The Treasurer has announced sweeping changes to the business tax system as part of the Federal Government's tax reform process. Although these changes are said to be a "boon" for the investor and small business, some are not so sure. As with previous tax announcements, the devil may prove to be in the detail of the legislation.

The key features of the reforms include:

• changes to capital gains tax;
• a reduction to the company tax rate;
• the abolition of accelerated depreciation;
• the abolition of deductibility of prepaid expenses;
• taxation of trusts as companies;
• simplified and concessional taxation of small businesses and farmers.

Capital Gains Tax

Capital gains tax for individuals on assets acquired after 30 September 1999 and held for 12 months or longer is to be halved. This will mean an effective top capital gains tax rate of 24.25% for individuals.

Superannuation funds will pay tax on two-thirds of capital gains made on assets held for 12 months or longer giving an effective capital gains tax rate of 10%. Some overseas pension funds and Australian superannuation funds for investment in venture capital will be completely exempt from the requirement to pay capital gains tax.

Shareholders issued shares on a "scrip for scrip" basis on a take over will be given roll-over relief from capital gains tax.
The sting in the tail to the reduction of capital gains tax rates is the end of indexation and averaging. As from 30 September 1999, capital gains tax indexation will be frozen and averaging of capital gains will be abolished for all assets sold after 21 September 1999.

The capital gains tax payable by taxpayers in relation to assets acquired before 1 October 1999, will be the lesser of the tax under the new rules and the difference between the realised price of the asset and its frozen indexed cost base.

As from 1 October 1999, taxpayers can offset capital losses against capital gains net of frozen indexation or the full nominal capital gain. In addition, revenue losses can be used to offset net capital gains.

Taxpayers will not have to pay capital gains tax on the sale of depreciable assets after 21 September 1999. However, any capital gains from such sale, net of the frozen indexed cost base, will be taxed as ordinary income.

It has been suggested by some commentators that many investors will end up paying more capital gains tax after the reforms despite the proposed reduction in the rates of capital gains tax. This is said to be because of the effects of freezing of indexation and the abolition of averaging.

In order to minimise capital gains tax payable, some commentators are suggesting that taxpayers should crystallise capital gains on assets acquired after 1 October 1999 sooner rather than later if they have a choice. Taxpayers will thereby avoid paying tax on a capital gain effectively eroded by inflation.

It has also been suggested that taxpayers acquire new assets through self-managed superannuation funds in order to have the benefit of the lower 10% capital gains tax rate applying to superannuation funds.

Company Tax Cuts

Companies will be given a two stage reduction in the rate of income tax. The company tax rate will drop from 36% to 34% for the financial year ending 30 June 2001 and will drop further to 30% from 1 July 2001.

New Depreciation Rules

As a trade off for the drop in company tax rates, accelerated depreciation is to be abolished and replaced with "effective life" depreciation. Assets acquired after 21 September 1999 will be depreciated over their effective life whilst assets acquired before that date can continue to be depreciated at the existing accelerated rates.

In addition to the removal of accelerated depreciation, the balancing charge adjustment for profits on disposal of depreciable assets will be removed. These charges which enable a profit to be applied to reduce the tax cost of a replacement asset will only be available for the disposal of assets after 21 September 1999 if the disposal is involuntary.

Finally, taxpayers will no longer enjoy the 100% depreciation on items costing less than $300 as from 1 July 2000. However, non-small business taxpayers will be able to pool together assets costing less than $1,000 and depreciate the pool at the rate of 37.5% per annum.

Prepaid Expenses

The 13 month prepayment rule will be abolished. Up until now, taxpayers have been able to claim a deduction for the whole of prepayments of expenses made up to 13 months in advance. After 21 September 1999, taxpayers will have to apportion such deductions across the period to which the prepayment relates.

Taxation of Trusts

All trusts, apart from widely held investment trusts, will be taxed as companies as from 1 July 2001. Trust distributions will be franked in a manner similar to the way in which dividends paid by companies are franked. However, special rules will apply to ensure that capital gains can be distributed to beneficiaries without further tax where the gain relates to pre capital gains tax assets or assets which have been the subject of indexation and other special treatment.

Small Business

Businesses and farmers with an average turnover of less than $1 million per annum over 3 years will be able to elect to use a "Simplified Tax System" as from 1 July 2001. Taxpayers electing to use this tax system will be able to:

• adopt a cash accounting system rather than an accrual system;
• immediately expense depreciable assets costing up to $1,000 rather than depreciating them over time;
• "pool" depreciable assets with an effective life of less than 25 years and depreciate the pool at the rate of 30% per annum;
• avoid having to perform a stock take where it is likely that there will be less than $5,000 difference in the opening and closing balances of the trading stock for the year. In such cases, the tax payer will be able to assume that the closing balance will be the same as the opening balance for the year;
• sell business assets which have been held for 15 years or more without paying capital gains tax provided the taxpayer is aged 55 or more and retires at the time of sale.

Until 1 July 2001 when the Simplified Tax System for small business will come into operation, small business and farmers will be able to keep accelerated depreciation and fully expense prepayments made up to 13 months in advance. They will also be able to continue to immediately depreciate 100% of items costing $300 or less. These concessions will not be available to small business after 1 July 2001.

If a small business chooses not to enter the Simplified Tax System it will be required to convert to an accruals accounting system of reporting and will be subject to the new depreciation rules which will apply generally.

Word of Warning

The changes heralded by the proposed tax reforms are complex and wide ranging. They will affect investors, small businesses, farmers and big business. All such tax payers should seek professional advice from their accountants or investment advisors as to the detail of the proposals and what impact the proposals might have on their operations.

For further information on this article please contact Johanna Churchill, Senior Associate on (61 8) 8210 1236 or via email: jchurchill@normans.com.au.