Questions and Answers

About the Tax Value Method

Q: What is the tax value method?

A:

• The tax value method was recommended by the Review of Business Taxation as a better way to calculate your taxable income.
  • The tax value method applies one set of uniform rules to the calculation of all forms of taxable income and losses.
• Under the tax value method taxable income is calculated on the basis of annual changes in the tax values of assets and liabilities (including cash).
  • This is in contrast to the current income tax law, which relies on legal definitions of income and deductible expenses and a myriad of separate rules.
  • In many ways the tax value method replicates the current system, but in a way that is potentially much simpler and more logical.
  • This improved structure of the law could reduce tax administration costs for businesses and individuals.
• Some things would not change.
  • The tax value method is not a new tax.
  • The tax value method would not mean an increase in tax revenue.
  • You could still calculate your taxable income under the tax value method by filling in boxes in a TaxPack or other form, as you do now.

Further information

• The Board of Taxation has developed prototype legislation and other supporting material to evaluate and test the tax value method. Details are available at the Board’s website www.taxboard.gov.au.

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Q: Where did the tax value method come from?

A:

• The tax value method was recommended by the Ralph Review of Business Taxation.
  • Before the Ralph review began, tax practitioners said that Australia’s tax system was in a terrible state. They asked for changes based on simplicity, efficiency and equity.
  • Tax practitioners said lower compliance costs and the minimisation of tax avoidance opportunities would ease administration for taxpayers and the Australian Taxation Office alike.
  • Practitioners urged the Ralph review to design a new system that would allow us to properly compete in the global economy. They said that, without a major overhaul, our tax system would continue to place Australian business at a competitive disadvantage.
• The Ralph review considered income tax laws to be very complicated and, in some areas, difficult to administer and comply with. It said simpler and transparent tax laws would make their operation more certain.
  • The overall aim of the tax value method is to simplify income tax law with standard tax rules.

Further information

• The Board of Taxation has developed prototype legislation and other supporting material to evaluate and test the tax value method. Details are available at the Board’s website www.taxboard.gov.au.

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Q: Why introduce the tax value method?

A:

• While the tax value method would not increase tax revenue, it could have a number of benefits.
  • The tax value method could make income tax law easier to learn, understand and apply.
  • The tax value method could reduce tax administration costs for businesses and individuals.
• The tax value method could simplify the income tax system because the tax value method is based on as few, and as simple, concepts and mechanisms as possible.
  • The current law income tax has many different ways of assessing gains and recognising losses for tax purposes; the tax value method would have one standard way.
• The tax value method could add to certainty in the income tax system because it would replace the different approaches the current income tax law takes to different transactions with one standard treatment that deals with all transactions in the same way.
  • Because there would be fewer variations, it would be easier to reliably predict how the tax law would treat any particular transaction.
• The tax value method could make the income tax system more durable because it completely describes the tax base.
  • It would be less likely that the law would have to be amended to accommodate such changes as technological developments. Changes to the law would only be necessary to add to or reduce taxable income for particular policy reasons.
• The tax value method could make the income tax system more transparent because it has one standard way of doing things.
  • It would be easy to identify departures from the standard way.
• The tax value method could make the income tax system more equitable because it would treat different taxpayers with the same economic circumstances in the same way.
  • It would do that because it deals with every transaction in one main way.
  • The current income tax law provides many different ways of treating a transaction depending on how it is characterised. In some cases, more than one regime can apply to the same transaction.
• The tax value method could make the income tax system more robust because there would be fewer ways to avoid tax under the tax value method.
  • The tax value method deals with all transactions in one standard way and treats different taxpayers with the same economic circumstances in the same way.
  • There would be a smaller variety of different regimes, so there would be less incentive to re-characterise a transaction to move it to a more favourable regime.

Further information

• Other questions and answers provide more detail about these possible advantages the tax value method.

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Q: How would the tax value method cut income tax law?

A:

• The tax value method would help to reduce the size of the income tax law, perhaps by around 40 per cent.
• The reduction in the size of the law would come in two ways.
  • The tax value method’s core rules and standardised concepts would automatically deal with what is now covered by many disparate rules scattered throughout the current law. For example, perhaps the debt forgiveness provisions in Schedule 2C of the 1936 Act and the 24 or so pages of existing law in sections 82KH to 82KK of the 1936 Act that deal with tax avoidance schemes could go.
  • The Income Tax Assessment Act 1936 has to be rewritten anyway, to complete the work of the Tax Law Improvement Project, whether or not the tax value method proceeds – this project halved the size of those provisions which were rewritten.
• The redraft of the key capital gains tax rules into the tax value method format is an example of the significant reduction in income tax law possible under the tax value method.
  • The tax value method redrafting has reduced the size of the capital gains tax rules by more than 70 per cent so far, and would reduce 40 capital gains tax events to 8 at most.
• There are other areas where the tax value method could reduce or eliminate existing provisions.
  • The recoupment provisions in Subdivision 20-A of the Income Tax Assessment Act 1997.
  • The provisions for deducting exploration and prospecting expenses in Subdivision 40-H of the 1997 Act.
  • A whole lot of the trading stock rules that already use a system very similar to the tax value method.
  • The hire purchase provisions in Division 240 of the 1997 Act.
  • The limited recourse debt provisions in Division 243 of the 1997 Act.
  • The securities lending provisions in section 26BC of the 1936 Act.

