Submission No. 258 Back to full list of submissions
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Dr Alan Preston
Review of Business Taxation
Department of the Treasury
Parkes Place
Canberra ACT 2600


Dear Dr Preston

Victorian Treasury Submission to the Ralph Review

As you know, the Victorian Department of Treasury and Finance (DTF) has been an active participant in national tax reform, including the Review of Business Taxation conducted by John Ralph, AO.

DTF has prepared the attached submission as a technical contribution to the Review. The DTF paper addresses issues that the State has encountered in the process of implementing a vigorous public sector reform programme.

The main theme of the DTF paper is the desirability of changing certain provisions of the Tax Act, and their practical application, in order to facilitate national competition policy objectives. Central to an understanding of the retarding effects of the current tax regime is an appreciation of the changes in the fundamental role of State Governments in the nineties, from one of direct supplier to regulator, with the private sector increasingly taking the full responsibility for the delivery of services. DTF considers that such framework changes should not be inhibited by tax considerations.

Should the Review Secretariat wish to further explore the issues raised in the DTF paper, the appropriate point of contact is Jim Ferguson at DTF (phone 03 9 651 5475). DTF would welcome the opportunity to be involved with the Review Secretariat and/or Commonwealth Treasury in the development of practical solutions to the issues raised in this paper.

The DTF Technical Paper may be treated by the Review Secretariat as a public document.

Yours sincerely


Ian Little

F 98 / 03011



Review of Business Taxation

Technical Paper

Encouraging Public Sector Reform


Victorian Department of Treasury & Finance

April 1999

Victorian Treasury Submission to the Review of Business Taxation


A State Government encounters the Federal income tax regime as a client or direct participant in a number of ways that potentially inhibit the momentum for public sector reform. These include matters such as:

The potential for the misallocation of resources where tax preferences cannot be accessed by tax exempt entities (Section 51AD/Division 16D).

The likely improvement in investment outcomes if tax rules do not apply to the depreciation of assets in the tax exempt period prior to privatisation (Division 58).

The tax bias against risk taking if timing differences, which have traditionally benefited investments in infrastructure, are removed (deferred company tax proposal).

At all levels of Government, desirable micro-economic reforms should not be obstructed by unforgiving (and out-dated) income tax law. If contracting out and private sector provision are superior options on commercial grounds, the tax system should not distort the choice back towards public sector provision.

This submission proposes appropriate measures that will facilitate further public sector reform.

The Victorian Department of Treasury and Finance (DTF) has benefited from discussions on technical matters with members of the Secretariat to the Ralph Review, and would welcome the opportunity to engage in further consultation on the issues covered in this paper, and in particular the development of a new tax approach to leasing.


Ian Little

Department of Treasury & Finance

16 April 99


Victorian Treasury Submission to the Review of Business Taxation

Encouraging Public Sector Reform

Table of Contents



Executive Summary

Chapter I: Opening Tax (Transitional) Values

Identified Issue

Chapter II: Entity Taxation – Deferred Company Tax

Identified Issue

Chapter III: Leasing (Section 51AD/Division 16D)

Identified Issue

Chapter IV: Refund of Unutilised Franking Credits

Identified Issue

Chapter V: Australia as a Regional Finance Centre - CBA Role

Identified Issue

Chapter VI: Division 243 – Limited Recourse Debt

Identified Issue

Chapter VII: Trusts

Identified Issue

Appendices Number

Reform of Section 51AD/Division 16D

Letter from the Federal Treasurer (Interest Withholding Tax

Victorian Treasury Submission to the Review of Business Taxation

Executive Summary

Every (business) transaction that occurs has tax implications. Logically, the parties to commercial dealings consider the tax impacts before concluding transactions. It is impossible to design taxes that have no distorting properties.

Knowing that the imposition of tax necessarily distorts to varying degrees the choices of businesses, individuals and governments, the challenge for tax design is to minimise these side effects. Where a more pro-active approach is considered to be consistent with national goals, intervention should be explicit and transparent.

This submission makes a number of recommendations on micro-economic reform issues which are impacted by Federal income tax. The main recommendations are:

Chapter Subject Proposal
I Tax Transitional Values Replace the use of tax depreciation provisions to write down asset values in the tax exempt period, with audited values.
II Deferred Company Tax Resident Dividend Withholding Tax preferred. Thin capitalisation rules should not be made punitive.
III Leasing Repeal both Section 51AD and Division 16D, replacing those provisions with a leasing code based on majority interest tests.
IV Franking Credits Tax exempts should also benefit from a refund of unutilised franking credits.
V Regional Finance

(The role of CBAs)

Interest Withholding Tax - Government bonds be treated consistently with corporate bonds.
VI Limited Recourse Debt Protection for commonly owned entities in a Group.
VII Trusts (Tax Exempt) Entity tax not apply to Government owned trusts.

DTF acknowledges the stated requirement for the recommended changes to business taxes to be revenue neutral overall. The proposals made in this submission should not be viewed as requests for concessions or subsidies, but rather as measures designed to facilitate the nation’s participation in global economic growth. The measures outlined should "pay for themselves" through tax base broadening.

Specific Tax Issues of Concern to the Victorian Government

Chapter I: Opening Tax (Transitional) Values


By press release of 4 August 1997, major changes were announced by the Federal Treasurer to the tax treatment of (formerly) exempt assets. Amongst other things, the new policy was announced as a (proposed) amendment to tax law to align the tax treatment of Government business sales with the tax treatment of plant and articles sold separately to the (Government) business, but "associated with the sale of a business".

The new arrangements, effective from the 4 August 1997, but not yet law, represent a major shift of policy from the traditional approach to asset sales. Previously, such assets could enter the Federal (income) tax net at market value. In turn, the sharing of the rewards from privatisation programmes has been shifted in favour of the Commonwealth, at the expense of vendor States. Nevertheless, DTF has noted that the proposals, as represented by TLAB No. 4, December, 1998, contain a number of positive attributes such as the scope for a taxpayer to opt, on an asset by asset basis, for prior audited book values (PABV) in preference to notional written down original cost (NWDOC).

In June 1998, the Victorian Treasury made a submission to the Senate Economics Legislation Committee when the matter of tax transitional values was referred to that body (being schedule 10 of the Bill as it then stood). Given the extensive review of TLAB 4, 1998, (which is again before the Senate Committee), and in the interests of moving the new arrangements from policy proposal to law as quickly as possible, so as to provide greater certainty for the tax treatment of privatisation programmes (which have continued in an uncertain climate), DTF is now willing to support schedule 3 to the Bill currently with the Senate Committee.

Identified Issue

One residual matter, not previously raised, that is worthy of further assessment is the method of deriving transition values where there is a significant delay (greater than one year) between "test time" and privatisation. Under current proposals, the PABV is to be notionally depreciated if the reference point is the undeducted PABV, and the asset(s) can be depreciated at an elected rate (provided the rate is not below the pure effective life rate as determined by the Commissioner). However, once an elected rate is adopted, that nominated rate will apply to all subsequent income years (post privatisation).

DTF submits that such an approach to the derivation of asset values in what is the tax exempt period, is unnecessarily conservative and inequitable ie it may unduly reduce transitional values and advantage hasty privatisations. A jurisdiction should not be rushed into privatisation purely because a tax provision (as distinct from technology, the level of commercial demand etc) sets a "use-by" date on the worth of assets.

