3.1 In addition to the complexities associated with valuations generally, particular challenges arise when valuations are required by the tax system. There are at least 206 different tax provisions that may require a taxpayer to determine an unrealised value of an asset or liability, or an alternative value to a realised asset or liability. These provisions are not all uniform and mandate different valuation approaches. A table of these provisions is contained in Appendices 2 and 3.30

Summary of stakeholder concerns

3.2 The tax-specific concerns that stakeholders have raised relate to practical difficulties and the compliance costs that valuation impose. These include:

  • the requirement to allocate value to assets in a commercially unrealistic manner and the inability to rely on valuations already obtained for other purposes such as those required by accounting standards;
  • the lack of safe harbours to minimise the need to undertake valuations;
  • valuation requirements for small business taxpayers, particularly those for accessing the small business capital gains tax (CGT) concessions; and
  • provisions that created 'all or nothing' outcomes for taxpayers or the ATO, with a small valuation difference causing a large, disproportionate change in tax liability.

Use of existing valuations

Stakeholder concerns

3.3 Stakeholders have contended that the notion of market value is used in a plethora of provisions in tax legislation like a 'cure-all' when it may be impractical or even frustrated due to a lack of market prism. The increasing use of market value, as a means of determining a taxpayer's liability, has also necessitated more valuations and added to the compliance burden.

3.4 Stakeholders have also argued that legislative mechanisms, which rely on pre-existing business or accounting concepts, should be available as an alternative to valuations where they achieve significantly the same outcomes. For example, stakeholders have cited reinstatement value (often used to value assets for insurance purposes) and unimproved land value as potential substitutes for market value in certain circumstances. It should be noted that these substitutes are relatively uncomplicated concepts compared to market value which is required by many tax provisions.

3.5 Stakeholders have also raised concerns with laws that require the taxpayer to identify and allocate value to assets which were commercially unrealistic or inconsistent with how businesses treated those assets. For example, stakeholders highlighted the case of Resource Capital Fund III LP v Commissioner of Taxation (RCF case)31 where the Taxable Australian Real Property (TARP) provisions require the taxpayer to value mining rights and mining information separately. In practice, such assets would be sold as a bundle for the reason that the mining rights would be far less valuable without the mining information.

3.6 Furthermore, many tax provisions were said to require valuers to determine separate future cash flows derived from each asset, whereas such cash flows are not allocated separately to these assets in commercial practice. For example, valuers may be required to allocate a portion of the value to intellectual property attaching to a physical asset, such as copyright to an electricity distribution network, even though a sale agreement may make no such allocation as the physical assets would not be fit for purpose without that intellectual property.32

3.7 Stakeholders have also raised concerns regarding the considerable cost created by tax laws which effectively require taxpayers to obtain valuations. The costs of such valuations are regressive and small businesses generally consider these costs prohibitive where their transactions are low in value. As a consequence, taxpayers may forego access to certain regimes such as the consolidation regime or incorrectly claim a concession to which they are not entitled such as the small business CGT concessions.

3.8 The requirement to obtain a valuation for tax purposes may arise as a result of legislative requirement to do so or as a means for a taxpayer to reduce their risk. For example, some tax provisions, such as those relating to consolidation, make reference to 'market value' as part of a calculation, such as applying the allocable cost amount to reset cost base assets.33 The level of risk and complexity of determining market values for a joining entity's34 assets may effectively require the taxpayer to obtain a professional valuation, although the legislation itself may not mandate it as such.

3.9 Other tax provisions, such as thin capitalisation, explicitly require the taxpayer value their assets, liabilities and equity capital. In doing so, taxpayers are required to comply with the accounting standards.35 This is also an example of a valuation provision in the tax law where the standard of value is not 'market value' but 'fair value' as required by the accounting standards.

3.10 The key tax law provisions that were raised with the IGT in this review which require taxpayers to obtain valuations include36:

  • Thin capitalisation — requires taxpayers to value assets, liabilities and equity capital according to accounting standards.37
  • Self-managed superannuation funds — trustees must annually prepare financial accounts using the market value of assets38 and the market value ratio of in-house assets to other assets cannot exceed 5 per cent.39
  • Consolidation — market value is used as the basis for applying the allocable cost amount to reset cost base assets40 and determining available fractions for transferred losses.41
  • Philanthropy — taxpayers seeking deductions for particular kinds of gifts of property must have the valuation determined by the Commissioner.42
  • Cultural gifts — taxpayers seeking deductions for donations of cultural gifts to certain institutions must obtain valuations from two approved valuers.43
  • Goods and Services Tax (GST) margin scheme — taxpayers are required to use 'approved valuations' when applying the margin scheme. The Commissioner can determine the requirements of approved valuations.44
  • CGT assets:
    • Generally, the cost base45 or capital proceeds46 of a CGT asset may be substituted by the market value of the asset at the relevant time if the parties were not dealing with each other at arm's length.
    • TARP — foreign residents may be subject to CGT based on whether they satisfy the principal asset test. The test requires a calculation of the market values of the TARP and non-TARP assets of a test entity.47
    • Small business concessions — taxpayers seeking these concessions may access them through four alternative tests, one of them being the Maximum Net Asset Value (MNAV) test. This requires the taxpayer to consider the market values of its CGT assets before subtracting various liabilities and provisions.48
  • Taxation of financial arrangements (TOFA) — certain taxpayers who prepare audited financial statements may elect to have their gains or losses measured using 'fair value' consistent with 'the accounting principles'.49

