Leasing & Tax Benefit Transfer
At the Commonwealth level the tax framework generally applies to leasing such that, provided the equipment is used for business purposes, the lessee claims the lease rental as a business running expense tax deduction. The lessor is generally tax-assessed on the basis that the capital item is being used to produce assessable income: taxable income therefore is lease rentals received less depreciation and any investment (dis)incentives operating through the tax system and taking into account any balancing amounts (profit or loss on sale) at the end of the respective lease agreement. For non-lease equipment finance on the other hand, the business borrower claims tax deductions for interest and depreciation and the financier is taxed on its interest income.
Compared with such other financing techniques, leasing has a number of competitive features: the lack of equity outlay conserving the lessee’s cash resources; the ability to tailor lease rental schedules to seasonal or irregular income streams; a lesser effect of the equipment utilisation decision on balance sheet ratios; the removal of the lessee’s need to maintain an asset register for tax purposes; the regular review of the equipment’s technological appropriateness to the task; and the greater flexibility for unbundling equipment, supplier and maintenance risk and service delivery. A particular feature in relation to the Commonwealth tax system is the ability of the lessor (as equipment owner) to concentrate the various taxation attributes of that ownership into the amount of the lease rental. This tax benefit transfer (TBT) enables the lessor to price depreciation and investment incentives (when applying) on an after-tax basis and offer a rental stream that is lower than other products’ repayment schedules. This is especially important for lessees with minimal current year taxable income (firms just starting-up, those restructuring or those otherwise in a bona fide tax loss situation) for whom interest, depreciation and incentives deductions only add to carry forward losses.
Without leasing, the otherwise available benefits of the tax system would be lost or significantly diminished. In AELA’s view Australia’s production and employment, as well as the economy’s essential infrastructure, have been well-served by this tax benefit transfer capacity, as well as by leasing’s other product features. The leasing industry’s commitment to further improving the lease product has, over the years, led to an increasing sophistication, which has put other financing techniques on their mettle. Occasionally policy or administrative responses have been introduced to curb the impact of some of these product refinements.
An important role of AELA is to liaise with governments and officials regarding such measures to ensure that their objective is achieved without prejudicing the other economic benefits and features of the lease product.
For example, this role was much in evidence during 1988 when, in the context of a Tax Commissioner’s Ruling (IT2512) on Financing Unit Trusts, the Government considered its policy response to this issue of ‘tax effective financing’. AELA along with other affected parties made representations and on 20 December 1988 the Government announced the result of its review as follows:
‘This review has confirmed the need to act against tax effective financing. Tax effective financing relies upon the ability to transfer or share tax benefits. The Government considers that the broad scheme of the tax law requires that tax losses be carried forward by the taxpayer who in substance incurs them and that in general, such losses should not be available for transfer to other parties, including financiers. An exception, long accepted by revenue authorities, has been in respect of genuine leasing transactions for plant and equipment but the Government believes that other forms of tax benefit transfer should not be accepted.’
AELA welcomed the decision in relation to leasing. At the same time the Government announced that a consultative paper on the ‘economic issues and taxation law relating to tax benefit transfer arrangements’ would be prepared. To assist this process AELA commissioned the Bureau of Industry Economics to research the issues involved; their report ‘Tax Losses and Tax Benefit Transfer’ was finalised in October 1990 and remains relevant in today’s environment.
The research focused on the extent of tax losses in the system, the distortion to resource allocation and investment caused by the carry-forward of such losses, the potential gains that might result from reducing those distortions via tax benefit transfer and the options available for remedying the problems identified without opening-up too great a drain on Commonwealth Revenue. In identifying the discrimination against riskier projects and newer investors caused by the carry-forward of losses, the report found that ‘if the businesses which were deterred from making particular investments would have been more efficient at undertaking them, or if potentially valuable but riskier projects are abandoned because those who do not face the tax-related disincentive are not well-placed to invest in them, the economic costs associated with this discrimination are likely to be significant’.
A number of options were considered to overcome the distortions; these included – refunds for tax losses, loss carry-forward with interest, the sale of tax losses and the availability of tax benefit transfer arrangements. As a significant source of tax losses in the system was depreciation and investment incentives for plant and machinery, the report found that the overall level of tax losses would have undoubtedly been higher but for the use of leasing’s tax benefit transfer capacity. The research noted the long-standing exception of equipment leasing from restrictions on tax benefit transfer and, in relation to the current taxation regime, found that ‘leasing has the desirable effect of making the investment feasible for entities either in tax loss or anticipating some tax losses, without encouraging them to any greater extent than for fully taxed entities.’
While the theoretical preferred means of ameliorating the tax loss carry-forward distortions were loss refund, loss sale or loss carry-forward with interest, they involved other problems; the report concluded that in such cases the continued allowance of current tax benefit transfer mechanisms (i.e. leasing) was ‘useful in alleviating these distortions’. The Bureau of Industry Economics report represented a constructive input into the broader consideration of the future structure and features of the taxation system.
In November 1994, the Government commissioned its then Economic Planning Advisory Commission (EPAC) to investigate how the private sector might best participate in the provision of public infrastructure. In May 1995, EPAC’s Private Infrastructure Task Force Interim Report noted that the issue of tax arbitrage through leasing by tax exempt bodies should be dealt with by developing appropriate rules for leasing rather than placing restrictions (legislated initially as section 51AD and Division 16D and replaced from 1 July 2007 by Division 250) on particular types of infrastructure investments. In response to this and to the need to define leasing for the purposes of its exclusion from the proposed accruals legislative regime for the taxation of financial arrangements, in June 1995 a joint Treasury/Tax Office review of leasing arrangements was announced. Its objective was to replace the current leasing framework (based on Tax Office public and private rulings and advices and on passing regulatory references) with a comprehensive legislative framework which did not ‘place unwarranted roadblocks in front of legitimate separations of economic from legal ownership (including in relation to private sector participation in infrastructure provision) while also preventing unwarranted tax benefit transfers’. AELA made preliminary input to this forum, which was then overtaken by the broader Review of Business Taxation (RBT).
