Blog

The Financial System Enquiry (“FSI”) headed by David Murray (ex-CEO of Commonwealth Bank) released its final report on 7 December 2014. The report contains a number of recommendations that could have major consequences for investors and small business owners. Many of these recommendations require further discussion and consideration, and the government is still to decide what action they will take.

The Financial System Enquiry was set up as an independent panel to examine how the financial system could be positioned to best meet Australia’s evolving needs and support Australia’s economic growth. The FSI was asked to look at changes in circumstances since the last financial system enquiry in 1997 and recommend policy options to the government. The panel received more than 6,500 submissions (over 5,000 of which were on the subject of credit card surcharges!)

The final report identified a number of tax issues that were distorting the allocation of funding and risk in the economy, and recommended that these should be reconsidered:

Different tax treatment of savings – the FSI is concerned that interest income is taxed relatively heavily compared to investments in shares or property, causing households to prefer these rather than bank deposits or bonds.

Negative gearing – the FSI was concerned that the combination of negative gearing and the 50% capital gains tax discount on assets owned for more than 12 months encourages investment in housing. There is a mismatch when investors obtain a negative gearing tax deduction while they own the property but pay tax at half the normal rate when they sell the property. The tax advantages are greater for those on higher tax rates. This has encouraged speculative investment and has resulted in higher levels of housing debt.

• Dividend imputation – the FSI suggests that dividend imputation has outlived its usefulness and recommends removing dividend imputation and instead lowering the corporate tax rate. The FSI makes the case that the benefit of dividend imputation is not available to foreign investors and so acts as a subsidy to Australian investors. The FSI is also concerned at the cost of refundable credits to Government revenue. The FSI does not appear to consider the implications of their recommendations on small business owners, who would be faced with double taxation on business income earned in a company structure which would not apply to income earned in a partnership or a trust. If the FSI recommendations are accepted it would mean a major disadvantage for small businesses to trade using a company structure.
• Taxation of Superannuation – The FSI does not believe that tax concessions in the superannuation system are well targeted to achieve provision of retirement incomes. In particular the report recommends against having  earnings taxed at 15% in accumulation phase and untaxed during pension phase, preferring income in both phases to be taxed at the same rate. The FSI also would like the provision for limited recourse borrowing arrangements in super to be removed, and the caps for after-tax contributions to super (currently at $180,000 per year) to be reduced.
• GST on Financial Services – GST does not apply to most financial services such as bank charges and interest. The FSI feels that this creates an incentive for households to consume more financial services than they would if GST was added to them, and businesses may be consuming less financial services than they would if they could claim GST input tax credits on them.

Other recommendations that could affect small businesses are:

• Reducing Interchange Fee Caps – These are the fees charged by financial institutions on debit and credit card payments. At present large businesses pay much lower fees than small businesses due to economies of scale. By lowering the fees that may be charged the FSI hopes to reduce the difference in fees paid by small and large businesses.
• Allowing all Employees to Choose Their Own Superannuation Fund – At present the choice of fund legislation does not apply to the 20% of employees whose award or enterprise agreement stipulates the superannuation fund that must be used. The FSI is concerned at the level of fees levied in superannuation and suggests options to increase competition between funds.

The Government has said that they will be issuing a Tax White Paper soon (a government policy document released for consideration and public submissions). Watch the this site for updates on the progress of these recommendations.

In my opinion the FSI recommended policies are likely to have unintended consequences, such as the effect on small business owners if dividend imputation is removed. Also much of the reasoning appears to be highly theoretical and not applicable to the real world (who really would incur additional bank charges and interest expenses just because it is GST-free?!)