|Submission No. 243||Back to full list of submissions|
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16 April 1999
Mr John T. Ralph, AO
Dear Mr Ralph,
Taxation of Leases
As its name implies the Australian Equipment Lessors Association (AELA) is the national association of equipment lessors. AELAs members, comprising banks, finance companies, manufacturers and vendor financiers, offer leasing as part of the range of their equipment finance products. Leasing in Australia accounts for around 20% of national capital expenditure on plant and machinery; members other equipment financing options represent another 20% of equipment investment.
Our comments on the Taxation of Leases and Rights chapters of Discussion Paper 2 Volume 1 note that the "lease as loan" device is used in constructing a theoretical model which solves much of the complexity and inconsistency which has bedevilled the tax administration of this area for the last 20 years: tax exempts, overseas use, assignments, luxury vehicles, etc. AELA has no problem with this approach to those high profile but largely periphery issues.
However to apply the device to the daily reality of commercial equipment financing will significantly disadvantage lessees to the detriment of their investment, production and employment. A lease is a lease; it is not a loan. To construct a model which equates and compares the two simply results in the predictable outcome.
While defining a tax preference transfer concept within the model, the chapter ignores the much broader question of tax benefit transfer. This should have been the starting point of the analysis: whether companies that are just being established or which are otherwise in bona fide tax loss, should be denied the benefit of capital allowances and
incentives otherwise available as part of Government policy. If such denial is determined, then the appropriate policy response may well be the legislation of the homogenous debt product envisaged in the chapter. However this will clearly damage the position of particularly small-to-medium sized businesses, those just starting-out, restructuring or otherwise in or facing a period of tax loss.
Its other product attributes aside, leasing allows available capital allowances to be crystallised by the lessor and reflected in the incentive of a lower monthly rental repayment by the lessee. Bureau of Industry Economics research commissioned by AELA in 1990 found leasing to have "the desirable effect of making the investment feasible for entities either in tax loss, or anticipating some tax losses, without encouraging them to any grater extent than for fully-taxed entities." Accepting this product feature of leasing (i.e. tax benefit transfer) as the current policy framework does, it is sophistry to then be concerned about "preventing a bias in favour of leasing" when leasing is the only means of effecting that transfer.
From the foregoing comments, as supported by the accompanying submission, it would be clear that AELA does not support either of the Options (at 9.15 and 9.21) for ordinary commercial equipment leasing as both represent a major disadvantage to our lessee customers compared with the status quo. To the extent that the removal of tax benefit transfer or the newer concept of tax preference transfer, increases the cost of equipment utilisation to customers, less national capital expenditure will occur and AELA members total volume of new business will be down. Beyond this self-interest, members will still provide the spectrum of finance for the end level of investment, whether by chattel mortgage, hire-purchase or whatever remains of the lease product. As even the cameos indicate the financier will be indifferent. For any given policy setting of capital allowances however, the losers will be lessees.
AELA would therefore strongly argue that the current treatment of ordinary commercial equipment leasing remain unchanged.
We would be pleased to provide any further supporting information as you require.
REVIEW OF BUSINESS TAXATION
TAXATION OF LEASES
The 80 plus AELA member companies belong to a diverse range of industry sectors and parent groupings: from banks and independent finance groups, to manufacturers, suppliers and service providers. AELA views therefore are confined to members interests as equipment lessors and, to a secondary degree, equipment financiers.
If the Government decides to remove the acceleration within the present broadbanded depreciation regime and reduce the rate of company tax, AELA is neutral. If the Government decides to reintroduce a 20% or 100% depreciation acceleration, a 40% Investment Allowance and a 46% company tax rate, AELA is again neutral. These are matters for Government policy decision.
AELAs particular perspective and role on the other hand is to ensure an appreciation of the micro and macroeconomic effects and benefits of leasing, the importance within these that its tax benefit transfer capacity brings and the implications for these features of other policy or administrative changes. Examples of these would include dividend imputation, treatment of financial arrangements and the various means to a minimum company tax regime.
