Tax Value Method

1. Tax Value Method

2. Outline of presentation Part A: Four instances for benefit Part B: Observations on the four instances Part C: What benefits arise? Part D: Reform alternatives to TVM Part E: Future actions Part F: Summary

3. Assumptions for presentation • Presentation focuses on outcomes and benefits sought from TVM, plus reform alternatives and reform actions • Presentation assumes that a case has been made for reform of the income tax system (“The Essential Thesis”) • Presentation assumes operation of TVM is understood (“The Mechanism”)

4. Part A: Four instances for benefit

5. CGT: No regime required! • TVM automatically brings all capital gains and capital losses to account • Only need rules for 50% discount, small business concession and capital losses • TVM reduces CGT law. So far, • 126 pages  29 pages • 39 CGT events  2 events (likely) • Why? • Net income calculation captures gain/losson all assets/liabilities

6. CGT: Predicted administrative benefits • Estimated administrative and compliance improvements could be: • 51% reduction in CGT related rulings • 32% reduction in CGT related litigation • 180,000 fewer phone calls to ATO p.a. • 19,000 fewer requests for amendment p.a. • 15,000 fewer letters p.a. • 770 fewer objections p.a. • 800 fewer private binding rulings p.a.

7. 1. $80m loan 2. interest12.5% p.a. 5. $80m loan repayment 3. $45.4massignment fee 4. Interestpayments Myer Emporium Facts: MyerEmporium MyerFinance Citicorp

8. Myer Emporium under current law • Lower courts: • $45.4m not taxable, so • Parliament added new income alienation rules • Then High Court: • $45.4m taxable to Myer Emporium at time of assignment • Many sets of rules can now apply: • ordinary income, CGT, alienation rules, Division 16E, traditional securities

9. Myer Emporium under TVM • Single set of rules apply to deny anticipated tax benefits • No gain arises on assignment because receipt equals tax value of the asset (right to interest) given up • $45.4m gain assessed over loan period, on accruals basis (TOFA rules apply) • Result reflects economic outcome

10. Consolidation of Company Groups • Under consolidation proposals, allocation of tax values to assets and liabilities is complex because • consolidation requires the tax value of assets to be restated • assets/liabilities do not have a unique tax value under current law • complex law required to specify multiple tax values of certain assets • varied valuation rules apply

11. Consolidation under TVM • Simpler to apply • Assets/liabilities have a unique tax value under TVM • Easier to restate this tax value on commencement of consolidation • Simpler drafting of consolidation legislation. Legislation less complex

12. Sale of plant $50m Metal Manufactures State Bank Lease payments Lease of plant Metal Manufactures Facts:

13. Metal Manufactures under current law • Commissioner argued portion of lease rental was a non-deductible capital expense • Full Federal Court: • finance lease could not be characterised as loan • lease payments were fully deductible. No portion was a capital expense • Effective outcome is a deduction for loan repayments • Will the Parliament make a legislative response?

14. Metal Manufactures under TVM • Characterisation of the arrangement irrelevant • TVM effectively divides rental payments: • notional interest  ‘deductible’ • notional principal  not‘deductible’ • Reflects economic outcome because only actual losses recognised • Specific amendments to the law not required

15. Part B: Observations on four instances

16. These four instances deal with... • Current legislation • e.g. CGT • Current case law • e.g. Myer Emporium • Current policy development • e.g. Consolidation of company groups • Possible future policy development • e.g. Sale and lease-back transactions/Metal Manufactures

17. What do the four instances show… Myer Emporium • Current income recognition faults are eliminated • Case law and litigation should be reduced • Tax scheme opportunities and incentives reduced • asymmetry and timing anomalies eliminated • some schemes not have tax advantages, so not happen

18. What do the four instances show… CGT and “Myer Emporium” Rules • TVM reduces volume of law • Legislation shorter and simpler because: • one way of doing things • standardised core rules • no overlapping • Other areas will be shorter, or removed, for the same reasons (e.g. debt forgiveness rules)

19. What do the four instances show… Consolidations • TVM improves current policy process • One way of doing things: • cohesive platform for policy development • simpler legislation means easier development • easier to identify policy departures • simplifies support products (e.g. publications explaining obligations)

