The Case for Small Business Tax Reform

  • May 29th, 2019 at 1:13 pm

Many developed countries take steps to make it easy to start a small business but also support and protect them. Costs are usually low, registrations are efficient and there are few red tape restrictions that slow early progress. Australia could do the same by overhauling it regulations, red tape, costs and fines and replace them with incentives that sustain small businesses and attract higher participation rates from willing entrepreneurs. We need to make it easier for small business to succeed. By comparison, our systems are seen as more punitive than they are promotional.

Much has been written about the need for taxation reform in Australia which is a country with a high number of taxes e.g. best estimates show there are 99 at Federal level, 25 at State level and one at local government level. (Tax Institute JOTHAM LIAN – 13 August 2018).  This in itself indicates the complexity that has grown over years of Governments tinkering with taxes in order to raise revenues. There are several studies that show taxation can be an inhibiter of growth especially for small businesses. In many cases the Red Tape around the reporting and collection of taxes is considered both cumbersome and costly.

Inhibiting Taxes

Polls in 2018 showed that the 3 most hated taxes are GST, FBT and Payroll tax with the last two being seen as inhibitors to growth. Both these taxes raise large amounts of revenue nationwide:

  • According to ABS data Payroll Tax raised around $22.7 billion or about 28% of total taxation revenue for the Australian States
  • The Institute of Public Accountants which also represents small businesses in Australia, said its members “go to extraordinary lengths” to avoid Payroll Tax. “They just don’t want to incur a tax they perceive as being unfair”
  • IPA’s senior tax adviser Tony Greco told Accountants Daily “We’ve heard it directly from small businesses that some are happy not to grow so they stay underneath the threshold”.
  • In a recent ‘My Business’ straw poll 24.6% of the 239 respondents ranked Payroll Tax as their most cumbersome tax in business, making it the third most disliked tax behind GST and FBT
  • SMEs have hit back at Treasury claims that Payroll Tax has minimal impact on businesses, suggesting the “extremely unfair” tax is not just affecting business growth but also employee wages. (Reporter ADAM ZUCHETTI – Tuesday, 17 April 2018)

Complexity

Taxation is now so complex that many small business owners find it difficult to understand the extent of their obligations, including concessions and allowances. They default to their Accounting Advisers and pay the fees to have their tax situation sorted out. The ATO itself has reported that mistakes are frequently made in tax returns, many of which are because their complexity.  

Not so for Corporations, some of which can afford to use taxation specialists or engage in-house experts. Smaller employing organisations must be aware of their tax obligations depending upon category, as they can be responsible for:

  • Superannuation (frequently lagging in payment)
  • PAYG withholding tax
  • Payroll Tax depending on the threshold limit per State
  • FBT calculations based on 28 variations on how the tax can be applied
  • Owners annual tax rate on salary and/or other drawings
  • GST reporting has a high cost of compliance and a lagging in payment (to the ATO)

Small business owners can be constantly under pressure to pay trade creditors and other suppliers. They need to pay staff first before business operating costs, causing owners to hold back available cash. The result can be to fall behind with taxation obligations which in the worst cases can lead to trading whilst insolvent – causing embarrassment, reputational damage and winding up.

Survival Rates

Small businesses require all the help they can get in the early years.  The ‘danger’ lies in the first 5 years as the ABS records show i.e. overall some 54% only are still in business 5 years after commencing. Cash flow shortages are a major cause of failure when revenues are low and costs are rising leading to the avoidance of taxation responsibilities.                                                                                            

ABS statistics: At the end of 2017 there were 2,238,299 actively trading businesses in the market sector in Australia, an increase of 3.1% from the end of 2016. During this period the number of businesses entering the market was 328,205. The number of businesses exiting the market was 261,450.                                                                                                                           

The gain between start-ups entering and small businesses leaving was only 66,755 (20%).

Whilst there are a number of reasons why small businesses exit the market, results at this low net gain are alarming.  When considered against the destruction caused to stakeholders, the lost opportunity for job engagements and future taxation revenues for Governments, plus the failure to establish financial independence for owners, it is economic vandalism not to act to improve such poor results.

Need for supporting policies

Australia now ranks 14th on the current World Bank scale of over 100 countries for ‘Ease in Doing Business’ – having ranked 15th for some years. However some of the Countries rated are second and third world economies.  Surely Australia can do better with some serious forethought and planning.