In its representations to the range of business taxation reviews and inquiries over the last 15 years, AELA has put forward a set of minimum conditions for reform which focus specifically on international tax relativity and which assume a reasonable comparability in the range of other economic, regulatory and commercial attributes. These are that:
As noted above these Principles are selective, in line with our organisations areas of interest and competency. We can however understand other sectors desire for and pursuit of similar principles tailored for their interests and in increasingly globalised markets we would support them.
Also as noted the 3 Principles are set as minimal. To the extent that Australian policy settings can produce an outcome with greater incentive or support, then such framework can go some ways to mitigating the factors of distance, proximity and depth of secondary markets and extent of regulatory burden which differentiate the Australian market from those of our major trading partners and competitors.
THE AUSTRALIAN LEASING MARKET
Lease finance in Australia is a mature financial product having been offered as part of a portfolio of financing techniques for over 40 years. Such offering allows its particular merits vis-à-vis other equipment financing methods to be weighed and tailored to the customers particular needs and financial position.
Applicants can usually choose between a number of sources including financiers/lessors with whom they have an existing relationship, those which may be offering leasing at the point of sale and those independently operating in the market; lease packagers are involved in structuring some of the more complex transactions. Lease brokers also play a role in promoting the product.
In terms of general market functioning, leases are written for most capital equipment items (provided they are used for commercial purposes) and for periods ranging between two and five years; implicit rates are competitive and are usually fixed for the period of the lease. Providing the commercial use test is met lessees claim the full amount of the lease rentals as a tax deduction; the lessor, as owner, claims the depreciation and usually any investment incentives the latter in the case of the Investment Allowance (when applicable) can be claimed by either the lessee or the lessor as appropriate, with leasings tax benefit transfer capacity reflecting the incentive of the Allowance in the amount of the lease rentals. Until mid-1990 lessors may have elected to tax account and price on the finance or receivables method (i.e. on the implicit interest income stream); IT 2594 however removed this election ability. Equipment acquisition better priced through financing via the finance method (i.e. longer depreciating items of plant) are now in many instances financed via commercial hire-purchase.
There can be no option during the lease contract to purchase the leased goods at the end of the term. The lessee may however re-lease the goods at the end or make an offer for them. In any event the finance lease will provide for the lessee to indemnify the lessor for any loss on sale for less than the residual value; this provision aims at ensuring that the lessee properly maintains and uses the equipment and, from a pricing point of view, keeps any equipment technological risk implicit in the credit risk.
Leasing is part of a spectrum of equipment acquisition and utilisation financing products. Its tax benefit transfer capacity is clearly a significant factor defining that part of the spectrum. It is not the only factor however. The decision to seek or offer lease finance is also dependant on a range of non-tax features: the degree of security available or required; the impact on other borrowing lines; the flexibility needed in the particular accommodation; the convenience involved in the application, servicing or systems/ administration details; and the operation of other laws or taxes on competing products.
A classic example of this latter factor was the impact of several State stamp duties in the early to mid-1990s as low interest rates and the abolition of hire-purchase statutes in several jurisdictions coincided with stamp duty (@1.5% of rentals) on leases but not on other equipment finance products.
Leasing went from around 80% of equipment finance to 50% in a very short period of time. The removal of the distortion (0.75% on both lease and non-leases) has quickly seen the reversal of this trend. The sensitivity also gives an implicit estimate of the value and role of tax benefit transfer in the financing equation.
TAX BENEFIT TRANSFER
In 1988 the then Treasurer in the context of a crackdown on tax effective financing via financing unit trusts in property transactions, confirmed the tax benefit transfer capacity of leasing as follows:
"The Government considers that the broad scheme of the tax law requires that tax losses be carried forward by the taxpayer who in substance incurs them and that, in general, such losses should not be available for transfer to other parties, including financiers
"An exception, long accepted by revenue authorities, has been in respect of genuine leasing transactions for plant and equipment, but the Government believes that other forms of tax benefit transfer should not be accepted."
