2022 October Federal Budget Tax Alert

The Australian Federal Treasurer handed down the second 2022-23 Federal Budget on 25 October 2022, following the previous government’s 29 March 2022 Budget, outlining the new Labor Government’s priorities following the May 2022 Federal election.

At a glance

• Updated 2022-23 Australian Federal Budget delivered 25 October 2022, follows previous government’s 29 March 2022 Budget. Tax measures were mostly election policies
• Multinational tax integrity package includes changes to the thin capitalisation interest deduction limitation rules, new rule limiting SGE’s ability to claim tax deductions for payments relating to intangibles and royalties, and adds ‘enhanced’ tax transparency measures
• List of tax measures not proceeding – silent on corporate & personal residency, patent box and more

This Tax Alert focuses on the key announced tax measures that impact your business tax planning and compliance processes. The broader economic and policy issues in the Budget are on the EY Australia website. 

The Budget delivers a lower than expected deficit of $37 billion but foreshadows a dire future of expected low GDP growth of 1.5% by 2024, higher inflation of nearly 8% next year and no growth in real wages, if at all, until 2024. The Budget has been carefully curated to ensure new policy spending did not fall into the current financial year when the inflation risk is (at least on current forecasts) most acute. Only a net $1.6 billion was added to the net policy spend in 2022-23 and $130 million to direct capital spend. The stimulatory policy flows from 2024-25, when the forecasts safely park inflation in the 2-3 per cent target band.

Whilst the Budget noted possible productivity improvements to come from cheaper childcare and a few other measures, it is hard to see any significant drivers or incentives to promote materially higher investment in manufacturing or other job creating or export driven sectors, especially given we expect GDP growth to slow down significantly in 2024 to 1.5%.

The revenue raised from this Budget is low compared to Australia’s structural budget deficit and without significant tax reforms in the near to medium term ahead, Australia’s budget position remains precarious.

Perhaps, by May 2023 when the next Budget is due, the Government can articulate a longer-term plan to address this, as well as hopefully some incentives to encourage the significant energy transition investment to renewables that Australia needs.

International Tax

Multinational tax integrity package

The Budget includes details of three measures announced by the Australian Labor Party during their election campaign “to ensure multinationals pay their fair share of tax”. This follows an August 2022 Treasury consultation paper and submissions in response to that paper by EY and others. It is proposed to:

• Change the thin capitalisation interest deduction limitation rules
• Introduce a new rule limiting multinational enterprises (MNEs) ability to claim tax deductions for payments relating to intangibles and royalties that lead to insufficient tax paid
• Introduce a series of ‘enhanced’ tax transparency measures.

A further election announcement to implement a public registry of beneficial ownership to improve transparency on corporate structures, to show who ultimately owns or controls a company or legal vehicle, is yet to be developed.

Consultation is currently ongoing concerning the election commitment to implement the OECD BEPS Two-Pillar solution which includes the 15% global minimum effective tax rate on profits of large MNEs.

MNE package - Amending Australia’s interest limitation (Thin Cap) rules

The Budget confirmed the Government’s election commitment to amend the thin capitalisation rules to limit debt deductions of MNEs to 30% of earnings before interest, taxes, depreciation and amortisation (EBITDA) in line with the OECD’s recommended approach under the BEPS program. The current thin cap rules provide 3 tests for MNEs, being:

• The safe harbour test (which broadly disallows debt deductions to the extent that debt exceeds 60% of an entity’s Australian assets)
• The arms’ length debt test (ALDT) (which considers the amount of debt that ‘could’ have been borrowed by an independent party carrying on the same operations as the Australian entity and is widely acknowledged to be compliance heavy and uncertain)
• The worldwide gearing test (which allows an entity’s Australian operations to be geared equivalently to its worldwide group).

