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Review of Business Taxation
A Platform for Consultation
Discussion Paper 2
Robert M C Prowse
Chief Financial Officer
National Australia Bank Limited
Chief Financial Officer
ANZ Banking Group Limited
Graeme W McGregor
Executive Director Finance
The Broken Hill Proprietary Company Limited
Wednesday 14 April 1999
CONDUIT INVESTMENT THROUGH AUSTRALIA
Discussion Paper 2 recognises that as a general principle where income derived by Australian multinationals from foreign investments in listed comparable tax countries flows through to foreign shareholders that income should not be subject to Australian tax (paragraph 31.10).
In this paper, three alternative options, in order of preference, are presented that would achieve an outcome that is consistent with the above principle.
2. Executive summary
Option 1 - Streaming of foreign income to foreign shareholders
The current anti-dividend streaming rules are a major impediment for Australian multinationals which are seeking to become internationally competitive. Foreign shareholders of Australian multinationals should be allowed to receive dividends direct from foreign subsidiaries located in foreign comparable tax countries without the imposition of Australian franking penalties. Australian multinationals should be permitted to pay unfranked dividends out of foreign income to foreign shareholders without any franking consequences and withholding tax.
This option would represent the most viable as a major component of it involves an extension of the current Foreign Dividend Account regime. In addition, it should be relatively simple to implement and administer as it should not require any major redrafting of the current tax law and it should not create any major additional compliance issues for Australian multinationals.
Option 2 - Imputation credits for foreign tax
Australia does not recognise foreign tax (underlying tax and withholding tax) paid by Australian multinational groups in respect of foreign income derived in foreign comparable tax countries. This creates a double layer of tax on such foreign income when ultimately distributed to Australian resident individual shareholders. If full streaming of comparably taxed foreign income to foreign shareholders is not accepted, then Australian imputation credits should be allowed for foreign tax paid (underlying tax and withholding tax) on foreign income which has also been subject to comparable tax in a foreign country.
Option 3 - Exemption for comparably taxed foreign source income distributed through Australian companies to Australian shareholders
To alleviate the double layer of taxation on foreign source income, which is derived and distributed by Australian multinationals, that income should be exempt from Australian tax in the hands of Australian resident individual shareholders. This could be considered as an alternative to full streaming of foreign profits and the recognition of imputation credits for foreign tax paid.
Cost to revenue
We understand that Treasury officials have indicated to an industry association that a broad estimate of the revenue cost of the streaming option would be in the range of $500 million per annum. In the absence of sufficiently relevant and accurate information, it is difficult to provide a more accurate estimate of the revenue cost of each of the three options presented in this paper. Accordingly, we have assumed that the estimated revenue cost of each option would be in the range of $500 million.
It should also be noted that the options presented are likely to have spin off revenue benefits such as the likely additional tax that will be generated as a result of the favourable impact on Australian share prices and the investment of capital. These additional revenue benefits must be taken into account in assessing the potential revenue cost of the options.
The three options presented in this paper should be considered as an integral component of the overall package that achieves tax reform in a revenue neutral manner.
3.0 Detailed analysis and recommendations
3.1 Streaming of foreign income to foreign shareholders
The principle of allowing comparably taxed foreign income to be streamed to foreign shareholders of Australian companies has been adopted by Australian tax law in a limited sense under the Foreign Dividend Accounts (FDA) regime. We support this general principle. However, it is submitted that the principle should be applied in a broader sense.
As a general comment, the option of expanding the FDA regime to include more types of foreign income that have been subject to comparable tax is supported. The option of recording the total of such foreign income to a Foreign Income Account regardless of the percentage of foreign shareholders at the time the foreign income was derived is also supported. That is, all such foreign income should be available for distribution to foreign shareholders. However, it is submitted that the options considered do not totally address the concerns that Australian multinationals have with the current tax law.
It is considered that where Australian multinationals, with foreign shareholders, have non portfolio investments in listed comparable tax countries the foreign income from such investments should be allowed to be distributed to the foreign shareholders without any further Australian tax and negative Australian franking consequences. Conversely, the Australian sourced income of Australian multinationals should be allowed to be distributed to Australian resident shareholders without any adverse franking penalties.
Due to the effect of several anti-dividend streaming rules, it is very difficult for Australian multinationals to stream Australian tax paid profits to their Australian shareholders and foreign profits to their foreign shareholders without being penalised.
The FDA rules permit some streaming of foreign profits to foreign shareholders. However, these rules are inefficient because:
Accordingly, the FDA regime has the effect of utilising franking credits on dividends paid out of foreign income to foreign shareholders and limiting the amount of the dividend that can be paid out of an FDA to an amount in proportion to the capital ownership interest that foreign shareholders have in the Australian company.
The FDA provisions are biased against Australian based companies which have substantial Australian taxable profits which generate franking credits. The FDA provisions also do not eliminate the potential double taxation of foreign source income derived through Australian resident companies.
The proposal to expand the FDA regime is supported, but it appears that the inefficiencies associated with the current FDA regime, as described above, will not be eliminated.