Taken to its logical conclusion, the PABV will derive a tax value similar to the NWDOC approach if a privatisation of existing assets is delayed for a number of years. Yet PABV is supposed to be an advance on NWDOC.

Particularly where significant industry restructuring is required prior to privatisation in order to establish competitive tension between the future (private sector) participants, and/or the industry in new hands will require elaborate regulatory control for safety, security, or public welfare reasons, it may take years to re-configure an industry (prior to privatisation). Victorian experience indicates that there is great benefit for the end customer of a privatised service where the right model has been selected.

Since the Bill before the Senate already provides for different notional depreciation arrangements (in the tax exempt period) between the options of PABV and the traditional (NWDOC), DTF submits that its suggestion cannot be dismissed merely on grounds of divergence from established tax practice. Indeed, the whole concept of PABV is innovative – and since it is progressive, DTF strongly supports the overall concept, despite concerns with depreciation in the tax exempt period.

In essence, the DTF proposal is for a marginal adjustment to the current Bill so as to allow accounting values to continue to represent asset values in the exempt years – essentially an expansion of the audited value approach already contained in the Bill. The prime revision would be to maintain the scope already in the Bill for a nomination of depreciation rates, but remove the floor imposed by the reference to effective lives as determined by the Tax Commissioner. Of course, re-valuation would not be permitted (for eventual tax purposes), and the revised reference points would need to pass an audit test each year (prior to privatisation), so that there was consistency with accounting standards (and in the process, effective lives may form the basis of the right-down).

The concerns with the Commissioner’s determination of effective lives includes the unique nature of many GBE assets subject to privatisation, and the capacity of able management to re-furbish "old" plant so as to continue its productive life. There are many examples of assets in use with zero tax values.

Post privatisation, having acquired the plant and articles under a competitive tender, often for substantial consideration, the depreciation arrangements for privatised assets should not be distinguished from alternative investments subject to federal taxation (other assets).

DTF further submits that since the matter of transitional values has been in the public arena since 4 August 1997, without legislative backing, an immediate (further) public commitment to the principle that taxpayers will have a basic choice between PABV and NWDOC would be timely.


Having struck a reference point under the PABV pathway, no specific floor should be placed on the subsequent rate of depreciation in the tax exempt period that is relevant to the determination of opening tax values (upon sale). Rather, the proposal for closer integration between accounting and tax methods should be taken a step further, and audited values should be acceptable for transition purposes [excluding revaluations].

The depreciation arrangements for privatised assets (after transition) should not be distinguished from alternative investments subject to federal taxation.

A further public commitment to the general principles embodied in the 4 August 1997 press release should be made so as to reduce taxpayer uncertainty (given that there may not be any legislative backing for these policies in the near term).

Chapter II: Entity Taxation – Deferred Company Tax


Taxation at the entity level and deferred company taxation are two (related) and more radical proposals included in the August 1998 publication "Tax Reform – Not A New Tax / A New Tax System (ANTS)". Subsequently, the Ralph Report of 22 February 1999, widened the discussion of the options for the taxation of entity distributions by including the resident dividend withholding tax (RDWT) and inter-entity (Section 46) proposals.

Prima facie, greater consistency in the tax treatment of entities has broad appeal. However, it is necessary to examine the outcomes and the tax policy trends of Australia’s international competitors before concluding a view on the merits of standardisation with respect to Australian tax obligations.

Following the announcement of the ANTS proposals on entity taxation, the corporate sector has been a vocal critic. Some leading Australian based firms have indicated a willingness to move off-shore (because of the implications of the proposals on overseas earnings, conduit income etc). DTF does not intend to comment on these aspects, and will restrict the observations made to the expected impacts on national economic growth and restructuring.

Identified Issue

The deferred tax proposal may harm the nation’s ability to attract adequate capital, especially into activities with (relatively) high risk/reward profiles, and the application of deferred company tax does not sit well with overseas trends. In short, Australia could find itself disadvantaged in the quest for capital. Therefore, despite the stated aim of deferred taxation being the protection of revenue, the taxation base could be reduced.

Further, the impact could be immediate. Whilst the proposals, if legislated, would not come into play until the 2000-01 year of income, current and potential investors are certain to take account of the possibility of changes to tax law. This is not good news for a jurisdiction running a privatisation programme supported by overseas capital.

DTF considers the most negative aspect of the deferred tax proposal to be the lack of a credit system for deferred tax paid (against subsequent corporate tax paid), and the possible effects on particular categories of income, and hence investors. Whilst resident taxpayers could expect to offset higher entity taxation through imputation credits, off-shore investors may well be disadvantaged. Even with a perfectly functioning dividend withholding tax (DWT) "module" added to the deferred company tax proposal, the tax treatment of unfranked dividends is not "corrected".

Chapter 30 of the Ralph Report illustrates that with a "balanced portfolio", returns to non-residents under the deferred company tax/DWT switch can be superior to current arrangements, but a critical assumption is that 10% only of the profit of the Australian company is not subject to company tax (and subject to deferred tax) – Table 30.3, page 640.

A critical issue is the acceptability of the DWT switch to foreign taxing authorities. Regardless, DTF maintains that deferred company tax will impose a bias against foreign investment in slow start up industries or highly capital intensive industries where little Australian company tax is payable in the early years. The timing differences between book and taxable income currently driving carry forward losses and hence the sustained distribution of unfranked (Australian sourced) dividends are an important "cushion" allowing overseas investors to take risks on venture capital (and other) projects in Australia. Even without accelerated depreciation provisions, tax negative periods for certain types of investments can be extensive. The concept of holding an investment stake in the long run (to reach a strongly tax positive period), or more generally, holding a so called balanced portfolio, simply may not entice investors into higher risk fields for all sorts of reasons eg Australian CGT rules, grouping considerations in their own (tax) jurisdiction.

The venture capital markets for example, might be particularly sensitive to this part of the tax reform package were it to become law. Several reports commissioned federally eg Mortimer, Goldsworthy, have argued that substantially more investment is required in high skill, high value adding activities if Australia is to share fully in the global knowledge based economy of the future. A common theme running through these reports is that co-ordinated "investment attraction" programmes are required.

The recent turbulence in financial markets also underlines the desirability of sending clear and consistent messages to potential investors.

Taking advantage of the improved relative tax position of debt over foreign equity, which is implicit in the deferred tax proposal, might be expected to encounter practical difficulties with thin capitalisation rules. Further, the latest proposals on thin capitalisation rules suggest a tightening of the tests and conditions under which tax deductions for debt servicing are currently available on relevant debt anyway - the RBT estimate of scope for a half billion dollar revenue gain is highly significant.

All in all, the picture emerging with deferred company tax is one of an increased Australian tax take on overseas capital inflow (in an era of globalisation). The resident dividend withholding tax (RDWT) option is preferred.


General support for the principle of consistency of tax treatment provided that it is moderated by the requirement to maintain an active investment inflow. In this regard the resident dividend withholding tax is the preferred option (despite the timing implications).

Further changes to the thin capitalisation rules should not be approached from the viewpoint of making key tests (eg arms length; related/unrelated debt) catch-all provisions.

Chapter III: Leasing (Section 51AD/Division 16D)


Section 51AD and Division 16D are known as the leasing provisions and, broadly speaking, they operate to prevent (alleged) cases of tax benefit transfer.

