Submissions
 
Submission No. 52 Back to full list of submissions
Download in either PDF or RTF format

 

Review of Business Taxation

Submission by

The Australian Council for Infrastructure Development

December 1998

REVIEW OF BUSINESS TAXATION

Taxation Impacts on Infrastructure Investment

EXECUTIVE SUMMARY

There has been a paradigm shift this decade towards greater private provision of public infrastructure. Australia’s tax system is, however, inclined more towards public ownership and funding of infrastructure. AusCID estimates that over $70 billion of Australian infrastructure is now in private ownership, with a total national infrastructure base of some $500 billion. The latter figure is about the same as Australia’s GDP and the value of listed equities on the ASX.

Infrastructure is often different from other business investment because of project size and complexity, long payback periods and provision of parallel social and environmental benefits, the value of which is often not adequately captured.

These attributes are inadequately acknowledged by the present tax system, necessitating an increasingly complex and frustrating array of incentives and rulings to combat the absence of neutrality and, so far, an unwillingness to simplify and modernise in recognition of this new era of private infrastructure investment.

AusCID submits that successful and sustained private investment in Australia’s future infrastructure will require the following characteristics in a new business tax system:

  • Greater neutrality;
  • Modernisation of provisions such as Section 51AD which belong to another era;
  • Commercially realistic and consistent depreciation regimes;
  • Early resolution of policy in relation to interest deductability during construction;
  • Reduced need for private rulings and more prompt outcomes where they are required;
  • Design of incentives with increased robustness, consistency and operability;
  • Sufficient simplification to reduce considerably legislation by press release;
  • Effective policy, legislative and administrative consultation with investors.

REVIEW OF BUSINESS TAXATION

Taxation Impacts on Infrastructure Investment

Background

The Australian Council for Infrastructure Development (AusCID) is the principal industry association representing the interests of companies and organisations owning, operating, building, financing, designing and otherwise providing advisory services to private investment in Australian public infrastructure.

The Council was formed in 1993 and currently has nearly 60 members, of whom 18 are Full Members (directly or indirectly own equity in Australian infrastructure) and 35 are Associate Members (support private infrastructure development). Many of AusCID’s members (list attached) are also members of other peak business associations and through these organisations will direct broader comments about the need for a more relevant Australian taxation system.

What is Infrastructure?

In using the term ‘infrastructure’, AusCID means economic or ‘hard’ infrastructure, which comprises the structures and facilities which provide for transport networks, power generation and distribution, water collection, treatment and reticulation and telecommunications; and social or ‘soft’ infrastructure which includes facilities catering for education, health , housing, aged care, sport and recreation and law and order.

The principle characteristics of infrastructure facilities are:

  • High initial capital cost and early negative returns;
  • Significant construction effort and duration;
  • Long lives;
  • Support for the economic, social and environmental fabric of society, not merely as an end in themselves.

Infrastructure is Different

In this submission, AusCID addresses only aspects of the current tax system and related comments made in the RBT discussion paper A Strong Foundation which, in its view, impact directly on private sector investment in Australian public infrastructure. Infrastructure is often different from other business investment because of project size and complexity, long payback periods and provision of parallel social and environmental benefits, the value of which is often not adequately captured.

A Paradigm Shift

Until the late 1980’s most of Australia’s public infrastructure was owned and funded by governments, principally State governments. Since then a series of privately funded and owned greenfield projects emerged in various sectors - water, roads, pipelines. Post-competition reform in the early 1990’s, they were joined by airports, telcos, power generation, transmission and distribution, rail and ports, as state-owned assets were sold to the private sector. Along the way, several privately funded public hospitals were constructed as were a number of private prisons.

AusCID estimates that over $70 billion of Australian infrastructure is in private ownership, with a total national infrastructure base of some $500 billion. The latter figure is about the same as Australia’s GDP and the value of listed equities on the ASX.

Australia can ill-afford to treat infrastructure as a policy orphan. Apart from competition policy, public policy development in support of sustained private infrastructure investment has unfortunately lagged. The market alone cannot deliver all the answers. The lack of a Commonwealth policy perspective is reflected in the ad hoc nature of tax policy as it relates to infrastructure investment. Issues have been approached on a case by case basis and, in the absence of a strategic framework, this often results in unreasonable delay and inconsistent outcomes. These outcomes are reflected not only in higher transaction costs but also in sub-optimal national economic growth and job creation.

