 million towards the Bruce Highway Upgrade and a further $400 million each for the Inland Freight Route and ‘Beef Corridor’ road improvement programs;
- $1.4 billion to projects in New South Wales, including a $500 million commitment for planning corridor acquisition and early works for the Sydney to Newcastle High Speed Rail;
- $400 million committed to the Alice Springs to Halls Creek Corridor roads upgrade;
- $400 million committed to the South Australian component of the Freight Highway Upgrade Program; and
- $350 million to seal Tanami Road and the Central Arnhem Roads in the Northern Territory.
Snapshot of key Treasury measures
Below is a summary of the key Treasury announcements contained in the Federal Budget.
Key Treasury announcements
Australia’s Foreign Investment Framework – an increase to fees and penalties
As previously announced, there will be an increase in foreign investment fees and increase in financial penalties for breaches that relate to residential land.
Fees doubled on 29 July 2022 for all applications made under the foreign investment framework.
The maximum financial penalties that can be applied for breaches in relation to residential land will also double on 1 January 2023.
Depreciation – reversal of the measure allowing taxpayers to self-assess the effective life of intangible depreciating assets
The Government will not proceed with the measure to allow taxpayers to self-assess the effective life of intangible depreciating assets, announced in the 2021–22 Budget.
Reversing this decision will maintain the status quo – the effective lives of intangible depreciating assets will continue to be set by statute.
Digital Currency – clarification that digital currencies are not taxed as foreign currency
The Government will introduce legislation to clarify that digital currencies (such as Bitcoin) continue to be excluded from the Australian income tax treatment of foreign currency.
This maintains the current tax treatment of digital currencies, including the capital gains tax treatment where they are held as an investment.
This measure removes uncertainty following the decision of the Government of El Salvador to adopt Bitcoin as legal tender and will be backdated to income years that include 1 July 2021.
The exclusion does not apply to digital currencies issued by, or under the authority of, a government agency, which continue to be taxed as foreign currency.
Extension of ATO Compliance Programs – including the Personal Income Taxation Compliance Program, Shadow Economy Program and Tax Avoidance Taskforce.
Various ATO Compliance Programs have received significant new funding and there will be an increased focus on work deductions for individuals, the cash economy and various tax avoidance programs.
Improving the integrity of off-market share buy backs
The Government will improve the integrity of the tax system by aligning the tax treatment of off-market share buy-backs undertaken by listed public companies with the treatment of on-market share buy-backs.
This measure will apply from the announcement on Budget night (7.30 pm AEDT on 25 October 2022).
Incentivising pensioners to downsize
The Government will allow more people to make downsizer contributions to their superannuation, by reducing the minimum eligibility age from 60 to 55 years of age.
The measure will have effect from the start of the first quarter after Royal Assent of the enabling legislation.
The downsizer contribution allows people to make a one-off post-tax contribution to their superannuation of up to $300,000 per person from the proceeds of selling their home.
Both members of a couple can contribute and contributions do not count towards non-concessional contribution caps.
Multinational Tax Integrity Package – amending Australia’s interest limitation (thin capitalisation) rules
The Government will strengthen Australia’s thin capitalisation (‘thin cap’) rules to address risks to the corporate tax base arising from the use of excessive debt deductions. This measure will apply to income years commencing on or after 1 July 2023.
The current thin cap regime limits debt deductions up to the maximum of three different tests:
- a safe harbour (debt to asset ratio) test;
- an arm’s length debt test; and
- a worldwide gearing (debt to equity ratio) test.
The Government will replace the safe harbour and worldwide gearing tests with earnings-based tests to limit debt deductions in line with an entity’s activities (profits).
This measure includes changes to:
- limit an entity’s debt-related deductions to 30% of profits (using EBITDA — earnings before interest, taxes, depreciation and amortisation – as the measure of profit). This new earnings-based test will replace the safe harbour test;
- allow deductions denied under the entity-level EBITDA test (interest expense amounts exceeding the 30% EBITDA ratio) to be carried forward and claimed in a subsequent income year (up to 15 years);
- allow an entity in a group to claim debt-related deductions up to the level of the worldwide group’s net interest expense as a share of earnings (which may exceed the 30% EBITDA ratio). This new earnings-based group ratio will replace the worldwide gearing ratio; and
- retain an arm’s length debt test as a substitute test which will apply only to an entity’s external (third-party) debt, disallowing deductions for related party debt under this test.
The changes will apply to multinational entities operating in Australia and any inward or outward investor, in line with the existing thin cap regime. Financial entities will continue to be subject to the existing thin capitalisation rules.
Multinational Tax Integrity Package – denying deductions for payments relating to intangibles held in low or no tax jurisdictions
The Government will introduce an anti-avoidance rule to prevent significant global entities (entities with global revenue of at least $1 billion) from claiming tax deductions for payments made directly or indirectly to related parties in relation to intangibles held in low- or no-tax jurisdictions.
For the purposes of this measure, a low- or no-tax jurisdiction is a jurisdiction with:
- a tax rate of less than 15%; or
- a tax preferential patent box regime without sufficient economic substance.
The measure will apply to payments made on or after 1 July 2023.
Multinational Tax Integrity Package – improving tax transparency
The Government will introduce reporting requirements for relevant companies to enhance the tax information they disclose to the public for income years commencing from 1 July 2023. The Government will require:
- large multinationals, defined as significant global entities, to prepare for public release of certain tax information on a country-by-country (CbC) basis and a statement on their approach to taxation, for disclosure by the ATO;
- Australian public companies (listed and unlisted) to disclose information on their number of subsidiaries and their country of tax domicile; and
- tenderers for Australian Government contracts worth more than $200,000 to disclose their country of tax domicile (by supplying their ultimate head entity’s country of tax residence).
This measure is estimated to have an unquantifiable impact on receipts and to increase payments by $5.1 million over the 4 years from 2022–23.
Powering Australia – Electric Car Discount
The Government will cut taxes on electric cars so that more Australians can afford them. From 1 July 2022, the measure will exempt battery, hydrogen fuel cell and plug-in hybrid electric cars from fringe benefits tax and import tariffs if they have a first retail price below the luxury car tax threshold for fuel-efficient cars. The car must not have been held or used before 1 July 2022. Employers will need to include exempt electric car fringe benefits in an employee’s reportable fringe benefits amount.
Providing certainty on unlegislated tax and superannuation measures announced by the previous Government
The Government has reviewed and will not proceed with the following legacy tax and superannuation measures that were announced, but not legislated, by the previous Government:
- the 2013-14 mid-year economic and fiscal outlook (MYEFO) measure that proposed to amend the debt/equity tax rules;
- the 2016–17 Budget measure that proposed changes to the taxation of financial arrangements (TOFA) rules (a delayed start date was announced in 2018–19 Budget);
- the 2016–17 Budget measure that proposed changes to the taxation of asset-backed financing arrangements;
- the 2016–17 Budget measure that proposed introducing a new tax and regulatory framework for limited partnership collective investment vehicles;
- the 2018–19 Budget measure that proposed changing the annual audit requirement for certain self-managed superannuation funds (SMSFs);
- the 2018–19 Budget measure that proposed introducing a limit of $10,000 for cash payments made to businesses for goods and services (a delayed start date was announced in the 2018–19 MYEFO);
- the 2018–19 Budget measure that proposed introducing a requirement for retirement income product providers to report standardised metrics in product disclosure statements; and
- the 2021–22 MYEFO measure that proposed establishing a deductible gift recipient category for providers of pastoral care and analogous well-being services in schools.
This publication is introductory in nature. Its content is current at the date of publication. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this publication. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.