AELA welcomed the decision in relation to leasing. At the same time the Government announced that a consultative paper on the economic issues and taxation law relating to tax benefit transfer arrangements would be prepared. To assist in this process AELA commissioned the Bureau of Industry Economics to research the issues involved; their report "Tax Losses and Tax Benefit Transfer" was finalised in October 1990.
The research focused on the extent of tax losses in the system, the distortion to resource allocation and investment caused by the carry-forward of such losses, the potential gains that might result from reducing those distortions via tax benefit transfer and the options available for remedying the problems identified without opening-up too great a drain on Commonwealth Revenue. In identifying the discrimination against riskier projects and newer investors caused by the carry-forward of losses, the report found that "if the businesses which were deterred from making particular investments would have been more efficient at undertaking them, or if potentially valuable but risky projects are abandoned because those who do not face the tax-related disincentive are not well-placed to invest in them, the economic costs associated with this discrimination are likely to be significant."
A number of options were considered to overcome the distortions; these included refunds for tax losses, loss carry-forward with interest, the sale of tax losses and the application of tax benefit transfer arrangements. A significant source of tax losses in the system was depreciation and investment allowances for plant and machinery. The report found that the overall level of tax losses would have undoubtedly been higher but for the use of tax benefit transfer arrangements, particularly leasing.
The research noted the long-standing exception of equipment leasing from restrictions on tax benefit transfer and in relation to the current taxation regime found that "leasing has the desirable effect of making the investment feasible for entities either in tax loss or anticipating some tax losses, without encouraging them to any greater extent than for fully taxed entities."
While the theoretical preferred means of ameliorating the tax loss carry-forward distortions were loss refund, loss sale or loss carry-forward with interest, they involved other problems; the report concluded that in such cases the continued allowance of current tax benefit transfer mechanisms (i.e. leasing) "could prove useful in alleviating these distortions."
The accepted tax benefit transfer capacity of leasing is the main product feature which differentiates it from similar financial products such as hire-purchase and chattel mortgage. This is not a bias in favour of leasing but is the means to the end of tax benefit transfer. The sophisitc argument in the chapter of removing a bias can only be achieved in one of two ways: prohibit tax benefit transfer (in which case this needs to be justified) or apply it to all finance (which AELA isnt suggesting).
Leasings other product features aside, it is this capacity that allows it to facilitate the development of businesses just starting-out or to smoothe the restructuring of established companies. This availability of the benefit of capital allowances via lower repayments is of major economic consequence to lessees and should not be disparaged as "tax shelter".
In terms of Revenue consequence, it is not clear how the $30 million (2003-04) cost is arrived at and therefore we cannot comment on this other than to note that this is in line with the fact that recent Tax Expenditure Statements have not seemed to be concerned with its measurement. The larger estimate of $420 million is a feature of the accelerated depreciation regime and not of tax benefit transfer unless the policy decision is to not allow lessees in tax loss to benefit from accelerated capital allowances.
As would be expected AELA strongly supports the continuation of the current capacity of leasing for tax benefit transfer.
TAX PREFERENCE TRANSFER
As we understand it from the chapter, tax preference transfer provided through "tax preferred leasing" allows the lessor to claim the difference between effective life depreciation and the relevant broadbanded one while at the same time confining the lessee in the lease as loan model to the effective life deduction.
Thus if the customer is in tax loss, the only element that leasing could reflect in a lower rental is the above difference, denying the customer the benefit of the larger effective life component. Should the Government decide to remove the acceleration in the broadband depreciation schedule, there would be no tax preference to transfer and the customer would be denied the benefit of all of the capital allowance.
Either of these outcomes disadvantage customers and AELA does not believe that either represent sound policy. As noted in the foregoing section, the existing capacity for leasing to tax benefit transfer should be retained.
RBT MODEL AND CAMEOS
In considering the lease as loan model put forward in the chapters, AELA has several concerns.
