i
The Kyscope
A kaleidoscope for
assessing business income
taxation options
Press the ‘slide show’ button
in
the bar below this slide, sit back
and watch the show
© Copyright 2004 Wayne Mayo
ii
The main show runs for
about 28 minutes
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The Kyscope
You can interrupt the show
for extra information by
pressing any question
underlined in blue
A kaleidoscope for
assessing business
income taxation options
To return to the main show
at the end of extra
information detours, press
‘Go back’
How you can use
the Kyscope
To exit at any time, press
‘Esc’ key
Examples of Kyscope ‘runs’ are referred to in
the show (eg Kyscope Example 1). They
can be downloaded from the web site.
© Copyright 2004 Wayne Mayo
iii
Contents

Overview

Assets and liabilities



from a domestic perspective
Entities

Go there now
from a domestic perspective
International

Go there now
Go there now
assets/liabilities and entities (and their owners) from a
global perspective
1
Overview
The Overview runs for about 11 minutes
At the end of the Overview you will be asked
if you wish to exit
In ensuing sections on assets/liabilities,
entities and international, issues are
discussed in more detail
2
What does the Kyscope do?
The Kyscope brings together:
• assets and liabilities
It measures the income of
assets and liabilities
• entities that own the assets/liabilities
• and the people that own the entities
And tracks that income as it flows
from the assets/liabilities through the
entities and out to the owners
And shows the tax paid at
each stage depending on
the tax treatment selected
for the assets, entities and
owners
3
What can the Kyscope be
used for?

To undertake aggregate revenue analysis

estimating changing year-by-year tax receipts across a
sector/economy caused by a change in tax treatment
This is illustrated in Kyscope Example 1 – ‘Economywide effects of accelerated depreciation’

To compare tax outcomes for an investor under:


benchmark tax treatment
versus
selected tax treatment
Use this comparison and
associated effective tax
rate calculations from
the Kyscope in tax policy
analyses
All the Kyscope
examples
except Example
1 illustrate such
use
The ‘benchmark’ tax treatment is simply taxing people on the income
from their assets/liabilities in the year it is earned - whether these
people own the assets or liabilities directly or indirectly (via entities)
While an understanding of the benchmark base is not required
to use the Kyscope, it adds to the depth of analysis possible
4
The Kyscope measures
income earned in a year

B
E
N
C
H
M
A
R
K


Annual receipts
less
Annual expenses
plus
Change in annual value
of assets (and liabilities)
How, when
and whether
the income is
taxed is a
separate issue
The Kyscope
measures ‘full’
annual income
whether or not
assets are sold
Everyone knows that the money
earned from selling apples from an
orchard less annual costs of
maintaining the orchard is profit or
‘income’.
But if the value of the orchard
goes down (up) in the year the
orchard investor’s income also
goes down (up).
This is clear if the investor sells the
orchard, as the cash received on
sale is then less (or greater) than
the investment at the start of the
year.
Change in value has to be added,
however, even if the asset is not
sold. A sound measure of
income cannot change simply
because the asset is retained.
5
The Kyscope shows effect of
benchmark on investor returns
The pre-tax return of
a ‘marginal’
investment is 10%.
10% pre-tax return
A 10% pre-tax return from
all of a person’s investment
choices (the bank, bonds,
property, manufacturing,
etc) is reduced in proportion
to his/her tax rate
If the benchmark
base applies to this
investment…
…and if the investor has
sufficient other income
against which to writeoff any annual losses in
the same year…
Annual net receipts
10% pre-tax becomes say
5.3% across the choices
plus
…the pre-tax return is
reduced after tax in
proportion to the
investor’s tax rate.
Change in value of
assets/liabilities
His/her investment
decisions would therefore
not be much affected by
the imposition of tax
30% tax rate
7% post-tax return
What about risk?
What is a marginal
investment?
47% tax rate
5.3% post-tax return
6
Use the Kyscope to choose preand post-tax look of assets
T
A
X
A
B
L
E
I
N
C
O
M
E