The anti-streaming rules are a major impediment for Australian multinationals seeking to become internationally competitive. The rules restrict the ability of Australian groups to expand their business operations in foreign countries and make it difficult for Australian companies to raise cost effective domestic and foreign capital to fund such expansion.
To the extent to which Australian multinationals raise capital from domestic and foreign investors and use that capital to fund the expansion of their business operations in foreign comparable tax countries, Australian shareholders of such companies are being penalised because of reduced franking capacity. Therefore, the current anti-streaming rules are biased against Australian multinationals (and their Australian shareholders) which seek to become internationally competitive by creating a global presence through expansion in foreign markets.
The Government must recognise that Australia only represents 2% of the worlds capital markets and that Australian multinationals are competing for capital (which is a very mobile resource) in a global market place. Shareholders in foreign countries will be discouraged from investing in Australian multinationals if the total tax impost on such companies is internationally uncompetitive.
Where Australian multinationals finance foreign expansion from foreign sourced capital, the anti streaming rules effectively prevent these multinationals from servicing this capital from the foreign sourced profits so generated without incurring franking penalties.
Enabling Australian multinationals to stream foreign profits to foreign shareholders directly would allow such companies to compete effectively for foreign capital as they would be able to offer foreign based investors after tax returns similar to the after tax returns that such investors would be able to obtain by investing in companies located in their country of residence.
It is also noteworthy that Australias major financial institutions are trading on price/earnings multiples of approximately 13% below those of their international peers. This impacts on the ability of Australian financial institutions to compete effectively in foreign business and capital markets.
We recommend that:
The likely benefits of such a proposal are as follows:
The reduction in Australian tax revenue from the introduction of streaming should be offset to some extent by the tax revenue that is likely to be collected from the increased domestic demand for shares in Australian multinationals and the investment of additional capital.
3.2 Imputation credits for foreign taxes
The proposal to allow imputation credits for non-portfolio foreign dividend withholding tax for both Australian resident trusts and companies is supported. This will largely reduce the existing disincentive for Australian multinationals to repatriate profits from foreign subsidiaries in listed countries because of the imposition of non-creditable foreign dividend withholding tax.
However, this particular proposal raises a much more fundamental issue concerning the lack of recognition of imputation credits in Australia for foreign tax (underlying tax) paid by Australian multinationals with foreign operations in listed comparable tax countries. A fundamental structural flaw with the existing business tax system is the double taxation of foreign source income derived by Australian resident companies through non resident subsidiaries operating in listed comparable tax countries.
That is, such income is taxed in the foreign country at a comparable tax rate and is also subject to further Australian tax when distributed (either Australian income tax when eventually distributed to Australian resident individuals or possibly Australian withholding tax when distributed to non resident shareholders). Discussion Paper 2 recognises that Australia should not cause foreign income to be double taxed.
This issue may not be as significant if full streaming of foreign profits to foreign shareholders is permitted. The clear preference is to allow full streaming of foreign profits to foreign shareholders. However, the option of allowing imputation credits for comparable foreign tax paid could be considered as an alternative.
The Federal Government has agreed to consider the issue of reciprocal imputation credits for underlying tax with New Zealand under the Trans Tasman Closer Economic Relations treaty with New Zealand (Treasurers Press Release No.100, 25 September 1996). It is submitted that this issue should be considered in a broader sense with other listed countries if full streaming of foreign profits to foreign shareholders is not accepted.
If full streaming of comparably taxed foreign income to foreign shareholders is not accepted, then Australian imputation credits should be allowed in respect of non portfolio foreign dividends and foreign branch income derived by Australian multinationals which have been subject to comparable tax in a listed country.
3.3 Exemption for foreign source income distributed to Australian shareholders
In general, exempt foreign dividend income and foreign branch income, which is derived by Australian companies, is subject to double taxation as a result of the operation of Australias tax system. That is, the foreign income derived by Australian companies is subject to comparable tax in a foreign country and is also subject to Australian tax when distributed by Australian companies to Australian resident individual shareholders. Therefore, double taxation arises because the foreign income is taxed both in Australia and in the country of source.
The double taxation of foreign income derived by Australian companies is a major disadvantage for Australian multinationals with foreign operations in listed comparable tax countries. It restricts the ability of Australian multinationals to raise equity from Australian domestic shareholders in a cost effective manner and penalises such multinationals seeking to compete in international markets by expanding their business operations in foreign countries.
Other countries recognise the potential double taxation of foreign income and have taken steps to relieve all or some of this double layer of taxation. For example, the United Kingdom, Canada and Japan all allow a partial relief of the double layer of taxation. Singapore allows full relief on the basis that foreign income is exempt from Singapore tax when distributed to Singapore shareholders.
It is submitted that where Australian companies distribute exempt foreign income which has been subject to comparable tax in a listed foreign country, that income should not be subject to further Australian tax in the hands of Australian resident individual shareholders.
This option could be considered as an alternative to the option of allowing full streaming of foreign income to foreign shareholders of Australian companies or the option of allowing imputation credits for foreign tax paid.