What is a tax expenditure benchmark?
In order to identify and measure tax expenditures a benchmark must be specified. Tax expenditures are defined and measured as deviations from this benchmark.
The framework for defining the benchmarks used in this statement is based on two principles.
- The benchmark should represent the standard taxation treatment that applies to similar taxpayers or types of activity. Consequently, a benchmark taxation treatment should neither favour nor disadvantage similar taxpayers or activities.
- The benchmark may incorporate structural elements of the tax system where there are difficulties adopting the standard treatment as the benchmark. Such elements could include integral design features; for example, the progressive income tax rate scale for individual taxpayers.
Reconciling these two criteria often involves an element of judgment. In particular, there may be different views on which structural elements to include in the benchmark. Consequently, benchmarks vary over time and across countries and can be arbitrary.
Benchmarks used in the TES
To provide a clear structure for reporting tax expenditures, the benchmark is split into two major components reflecting Australia’s taxation arrangements.
- The income tax benchmark describes the standard taxation arrangements applying to personal and business income, superannuation, fringe benefits and capital gains
- The commodity tax benchmark describes the standard taxation arrangements that apply either directly or indirectly to specific commodities; namely tobacco, fuel, types of alcoholic beverages, motor vehicles, natural resources and customs duty.
The remainder of this chapter provides details of the key elements of the income and commodity tax benchmarks. The discussion focuses on the following elements of each benchmark:
- the tax base — the activities or transactions subject to the tax;
- the tax rate — the rate of tax that applies to the base;
- the tax unit — the entity liable to pay the tax; and
- the tax period — the period in which the activities or transactions are undertaken.
Most Australian Government taxes are imposed on income rather than commodities. The following sections outline the general features of the income tax benchmark. The benchmarks for superannuation, fringe benefits and capital gains are discussed separately because they have distinct tax regimes that affect how tax expenditures are measured against the general income tax benchmark.
The tax base for the income tax benchmark is based on the Schanz-Haig-Simons definition of income.1 An entity’s income is defined as the increase in the entity’s economic wealth (stock of assets) between two points in time, plus the entity’s consumption in that period. Consumption includes all expenditures, except those incurred in earning or producing income.
The Schanz-Haig-Simons definition of income conforms to the principal criterion of benchmark design: all income is included in the base regardless of the income earning activity. Adopting a benchmark based on this definition would exclude structural elements of the current tax system from the benchmark. Consequently, the income tax benchmark is based on the Schanz-Haig-Simons framework, but modified to accommodate structural elements.
Under the income tax benchmark, income includes:
- wages and salaries;
- business receipts;
- capital gains;
- interest, royalties and dividends;
- partnership income;
- government cash transfers2; and
- distributions from trusts.
Where an expense is incurred for both income-producing and private purposes, deductions are limited to the portion of expenses relating to income production.
A number of tax arrangements depart from the Schanz-Haig-Simons definition of income but are structural features of the tax system and therefore included in the benchmark. These elements are outlined below.
- Assessment applies to nominal rather than real income. Expenses incurred in earning income are deductible at historical cost.
- Some taxpayers (typically individuals) recognise income when it is actually received (cash basis) and other taxpayers (typically businesses) recognise income when there is a right to receive benefits, or, in the case of financial arrangements in the period to which it relates (accrual basis).
- Deductions for expenses related to economic benefits that extend beyond the income year in which the expenditure is incurred are spread over the period of the benefits.
- Imputed rent from owner-occupied housing is not included in income, and expenditure incurred in earning imputed rent is not deductible.
- The mutuality principle excludes income from dealings with oneself or members of mutual associations and societies. For instance, goods produced by taxpayers for their own consumption, or services performed by taxpayers for their own benefit are generally not included in the tax base.
- Certain gains, such as gains received by way of compensation for damage or any wrong or injury suffered by a taxpayer (where they are not solely for the loss of income), or gains or winnings from gambling (where taxpayers are not considered to be carrying on a business of gambling), are not included in income.
- Investment income derived from income bonds, funeral policies and scholarship plans of friendly societies that were issued before 1 January 2003 is not included in income.
- Income relating to policies issued after 1 January 2003 is included in a friendly society’s assessable income.
- To prevent double taxation of income from bonds, funeral policies and scholarship plans, friendly societies can deduct the investment component of the benefits paid out to policyholders (other than the benefits from scholarship plans that are returned to investors rather than paid to the nominated students).
- Losses are deductible against assessable income for a later income year. Losses generally cannot be transferred to other taxpayers, and some losses may only be claimed against certain types of future income.
- Depreciation deductions are made over the effective life of the asset.
