House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 1 - The 25 per cent entrepreneurs' tax offset

Outline of chapter

1.1 Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide a 25 per cent entrepreneurs' tax offset on the income tax liability of a taxpayer that is attributable to business income from certain small businesses in the simplified tax system (STS).

1.2 This Schedule also makes a consequential amendment to the Taxation Administration Act 1953 to exclude the 25 per cent entrepreneurs' tax offset from the calculation of the rate of pay as you go (PAYG) instalments.

Context of amendments

1.3 In the 2004 election policy statement Promoting an Enterprise Culture, the Government announced a number of measures designed to foster the entrepreneurial spirit of small businesses. The Government stated that it would provide further incentive and encouragement to small businesses - particularly those that set up and operate from home - through the introduction of a tax offset for entrepreneurs. This proposal is targeted at very small, micro and home-based businesses that are in the STS.

1.4 The STS, which commenced on 1 July 2001, was introduced as a result of recommendations in the Ralph Review of Business Taxation to reduce the disproportionate tax compliance burden that falls on small business. This aim was achieved by providing eligible small businesses with simpler depreciation rules than under the uniform capital allowances regime, a cash basis for recognising income and deductible expenses (see Chapter 2 for changes to this component), and simple trading stock rules. The rules relating to the STS are contained in Division 328 of the ITAA 1997.

Summary of new law

1.5 The ITAA 1997 is amended to allow a 25 per cent entrepreneurs' tax offset on the income tax liability of a taxpayer that is attributable to business income from certain small businesses in the STS.

Comparison of key features of new law and current law

Detailed explanation of new law

1.6 Subdivision 61-J is inserted in Division 61 of the ITAA 1997 to allow a 25 per cent entrepreneurs' tax offset on the income tax liability of a taxpayer that is attributable to business income from certain small businesses in the STS. [Schedule 1, item 5, Subdivision 61-J]

1.7 The offset is available either to:

•

the STS taxpayer in the case of an individual or company operating as an STS taxpayer;

•

the partners of a partnership that is an STS taxpayer; or

•

the trustee or beneficiaries of a trust that is an STS taxpayer, depending on who is liable for tax on the trust income.

[Schedule 1, item 5, section 61-500]

1.8 Under section 328-365 of the ITAA 1997, an entity is eligible to be an STS taxpayer for an income year if:

•

it carries on a business during that year;

•

the STS average turnover of the business and related businesses for the year is less than $1 million net of goods and services tax (GST) credits; and

•

the business and related businesses have depreciating assets with values less than $3 million at the end of that year.

1.9 The amount of the tax offset varies depending on the amount of STS group turnover of the STS taxpayer. Where the STS group turnover of the STS taxpayer is $50,000 or less, the offset is calculated as 25 per cent of the income tax liability attributable to the STS income. The offset phases out when STS group turnover is greater than $50,000 and less than $75,000. [Schedule 1, item 5, section 61-500]

1.10 'STS group turnover' has the meaning as given by section 328-375. The grouping provisions in section 328-380 also apply for the purposes of the 25 per cent entrepreneurs' tax offset to prevent businesses that fail the turnover test from subdividing in order to access the tax benefit provided by the 25 per cent entrepreneurs' tax offset. (Additional explanation of the STS grouping rules and turnover can be found in Taxation Ruling TR 2002/6 and Taxation Ruling TR 2002/11.)

1.11 An entity's STS group turnover for an income year is defined in section 328-375 as the sum of:

•

the value of the business supplies made during the year by the entity; and

•

the value of the business supplies of entities during the period it is grouped with those entities.

The STS group turnover is reduced by any supplies made between the entity and the grouped entities or between the grouped entities themselves.

1.12 A taxpayer may be eligible for more than one tax offset. For example, if a taxpayer is a sole trader who has elected into the STS and that taxpayer is also a partner in a partnership that has also elected into the STS, the taxpayer may be entitled to a tax offset in respect of their income as a sole trader and also in respect of their share of the STS income from the partnership [Schedule 1, item 5, section 61-500]. However, if the sole trader and the partnership are grouped entities, the amount of STS group turnover is relevant to determining eligibility for an offset.