Different standards of value

3.11 The tax laws predominantly rely on the concept of market value which is not defined in the legislation and may lead to inconsistent application.

3.12 Furthermore, a number of tax provisions rely on other standards of value. For example, use of accounting standards in the thin capitalisation and TOFA regimes has facilitated an express reliance on 'fair value' rather than market value as mentioned above.50

3.13 In relation to the thin capitalisation regime, a choice was provided to allow taxpayers to use accounting standards as a way of reducing compliance costs:

The Review of Business Taxation considered it appropriate to have regard to accounting principles in the development of taxation legislation. The use of Australian accounting standards in determining the value of assets for the purpose of applying the … debt test will reduce compliance costs for many taxpayers as the tax values of assets will be more closely aligned with accounting principles and practice. For some taxpayers who do not need to prepare financial reports in accordance with accounting standards there may be initial compliance costs in applying the accounting standards. However, the use of accounting standards will provide a reliable, consistent and transparent method to value assets. All of which will provide greater certainty to taxpayers in applying the new measures.51

3.14 The tax laws also use other value concepts such as adjustable value, termination value52, market selling value and replacement value.53

3.15 Examples of previous stakeholder concern regarding the use of different standards of values in legislation were conveyed during the reforms to the Superannuation Industry (Supervision) Act 1993 (SIS Act) and associated regulations to mandate annual financial reporting by self-managed superannuation fund (SMSF) trustees. The proposed regulations called for assets to be regularly valued at their 'net market value'.54 Concerns were raised with the use of a different standard of value to that already existing in the SIS Act, being 'market value' defined in section 10 of that Act.

3.16 Stakeholders recommended that net market value should be replaced with the existing market value concept55, or with fair value to aid comparability with Australian Prudential Regulation Authority (APRA) superannuation funds56 which was one of the original policy intents.57 It was noted that a different concept would create confusion58 and increase valuation costs:59

Inconsistencies with valuation requirements for other superannuation purposes and other legislation is also a likely consequence as is a likely increase in costs for SMSF trustees.60

3.17 The Regulations eventually adopted the pre-existing market value concept in the SIS Act. It should also be noted that, although the SIS Act uses market value, it is defined within the SIS Act.61

ATO valuation costs

3.18 The ATO approved expenditure for at least $6 million on 205 valuer engagements during the period 1 July 2011 to 31 December 2013.62 This amount does not include the ATO's opportunity costs, for example, time staff spent in collecting valuation-related information and drafting instructions for valuers.

3.19 The ATO has sought to reduce its costs by creating a specialist internal Valuation Gatekeeper Unit (VGU), which vets the need for external valuations. The ATO's Small Business and Individual Taxpayers (SBIT) business line also uses a customised risk tool which estimates the likelihood of taxpayers breaching the asset value threshold for the small business tax concessions, without the need to obtain external valuation advice.

3.20 As explained in the next chapter, case statistics from the ATO has highlighted that CGT is an area of tax law that the ATO incurs the greatest costs in obtaining external valuation advice. Some of these CGT areas are described below.

Market value substitution

3.21 Paragraph 112-20(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) generally requires a taxpayer to substitute the first element of the cost base of a CGT asset with its market value if they have not dealt at arm's length with the entity from which they acquired the CGT asset. Similar provisions exist in relation to capital proceeds from various CGT events.63

3.22 During 1 July 2011 to 31 December 2013, the ATO engaged valuers on 21 occasions (11% of total ATO compliance and litigation valuer engagements) at a cost of $427,824 (7% of total ATO compliance and litigation valuer costs) regarding this area of tax law.

Small business CGT concessions

3.23 The small business CGT concessions are contained in Division 152 of the ITAA 1997. In order to access these concessions, the taxpayer must establish their eligibility by passing one of the following four tests:

  • the 'small business entity' (SBE) test, whereby taxpayer must carry on a business with an aggregated turnover of less than $2 million per annum64;
  • the taxpayer is partner in a partnership that is itself an SBE;
  • the taxpayer is an affiliate of or connected with an SBE65; or
  • the MNAV test, whereby the net value of the CGT assets of the taxpayer and any connected or affiliated entities does not exceed $6 million just before the CGT event.