20. What do the four instances show… Sale and leaseback transactions • Future policy issues do not arise (or can be better handled) • advantage of standard core rules and cohesive principles • Reduces need to amend legislation • Demonstrates ability to deal with economic/commercial developments (even those not presently anticipated)

21. What are wider implications? • Instances identified demonstrate positive outcomes from TVM proposal • Further instances where positive outcomes arise can be identified e.g. write off of IRU’s • Issue remains whether these outcomes will extrapolate into benefits for the income tax system per se

22. Part C: What benefits arise from these instances?

23. Benefits to legislation • Clearer and more coherent structure • e.g. better consolidations provisions • Better drafted provisions • Shorter and less complex • fewer provisions to assess specific circumstances (e.g. no specific CGT rules) • No gaps, no overlaps

24. Benefits to law design • Standardised definition of income and core rules • cohesive platform for policy development (clear benchmark for assessing appropriate income and expenditure recognition) • easier to explain effect of policy decisions • easier to implement actual policy intent • no need to reinvent the wheel • Appropriate default treatment • fewer amendments

25. Benefits to law users • One way of doing things • easier to analyse transactions and avoid errors • easier to understand and explain the law • easier to discern policy intent • Reduced volume of law • Less new law to learn and teach • Less support material • fewer rulings, cases

26. Benefits to taxpayers • Law more certain • More appropriate assessments • closer to economic outcomes (e.g. no timing anomalies) • Less tax litigation (and less dispute) • Impact: • improved certainty in making business decisions • less resources diverted to tax planning and audits • improved support products

27. Part D: Reform alternatives to TVM?

28. Are other options available? • Three alternatives can be discerned: • piecemeal reform of particular problems • trialing TVM (e.g. with TOFA) • use accounting profit as taxable income • “Option 3” • Working Group proposal to (i) capture TVM benefits and (ii) provide an alternate approach to establishing case for TVM

29. Piecemeal reform • Enact legislation for specific problems • e.g. relieve identified black hole expenses • likely to compound existing complexity • can only solve identified problems • Does not allow a single integrated systemic solution (unlike TVM) • discrete solution for each problem • lack of clear platform for future developments

30. Trialing TVM • Another approach to piecemeal reform • Trialing is inconsistent with TVM’s “essential thesis” • TVM’s objective is to standardise the definition of income and use core concepts across the law • TVM mechanism already pervades current law • e.g. most recently in uniform capital allowances • TVM mechanism has a proven success record (e.g. trading stock, CGT)

31. Accounting profit as taxable income • Adjustments required for • policy and jurisdictional issues (e.g. R&D, CGT discount, non-deductible gifts, non-residents, etc) • unrealised gains and losses • “Adjusted accounting profit” is equivalent to TVM • Gammie proposals are close to TVM

32. Option 3: Working Group proposal • Implement components of TVM proposals if “Big Bang” TVM not adopted • Alternative to benchmark TVM against (other than current law) • Means to justify introduction of “Big Bang” TVM • Natural conclusion of incremental improvement is TVM! • Conduct as part of TVM Project (underBoard auspices). Resources? Funding?

33. Part E: Future actions

34. Proposed action plan for TVM • Complete draft legislation (including CGT, private and domestic, STS, non-residents) • Issue draft legislation, explanatory material and support products (returns, guidelines) for public comment • Undertake detailed compliance and consequence testing (Chris Evans, Neil Warren, et al) • Complete “Option 3” work • Review introduction timetable

35. Board decision: Govt. decision: Board decision: Board decision: • Board to developprototype law andadministrationpackage • Continuedevelopment& evaluation? • Formal releasefor publiccomment • Recommendfuture actionto Govt. We arehere A deferred (realistic) timetable 10/8/00 20/9/01 30/9/02? 1/3/03? 1/7/04 or 1/7/05? Ralph review andrecommendation Communicate and educate Develop law and administration package Test and evaluate TVM in use Tax Reform Fatigue

36. Part F: Summary

37. What are the benefits of TVM? • TVM has benefits, but must be weighed against costs • TVM Project has benefits: • “spin-off” technology • insight into current tax system • Income tax system has three basic components: assessing, entities and administration • TVM Project is vehicle to improve the assessing function