|Submission No. 19||Back to full list of submissions|
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24 December 1998
Electricity Supply Association of Australia Limited (ESAA)
Submission on the Review of Business Taxation - A Strong Foundation Discussion Paper
The Electricity Supply Association of Australia Limited (ESAA) represents a wide range of participants in the electricity industry, ranging from electricity generators and distributors/transmission entities through to electricity retailers. Our membership includes Government business enterprises and privatised enterprises.
The Association supports the business tax reform process and the need to develop an equitable and efficient tax system that will enhance the growth and performance of the Australian economy. We commend the Review on the objectives and policy initiatives outlined in its discussion paper entitled ‘A Strong Foundation’ ("the paper").
The paper develops a strong policy framework for the design of a new business tax system to achieve the core national objectives of optimising economic growth, ensuring equity and facilitating simplicity. These objectives are desirable and the manner in which they are to be achieved is of paramount importance to the Association and its members.
The Association welcomes the opportunity to participate in the reform process and the purpose of this letter is to comment on behalf of our members on four issues raised in the paper, being:
1. the possibility of aligning taxable income with accounting profit
2. the provision of tax incentives
3. the possibility of taxing income on a comprehensive basis
4. the tax treatment of ‘black hole’ expenditure.
1. Alignment of taxable income with accounting profit
The Association understands the Review will be consulting on the potential use of accounting principles for tax purposes as one of the issues to be raised in its second discussion paper. We set out below our initial response to this issue and look forward to the opportunity of providing a more detailed response following the release of the second discussion paper.
As recognised in the paper, differences between taxable income and accounting profits are largely attributable, under the current regime, to "timing differences" between income and expense recognition.
As you will be aware, timing differences do not give rise to any actual tax leakage from the tax system over time. Therefore, whilst there may be benefits in taxing accounting profit over taxable income, these benefits should be weighed up against the resulting costs to the economy in terms of foregone/deferred investment associated with the elimination of accelerated tax depreciation rates. In our view, economic policy objectives (as outlined above) should override basic tax design aimed at achieving tax simplicity and reducing compliance costs.
Accelerated Rates of Depreciation
Accelerated rates of depreciation for tax purposes give rise to timing differences. There were clear policy objectives for departing from accounting rates for tax purposes. More specifically, accelerated depreciation rates were legislated to stimulate growth in the economy. This economic objective has not changed. It is consistent with the national objectives and is even more important today as we move further into a globalised market.
If tax on accounting profits is adopted with the consequential removal of tax concessions such as accelerated depreciation, investors will inevitably look to other jurisdictions to make their investments (ie other countries which offer tax concessions, the benefit of which cannot be obtained in Australia). This clearly runs counter to the objective of improving the competitiveness and efficiency of Australian business and competitiveness of the Australian economy.
The issue of accelerated tax depreciation is of particular concern for members of the electricity industry and other infrastructure type enterprises which have invested heavily in capital assets. The removal of accelerated rates is counter to stimulating economic growth and will result in
- a substantial decline in new asset investment
- a deferral of necessary investment
- existing technology will be used for longer, increasing the potential for functional
failures (similar to the recent power failure in Auckland) and
- any investment that is undertaken will inevitably be on a smaller scale thereby making
a less than maximum contribution to GDP.
The removal of accelerated depreciation rates, the alignment of taxable income with accounting profit or indeed any fundamental change in the tax system will have a significant impact on the valuation of underlying businesses. This is no more apparent than in the instance of the privatisation of utilities which have already been impacted by the proposed enactment of Division 58 as contained in Taxation Laws Amendment Bill (No 4)
1998. Accordingly, any review which sought to dramatically redefine the tax base must consider in detail these important transitional issues.
2. Provision of Tax Incentives
The electricity industry in Australia has historically been public sector dominated. In many cases, social imperatives associated with matters such as infrastructure development have taken precedence over financial and economic imperatives.
Whilst it is important to have improved, more rigorous, processes for proposing, implementing and evaluating the efficacy of tax preferences, the social objectives for continuous development of the Australian economy should not be ignored in that process. Care must be taken to ensure that certain tax incentives (eg R&D, infrastructure borrowing concessions, accelerated tax depreciation rates) are not abolished so as to render infrastructure investment decisions less economically viable.
