Closing down one tax lurk for the rich; what about the others?
Often seemingly appropriate policy responses can lead to tax rorts. Take section 23AG of our income tax laws.
Back in the mid 1980s Australia moved from an exemption system for foreign taxed income to a foreign tax credit system (FTCS).
In essence under the FTCS Australian residents declare their foreign income and receive a credit for the foreign tax they have paid on it. (The credit is now called a non-refundable tax offset.)
As a rough rule of thumb an Australian resident can live overseas for about two years and still have Australian residency status for tax purposes.
There was one exception to the FTCS. For residents whose salary and wages was earned overseas the Labor Government of the day decided it would remain exempt if it was taxed overseas. This exemption is found in section 23AG of the income tax law.
The argument Hawke Labor used was that the exemption would save these Australian resident salary and wage earners from the compliance costs associated with including the income only to see them receive a credit roughly equivalent to Australian tax.
This has some superficial appeal. Many Australian resident expatriates do pay income tax in other countries on their overseas salary that is roughly equivalent to Australian tax levels on the same income.
But of course, many do not. Expatriates in Hong Kong for example pay a maximum of 17.5 percent tax on their salaries there. Until recently, as Australian residents they were exempt from any tax in Australia on that lightly taxed income.
However it is likely the real driver for the section 23AG exemption was political. Labor didn’t want to be seen as attacking working people.
And no doubt they reasoned that since the exemption was limited to Australian tax residents earning foreign salary and wages this meant that these people were out of the country for up to two years and so wouldn’t be getting the benefits of Government expenditure on taxpayers in Australia, things like schools, hospitals and roads, without contributing to Australia’s tax coffers.
Almost immediately there was a problem. What about offshore oil workers who worked five weeks on in foreign waters nearby and paid foreign tax, and then spent 5 weeks at home with the family in Australia?
The Tax Office developed a ruling which decided the 23AG exemption applied to such people.
Then pilots began to get in on the lurk. Many had families in Australia. Yet they themselves might notionally be based in a foreign city and pay tax in that low tax country.
Pilots would structure their flights in such a way that they spent their rest days and other leave days in Australia. This meant they were with their family, enjoying our roads, hospitals and schools, but arguably paying no Australian tax on that income.
In other words globalisation and the free flow of labour (a free flow for some skilled workers, not refugees unfortunately) undermined the exemption. The inequity was obvious – why should pilots of foreign airlines pay no tax in Australia when they, like their Qantas counterparts, really lived here?
The Tax Office tried to deal with the problem administratively by issuing a ruling. The outcome was an interesting comprise between competing interests which didn’t really prevent the rort.
Interested parties merely sought the advice of counsel that their arrangements were OK and ignored the ruling.
The personal tax area of the ATO did not see enforcing the ruling (for example by auditing a large number of foreign airline pilots living in Australia) as a priority. It didn’t have the staff and international matters were not given high priority.
Treasury took the position that the matter could best be resolved administratively. Why waste Parliament’s time? And, so the argument went, there were bigger tax fish to fry.
But, as Treasury’s own Tax Expenditure statement shows, the cost of the exemption (and another minor one) was estimated at $520 million last financial year.
Couple that with a Government keen to cut its deficit in any fashion possible to fund its stimulus package and it is not surprising the Government changed the rules with effect from 1 July 2009.
Only charity workers, aid works and defence personnel (to simplify) will now be eligible for the exemption.
The Treasurer estimates this reform will bring in an extra $675 million over the next four years. That is likely to be an underestimate.
So what seemed to be a sensible policy exemption became a burgeoning drain on revenue as globalisation made it easier for skilled labour to exploit the weaknesses in the provision.
The good thing has ended, and with many tax arrangements cleverly designed as agricultural schemes collapsing, I wonder now where the pilots and their crew will put their money?
My guess is superannuation and negative gearing, using the halving of the capital gains rate as an extra incentive.
Let’s hope the Henry Tax Review fixes up superannuation and negative gearing, and the capital gains concessions, all of which favour the rich.
After all, Treasury’s own Tax Expenditure statement shows the cost to revenue of tax exemptions, deferrals and the the like at around $80 billion a year.
Most of these disguised grants go to the rich or go disproportionately to the rich.
I won’t hold my breath that the Henry Review will do anything since the whole of our tax system is one giant conduit of revenue from ordinary workers to the well off.