Section 51AD denies depreciation and other tax deductions to the (private sector) legal owner of an asset if a tax exempt entity:

  • Is leasing the asset, has the right to use the asset, or has effective control of the asset; and
  • The whole, or a predominant part of the purchase price, or construction costs of the property leased is financed by non-recourse debt.

Non-recourse debt is debt where the rights of the lender against the borrower in the event of default are limited to the property, mortgages or other security over the property which is the subject of the lease, or the income derived from that lease.

Division 16D addresses non leveraged arrangements, and its effect is to treat the financing arrangement as if it were a loan, thus interest is deductible, but depreciation cannot be claimed by the lessor.

Section 51AD applies to all domestic tax exempts plus non-residents. Division 16D is restricted to exempt public bodies and external use (outside Australia) for the purpose of producing exempt income.

Identified Issue

The leasing provisions are drafted very broadly. Not only do key terms such as "lease" have wide ranging application (virtually any granting of rights to use property), but the provisions are able to be used in a way that goes well beyond the targeting of "tax abuse".

In their contractual dealings with private sector taxpayers, Victoria and some other States

have experienced great difficulty with the leasing provisions. Essentially, DTF considers that the leasing provisions are obstructing the introduction of competition into sectors of the Australian economy previously dominated by State and Territory Governments.

By hindering the active pursuit of micro-economic reforms, especially in the business segments of State and Territory Governments, it is more difficult to realise benefits such as:

  • Market driven outcomes leading to lower sustainable service charges.
  • Improved customer choice.
  • Technological innovation, and adequate renewals investment.
  • Industries adopting the lowest cost curve under competition for market share.

Central to the modernisation of the leasing code is the acceptance by the Commonwealth that when competition and private sector providers are introduced, the State Government sponsor cannot completely withdraw from the arrangements. DTF considers that this type of minimalist intervention should not be assessed as end use and control as contemplated by the tax law.

There is an urgent need to recast the leasing code, and this requirement remains even if accelerated depreciation is removed.

DTF firmly believes that there should be continued availability for tax exempts to enter tax preference transfer arrangements ie constrained opportunities. Further, DTF strongly prefers to deal with the matter of availability directly in the Tax Act rather than allow "open slather" on leasing with a subsequent adjustment to Commonwealth-State finances (which would be impossible to quantify).

The constraints applied should be such that approved projects are competitively neutral, and the private sector participant is neither "protected" by the contractual arrangements, nor merely participating as a low risk financier.

The case for allowing some tax preference transfers in arrangements involving tax exempt entities under new provisions largely depends on the expected gains under the generic heading of "the promotion of national economic growth". The supporting elements are:

  • Removing distortions to investment patterns and improving competitive neutrality – currently tax exempts are retarded from investing in some assets (RBT clauses 8.25 & 9.35).

  • Avoiding waste as tax exempts may otherwise attempt to access the benefits of tax preference transfer through convoluted arrangements – better signals for investment choice (RBT clause 9.38).

  • Remove a bias against leasing.
  • Avoid waste as tax authorities and taxpayers comply with over-engineered tax law.

The participation of tax exempts in tax preference transfers should be on a go forward basis. This has two dimensions:

  • Not revisiting the tax status of projects previously approved (under the existing leasing provisions).
  • Building on the case law and threshold conditions that the ATO has accepted over time.

Appendix One provides a full assessment of the efficiency and effectiveness of the leasing provisions and suggests directions for reform.


The activities to be tested for risk bearing should be financial leases.

Both Section 51AD and Division 16D should be repealed.

The mainstay of the replacement tax provisions on leasing should be based on simpler tests than "use", and "control of use". DTF supports the "majority interest" option included in the Ralph Report (Appendix C to Ch 9). This option is more likely to achieve a reasonable balance between encouraging competitively neutral commercial transactions on the one hand, and compliance costs, complexity, and revenue protection on the other hand. DTF support for a "majority interest" approach is dependent on the concept being entirely based on asset ownership principles as outlined in section 4.2 of Appendix 1 to this submission.

A go forward approach be adopted on the restriction of tax preference transfers through leasing. Therefore, the concepts and design criteria that have been cleared by the ATO in recent years should form the starting point for the creation of a code of principles (to be included in legislation). Each new project could then be tested on the basis of where the envelope of acceptable contractual obligations has been extended to, rather than going back to square one for a microscopic examination of the detail of the roles and responsibilities of the parties.

If by default, Division 16D is to become the means of testing and filtering arrangements regarding asset use between parties, it will require extensive overhaul, to ensure that its target is transactions which are basically loans. For example, in the current provisions on qualifying arrangements, the 90% nominal values test for the sum of the payments exceeding the value of the assets should be deleted, and other clauses relating to cash flows should be revised to more correctly reflect financing flows.

A new facility allowing the Federal Treasurer to use regulations to fast track projects of national significance should be included.

Moving from principle to practice will involve a fine balance between commercial reality and revenue protection. DTF has benefited from participation in the RBT Focus Group on leasing, and would welcome the opportunity to further contribute, even informally, in the development of replacement legislation for Section 51AD and Division 16D.

Chapter IV: Refund of Unutilised Franking Credits


A number of Victorian Government bodies and public benevolent institutions have significant investment portfolios which are essential to their operations. It is not entirely clear from the Ralph Report how resident tax exempts stand on the various proposals for refunding unutilised franking credits – See for example, RBT Chapter 15; Clauses 15.64 and 15.72.

Three main options for changes to the imputation system are canvassed in the Ralph Report. They involve reducing, to various degrees, the scope for a company to pay a dividend that is not subject to the full rate of company tax. The deferred company tax option (at least the original proposal contained in ANTS), would impose tax on a company sufficient to ensure that all distributions are subject to the full rate of corporate tax. Given that the deferred company tax is imposed on the payer company, there would be no barrier to the application of this tax where the shareholder is a tax exempt body. The second option, labelled a resident dividend withholding tax, comprises a withholding tax borne by the recipient and it is not obvious whether or not this would apply where the shareholder is a tax exempt body. Similarly, the taxation of intercompany dividends is achieved by taxing the shareholder company in respect of dividends, to the extent the dividend is not fully franked. As such, the tax is one levied on the recipient company and presumably would not be levied where the shareholder is a tax exempt body.

Clearly, the deferred company tax option would produce the most adverse outcomes for tax exempt shareholders.

It should be noted that the Government’s proposal for the refund of excess franking credits is not necessarily linked to the three options - deferred company tax, resident dividend withholding tax, or taxation of intercompany dividends. Deferred company tax is directed at providing improved integration of the shareholder and the corporate vehicle. The latter options are directed at improving the integrity of, and simplifying the existing imputation system.

Identified Issue

In both ANTS and the Ralph Report, the consistent theme is that the distortions created in the existing tax system between different investment vehicles as compared to direct investment should be removed.

To achieve this, it is stated that the shareholders should be integrated with the investment vehicle. The "perfect world" policy may be to treat the investment vehicle as entirely transparent by either attributing to the shareholder a share of the income and expenses of the investment vehicle, or by taxing the investment vehicle at the various marginal tax rates of the shareholders. The practical course is to tax the company and provide the adjustment at the shareholder level. Where the amount of company tax paid exceeds the obligations of the shareholder, refunds to the shareholder of the excess franking credits are to apply.