In its initial February 1999 discussion paper, the RBT proposed that a lease be treated as a sale-and-loan for tax purposes. This approach was in line with its high level design principles of simplicity and certainty, on the basis that ‘transactions with similar economic substance should be treated in a similar manner’ so that the ‘allocation of resources reflects market realities’. AELA disagreed with the presumption of this device and argued for the benefits of leasing’s tax benefit transfer capacity, which its adoption would negate. In subsequent discussions with officials, the exclusion of so-called ‘routine’ leases from the proposed regime was canvassed, with the criteria for such leases being those tests which had been developed over the years to identify genuine leases. AELA supported this policy direction. However, when the RBT’s final report was released in September 1999, the criteria for such ‘routine’ leases bore little resemblance to market practice. In the event, the Government did not include them in the first or subsequent tranches of implementation.
During 2006 AELA made a number of submissions to Treasury on the proposed new regime for the Taxation of Financial Arrangements (TOFA), and met with the Assistant Treasurer and Minister for Revenue in this regard. AELA accepts that leases are but one of several arrangements (including hire purchase and chattel mortgages) widely used to finance the acquisition of plant and equipment, and at one level a case could be made for the inclusion of leasing in a TOFA regime. However to do this, i.e. to treat leases as ‘sales-and-loans’ and tax their implied interest income stream rather than to maintain the established approach of taxing their periodic ‘rentals less depreciation’, would destroy leasing’s TBT capacity to the detriment of the business sector.
AELA maintained that there was no intrinsic reason for the TOFA regime to include leases. The overriding policy issue is whether leases should continue to facilitate TBT; that is, should firms just starting-up, those restructuring or those otherwise in a bona fide tax loss situation be given the benefit of the same depreciation and similar allowances that are available generally. Accordingly AELA submitted that the TOFA proposals should reflect existing policy, by way of the specific exclusion of leasing from the proposed regime.
The TOFA Stages 3 and 4 Exposure Bill was released for comment in October 2008, as the 2007 TOFA Bill lapsed due to the Federal election. Division 230 applies to ‘financial arrangements’, and sets out the methods for bringing gains and losses to account for tax purposes. In broad terms, a Division 230 financial arrangement is one where the rights and obligations under that arrangement are ‘cash settlable’. It is pleasing to report that the Explanatory Memorandum noted that most leasing arrangements will not be cash settlable financial arrangements under Division 230, and to that extent leasing will continue to retain its TBT capacity. Division 230 applies to income years commencing on or after 1 July 2010.
As indicated previously, leasing is a mix of debt and equity in financing equipment utilisation, which will test any regime preferring the simplicity of rules, which avoid this duality. AELA’s role continues to be to advance the long-term economic benefits of the lease product’s tax benefit transfer capacity.
As part of Australia’s response to the global financial crisis, the Government introduced an investment allowance, to apply from 13 December 2008. The allowance was initially set at 10%, then revised to 30%, and in the 12 May 2009 Budget increased to 50% for small businesses (turnover not exceeding $2 million pa). The legislation received Royal Assent on 22 May 2009. AFC sought Treasury guidance on a number of Investment Allowance issues, and with the legislation receiving Royal Assent met with the ATO to finalise these issues .The Small Business and General Tax Break measure provided an additional deduction for business investment in new, tangible depreciating assets and new expenditure on existing assets. The legislation is based on the Division 40 uniform capital allowance provisions, with important variations, and generally applicable where a capital allowance is available under section 40-B 0f the ITAA 1997. The ‘new investment threshold’ was $1,000 for small business entities, and $10,000 for all other entities, and assets had to be used principally in Australia for the principal purpose of carrying on a business. For small businesses the investment commitment time was from 13 December 2008 to 31 December 2009, and for other businesses from 13 December 2008 to 30 June 2009 to be eligible for the 30% rate.
Consistent with Division 40, lessors were entitled to claim the allowance in most cases; to do so the lessor must use the asset principally in Australia for the principal purpose of carrying on their business; accordingly the lessor does not need to look through to the actual use of the asset by an individual lessee. AELA suggested to the Government that the allowance should incorporate the flexibility for the lessor to transfer entitlement to the Allowance to the lessee, which had been a feature of past Allowances of this nature; however, in the event this election was not provided. The Tax Office produced a guide to the Investment Allowance, with an updated version detailing eligibility and timing arrangements where the equipment is financed or leased. AELA provided a brief for Members concentrating on the equipment finance issues in relation to the Investment Allowance, covering hire purchase, chattel mortgage, sale and leasebacks, valid contracts, and demonstrator vehicles. The Tax Office also issued an Interpretative Decision (ATO ID 2009/89), which confirmed that after an asset is sold to the financier and leased back it will continue to be used by the taxpayer (lessee) for the purpose of carrying on its business, thus satisfying the ‘purpose’ test.
In the 2015 Federal Budget the Government announced accelerated depreciation in the form of immediate tax deductions for small business for individual assets costing less than $20,000. This measure applies for businesses with an aggregate annual turnover of less than $2 million, commencing Budget night (ie from 7.30pm AEST 12 May 2015) and continues until 30 June 2017. Businesses can apply this $20,000 rule to as many items as they wish. This is a temporary increase on the previous $1,000 threshold.