Submission to the Tax White Paper
Aim
To provide: a fair and systematic approach to the treatment of Capital Investment.
Summary
An accounting system designed to remove current difficulties imposed by the Taxation treatment of
Asset Depreciation.
Tax payers establish a register of Debt Accrued as a result of acquiring Capital Business Assets,
Named Debt Pool
The Debt Pool would operate in a Similar manner as the Assets Pool of the Simplified Tax System
(STS) and available to the same entities as the STS.
Depreciation allowed as STS Write Off would then become the Difference between the Value of the
Assets Pool less the Value of the Debt Pool.
Applying Depreciation to the Assets Pool at the end of each Tax Period; makes the Values of both
Asset and Debt Pools the same at the beginning of each Tax Period.
To receive a Tax deduction for Depreciation the Tax Payer would have to repay some debt during the
current Tax Period.
This leads to many benefits both for the Business and the Government through more secure and
prosperous Businesses increasing the GDP and paying more Taxation through greater profits
Benefits
Makes Repaying debit effectively Tax Deductible for Small Business
Ensures that Small Business is not victimised for investing in Capital
Remove Cash Flow challenges when Small Business invests in Capital
Makes the use of Debt a business decision, rather than a Tax Planning issue.
Stronger, more secure Small Businesses.
Less Small business debt
Increases Australia’s GDP
Decreases Un-Employment
Long term increases in the Government’s Tax Income
Cash Flow Issues are a Major Source of Business Failure
A Cash flow crisis if often generated if a Business Retires a large amount of Debt!
Because of the limited amount of Depreciation that can be claimed.
Similarly if Debt is retired over an extended period, also causes a Cash Flow issue because a
deduction was taken when not needed and when the Debt is finally retired a Cash Flow Shortage
occurs, due to the lack of Depreciation available.
(This effect also happens when accelerated Depreciation Rates are allowed for political reasons)
I am sure it should not be our intent to punish Businesses for being successful and retiring Debt!
The Ideal time to allow a Tax Deduction for Depreciation of Assets is when the Debt is retired.
Method
The concept of an Asset Pool has been available, to Tax Payers who are eligible to operate under the
Simplified Tax System (STS), for some time now. The system is well understood and operates
efficiently.
Our submission is to improve on the Asset Pool system by extending it to include an additional Pool
on the other side of the ledger a Debt Pool
The Debt Pool will contain the related debt incurred as a result of Assets purchased to form the
Asset Pool. Along with any repayments made.
Effectively the End of Year balance of asset related borrowings.
Asset Write-Off Expense (Depreciation) for Income Taxation Assessment will be the difference
between the balances of the Assets Pool and the Debt Pool.
At the beginning of the next Taxation period the Debt Pool and Asset Pool will be at the same figure,
because last year’s depreciation applied to the Asset Pool reduces it to the value of the Debt Pool.
For a Tax Payer to receive a Tax Deduction for Depreciation they will have to reduce their asset
related borrowings and therefore the balance of their Debt Pool.
Practical effects of the Debt Pool System
Because Tax Payers will only be asked to pay tax when they have money to pay; the Debt Pool
System will encourage Income Producing Assets to be purchased with a minimum of Debt. This will
result in more secure Small Business with reduced Non- discretionary spending.
Businesses that reduce their existing borrowing will be rewarded under the Debt Pool System with a
Larger Tax Deduction for Depreciation. This removes the current disincentive against retiring large
amounts of Debt if a Business achieves a larger than normal profit in a tax period.
The Debt Pool System will also remove the Trap offered to Tax Payers through Accelerated
Depreciation, if a Business Depreciates its Assets in a Tax Period, without retiring the Associated
Debt, In future Tax Periods when the Debt is finally retired but no Depreciation is claimable the Tax
Payer is looking at a Large Tax Bill without the funds to pay (because it gave its money to the bank to
retire the debt)
The Ideal time to allow a Tax Deduction for Depreciation of Assets is when the Debt is retired.
Finance companies are the best guide to Depreciation Rates, they use a market based approach, and
give best guide to effective asset life. This is much superior to some arbitrary measure or a political
accelerated rate.
This is why car leasing is over 3 or 4 years but some other assets can be leased for up to 10 years.
The Government does not miss out under the Debt Pool System because the Value of Assets can
ONLY be written down ONCE.