However, the refund is only to be provided where the distribution is made to the ultimate underlying (resident) shareholder. Hence, refunds will mainly flow to low income individuals. Refunds are also to be provided to superannuation funds. No explicit reason is given for providing the refund to superannuation funds rather than to the superannuation fund beneficiaries. However, a superannuation fund can be construed as an "ultimate" shareholder. This approach allows refunds to be shared by the entire fund rather than directed at particular beneficiaries, and it also favours the preservation of the current 15% rate of tax for superannuation funds.

If (resident) tax exempt bodies are denied refunds of excess franking credits, then this class of investor will become the only category of ultimate (resident) shareholder with a rate of tax below the corporate rate of tax, that is denied full integration between shareholder and investment vehicle.

This treatment is distortive and perpetuates the non-neutrality that currently exists between direct investment by a tax exempt body compared to investment through corporate vehicles. This bias imposes a choice on tax exempt bodies between a higher rate of return (for direct investment) or diversified risk (for indirect investment). While this treatment may have had some justification on revenue grounds under the current partial imputation approach, there is no basis for continuing this bias when other resident shareholders are to become subject to full imputation. Other investors are clearly at a competitive advantage.

Additionally, at least in the domestic context, a full imputation system assists the efficient allocation of capital to companies that achieve the greatest pre tax return. However, for a tax exempt body, there is a preference to allocate capital to a company that provides the greatest after tax return notwithstanding that the investments of that company may be inferior on a pre tax basis.

Finally, the other class of ultimate shareholder not currently subject to a refund of excess franking credits is non-resident shareholders. However, the policy basis for this is not comparable and is not distortive. It is axiomatic that non-resident investors should be subject to some level of Australian tax on Australian sourced income. Further, a policy of refusing to unilaterally refund corporate tax to non-resident shareholders is consistent with international norms.


The absence of a mechanism to refund excess franking credits to tax exempt bodies is inequitable and distortive to investment choices. This deficiency needs to be corrected. Any problems with the streaming of franking credits could be addressed by restricting the relief to accredited bodies (eg registered charities, or entities favoured under the FBT rules), plus Government bodies.

Chapter V: Australia as a Regional Finance Centre - CBA Role

(Section 128F exemptions)


Interest withholding tax is charged (generally at 10%) on interest payments made by Australian borrowers to off-shore investors/lenders (including non-resident investors holding bonds issued by governments). Some exemptions are available under current tax law, but only in respect of debt issued outside Australia.

In Australia, loan raisings by the Commonwealth, and to a lesser extent the States, are the backbone of local bond issues.

In December 1998, the Commonwealth reintroduced legislative amendments to provide for exemptions from interest withholding tax on domestic corporate bonds. The effect of these legislative changes would leave existing and future Commonwealth and State Government bond issues at a disadvantage. The Federal Treasurer has written to the States indicating that they may wish to take this matter up with the Ralph Review (23 December 1998) –

Appendix 2.

Identified Issue

DTF concedes that the removal of existing withholding taxes is not consistent with concepts of taxation at the entity level and other proposals concerning the application of Australian corporate taxes to foreign investment in Australia, as outlined in the August 1998 national tax reform package – ANTS. (See for example page 118). However, there appears to be little policy merit in the proposal for a selective exemption from interest withholding tax in favour of corporate bonds.

Essentially the Commonwealth proposals are discriminatory on the borrowing programmes of the States, and more broadly, may have unintended consequences on the Australian finance sector.

The main argument against the Commonwealth’s position is that on the one hand, the proposals may be ineffective in terms of developing the corporate bond market, but there is clear downside in limiting the interest withholding tax relief, and these costs are not restricted to the direct effects just on Government.

Firstly as regards the Australian corporate bond market, despite recent growth, the market remains thin with relatively low turn-over, and off-shore investors seeking liquidity and an active secondary market will not necessarily purchase corporate bonds as a substitute for Government bonds.

Secondly, the negative effects of the restricted relief proposed by the Commonwealth include the impacts on State and Commonwealth Government borrowing programmes, and a more pervasive effect on the domestic finance sector as a whole.

The most obvious direct measure of the benefits that would accrue from an extension of interest withholding tax relief to include Government bonds would be the resulting budgetary expenditure impacts, estimated to approach $30m (NPV) of savings per $5b of ten year bonds issued. (Based on J P Morgan estimate that interest withholding tax relief would lower bond yields by 6-8 basis points).

The majority of this benefit would accrue to the Commonwealth Government. Not only do Commonwealth bonds dominate the Australian bond market but about 40% of the Commonwealth stock on issue is estimated to be held by non-residents. The lower cost of Commonwealth loan raisings should account for a proportion of the loss of withholding tax revenue that would be incurred by extending the exemption.

More broadly, the need to structure separate loan raisings to benefit from current section 128F exemptions adds to confusion and reduces the liquidity of Government securities. Such differential tax treatment is not welcomed by bankers and fund managers, and is a negative influence on the level of market activity. The availability of the section 128F exemptions are dependent on the securities being issued (and being retained) off-shore ie market separation. These factors work to retard active local bond market trading and hence exert a negative influence on the development of Australia as a regional financial centre. This is occurring at a time of renewed interest in Australia given our economic prospects compared with competing neighbours such as Singapore and Hong Kong.

Clearly, the level of demand for Australian stocks has implications for the general level of interest rates, and hence federal tax revenue. It is expected that without the burden of withholding tax on government bonds, the flow on benefits from a marginal increase in the level of (finance) market activity in Australia could allow the policy on bonds to be modified, as outlined, and for this extension of relief to be revenue neutral (overall) for the Commonwealth (driven by a marginal expansion in the tax base).


If interest withholding tax relief is provided for corporate bonds, it should also be provided on the bonds of Australian Governments.

Chapter VI: Division 243 – Limited Recourse Debt
Tax laws Amendment Bill (No 5) 1999


The original (stated) aim of this policy initiative was to prevent taxpayers from obtaining deductions for capital expenditures in excess of their actual outlays. Under existing law, the taxpayer could in fact meet only part of the cost of the asset, but claim the full value of the asset in tax deductions, and then walk away at the end of the contract, with the asset reverting to the financier/hirer. The current law does not allow for recapture of the "excess" tax deductions claimed.

DTF supports the policy principle behind the proposed Commonwealth legislation to address the identified revenue leakage. The concern has been whether the policy would be put into effect in a manner which would catch transactions where there is no mischief.

The matter has been in the public arena for some time, with the proposals originally foreshadowed in the May 1997 Federal Budget, expanded and released as an exposure draft in Bill form on 27 February 1998, then included as part of Tax Laws Amendment Bill (TLAB) No. 4 1998, and recently re-submitted as TLAB 5, 1999.

Whilst the intent of the new legislation is a little difficult to follow, DTF considers that the operational outcomes under the latest Bill should be superior to the previous version. However, the interpretation of the status of parties to transactions appears to be discretional.

Identified Issue

Under certain circumstances, Division 243 could affect genuine commercial asset financing. For example, as the Bill (TLAB 5 1999) is currently drafted, any time a leveraged lease or other limited recourse debt arrangement involving subsidiaries (or companies in a group) is modified, this may be deemed a debt termination, and trigger an effective depreciation recapture to the extent that the debt remains outstanding.

The outcome swings on the interpretation of "arms-length" ie are the creditor’s rights under the debt arrangement assigned to an arms length party. (Sub-Division 243-25, (1) (d)).


The taxation rules involving the depreciation adjustment on the termination of limited recourse debt (ie. Division 243 in TLAB 5 1999) require tighter formulation. Particular attention should be paid to the "arms-length" test to provide greater certainty for legitimate commercial asset financing involving commonly owned entities in a group.