3.24 As the MNAV test relies on the market values of assets 'just before' the CGT event, small changes to the market values of assets can affect a taxpayer's eligibility to the concessions. For example, ATO Interpretative Decision (ATOID) 2003/745 highlights that a $6,000 increase in the value of the taxpayer's assets, due to movements in share prices during the day, pushed the taxpayer from under the threshold (passing the test) earlier in the day to over threshold (failing the test) just before the CGT event later in the same day.66

3.25 During 1 July 2011 to 31 December 2013, the ATO engaged valuers on 16 occasions (8% of total ATO compliance and litigation valuer engagements) at a cost of $298,730 (5% of total ATO compliance and litigation valuer costs) regarding this area of tax law.

3.26 The ATO does not collect data to determine the direct costs incurred by taxpayers in obtaining valuations for tax purposes. However, the Board of Taxation (Board) has reported that the average cost of a valuation for the purposes of claiming the small business CGT concession was $536.67 This very low cost may be explained, in part, by the Board's observation that in some cases, 'the complexity of eligibility tests [for the small business tax concessions] means that some [small] businesses do not even bother trying to determine eligibility and may miss out on benefits because of the high cost of compliance.'68

3.27 During this review, stakeholders have asserted to the IGT that a small business was more likely to incur costs of around $10,000 to $20,000 for a full valuation for the purpose of the small business CGT concessions. Indeed, the costs may be substantially higher for more complex assets and transactions.

Taxable Australian Real Property (TARP)

3.28 Foreign residents are generally exempt from CGT unless their capital gain is in relation to a CGT asset which is taxable Australian property.69 Where the taxpayer is disposing of their membership interest in another entity, it is necessary to determine if the 'entity's underlying value is principally derived from Australian real property.'70 This is the principal asset test and requires a comparison of the market values of the entity's 'TARP assets' and 'non-TARP assets'.71 Where the sum of the market values of the entity's TARP assets exceed the sum of the market values of the entity's non-TARP assets, the test is met. If the principal asset test is met, the foreign resident, who would otherwise disregard their capital gain, must include that capital gain in their Australian assessable income.

3.29 During 1 July 2011 to 31 December 2013, the ATO engaged valuers on 9 occasions (5% of total ATO compliance and litigation valuer engagements) at a cost of $1,563,365 (25% of total ATO compliance and litigation valuer costs) regarding this area of tax law. Recent litigation indicates that the quantum of tax in dispute can be significant in TARP cases.72

3.30 The IGT notes that in the particular case of distinguishing between mining rights (TARP) and mining information (currently non-TARP), the 2013-14 Federal Budget73 contained measures aimed at treating mining information as a TARP asset rather than a non-TARP asset.

IGT observations

3.31 The increasing use of the concept of market value in tax legislation is significantly adding to the compliance and administrative burdens for both taxpayers and the ATO respectively. However, market value has the advantage of being a long-standing concept that has received general acceptance and significant experience has been gained with its application particularly amongst the tax profession. Over time, the ATO has also developed and published some guidance in this area, such as the Market valuation for tax purposes74 publication.

3.32 Nevertheless, the IGT considers that, in appropriate cases, taxpayers and the ATO may be able to use other standards of value rather than market value without a significant impact on revenue and with the benefit of avoiding tax specific valuation costs. For example, 'fair value' valuation necessitated by the accounting standards may be an appropriate substitute for market valuation bearing in mind that some taxation regimes, such as thin capitalisation and TOFA, already allow the use of such accounting standards for valuation.

3.33 Substantial additional compliance costs may be imposed, however, where such accounting standards are required to be used by taxpayers who do not already apply those standards, such as individuals and small businesses. In such instances, values generated by other natural business systems, as a result of comparable reports75 or in accordance with existing taxation obligations may provide a lower cost alternative to requiring the adoption of accounting standards or valuations for tax purposes. For example, the ATO and taxpayers may find a turnover-based standard less costly and easier to apply than one based on asset value.

