On 31 July 2025, the Productivity Commission released an interim report regarding its inquiry into 'Creating a more dynamic and resilient economy', which included significant proposals to reform Australia's corporate tax system.

The interim report highlights that the current corporate tax settings distort and restrict investment, and favour incumbents over newer, and smaller, firms. Further, Australia's statutory corporate tax rate has fallen out of step with peer countries (Australia’s corporate tax rate is one of the highest in the developed world). As competition for global capital becomes more intense, Australia needs to move to a form of taxing companies in a way that encourages investment.

Key proposals

The Commission recommended a two-part reform:

1. Lowering the corporate income tax rate: the company tax rate would be reduced to 20% for companies with annual revenue below A$1 billion. This captures almost all Australian companies. Firms with revenue above the threshold would continue to be taxed at the current 30% rate.
2. Introducing a Net Cashflow Tax: a new 5% 'Net Cashflow Tax' would apply to all companies in addition to the existing corporate tax rate. This novel (and untested) tax allows firms to deduct the full value of capital expenditure in the year it is incurred, rather than it depreciating over time. The Net Cashflow Tax is designed to encourage capital investment by reducing the after-tax cost of such expenditure.

Modelling suggests the reform package could increase investment by A$7.4 billion (1.6%), lift GDP by A$14.6 billion (0.5%), and improve labour productivity by 0.4%, all in a broadly revenue-neutral manner.

Design features and uncertainties

The proposals are in their infancy. In our preliminary view, there are several aspects which will need to be ironed out, which we consider below.

Threshold mechanics and revenue definition: the $1 billion threshold is based on domestic sales plus exports. This means that multinationals with substantial offshore income may still qualify for the lower tax rate if their Australian-sourced revenue is below the threshold. However, the way domestic sales are calculated remains unclear. This definitional gap will impact companies on the margin of the threshold, especially those with complex supply chains or intercompany transactions.

Treatment of the Net Cashflow Tax:

• Overview: this tax aims to tax profits after deducting all capital expenditure in the year incurred.
• Key differences: unlike the current system, it excludes financial transactions. Interest payments are not deductible, and interest income is not taxable. This design aims to reduce the 'bias' toward debt financing and support equity-funded investment, particularly for smaller firms.
• Uncertainties: it is unclear whether the Net Cashflow Tax will be treated as a form of income tax under Australia’s double taxation agreements. This classification could affect foreign tax credits and the overall tax burden on multinationals operating in Australia. Likewise, the report does not specify whether it would be subject to the tax consolidation regime.

Carry-forward losses: losses under the Net Cashflow Tax may be offset against company income tax liabilities and, if unused, uplifted at a rate (the Commission floated the 10-year government bond rate) for future use. However, the mechanics of this interaction – particularly in cases of ownership changes or group consolidation – require further clarification. It is also unclear whether losses under the Net Cashflow Tax will be subject to the same continuity of ownership and same business tests as under the current income tax regime.

Calculation of cashflow: the report identifies the following 'design characteristics' of the proposed Net Cashflow Tax:

• all sales of goods and services would be recognised as turnover, avoiding the distinction in company income tax between capital and revenue items. This means that export sales and the sale of land and buildings would all be included in the calculation of turnover;
• outflows would be recognised as expenses within the year of purchase, removing the need to separately account for depreciation or capital items;
• financial transactions would be excluded from both sales and expenses, meaning that interest earnings will not be recognised as turnover, nor payments as expenses; and
• companies may offset any losses against their company income tax liability down to zero, enabling faster access to tax relief. Where losses cannot be immediately used, they will be uplifted – potentially at the 10-year government bond rate as noted above – to preserve their real value.

Threshold effects and potential responses: the $1 billion revenue threshold may create incentives for companies near the cutoff to defer income or restructure operations to remain below the threshold (particularly if the threshold is a step-change, rather than being phased in). While the Commission acknowledges this risk, it suggests that existing grouping and anti-avoidance rules may mitigate such behaviour. We would counsel against introducing further specific integrity provisions given the significant number of integrity rules already operating across the tax law.

Dividend imputation: changes to the dividend imputation system would be limited. Franking credits would continue to be calculated based on company income tax paid, not Net Cashflow Tax paid.

Financial services sector: This sector’s primary source of turnover is interest payments, which are excluded in the Net Cashflow Tax design. Consequently, the Commission is considering different design approaches for the sector, namely:

• introducing a financial net cashflow tax that would include financial inflows and outflows in the tax base for firms in the financial services sector; or
• levy additional company income tax.

Other considerations: the Net Cashflow Tax might increase the tax imposed upon foreign investors in a way that is not protected under double-taxation agreements. It is unclear whether the Commission has considered the retaliatory use of economic levers – such as tariffs – by foreign governments in response. It is unclear how the Net Cashflow Tax interacts with the OECD's Pillar Two global minimum tax rules.

Introduction of rules: the Commission is yet to form a view on whether these changes should be phased in, or whether the proposed changes should have a single changeover date.

Timeline: the Report does not specify a timeline for the proposed reforms. The Commission is seeking public submissions until 15 September 2025, with a final report expected by December.

Businesses should assess how these reforms could affect their operations and consider making a submission. Our tax team is available to assist with modelling, strategic planning, and preparing feedback.