Further information

• A new income tax Act written using the tax value method could be around 3000 pages (this number of pages would be necessary to reproduce current income tax policy, such as adjustments and reductions in taxable income).
  • The income tax legislation has grown from 81 pages (in 1936) to around 4500 pages (in 2002).

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Q:Have the many alternatives to the tax value method been considered?

A:

• There are many alternatives to the tax value method. The income tax regimes of most countries are unique. There are also alternative tax bases, like expenditure taxes or wealth taxes.
  • The Review of Business Taxation discussion papers considered an alternative approach based on the structure of the current law.
• The Board of Taxation has only been asked to evaluate the tax value method, but has indicated that it will consider any alternative the business community presents.
  • The tax value method aims to broadly reproduce present outcomes. Alternative systems are more likely to change outcomes.
• The Board’ s tax value method working group has appointed a sub-group to consider an approach (‘Option 3’) that takes some of the advantages of the tax value method (for example, standardising some concepts) but not the whole package.

Further information

• In its 1999 consultative document A platform for consultation (pages 39-44) the Review of Business Taxation put forward two options – build reforms into the existing structure or the tax value method.
• In relation to ‘Option 3’, also see the separate question ‘Why is the tax value method necessary when you could do all the tax value method would do by fine-tuning the current law?’

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Q:How would the tax value method reduce administration costs?

A:

• The tax value method has the potential to save the community time and money by reducing the need for:
  • taxation rulings and determinations
  • private rulings
  • litigation
  • taxpayer contact with the Australian Taxation Office (ATO).
• For example, the analysis to date of capital gains tax related matters indicates that the tax value method may reduce the need for capital gains tax related taxation rulings and taxation determinations by up to 28 per cent and litigation by around 60 per cent. From this analysis, significant community savings would result from reducing the number of annual:
  • telephone calls by around 166 000
  • requests for amendment by around 17 000
  • letters by around 14 000
  • objections by around 700
  • private rulings by around 730.

Further information

• Attachment B to Tax value method: information paper contains a general overview of the potential impact of the tax value method on rulings, cases and taxpayer interactions with the ATO. This paper is on the Board website www.taxboard.gov.au

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Q: Why is the tax value method necessary when you could do all the tax value method would do by fine-tuning the current law?

The argument here is that you don’t need the tax value method because all the benefits could be obtained by amending the current system.

A:

• You could not do all that the tax value method would do by fine-tuning the current law, although you could do some of the things the tax value method would do.
  • For instance, you could fix black holes and standardise some concepts in the current law without the tax value method.
• But what fine-tuning the current law can’t do is give you a structured approach to expressing the tax base.
• Without that structured approach, you don’t get the benefits that only the tax value method brings.
  • Starting with ordinary income and adding patches to build up the tax base doesn’t systemically eliminate gaps, so you can never be sure that further patches won’t be needed. You don’t remove the need for rules to cope with overlaps. You don’t eliminate repetition and subtle linguistic variation.
  • You can never see the tax base as a big picture but are instead stuck with a patchwork view. That hampers good policy analysis and prevents policy transparency.
  • You obscure the patterns inherent in the law and so make it harder to learn and understand, inevitably imposing higher compliance costs.

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Q: Would the tax value method be revenue neutral?

Some have claimed that the tax value method departs from the original Review of Business Taxation proposal by not being revenue neutral for all taxpayers.

A:

• The overall result of introducing the tax value method is intended to be revenue neutral.
• The tax value method would not produce the current outcome in every case for every taxpayer.
  • Policy changes to be implemented at the same time as the tax value method (such as removing black holes and the taxation of financial arrangements) would change current outcomes in some cases.
  • The standardisation inherent in the tax value method would also change outcomes in some cases.
• Changes would benefit either taxpayers or the revenue; they do not only work in the revenue’s favour.
  • Significant changes will be identified and costed.
• The Review of Business Taxation report A tax system redesigned never claimed that every taxpayer would get exactly the same result under its recommendations; merely that the overall result would be revenue neutral.

Further information

• The Review of Business Taxation report said that the overall result of its recommendations would be revenue neutral (page 24).

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Q: Why waste the limited resources for tax legislation on a project, like the tax value method, that isn’t going to happen?

A:

• As no decision has yet been made about whether or not the tax value method proceeds, views about its ultimate fate are only guesses.
  • The Government has set in train a process of developing the legislation so that the Board can evaluate it before it makes a recommendation to the Government.
• The resource commitment is fairly modest.
  • In the Australian Taxation Office, only 7 legislative officers out of approximately 115 (that is, about 6 per cent) are working full-time on the tax value method prototype legislation.
• The Income Tax Assessment Act 1936 has to be rewritten to complete the work of the Tax Law Improvement Project. If the tax value method proceeds, it would create leverage to complete that task more efficiently.
  • For example, the redraft of the key capital gains tax rules into the tax value method format has reduced the size of the capital gains tax rules by more than 70 per cent. It achieved that by removing the many rules that become redundant under the tax value method.

