Tax Cuts and Tax Reform Part 2

Published on 02 May 16.

In this post I'll give you some real facts about tax from a 30 year practising public accountant. We will investigate company tax, and then the way tax is different for the wealthy vs the rest of us.

Company Tax

• Australian companies pay 30% on taxable profit (ie gross income less tax deductions).
• Malaysian companies pay 20% on first 500,000 Malay dollars profit and 25% on profit above 500,000.
• USA companies pay up to 35% when state and municipal taxes are added to federal tax
• Thailand companies pay 20% and branch tax of 10%, total for foreign companies thus 30%
• German corporates pay 35% tax
• Chinese companies pay 25% tax NOT including nebulous payments made to questionable recipients.
• Singapore companies pay between 17 and 55% tax.

Irish based companies are a more complex issue. They pay 12.5% and 25% tax, but look what the GFC did to them. Government services declined significantly below what they were before the GFC. But there has been no call on the corporate community to contribute to the repayment of their crippling Government debt.

So let’s dismiss the notion that Australian company tax is excessive compared to alternative neighbouring and distant countries. In fact, given the level of political stability, first world transport, uninterrupted power supply, a skilled work force, affluent consumers and general infrastructure our tax rate is arguably lower than it should be.

The recent history of Australian corporate tax is very instructive. The company tax rate until 1987 was 47%. It then fell to 36% between 1987 and 2000. By 2001 it had fallen further to 34%.Finally after 2001 the company tax rate cam down to 30%. It is now to drop again to 28.5%.

In the past 30 years the corporate tax rate has fallen by nearly half, from 47% to 28.5%.of profits. But the Chamber of Commerce, the Business Council and a myriad CEO’s around the Australian corporate scene still demand more tax cuts. This is unfounded and socially unconscionable.

Corporate Tax Evasion and Avoidance

So how do multinationals avoid paying tax in Australia? And why has the UK initiated a 25% Google tax?

International Transfer Pricing and Profit Shifting

Simply put, this means multinational corporations arbitrarily move profits from high to low taxing jurisdictions i.e Australia to Ireland.

Let's look at an example. The earPhone is a great smart phone made by Apricot P/L. We love them, and are quite happy to part with $900 of our hard earned cash. But let's unravel the complex web of transactions behind

our simple purchase.

Firstly there is the complex structure of companies, holding companies and subsidiaries. The factory is in Thailand, and is run by Apricot (Thai) P/L. There is an office in Ireland, Apricot (Ireland) P/L. And headoffice is in the US, with a sales and service office in Australia, Apricot (Aust) P/L.

Secondly, we look at who does what. Apricot (Thai) manufactures the phone. Apricot (Aust) sells the phone. It isn't clear what Apricot (Ireland) do, although the sign on the door of their only office reads Development and Marketing.

Thirdly, lets look at the financial transactions that come from manufacturing and selling a single phone. It costs Apricot (Thai) $20 to make the earPhone, and they sell it to Apricot (Aust) for $600. Apricot (Aust) then has cost of sales (wages, rent etc) of $200, so they sell the phone for $900, for a final net profit of $100

The earPhone is manufactured in Thailand by Apricot (Thai) P/L. Apricot has another subsidiary in Ireland, Apricot (Ireland) P/L. While it appears to only be a PO Box and and an office with just one desk, it is documented as a research and marketing centre. It costs $20 to produce and is sold by Thai Apricot P/L or an Irish Apricot Holding Corporation to the Australian branch of Apricot Pty Ltd for $600.

The profit in Thailand is $580 (ie $600 less $20) but that profit is reduced by the Irish holding company charging its Thailand branch $500 for service and sundry expenses. In theory that was spent in Ireland to develop and market the product. In many cases this an expense of unsubstantiated merit and dubious rationale.

Therefore the taxable profit subject to Thai tax is $600 less $20 less $500 which equals $80 profit. Total tax paid on that one earphone in Thailand is $24 ie $80 x 30% tax rate. Yet it had a saleable value of $600, leaving the Thai Government $24 from its sale or 4% of the phones sale price. Legal, but hardly an example of an ethical principled or moral corporate citizen. One might think the slums of Thailand could use these funds bound for Apricot P/L in Dublin, then to be distributed back to silicon Valley in California and to its shareholders throughout the USA.

But there’s more defrauding to be explained in the one transaction. Let’s see what happened in Australia.

The Australian Apricot P/L paid Thailand Apricot P/L $600 for the Ear Phone (as above) Australian Apricot P/L has local wages and rent expenses of 200 per Earphone. So, one Earphone costs the Australian Earphone company $800 and sells it for $900 in our country. It pays 30% tax on the profit of $100 and thus our Government receives $30 per Earphone or $3.3% effective tax on an earphone sold for $900. Remember $500 of the $900 went to Ireland. This is not the act of a good corporate citizen. This 3% tax rate coincidentally is the same as Google paid on its UK sales of 17 billion pounds over 8 years.

But back to our earphone sales. The unsubstantiated expenses that Irish Apricot P/L has charged the Apricot Thailand P/L has cost our revenue up to $150 per Earphone less the $30 we received in tax. The result is that for every Earphone sold in Australia we are potentially losing $120 from our Budget coffers.

These figures are just an example, but the mechanics of global tax strategies follows the same logic as this example.

Another tax avoidance scam is where Australian branch companies are forced to import useless machinery (needing disposal) at inflated prices from Head office companies in low tax regimes. The machinery is written off over a few years generating large tax deductions in Australian branch accounts thus reducing tax here while head office Corporations pay little if any tax on its income from the Australian purchase.