Chapter VII: Trusts

(Tax Exempts)


Investment Trusts are a means by which investors pool funds for the purpose of collective investment in listed and unlisted securities. Under current tax law, Investment Trusts are essentially "pass through" entities – all income and capital gains are distributed to the unit holders. Income tax is then levied on those distributions in the hands of the unit holders.

The use of trusts is a cost-effective means of accessing investment markets. For large and small investors, the economies of scale afforded by pooled investment vehicles makes the investments affordable and reduces risks through portfolio diversification.

The Ralph Report has indicated that trusts could be treated like companies ie become taxpaying entities. The proposal is that tax would be levied at the corporate rate and a franked distribution paid to unit holders, who would then claim a rebate for the tax paid by the trust.

Subsequently, the Federal Government has stated that certain "retail" trusts will be "excused" from entity tax, namely widely held trusts. These are defined as entities which have more than twenty unit holders.

Identified Issue

Trusts are extensively used by the wholesale investment industry. Wholesale investors include superannuation funds, insurance companies, endowment funds, charities, and State Government institutions and Local Government bodies. In may instances, the trust vehicles have less than twenty (primary) unit holders.

This matter has relevance to a number of Government bodies including State Government Business Enterprises (GBEs). State GBEs are exempt from Federal income tax. However, where they employ trusts as an efficient and effective means of pooling investments and accessing securities markets, they may (under the Ralph proposals) bear income tax via the entity tax initiative.

Even if the unutilised franking credits held by tax exempts were to be credited or cashed out, there may be a loss of value through timing effects, and regardless, the tax exempt sector should not have to bear the compliance cost of a new tax system.

As an illustration, the Victorian Funds Management Corporation (VFMC) manages a suite of trusts whose units are held by State GBEs and authorities. Typically, these trusts are not "widely held" ie they have less than twenty unit holders. In order to prevent the unintended consequences of these investors paying Federal income tax (via trusts) under the new proposals, VFMC would be required to dissolve the trusts and implement discrete portfolios for each investor.

Such action would have the following undesirable effects:

  • The investors would be forced to bear the costs of realising their investments in the trusts, and then reinvesting in the underlying securities.

  • The costs of managing individual discrete portfolios for each of the investors would be significantly greater due to lower economies of scale.

  • The ability to achieve full diversification for the smaller investors would be constrained, leading to higher risks for the portfolio.

It needs to be appreciated that the entities investing in the aforementioned trusts may themselves be defined as "widely held" ie the funds invested are held on behalf of a large

number of individuals. For example, local Council funds are held on behalf of ratepayers. Workers’ Compensation funds are held on behalf of employers/employees. Third party motor accident insurance funds are held on behalf of motorists/claimants.

In summary, the taxation of trusts whose unit holders are State or Local Government bodies exempt from Federal income tax would have unintended consequences, namely the Commonwealth (income) taxation of the funds of other levels of Government.


Exemption from entity tax be granted to:

Those trusts whose beneficiaries are State or Local Government public institutions, and GBEs, who are themselves normally exempt from Federal income tax; or

Those trusts whose beneficiaries may themselves be defined as "widely held" institutions/entities.

Appendix One

Leasing (Section 51AD/Division16D)

Executive Summary

The second RBT Discussion Paper , Volume I, "A Platform for Consultation", Chapters 8-10, examined tax preference transfer and various options for reforming the existing income tax treatment of leasing and similar arrangements.

The DTF submission proceeds on the basis that, in the future, tax preference transfer will occur under the income tax law of the Commonwealth of Australia, in various ways. (See RBT Ch 9; paragraphs 9.40 - 9.44). Whatever restrictions may be imposed on tax preference transfer that occurs by way of leasing between taxpayer entities, it is recognised that there is also a need to limit the exposure of the Commonwealth tax base to tax preference transfers for the benefit of tax exempt entities and non-residents of Australia.

For the past two decades, Section 51AD and Division 16D have protected the Commonwealth tax base in an effective, but highly cumbersome way. However, the provisions were formulated long ago, and "A Platform for Consultation" acknowledges the need for reform – see for example, RBT paragraphs 9.76-9.82.

It is submitted that there is universal support from tax practitioners for the repeal of both Section 51AD, with its draconian consequences, and Division 16D, because of its focus on which entity controls the relevant asset(s) which in turn means that it is very difficult to administer the Division. (RBT Ch 9; Appendix C; clause C 1).

In considering how new provisions might best be formulated in terms of specification, scope and application, it is instructive to review the practical difficulties encountered with Section 51AD/Division 16D. A central issue is that the current provisions are drafted in a way that causes them to apply so broadly that unwarranted barriers to entry/exit are created preventing Governments working co-operatively with the private sector as they would like to in the interests of efficiency.

The structural flaws in Section 51AD/Division 16D must be overcome. The design criteria for the new/replacement provisions should aim to approve competitively neutral outcomes, thus facilitating rather than obstructing micro-economic reforms. Further, they should be applied in a commercially sensible manner, so that bona fide transactions consistent with competition policy principles are able to be processed quickly and definitively by the Australian Taxation Office (ATO).

A Commonwealth Treasury paper (dated 19 July 1995) which was prepared for Heads of Treasuries claimed… "The provisions (Section 51AD and Division 16D) do not however, prevent a private sector investor who carries the risks and benefits of ownership of property from enjoying the tax advantages of ownership".

This observation goes to the heart of the practical problems encountered with the existing provisions. The issue is one of degree. Under the current Act, to be certain of gaining clearance under Section 51AD/Division 16D, it has to be proven to the ATO’s satisfaction that the tax exempt party retains no business risks at all. Basically, this is not possible in commercial transactions. Therefore, the inevitable initial consequences are:

1. tax uncertainty;

2. commencement of a major consultative/negotiating programme with the ATO to ensure a comprehensive understanding of the real substance of the commercial transactions and respective obligations of the parties involved.

This process entails compliance costs that can be excessive, possible re-design of the project concept; project termination; extensive "holding costs" driven by delays; expensive support costs (legal fees etc) incurred in progressing the project through Government channels, and lost opportunities where potential (private sector) participants withdraw from projects in response to the tax uncertainty. The continual demand placed on scarce ATO resources is undesirable and inappropriate as the ATO would agree.

In short, even if tax clearance is eventually gained, it generally comes at a significant cost/delay. DTF considers that the current wording of the existing provisions is too broad and imprecise and key terms, especially "control", "end-user", and "lease" have such general coverage that nearly all major projects directly involving the private sector in some form of service provision of what were previously "public services" are likely to encounter Section 51AD difficulties until the Act is modernised by the adoption of a more precise formulation.

The overwhelming conclusion is that it is too difficult to repair Section 51AD/Division 16D, and therefore they should be repealed. The replacement framework would subject financial leases and similar transactions to tests which aim to determine whether or not the required degree of equity (risk) interest in the relevant assets has been retained by the (taxpaying) lessor.

The Changing Role of Government

The existing provisions were enacted long before outsourcing and privatisation were practised in Australia and understandably do not accommodate the way Governments have restructured their operations (in a way which has nothing to do with financing arrangements). Based on the difficulties that Victoria has encountered with the practical operation of the existing law it is readily apparent that public sector reforms aimed at increasing allocative efficiency have occurred well ahead of the reform of the relevant provisions of the income tax law (which was designed to prevent tax benefit transfer by way of financing arrangements).