The Need for such a measure
Capital Investment is a relatively larger problem for a Small Business than a Large Business.
If McDonalds invest $100,000 on tables to expand an outlet this represents a very minor percentage
of its total worth. But if Joe’s Local Burgers expends the same $100,000 this could represent a very
large amount of its total worth.
A small business is therefore placed in a perilous Cash Flow situation when investing in capital. The
ramifications of which can easily lead to bankruptcy.
It is in the National Interest that our Taxation system reward small business for investing in capital
because such investment expands our GDP and reduces Un-employment rates.
The fact is; that for a Small Business to become a Medium Business it must expand itself many fold. 4
times, 10 times, 100 fold, 1000 fold…. This requires much Cash Flow risk, which is exaggerated by the
current Taxation implications caused.
The Very least the Taxation system should be; is neutral when a Business Invests in Capital
Equipment; but unfortunately the current system is still punitive.
The government is in a much better position than Small Business to cover the Cash Flow implications
of investing in Capital and will benefit if fewer Small Businesses go bankrupt or grow into Medium
Businesses.
Debt Pool system fixes problems and creates fairness.
Debt Pool
Simply calculated; The Amount of debt taken on to purchase income producing assets, less any
repayment of that debt. (Interest to be treated separately and expensed as usual)
The amount of STS Pool Write Off claimed as a Tax Deduction is now very easily calculated
Value of the Asset Pool (at 30 June)
LESS
Value of the Debt Pool (at 30 June)
EQUALS
STS Pool Write Off (depreciation)
This one simple formula allows for all situations.
Like all good rules there is one exception any Negative Amount for STS Write Off is treated a NILL
AMOUNT (Explained below Example 3, 4)
Example - Year 1
A company Purchases a New Income Producing Machine for $100,000
Borrowing $80,000 with a $20,000 cash deposit paid from income produced this year
Asset Pool $100,000
LESS
Debt Pool $80,000
EQUALS
STS Pool Write Off $20,000
(Immediate Write Off Reflecting the non-Debt portion of the capital investment)
Cash Flow
New System
$1.00CR
$20,000
Opening Bank Balance
Income
Current STS
$1.00CR
$20,000
Tax Deductible STS Write off $20,000
Debt Repayment
$0
$15,000 (15% first Year)
$0
Closing Bank Balance
(Before Tax)
$1.00CR
Taxable Income
Tax to Pay
Closing Bank Balance
$1.00CR
$0
$5,000
$0
$1.00CR
$1,500 *
$1,499DR (After Tax)
* $1,500 Tax is payable despite the entities bank balance remaining unchanged, in fact they have
nothing in the bank after investing in Australian infrastructure.
Income Tax is $1,500 because they have an Income of $20,000 but deductions (STS Pool Write Off )
for Taxation Purposes of only $15,000. (15% first year)
This is a key disincentive of investing in Income Producing Assets under the current Tax System
Example - Year 2
One year on, our company has their new machine on line
Income $60,000
Debt Retirement $50,000
Asset Pool $80,000 ($100,000 - $20,000 Depc Last Yr)
LESS
Debt Pool $30,000 ($80,000 - $50,000 paid off the debt this year)
EQUALS
STS Pool Write Off $50,000 (Asset Pool less Debt Pool)
New System
Current STS
Profit and Loss
Income
$60,000
Tax Deductible STS Write Off $50,000
Taxable Income
$10,000
$60,000
$25,500 (30% $85,000)
$34,500
Cash Flow
Opening Bank Balance
Income
Debt Repayment
Closing Bank Balance
$1,499DR
$60,000
$50,000
$8,551CR (Before Tax)
Tax to Pay
Closing Bank Balance
$1.00CR
$60,000
$50,000
$10,001CR
$3,000*
$13,001CR
$10,350 **
$1,799DR # (After Tax)
*$3,000 = 30% of $10,000 (the correct taxation amount)
** $10,350 = 30% of $34,500 ($60,000 - $25,500)
# $1,499DR opening balance + $10,000 cash flow in ($60K income less $50K to Bank) Less Taxation
Paid $10,350 [-1499 + 10000 – 10350]
As can clearly been seen from the above examples, Retiring more Debt than Depreciation leaves the
entity paying more Taxation under the current system
This is a major disincentive to paying off Debt, especially considering that you have emptied your
current account into the loan, so you do not have money to pay Tax
The new Debt Pool system corrects this inequity – effectively making re-payment of Debt, Tax
Deductable – this will lead to an increase rate of debt retirement for Small business.