The Budget indicated the following key changes to the thin cap rules:

• The safe harbour test and worldwide gearing test will both be replaced with earnings-based tests, specifically:
  • The safe harbour test will be replaced with an earnings based test that will apply to limit an entity’s debt deductions to 30% of EBITDA. Denied debt deductions (i.e., debt deductions above the 30% EBITDA ratio) can be carried forward and claimed in a subsequent income year (up to 15 years)
  • An earnings based group ratio will apply to allow an entity in a group to claim debt deductions up to the level of the worldwide group’s net interest expense as a share of earnings (which may be in excess of the earnings based tests’ 30% EBITDA ratio). This will replace the worldwide gearing test
• While it will be retained as a substitute test, the ALDT will apply only to an entity’s external (third party) debt, resulting in debt deductions for related party debt being denied under this test.

The Budget confirms that financial entities (and presumably authorised deposit-taking entities) will not be subject to the amended thin cap rules.

The amended thin cap rules will apply to income years commencing on or after 1 July 2023. This is a very tight timeframe for taxpayers to prepare for the amendments.

Since there is no mention of transitional rules, it appears that existing debt arrangements will not be grandfathered. As such, borrowers need to urgently review the impact of these new rules on interest expenses arising on existing debt structures which up until now may have been fully deductible.

The Budget is silent on a number of key points, including whether:

• A carry forward of excess debt capacity (where an entity’s actual net debt deductions are below the maximum permitted) will be made available. As such, it appears the proposed rules will not allow for this
• Any carve outs will be provided for large scale infrastructure and real estate projects.

The insurance industry may be excluded from being subject to the amended thin cap rules. 

MNE package - Denying deductions for payments relating to intangibles and royalties paid to low or no tax jurisdictions

The Budget builds on the Government’s election commitment for an integrity measure applying to significant global entities (SGEs) which would deny deductions in Australia on related party cross-border payments relating to intangibles.

The anti-avoidance measure will apply to organisations in Australia who are SGEs (entities with global revenue of at least $1 billion) who make payments, directly or indirectly, in relation to intangibles in low or no tax jurisdictions. The measure is proposed to apply to payments made on or after 1 July 2023.

Specifically, the anti-avoidance measure will apply to payments where:

• The payments are made to jurisdictions where they are taxed at a rate of 15 per cent or less; or
• The payments are made to jurisdictions with a tax preferential patent box regime without sufficient economic substance.

The announcement contains limited detail on the proposed extent of the rule. It is unclear whether a payment for ‘intangibles’ will include circumstances where the payment is for intangibles and/or royalties, even if the payment is not so characterised or is an embedded one (such as those arrangements covered under the ATO’s Taxpayer Alerts, TA 2018/2 - Mischaracterisation of activities and payments in connection with intangible assets and TA 2020/1 - non-arm’s length arrangements and the DEMPE of intangible assets). A complementary statement on the ATO website suggests that the rules will extend to payments for advertising algorithms and customer data bases.

It is also unclear the extent to which the measure would apply to an indirect payment and the required tracing which would need to be undertaken by an Australian payer. This could result in significant compliance costs.

Further, while the measure is described as an “anti-avoidance rule”, it is unclear whether the measure will also include a purpose test and whether the measure is proposed to form part of the anti-avoidance rules in the tax legislation. This would potentially result in the rule being carved out of Australia’s Double Tax Agreements (DTA). The use of the term “anti-avoidance rule” as well as the reference to “sufficient economic substance” (a term defined in the current anti-avoidance rules) suggests the intention is to include the rule within the anti-avoidance provisions.  

It is disappointing to see this measure announced in the proposed form. Australia’s tax rules already contain significant powers and anti-avoidance rules to tackle structures and behaviours to which the proposed measure is targeted at. Furthermore, the proposed measure is likely to apply to a range of normal commercial arrangements that are not tax-driven. The measure has the potential to deter investment into Australian and certainly runs contrary to limiting compliance costs for businesses conducting genuine commercial activities. The measure also has the potential to run contrary to Australia’s DTA commitments and obligations. 

MNE package - Multinational tax transparency

Under the Government’s broader Multinational Tax Integrity Package, the Budget confirms the Improved Tax Transparency measures that will require certain companies to disclose information to the public for income years beginning on or after 1 July 2023.  

The Improved Tax Transparency measures will require:

• SGEs to prepare for public release of certain tax information on a country by country basis and a statement on their approach to tax, for disclosure by the ATO
• Listed and unlisted Australian public companies to disclose information on the number of subsidiaries and their country of tax domicile
• 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.