Net STS income and STS annual turnover

1.13 Regardless of whether the tax offset is available to the STS taxpayer, a partner, a trustee or a beneficiary, there must be an amount of net STS income before an entitlement to an offset arises. That is, the entity claiming the offset must have net STS income for the year. The entity eligible for the offset must have a share of that net income included in its assessable income in order to be eligible for an offset.

1.14 An entity's net STS income for an income year is the amount by which:

where STS annual turnover for a year is the total of the value of the business supplies the entity made in the year. [Schedule 1, item 5, subsections 61-525(1) and (2)]

1.15 The deductions attributable to the STS turnover are the allowable deductions that the entity can claim against its assessable income which specifically relate to that turnover.

Example 1.1

Fred is an STS taxpayer who sells home-made greeting cards via the Internet. Fred's STS annual turnover is $35,000 for the year. Fred runs his business from a home office in his house. Fred claims deductions for his business expenses such as the cost of the materials used in making the greeting cards, stationery, postage and the electricity expenses relating to the home office. These business expenses total $5,000.

Fred also has salary and wage income of $75,000 for the year. He is a member of a trade union and he subscribes to a professional journal. His work-related expenses total $1,200.

Fred also has a negatively geared share portfolio from which he receives $5,000 worth of dividends and has $6,000 of interest expenses related to borrowings to acquire the shares. Fred therefore makes a loss for taxation purposes of $1,000 from his share investments.

Fred's net STS income for the year is the amount by which his STS annual turnover of $35,000 exceeds his deductions attributable to that turnover of $5,000. Therefore, his net STS income is $30,000.

Fred's work-related expenses and the expenses relating to his share investments do not affect his STS annual turnover. The income from Fred's share investments is not included in his STS annual turnover, as the dividends do not constitute taxable supplies.

1.16 Value of the business supplies does not include supplies that constitute an insurance recovery or the principal component of a loan. These are disregarded when calculating turnover. [Schedule 1, item 5, subsection 61-525(4)]

1.17 With respect to gambling supplies, the amount included in the calculation of STS annual turnover is the difference between the total amount wagered and total monetary prizes paid out. Total amounts wagered is the sum of the consideration for all gambling supplies that are attributable to that tax period. Total monetary prizes are the sum of prizes paid or payable in money (including casino chips) in that tax period. [Schedule 1, item 5, subsection 61-525(3)]

1.18 The definition of 'STS annual turnover' is consistent with the broader definition of STS group turnover in section 328-375.

1.19 The turnover of a business reflects the ordinary activities of carrying on that business, such as the sale of goods and the provision of services, and also includes interest received on amounts deposited in business banking accounts. The turnover does not include items such as dividends, rental income where the rental activities do not form an ordinary part of the business or amounts resulting from realisation of an investment.

1.20 'Value of the business supplies' is based on the terms defined in the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) and is defined in section 995-1 of the ITAA 1997. The value of the business supplies an entity makes during an income year is the sum of the values of all the taxable supplies the entity made during the year in the ordinary course of carrying on a business (calculated exclusive of GST payable on supplies) and the prices of the other supplies made in the ordinary course of carrying on the business. Both 'price' and 'value' are defined in section 9-75 of the GST Act.

1.21 The GST Act explains the method of working out the value of a taxable supply. A 'taxable supply' is defined in section 9-5 of the GST Act and is one on which GST is payable. The value of a taxable supply is worked out as 10/11 of the price of the supply. This calculation excludes the GST payable on the supply (the other 1/11).

1.22 If the supply is not a taxable supply, the price of all the non-taxable supplies made during the year in the ordinary course of carrying on a business is added to the value of all taxable supplies. The price of a supply is generally the amount of money an entity pays for the supply. Supplies that are not taxable include those that are GST-free and input taxed for the purposes of the GST Act.

1.23 Diagram 1.1 illustrates how the offset will operate.

Tax offset for an individual or a company

Eligibility for the offset

1.24 A taxpayer is entitled to a tax offset for an income year if the taxpayer:

•

is an individual (operating as a sole trader) or a company;

•

has elected to be an STS taxpayer for the year;

•

has STS group turnover of less than $75,000 for the year; and

•

has net STS income for the year.

