Tax Insight - Tax Measures in Australia’s 2023-24 Budget

So far as tax is concerned, the ALP’s second Budget served as a reminder of measures already in train and other measures selectively released to the press in the last few weeks. Even so, there were still a few tax surprises in store for the business community.

1.     Changes to Part IVA

One of the unexpected announcements in the Budget involves two changes to Part IVA which take effect for income years starting on or after 1 July 2024.

The first change will expand Part IVA to extend to schemes that result in a taxpayer “accessing a lower withholding tax rate.” Presumably the scenario Treasury has in mind is arranging to extract income from Australia at a rate of 10% (interest, MIT distributions from green building MITs), rather than 15% (MIT distributions to exchange of information countries), or even 30% (unfranked dividends, royalties, non-concessional MIT income, and MIT distributions to non-exchange of information countries). Treasury may also be concerned about contrived access to the build-to-rent MIT withholding tax rate.

The announcement suggests the measure will cover just this “rate arbitrage” issue – arranging for an amount currently liable to withholding tax to be replaced by an amount liable to withholding tax at lower rate. Situations where a scheme results in an amount not being liable to withholding tax at all (franked dividends, interest paid to financial institutions in certain treaty countries, amounts earned in a form that is not liable to withholding tax) are likely already within Part IVA.

The second change will amend the idea of an offending purpose to refer to schemes that achieve an Australian tax benefit even though the dominant purpose of the actor was to reduce foreign income tax. This measure takes off the table the “defence” that, the dominant purpose of the scheme was to save $100m foreign tax; the $10m Australian tax saving was just a happy coincidence. It mirrors similar rules already in the Multinational Anti Avoidance Law and the Diverted Profits Tax which allow a scheme to be struck down if it is undertaken to obtain both an Australian tax benefit “and to reduce one or more of the relevant taxpayer's liabilities to tax under a foreign law.”

2.     Changes to the Petroleum Resource Rent Tax

2.1     PRRT changes

The operation of the PRRT has been the subject of much scrutiny in the last six years: the Callahan Review in 2017, the announcement by the former Government of changes to the PRRT in November 2018 in light of that report, and a further Treasury review released last week.

The Budget confirms the announcement by the Treasurer on 7 May. The main change is the introduction of a 90% annual cap on deductions for LNG projects which effectively results in a minimum annual PRRT payment of 4% of assessable receipts (10% of assessable receipts x 40% PRRT rate). The denied deductions are carried forward and augmented but only at the long-term bond rate.

Industry, on the whole, is apparently accepting of the measure on the understanding that this brings to an end the six years of uncertainty. It remains to be seen whether the Senate will pass the legislation or try to revisit the measure.

2.1     Reversing the Shell case

The Budget reverses some outcomes from the Full Federal Court decision in Shell that conflict with long standing ATO views (a) ensuring the decision is not applied in the PRRT context (despite the statutory language and context being essentially identical) – a change made retrospective to 2013 and (b) from an income tax perspective, and with effect for mining, quarrying and prospecting rights which start to be held on or after 9 May 2023:

• ‘clarify’ that mining, quarrying and prospecting rights cannot be depreciated until they are used (not merely held) – this seems an odd reaction given that first use for exploration no longer generates an immediate deduction and so there is no longer a real integrity concern – in addition, at least in the ATO’s view, use may be difficult to show if you not yet doing work at the project site even if you are progressing the project – it will be interesting to see the detail on this one; and
• limiting the circumstances in which the issue of new rights over areas covered by existing rights lead to tax adjustments – we assume this is to deal with some of the comments in Shell that meant it is possible pre-2001 tenements could come into the depreciation regime – however, it is hard to decipher the precise scope (which could be wider) from the single line in the Budget papers.