AusCID asserts that most if not all of the project areas referred to above suffered the effects of a tax system favouring public ownership and funding of infrastructure. The impacts varied from unnecessary and costly delays, adverse rulings, depreciation and tax loss regimes unsympathetic to the characteristics of infrastructure as outlined above, to uncertainty, unpredictability and lack of transparency in policy formation, legislative action and administration. These impacts blunted many of the efficiency advantages offered by the private sector in the first instance.

Infrastructure Taxation Needs

AusCID submits that successful and sustained private investment in Australia’s future infrastructure will require the following characteristics in a new business tax system:

  • Greater neutrality;
  • Modernisation of provisions such as Section 51AD which belong to another era;
  • Commercially realistic and consistent depreciation regimes;
  • Early resolution of policy in relation to interest deductability during construction;
  • Reduced need for private rulings and more prompt outcomes where they are required;
  • Design of incentives with increased robustness, consistency and operability;
  • Sufficient simplification to reduce considerably legislation by press release;
  • Effective policy, legislative and administrative consultation with investors.

A Strong Foundation

In addressing selected aspects of the RBT Discussion Paper, AusCID seeks recognition of the importance of suitably neutral treatment for infrastructure investments within a revised tax system. In this paper it touches on relevant issues only in passing and will revert in more detail in response to the RBT’s second discussion paper.

EPAC in 1995 noted reduced public investment in Australian infrastructure since the early 1960’s from about 10 per cent of GDP to 5 per cent. The reduction continues and average infrastructure age increases. While EPAC found this measurement "unlikely to be a good or a reliable indicator of the adequacy of infrastructure", it does signal the need for closer scrutiny, perhaps on a sectoral basis. There are clear signs that aspects of Australia’s infrastructure now suffer from under-investment.

Transport congestion in Sydney and Melbourne, closing supply/demand curves for electricity in Queensland and Victoria, water and gas supply problems elsewhere point to this. Increasingly the private sector, not governments, will be required to make good the shortfall given the pressures on the public purse and the demonstrated efficiencies of using private finance and project delivery. To do so successfully, against more competitive investment opportunities elsewhere, the private sector must look to a more attractive tax system than currently prevails.

A Design Framework: the National Objectives

AusCID strongly supports allocating high weighting to optimising economic growth. Aspects of the present tax system result in sub-optimal infrastructure investment, not only due to delays resulting from administrative requirements and undue complexity necessitating private rulings, but also through imperfect markets leading to inadequate information levels and distortions embedded in a tax system geared for public provision of public infrastructure. The desired growth outcome is, however, less likely if equity and simplification are not also achieved in sufficient measure.

The economic jury remains undecided on the "new growth" spillovers created by investment in public infrastructure. US data suggests, however, that those states which invested more in infrastructure tended to have greater output, more private investment and more employment growth.

Though capital intensive and not a great employment generator itself beyond the construction phase, upgraded infrastructure provides a catalyst for trickle-down effects in the economy, either via greater efficiencies and reduced input costs or through provision of new services where previously none existed.

Accelerated infrastructure investment in Australia over the next few years would assist in cushioning the non-dwelling construction downturn anticipated post-2000 as well as further insulating this economy from the effects of Asian economic instability. A suitably responsive tax system is required to make this a reality.

Further, with the successful entrenchment of competition reform, many businesses which were previously protected public monopolies must now operate within competitive markets. This new era poses commercial risks which private investors are better placed to bear than taxpayers. A relevant tax system for this new era must not stifle incremental investment in infrastructure.

Neutrality

AusCID’s desire for greater neutrality seems to be reflected in the RBT’s term horizontal equity.

AusCID places considerable importance on achieving enhanced neutrality in the tax treatment of investment in Australian infrastructure. This neutrality is sought in two dimensions; first, as to infrastructure investment vis a vis other types of investment, and, secondly, as to Australian investment in Australian infrastructure assets vis a vis foreign investment in these assets.

Greater neutrality for tax treatment of private infrastructure investment may reduce the need for incentives to deal with specific characteristics of infrastructure, set out below, not handled well by the present tax system. It could also assist in prompting the private sector to play a greater role in regional infrastructure provision which currently suffers from lack of critical mass, high transaction costs and limited exit opportunities for medium-term investors. AusCID does not suggest, however, that enhanced neutrality will eliminate the need for tax-based incentives to optimise infrastructure investment.

An intriguing attack on this objective of horizontal equity is currently the subject of policy consideration by the Government. This attack - on depreciation available upon the use of limited recourse debt - was initiated by press release and now, some 10 months later, legislation to validate the policy change in the press release still has not been finalised.

