A recent report from think tank Per Capita highlighted increasing concern over inequality in Australia’s taxation system, particularly whether high income earners are paying their fair share of tax.
Despite the 2% tax rise on incomes of more than A$180,000 flagged in May’s federal budget, it is low income families that are doing most of the heavy lifting through cuts and freezes on transfer payments.
Per Capita’s 2014 Tax Survey explored the attitudes of Australians to taxation and government expenditure, and was conducted in February - well before the budget.
Most Australians believe they pay the right level of tax and would support more spending on health, education and transfer payments, according to the survey. Significantly they also think high income earners are not paying their fair share and would support higher taxes on the top 5% of income earners to fund improved services.
The 2011/12 tax statistics show that only 2% of income earners return a taxable income of more than $180,000, contributing 26% of the total tax revenue. This compares with 37.4% of income tax collected from the 14.4% of individuals earning between $80,000 and $180,000.
Many people would be surprised to find out that only 2% of Australians pay the top rate of tax, which raises questions over how high flyers are reporting their income, or structuring their tax affairs.
Last week the Australian National Audit Office (ANAO) released its report on the Australian Tax Office (ATO) program to manage tax compliance of high wealth individuals.
The ATO identifies wealthy individuals as individuals controlling wealth of $5 million or more, with highly wealthy individuals controlling $30 million or more. Importantly, this takes account of the assets and entities controlled by the taxpayer, not on the taxable income returned by the taxpayer as an individual.
In 2010 the 2,600 individuals identified in the report as high wealth individuals contributed 1.2% of the tax paid by individuals and 5% paid no tax. By 2012/13 the number of high wealth individuals had increased to 2,650, controlling $301 billion in wealth, with a further 3,700 controlling a further $212 billion, although their contribution to the tax pool is not yet available.
How they do it
High wealth individuals are often able to structure their affairs with resources to support their lifestyle that don’t include taxable income. Lifestyle assets owned by other entities within their control may be used. For audit purposes, the ATO looks at the structures these individuals adopt, particularly the movement of funds and profits between these structures.
They also have access to tax planning opportunities that facilitate tax minimisation. Their tax structures can be very complex, usually involving a number of different entities often located in different tax jurisdictions. As most income is taxed on receipt, the use of foreign structures can defer the taxing point.
The Australian foreign attribution rules are intended to tax income where an Australian resident controls a foreign entity, but these rules are complex and have been criticised as being an impediment to international business.
Different entities can also be used to divert income to other members of the controlling individual’s family; in particular family trusts have become notorious for their flexibility in diverting income away from the controller.
Although the maximum rate of tax is applied to minors, adult beneficiaries are taxed at their personal marginal tax rate which may well be less than the tax payable by the individual who controls the family arrangements.
What the ATO is doing about it
None of these strategies alone constitute tax minimisation: all of them can be validly explained as a commercial arrangement, or on the basis of providing for one’s family. High wealth individuals will tend to use a combination of strategies that, in combination, move funds around between entities in a way that makes it difficult to identify who the proper taxpayer is, and the point at which the income becomes taxable. They also have the resources to contest assessments – 65% of assessments issued to a high worth individual following compliance activity are contested, and half of these result in a reduction in the tax payable, according to the ANAO report (page 99).
The government needs to empower the ATO and other authorities to pursue those high wealth individuals who are not pulling their weight. Unfortunately, it has already sent signals that it is not committed to action in core areas: in December 2013 it announced the proposal to modernise the foreign source income attribution rules would not proceed; and the review of the taxation of trusts has also disappeared from the Treasury work program.
The ANAO report highlights some inefficiencies in the audit of high wealth individuals that must be addressed, but the ATO is also facing staff cuts as a result of the 2014 budget.
In the mean time Australians will continue to ask if the highly wealthy are bearing their share of the pain.