Barkoczy, Stephen --- "Editorial" [2000] JlATax 22; (2000) 3(5) Journal of Australian Taxation 330

Editorial

Associate Professor Stephen Barkoczy

In A Tax System Redesigned, the Review of Business Taxation recommended the introduction of a consistent entity regime which would tax companies and all trusts other than certain excluded trusts in a uniform manner. Under this recommendation, all non-excluded entities were to be taxed at the entity level (ie like companies). Distributions would also be taxed in the members' hands (subject to franking credits flowing through for tax paid at the entity level).

Underpinning the consistent entity regime was the recommendation that a "profits first rule" be introduced in relation to distributions. Under this rule, distributions from entities are deemed to be paid from profits to the extent that the entity has available profits. In other words, before any capital can be returned to members, the available profits of the entity must first be exhausted. The profits first rule was intended to operate subject to a number of limited exceptions, including the "slice rule" which applies where membership interests are terminated.

For some time, the taxation profession had been awaiting the release of the Bill that would contain the consistent entity reforms. It was expected that the Bill would resemble the Draft Bill handed down with the Review of Business Taxation's final report. This Draft also contained the cashflow/tax value proposal which the Government had stated it supported "in principle", but which it subsequently indicated that it would not introduce from 1 July 2001 (as originally proposed). As I mentioned in my previous editorial, this recommendation has been referred to the new Board of Taxation for consideration.

Eventually, in October, the Government released the Draft New Business Tax System (Entity Taxation) Bill 2000, which included draft provisions relating to various measures including entity taxation (it also included draft rules for a simplified imputation system). To the surprise of many in the profession, the Draft Bill only contains entity measures in relation to "non-

fixed trusts" such as discretionary trusts. There is no corresponding regime for fixed trusts. In this respect, the regime is much narrower than the original proposal, which only excluded those limited widely held unit trusts that were classified as "collective investment vehicles". Moreover, whilst the draft provisions contain the controversial profits first rule, this rule has not been extended to companies as originally proposed. It therefore seems that despite the Review's insistence for consistency in the tax laws, it looks like we will have an inconsistent entity regime.

It would appear that from 1 July 2001, there will be three key regimes for taxing entities:

1. a regime for non-fixed trusts and their members (under this regime there will be entity level taxation, a profits first rule and imputation);

2. a regime for companies and their shareholders (under this regime there will be entity level taxation and imputation, although there will not be a profits first rule); and

3. a regime for fixed trusts and their beneficiaries (under this regime flow through taxation will continue under present Div 6 of Pt III of the ITAA36 - in other words there will be no entity taxation, imputation or profits first rule).

It is evident that the Draft Bill signifies a major change in policy and a back down by Government. The two most fundamental reforms recommended by the Review of Business Taxation to the Australian taxation system, namely the cashflow/tax value and consistent entity reforms, therefore seem to be suffering strange fates only a year after they were announced. The future of the first measure appears to be quite uncertain whereas the second measure appears to be significantly restricted in its operation.

October 2000