3.34 The IGT is of the view that, when designing new tax laws which may rely on market valuations, the potential compliance and administrative costs of obtaining such valuations should be considered as part of the Regulation Impact Statement (RIS). Such consideration would determine whether the reliance on market value has the 'highest net benefit' compared to other approaches.76

Safe harbours

Stakeholder concerns

3.35 A safe harbour may be defined as:

An objective standard or measure, such as a range, percentage, or absolute amount, which can be relied on by a taxpayer as an alternative to a rule based on more subjective or judgmental factors or uncertain facts and circumstances. A safe harbour cannot normally be used to the disadvantage of a taxpayer. A common use of a safe harbour is in relation to thin capitalization where a minimum proportion of equity to debt may be used as an alternative to demonstrating what an independent party would have been prepared to lend.77

3.36 Stakeholders have suggested that, where there are no suitable alternatives to the use of market value, proxies, shortcuts or safe harbours should be considered. They believe that the revenue foregone by using such safe harbours would be offset by the reduction in valuation costs for taxpayers and the ATO as well as the scope of risks that the ATO must manage.

3.37 As safe harbours may be less advantageous to some taxpayers, stakeholders have suggested that it should be provided as an alternative to current valuation requirements rather than a replacement for them.

3.38 Safe harbours may be provided either through legislation or by administrative means and may either provide an alternative or replace legislatively required methods or inputs for calculation. A safe harbour, which does not displace the taxpayer's option of undertaking a market valuation or similar approach, provides flexibility for taxpayers to choose whether additional compliance costs should be incurred.

3.39 An example of a legislative safe harbour is found in the taxation of employee share schemes. While this regime generally refers to 'market value' when determining the discount provided to employees, taxpayers are permitted to use a range of methods to determine the market value of unlisted rights without resort to a formal valuation.78

3.40 An example of an administrative safe harbour is the schedule of values for goods taken from trading stock, published by the Commissioner as a Taxation Determination (TD) from time to time. Where a sole trader, such as a butcher or baker, takes trading stock away from the business for personal use, section 70-110 of the ITAA 1997 requires them to return the cost of that trading stock as assessable income. Law Administration Practice Statement (PS LA) 2004/3 (GA) states:

However, in recognition that it is difficult, in certain businesses or industries, to determine the value of an item taken from trading stock for private use, the Commissioner has issued rulings providing a schedule of values of goods taken from trading stock for private use that may be used by taxpayers as a guide.79

3.41 The latest iteration of this schedule is found in TD 2014/2.80 This determination indicates the Commissioner will accept the amounts in the schedule as estimates of the value of goods taken from trading stock for private use by taxpayers in listed industries. In the context of valuations, a safe harbour could be used as an alternative choice for taxpayers by allowing them to use a pre-determined range of figures, percentages or amounts instead of determining the rate of apportionment themselves. An example of such use is found in the fuel tax credit system where the Commissioner will accept a fuel tax credit claimant's application of pre-determined ATO percentages81 as a 'fair and reasonable basis', rather than the claimant determining the rate of apportionment themselves. This example did not require any legislative change as the alternative method, or shortcut, was allowable within the scope of the legislation.

3.42 Alternatively, a safe harbour may actually replace a default approach, such as the write-off provisions for low-cost depreciating assets. Where certain taxpayers acquire a depreciating asset below a certain threshold, they have no choice but to treat the decline in value of a depreciating asset as its cost in the year the asset is first held, regardless of the effective life of the asset pursuant to subsection 40-80(2) of the ITAA 1997. This was intended to be a compliance cost saving measure.82

3.43 The default rules under the capital allowances regime normally require the taxpayer to spread the decline in value of the asset over the effective life of the asset.83 Certain taxpayers may have been better off using the default rules, but such an advantage is denied to them by the compulsory application of the low-cost asset write-off provision.84 In this case, there is a trade-off between compliance cost savings to taxpayers and potentially disadvantaging them by denying them the choice to use a default method which may be more costly or complex.

IGT observations

Safe harbours

3.44 The tax laws often seek an appropriate balance between policy design and minimisation of costs in achieving the underlying intended outcome. Safe harbours which are used as substitutes for calculations of market-based values may minimise costs, however, they need to fit within policy design.

3.45 For example, the Board found Small and Medium Enterprises (SMEs) are discouraged from entering the consolidation regime due to the upfront costs and complexity associated with forming a consolidated group of which valuations perform a key role.85 The Board's research found a 'clear trend that the smaller the size of a wholly-owned group, the less the likelihood that the group has chosen to enter the consolidation regime'.86 As a result, the Board proposed simplified formation rules for SMEs by allowing a proxy for market value.87

3.46 The above simplified formation rules were intended to replace the general asset tax cost setting rules. Some small businesses may be disadvantaged by this approach as compared to applying the general rules albeit with additional cost and complexity.

3.47 The above example illustrates that despite the difficulties and trade-offs associated with implementing safe harbours, they remain an important legislative and administrative tool for policy makers to reduce red tape and contain compliance costs.