A fundamental one is the definition of an amortising loan as the correct reflex of tax for a wasting asset. Once this is assumed the logic is set in place for any comparative financial and revenue flows which differ from that defined, to require a policy or administrative response to equalise the lease with the reflex of the loan. Had the current lease been defined as the true reflex or had an interest only loan model or a mark-to-market asset valuation approach been used, different comparisons would have been derived and different responses considered.
Moreover to take the amortising loan (which by definition excludes tax benefit transfer), as the benchmark, is to exclude such transfer from comparative outcomes for leasing. If a policy decision is to be taken to remove the current tax benefit transfer, then it should be based on a solid economic assessment, not on circular logic.
In terms of the examples given several queries have been raised with AELA. Principal amongst these is the procedure in cameo 9.3 of reducing the Net Receipts on which the taxable lessees IRR (10% and 6.4%) is calculated from those in cameos 8.1, 8.2, 9.1, and 9.2. Whatever its original basis in specification, the lessees Net Receipts should not then change with the different lessor tax assumptions. Because of this change the IRRs are equalised and the outcomes can be construed as neutral. If on the other hand the lessees Net Receipts are maintained, then the cameo would have produced a higher return to the lessee from the same return to the lessor clearly illustrating the benefit to the lessee of tax preference transfer which the model proposes to be reduced or removed.
Other concerns relate to the fact that much of the cameo design is not typical of ordinary commercial leasing (e.g. no residual, rentals annual in arrears) and does not correspond to industry pricing models. Also the assumption that the lessees Net Receipts from the asset decline over the period is as questionable as the assumption that they equate to the lessors financing cost. Ordinarily a lessee would utilise an asset in the performance of a contract for which sales would be fixed. Even if the acquisition was speculative, it would be assumed that the lessee was intent on a stable if not increasing revenue result. It is appreciated that the cameos were simplified for illustrative purposes but their lack of commerciality in these respects must test the outcomes.
RBT OPTIONS AND ALTERNATIVES
The earlier section put AELA views on the two options in chapter 9 rejecting both in favour of the tax benefit transfer that currently applies. In the development of the options two alternatives are mentioned which warrant AELA comment. These are whether the lease as loan device should be applied only to finance leases or to all leases.
As previously indicated a finance lease (as compared to an operating lease) allows the technological risk inherent in the equipment to be implicit in the credit risk. Thus for an item of plant that the lessee has generally chosen as suitable for its business, the lessor is only exposed to the equipment risk (i.e. will the plant become obsolete, remain reliable, will the manufacturer/supplier continue to provide servicing) if the lessee ceases to repay and the goods are returned or repossessed.
This equipment risk is greater where the secondary market for the particular equipment is insufficiently deep to enable predictability in second-hand prices. Any legislative measure which results in a move away from finance leases towards operating leases out of balance with the markets capacity to cover this risk will have prudential consequences, as well as forcing that risk, currently implicit in the finance lease to be explicitly priced in the operating lease.
The current treatment allows both forms of leasing to apply tax benefit transfer. This allows for a reasonable balancing of security and tax in the pricing. As both of the alternatives restrict tax benefit transfer, neither should be supported without a proper economic assessment of the threshold questions.
TAX EXEMPTS, ETC
AELA was surprised at the chapters suggestion of allowing tax preference transfer for tax exempts and overseas asset use. We were not aware of any groups who have been suggesting this and given the revenue cost and nature of Commonwealth/State financial arrangements would not have thought that it would receive serious policy attention.
We have however for many years, made representations to the Tax Office and others (e.g. Private Infrastructure Task Force) to relieve the complexity and severity which the RBT finds in the operation of section 51AD and to a lesser extent Division 16D. AELA believes that these provisions which apply the lease as loan mechanism, be revisited and improved along the lines previously and regularly put to Government.
In a similar vein, the other problems of lease administration which the chapter identifies (e.g. assignments) should also be addressed through specific provisions tailored to their specific circumstances. It may be appropriate in this context to adopt the lease as loan device in their resolution. However AELA remains opposed to its blanket application which results in the removal by default of tax benefit transfer in ordinary commercial equipment leasing transactions.
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