In the meantime many commercial activities involving refinancing of existing limited recourse debt have been suspended pending resolution of the matter. This delay now implies considerable retrospectivity.

In Division 243 of original Tax Law Amendment Bill No. 4 (1998), the Government sought to introduce depreciation clawback measures where was refinanced. It also expanded the definition of limited recourse debt in a way which would capture financing methods used increasingly by common smaller businesses such as farms, retail outlets and the tourism sector.

Exchanges between AusCID and the Government have clarified that the Government seems committed to the view that the availability of capital allowances in project financing should henceforth be linked to the risk exposure associated with the borrowing. Thus, by definition, limited recourse debt is deemed to be less risky to the borrower because it is secured only against project assets and cash flows and is not linked to the borrower’s balance sheet.

Infrastructure and resource developers are thus facing a future where neutrality in relation to sources of capital will suffer in favour of a risk-based approach which will favour equity and corporate debt as the preferred sources of development capital.

As much of Australia’s private investment in infrastructure, its petroleum and mineral resource sectors and, increasingly, its tourism developments use limited recourse debt as the basis for their project finance, the commercial damage which will ensue should this policy be imposed cannot be overstated.

AusCID’s submission to the Senate Economics Legislation Committee and related correspondence to the Government on this matter is submitted at Appendix A.

Neutrality is also absent where infrastructure concessions run for less time than is allowed for depreciation of the underlying asset. Thus a Build Own Operate Transfer (BOOT) project may involve a concession of, say, 25 or 30 years whereas the underlying asset is depreciated over 40 years. Introduction of appropriate neutrality principles for infrastructure investment suggests that depreciation should run in parallel with the concession period.

To quote EPAC, "In summary, while neutrality is a useful concept, it does not obviate the need to assess whether projects benefit the overall community, taking all costs and benefits into account."

Simplification and Modernisation

Simplification and modernisation should deliver reduced administrative delay and need for private rulings. Under the present arrangements, a prime example of complexity and unnecessary administrative imposition is imposed by Section 51AD which exists to prevent State governments obtaining infrastructure and equipment benefits at the expense of Commonwealth tax revenues.

AusCID, at the invitation of the Assistant Treasurer, recently submitted its suggestions for reform of S.51AD, which retain its policy intent while also reducing cost, delay and complexity to the private sector. A copy of that submission is at Appendix B. It is AusCID’s view that the inefficiencies imposed by S.51AD can be remedied now and do not need to await the outcome of the RBT.

The objective of simplification also appears at risk in the current provisions for Division 58 in Tax Law Amendment Bill No. 4 (1998). This has been introduced by the Government to clarify arrangements relating to the depreciation of formerly tax-exempt assets (for example, power stations). AusCID has pressed for use of a "tainting" approach while the Government is intent on use of a "balancing charge" approach. The Government’s approach, while valid, is seen by industry as overly theoretical and ignorant of the realities of the market, not to mention the time cost of money. AusCID’s most recent views on D.58 are also addressed in its letter to the Assistant Treasurer at Appendix C as well as in the submission at Appendix A.

Rulings are a major aggravation to infrastructure investors, particularly the inordinate time taken to issue many of them. While simplification and modernisation may reduce the need for rulings, those that are required will need to be made available in a more timely way.

A related issue, in that it provokes a considerable need for rulings, has been the question of interest deductability during construction. This remains shrouded in uncertainty and should be remedied soonest. Although Steele’s case invoked the issue, AusCID submits that most infrastructure projects are not property developments (as was the investment underlying Steele’s) and the length of construction and already high capital costs of infrastructure warrant relief through deductibility of interest as incurred.

In short, private investment in infrastructure suffers from the absence of greater neutrality within the tax system in comparison with other investment opportunities, for example, mining.

Incentives

This absence of neutrality increases industry pressure for incentives to counteract the biases against infrastructure investment exerted by the present tax system.

Inadequate design of, for example, the original Infrastructure Borrowings scheme, led to hurried changes and then withdrawal within only a few years of their introduction, an example of the difficulties and inconsistencies inherent in the present system.

The replacement incentive arrangements, the Infrastructure Borrowings Tax Offset scheme, has already been the subject of several adverse draft rulings, such that AusCID doubts whether the Government sincerely wants such infrastructure incentive schemes to work. Certainly there appears to be a lack of robustness in the incentives offered so far to infrastructure investors and no durability or sustainability.