3.     Real estate measures

3.1     Build-to-rent

After the National Cabinet meeting in Brisbane on 28 April, the Prime Minister announced two tax changes to try to stimulate build-to-rent investments to encourage the supply of housing. The two tax incentives are:

• increasing the depreciation rate from 2.5% to 4% for new build-to-rent projects where construction commences after 9 May 2023; and
• reducing the MIT withholding tax rate from 30% to 15% on fund payments made after 1 July 2024 to foreign residents attributable to income from newly-constructed residential build-to-rent projects.

Some further details were announced in the Budget:

• there must be at least 50 dwellings in the project,
• the dwellings must be retained for at least 10 years before being sold,
• the landlord must offer lease terms of at least 3 years, and
• the Budget also indicates there will be a requirement to include a specific proportion of affordable housing in the development.

The announcement assumes BTR projects can qualify for MIT status, though the ATO has had mixed views in the past on whether residential property investments (including BTR) are made primarily for the purpose of deriving rent and therefore not a trading business. Presumably the 3 year minimum lease term and the 10 year ownership period requirements are meant to codify what the Government considers acceptable criteria.

3.2     Expanding the existing clean building measures

In addition, the Budget has announced that the current clean building MIT rules will be amended.

First, qualifying MITs will now be allowed to hold data centres and warehouses that meet the designated energy efficiency standard.  The current definition limits the measure to a commercial building that is an office, hotel or shopping centre. The new rules will apply to buildings where construction commences after 9 May 2023 (Budget night), and apply to fund payments from 1 July 2025.

Secondly, the Budget has announced that buildings held in a clean building MIT will need to meet a higher 6-star energy efficiency rating to qualify for the new MIT withholding tax rates (the current level is 5 star or 5.5 star depending on the rating system). This change will apply from 1 July 2025.

4.     Superannuation measures

The Budget included 3 superannuation measures.

The first deals with the problems that have arisen from the decision of the former Government in 2017 to try to incorporate into the non-arm’s length income rules a scenario where the fund incurs expenses (usually for acquiring goods or services) to an associate and pays below market rates, artificially inflating the net income of the fund. These rules are commonly referred to as the non-arm’s length expenditure (NALE) rules.  The NALE rules are directed at practices that are possible in the SMSF sector but would not represent an integrity concern in the case of large APRA regulated funds; unfortunately the rules did not differentiate between sectors.  The potential problems for large funds became more urgent in 2021 when the ATO released LCR 2021/2 in which it specifically referred to trustees of large APRA-regulated superannuation funds insisting they “have appropriate internal controls and processes in place to enable trustees to demonstrate that they have made reasonable attempts to determine arm’s length expenditure amounts when making acquisitions from related parties.” The LCR also took the view that, if a fund did incur non-arm’s length expenditure on general operating expenses (eg, audit fees, accounting, trustee fees, in-house book-keeping, etc) then, “all the income derived by the fund” is non-arm’s length income, meaning the fund must pay tax at the rate of 45% on all its taxable income, an outcome which the ATO conceded was “very significant … where the relevant expenses are immaterial.”

Treasury conducted consultations on options to address the problems with these rules in January and, it seems, accepted the industry submissions that there were easier solutions than the ones it was proposing.  The Budget has announced large APRA-regulated funds will be exempt from the expense limb of the test for both general and specific expenses (the consultation suggested the exemption would be limited to general expenses). SMSFs and small APRA-regulated funds will remain within the rules but will be subject to less onerous consequences than were proposed in the consultation.  And the Government has decided to draw a veil over past indiscretions: expenditure incurred prior to the 2018-19 income year will be disregarded.

The other two measures had been announced in the lead-up to the Budget:

• the government will impose tax at the rate of 15% on members with a total superannuation balance exceeding $3m. The tax will be imposed on the earnings of accumulation accounts both realised and unrealised, and will be in addition to the (15%) tax imposed on the fund on realised earnings.  Members will be able to have funds released from their account to pay the tax. The measure will start on 1 July 2025; and
• employers will be required to pay their employees’ superannuation guarantee amounts to the relevant fund on the same day that they pay salary and wages. This will apply from 1 July 2026.