As part of the process of introducing competition, the Hilmer Committee advocated the separation of natural monopoly elements from competitive activities. Structural reform is a centrepiece of Victorian public sector reforms. The private sector has been invited to take a direct role in reform, by placing its equity at risk. However, it must be recognised that whilst the private sector can be made fully responsible for the provision of goods and services, in most industries the Government cannot cease to be involved altogether. This is especially true where essential goods and services are involved. Reform of Section 51AD/Division 16D will necessarily involve an understanding of the different roles that Government may adopt. The required legislative rules for the future should provide precise tests for deciding whether or not the arrangement involves an unacceptable level of tax preference transfer, but not unduly intrude where adequate equity risk is borne by the private sector.

When Section 51AD was first enacted, typically Government was the sole provider of essential services and the owner of the assets providing the benefits. Today, many examples can be found where it is more efficient for Government to cease being the provider of goods or services and instead, develop and apply the conduct rules, or otherwise regulate the activities of the market participants. In other words there has been a defining change in the core functions of Government.

For example, in the Victorian energy sector, the national regulator (ACCC) may monitor and take action on industry concentration; anti-competitive behaviour, etc. The Victorian Office of Regulator General (ORG) supervises compliance with industry licence conditions which could involve safety and security issues; reviews tariffs (for parts of the system where there is market failure) etc. In some sectors, there is also an industry Ombudsman, eg the Victorian Electricity Ombudsman is an additional component of the framework established to protect electricity consumers.

The Victorian electricity system itself is overseen by a specific regulatory type body (Victorian Power Exchange – VPX). Essentially, VPX "supervises" the system rather than controls the assets providing the services, and organises continuous real time balance between supply and demand (stock exchange analogy). With the implementation of the national electricity market, NEMMCo will assume the role of system supervisor. In the Victorian gas industry, the regulating and monitoring role is performed by VENCorp (which will soon assume residual VPX functions ie system planning).

Since the ACCC, ORG, and the electricity Ombudsman are all independent bodies, the extent of direct participation and control by the Victorian Government in the energy sector has largely shrunk to monitoring and protection of system security, plus the usual generic tasks such as occupational health and safety, environmental controls etc.

The changing role of Government from one of direct provider of goods and services with full economic control and risk to that of a regulator or monitor of private sector goods and service providers with risks commensurate with this role, is essential to understanding the requirement for reform of the existing provisions.

In such circumstances, it should be self evident by reference to revised tax preference transfer provisions that adverse tax consequences will not befall a genuine (at risk) private sector provider of goods or services, operating in a sector which was previously the domain of Government.

Under the existing provisions, that is demonstrably not the case. This situation ought not be permitted to continue any longer than can possibly be avoided.

ATO Assessment

The difficulties with the application of the current provisions are illustrated below using two contemporary examples, one concerning private sector provision of infrastructure and related services, and the other deals with the assets in the Victorian gas industry (currently subject to a privatisation programme). Whilst clearance from the ATO on Section 51AD/Division 16D has recently been gained on several projects (including gas transmission services), the two examples provide a good illustration of the need for substantial surgery on the Income Tax Assessment Act. The aim should be to upgrade the legal construction of the leasing clauses so as to accommodate today’s contractual obligations between Governments and investors for the provision of essential goods and services at the risk of the private sector.

The Commonwealth was itself confronted with this very issue in the recent phase one airport privatisation programme.

DTF submits that new provisions must achieve certainty in application without a cumbersome and intrusive assessment process by the ATO.

2.1 Infrastructure

Over the past 20 to 25 years the private sector has become a more significant player in the provision of public infrastructure and related services. The reasons for this include the benefits of subjecting such activities to competitive provision, the recognition that many of these facilities and services can be more efficiently provided by the private sector, Government budgetary constraints, and more generally, many services should be supplied through a market anyway (price rationing as distinct from administrative allocation).

Over the past 5 to 10 years, there has been a significant evolution in the financial and commercial arrangements underpinning private provision of infrastructure. Typically major new infrastructure projects now use project finance, with debt financiers having recourse only to the project cash flows and assets, and business risks lie almost exclusively with the private sector provider. Also, it is now more common to find lease like contracts written for extensive periods (which better match the life of underlying assets in use, but can be more easily tripped up by some of the detail in the current tax law eg the 90% cash flows test in the qualifying arrangements section of Division 16D).

The Victorian Government is clear in its objective of allocating business risks to the private sector. In its Infrastructure Investment Policy for Victoria (IIPV), released in 1994, the Victorian Government indicated that a guiding principle was that risks be allocated to those parties which the Government considers best positioned to assess and manage them. In this policy document, the Government further stated that "the risks associated with the design, construction, financing and operation of an asset will generally be borne by the private sector". In the ensuing period, the Victorian Government has earnt a reputation for "pushing the envelope" in risk transfer to the private sector.

However, using the existing leasing provisions as a filter, it can be exceedingly difficult for the ATO to accurately test the extent of risk borne by the private sector in build-own-operate (BOO) and build-own-operate-transfer (BOOT) transactions. DTF is especially concerned with the trend in this regard. That is, it has been DTF’s experience that the ATO, understandably cautious as it must be in determining the application of the existing provisions to transactions involving billions of dollars of investment capital, is very hesitant in adapting its risk transfer (or "control") tests to new situations, sometimes appearing to propose thresholds higher than those commonly applying in private sector-private sector contracts.

Whilst some Victorian projects have been accepted, quite appropriately, as falling outside the reach of Section 51AD/Division 16D, many projects have not, and eventual confirmation that Section 51AD/Division 16D does not apply has only been forthcoming after substantial costs, delays and tensions for all concerned. Moreover there is a perception that the ATO has not demonstrated great consistency in its rulings.

The costs to the Australian economy of the current Section 51AD and Division 16D arrangements are very large indeed, and the problems appear to be escalating.

These costs comprise:

  • tax uncertainty complicating project completion and leading to higher costs of investment capital;

  • extensive delays;
  • significant compliance costs and related impacts including the costs of expert advisers;

  • higher customer service charges arising from pass through of the above costs, or project re-design (potentially including cancellation); and

  • adverse effects on economic activity throughout the economy resulting from delays or cancellation of projects (the "multiplier effect")

An illustration of these costs is provided through documenting the process for seeking Section 51AD approval on a recent private infrastructure project.

2.2 Privatisation of New Correctional Services Facilities

When the contractor for the first Victorian BOO prison sought (informally) an ATO preliminary ruling, the ATO advised that if the project proceeded as proposed (specifically financed by non-recourse debt), Section 51AD would apply (April 1995). The ATO’s principal argument supporting its decision centred on use and control of the underlying assets.

The ATO considered that the use of the prison would be "effectively controlled" by Government, since (it was argued) Government is the only buyer (user) of correctional services and has the capacity to control utilisation of the facility by allocating prisoners, and other regulatory powers. In other words, the ATO argued that the Victorian Government is the economic owner of the prison, essentially because the inmates of the facility would be prisoners of the State. This view is directly contrary to the objective of BOO projects

In practice, however, the party using the assets is the owner of the infrastructure (a Federal taxpayer) and this party is using the assets to generate an income stream that reflects the risks – business risk; finance risk; regulatory risk etc – of the project. There is not a guaranteed income to the owner. The owner is not a passive investor.