Annual receipts
less

Annual expenses

plus
Change in annual
tax value of assets
(and liabilities)
Use the Kyscope to
choose pre-tax
features of assets and
measure the annual
income from them
It is not surprising that income tax systems usually
include annual net receipts from investments in
taxable income.
Income tax systems differ, however, in whether they
incorporate changes in value of assets in taxable
income – and, if so, when.
If included, change in ‘tax value’, rather than change
in value, is used in calculating annual taxable income.
Change in tax value may seek to estimate change in
annual value.
Want to view a typical depreciating asset?
Or tax value may remain unchanged at original cost
prior to sale, etc. Want to view an appreciating asset?
Use the Kyscope to select
tax treatment of the
assets and see how tax
value of the treatment
differs from actual value
Use the Kyscope to see the
effect of tax value differing
from actual value on tax
revenue, after-tax returns
and effective tax rates
Want to compare pre- and post tax returns of depreciating/appreciating assets?
7
Use the Kyscope to compare
options against the benchmark
Use the Kyscope to
get a feel for
behavioural effects,
price effects etc of
your selected tax
treatment………
………effects relating not
only to the treatment of
assets, but also to the
entities that own them
and the people owning
the entities
Value
INVESTMENT OVER TIME
3000
Moreover, the income
2500
from an entity’s
Value
2000
assets and liabilities
1500
(including changes in
1000
their actual values)
500
Tax value
ultimately flows
0
through to the entity’s
0
1
2
3
4
5
6
7
8
9
10
Year
owners
Therefore, comparisons against the benchmark base
can help you get a feel for the effects of selected tax
treatment of entities, as well as of the people owning
the entities
Use the Kyscope to identify ‘tax breaks’ and to estimate
the aggregate cost of them year by year as required by
many governments (in tax expenditure reports)
Use the Kyscope to
estimate the tax
revenue cost of tax
treatments relative to
the benchmark (ie ‘tax
expenditures’)
Comparing rates of return of your
selected tax treatment against those of
the benchmark base should help you get
a feel for behavioural effects, price
effects, etc.
Why?
Because, without tax, actual
values drive investment decisions. The
share investor is interested in share
value not just dividends. The property
investor is interested in increases in
value not just rents, etc.
And the benchmark tax base (with its
limited effect on investment decisions)
incorporates actual asset values
8
The Kyscope integrates the
Overview complete
three key components Want to exit now?
Assets and
liabilities
Use the Kyscope to assess how your selected tax
treatment applies to the source of all income: ie assets
and liabilities. With each asset/liability, the Kyscope
compares the selected treatment against the benchmark
ASSETS AND LIABILITIES SECTION
Entities
Entity
owners
Use the Kyscope to judge the impact of selected tax
treatment of the domestic interface between entities and
their owners. See whether a single (or double) layer of
tax applies. Run a benchmark comparison separately
ENTITIES SECTION
Use the Kyscope to move to the global scene and assess
the impact of credits for foreign taxes (or lack of them)
and the impact of exchange rates
INTERNATIONAL SECTION
In the Kyscope examples, the tax rate of the people investing is usually 47%
and the pre-tax return is 10%. Thus, the benchmark after-tax return is 5.3%
from directly owned assets and for people selling their entity ownership
9
Go back
Contents
Assets and liabilities
Assets and liabilities change in value
year by year
However, in practice, it is change in ‘tax
value’ that is used to calculate annual
taxable income
The Kyscope enables you to choose the
‘tax value’ profile of selected assets
and assess the impact of those profiles
10
Use the Kyscope to assess the
tax impact of tax value profiles

Annual changes in the tax values of assets (and liabilities) in a
country’s income tax base feed into taxable income
Use the Kyscope to simulate tax treatment of depreciating and
appreciating assets, financial assets/liabilities and trading stock
How does

that
work?
See it
again?
The actual change in value of an asset is, however, often reflected
in the owner’s taxable income over the period of ownership

It is then the profile of tax value versus value over time that
represents difference in treatment from the benchmark base
Use the Kyscope to get a feel for the impact of different tax value
profiles on behaviour, prices, tax revenue, etc