A robust and growing small business sector is the backbone to many a contemporary economy. This is due to the monetary circulation at the domestic base of a contemporary economy where spending fosters growth, sustainability and employment opportunities. The world’s current top 10 easiest economies in which to start a small business are:

 Base tax rates

  1. New Zealand – Tax rate is 10% to 33%                              
  2. Singapore      – Tax rate is zero to16.1%   
  3. Denmark        – Tax rate is 22%                              
  4. Korea              – Tax rate is 10% to 25%                                                                  
  5. Hong Kong    – Tax rate is 8.5% to 16%                 
  6. United States- Tax rate is 21% max rate               
  7. United Kingdom -Tax rate is 9% average             
  8. Norway           – Tax rate is 23% average                
  9. Georgia          – Tax rate is 0% to 39.6%                 
  10. Sweden          – Tax rate is 22% top rate    

Australia – Tax rate 27.5% for a small business and 30% for other corporations.     

Broad based taxes

Some countries have higher Sales / VAT taxes (similar to our GST) which range between 10% on the low side to 25% on the high side allowing them to mitigate or eliminate other lower level taxes, thus relieving much of the associated taxation red tape and its related costs to Industry.

Broad based taxes are more efficient and less complex than targeted taxes so raising the GST by 5% in Australia would generate some $65bn (at 2018 levels) and may allow for the elimination of other inefficient taxes and the lowering of rates for others.

A patent already exist for the automation of the collection of GST and other taxes and this should be seriously considered for adoption by Government. It has been estimated that small businesses spend on average $2500 in fees to Accountants to assist with their GST compliance alone. Therefore the estimated cost of GST compliance when spread cross the 2 million or so of small businesses is $3.7bn – which could be a material saving to the sector. Automation of taxes would also lead to the permanent elimination unpaid backlog, completely obviate the BAS statement and increase ATO revenues by eliminating tax backlogs and by defeating fraud (of many millions annually). 

Conclusions

Australia needs to realise that the more complex tax applications become, the more they are exposed to manipulation and fraud. The higher the tax rates the more the practice of tax avoidance is adopted. Allowing small businesses to flourish in the formative years provides a larger tax take and increases employment as they mature.

Tax incentives can be conducive to survival and would attract more activity in establishing small entities in the first place – rather than punishing early starters during their difficult years, which simply6  kills their future potential to the nation – it’s hardly intricate science to figure out we need those businesses!

Some examples to assist the growth of small businesses in Australia could be:

  • 0 -10% tax over the first 3 years in stages =  0% / 5% /10%
  • 11% – 15% over the next two years to year 5 – then step up to maximum of 20% for small enterprises with revenues under $2.5m. Thereafter normal rates to be applied as their revenues rise.
  • Low establishment fees in years 1-3 e.g. limit naming and registration fees at $100. Eliminate Annual Return requirements and associated fees until year 4.
  • Personal tax for small business owners to be 10% for first 3 years; 15% for next two years for revenues under $2.5m. Normal rates to be applied thereafter.
  • FBT to be simplified and less expensive in order to stimulate business spending. The collection of this tax can be automated to eliminate the costs of compliance of its 28 variations – which is far too many.
  • GST to be increased and automated and traded off against nil BAS reporting, the reduction or elimination of other less productive taxes. Every 1% of GST raised means additional taxation revenue of approx. $10bn so a 5% increase would produce $50bn.
  • Payroll tax thresholds to be unified for all States i.e. the common threshold to be lifted to $2.5m to encourage business growth and related employment.
  • Protections for owners to prevent bankruptcy by third parties during the first 3 years

We should not forget that many big businesses started small. Destroying business whilst in their early stages can be tantamount to killing off a better future for their owners but also denying Government higher tax revenues in future. In Australia there is basically no protection for owners or minority shareholders and the ATO has at times been a leading cause of small business closures through the pursuit of back taxes. This is something that could be examined as to its destruction of the opportunities and the reputations of the entrepreneurs involved in comparison to adopting less damaging pathways. 

Regional Incentives: In regional areas where business growth would assist local economies with population expansion plus generate employment, it could be wise to extend incentives to encourage the establishment of small businesses.  Such growth would generate jobs and with suitable planning, could lead to the creation and access of products and services not previously available locally.

Written by Colin Coverdale, SBAA Policy Chair