There are some critical features differentiating the Victorian prisons project from the Eraring power station example often quoted by the Commonwealth such as:

There is no sharing of a tax benefit transfer between purchaser and provider of a private prison as was evidenced in the reduction in lease payments by the relevant Government to the "owner" of the power station.

The absolute level of business risk accepted by the prison owner-operator is markedly different to the power station example (where it is understood that a tax indemnity was also supplied by the State Government).

The commercial arrangements underpinning the prisons project make it clear that (economic) control (and risk) also rests with the owner, notwithstanding that regulatory control resides with the Victorian Government. DTF submits that regulatory control of a service/system should not trigger Section 51AD/Division 16D (or the replacement provisions), especially when it is clear that operational and financial control in meeting the regulated standards are the responsibility of the Federal taxpayer.

In the event, the prisons project went ahead because the tax impacts/issues were passed by the ATO (November 1995). However, this clearance may have depended on the Commissioner’s discretionary powers (he referred to market development), and regardless, the tax clearance led to a delay in the project and to significant legal costs.

The general public needs to have faith in private sector provision of social infrastructure and public services, especially in the law and order portfolio. Accordingly, Government needs to set standards, monitor compliance, and retain emergency intervention powers. Such strategic oversight is not synonymous with "effective control" of a prison facility as contemplated by Section 51AD. Nor is the mere status of prisoners, as such, a determining attribute of Government control of the use of the facility. Regrettably it took almost 12 months to convince the most senior ATO officials of that, despite stark financial projections that demonstrated that project risk was borne by the private sector owner operator and his financiers.

2.4 Victorian Gas Industry

DTF’s negotiations with the ATO regarding the gas industry provide an excellent example of the difficulties encountered when tax law lacks clarity, the policy intent and design principles of the law are not obvious, and the interpretation of the law is not modified over time to maintain relevance to evolutionary changes in the circumstances in which Governments and business operate eg globalisation and international competitiveness.

Essentially, DTF found it difficult to gain acceptance by the ATO that Government may adopt various interventionist roles (for public purposes) without determining profit/taxable income of the private sector service provider, and without participating in a tax preference transfer of prohibited degree. Further, even if there is acceptance of this salient point, discretionary powers aside, the ATO can only work within the wording of the existing law.

In gas, VENCorp is the system regulator (currently Government owned, and established on 15 December 1997), and Transmission Pipelines Australia (TPA) is the grid/transmission body, (established as a corporate body on 11 December 1997), and is about to be privatised. The respective roles of the entities are:


Continuous monitoring of the Victorian gas system, and in the event of a safety or security issue, take action (eg. issue directions) to services providers to cease supplies, improve pressures, provide supplies etc as the case may be. VENCorp also operates the wholesale gas market (which only requires co-ordination of the dispatch of gas when imbalances occur). This role has analogies with the central powers of the stock exchange.

VENCorp has been established on an international model, called the independent system operator (ISO) model.


TPA, and the other service providers, own, operate and maintain their assets and use them to make sales (taxable income).

TPA is entirely responsible for its investment, the only function relevant to its investment over which it has little control is the safety and security aspect regarding the flows/pressure of gas through the pipelines, which is the responsibility of VENCorp on a system wide basis. Further, when VENCorp intervenes, it typically does so through the service providers ie. VENCorp does not have its own field staff to close off valves etc on TPA pipeline assets.

Regrettably, it would seem that the ATO struggled with the following points:

1. Why VENCorp’s functions cannot be assigned to TPA – VENCorp has to be independent of all market participants for conflict of interest reasons (and to further competition, and prevent possible abuse of privilege).

2. That VENCorp is neither the real end user, nor in control of TPA’s assets – TPA uses its assets to generate taxable income. The broadness of the Section 51AD definition of lease, potentially assigns the label "end-user" to VENCorp. In substance, VENCorp’s prime activity is system monitoring, not asset use. VENCorp is strictly a cost recovery operation.

VENCorp is in control as much as any regulator is, but the control is for system security purposes and intervention is for safety and continuity of supply purposes not for income control/guarantee purposes. That is, the form of control by VENCorp should be distinguishable from the type of control that ordinarily triggers the application of Section 51AD. VENCorp’s interventionist role is for public purposes and not in any way driven by tax transfers.

After intensive negotiations throughout most of calendar 1998, eventually the ATO issued a positive Advance Opinion on the Section 51AD status of TPA (23 November 1998). In summary, the experience of the Victorian energy sector is that an industry configuration proven overseas as the most efficient and competitively neutral can be problematical in Australia because of out-dated tax law. Reform of the existing provisions must achieve appropriate protection of the Commonwealth tax base in a way that removes the practical problems illustrated, which have been the hallmark of the existing provisions.

3. Policy Issues

Section 51AD (leveraged finance), and the more recent Division 16D (non-leveraged finance), arose in response to creative financing arrangements where goods and services provided by private sector parties (taxpayers) substituted for traditional borrowing (semi-government loan program) to fund Government controlled provision of services at a cost subsidised by considerable tax benefit transfer. In many cases, the bulk of the project risk remained with the always exempt person, and actual utility services continued to be (physically) provided by the Government.

Private sector provision of essential goods and services in the modern era is driven by different imperatives. A combination of factors such as the "tax revolt"; the preference for smaller and open Government; the desire to reduce Government liabilities, guarantees, and risk exposures; the substitution of demand driven outcomes for centrally planned/managed resource allocation etc all contribute to the involvement of the private sector in direct service provision.

In other words, today’s arrangements recognise that markets can be established for many goods/services and that competition benefits consumers.

In privatised industries, the residual role of the Victorian Government depends somewhat on the industry in question, but the extent of on-going involvement should not trigger use and control concerns with Section 51AD/Division 16D. In the energy sector, the State retains a regulatory role, and intervenes (as required) for safety and security purposes, and to facilitate market outcomes, such as matching suppliers’ volumes to users’ needs, so as to ensure a balanced system (the wholesale spot market role).

In transport, the Government’s main residual functions (post rail and tram privatisations) will be monitoring and contract management. The new operators will carry the business risks. In forestry, the Victorian Government has ceased to have any significant role over Victorian Plantation Corporation assets and operations, following privatisation in late 1998, other than the application of State laws and industry wide policies eg the Victorian code of forestry practice.

The present leasing provisions are not consistent with the pursuit of higher order objectives such as attracting overseas capital; introducing private sector management techniques; directly reducing Government debt and also reducing the contingent liabilities on State Budgets for service delivery etc. DTF’s experience is that private sector provision benefits consumers of services, both business and domestic, thus generating national economic benefits. Given the Victorian model of industry re-structuring prior to privatisation, out-sourcing etc, sufficient competition is introduced to ensure that the benefits are sustainable. In fact, the use of market mechanisms allows Government intervention to be minimised (light handed regulation).

Since 1992, the Victorian Government has actively encouraged private sector participation in the development of public infrastructure and the provision of services. The objective has been to deliver public services on a cost effective basis, whilst transferring the ownership and management risks to the private sector. Victoria is acknowledged as being at the forefront of risk transfer to the private sector in contract transactions of this type. Section 51AD/ Division 16D need to be replaced in order to accommodate efficiency driven public sector reforms which ultimately expand the Commonwealth tax base.

4. Go Forward

Appendix C to Chapter 9 of "A Platform for Consultation" outlines a number of options for reforming Section 51AD/Division 16D. (Clause C 3).