3.48 The IGT is therefore of the view that where the relevant RIS has found that the 'highest net benefit' involves taxpayers undertaking a valuation, consideration be given to providing safe harbour as an alternative to reduce compliance costs particularly for SMEs.

Recommendation 3.1

The IGT recommends that, in designing tax laws, the Government consider:

  1. requiring valuations only where the relevant regulation impact statement demonstrates that it would be of the 'highest net benefit'; and
  2. where valuation is required, provide safe harbours or allow the use of existing valuations obtained for other purposes such as accounting standards or as part of natural business systems.

ATO response

In relation to 3.1(a) – Matter for Government

In relation to 3.1(b) – Matter for Government

3.49 The next chapter considers the use of administrative safe harbours where legislative ones are not appropriate or do not currently exist.

Small business CGT concessions

Stakeholder concerns

3.50 Stakeholders gave strong support to safe harbours for smaller taxpayers or transactions presenting lower or common risks. The MNAV test in the small business CGT concessions was identified as a primary candidate. Stakeholders also noted that the current $2 million SBE turnover threshold has not been updated since its introduction in 2007. The SBE test is a turnover-based rather than asset-based test which is an alternative means to access the small business CGT concessions. In addition, The Tax Institute's 2012 proposal to increase this turnover threshold to $5 million also received strong support.88 Stakeholders noted that complying with a turnover-based test was less complex that an asset-based test such as the MNAV test.

3.51 The ATO has advised that there were 27,841 and 23,984 small business CGT concession claimants in the 2009–10 and 2010–11 financial years respectively. Due to ATO data limitations, however, the ATO cannot determine what proportion of these claimants used the MNAV test to access the concession. A taxpayer, however, would be unlikely to use the MNAV test if it already satisfied an alternative SBE-based test.

3.52 In considering an eligibility threshold for small businesses to access the simplified consolidation entry rules, the Board considered a combined turnover and asset based threshold89 and determined that a threshold based solely on turnover would be most appropriate:

6.25 The Board therefore recommends that the simplified formation rules should be made available to small to medium sized corporate groups with aggregated turnover of less than $50 million in the prior income year …

6.26 The definition of aggregated turnover should be consistent with that under the small business entity concessions, which includes the turnover of connected and affiliate entities. Although some submissions suggested that the test should apply to the turnover of the wholly-owned corporate group, the Board considered that this could be vulnerable to manipulation and that the aggregated turnover test would provide a degree of integrity for these simplified formation rules. The Board also considers that the aggregated turnover test under the small business entity concessions should already be familiar and understood by small to medium size businesses.

6.27 The Board agreed with comments raised by stakeholders that an asset threshold test would require independent valuations or the preparation of audited financial accounts, and would thus impose a significant compliance burden on small businesses. It therefore considers that an asset threshold test should not be incorporated into the eligibility criteria for the simplified formation rules unless, on further examination by the Government, this would allow very large businesses to obtain unintended benefits from these simplified rules.90

3.53 The ATO has also advised that its SBIT business line uses a customised spreadsheet to risk assess the likelihood that a taxpayer fails the MNAV test. Although currently not a safe harbour used by taxpayers, this internal tool assists ATO officers to make decisions about whether to further test a taxpayer's valuation without the need to call upon the input of an expert valuer.

IGT observations

3.54 A method to reduce the overall valuation-related compliance costs, without removing taxpayer choice, is to reduce the number of taxpayers who need to obtain valuations. In relation to the small business CGT concessions, ultimately, there are three main options:

  • option 1 — repeal the MNAV test and raise the SBE turnover threshold;
  • option 2 — retain the MNAV test and raise the SBE turnover threshold; or
  • option 3 — introduce a specific higher turnover-based threshold.

3.55 Current ATO data limitations prevent accurate quantification of the potential taxpayers and revenue affected by each option. However, in relation to option 1, the repeal of the MNAV test would increase economic simplicity as no valuations would need to be obtained or tested, thereby reducing the costs for the ATO, taxpayers and their advisors. Legal simplicity would also increase as the provision itself would cease to exist and the reliance on the SBE test is relatively straightforward. However, those taxpayers with very large turnovers and a maximum net asset value below the current threshold would be disadvantaged.

3.56 Where certain small business taxpayers have very high turnovers due to a unique feature of their particular industry, the law could specifically carve out those industry-related sales amounts from the turnover calculation as the SBE test currently does for retail fuel sales.91 It should be noted, however, that there may be a cost to the government in that more taxpayers may be able to access other tax concessions which rely on the SBE test.92

3.57 In relation to option 2, increasing the SBE turnover threshold and retaining the MNAV test would increase economic simplicity for those taxpayers that would no longer need to incur costs to obtain valuations. However, it would not increase legal simplicity as the MNAV test would continue to exist along with its reliance on valuations for those affected taxpayers.

