Neutrality Matters: Lease Payment in Australian Taxation

Abstract

Although Australia's federal income tax rules have gone through several reforms since the beginning of the 20th century, they remain inadequate in several important respects for a 21st century market economy. One key aspect of current deficiencies is that the tax law does not observe the important principle of tax neutrality, whereby similar characterisations of property should not lead to wildly different tax outcomes. Another characteristic is complexity, as it is a sine qua non of tax law that greater complexity is directly related to more tax evasion, greater inefficiency, and eventual failure of specific rules. Both aspects are especially problematic in relation to lease payments in the Australian tax system. This article provides a historical and legal analysis of Australia's tax law, laying out the principles and methods by which tax neutrality and simplicity can be achieved. It shows the inconsistencies in the rules related to leases and how these undermine tax neutrality and how specific rules and misconceived accounting principles create unnecessary complexity in the tax law. These issues can, however, be mitigated, if not entirely resolved, by incorporating the risk-free rate of return into any rule affecting leases and all transactions related to them. The recommendations that follow this approach include adding deferred allowances to the existing capital gains tax regime or a newly implemented capital allowance scheme for lease payments, and removing the loss quarantine rule. Although trade offs between tax neutrality and simplicity may occur in some instances, reforms based on these recommendations will at least be an improvement on the present tax situation in Australia.