The effect is stronger, more secure Small Businesses, with improved prospects of growing into
medium Businesses
A tax payer might think to beat the current STS it is cleaver Retiring Less Debt than Depreciation BUT
this is incorrect in the long run (and a trap) because their Asset Pool will be reduced by more than
the correct amount, which will not be available to depreciate in coming years when you want to
retire Debt. Leaving less Depreciation to claim and More tax to pay from their EMPTY bank account.
Conversely the ATO might look at the $7,350 extra taxation collected in the above example and fret
that this amount of tax is lost; also untrue in future years this amount will be collected (and more)
because the Tax Payer can only depreciate the Asset Pool ONCE. When the debt is repaid
depreciation is automatically expired the Business will be in a more profitable position and rightly
assessed for increased Taxation.
It could be argued that this is just a timing issue or a Cash Flow issue; maybe correctly but who is
more suited to weathering a Cash Flow issue? A small Business or the Australian Tax Office!
What Good does it do the ATO if it bankrupts many Small Businesses? How much tax does it collect
then! Much better the ATO carry the timing of depreciation.
If you want Lemon Juice, you have two choices, you can squeeze the Lemons harder or you can plant
more Lemon Trees!
What happens if you sold an asset and debt not retired?
Example 3 (Special case)
This is a rare example which proves the soundness of the system
In such a case No Depreciation allowance would be claimable until Debt Pool is Reduced to be less
than the Asset Pool.
From our previous example
Say that the machine is sold for $20,000 ($10,000 less than the written down value of the asset)
New System
Asset Pool
$30,000
Sale
$20,000
Asset Pool (After Sale) $10,000
Debt Pool
$30,000
Under the current system the Tax payer continues to get a tax deduction for Depreciation even
though they did not reduce their Debt
Under the new system, No Tax Deduction for Depreciation occurs until the Debt Pool fall below
$10,000 in this example. (Less than the Asset Pool value)
The Standard formula applies
Value of the Asset Pool (30 June) 10,000
LESS
Value of the Debt Pool (30 June) 30,000
EQUALS
STS Pool Write Off -20,000 (Negative Amount, treated a NILL)
Write Off’s are not refundable therefore NO ASSET Pool Write Off can be claimed if the calculated
amount is a negative figure.
Taxpayer will have to wait until Debt Pool is reduced to Under the Amount left owing in the Asset
pool to continue Writing off the Asset Pool.
In other words no Tax Deduction this year.
Even if the Windfall from the sale was put towards the Debt, a unfair Tax Deduction would Not have
occurred because the Debt Pool would then be $10,000 and the Asset Pool $10,000.
10K – 10K = $0 (Assuming no additional debt reduction this year)
The correct tax has been paid all along and the correct tax is due now.
Neither the government nor the tax payer has been disadvantaged.
The New System does not allow any unfair Tax Deductions for Depreciation for the Sale of an asset
But it should and does allow for any Capital Loss Involved. This is reflected in the example above by
the $10,000 (capital loss) remaining in the Asset Pool. Which is then Written Off in due course when
the Debt is Repaid.
Capital Gain Event - Example 4
Lets go back to our example and assume that the Capital Item was sold for $80,000 (a Capital Gain)
and no debt was repaid.
New System
Asset Pool
$30,000
Sale
$80,000
Asset Pool (After Sale) -$50,000
Debt Pool
$30,000
Because the Asset Pool at the end of the year is negative there is no STS Pool Write Off to be
claimed, even if debt is reduced. You may think this is unfair to the taxpayer, but merely reflects the
writing off of the sold asset, you cannot claim depreciation for an asset you have sold.
Again the Standard formula applies
Value of the Asset Pool (30 June)
LESS
Value of the Debt Pool (30 June)
EQUALS
STS Pool Write Off (for the year completed)
-50,000 less 30,000 = -80,000 (Negative Amount, Treated as NIL)
You will also note this is the amount of the sale. (Assuming no other debt reduction)
The -$50,000 Balance of the Asset Pool gets transferred to the Profit and Loss as Income.
This reflects the amount of recouped depreciation / capital gain 50,000 which is payable.