[Schedule 1, item 5, subsection 61-505(1)]

Calculation of the offset

1.25 If the STS group turnover is $50,000 or less, the taxpayer is entitled to a tax offset of 25 per cent of their income tax liability that is attributable to STS income. If the STS group turnover is more than $50,000, the tax offset is phased out until it equals zero at turnover of $75,000. The offset is calculated using the following method:

Step 1: Calculate taxable income for the year.

Step 2: Calculate 25 per cent of the basic income tax liability for the year on the taxable income; that is, using the applicable tax rates and taking into account any special provisions that affect the calculation of the liability.

Note: the basic income tax liability does not take into account any tax offsets.

Step 3: Calculate the STS percentage, which cannot exceed 100 per cent, as:

Step 4: If the STS group turnover is $50,000 or less, multiply the step 2 amount by the STS percentage to determine the amount of the tax offset.

Step 5: If the STS group turnover is more than $50,000, calculate the STS phase-out fraction as:

($75,000 - the STS group turnover for the year) / $25,000


The tax offset is calculated as:

step 2 amount * STS percentage * STS phase-out fraction


[Schedule 1, item 5, subsection 61-505(2)]

Example 1.2: Sole trader with other non-business income

Jenny runs a physiotherapy practice from her home and she is an STS taxpayer for the income year commencing 1 July 2006. The net income from her practice is $20,000 (i.e. $30,000 turnover less $10,000 business expenses). In addition, she has a part-time job as a shop assistant from which she receives salary and wages of $25,000.

Step 1: Jenny's taxable income for the year is $45,000.

Step 2: Basic income tax liability is $9,671.53

25 per cent of her basic income tax liability is:

25% * 9,671.53 = 2,417.88

Step 3: The STS percentage is:

(20,000 / 45,000) * 100 = 44.44%

Step 4: Jenny's STS group turnover is $30,000; therefore, the tax offset is:

2,417.88 * 44.44% = 1,074.51

Step 5: Not applicable.

Therefore, Jenny's entrepreneurs' tax offset is $1,074.51.

Example 1.3: A company with a turnover between $50,000 and $75,000

Company A is an STS taxpayer for the income year commencing 1 July 2006. Company A has net STS income of $20,000 (i.e. annual turnover of $60,000 less expenses of $40,000) and no other source of income. Company B is a grouped entity of Company A, which has a turnover of $10,000, but is making a tax loss. The STS group turnover of the two companies is $70,000.

Step 1: Company A's taxable income is $20,000.

Step 2: Basic income tax liability is $6,000 (i.e. $20,000 * company tax rate of 30%)

25 per cent of the basic income tax liability is:

25% * 6,000 = 1,500

Step 3: The STS percentage is: (20,000 / 20,000) * 100 = 100%

Step 4: STS group turnover is greater than $50,000.

Step 5: The STS phase-out fraction is:

(75,000 - 70,000) / 25,000 = 0.2

The tax offset is:

1,500 * 100% * 0.2 = 300

Therefore, Company A is entitled to an entrepreneurs' tax offset of $300.

Tax offset for a partner in a partnership

Eligibility for the offset

1.26 A taxpayer is entitled to a tax offset for an income year if:

•

the taxpayer is a partner in a partnership;

•

the partnership is an STS taxpayer for the year;

•

the partnership's STS group turnover is less than $75,000 for the year;

•

the partnership has net STS income for the year; and

•

a share of the partnership's net STS income is included in the taxpayer's assessable income for the year.

[Schedule 1, item 5, subsection 61-510(1)]

Calculation of the offset

1.27 If the partnership's STS group turnover is $50,000 or less, the partner is entitled to a tax offset of 25 per cent of their income tax liability that is attributable to their share of the partnership's net STS income. If the partnership's STS group turnover is more than $50,000, the tax offset available to the partner is phased out until it equals zero at turnover of $75,000. The offset is calculated using the following method:

Step 1: Calculate the partner's taxable income for the year.

Step 2: Calculate 25 per cent of the basic income tax liability for the year on the taxable income; that is, using the applicable tax rates and taking into account any special provisions that affect the calculation of the liability.