- Expenditure in advance (prepayments) for services are generally apportioned over the service period. These apportioned amounts are deductible.
- From 1 July 2005, under a provision of last resort, business capital expenditures not elsewhere recognised within the taxation laws (blackhole expenditures) are deductible over five years.
Arrangements to prevent double taxation
Arrangements to reduce or eliminate double taxation are integral features of the tax system and are included in the benchmark.
- For example the imputation system, which eliminates the double taxation of company profits distributed to resident shareholders, is included in the income tax benchmark.
International tax arrangements
Australian residents are taxed on their worldwide income under the income tax benchmark. Consequently, residents are taxed on their Australian-source and foreign-source income. Various international tax arrangements that ensure foreign-source income is subject to the appropriate level of Australian tax are included in the income tax benchmark. These arrangements are noted below.
- Resident taxpayers are allowed to claim foreign income tax offsets up to the amount of Australian tax payable on their foreign income. These arrangements ensure foreign-source income is not excessively taxed.
- The controlled foreign company, foreign investment fund and transferor trust rules ensure Australian residents cannot escape or defer taxation of tainted income by interposing a foreign resident legal entity.
- Tainted income is generally income derived by investments which are mobile and whose location probably was influenced primarily by tax considerations, or certain related party transactions. It includes passive income such as interest, royalties and dividends and highly mobile forms of active income.
Foreign residents are taxed on their Australian-source income only. As part of this benchmark, where foreign income (or foreign capital gains) earned by an Australian entity is subsequently distributed to a foreign resident, the distribution attracts no Australian tax.
Persons in Australia on temporary visas are taxed essentially the same as foreign residents.
Transfer pricing and thin capitalisation rules and interest, dividend and royalty withholding taxes aim to tax appropriately Australian sourced income and are included in the benchmark.
The benchmark also includes the allocation of taxing rights in Australia’s double tax treaties (other than tax sparing provisions) which are longstanding or integral features of the tax system. These arrangements provide greater certainty for taxpayers by determining which jurisdiction has the right to tax various categories of income.
Tax rates and income brackets
The tax rate under the income tax benchmark is the legislated tax rate that applies to the relevant entity in each financial year.
The personal income tax system includes the tax-free threshold, the progressive personal income tax rate scale, low-income tax offset and the Medicare levy. The progressive income tax rate scale is an integral and longstanding feature of the tax system.
Foreign residents are not entitled to a tax-free threshold on Australian sourced income, as they typically receive a tax-free threshold in their home jurisdiction. As a result, the foreign resident income tax scale is included in the benchmark.
Individuals and companies are subject to tax under the income tax benchmark. Sole traders, partnerships and trusts are not separate tax units. Income earned by these entities is taxable in the hands of the recipient.
For the personal income tax system in Australia, the benchmark unit is the individual.
For companies, the benchmark tax unit is the company. From 1 July 2002, the benchmark tax unit for companies also includes the head entity of a consolidated group or a multiple-entry consolidated group.
The taxation period adopted under the income tax benchmark is the financial year (1 July to 30 June). Consequently, measures that defer taxable income to another financial year such as income averaging for primary producers (B41) or the farm management deposit scheme (B40) are reported as tax expenditures. Tax deferral arrangements will generally give rise to tax expenditures in the year income is earned, offset by a negative tax expenditure when the income is taxed.
Departing from this framework, the carry-forward loss provisions are an integral feature of the tax system and are included in the benchmark. These provisions allow an entity with a loss to carry the loss forward and deduct it in the future.
The benchmark also includes arrangements for entities whose accounting period differs from the standard financial year (for example, companies with a substituted accounting period).
General features of the income tax benchmark
The personal income tax benchmark comprises:
The business income tax benchmark comprises:
Income contributed to superannuation funds (contributions) and earnings of superannuation funds are classified as income under the Schanz-Haig-Simons definition. While such income could be considered under the personal income and capital gains tax benchmarks, the unique (and concessional) taxation treatment of superannuation warrants further detail on how the general income tax benchmark is applied to superannuation.
Superannuation in Australia may be taxed at three stages:
- when contributions are made to a superannuation fund;
- when investments in superannuation funds earn income; and
- when superannuation benefits are paid out.
The income tax benchmark treatment of superannuation is that contributions are taxed like any other income in the hands of the fund member, earnings are taxed like any other investments in the hands of the investor and benefits from superannuation are untaxed. Any costs associated with superannuation investments are deductible under the benchmark.
Special features of the superannuation benchmark
The superannuation benchmark comprises:
Fringe benefits tax benchmark
Fringe benefits are classified as individual employee income under the Schanz-Haig-Simons definition. This section defines the benchmark for the fringe benefits tax system drawing on the general features of the income tax benchmark outlined above.
