The Murray Inquiry’s Final Report has identified a number of taxes that distort the allocation of funding and risk in the economy. It also indicated that the major review of Australia’s taxation system currently being undertaken – the Tax White Paper due for release in 2015 – should consider reform in these areas.
However, consistent with the taxation comments foreshadowed in the Interim Report, and having regard to the Tax White Paper, the Inquiry did not purport to make any express recommendations so far as tax was concerned.
Among the tax distortions identified by the Inquiry were the following:
Negative gearing and capital gains tax
Housing was identified as a potential source of systemic risk for the financial system and the economy. The combined effect of concessional rates of capital gains tax for assets held for longer than a year and the deductibility of interest on borrowings to acquire investment properties was seen as a tax subsidy. Since these tax breaks have long been a feature of the Australian tax system – apart from the short lived attempt to deal with negative gearing in 1985- there would be clear political implications in any attempt to remove this particular tax subsidy.
The Inquiry saw the case for retaining dividend imputation as being less clear than in the past. With Australia’s economy becoming more open and connected to global capital markets, imputation is viewed as a subsidy for domestic investors, including superannuation funds, to invest in domestic equities. The benefits of imputation have been an important factor in investment decisions by many Australians – particularly retirees relying on superannuation. There would be a political dynamic associated with any attempted removal. (Read more on Murray and Superannuation)
Interest withholding tax
Withholding taxes were said by the Inquiry to generally increase the required rate of return for foreign investors which, in turn, reduces the relative attractiveness of Australia as an investment destination. Where the tax cost is passed on to domestic borrowers, this raises the cost of capital in Australia.
Lower, more uniform, withholding taxes would reduce distortions. This observation has considerable merit. There do exist exemptions from interest withholding tax in a few tax treaties to which Australia is a party and, otherwise, some large scale borrowings can be structured to take advantage of domestic exemptions – such as the s128F ITAA 1936 exemption for public offers of debt securities. It would be more equitable if a lower interest withholding tax regime were more widely available rather than being confined to those foreign lenders who benefit under a tax treaty or where the borrowing can be structured to utilise an exemption.
To find out more, see our related posts or our comprehensive analysis on our website.