Note: the basic income tax liability does not take into account any tax offsets.

Step 3: Calculate the STS percentage, which cannot exceed 100 per cent, as:

(the partner's net STS income for the year / the partner's taxable income for the year) * 100


Step 4: If the STS group turnover of the partnership is $50,000 or less, multiply the step 2 amount by the STS percentage to determine the amount of the tax offset available to the partner.

Step 5: If the partnership's STS group turnover is more than $50,000, calculate the STS phase-out fraction as:

(75,000 - the partnership's STS group turnover for the year) / $25,000


The partner's tax offset is calculated as:

step 2 amount * STS percentage * STS phase-out fraction


[Schedule 1, item 5, subsection 61-510(2)]

Example 1.4: Partner in a partnership

Liz and Richard are equal partners in Partnership A. The partnership, a costume-making business, is an STS taxpayer for the income year commencing 1 July 2006. The net income of the partnership is $45,000 (i.e. $50,000 turnover less $5,000 business expenses). Liz also has a part-time job from which she receives salary and wages of $30,000.

Step 1: Liz's taxable income for the year is $52,500 (i.e. 50% of $45,000 + $30,000)

Step 2: Basic income liability is $11,921.53

25 per cent of her basic income tax liability is:

25% * 11,921.53 = 2,980.38

Step 3: The STS percentage is:

Step 4: The partnership's STS group turnover is $50,000 or less; therefore, Liz's tax offset is:

2,980.38 * 42.86% = 1,277.39

Step 5: Not applicable.

Therefore, Liz's entrepreneurs' tax offset is $1,277.39.

Example 1.5: Partner and sole trader

Rick, Ingrid and Sam are equal partners in the partnership trading as Rick's Cafe. Rick's Cafe is an STS taxpayer for the income year commencing 1 July 2006. Rick's Cafe has net STS income of $45,000 (i.e. $60,000 turnover less $15,000 business expenses). Rick also has a consulting business, Consultations By Rick, which he operates as a sole trader and which is also an STS taxpayer. Consultations By Rick has net STS income of $40,000 (i.e. $50,000 turnover less $10,000 expenses). Rick also does some part-time work as a pilot from which he receives salary and wages of $25,000. Rick's Cafe and Consultations By Rick are not grouped entities for STS purposes.

Note: If Rick's Cafe and Consultations By Rick were grouped entities, there would be no entitlement to the offset because group turnover ($60,000 + $50,000) exceeds $75,000.

Rick's offset in relation to the partnership income

Step 1: Rick's taxable income for the year is $80,000 (i.e. 1/3 of $45,000 + $40,000 + $25,000)

Step 2: Basic income tax liability is $22,211.11

25 per cent of Rick's basic income tax liability is:

25% * 22,211.11 = 5,552.78

Step 3: The STS percentage is: (15,000 / 80,000) * 100 = 18.75%

Step 4: The STS group turnover of the partnership is greater than $50,000.

Step 5: The STS phase-out fraction is:

(75,000 - 60,000) / 25,000 = 0.6

Rick's tax offset in relation to his partnership income is:

5,552.78 * 18.75% * 0.6 = 624.69

Rick's offset in relation to his income as a sole trader

Step 1: Rick's taxable income for the year is $80,000 (i.e. 1/3 of $45,000 + $40,000 + $25,000)

Step 2: Basic income tax liability is $22,211.11

25 per cent of Rick's basic income tax liability is:

25% * 22,211.11 = 5,552.78

Step 3: The STS percentage is: (40,000 / 80,000) * 100 = 50%

Step 4: Rick's STS group turnover for his consulting business is $50,000 or less; therefore, Rick's tax offset in relation to his income from operating as a sole trader is:

5,552.78 * 50% = 2,776.39

Step 5: Not applicable.

Therefore in total, Rick is entitled to an entrepreneurs' tax offset of $3,401.08 (i.e. $624.69 + $2,776.39)

Tax offset for a trustee of a trust

Eligibility for the offset

1.28 A taxpayer is entitled to a tax offset for an income year if:

•

the taxpayer is a trustee of a trust;

•

the trust is an STS taxpayer for the year;

•

the trust's STS group turnover for the year is less than $75,000;

•

the trust has net STS income for the year; and

•

the trustee is liable to be assessed under either section 98, 99 or 99A of the Income Tax Assessment Act 1936 on a share of the trust's net STS income.