The tax base for the fringe benefits tax benchmark is the value of fringe benefits provided to an employee or an associate of an employee in respect of the employment of the employee. Fringe benefits include property rights, privileges or services. Payments of salary or wages, eligible termination payments, contributions to complying superannuation funds and certain benefits arising from employee share schemes are excluded. The benchmark value of a fringe benefit to an employee is taken to be its market value less any contribution the employee pays. Generally, employers may claim the cost of providing fringe benefits and the amount of fringe benefits tax paid as income tax deductions.
The tax rate that applies under the fringe benefits tax benchmark is the employee’s personal marginal income tax rate.3 In all cases, fringe benefits tax is calculated on the grossed up taxable value (that is, the pre-tax equivalent value) of the fringe benefit. In some cases, discount valuation methods are available to calculate the taxable value of a fringe benefit. Such methods are reported as tax expenditures.
The employer providing the fringe benefit (rather than the employee receiving the benefit) is the tax unit under the benchmark. This is consistent with the legal incidence of fringe benefits tax, which is payable by employers. The benchmark tax period is the fringe benefits tax year (1 April to 31 March).
Special features of the fringe benefits tax benchmark
The fringe benefits tax benchmark comprises:
Capital gains tax benchmark
Capital gains are classified as income under the Schanz-Haig-Simons definition. This section defines the benchmark for the capital gains tax system drawing on the general features of the income tax benchmark outlined above.
The tax base for the capital gains tax benchmark is realised nominal gains and losses. The benchmark only includes gains or losses arising from the realisation of property where the realisation is not an aspect of the carrying on of a business. This excludes gains or losses that form part of a business’s normal trading activities from the capital gains tax benchmark, for instance, gains or losses on trading stock of a business and gains or losses realised in the business of trading particular assets. These gains or losses are dealt with under the general features of the income tax benchmark.
Capital gains are taxable upon realisation. While the taxation of gains on an accrual basis aligns more closely with the broad Schanz-Haig-Simons definition, taxation on a realisation basis is consistent with longstanding practice and recognises the administrative problems associated with an accrual system.
Consistent with the general features of the income tax benchmark, the benchmark for Australian residents is their worldwide capital gains. In the case of foreign residents, Australia has limited its domestic and treaty capital gains tax rules to the direct or indirect disposal of interests in Australian land (and similar interests such as mining rights) and branch office assets from 12 December 2006. In respect of both the foreign capital gains of residents and the Australian capital gains of foreign residents, the allocation of taxing rights in the domestic laws and tax treaties is part of the benchmark.
The tax rate and tax unit adopted under the capital gains tax benchmark is the same as that which applies under the general benchmark outlined above.
Special features of the capital gains tax benchmark
The capital gains tax benchmark comprises:
4.3 Consumption tax benchmark
The Australian Government imposes taxes on particular commodities. The tax base for the commodity tax benchmark is made up of three components.
- The consumption tax benchmark relates to the consumption of fuel (or energy), tobacco, types of alcoholic beverages and motor vehicles.
- The natural resource tax benchmark relates to the extraction and production of Australia’s natural resources.
- The customs duty benchmark relates to the importation of goods into Australia.
This statement only reports tax expenditures that relate to Australian Government taxes. As the GST was not reported as an Australian Government tax in the period up to the Pre-Election Fiscal and Economic Outlook 2007, the consumption tax benchmark in this statement does not include the GST. The GST will be reported as an Australian Government tax under the consumption tax benchmark from the 2008 Tax Expenditures Statement.
Commodity tax benchmark
Consumption taxes are either ad valorem or volumetric. Ad valorem taxes are charged as a fixed proportion of the value of the commodity sold. Volumetric taxes are charged as a fixed proportion of the quantity of the commodity sold. Consequently, the tax base for consumption taxes is determined either by the value or quantity of the commodity sold.
The Australian Government imposes volumetric taxes on the consumption of tobacco, fuel, beer, spirits and certain imports, and ad valorem taxes on the consumption of wine and luxury cars. These taxes are imposed at either the retail, manufacture or importation stage. In each case, the tax unit is the entity that has the legal obligation to pay the tax.
The following sections outline how the general features of the consumption tax benchmark apply to the consumption of tobacco, fuel, alcohol and motor vehicles.
General features of the consumption tax benchmark
The consumption tax benchmark comprises:
The benchmark for the consumption of tobacco and tobacco products is the excise rate that applies to tobacco other than in stick form.