More effective consultation with users could be a useful starting point from which defects may be remedied through cooperative engagement between policy and legislative designers and users.

The Supporting Principles

In relation to policy design principles, AusCID’s views on investment neutrality and risk neutrality are summarised above.

As to balanced taxation of international investment, AusCID notes that, under current arrangements, foreign bidders for Australian infrastructure assets frequently enjoy depreciation benefits in their home tax jurisdiction which they can leverage into higher bids than their Australian competitors can muster. A competitive tax system should operate to ensure neutrality between all bidders in these circumstances.

AusCID agrees with the statement on provision of tax incentives. As stated above, appropriate operation of neutrality principles should minimise the need for incentives, However, where they are required, the net impact referred to in the discussion paper needs to reflect the costs and benefits over life of the project, not just costs to the first few years of Commonwealth revenues after project commencement.

It is difficult to understand why some of the legislative design principles cannot be implemented under present arrangements. AusCID has struggled to convince the Government that the nature of infrastructure investment and the complexities of the present system call for a cooperative approach between government and the private sector for both policy development and for legislative design. To date consultation consists of generalised correspondence and discussion, with little attention to detail which appears to be solely a responsibility of officials..

AusCID therefore strongly supports the concept of an advisory board with specialist consultative committees or task forces which would make use of industry expertise. Additionally, all taxation legislation would benefit, with appropriate confidentiality arrangements and before tabling, from an impact statement from the principal industry group(s) likely to be affected.

Conclusion

Infrastructure is such a fundamental building block for national economic performance that tax-based impediments or disincentives to new investment are a wasteful impost. Infrastructure investments have particular characteristics deserving of careful design and treatment in a new tax system if sustainable private funding is to be attracted to this relatively new investment class.

Essential tax design features, currently insufficiently available to Australian infrastructure investors include:

  • Neutrality among investment classes, in relation to depreciation and between domestic and foreign bidders in existing government asset sales;
  • Recognition of demanding infrastructure investment characteristics through acceptance of deductability of interest as incurred during construction;
  • Greater and more detailed consultation between private and public sectors in relation to policy, legislative design and administration to improve legislative quality, consistency and durability;
  • Increased simplification to reduce need for rulings and to ease administration;
  • Where incentives are introduced, ensure adoption of a ‘whole of project’ perspective in place of a shorter-term ‘loss to revenue’ perspective;
  • Immediate elimination of unnecessary administration, cost, delay and complexity by modernisation of provisions such as S.51AD reducing the need for rulings.

References:

  1. Public Accounts Committee, (1993), Infrastructure Management and Financing in New South Wales, Parliament of New South Wales.
  2. Economic Planning Advisory Commission, (1995), Private Infrastructure Task Force, AGPS.

MEMBERSHIP LIST

FULL MEMBERS

Abigroup Limited

AMP Asset Management Australia

Australian Gas Light Company

Baulderstone Hornibrook Engineering Pty Ltd

Commonwealth Bank of Australia

Edison Mission Energy Holdings Pty Ltd

Hastings Funds Management Pty Ltd

Infrastructure Trust of Australia Group

Infratil Australia Ltd

Leighton Holdings Limited

Lend Lease Infrastructure Pty Ltd

Morgan Grenfell (Australia) Limited

National Australia Bank Ltd

NRG Asia-Pacific Ltd

Statewide Roads Ltd

The Hills Motorway Ltd

Transfield Pty Limited

Transurban City Link

ASSOCIATE MEMBERS

Allen, Allen & Hemsley

Alstom

Arthur Andersen & Co

Australia Pacific Airports Corporation Ltd

Bovis Australia Pty Ltd

Brisbane Airport Corporation Ltd

Clayton Utz

Concrete Constructions Group Ltd

Corrs Chambers Westgarth

Deacons Graham & James

Deloitte Touche Tohmatsu

Deutsche Bank A.G.

Dresdner Kleinwort Benson

Dunhill Madden Butler, Solicitors

Evans & Peck Management

Freehill Hollingdale & Page

Hyder Consulting Pty Ltd

Kinhill Pty Ltd

KPMG Corporate Finance

MacMahon Contractors Pty Ltd

Macquarie Corporate Finance Ltd

Mallesons Stephen Jaques

Matrix Group Ltd

Merrill Lynch (Australia) Pty Ltd

National Australia Asset Management Ltd.