[Schedule 1, item 5, subsection 61-515(1)]

Calculation of the offset

1.29 If the trust's STS group turnover is $50,000 or less, the trustee is entitled to a tax offset of 25 per cent of its income tax liability that is attributable to its share of the trust's net STS income. If the trust's STS group turnover is more than $50,000, the tax offset available to the trustee is phased out until it equals zero at turnover of $75,000. The offset is calculated using the following method:

Step 1: Calculate the net income of the trust for the year.

Step 2: Calculate 25 per cent of the amount of tax that the trustee is liable to pay on that net income, ignoring any tax offsets.

Step 3: Calculate the STS percentage, which cannot exceed 100 per cent, as:

(the trustee's net STS income for the year / the net income of the trust for the year) * 100


Step 4: If the STS group turnover of the trust is $50,000 or less, multiply the step 2 amount by the STS percentage to determine the amount of the tax offset available to the trustee.

Step 5: If the trust's STS group turnover is greater than $50,000, calculate the STS phase-out fraction as:

($75,000 - the trust's STS group turnover for the year) / $25,000


The trustee's tax offset is calculated as:

step 2 amount * STS percentage * STS phase-out fraction.


[Schedule 1, item 5, subsection 61-515(2)]

Tax offset for a beneficiary of a trust

Eligibility for the offset

1.30 A taxpayer is entitled to a tax offset for an income year if:

•

the taxpayer is a beneficiary of a trust;

•

the trust is an STS taxpayer for the year;

•

the trust's STS group turnover for the year is less than $75,000;

•

the trust has net STS income for the year; and

•

a share of the trust's net STS income is included in the beneficiary's assessable income for the year.

[Schedule 1, item 5, subsection 61-520(1)]

Calculation of the offset

1.31 If the trust's STS group turnover is $50,000 or less, the beneficiary is entitled to a tax offset of 25 per cent of its income tax liability that is attributable to its share of the trust's net STS income. If the trust's STS group turnover is more than $50,000, the tax offset available to the beneficiary is phased out until it equals zero at turnover of $75,000. The offset is calculated using the following method:

Step 1: Calculate the beneficiary's taxable income for the year.

Step 2: Calculate 25 per cent of the basic income tax liability for the year on the taxable income; that is, using the applicable tax rates and taking into account any special provisions that affect the calculation of the liability.

Note: the basic income tax liability does not take into account any tax offsets.

Step 3: Calculate the STS percentage, which cannot exceed 100 per cent, as:

(the beneficiary's net STS income for the year / the benficiary's taxable income for the year) * 100


Step 4: If the trust's STS group turnover is $50,000 or less, multiply the step 2 amount by the STS percentage to determine the amount of the tax offset available to the beneficiary.

Step 5: If the trust's STS group turnover is greater that $50,000, calculate the STS phase-out fraction as:

(($75,000 - the trust's STS group turnover for the year) / $25,000) * 100


The beneficiary's tax offset is calculated as:

step 2 amount * STS percentage * STS phase-out fraction


[Schedule 1, item 4, subsection 61-520(2)]

Application and transitional provisions

1.32 The amendments made to the ITAA 1997 to allow a 25 per cent entrepreneurs' tax offset apply to assessments for the first income year commencing on or after 1 July 2005 and later years. [Schedule 1, item 11]

1.33 The amendment made to the Taxation Administration Act 1953 applies in relation to the calculation of an entity's adjusted tax:

•

for a base year that is the first income year starting on or after 1 July 2005 or a later income year; and

•

in relation to a PAYG instalment period that includes or starts on the date of Royal Assent of this Bill.