3.58 Furthermore, tax advisor costs in maintaining knowledge of this area may remain relatively fixed as they may be required to provide advice with respect to the MNAV test. The ATO's costs may be reduced to some degree if compliance verification is limited to a smaller risk population. However, some fixed costs will remain, such as maintaining staff knowledge and support.

3.59 Unless the turnover threshold is indexed to a particular cost or growth factor, the economic simplicity of this measure would decline over time as more businesses, being still relatively 'small', would begin exceeding the turnover threshold and would thus need to turn to valuations to access the small business CGT concessions.

3.60 Whilst option 3 increases the legal complexity by introducing yet another option, it does provide economic simplicity in that the valuation costs would be reduced as few taxpayers would have to rely on the MNAV test. To minimise the impact on government revenue, those relying on this option could be prevented from accessing other small business concessions.

3.61 The IGT is of the view that reducing small business' reliance on valuations to access the small business CGT concessions is an important issue and that further consultation with the relevant stakeholders on the above three options would be worthwhile before any legislative change is recommended. In the meantime, the ATO may be able to provide some administrative assistance in this area which is explored in Chapter 4.

Recommendation 3.2

The IGT recommends that the Government consider consulting with small businesses and their representatives with a view to reducing the reliance on valuations to access the small business CGT concessions.

ATO response

Matter for Government

Concession value thresholds' implications and behaviours

Stakeholder concerns

3.62 Stakeholders raised concerns that certain tax concessions or exemptions rely upon specific thresholds. These thresholds usually result in a taxpayer being subject or not subject to tax or being entitled to a certain concession. Stakeholders raised the small business CGT concessions' MNAV test and the TARP provisions applying to foreign resident capital gains as typical examples of provisions that depend upon valuation for effect.

3.63 As a result, a small change in a valuation may result in a taxpayer losing their entitlement to a concession, resulting in a large additional tax liability. Stakeholders were of the view that this 'all or nothing' relationship between the valuation and the tax outcome incentivised both the taxpayer and the ATO to devote significant resources to support their preferred valuation.

3.64 The concept of market value is generally used by the tax laws in two different ways, giving rise to two different revenue risks, namely:

  • a value used as an amount to which the rate of tax is applied (directly or indirectly) to calculate a taxpayer's liability, giving rise to a 'proportional revenue risk'; and
  • a value used to determine whether a taxpayer is liable to a tax or may access a concession, giving rise to a 'threshold revenue risk'.

Proportional compliance risk

3.65 A different opinion regarding the values to be applied in a market value substitution for the cost base of a CGT asset will have a corresponding or, 'proportional', effect on the tax payable. In these circumstances, the lower the market value, the lower the cost base and hence the larger the potential capital gain. In this case, any differences in the market value, say as a result of differences of opinion between valuers, has a direct and proportional impact on tax outcomes. This valuation risk may be described as a 'proportional compliance risk'.

Threshold compliance risk

3.66 The MNAV test explained earlier is an example of where a valuation risk can be described as a 'threshold compliance risk', where a relatively small change in market value can result a large and disproportionate change to the taxpayer's tax liability. In this test case, the threshold is an absolute amount, currently $6 million.

3.67 An example best illustrates this threshold compliance risk effect. Assume that a taxpayer would have been otherwise eligible for the 15-year exemption (one of the four CGT concessions) and the capital gain from the disposal of the CGT asset was $1 million. If the relevant conditions had been met, the taxpayer would be entitled to disregard the entire capital gain, resulting in no CGT. If, however, the market values of the taxpayer's assets were revised or challenged by the ATO so that it was $5000 higher, the taxpayer would fail the MNAV test and not be eligible for the concession. The $1 million gain would likely be subject to the normal rules, with a 50% discount applied and the resulting net capital gain of $500,000 levied at the taxpayer's marginal tax rate. Assuming the highest marginal tax rate of 45% and 1.5% Medicare levy, the taxpayer may be facing an additional tax liability of $232,500. In this example, a $5000 change in a valuation results in a $232,500 additional tax liability. The example is also illustrated in the table below.