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Q: When will the tax value method be introduced?

A:

• If the tax value method is to be introduced, it is still some way off.
• The Board of Taxation is evaluating and testing the tax value method.
  • The tax value method was recommended by the Review of Business Taxation in 1999.
• The consequences of introducing the tax value method will be carefully thought out by the Board before it makes any recommendations to the Federal Government about introducing the tax value method.
  • Board chairman Dick Warburton is convinced of the need to change the old tax laws. But he believes such a major change – if it was to proceed – deserves time to get it right, the first time.
• The big question that needs to be answered is whether the benefits of any change would be greater than the cost of transition.
  • This transitional cost will be an important factor in the evaluation of the tax value method and its acceptance.

Further information

• The Board of Taxation has released a package of material to assist the evaluation of the tax value method. This material can be found on the Board’s website at www.taxboard.gov.au. The Board is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method. Submissions should be made by 30 April 2002.

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Q: Are the transitional costs of implementing the tax value method too high?

A:

• The cost of transition is a significant factor in the evaluation and acceptance of the tax value method.
• There would be transitional costs in a change to the tax value method.
  • They would be lower for some than for others. The effect on individuals, for example, is expected to be minimal.
• A decision will have to be made about where the advantage lies for the Australian taxpaying population as a whole, taking into account a range of factors, including the size and duration of transitional costs.
• However, it is not yet possible to measure the transitional costs.
  • The Board of Taxation’s process is to develop the legislation and related administrative products (for example, worksheets to calculate taxable income and information sheets) to the point where a reasonable measurement can be made.

Further information

• The Board of Taxation has released a package of material to assist the evaluation of the tax value method. This material can be found on the Board’s website at www.taxboard.gov.au. The Board is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method, including the transition costs. Submissions should be made by 30 April 2002.

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Q: Why is such an important change given such a limited period for consultation?

A:

• This is not the first round of consultation.
  • The tax value method was recommended by the Review of Business Taxation back in 1999.
  • The Board has sought wide community involvement, publishing all material developed on its website, holding a consultative conference in July 2001 and meeting with key stakeholders.
  • The current prototype legislation released by the Board is the fourth iteration. All previous prototypes were also placed on the Board website for comment.
• The Government has asked for a recommendation from the Board by June 2002.

Further information

• The Board of Taxation released a package of material to assist the evaluation of the tax value method on 6 March 2002. The Board is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method. Submissions should be made by 30 April 2002.

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Q: How is the tax value method being developed, evaluated and tested?

A:

• The Board of Taxation has developed prototype legislation and other supporting material to evaluate and test the tax value method.
• The development process has been an open one, with all prototype material being available on the Board’s website for comment.
• The Review of Business Taxation stated that the tax value method has a number of benefits.
  • The Board wants to confirm whether these benefits are real through a process of public consultation.
  • The Board has commissioned analysis of particular aspects of the tax value method.
• The Board formally released legislative and administrative material to help evaluate the tax value method on 6 March 2002.
• The consequences of introducing the tax value method will be carefully thought out by the Board before it makes any recommendations to the Federal Government.

Further information

• The Board of Taxation has released a package of material to assist the evaluation of the tax value method. This material can be found on the Board’s website at www.taxboard.gov.au. The Board is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method. Submissions should be made by 30 April 2002.
  • Chapter 3 of Tax value method: information paper outlines the evaluation and testing process.

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Q: Is the limited legislation drafted sufficient to make a decision about the merits of the tax value method?

There is a suggestion that the prototype legislation drafted so far is insufficient to make a decision about the merits or otherwise of the tax value method.

A:

• The tax value method prototype legislation demonstrates what tax legislation would look like if the tax value method were introduced.
  • The prototype legislation covers major areas of the current law and proposed new areas, including the tax value method core rules, depreciation, rights, accruals under the taxation of financial arrangements and capital gains tax.
  • While provisions in the Income Tax Assessment Act 1936 must be rewritten whether or not the tax value method is introduced, many provisions in the Income Tax Assessment Act 1997 would not be substantially affected by the tax value method.

Further information

• The Board of Taxation has developed prototype legislation and explanatory material to evaluate and test the tax value method. Details are available at the Board’s website www.taxboard.gov.au.

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Q: Would the tax value method make existing case law and rulings irrelevant?

The argument is that we get an absolute benefit from accumulated judicial analysis of the current law and from the rulings on it.

A:

• Many cases and rulings would remain relevant because the tax value method would only change some of the current law, not everything.
  • Many ideas would be re-used. For example, the case law and rulings on the difference between a repair and an improvement would still be useful because the tax value method would re-use that distinction.
• Analysis of a system is only useful if the system is retained. To the extent that the tax value method replaces parts of the system with something better, the loss of case law on those parts should not matter.
• Any fear that the loss of case law would plunge us into doubt, because there would be less certainty in the law, is unfounded.
  • The areas most analysed are revenue versus capital issues. While some general conclusions can be drawn from those cases, there is no certainty emerging from them. Issues continue to arise. The tests used by the courts to answer them are many, have evolved or even changed radically over time, and often conflict with each other. The cases are often useful only for their particular circumstances.
  • Most areas of the law have had little or no judicial consideration.
• Even if there were a short term loss of certainty, the longer term benefits of simplifying the law would still make the tax value method worthwhile.
• Preliminary analysis of the draft tax value method investment asset rules (currently capital gains tax) indicates there could be a significant reduction in the need for rulings and determinations and litigation leading to real benefits for the community and the Australian Taxation Office.