The Review proposes that business tax incentives should be provided only following a formal assessment of their net impact on the national taxation objectives, and only where assessed to be an essential or superior form of government intervention. In making that assessment, taxation objectives should not be considered in isolation, but should be balanced against social objectives, the latter considerations often being instrumental in ultimately promoting economic growth, particularly for business involved in infrastructure development.
3. Taxation of Comprehensive Income
In the Association’s opinion, a fully implemented comprehensive income tax regime will be unworkable. As the paper recognises, the business income tax system entails a number of important departures from comprehensive income taxation. If comprehensive income tax were to be adopted as the basis for taxation, the legislation would be fraught with provisions implemented to deal with these departures and over time, we are likely to witness the surgence of ad hoc provisions perpetuating the situation which has led to the complexity of our current system.
Whilst measuring income comprehensively has equity benefits in taxing all forms of income comparably, there are obvious practical difficulties under this model. Aside from those mentioned in the paper, the adoption of a comprehensive income tax will give rise to increased compliance costs and cash flow problems for most businesses.
The taxation of comprehensive income (whether on a nominal or real basis) necessitates the calculation of unrealised movements in underlying assets. This will require businesses to continually obtain asset valuations purely for taxation purposes. This increased administrative and financial cost runs counter to the dual aims of reducing the compliance cost of taxation and improving simplicity. For asset-laden businesses such as those carried on by our members, this continual valuation exercise is impractical, will not add value and is an inefficient allocation of resources.
Cash Flow Implications
The taxation of unrealised gains will give rise to cash flow problems for many businesses. Most of our members will simply not have sufficient cash flow to fund the tax payable on gains which have not been realised. Funding tax payable on unrealised gains (either through debt financing or conversion of investments into cash) leads to an inefficient allocation of resources. This result discourages investment and is in direct conflict with the national objective for economic growth.
4. ‘Black Hole’ Expenditure
We agree that so-called ‘black hole’ expenditure must be reviewed in light of the national objectives for the redesign of business taxation. Genuine business expenses which are not deductible under current policy and law is inherently inequitable and is inconsistent with the principles of investment neutrality and risk neutrality proposed as fundamental policy design principles.
The electricity industry is very sensitive to ‘black hole’ expenditure. Of particular concern to our members is the non-deductible nature of easement expenditure (ie payments made for easements over land for the erection of electricity lines). Under the current system, the expenditure is neither deductible outright, deductible over time, nor, in certain circumstances, eligible for "relief" on sale as part of an asset’s capital gains tax ("CGT") cost base, even though the gains produced by the expenditure are brought to account by the business income tax system.
Easement payments are an unavoidable and genuine business expense for some of our members. Unless there are strong policy reasons for disallowing a deduction for easement expenditure, we believe that these costs should either be deductible in full or included in a business’ capital base for CGT purposes.
Similar "black hole" issues arise in respect of certain franchise (licence) fees, and feasibility and related "preliminary" outgoings that are large business costs for the electricity industry. The ESAA will be making a more detailed submission in relation to these issues in due course.
Transitional impacts will need to be considered in detail in any proposal to change such fundamental aspects of the tax system as the definition of the tax base and the move towards substance over form. As regards the latter, a substance over legal form approach will be diametrically opposed to our current legal system and could potentially fail to recognise significant commercial differences which different entity structures offer (eg limited liability, etc). In addition a substance over form approach can take away a key design ingredient to a good tax system that the law must be clear, certain and consistent. A substance over form approach left unchecked can undermine the system by introducing uncertainty.
We note that the treatment of depreciable assets, the taxation of financial arrangements, transitional provisions and international taxation implications will be considered as part of the overall design of a new tax base. These issues are important to the Association and its members and we look forward to the opportunity to provide more detailed correspondence and submissions following the release of the Ralph Committee’s second discussion paper.
For communications in respect of this submission, please contact
Phone: (61 2) 9233 7222
Acting Chief Executive Officer