Table 1: Example of a binary outcome for a threshold revenue risk
  Scenario 1 Scenario 2
Taxpayer's sum of relevant amounts of the purposes of the MNAV test. $5,996,000 $6,001,000
Difference between relevant amounts $5,000
Taxpayer's capital gain $1,000,000 $1,000,000
MNAV test status Pass Fail
Taxpayer's assessable capital gain $0 $232,500
Difference between assessable capital gain $232,500

Source: IGT

3.68 The Board received submissions that the MNAV test's fixed threshold encouraged 'distortions to ensure that [the threshold] is not exceeded' or 'costly/artificial manoeuvring to ensure taxpayers fall within the concession.'93

3.69 The ATO also recognises this 'all or nothing' effect on taxpayer behaviour. Of the SBIT small business CGT concessions compliance cases in 2010-11 and 2011-12 resulting in an amended assessment, objections were lodged in 71% and 100% of these cases respectively.94 The ATO has observed:

… the significant dollars involved with any amended assessment (average case $2.3m), would warrant the taxpayer incurring additional legal costs to progress the case to objections and appeals. This is particularly so where there are market valuation issues surrounding the determination of the maximum net asset value test.95

IGT observations

3.70 The advantage for taxpayers to access a tax concession creates very strong incentives to incur significant valuation costs and to be over-zealous in defending the resulting favourable valuation.

3.71 Conversely, the ATO may be incentivised or be perceived to be incentivised to pursue marginal differences in valuation outcomes to deny a specific concession.

3.72 Importantly, where taxpayer and ATO valuations provide values within either side of a statutory threshold, the above advantages may result in both parties adopting uncompromising positions resulting in prolonged disputes and significant costs for both parties.

3.73 The use of market values as thresholds to tax liabilities or concessions may have a disproportionate effect on taxpayers and the ATO's risk-based decision making. In these cases, the IGT believes that such behavioural effects can be minimised by 'shading out' or tapering concessions whereby any difference between taxpayer and ATO valuations has more proportional impact. The IGT is of the view that such tapering may be considered as part of the preparation of the RIS.

3.74 It should be noted that in considering such tapering, the behavioural effects at the margins between shading out thresholds should be taken into account. In this respect, consultation with affected stakeholders, including the ATO, would ensure policy analysis takes into account potentially unintended consequences.96

Recommendation 3.3

The IGT recommends that, where eligibility criteria for tax concessions or benefits require valuation, the Government should consider the use of tapering to avoid disproportionate outcomes that may arise due to minor differences in valuations.

ATO response

Matter for Government

30 These provisions were identified by ATO officers during preliminary research for a research project to identify sources of valuation risk. This project was discontinued at the commencement of the IGT review.

31 [2013] FCA 363.

32 See also, SPI PowerNet Pty Ltd v Commissioner of Taxation [2014] FCA 261.

33 Income Tax Assessment Act 1997 s 705-35(1)(c).

34 A joining entity is an entity that is joining a consolidated group.

35 Income Tax Assessment Act 1997 s 820-680(1).

36 These are reproduced in Appendices 2 and 3.

37 Income Tax Assessment Act 1997 Division 820.

38 Superannuation Industry Supervision Regulations r 8.02B.

39 Superannuation Industry (Supervision) Act 1993 s 82.

40 Income Tax Assessment Act 1997 s 705-35(1)(c).

41 Income Tax Assessment Act 1997 s 707-320.

42 Income Tax Assessment Act 1997 s 30-212; Regulation 30-212.02 then requires taxpayers to make applications for valuations directly to the Commissioner (previously the General Manager of the Australian Valuation Office).

43 Income Tax Assessment Act 1997 s 30-200.

44 A New Tax System (Goods and Services Tax) Act 1999 s 75-35. A New Tax System (Goods and Services Tax) Margin Scheme Valuation Requirements Determination MSV 2009/1 is an example of such a determination.

45 Income Tax Assessment Act 1997 s 112-20.

46 Income Tax Assessment Act 1997 s 116-30.

47 Income Tax Assessment Act 1997 s 855-30.

48 Income Tax Assessment Act 1997 s 152-20.

49 Income Tax Assessment Act 1997 s 230-210.

50 Income Tax Assessment Act 1997 Division 230.

51 Explanatory Memorandum, House of Representatives, New Business Tax System (Thin Capitalisation) Bill 2001, para [11.19].

52 Income Tax Assessment Act 1997 Division 40.

53 Income Tax Assessment Act 1997 Division 70.

54 Exposure Draft, Superannuation Industry (Supervision) Amendment Regulation 2012 (No. ) Clause 5.

55 The Association of Superannuation Funds of Australia Limited, Submission to The Treasury, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value (4 June 2012) para [1.3] and SMSF Professionals' Association of Australia, Submission to The Treasury, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value (1 June 2012) p 3.

56 The Institute of Chartered Accountants in Australia, Submission to The Treasury, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value, 1 June 2012, p 2; CPA Australia, Submission to The Treasury, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value, 1 June 2012, p 1; and WHK, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value (1 June 2012).

57 Explanatory Memorandum to Exposure Draft, Superannuation Industry (Supervision) Amendment Regulation 2012 (No. ).

58 The Association of Superannuation Funds of Australia Limited, Submission to The Treasury, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value (4 June 2012) para [1.3].