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Tax value method advantages

Q: How would adopting the tax value method simplify the income tax system?

A:

• The tax value method would simplify the income tax system because the tax value method is based on as few, and as simple, concepts and mechanisms as possible.
  • The current law has many different ways of assessing gains and recognising losses for tax purposes; the tax value method would have one standard way.
• Some complexity in the tax law is necessary to give appropriate treatment to the variety of business activities.
  • But much of the existing complexity is unnecessary because it reflects the ad hoc development of income tax law over the last century.
• The redraft of key capital gains tax rules into the tax value method format is an example of the significant simplification possible under the tax value method.
  • So far, the tax value method redraft has reduced the size of the key capital gains tax rules by more than 70 per cent and will reduce 40 capital gains tax events to 8 at most.
• Simplifying and reducing the size of the current tax law should lower the cost to comply with and administer the law.

Further information

• The redraft of capital gains tax into tax value method investment asset rules has so far dealt with the key issues of the capital gains tax discount and capital loss quarantining. This has reduced 126 pages of the current law to 32 under the tax value method.
• The capital gains tax events have been reduced to 3 under the tax value method redraft. However, 5 others will need to be considered further as drafting proceeds.

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Q: How would adopting the tax value method add to certainty in the income tax system?

A:

• The tax value method would add to certainty in the income tax system because it would replace the ad hoc approach the current law takes to transactions with a standard treatment that applies to all transactions in the same way.
  • The current law has grown to accommodate expansion of the tax base by adding new regimes. The regimes seldom deal with issues in a standard way.
  • The tax value method proposes one standard regime that deals with all transactions in the same way.
• Because there would be fewer variations to learn, it would be easier to reliably predict how the tax law would treat any particular transaction.
• The tax value method would also replace woolly judicial tests, like whether an expense is of an income or a capital nature, with more definite tests, like whether the expense generates an asset.
  • For example, if a taxpayer sells a future income stream (as happened in the Myer Emporium case), there are 5 different treatments available under the current law that could cover it.
  • These treatments do not produce consistent results, so it is not clear how the law deals with them.
  • Under the tax value method, this transaction would be treated in just one way.

Further information

• The Board of Taxation has arranged for Professor Cooper of Melbourne University, in conjunction with the ANU’s Centre for Tax System Integrity, to test the tax value method provisions against their current law equivalents to see if certainty is improved.
• A detailed analysis of the Myer Emporium case, explaining how it is treated under the current law and how tax value method would treat it, can be found at Attachment A to Tax value method: information paper. This paper is on the Board website www.taxboard.gov.au.

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Q: How would adopting the tax value method make the income tax system more durable?

A:

• The tax value method would make the income tax system more durable because it completely describes the tax base.
  • Changes to the law would only be necessary when you want to add to or reduce taxable income. Unless the tax base is contracting, those things are fairly uncommon.
• The current law is not durable because it doesn’t completely describe the tax base. Whenever something else has to be made assessable or deductible, the law has to be amended.
• The standard tax value method treatment produces appropriate economic outcomes. The default treatment under the current law often produces inappropriate outcomes (for example, legitimate business expenses that are not deductible at all – the so-called ‘black hole expenses’).
  • Inappropriate outcomes lead to the need for frequent legislative amendment.
• As an example, in 1999, 3 new regimes had to be added to the law to cope with expenditure on developing software, on rights to use submarine cables and on spectrum licenses.
  • These were things that had grown out of technological developments and, so, were not covered by the existing law.
  • If the tax value method had been in place, the expenditure would have reduced taxable income without a need to amend the law.

Further information

• The Australian Taxation Office’s TVM Centre of Expertise has begun to evaluate improvements in durability by examining what proportion of recent changes to the law would have been necessary had the tax value method been in place.

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Q: How would adopting the tax value method make the income tax system more transparent?

A:

• The tax value method would make the income tax system more transparent because it has one standard way of doing things. It would be easy to identify departures from the standard way.
  • For example, the main way of increasing tax under the tax value method (other than just raising the rates) would be to change an asset or liability’s tax value. Such a change would be very obvious.
• Knowing that there is a change from the norm is a necessary step in understanding why the change was made.
  • That a change is more widely known would increase demand for a detailed explanation of the reasons for it.

Further information

• Comprehensive testing of transparency will commence when more complete drafting (especially in non-core areas) allows the testing to be more useful.

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Q: How would adopting the tax value method make the income tax system more equitable?