Other details (such as format and detailed content of reporting) are yet to be released.

Increased levels of Australian tax transparency for multinationals will require a strengthening of local and global tax governance frameworks. This latest requirement for companies to make their historically private tax affairs public, will enhance the necessity to ensure disclosures are supportable and based on accurate and tested data. In making the new disclosures, multinational companies will need to manage internal stakeholder expectations, particularly given local Australian disclosures may require review of global tax issues and therefore consideration and sign-off of the company’s global communications / public disclosure protocols. Increased resources may be required for companies to obtain the required information from subsidiaries and particular details of that subsidiary.

Program to expand treaty network behind schedule

The program announced in September 2021 to expand Australia’s tax treaty network to cover 80% of foreign investment by 2023 is behind schedule. The Budget reflects the DTA signed with Iceland on 12 October 2022 and the existing treaty with India has been unilaterally amended by Australian legislation.

Otherwise, there is no major update on negotiations with Luxembourg, Greece, Portugal and Slovenia nor has there been any announcement as to which countries make up the remaining four spots of the proposed ten updates in total. The lack of progress means impacted businesses may need to make representations to ensure this remains on the Government’s agenda.

Business Tax

Providing certainty on unlegislated tax and superannuation measures announced by the previous Government

The Budget includes a list of certain tax and superannuation measures which were announced but not legislated by the previous Government which will now not proceed:

• Amendments to the debt/equity tax rules (2013-14 MYEFO)
• Changes to the taxation of financial arrangements (TOFA) rules (2016-17 Budget - to reduce scope, decrease compliance costs and increase certainty)
• Changes to the taxation of asset-backed financing arrangements (2016-17 Budget)
• New tax and regulatory framework for limited partnership collective investment vehicles (2016-17 Budget)
• Changing annual audit requirement to 3 year cycle for certain SMSFs (2018-19)
• $10,000 limit for cash payments made to businesses for goods and services (2018-19 Budget)
• Requirement for retirement income product providers to report standardised metrics in product disclosure statements (2018–19 Budget)
• Allowing taxpayers to self-assess the effective life of certain intangible depreciating assets acquired from 1 July 2023 (2021-22 Budget)
• Establishing a DGR category for pastoral care providers and analogous well-being services in schools (2021-22 MYEFO).

Further, the Government will defer the start dates of the following measures to allow sufficient time for policies to be legislated and implemented:

• Introducing a sharing economy reporting regime (2019-20 MYEFO – Bill before Senate), from:
  • 1 July 2022 to 1 July 2023 for transactions relating to the supply of ride sourcing and short-term accommodation
  • 1 July 2023 to 1 July 2024 for all other reportable transactions (including but not limited to asset sharing, food delivery and tasking-based services)
• Relaxing residency requirements for SMSFs (2021-22 Budget), from 1 July 2022 to the income year commencing on or after the date of Royal Assent of the enabling legislation
• Making technical amendments to the TOFA rules (2021-22 Budget), from 1 July 2022 to the income year commencing on or after the date of Royal Assent of the enabling legislation.
• We note that the Government remains silent on the status of a number of key announced but unlegislated measures including:
• Patent box tax regime, and proposals to expand the regime to agricultural chemical and low emission technology measures
• Clarifying the corporate residency test
• Modernising Australia’s individual residency rules
• Digital Games Tax Offset
• Division 7A changes.

Improving the integrity of off-market share buy-backs

Without undertaking a public consultation process, the Government has announced the taxation treatment of off-market share buy-backs will be aligned with on-market share buybacks for listed public companies. Although there is no further detail accompanying the announcement, this is expected to mean that no part of the purchase price for an off-market buy-back can in future be treated as a frankable dividend and the tax outcomes on disposal of the share (such as CGT) for participating shareholders will also change. The measure applies from 7:30pm AEDT on 25 October 2022.

Incentives for Industry – Creating a stronger and more resilient economy

The Government has signalled strong support for industry through multiple measures which target priority sectors to grow and expand Australia’s industrial manufacturing base and reduce Australia’s environmental impact. To fund these new measures, the Government has redirected significant funding programs from the previous government, including the previous Modern Manufacturing Strategy, Building Better Regions Fund, and Entrepreneurs’ Program.

