Should there be a cap on tax advice deductions?

There is a solution to help individuals and businesses better manage the cost of tax advice – but it does not involve a cap on deductions, says UNSW Business School's Dr Ann Kayis-Kumar

Australia faces a heavy tax compliance burden compared to other countries. This is why around 70 per cent of individuals and around 90 per cent of businesses employ the help of a tax agent every year. But this year's tax time could present Australian companies, particularly smaller ones, with an even greater challenge and the compliance costs could be significant.

So, with tax time fast approaching, now is an excellent time to think about how business can mitigate some of the costs associated with tax advice while ensuring all necessary documentation is in order. To do this, they should consider the help of professionals.

However, in a time of increasing financial austerity and with many millions of Australians either unemployed or underemployed given the economic aftermath of COVID-19 restrictions, a troubling question is whether it is fair that around 50 of Australia’s millionaires pay no income tax each year – and claim back around $50 million in tax deductions for the privilege?

Should the government simply put a cap on this deduction?

This idea harks back to the lead-up to the 2019 Federal Election, where the Australian Labor Party proposed a cap on the cost of managing tax advice deduction at $3000. This policy aimed to address the problem of millionaires paying zero tax, and it would have applied from 1 July 2019, affecting individuals and other business-like structures such as trusts and partnerships taxed as individuals, not companies.

But a cap on tax advice deduction would not create a more level playing field for all taxpayers, nor lead to a fairer tax system, says Senior Lecturer and Tax Clinic Director Dr Ann Kayis-Kumar, who is the co-author of a recent paper To cap or not to cap? Policy options for dealing with the costs of managing tax affairs deduction in Australia.

The paper explores and extends the literature on the use and value of the cost of managing tax advice deduction, and the usage and benefits of tax advisory services more broadly, with a focus on underexplored high wealth individuals by providing insights gleaned from a survey of senior tax professionals in Australia.

'ATO should be conducting more audits'

A cap on the cost of managing tax advice deduction would not work, in part due to the interchangeability in practice between an agent's use of personal income tax deductions and corporate income tax deductions for some clients, including high net worth individuals, according to the authors of the paper.

Essentially, this means there are loopholes with or without a cap, and those with enough resources will find another way to (legally) reduce their tax liability. The problem, therefore, is structural, and so the only solution is fundamental reform to the tax system.

In the paper, the authors present evidence-based and practitioner-led policy recommendations for reform of the cost of managing tax advice deduction, such as increased audits. It would be better to target the "mischief" of those overclaiming deductions by conducting more tax audits of high net worth individuals, according to the paper.

"The first question that we asked ourselves was 'Will this [a cap on tax advice deduction] work?' Because the infamous thing about tax policy and design is that often we see people identifying issues, then a policymaker suggestion aimed at addressing that mischief is implemented. But then it doesn't work because there's a workaround," explains Dr Kayis-Kumar.

"It's a legislative and regulatory whack-a-mole: you plug one hole, but then another appears," she adds. Unsurprisingly, this doesn't yield results. If anything, it just increases complexity and compliance costs.

"The overwhelming response [to our survey] was that the Australian Taxation Office should be conducting more audits, including of high wealth individuals. This is in line with previous research and literature that the perception of increased risk of audit leads to changes in behaviour," she continues.

Steps businesses should be taking at this time

"Those compliance costs are generally more painful for those who are least able to afford them, for example, small businesses," Dr Kayis-Kumar continues.

So if the government is to reform the income tax system, and level the playing field for individuals and struggling businesses, it must look at measures designed to reduce or sensibly manage tax system complexity altogether, with more effective policing of existing rules for the deduction of expenses, says Dr Kayis-Kumar.

But for now, for businesses gearing up for tax time, there may be some comfort in knowing that they've engaged someone who's a professional.

"There's an absolute need, I think, for businesses to consult a professional, given all the current relief and support that is available," says Dr Kayis-Kumar.

Small businesses especially need to ensure their bookkeeping and lodgments are correct and up-to-date. Dr Kayis-Kumar recommends seeking professional tax advice, especially in areas where more complex tax issues arise: "someone who can help them navigate all the complexities, particularly with all the COVID reliefs too," she concludes.

For more information, contact Dr Ann Kayis-Kumar, Senior Lecturer and Tax Clinic Director, in the School of Taxation ＆ Business Law.