The $30,000 of unpaid debt remaining in the Debt Pool remains on the balance sheet
When the 30,000 Debt is retired in following Years No STS Write off is triggered because the Asset
Pool (Now $0) is still Not More than the Debt Pool, so a Negative result for Write off treated as NILL
The ATO actually wins here (but no worse than the current STS) Lesson for the Tax Payer – retire
debt upon asset sale – when they have the money to pay back the bank.
Problems with other systems
For many years successive governments’ have tried to address the issue of Accelerated Depreciation;
usually by increasing the rate at which an instant Write Off could occur. The figure has been as high
as $6000 now back down to $1000. Perhaps now being proposed to rise again to $10,000!
The problem with such an arbitrary write off is that it can lead to Tax Payers having written off an
asset without repaying the borrowings. When the borrowings are finally repaid; they have limited
moneys remaining after retiring debt but have a Tax Bill to pay. (Because they now have no
offsetting depreciation to claim)
Prior to the STS depreciation rates were arbitrarily set for different items with supposed reference to
Useable Life. This system left Tax Payers in the difficult situation of having spent surplus monies
improving their lot by investing in capital but then facing a Larger Tax Bill because of the small
Depreciation Deduction allowed.
The Useable Life method also fails to take into account the realisable value of a capital asset. Most
Assets used in a Small Business are virtually value less upon first use.
For example if a Café purchases some more tables to expand its seating area, but then is swatted
buy the local council and is forced to sell the tables. How much of its money do you think it could get
back; 25%, 15%, 5%?
In other words 75 to 95% of its money is lost; even if the council allows them to continue trading;
but the ATO only allows a 15% Depreciation in the first year.
Current Problem In a nut shell
Under the current system;
A Doctor, has made a bucket load of money this year, and is looking down the barrel of a huge tax
bill; his accountant friend at the golf club says SPEND.
He would like to buy a new machine that goes BING, It would make him another bucket load of
money, but that only gives him a 15% tax deduction. Alternative; he could go on the Drug Company
Junket that gives him a 100% deduction! And keeps his wife happy…. Let me see what does he
choose?
If the new system was introduced perhaps we might get more Medical Machines, and More Taxation
in coming years as the doctor makes Two bucket loads, or maybe he will open a new wing of the
clinic, to get more write offs….. Better outcome for every one!
What if Cash is paid for the full cost of a Capital Item?
$100,000 item paid cash (no borrowings)
If the Item is Income Producing, therefore adding Tax to the government coffers in future years full
depreciation is warranted.
Asset Pool
Debt Pool
Tax Deduction (STS write-off)
New System
$100,000
$0.00
$100,000
Extra Tax because of Purchasing Income Producing assets $0.00
STS
$100,000
$30,000
$21,000 ($70,000 x 30%)
If you have paid cash out of your Cash Flow, you should be allowed a Full Tax Deduction, if not you
would be taxed for investing in Australia’s infrastructure.
Remember that they have spent their cash on the Asset and have not any left to pay tax with – this
year.
You are worried that the government would miss out on legitimate revenue?
Not the case, because in the next year the Entity does not have a Tax deduction for Depreciation.
Asset Pool $0.00 (Full Write off of Asset Pool Last Year)
Debt Pool $0.00
Write Off $0.00
For the company Taxation equals actual Profit for the Year. (Money in their pocket)
The Government gets more Tax this year than under the current STS, because of the tax deduction
for Depreciation still occurring under current STS.
Capital Items would still ONLY BE WRITTEN OFF ONCE.
As you can see the New system automatically takes all possibilities into account.
The best feature for the proposed new system is that Tax payers get rewarded when they do good
by Retiring Debt. By not getting Taxed when their Bank is empty because Debt was repaid
Instead of the present system where you get rewarded for NOT Repaying Debt, then getting
slammed with high Taxes when Debt is repaid
This measure effectively makes Repaying Debt Tax Deductible.
This system also promotes Investment in New Income Producing Assets; by allowing a Full Write Off
if No Debt is accrued.
This Measure substantially Decreases the risk of Investing for the Tax Payer.
This system is completely fair to the government because Capital Items would still ONLY BE
DEPRECIATED ONCE.
And the Tax Payer is never asked to pay Taxation when they do not have the money in their pocket to
pay.