This includes:

• National Reconstruction Fund
  The Government will invest $15 billion over the next 7 years to establish the National Reconstruction Fund which will co-invest in projects aimed at diversifying and transforming the Australian economy. The fund will be delivered through loans, guarantees and equity, partnering with the private sector to unlock further investment. The fund will focus on seven priority areas including resources, agriculture, medical science, renewables, defence, transport, and enabling capabilities
• Support for the Regions
  The Government will invest $5.4 billion over 7 years to support the economic growth and development of regional Australia. This includes $1.0 billion for the Growing the Regions Program and the regional Precincts and Partnerships Program, which will delivered through competitive grants and collaborative partnership programs
• Powering Australia
  The Government is investing in a suite of measures under the Powering Australia Plan to build a future with cleaner and cheaper energy. This includes $20 billion for concessional loans and equity to invest in transmission infrastructure projects, $1.9 billion to transform regional industries and $275.4 million to reduce transport emissions
• Critical minerals and resources
  The Government will support the critical minerals sector by investing up to $1 billion under the National Reconstruction Fund, as well as $160.3 million over the next 4 years to drive innovation and enable projects to be market ready. This includes $99.8 million to support critical mineral producers in overcoming technical and commercial barriers.

COVID-19 business grants

Further COVID-19 payments from certain additional state and territory business grants made prior to 30 June 2022 have been made non-assessable non-exempt (NANE) for income tax purposes, under the current measure. 

Employment Tax

Electric car discount

The Budget paper notes the Government’s two electric car measures:

• FBT exemption for battery, hydrogen fuel cell and plug-in hybrid electric vehicles first held and used on or after 1 July 2022, where the retail price is below the luxury car threshold for fuel efficient cars ($84,916 for 30 June 2023) - for fringe benefits provided on or after 1 July 2022 (Bill before the Senate)
• 5% import tariff reduction on the importation of eligible electric cars from countries which Australia does not have a free trade agreement with.

Personal Taxation

No new personal tax bracket adjustments

As expected, no changes were announced to personal income tax brackets including the legislated “Stage 3” tax cuts (2019-20 Budget personal income tax relief plan) to commence from the 2024-25 income year. 

A reminder that the low and middle income tax offset (LMITO), which was extended and enhanced for the 2021-22 income year, has now lapsed and is not available to taxpayers in the 2022-23 income year. 

Superannuation

Superannuation downsizer measures extended

Eligibility for individuals utilising the proposed downsizer measures, which allow individuals to make a once-off transfer of up to $300,000 of personal home proceeds into superannuation, will drop from age 60 to age 55. All existing criteria must be satisfied, including that the home (excluding mobile homes) must have been owned by you or your spouse for more than 10 years, and must be eligible for the main residence CGT exemption.

Tax Administration

Extension of ATO compliance programs

The Budget announced that the Government will provide additional funding to the ATO to extend three of its key compliance programs.

The Personal Income Taxation Compliance Program, the ATO Shadow Economy Program and the Tax Avoidance Taskforce have been provided additional funds to allow the ATO to continue to operate the respective programs of work.

The Tax Avoidance Taskforce has been extended by an additional year and, importantly, has had its funding boosted by $200 million for each year over the next four years. This builds on the previous Government’s announcement in March to extend the Taskforce and provide additional funding. The Taskforce will now operate to July 2025. This additional investment is a major investment by Government into the Taskforce and the Budget details the anticipated returns from the activities of the Taskforce over the four years from 2022-23 of $2.8 billion. It is clear that the ATO focus on multinationals and large public and private businesses will be intensive and significant in the coming years – as evidenced by both this funding extension and by the announced multinational tax measures.

The Shadow Economy Program and Personal Income Taxation Compliance Program will also receive additional funds to continue their compliance programs focussing on, respectively, shadow economy compliance issues (including a GST focus) and personal individual compliance which includes both preventative and corrective activities. Both programs are estimated to result in collective receipts of over $2.7 billion over the four years from 2022-23.