Traditional gaps in the coverage of business assets in income tax
systems have been shrinking worldwide
Use the Kyscope to simulate a range of responses to two practical
questions on the treatment of assets and liabilities:
1. how is change in value to be estimated (to give change in tax value)?
2. what practical policy constraints cut across such estimations?
11
Set tax value profiles in the
Kyscope and see effects
In practice, transactions
to be included in the
tax base are often
identified individually
Is business expenditure involved?
All expenditure in the Kyscope is business related
Yes
Does the expenditure create/improve an asset?
No
Deduction
allowed in
the year
expenditure
is incurred
In all Kyscope
examples,
annual costs in
‘Net receipts’
are deducted
that year
Yes
With the Kyscope, instead of answering
this question, you select the assets to be
included in the analysis plus their pretax characteristics
Tax value at
cost until
sold – eg
appreciating
assets,
trading
stock
Change in
tax value
based on
write-off
rate – eg
depreciating
assets
Change in
tax value
computed
from future
net receiptseg financial
assets,leases
rights
Tax value in
line with
market
value – eg
trading
stock,
financial
assets
Tax value at
cost until
production
starts – eg
forestry,
mining
Kyscope
Kyscope
Examples 2
&3
Kyscope
Examples 4,
5, 8 & 9
Kyscope
Kyscope
Examples 2
&3
Example 7
Details?
Details?
Details?
The ‘details’ illustrate how the selected
treatment might arise in practice
Details?
How is this annual
change computed?
Example 6
Details?
Details?
13
Go back
Contents
Entities
An ‘entity’ (eg a company) is a separate taxpayer
from its owners
Income generated by an entity’s assets may flow
on to other entities
And ultimately out to the people who own the
entities
The Kyscope enables you to design entity taxation
confidently because it draws together the people
who own the entities and the entities themselves
14
The Kyscope draws together the
taxation of people and entities
Design of entity taxation
needs to recognise both the
entity and the people who
own it
Some entity tax systems are
designed to impose a single
layer of tax at owners’ tax
rates on domestic income
distributed to local people
who own the entities
The single layer of tax is
consistent with the single
layer of tax faced by the
direct investor (or
unincorporated
business)……………
……but the time profile of tax
payments depends on the
design of entity taxation and
the particular circumstances
applying, such as when the
entity distributes income
People - Direct Investors
Entity
Assets
and
liabilities
Income
Entity taxed each year on its
annual taxable income
Cash flow only distributed
when entity decides to do so
Cash flow received in the
year it is produced
Annual taxable income
goes straight to
individuals’ tax returns –
to be taxed once ( ie it
attracts a single layer
of tax at each
individual’s tax rate)
Entity owners –
Indirect Investors
They are taxed separately
from the entity
Other entity tax systems
impose a double layer
of tax
15
The Kyscope can assist in the
design of entity taxation

Entity taxation systems that are designed to impose at most a single layer of
income tax on domestic entity income include:




full integration
full imputation
trust treatment
The Kyscope handles all these tax systems, and is
able to accommodate plenty of options within each
Classical entity taxation is designed to impose at most two layers of tax – one
in the entity and another in the hands of individual owners
Use the Kyscope to ensure robust entity taxation design under either
single or double taxation
The Kyscope enables you to take into account the complexities imposed
by the separation of the entity and the people owning it
What are some of these complexities?

Under an entity tax system imposing a single layer of tax, it could be
expected that, in some years, the benchmark outcome would occur
 that is, annual income of entity’s assets sheeted home to individuals owning the
entity to be taxed at their rates (giving the ‘10% pre-tax to 5.3%’ outcome)
What circumstances would give rise to this?
In Kyscope Example 10, the benchmark outcome occurs each year
16
Kyscope
Example 10
Liquidation
Year 5
How does tax treatment on
liquidation look under full
imputation and CGT to ensure
a single layer of tax only?
The company owns two
local assets and is
liquidated in Year 5
All cash flow is distributed
over the 5-year period and
the owners may sell their
shares in any year
Full imputation and, on
sale, full capital gains tax
(CGT) apply
A single layer of tax at the
owners’ tax rate applies to
the company’s income
over the 5-year period
The Kyscope shows the
overall tax design
required to achieve this
single tax layer over time
Local
Entity
Depreciating asset
Appreciating asset
Dividends
Return capital
Owners
How would the tax treatment
of a share buy-back look
under full imputation and CGT
to ensure a single layer of tax
only?
In addition, the annual
pre-tax return of 10%
from the assets is reduced
by the owners’ 47% tax
rate to 5.3% each year
This benchmark outcome
occurs annually despite
unexceptional tax design
Why?
17
How the Kyscope assists
with entity taxation
The Kyscope allows analysis of alternative approaches
to taxing entities and the people who own them
The Kyscope
calculates
investment returns
to owners each
time they sell out
to others
Comparing investment returns with the relevant
benchmark rate (pre-tax return of entity’s assets
reduced by owner’s tax rate) gives a feel for
potential price pressures and behavioural effects
It will rarely be necessary to compare investment returns
from selected entity treatment against returns from a full
integration system under the same circumstances
Most importantly, the Kyscope allows you to design entity
taxation confidently to achieve a policy goal of a single (or
double) layer of tax without unforeseen side effects