A:

• The tax value method would make the income tax system more equitable because it would treat different taxpayers with the same economic circumstances in the same way.
  • It would do that because it deals with every transaction in one main way.
  • The current law provides many different ways of treating a transaction depending on how it is characterised. In some cases, more than one regime can apply to the same transaction (for example, 5 different regimes can apply to the transaction in the Myer Emporium case).
• The tax value method would only recognise actual gains and losses and would avoid the timing anomalies that arise under the current law.
  • The current law sometimes brings gains and losses to account before they are realised and sometimes doesn’t recognise them even after they are realised.
  • The current law doesn’t always bring gains and losses to account for both parties to a transaction at the same time.
• Of course, even under the tax value method, special rules could still be put in place to provide different treatments (for example, the simplified taxation system rules).

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Q: How would adopting the tax value method make the income tax system more robust?

A:

• The tax value method would make the income tax system more robust because there would be fewer ways to avoid tax under the tax value method.
  • That would happen because the tax value method deals with all transactions in one standard way and treats different taxpayers with the same economic circumstances in the same way.
  • There wouldn’t be a variety of different regimes, so there wouldn’t be any incentive to re-characterise a transaction to move it to a more favourable regime.
  • There wouldn’t be any timing anomalies to allow one party to a transaction a deduction for a loss before the other party was assessed on the corresponding gain.
• For example, a sale and lease-back arrangement seeks to characterise what is really a loan as a lease so that greater deductions can be claimed.
  • Under accounting, these arrangements are both treated as finance arrangements.
  • Similarly, under the tax value method, the different arrangements do not produce different tax results because they are economically identical.

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Q: Would the tax value method improve compliance?

A:

• By reducing the cost of complying with the law, the tax value method may reduce an incentive for taxpayers not to comply.
• The tax value method could also improve compliance because there would be fewer ways to avoid tax.
  • The tax value method deals with all transactions in one standard way and treats different taxpayers with the same economic circumstances in the same way.
  • There would be a smaller variety of different regimes, so there would be less incentive to re-characterise a transaction to move it to a more favourable regime.
  • There wouldn’t be any timing anomalies to allow one party to a transaction a deduction for a loss before the other party was assessed on the corresponding gain.

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Implementation issues

Q: How would you introduce the tax value method?

A:

• If the tax value method is to be introduced, introduction could happen in a number of ways.
• Introduction would involve identifying provisions relevant to the calculation of taxable income, or referring to assessable income and deductions, in the 1936 and 1997 Income Tax Assessment Acts and other Commonwealth statutes.
  • Provisions replaced by the tax value method core rules would be repealed.
  • Provisions being replaced by other business tax reforms not implemented before the tax value method could be repealed as part of the implementation of those reforms.
  • It would be necessary to examine other provisions for continued relevance and perhaps rewrite them.
• Using an iterative approach, the tax value method could be introduced gradually, through a series of amendments to the Income Tax Assessment Act 1997.
  • This would involve enacting the tax value method core rules, and any other provisions that could be written before the start date, to make the tax value method the new way of working out your taxable income.
  • Any provisions describing assessable income and deductions that were not redrafted before the start date would be bridged into the tax value method framework with a transitional mechanism to make the provisions work within that framework. These would be examined, and rewritten if necessary, after the start date.
• A big-bang approach would involve creating a new Act from scratch and developing it in parallel with the existing Assessment Acts. It would only be implemented once the entire tax value method law was drafted.
• The Income Tax Assessment Act 1936 has to be rewritten anyway, to complete the work of the Tax Law Improvement Project, whether or not the tax value method proceeds. If the tax value method proceeds, that rewrite could happen more efficiently.
  • For example, the redraft of the key capital gains tax rules into the tax value method format has reduced the size of the capital gains tax rules by more than 70 per cent. It achieved that by removing the many rules that become redundant under the tax value method.

Further information

• Chapter 4 of Tax value method: information paper discusses alternative approaches to introducing the tax value method. This paper is on the Board website www.taxboard.gov.au. The Board of Taxation is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method and in determining how it could be introduced. Submissions should be made by 30 April 2002.

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Q: How would introduction of the tax value method affect individual taxpayers?

A:

• Any negative impact of the tax value method on individual taxpayers should be minimal.
• The information individuals need to complete a tax return probably won’t change.
  • Two case studies based on the current TaxPack for individuals (including the TaxPack supplement) show how taxable income could be worked out under the tax value method.
  • There may be some minor changes in the terminology used in TaxPack. For example, in the case studies the term ‘reduction’ (label R) rather than ‘deduction’ (label D) is used.
• Tax offsets or concessions would not change under the tax value method.

Further information

• Attachment D to Tax value method: information paper contains two case studies showing how taxable income could be worked out under the tax value method based on the current TaxPack for individuals. This paper is on the Board website www.taxboard.gov.au.

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Q: How would introduction of the tax value method affect tax practitioners?

A:

• Tax practitioners are the main users of the income tax law. As such, they will face transitional impacts if the tax value method were to be introduced.
  • Tax practitioners also stand to gain the most benefit from the tax value method’s long-term potential to overcome difficulties with the current law.
  • Practitioners face the challenge of keeping up to date with the many developments in the current law with little interpretative guidance and unclear policy intent.
• Provisions in the Income Tax Assessment Act 1936 must be rewritten, whether or not the tax value method is introduced. Practitioners face this transition regardless.
• Many provisions in the Income Tax Assessment Act 1997 would not be substantially affected by the tax value method, so its impact on practitioners may not actually be as daunting as it first appears.
• Likely changes to software used by accountants are expected to be concerned with:
  • terminology
  • classification of transactions
  • report layouts.