In considering these options, DTF would reiterate the objectives described above:

As part of national tax reform, Section 51AD and Division 16D ought be repealed as soon as possible;

The new/replacement provisions must be structured from a transparent policy platform and drafted so as to greatly improve certainty of application, avoiding the extreme administrative difficulties that have plagued the current "use" and "control" tests. The compliance exercise must cease to be an end in itself; and

Facilitating a legislative scheme that gives due recognition to higher order goals and can more readily be adapted to meet the agreed objectives of the Commonwealth of Australia from time to time.

It is necessarily implicit in these objectives that reform of the existing tax law does not entail any extension of the provisions so as to apply to arrangements that have in the past been accepted as not being subject to Section 51AD/Division 16D (where "control" has not been apparent). In other words, any replacement provisions must not apply to existing arrangements that have been accepted by the ATO as not being subject to the existing provisions. Nor ought any future arrangements of a similar nature to those accepted as not being subject to Section 51AD/Division 16D become subject to the replacement provisions. It is submitted that any other approach would be regressive and contrary to economic reform objectives (unless it can be defended in terms of demonstrable adverse consequences for the Commonwealth tax base).

4.1 Consideration of the Options

First Option

DTF agrees that the first option proposed in clause C 3 of Appendix C to Chapter 9 of "A Platform for Consultation" is not to be preferred, for the reasons canvassed in the Appendix. It would likely result in no better a situation for the Commonwealth, the ATO, the States, the private sector and any other interested parties than is currently the case.

Second Option

The second option has considerable appeal provided it is faithful to the concept of ownership (equity risk).

A majority economic interest in assets test is on the face of it simple, clear and unlikely to be susceptible to uncertainty as is the "effective control" test. This approach has the potential to avoid definitional problems in attempting to define the scope of application of the replacement provisions, as between say leases of various types and various forms of service arrangements.

Whilst the principle is clear, the specification of the actual legislative tests may still be a challenging exercise. This submission will further consider how the majority interest might be determined (part 4.2).

Third Option

DTF does not support the third option as it would significantly broaden the scope of the existing provisions to embrace all service contracts, as Appendix C acknowledges. As submitted earlier, the existing provisions have been found in practice to be very difficult to administer in their current form, creating great uncertainty and adverse consequences for project sponsors whose arrangements may involve no material tax preference transfer (evident or intended). Economic efficiency objectives would be subjugated to short run Commonwealth revenue considerations. Administrative difficulties and costs would increase exponentially and inhibit economic activity to the detriment of the community overall. There would not seem to be any justification for examining this option further.

Fourth Option

It is submitted that the fourth option would involve a degree of complexity and potential for disputation that is not warranted. It would suffer from much the same objections listed for the third option above. By potentially "catching" projects that may gain clearance under the existing provisions, option four is a backward step and could not be legitimately described as "reform". Further consideration is not warranted.

4.2 The Second Option Preferred

As noted above, DTF considers the second option – majority interest - has considerable appeal (provided that it is based entirely on ownership criteria). The considerations which might be set to determine "majority interest" in assets could include tests such as those that were discussed in the course of RBT Focus Group meetings between Treasury Department and Tax officers in March/April 1999

The proposal dealt with in the Focus Group meetings starts from the perspective that any legal owner is entitled to depreciate his wasting assets committed to a business activity. It then progressively reduces this opportunity by a series of prohibitions (eg the asset is subject to hire purchase), followed by the application of project/asset risk criteria to test whether the requisite degree of equity has been retained by the legal owner (thus preserving his right to capital deductions). The specific tests outlined considered matters such as who bears the capital and operating expenditure; project cessation costs; market entry/exit obligations; the cost of service interruptions; responsibility for securing all productive inputs (and statutory permissions, licences etc).

It would seem appropriate to distil those tests into a precise form and enshrine them in a legislative form through an appropriate consultative process, in which DTF would like to be involved and share our project experiences. There would need to be testing of the criteria against pre-existing benchmarks to ensure no unintended consequences.

If tests were to be adopted which were other than precise factual attributes of a particular transaction, it probably would not be appropriate for the ATO to be responsible for the administration of the process. (The Development Allowance Authority model). Rather, that would seem to best be the responsibility of the Commonwealth Treasury, or some appropriate body properly qualified and accredited to determine the matter, but only insofar as the cost to revenue, valuation and national interest considerations were involved. Otherwise, the tests should be simply a matter of law, to be administered by the ATO

5. Commonwealth Revenue

One factor that the Ralph Report continually points to in Chapter 9 is cost to Commonwealth revenue of any relaxation of the leasing provisions. The commentary provided is a one dimensional test that compares the Commonwealth taxes that would, but for the tax preference transfer in mind, be collected in a particular year. In its simplest and most precise form, it is the tax projections for a particular transaction (involving a tax preference transfer) on a stand-alone basis. The ATO requires these as part of its administration of leveraged leasing and similar arrangements – see Tax Ruling IT2051 at paragraph 4. It is submitted that this single dimensional costing should be tempered with other benefits to Commonwealth revenue that are directly attributable to the particular transaction in mind. For instance, any major infrastructure project that may not generate Commonwealth income tax in its early years (even without accelerated depreciation) may still produce very substantial tax revenues for the Commonwealth in terms of:

  • sales tax/GST on goods/services for the project
  • PAYE tax on employment income of those engaged in the construction process and in operations of the facilities following completion;

  • tax on consultant’s/contractor’s profits engaged in the project;

  • tax on manufacturer’s/supplier’s profits that supply goods, to the project;
  • tax on financier’s income from the project, including while the project is itself unprofitable;withholding taxes on foreign capital invested in the project.

This is not, and is not intended to be, a comprehensive list, but it does illustrate that a more balanced approach may be in the interests of the Commonwealth itself, and it should be noted that the above tax revenues are those directly generated by the project under consideration. When consideration is also given to the efficiency benefits of a major project ie its contribution to micro-economic reform, the Commonwealth tax base looks even better placed. For example, the productivity gain from a privatised electricity sector exceeds that achieved by "equivalent" public sector systems. Competition ensures that the benefits are passed on to other businesses (consumers). They in turn expand production, improving GDP.

Based on the Victorian model, the other major contribution from a privatisation of electricity is the net increase in investment funds committed to income generating assets (net influx of foreign capital).

6. Fast Tracking

It occurs to DTF that there may be merit in providing enlarged discretionary powers, but linking these to national development goals, so as to allow more favourable treatment for major value-adding, pro-competitive projects ( such as essential services provided through national markets (eg big plays in electricity); major tollways, Olympics/Commonwealth Games etc).

The conclusion is that there is a case for a (selective) by-pass of the leasing provisions. The Federal Treasurer could be empowered, via regulations, to consult with a sponsor State/Territory to consider whether nominated projects are in the national interest and should be fast tracked. A pre-condition for consideration would still require private ownership risks. Also, only project designs/concepts that were judged to meet community needs in an economically efficient way would be eligible. (Tax subsidies are not being advocated).

7. Conclusion

DTF is supportive of detailed consultation with the Commonwealth and the other States with a view to developing a set of objective "majority interest" in assets criteria which rely on the outline provided in section 4.2. The new provisions ought not raise the thresholds any higher than has been the case in the past.

DTF is encouraged by the recognition in "A Platform for Consultation" of the need for reform of Section 51AD and Division 16D. It has offered the foregoing submission in a genuine attempt to make a positive contribution to the reform process based on its past experiences and positive expectations for the future in this regard.