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Australian Lawyers and Consultants

Australian Tax System Failure

September 2002

We begin this Baldwins Bulletin by asking whether the Australian income tax system is dead, or is it capable of resurrection? There are so many signs now that the system is unworkable and irredeemable.

A recent article by Alan Kohler, in the Australian Financial Review (21/8/02), quoted Sydney tax barrister Michael Inglis, who identified the introduction of the self-assessment system as the big mistake that began the terminal decline of the tax system.

Our own view is that when self-assessment came in, the tax assessment business was privatised even though the accounting profession (and the clients of accountants) may not have realised that they had to pay a price.

Meanwhile, the Tax Office, who were relieved of their tax assessment tasks, adopted the privileged position of “armchair critic” of taxpayers and tax agents. The removal of tax officials from dealing at the coalface of practical taxation assessment problems removed them from taxation reality, and hence taxpayers have suffered a plethora of indigestible, unworkable, incomprehensible and impractical tax legislation ever since self-assessment began. The Tax Act is now 8,500 pages long and lengthening every month, to which one can add the reams of paper constituting the “explanatory memoranda” and “tax rulings” that are meant to aid in the interpretation of the law but are often ambiguous, unhelpful and skewed to maximising tax revenue.

The Institute of Chartered Accountants has recently written to the ATO threatening steps that could result in the system grinding to a halt.

The tax legislators actually encourage a form of lawlessness by legislation that includes absolute discretions making the incidence of taxation a function of the whim or arbitrariness of a tax officer. One example is the legislation governing restrictions on thin capitalisation.

Under the old ‘thin cap rules’, taxpayers knew that there was a prescribed debt to equity ratio (e.g. 3:1). Yet under the new rules, no ratio is specified. Instead, one is required to rely on a totally subjective analysis by the Tax Office of what it considers to be notionally sufficient capital equity (terms such as “safe harbour capital amount” and “Arm’s length capital amount”). The legislation then goes on to describe the minimum capital requirement as an amount which the Tax Office will impute as a notional amount of capital that would reasonably be expected to exist for an entity based on factual assumptions and taking into account relevant factors (ss. 820-405 and 820-410 of ITAA 1997).

The ATO pours more mud into muddy waters by issuing a 128 paragraph draft tax ruling TR 2002/D4 (36 pages) that purports to set out a 6-step methodology which is meaningless in the context of the real world of business finance.

The trend with all new tax legislation has been to empower the Tax Office with more discretionary powers. The problem is that this creates uncertainty in the law and results in the system clogging up with enquiries from taxpayers and tax agents that cannot be dealt with properly.

For further information, contact Joe Lederman at BALDWINS, Australian Lawyers & Consultants.

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