Further information

• There is a need to consider the scope of re-education and re-skilling required if the tax value method were to be implemented, and to obtain a clearer view of the likely impacts for tax practitioners. The Board of Taxation has arranged for further testing to be carried out on the compliance aspects of implementing the tax value method.

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Q: How would introduction of the tax value method affect accounting software?

A:

• The tax value method is not expected to have a significant impact on the accounting software used by business taxpayers.
• There would be changes to accounting software. However, the impact is expected to be on the software used by accountants to meet tax obligations (for example, to prepare tax returns) rather than on the software used by business taxpayers in the day to day running of their businesses.
  • For example, when a business taxpayer acquires an asset the transaction would need to be recorded in the taxpayer’s accounting software much the same as it is now.
  • What may change is the way the accountant uses this information when calculating taxable income.
• The degree of the impact on accounting software used by accountants is expected to depend on the existing structure and functionality of the software and how it is currently used.
  • If the software is electronically linked to the taxpayer’s software (for example, data from the taxpayer’s business software is electronically loaded into the accountant’s software and visa versa) the software changes required are expected to be greater.
  • If the taxpayer’s software produces paper reports which are reviewed by the accountant before information is manually keyed into the accountant’s software then the impacts are likely to be less.
• Likely changes to software used by accountants are expected to be concerned with:
  • terminology
  • classification of transactions
  • report layouts.

Further information

• The Board of Taxation has released a package of material to assist the evaluation of the tax value method. This material can be found on the Board’s website at www.taxboard.gov.au. The Board is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method. Submissions should be made by 30 April 2002.

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Q: How would introduction of the tax value method affect small business?

A:

• Any negative impact of the tax value method on small business taxpayers should be minimal.
• Introduction of the tax value method would offer some benefits for small business, through improved compliance processes and publications.
• The cost of transition to the tax value method for small business taxpayers could include:
  • understanding and applying the tax value method concepts
  • modifying existing systems, if necessary.
• There should not be any need to change the accounting software used by small business taxpayers in the day to day running of their businesses.
• Small business taxpayers who do not currently prepare formal accounts would not have to start preparing them to work out taxable income under the tax value method. Equally, small business taxpayers who currently prepare formal statements could continue to use them to work out their taxable income under the tax value method.
• Because the tax value method is not expected to generally affect substantive outcomes of the current tax law, many areas would remain the same for the purposes of business systems and compliance, including the GST, PAYG and FBT.

Further information

• The Board of Taxation has released a package of material to assist the evaluation of the tax value method. This material can be found on the Board’s website at www.taxboard.gov.au. The Board is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method. Submissions should be made by 30 April 2002.

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Q: How would introduction of the tax value method affect simplified tax system (STS) taxpayers?

A:

• Any impact of the tax value method on simplified tax system (STS) taxpayers should be minimal.
• The version of the simplified tax system (STS) included in the prototype tax value method legislation largely replicates the current STS legislation.
• The prototype legislation maintains the three outcomes for taxpayers that qualify to be STS taxpayers and elect into the system.
  • It gives them a cash accounting treatment for most transactions.
  • It pools most depreciating assets and gives those pools a single rate of depreciation. Low cost assets have a nil closing tax value.
  • It allows them to choose not to bring to account small changes in trading stock values.

Further information

• The STS was added to the current law in 2001.
  • The STS modifies the method of determining taxable income for certain businesses with straightforward, uncomplicated tax affairs.
  • Broadly, business taxpayers with average turnovers below $1 million may be eligible to elect into the STS.
• The Board of Taxation has released a package of material to assist the evaluation of the tax value method. This material can be found on the Board’s website at www.taxboard.gov.au. The Board is seeking written submissions to assist it in evaluating the feasibility of introducing the tax value method. Submissions should be made by 30 April 2002.

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Q: How would introduction of the tax value method affect Parliament?

A:

• Parliament would benefit from the tax value method in a number of ways.
  • Parliament would not need to amend the income tax law so frequently.
  • The tax value method would reduce a significant source of complaints to members, senators and community representatives.
  • The tax value method could reduce tax administration costs for businesses, individuals and the Australian Taxation Office (ATO).
• Parliament would not need to amend the income tax law so frequently because the tax value method’s core rules cover the intended tax base completely. A law based on the tax value method would only have to be amended when Parliament wanted to actually change the tax base, which would be fairly uncommon.
  • The current law describes the intended tax base only incompletely. Whenever something new arises that isn’t covered but should be, the law has to be amended.
• The tax value method would reduce a significant source of complaint.
  • The tax value method could reduce the size of the income tax law, perhaps by around 40 per cent, and make it easier to learn, understand and apply.
• The tax value method could reduce tax administration costs for businesses, individuals and the ATO, saving the community time and money, by reducing the need for:
  • taxation rulings and determinations
  • private rulings
  • litigation
  • taxpayer contact with the ATO.