[Schedule 1, item 13]

Consequential amendments

1.34 The following consequential amendments are made to the ITAA 1997 as a result of the introduction of the 25 per cent entrepreneurs' tax offset:

•

the list of tax offsets in section 13-1 is updated to include references to the 25 per cent entrepreneurs' tax offset [Schedule 1, items 1 to 4] ;

•

a note is included in section 328-5 to guide taxpayers to the new offset in Subdivision 61-J [Schedule 1, item 6] ;

•

the notes in subsection 328-365(1) to the guide to Division 328 are amended as a result of the introduction of the new 25 per cent entrepreneurs' tax offset [Schedule 1, items 7 and 8] ; and

•

definitions of 'net STS income' and 'STS annual turnover' are inserted in subsection 995-1(1) [Schedule 1, items 9 and 10].

1.35 An amendment is made to section 45-340 of the Taxation Administration Act 1953. The amendment ensures that the 25 per cent entrepreneurs' tax offset is not taken into consideration when determining the rate of PAYG instalments. The offset is excluded from the calculation because it is only available on assessment. [Schedule 1, item 12]

1.36 If an entity anticipates that it will be entitled to the offset on assessment, the entity may vary its instalments during the year. However, the entity may be liable to general interest charge where a variation results in an underestimation of the instalments of more than 15 per cent.

1.37 The amendment made to the Taxation Administration Act 1953 applies in relation to the calculation of an entity's adjusted tax:

•

for a base year that is the first income year starting on or after 1 July 2005 or a later income year; and

•

in relation to a PAYG instalment period that includes or starts on the date of Royal Assent of this bill.

[Schedule 1, item 13]

1.38 This ensures that the Commissioner of Taxation is not required to recalculate an instalment rate given to an entity prior to the commencement of the amendments in this Bill.

REGULATION IMPACT STATEMENT

Background

1.39 The STS, which commenced on 1 July 2001, was introduced as a result of recommendations in the Ralph Review of Business Taxation to reduce the disproportionate tax compliance burden that falls on small business. This aim was achieved by providing eligible small businesses with simpler depreciation rules than under the uniform capital allowance regime, a cash basis for recognising income and deductible expenses, and simple trading stock rules.

1.40 As part of their election commitments to promote an enterprise culture in Australia, the Government announced the introduction of a 25 per cent tax offset on the income tax liability attributable to business income for small businesses in the STS that have an annual turnover of $50,000 or less and will be fully phased out once annual turnover reaches $75,000.

Policy objective

1.41 The objectives of this measure are to provide encouragement for enterprising Australians in the early days of a small business, in particular to provide a greater benefit to businesses with greater productivity, and to provide incentive for the growth of small business especially the very small, micro and home-based businesses which are in the STS.

Implementation options for 25 per cent entrepreneurs' tax offset

1.42 As announced in the Government's 2004 election policy statement Promoting an Enterprise Culture a 25 per cent tax offset will be applied to the tax liability in relation to STS income.

Option 1 - 25 per cent entrepreneurs' tax offset using average tax rates

1.43 Under this method the 25 per cent tax offset would be applied to tax on total income and averaged by an STS percentage (which is equivalent to net STS income divided by total taxable income).

1.44 This overcomes the situation where a taxpayer with $6,000 or less of net STS income would not be entitled to the tax offset because of the effect of the tax-free threshold.

1.45 The 25 per cent entrepreneurs' tax offset has the following features:

•

The tax offset will be available to small businesses that are in the STS and have an annual turnover of $50,000 or less:

•

the tax offset phases out for each $1 over $50,000 up to $75,000.

•

25 per cent tax offset on income tax liability in respect of net STS income.

•

The tax offset will flow through to the individuals who operate their small business through a partnership or trust.

•

The turnover test would be applied at the group level that is, the entity and its affiliates. The tax offset would apply at either the entity or recipient level depending on who is liable to tax on the income.

•

Integrity measures required to prevent existing businesses above the turnover threshold from sub-dividing to access the discount.

Option 2 - 25 per cent entrepreneurs' tax offset using the top slice of income

1.46 Under this option the 25 per cent tax offset would be applied to the tax liability on net STS income on the assumption that the net STS income represents the top slice of taxable income.

1.47 This maximises the tax offset available to the taxpayer because the tax offset is applied to the tax liability based on the taxpayer's top marginal rate of tax.