Fuel (or energy)
The tax base for the consumption of all fuel (or energy) is split into two activities:
- fuels consumed in an internal combustion engine (that is, primarily for transport use); and
- fuels consumed for a purpose other than in an internal combustion engine (for example, a product that can be used as a fuel in an internal combustion engine but is used in a solvent application or for heating).
The taxation of these activities reflects longstanding and integral features of the tax system whereby excise rates are dependent on whether the fuel is used in an internal combustion engine.
The benchmark excise rates for fuels consumed in an internal combustion engine are the full energy content based rates for the following bands:
- high-energy content fuels, with energy content of more than 30 megajoules per litre and excise rate of 38.143 cents per litre. These include fuels such as petrol, diesel, biodiesel and aviation fuel;
- medium-energy content fuels, with energy content between 20 and 30 megajoules per litre and excise rate of 25 cents per litre. These include fuels such as liquefied petroleum gas (LPG), liquefied natural gas (LNG) and ethanol; and
- low-energy content fuels, with energy content of less than 20 megajoules per litre and excise rate of 17 cents per litre. These include fuels such as methanol.
Fuels consumed other than in an internal combustion engine are exempt from excise under the benchmark.
The tax base for the consumption of alcoholic beverages is separated into three components based on the types of beverage:
- the consumption of lower alcohol content beverages (beverages with less than 10 per cent alcohol content) such as beer and ready to drink beverages;
- the consumption of higher alcohol content beverages (beverages with greater than 10 per cent alcohol content) such as brandy and other spirits; and
- the consumption of wine and alcoholic cider.
The taxation of these activities reflects a longstanding feature of the tax system whereby different tax rates apply to beer, spirits and wine:
- the benchmark excise rate for lower alcohol content beverages (for example, beer) is the volumetric excise rate that applies to full-strength packaged beer (including the excise-free threshold of the first 1.15 per cent of alcohol);
- the benchmark excise rate for higher alcohol content beverages (for example, spirits) is the volumetric excise rate on spirits other than brandy; and
- the benchmark rate for wine and alcoholic cider is the ad valorem wine equalisation tax rate.
Motor vehicle purchases are not taxed under the benchmark. Consequently, the luxury car tax (F19) is a negative tax expenditure.
Under the customs benchmark, goods imported into Australia are subject to the same taxes on consumption as domestically produced goods. Under this benchmark, goods imported into Australia are free from customs duty, except to the extent that the customs duty imposed is equivalent to taxes imposed on domestically produced goods, such as excise equivalent customs duties.
Customs duty, other than excise equivalent duty, collected on certain goods imported into Australia is reported as a negative tax expenditure in this Statement.
Estimates of the value of assistance provided to various industries, including tariff arrangements, appear in the Productivity Commission’s Trade & Assistance Review.
Taxes on natural resources (petroleum)
The Australian Government taxes profits from the extraction and production of unprocessed petroleum (for example, crude oil, LPG and condensate) and in certain cases natural gas. Different taxation arrangements for unprocessed petroleum products applied to projects that commenced before the 1986-87 financial year.
The benchmark for petroleum projects that commenced on or after 1 July 1986 is based on the petroleum resource rent tax (PRRT).
- The tax base includes receipts from offshore petroleum production (excluding projects located in the North West Shelf) less eligible project expenditures.
- Under the PRRT any eligible expenditure which is not offset against revenue in the current year can be compounded and offset against future PRRT income. The rate at which expenditure is compounded and carried forward depends on the category of expenditure and when it was incurred. The benchmark uplift rate for exploration expenditure is the long term bond rate plus 15 percentage points and for general project expenditure is the long term bond rate plus 5 percentage points.
- The benchmark tax rate is 40 per cent of the project’s profits.
- The benchmark tax unit is the petroleum project.
The benchmark for petroleum projects that commenced before 1 July 1986 (for example, the North West shelf) is the crude oil excise and is comprised of the following features:
- the barrel equivalent production of crude oil from fields of greater than 30 million barrels as the tax base;
- the rate of tax that applies to crude oil as the tax rate; and
- the entity that has the legal obligation to pay the tax as the tax unit.
1 Further information on the Schanz-Haig-Simons and other definitions of income can be found in J King, ‘The Concept of Income’, Tax Policy Handbook, International Monetary Fund, Washington DC, 1995, p 117.
2 Cash transfers are payments from the Australian Government to individuals or businesses which are not for services rendered (including refundable tax offsets). These transfers are included in the income tax benchmark. Non-cash government transfers such as the provision of health, education or road services are not included in the definition of income.
3 As a technical assumption, to allow estimation where the personal marginal income tax rate could not readily be estimated, the top personal marginal income tax rate plus the Medicare levy is assumed.
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