Further information

• In 2000, Parliament enacted 8 separate Taxation Laws Amendments Acts. In 1999 it enacted 9 Acts.

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Q: How would introduction of the tax value method affect other Government departments?

A:

• In conjunction with the introduction of the tax value method, a further Act would amend other Commonwealth legislation (including other legislation within the Australian Tax Code).
  • These amendments would be needed as other legislation currently refers to key concepts (for example, assessable income, exempt income and allowable deductions) used in the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997.
  • Government portfolios whose legislation currently relies on income tax terminology include Family and Community Services, Defence, and Education, Science and Training.
• Once a decision has been made about whether development of the tax value method is to proceed, other Government departments will necessarily be consulted to clearly identify legislative or other impacts.
  • Some Government departments have already become involved in the development and testing of the tax value method.

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What the tax value method would not do

Q: Why wouldn’t tax law drafted using the tax value method become just as cumbersome and clumsy as the current tax law?

A:

• Income tax law drafted using the tax value method wouldn’t grow the way the current tax law has grown over time because the tax value method provides superior design and policy principles to determine taxable income.
  • The current law describes the intended tax base only incompletely. Whenever something arises that isn’t covered but should be, the law has to be amended. These amendments add to the size and complexity of the law.
  • The tax value method’s core rules cover the intended tax base completely. A law based on the tax value method would only have to be amended when Parliament wanted to actually change the tax base, which would be fairly uncommon. So the law would require less amendment.
• The current tax base is very different from the tax base in 1936. For example, capital gains and most capital allowances have been added since 1936. The law’s structure was designed for the tax base in 1936, so it only accommodates the current tax base with difficulty. The tax value method would provide a structure tailor made for the tax base.

Further information

• Also see the question ‘How would adopting the tax value method make the income tax system more durable?’.

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Q: Is the tax value method a Trojan horse for the Haig-Simons model?

The argument is that the secret agenda behind the tax value method is to move Australia to a Haig-Simons comprehensive income tax base.

A:

• The tax value method is not a backdoor attempt to introduce a comprehensive income tax base which includes taxing unrealised gains.
• The tax value method does use a model that would be easily converted to a comprehensive income tax base.
  • At the heart of the tax value method is a calculation of the net change in the tax value of assets and liabilities.
  • If ‘tax value’ were changed to ‘market value’, the tax value method would produce most of the comprehensive income tax base.
• However, that conversion would never occur for the same reasons that no other country has legislated the Haig-Simons model.
  • Taxing unrealised gains has undesirable effects, on international competitiveness and politically.
  • The compliance costs in tracking market values of all assets and liabilities would be prohibitive.
  • If there ever were a move to a Haig-Simons tax system, it would be more obvious if made under the tax value method rather than the current law. So, the tax value method would work as a guard against Haig-Simons by stealth.
• Instead, the tax value method uses ‘tax value’.
  • For most assets, ‘tax value’ = cost, so gains and losses are only brought to account on realisation.
  • Market value is only used for financial assets and liabilities that are certain and only then if the taxpayer elects to use the market value.

Further information

• The Haig-Simons model is a theoretically ‘perfect’ income tax model that would tax all gains, realised or not. It is named for the two American economists who developed it, Robert M. Haig in 1921 and Henry Simons in 1938.
• It says that income = Net assets + consumption or, in other words, income is the value of what you could consume in the period while keeping your wealth constant.
• The Haig-Simons model is sometimes used by Treasury and other economists as a benchmark for judging our actual income tax base.

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Q: Would the tax value method require annual valuations of all assets?

Some people believe that the ‘tax value’ of assets and liabilities is equal to their market value, necessitating annual valuations.

A:

• The tax value method would not require annual valuations of all assets. This is a misconception. ‘Tax value’ is rarely market value. Usually, it is cost.
  • Market value is only used as the tax value for some financial assets and liabilities and only then if the taxpayer elects to use the market value.
  • There is no intention to value assets generally at market value because that would tax unrealised gains and losses.
• For some long-term financial assets and liabilities that have gains or losses that are certain, the tax value is worked out under a statutory formula on an accruals basis.
  • This is similar to the treatment that Division 16E of the Income Tax Assessment Act 1936 gives to some of those assets.
  • This does not require a market valuation.

Further information

• The Review of Business Taxation recommendations (pages 158-160) and the draft legislation that implemented them (pages 69-73), as well as the prototype legislation being developed for the Board (sections 6-40 and 7-75), make it explicit that tax value is not market value.

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Q: Would the tax value method cause problems for Australia’s double tax agreements?

There is an argument that the tax imposed on taxable income worked out under the tax value method would not be an income tax under Australia’s double tax treaties.