Ove Arup & Partners

Pacific Hydro Ltd

Philips Projects Group

Phillips Fox

PricewaterhouseCoopers Pty Ltd

Serco Asia Pacific Pty Ltd

Société Générale Australia Ltd

Warburg Dillon Read (Australia) Holdings P/L

Westralia Airports Corporation Pty Ltd

PERSONAL

INVITED

Infrastructure Advisers Pty Ltd

NLS Consulting Pty Ltd

Rail Services of Australia

Ecogen Energy

RBT Appendix A

Taxation Laws Amendment Bill (No. 4) 1998

Senate of Australia

Economics Legislation Committee

Submission

by

The Australian Council for Infrastructure Development Ltd

10 June 1998

Taxation Laws Amendment Bill (No. 4) 1998

Submission to Senate of Australia

Economics Legislation Committee

 

Executive Summary

Established in 1993, the Australian Council for Infrastructure Development (AusCID) is the principal association representing organisations involved in private sector development of public infrastructure.

AusCID membership currently comprises 13 Full and 29 Associate Members ranging from major Australian organisations such as National Australia Bank, Lend Lease, Commonwealth Bank, AMP and Transfield to professional firms and smaller engineering consultancies. Membership details and background information is contained in Attachment A.

AusCID makes the following points in support of changes to a number of the provisions contained in the Bill:

Schedule 1 - Sales Tax (Exemption and Classification) Act 1992

  • Under the Bill, the S192 exemption applies only if the land on which the construction takes place is actually occupied by a tax-exempt body or by someone providing a service to a tax-exempt body. This raises broad and potentially unforeseen consequences due to the interpretation of the expression "occupied" in relation to an exempt body. It is the view of AusCID members that private developers building and running a commercial project on leased Crown land will therefore no longer qualify. Private infrastructure projects currently under construction, including roads, rail, energy projects and sporting complexes (including Olympic facilities) may be affected.
  • At the very least, projects that have commenced under a given set of rules should be entitled to complete under the same set of rules.

Division 58 - Depreciation of Plant previously owned by an exempt entity

  • New depreciation regime affecting the on selling of assets acquired from tax exempt entities. AusCID members, representing private sector owners of newly privatised Australian infrastructure assets, understood earlier announcements by the Treasurer to mean that the depreciation available to a later purchaser of a privatised asset would be based upon the notional tax written down value of the asset in the hands of the exempt entity, rather than the price paid by the original purchaser.
  • The Bill provides for the claw back of depreciation based on the actual price paid by the first purchaser rather than being based on the original amount which the first purchaser was entitled to use for depreciation purposes. This could be a financially ruinous outcome with the practical result that any asset purchased from an exempt entity cannot be onsold.
  • AusCID members consider it to be more sensible and pragmatic to ensure that the low depreciation cost base is passed to the second purchaser rather than try to bankrupt the original purchaser as the Bill would do.

Division 243 - 15(3)(b) - Termination of limited recourse debt arrangements

  • Claws back deductions already allowed to a borrower and increases the amount of the limited recourse debt which is deemed not to be repaid by the amount of any repayments based on a limited recourse refinancing or that are proceeds from disposal of the financed property. Most privately financed infrastructure and major resource projects use limited recourse debt, often on fairly unfavourable terms, during and just after construction until refinancing can be based on better business conditions post "ramp-up".
  • The provision makes no distinction between genuine market-based refinancing activities and indefinite interest-free loans from one associated company to another.
  • The proposed section is unreasonable and does not even grant discretion to the Commissioner to apply it in appropriate circumstances. The policy behind the provision and its drafting require clarification to deal appropriately with abuses and to sanction genuine transactions.

Conclusion

AusCID submits that these proposed amendments discourage development of public infrastructure through private investment either by rendering unworkable otherwise legitimate financing arrangements or by introducing uncertainty, higher costs and outright uncommerciality.

To create an environment conducive to greater investment, fundamental to economic growth and job creation, it is imperative that tax legislation aim at encouraging rather than impeding business investment opportunities.

 

 

Taxation Laws Amendment Bill (No. 4) 1998

Submission to Senate of Australia

Economics Legislation Committee

 

The Australian Council for Infrastructure Development

The Council was formed in 1993 and incorporated in 1994 to represent the interests of private sector organisations having an interest in many aspects of private sector delivery of public infrastructure - ownership, investment, construction, operation, maintenance, finance and advisory services.

AusCID membership currently comprises 13 Full and 29 Associate Members ranging from major Australian organisations such as National Australia Bank, Lend Lease, Commonwealth Bank, AMP and Transfield to professional firms and smaller engineering and similar consultancies. Membership details and background information is contained in Attachment A.

