The debate and confusion surrounding the proposed tax system called the Tax Value Method (TVM) or Option 2 is a little like going to Detroit just before the car makers take the wraps of the latest model.
As is usual with these events, everyone has an opinion or theory on what the new model will look like, how it will perform and whether it is better than previous models. These opinions can vary from the assertion that it is just the old model with new features or a radical new design concept. The soon-to-be-released legislative detail by Treasury tax engineers of the TVM has created similar angst and opinion among the business community, particularly the accounting profession. What no one disputes is that the clapped out FJ Holden tax system built in the 1930s for the backroads of the Australian domestic economy has become too cumbersome, too makeshift and held together by too many legislative band-aids. The compelling argument championed by a number of business groups (including the AICD) is that the new economic autobahns of Australia and the world require a radical new tax platform.
The first stage was the new Simplified Tax System introduced as part of the GST. The benefit for the government from the first stage of tax reform is that it has moved the burden of tax collection and compliance to the private sector while significantly increasing tax revenue. This month is the deadline for the first Business Activity Statement. Hopefully the process will go smoothly. The fear, however, is that some small businesses will either face closure or take on too much debt when confronted with the double whammy of last year's provisional taxes and this year's pay as you go taxes. This is also the area of greatest angst in the accounting profession. Some accountants say they have enough problems coming to grips with GST-related problems and if the TVM arrives too soon, it will become an administrative nightmare. The government has listened to these concerns and has agreed to delay the introduction of TVM. So what is this new tax all about and why are Australian businesses being asked to choose between its familiar but cumbersome FJ Holden tax system and the shiny new tax vehicle?
In the first instance, the answer is both obvious and simple. Treasury and the Australian Tax Office have the common aim of reducing legislative paperwork. This is certainly the view of Dr Alan Preston, the former secretary of the Ralph Committee (and now a Second Commissioner of Taxation) who told the Business Coalition for Tax Reform that the first benefits of Option 2 are administrative in terms of the ATO, Treasury and the Office of Parliamentary Council. Underpinning this assumption is the believe that the Simplified Tax System coupled with the TVM will make things a lot easier in legislative terms. The corollary of this says that if the legislation is simple, compliance is simple and business costs are reduced. It is intended that TVM is tax revenue neutral. Both the Simplified Tax System and Option 2 use cash flows as their base – with cash inflows being taxable and cash outflows deductable, in broad terms. Importantly, the Simplified Tax System applies only to those companies with revenues exceeding $1 million per annum.
Adjustments are then made for assets and liabilities still on hand at year end, so that (in theory at least), the net amount subject to tax is the net profit made from that activity – much the same as at present. The controversy surrounding Option 2 centres on a couple of important matters. For instance, how easy will it be for taypayers to collate the cash flow, asset and liability information necessary for Option 2? How are assets and liabilities to be defined and valued? And, will Option 2 really collect only the same amount of tax as at present? A preview of this new tax platform was contained in the Ralph Review of Business Taxation (in February 1999) and labelled Option 2. Doing nothing was Option 1. In the same manner that Detroit engineers are sworn to secrecy about a new car, Treasury and the Government have exacted blood oaths from anyone who has seen the new vehicle up close. Ken Traill, a chartered accountant was one of those who got a sneak peak. According to Traill, the first element of TVM is fairly simple and one that should be welcomed by business. It deals with multi-national corporate groups being able to find an appropriate starting point of net cash flow for the consolidated group. This reform deals with the concern that some companies do not have very sophisticated cash flow reporting systems. AICD believes this element should be reviewed.
It is the proposal to defer deductions for certain expenditure over a future period where the expenditure could result in some form of future economic benefit that is one of TVM's more contentious proposals. While this proposal is aimed at prepayments such as prepaid interest or rents, it also applies to other forms of expenditure. The test will be whether this expenditure creates an asset (as defined by Treasury and the ATO). If an asset is found to have been created, the related cash flow will be effectively deducted for tax over the life of the asset rather than in the year it was spent. To understand what the expenditure rule means in practical terms suppose a company called fantastic dot.com was developing a new software. As with most start-up businesses, the company is short of cash and wants to claim the R&D as a tax deduction. Under the TVM expenditure rule there would be no outright tax deduction for the costs because the software would become a future asset of fantastic dot.com. Only a portion would be allowable this year.
According to Traill, imagine every year, the accountant and client sitting down with the payments details examining each and every expenditure item to determine whether it gives a future economic benefit and whether it falls within one of the stated exemptions. The Government says that TVM intends to introduce a universal measure of income derived from a collection of assets and comprises cash flows and the change in the tax value of net assets. The advantage of the TVM is that it explicitly recognises the two components of income in terms of net annual cash flows having relevant assets and liabilities and the change in the value of those assets and liabilities.* It also provides a flexible framework within which the change in asset and liability values can be measured in a practical way. The AICD supports the TVM for these reasons, as it will significantly reduce compliance costs. The Tax Value Method has yet to hit the road. When the covers come off, the debate about whether this is the appropriate vehicle to replace the FJ will truly begin.
* The author would like to thank the members of the AICD Tax & Economics Committee for their advice and help with this article.
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