A:

• The tax value method would not cause problems for Australia’s double tax agreements.
• Tax on taxable income worked out under the tax value method is still ‘income tax’ under the treaties.
  • This view was supported by all who spoke on the issue at the tax value method consultative conference at Coogee in July 2001.
  • The tax value method taxes income, just like the current system and uses the same conceptual basis as accounting to calculate profit. The double tax agreements apply variously to taxes on income or profits.
  • Australia’s treaty partners and the Organisation for Economic Cooperation and Development (OECD) have been supplied with information about the tax value method and none have expressed any concerns about it.
• Terminology is unlikely to be an issue under the tax value method.
  • For instance, our most recent treaties provide for taxation of ‘income, profits or gains’ from alienating real property to be taxed where the property is located. Clearly, this description encompasses net income under the tax value method.

Further information

• Like most nations, Australia deals with taxation rights over income potentially subject to tax in several countries by entering into treaties with those countries. These treaties are given the force of law by the International Tax Agreements Act 1953.
• Typically, the treaties assign taxing rights over ‘income’ or ‘profits’ to either country.

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Q: Is the tax value method a cash flow tax?

Some people think that the tax value method is about taxing money flows.

A:

• The tax value method is not a cash flow tax. The tax value method is really about taxing net changes in the tax value of assets and liabilities.
• Cash is just another asset.
  • Accounting treats cash in the same way as other assets (that is, it measures the difference between opening and closing cash).
• For non-individuals, the annual cash flow would equal the difference between the opening and closing cash in their accounts.
  • They would be able to deal with cash in the same way as any other asset.

Further information

• The tax value method was called the ‘cash flow, tax value method’ in the Review of Business Taxation report A tax system redesigned. Many journalists just shortened that to ‘cash flow method’. That is probably the source of the confusion.

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Q: Would the tax value method require you to create a balance sheet?

There is a view that the tax value method tax returns could only be prepared by starting with a balance sheet.

A:

• The tax value method does not require you to create a balance sheet.
  • The tax value method testing has shown that you can calculate a taxable income figure under the tax value method using a profit reconciliation, a balance sheet method or other methods that are similar to current processes.
• Taxpayers who don’t prepare accounts now would not have to create either a profit and loss statement or a balance sheet.

Further information

• During the tax value method consultative conference at Coogee in July 2001, some of the corporations involved in testing the tax value method commented that they found it easier to prepare a tax value method tax return from their balance sheet compared to the current method.
• Some people seem to have extrapolated from this that every taxpayer would need to prepare a balance sheet.
• Attachment D to Tax value method: information paper contains case studies with different approaches to working out taxable income under the tax value method. This paper is on the Board website www.taxboard.gov.au.

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Q: Would the tax value method implement accounting outcomes?

Some have assumed, from the claims that the tax value method is closer to an accounting approach, that it implements accounting treatments.

A:

• The tax value method would not implement accounting outcomes.
• The tax value method is conceptually closer to accounting treatments; it is not the same as an accounting treatment.
  • The tax value method is conceptually closer to accounting because it adopts the asset and liability framework used in accounting.
• Like the current law, the tax value method cannot replicate exact accounting outcomes because tax policy differs from accounting policy.

Further information

• The Review of Business Taxation report A tax system redesigned noted that the tax value method defines income in a manner more consistent with accounting and economic approaches and uses definitions of ‘asset’ and ‘liability’ based on those used in accounting (pages 157-159).

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Q: Would the tax value method move the tax law further away from accounting principles?

An argument is that the tax value method would be further from an accounting treatment than is the current law.

A:

• The tax value method would not moving the law further away from accounting principles.
  • The tax value method’s definitions of ‘asset’ and ‘liability’ are based on accounting definitions.
  • Its ‘hold’ rules often mirror the effect of accounting’s control rules.
  • Its comparison of the opening and closing values of assets and liabilities reflects an accounting methodology.
  • Indeed, the tax value method testing showed that there were more adjustments to get to taxable income from accounting profit under the current law than using a balance sheet method under the tax value method.
• Although tax value method-style asset and liability treatments can also be found in the current law, they are not employed systematically in the way they are in the tax value method.

Further information

• The Review of Business Taxation report A tax system redesigned noted that the tax value method defines income in a manner more consistent with accounting and economic approaches and uses definitions of asset and liability based on those used in accounting (pages 157-159).
• The Board of Taxation sponsored some early testing of the prototype tax value method legislation to determine whether there were any serious compliance issues. One observation was that the tax value method could actually reduce the number of adjustments required compared to the current system.

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Q: Does the tax value method have a hidden agenda?

• to prevent the deductibility of items that are currently deductible?
• to tax unrealised gains?
• to tax wealth?

A:

• The tax value method does not have hidden agenda.
  • Taxing wealth or unrealised gains or preventing deductibility have never been put forward by those recommending or developing the tax value method.
• The need for overall revenue neutrality is a constraint on the tax value method.
  • There would be some changes due to simplification and policy decisions (such as removing black holes and the taxation of financial arrangements).
  • Changes would benefit either taxpayers or the revenue, they would not only work in the revenue’s favour.
  • No revenue has been budgeted from the tax value method itself.
  • Revenue neutrality is to be tested – it is too early to say whether the tax value method would favour one side or the other.
• The open process for developing the tax value method would limit the opportunity to increase the tax base by stealth.
  • The real issue in increasing taxes is political.
  • The political dimensions of broadening the tax base under the tax value method are the same as under the current law.