The great majority of accountants despair over these corporate shams. However, while whistle blower legislation (ie protection) is as good as absent in Australia we will not hear of accountants exposing these rorts. We need USA type legislation where whistle blowers are paid a percentage of fines levied on corporate malfeasance.

Personal tax rates

Our income taxes are pretty much in the lower to middle of OECD countries. They are not as high as in some Scandinavian countries or as low as in many Asian countries. However, you get what you pay for. In Europe, health care, education and pensions are free to everyone. Why, because higher income taxes have paid for it. The opposite applies in most Asian countries where taxes are low but the individual has to pay out of his or her pocket for these services. Like the USA many in poverty cannot afford education nor adequate health services.

Also, to our advantage, our GST (tax on goods and services) is much less than most other countries consumption taxes including European and NZ VATs and American Sales Taxes. So the real federal tax take in personal tax and GST is at the lower end of advanced countries.

How tax rates have changed

Between 2004 and 2009 when the Howard and Costello Government was awash in company tax from the mining boom they gave massive income tax reductions rather than put the monies aside for the inevitable rainy day – which of course is here now, as we can all see. They did this by massive increases in the tax free thresholds, especially at the higher income levels.

The Sovereign Wealth Fund Institute says in March 2015 there was $7.1 trillion in various countries SWF’s. Norway and Arab states have locked up part of their oil revenues for a time when the oil price falls requiring them to draw down on those funds to maintain spending on essential and ongoing services for their populations. As the oil price has now collapsed those countries are spending as they did during the boom price years because they have massive savings to draw down on until the prices of oil increase. Sounds smart doesn’t it?

What did we do during the good years of the Treasury tax bonanza? The coalition gave most of it away in income tax cuts as Labor continued to do while the mining boom continued through part of the GFC.

The Budget is in almost permanent deficit now which is inevitable when you have permanently built unsustainably low tax rates and high tax thresholds into the system forever. Those tax cuts cannot because of our corporate mining tax receipts falling through the floor. As economic managers the coalition failed.

So how much did personal taxes fall? The following example explains those changes.

Tax on salary or taxable income of	$250,000	$150,000	$60,000
In 2005	$103,212	$56,212	$13,860
In 2009	$90,900	$46,000	$12,000
less tax p.annum	$12,312	$10,212	$1,386
tax cut per week	$236	$196	$27
percentage tax cut	12%	18%	10%

The biggest beneficiaries of these tax reductions as a percentage were those earning around the $150k pa. I wonder who they might include. Guess no longer. Federal government backbenchers and lower ministerial parliamentarians, inhabit those salary ranges. What a surprise.

To explain the built in structural destruction of our yearly budget from which our country continually suffers because of the Howard – Costello irresponsible tax policies over 10 years see the following article from The Australia Institute based on commentary from the IMF (International Monetary Fund).

The LNPs callous disregard for the economy will shock you. These are the facts, not the distorted Murdoch press spin echoed by vacuous neo con commentators. Follow this link to see the full details.

The only responsible course of action to restore the fiscal health of the nation is to reverse the tax thresholds to those existing in 2004 and just about everything else Costello did. Yes, we all need to pay more tax, particularly those on the higher tax brackets and the reason is mentioned later in this article.

Raising more income tax is unlikely though because parliamentarians will be the last to acknowledge the need for it, obviously & the rest of society is too individually aspirational to consider the common good. Critics of taxation increases usually scare monger that the economy will shrink as money is pulled out of it.

Well of course we don’t want to slow the economy at this point in time. So how do we increase the tax take to either fund essential services on an ongoing basis or reduce the deficit without damaging the economy?

The answer lies in the MPC (Marginal Propensity to Consume). This is an economic theory accepted by all economists.

Simply put, when you levy higher taxes on the wealthy they still spend the same, but save less. This means there is little reduction in demand for goods and services and the economy is left undamaged.

On the other hand middle and lower income earners spend a much higher percentage of their income than the wealthy do. The economy cannot afford to have them taxed higher because they will spend less. This reduces demand for goods and services and the economy suffers.

The Neo Con theory is that by taxing the rich less they will have more to spend and that some it may trickle down to lower income levels who will spend the extra droplets of cash and so stimulate the economy.

This premise has been disproven over and over again. High income earners when given extra cash save it, they don’t spend it and thus lower income earners don’t receive it. Trickle down theory conveniently ignores the MPC. Should that logic be activated in Public Budgetary Policy then the wealthier will return to saving more of their new higher disposable income. This does not increase aggregate demand for goods and services.

Making this worse is that the Budget deficit blows out even further to pay for these tax cuts because there is no compensating increase in demand or stimulation to the economy yielding similar tax revenues to the Government. What a waste of money that will be and always has been.

Sorry to be the messenger of bad tidings but it’s time for politicians to bite the bullet.

We simply have to pay more income tax otherwise our children, grandchildren and generations thereafter will never forgive us for burying them in mountains of Government debt. It’s bad enough that the National debt is now $1 trillion dollars of which Federal Government debt is about 20%, the balance being private.

The high income earning baby boomers and GenXers who have so enjoyed the coalitions irresponsible largess over the last 10 years must be the ones to endure the increased tax burden whether through increases in Super tax, Capital Gains Tax or income tax.

Unfortunately most politicians fall into this generational category. We can therefore expect self interest and the fear of losing their seat to result in good policy being left on the shelf.

Such is the nature of our nation these days. Sound economic and tax policies are now lost species. Hopefully they might soon be re discovered in the halls of power.

Gregory F. Smith B.Ec B.Acc CPA

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