59 CPA Australia, Submission to The Treasury, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value (1 June 2012) p 2.

60 The Institute of Chartered Accountants in Australia, Submission to The Treasury, Consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value (1 June 2012) p 2.

61 ITAA 1997 Dictionary only modifies the ordinary meaning of market value to account for GST.

62 See Table 2 in chapter 4.

63 Income Tax Assessment Act 1997 s 116-30.

64 Income Tax Assessment Act 1997 s 328-110; Note that If the taxpayer meets the definition, it is also eligible to access a range of other small business concessions, not just the capital gains tax concessions. These additional concessions are listed in section 328-10 of the ITAA 1997.

65 Income Tax Assessment Act 1997 ss 152-10(1)(c)(iii)–(iv).

66 ATO, CGT small business relief: maximum net asset value test - 'just before' the CGT event - immediately before, ATO ID 2003/745 (22 August 2003).

67 Board of Taxation, A Post-implementation Review of the Quality and Effectiveness of the Small Business Capital Gains Tax Concessions in Division 152 of the Income Tax Assessment Act 1997, A Report to the Treasurer (October 2005) para [17.13].

68 Board of Taxation, Scoping study of small business tax compliance costs, A report to the Treasurer (December 2007) para [8.6].

69 Income Tax Assessment Act 1997 s 855-10.

70 Income Tax Assessment Act 1997 s 855-5.

71 Income Tax Assessment Act 1997 s 855-30.

72 Resource Capital Fund III LP v Commissioner of Taxation [2013] FCA 363; Commissioner of Taxation v Resource Capital Fund III LP [2014] FCAFC 37.

73 Australian Government, Budget Measures, Budget Paper No.2, 2013-14, p 35.

74 Above n 15.

75 This was a specific policy objective of the SMSF valuation requirements. See Explanatory Memorandum to Exposure Draft, Superannuation Industry (Supervision) Amendment Regulation 2012 (No. ). See also Recommendation 8.16 and Paragraph 9.1.2 of the Review into the Governance, Efficiency, Structure and Operation of Australia's Superannuation System (Cooper Review), Final Report (30 June 2010).

76 Australian Government, The Australian Government Guide to Regulation (March 2014) p 48.

77 International Bureau of Fiscal Documentation, IBFD Tax Research Platform, Safe Harbour Definition: http://online.ibfd.org.

78 Income Tax Assessment Act 1997 s 83A-315 refers taxpayers to the Regulations for determining the market value. Income Tax Assessment Regulations 1997 Regulations 83A-315.01 to 83A-315.09 contain the relevant tables, percentages and instructions for determining some of these values.

79 ATO, The valuation of goods taken from trading stock for private use by sole traders or partners in a partnership, PS LA 2004/3 (GA) (18 June 2004) para [16].

80 ATO, Income tax: value of goods taken from stock for private use for the 2013-14 income year, TD 2014/2 (19 March 2014).

81 ATO, Fuel tax credits - Road user charge - apportioning taxable fuel used in a vehicle for powering the auxiliary equipment of the vehicle, PS LA 2013/4 (GA) (19 December 2013).

82 Explanatory Memorandum, House of Representatives, New Business Tax System (Capital Allowances) Bill 2001, para 9.6.

83 Income Tax Assessment Act 1997, ss 40-70, 40-72, 40-75.

84 For example, under the low asset write-off provisions, a $300 asset with a 50% taxable use percentage in Year 1 could only ever provide a $150 deduction in total. If this depreciating asset had an effective life of 3 years, using the prime cost method, the taxpayer could benefited from greater deductions if their taxable use percentage was 100% in years 2 and 3. The total deductions available would then be $250. Subsection 40-80(2) does not give taxpayers this option.

85 Board of Taxation, Post-implementation review into certain aspects of the consolidation regime, A report to the Assistant Treasurer (June 2012) para [6.20].

86 Ibid para [6.8].

87 Ibid para [6.21].

88 Australian Financial Review, Small businesses set to get bigger (16 March 2014) .

89 The Board of Taxation, Post-implementation review into certain aspects of the consolidation regime, Position Paper (October 2010) para [5.36].

90 Above n 85, paras [6.25] - [6.27].

91 Income Tax Assessment Act 1997 s 328-120(3).

92 These concessions are listed in section 328-10 of the Income Tax Assessment Act 1997.

93 Taxation Institute of Australia, Submission to The Board of Taxation Post-implementation review of the small business capital gains tax concessions (1 March 2005) .

94 ATO, 'Intel on CGT Small Business Concession Cases' (Internal ATO document, 11 October 2012) p 10.

95 Ibid p 11.

96 Above n 76 p 40.