5.     Further international tax announcements

5.1     Enacting Pillar Two

The Budget has given the clearest indication yet of Australia’s commitment to implementing the OECD’s “Two Pillar solution to reform the international tax”, and added the likely timeline.

In particular, the Budget has confirmed the speculation in Treasury’s Consultation Paper Global agreement on corporate taxation: Addressing the tax challenges arising from the digitalisation of the economy (October 2022) that Australia will enact a second corporate tax – a 15% domestic minimum top-up tax to operate alongside the current corporate tax.

The timetable for implementing Pillar Two is very ambitious:

• the Income Inclusion Rule will apply for income years starting on or after 1 January 2024;
• the Undertaxed Profits Rule will apply for income years starting on or after 1 January 2025; and
• the 15% domestic minimum top-up tax will apply for income years starting on or after 1 January 2024.

This means, Exposure Draft legislation would likely be released in the second half of this year.

The measures will apply to groups with annual global revenue of EUR 750 million (approximately A$1.2bn) although one might expect the legislation will adopt the Significant Global Entity test already used.

These rules will be a significant compliance burden for affected taxpayers. The Budget estimates they will produce little extra revenue for Australia.

5.2     Current measures

Since its election in May 2022, the Government has made steady progress on implementing four significant international tax measures:

• the repeal of s. 25-90. Our Tax Insight on this measure is available here;
• replacing the current new safe harbour in the thin capitalisation regime with a rule limiting interest deductions to 30% of adjusted earnings. Our Tax Insight on this measure is available here;
• a proposal to deny deductions to Australian entities for royalty and royalty-like payments made to associates if the income is earned in a low-tax jurisdiction. Our Tax Insight on this measure is available here; and
• the public release of detailed worldwide transfer pricing data by local and foreign MNEs if they have operations in Australia. Our Tax Insight on this measure is available here.

It was hoped that the Government would take the opportunity of the Budget to announce refinements to these measures in light of submissions made to Treasury. Unhappily that did not happen, and so, as things currently stand, some of these measures will start on 1 July and in their current form.

6.     Capital management measures

In 2022, the Government announced two tax measures which constrain the ability of companies to pay franked dividends:

• denying the ability to frank a dividend which occurs in connection with a capital raising; and
• denying the ability to frank a distribution made by a listed company in connection with an off-market share buy back.

Treasury conducted consultations on Exposure Drafts of these measures in late 2022, and a Bill to enact them was introduced into Parliament in February 2023. It is currently the subject of hearings by the Senate Economics Committee. The Budget contains no hint that the Government is minded to modify the measures despite the criticisms made of the measures before the Committee. The Committee’s report is due by 26 May 2023. Our Tax Insight on this measure is available here.

7.     The unfinished agenda

7.1     Patent box regimes abandoned

The Government has formally announced that it will not proceed with the patent box regime for income generated from Australian medical and biotechnology patents announced by the previous Government in its 2021-22 Budget, and will not proceed with the patent box regimes for income generated from agricultural and veterinary chemicals patents and patents over low-emission technologies announced by the previous Government in its March 2022-23 Budget.

7.2     Some other remaining measures

Last year’s October Budget cancelled a number of measures announced by the former Government but unenacted by the election in May 2022. Apart from the patent box announcement, this year’s Budget did not take the opportunity to clear away more of the income tax backlog.

For example, we are still awaiting news of any further developments with respect to:

• the draft legislation to rewrite the residence test for companies. The ATO has said it cannot extend the current transitional measures beyond 30 June 2023, so the position is becoming critical;
• the Board of Taxation’s proposal to rewrite the residence test for individuals;
• the Board of Taxation’s proposals to reform CGT rollovers;
• the reform of Division 7A and the rules which deem dividends from private companies; or
• the recommendations of the House of Representatives Standing Committee on Tax and Revenue to reform the tax treatment of employee share ownership schemes.