These uses of the Kyscope are equally applicable when income flows
are subject to foreign taxes in their travels back to the ultimate owners


Conceptually, handling international taxation is simple – just accommodate the fact
that foreign taxes have previously been taken out of the income
But the practicalities of foreign tax credit arrangements involve many complications
18
Go back
Contents
International
The same tax principles apply to international
investment flows as domestic flows
But there are many extra practical issues
involved
The Kyscope offers much help
with these practical issues
19
The Kyscope shows effects of
benchmark internationally
Foreign pre-tax return is reduced by the tax rate in the home country
10% pre-tax return
20% foreign tax rate
Investment
from home
country
Investment
from home
country
attracts 20%
foreign
income tax
Income
returning
to home
country
30% domestic tax
Full foreign tax credit
7% post-tax return
If full credit is given for the
20% foreign tax paid, only
10% extra needs to be paid in
the home country to meet its
30% domestic tax rate
20
Use the Kyscope to analyse
practical international tax issues

No new theoretical concepts are added just because foreign
taxes apply


If the home country provides a full credit for foreign taxes against
home country tax, investment decisions turn on the home country’s
tax base
But in practice many issues arise, for example, the:



extent to which credits for foreign taxes are provided
treatment of capital gains or losses when, for example, a local
company sells a previously acquired foreign company
design of arrangements to tax income of foreign entities even when
the income is not distributed (full integration is the conceptual model)
Use the Kyscope to analyse these and other practical issues

In Kyscope Example 15, the home country provides full credit for
foreign taxes
This Kyscope example enables you to see how administration
and compliance requirements change with different foreign
tax crediting arrangements
21
Use the Kyscope with foreign
tax credit issues
Use the Kyscope to address such issues
in a comprehensive and integrated way
The offshore income flows through
the home country to offshore
owners – ‘conduit’ income
Is the conduit
income subject to
additional home
country tax?
Foreign tax is paid offshore
on income flowing back to
the home country
Entity
Entity
People
owning it
People
owning it
If the foreign income flows
between local entities, are
the foreign taxes tracked to
allow foreign tax credits to
downstream entities and
local people who own them?
Does the local entity
get a credit against
domestic tax for the
foreign tax already
paid on the offshore
income?
Do people in the home
country who own the local
entity get a credit against
their personal tax for the
foreign tax on the offshore
income distributed to them
by the entity?
Kyscope
Example 15
22
In Example 15, The Home
Home
home country runs a
company
full
imputation system
company
of company tax.
buys offshore
sells offshore
The home company gets a full credit for
company
company
all foreign taxes paid on its income and
that full credit is passed through to its
local 2
shareholders.Year
A single
layer of tax
Year 5 Liquidation
Year
5
at local shareholders’ tax rates therefore
Offshore
applies
to the income
from all the foreign
Home Company
Offshore
Company
and tax
paid thereassets despite the foreign tax paid on it.
Home company is subject to
Offshore foreign
company pays
tax offshore would not
Moreover,
shareholders
domestic tax on the dividend
on
the
income
from
two
assets
it
be subject to additional
dividend
income from its offshore company
owns there
withholding
tax on dividends paid to
and the non-dividend income from
It distributes all cash flow to the
two offshore assets it owns directly
them.
home company in each year that
It gets a full credit for all the
foreign taxes paid on its offshore
income
Depreciating asset
Appreciating asset
Dividends/return capital
Local owners have the full foreign tax
credit passed through to them
Owners
the home company owns it
In Example
15, this policy framework is
Dividends
flowing
to the home
able to be implemented
simply by foreign
company attract the offshore
taxes
beingdividend
addedwithholding
to the company’s
country’s
tax
imputation credit account. Many ledgers
(represented Depreciating
by lines on the
entity’s
asset
Kyscope spreadsheet)
are notasset
required.
Appreciating
Under alternative policy options,
additional ledgers are required, reflecting
Dividends
Dividends
increased administration
and compliance
costs. Return capital
Return
capital to analyse the
Use
the Kyscope
link between policy design and
Capital gain
Capital loss
Owners
administration/compliance
on sale
on sale costs
23
Want to know more
about the Kyscope?

The show has only been able to cover the tip of
the Kyscope’s capabilities

For more information on these capabilities, see
the download ‘Kyscope features’

To contact the Kyscope’s developer, click on
‘Contact the developer’ on the website
Start
Assets/liabilities Section
© Copyright 2004 Wayne Mayo
Entities Section
(The two maps used are © Microsoft)
International Section