Option 3 - 25 per cent entrepreneurs' tax offset using the bottom slice of income

1.48 This option would provide the 25 per cent tax offset on the tax liability on net STS income on the assumption that the net STS income represents the bottom slice of taxable income.

1.49 The disadvantage of this method is that, as the first $6,000 of income earned by an individual is not subject to tax, individual taxpayers who have less than $6,000 of net STS income will not receive any discount.

Impact group identification

1.50 Groups affected by the 25 per cent entrepreneurs' tax offset are STS taxpayers and non-STS taxpayers in receipt of gross STS income under $75,000, namely very small, micro and home-based businesses who are in the STS. It is estimated that more than 300,000 small and home-based businesses will be able to benefit from the 25 per cent tax offset.

Analysis of costs / benefits

Option 1 - 25 per cent entrepreneurs' tax offset using average tax rates

Benefits

1.51 This measure will deliver the 25 per cent tax offset as announced in the Government's election commitment.

1.52 The measure will provide a further source of capital that can be ploughed back into a business at its most vulnerable start-up and development stage.

1.53 The offset provided by this measure will be more valuable the more profitable the business. That is, businesses with lower expense ratios will obtain a greater benefit.

Costs

1.54 The disaggregation of business income and other income increases compliance costs of small businesses. Small businesses will be required to isolate their gross business income and their deductions incurred in gaining that income, and then calculate the net income after deductions.

Option 2 - 25 per cent entrepreneurs' tax offset using the top slice of income

Benefits

1.55 This option would provide the same benefits as option 1.

Costs

1.56 This option would require the taxpayer to calculate tax on total income then tax on total income less net STS income. The taxpayer would then need to calculate that difference and then calculate 25 per cent of that difference as the discount. Therefore, additional calculations would be required compared with option 1.

1.57 This option provides a greater benefit to people with large amounts of other non-business income and therefore is not as well targeted as option 1. For example, a person with $100,000 salary and wages and $10,000 net STS income would have the tax offset calculated using the top marginal tax rate of 47 per cent.

Option 3 - 25 per cent entrepreneurs' tax offset using the bottom slice of income

Benefits

1.58 This option would provide the same benefits as option 1.

Costs

1.59 This option would require the taxpayer to calculate the tax on net STS income first and then apply the 25 per cent tax offset to that amount of tax. The taxpayer would then reduce the tax on total income by the amount of the tax offset. Therefore, two calculations would be required. Where the net STS income was below $6,000 the taxpayer would not get any benefit owing to the operation of the tax-free threshold. Taxpayers with low levels of taxable income would benefit less under this option than either option 1 or 2.

Revenue cost

1.60 The financial cost to the revenue as a result of the introduction of a 25 per cent entrepreneurs' tax offset is expected to be as follows, based on average rates of tax:

Administration cost

1.61 It is estimated that the 25 per cent entrepreneurs' tax offset will have an impact on Australian Taxation Office (ATO) expenses of $7.3 million over four years from 2004-05 to 2007-08 to administer. The annual breakdown of this is:

Economic benefits

1.62 The 25 per cent entrepreneurs' tax offset will be an incentive for enterprising Australians to get a kick-start in the early days of a small business. These amendments will provide encouragement to small business growth.

Other issues - consultation

1.63 The Department of the Prime Minister and Cabinet and the ATO have been consulted on this issue. In view of the requirement to introduce legislation on 9 December 2004, there is not sufficient time to consult more widely.

Conclusion and recommended option

1.64 The design implementation using average tax rates (option 1) is the preferred approach. This approach will deliver the policy objective with reduced compliance costs to taxpayers and the ATO. The change will provide small business taxpayers with greater incentive for the growth of small business.

1.65 The other options have the potential to increase compliance costs for business taxpayers and would provide either a greater or reduced benefit to taxpayers. Options 2 and 3 are also not as well targeted as option 1. The top slice approach (option 2) provides a greater benefit to people with high levels of non-business income. The bottom slice approach (option 3) provides no benefit where net business income is less than $6,000. Many small businesses in the start-up phase will be in this situation.

1.66 The Treasury and the ATO will monitor this taxation measure, as part of the whole-of-taxation system on an ongoing basis.