AusCID addresses in this submission issues in Item 192 of Schedule 1 relating to Sales Tax Exemptions, Division 243 relating to Limited Recourse Debt and Division 58 relating to Depreciation Claw-Back and Exempt Entities as these are relevant to the interests of its members.

Sales Tax Item 192 Exemption

The proposed changes to the availability of sales tax exemption under Item 192 of the Sales Tax (Exemptions and Classifications Act) imply that exemption will not be available unless:

  1. the property being constructed is housing provided at below market rates by or on behalf of an exempt body;
  2. the property is occupied principally by the exempt body; or
  3. the property is used principally by a person providing services to the exempt body for the provision of those services.
  • AusCID submits that the requirement for the relevant property to be "occupied" by an exempt body has very broad and potentially unforeseen consequences when viewed in the context of public infrastructure developments such as roads, rail, airports and sporting complexes.
  • This raises questions such as whether a BOOT roadway can be said to be "occupied" by a Government body. This could similarly bear immediate consequences for a number of large BOO and BOOT road, rail, sporting (including Olympic), energy and other projects currently under construction.
  • AusCID is given to understand that the ATO has provided advice to business that amendments were drafted with buildings specifically in mind and that other structures would continue to be exempt. This is, however, not the prevailing view among the Council’s members.
  • Clarification of the Government’s intent is sought. There are a number of large BOO and BOOT projects currently under way in Australia. If this amendment is passed and affects the ability of these projects to continue to receive appropriate sales tax exemptions, the result will go directly to their bottom line.
  • At the very least, projects that have commenced under a given set of rules should be entitled to complete under the same set of rules.

 

Depreciation Claw Back

On 4th August 1997 a new depreciation regime for assets acquired from tax exempt entities was announced.

  • AusCID members, representing private sector owners of Australian infrastructure assets, understood this to mean that the depreciation available to a new purchaser would be based on the notional tax written-down value of the asset in the hands of the exempt entity, rather than the price paid for by the first purchaser.
  • The problem will be when the taxpayer who purchased the asset decides to sell it. The Bill provides for the claw back of depreciation when the first purchaser wants to sell the asset, the claw back being based not on the original amount which the first purchaser was entitled to use for depreciation purposes, but instead upon the actual price paid by the first purchaser.
  • For example, the purchaser paying say $2.5 billion for an asset with a written down value of say $100 million and then on-selling the asset some years later for maybe $2.3 billion with a then tax written down value of say $20 million will now be assessed on the difference between $20 million and $2.3 billion, that is, $2.28 million.
  • Allowing what would be regarded as a reasonable claw back of depreciation, that is, $80 million, it means that the first purchaser is going to be assessed on the notional profit of $2.28 billion when in reality he has made a loss of $200 million.
  • This causes a financially ruinous outcome with the result that any purchase of an asset from an exempt entity cannot be onsold without structuring the holding.
  • An alternative treatment of this issue has been addressed in the explanatory memorandum to the Bill. The memorandum goes on to explain that the alternative was not adopted because "A different taxation treatment would have applied to an asset that was once owned by an exempt entity compared with the taxation treatment that would apply to an identical asset had it been always owned by private tax payers"
  • AusCID members consider that it would be more sensible and pragmatic to ensure that the low depreciation cost base is passed to the second purchaser rather than try to bankrupt the original purchaser as the Bill would do.
  • Although Australia may stand out as a relatively safe haven for investment in the region, it does not stand it in good stead with potential investors when provisions of the type proposed in this Bill are seriously offered to the business community as credible solutions to significant issues. Australia is a high risk jurisdiction from a taxation perspective and examples such as this add weight to this assessment.
  • AusCID strongly urges the immediate withdrawal of the provisions in Bill No. 4 relating to the depreciation claw back and the re-write of that part of the Bill to give effect to the alternative approach recognised in the explanatory memorandum.

Limited Recourse Debt

  • Where an asset is financed by limited recourse debt, a taxpayer obtains "capital allowance deductions" which have previously been allowed if the debt was not paid in full. This Division 243 intends to claw back these deductions. The definition of limited recourse debt is similar to that contained in S51AD.
  • There are two aspects concerning the proposal in the Bill that AusCID believes goes way beyond anything reasonable.
  • Proposed Section 234 - 15(3)(b) has the effect of increasing the amount of limited recourse debt that is deemed not to be repaid by, (a) the amount of any actual repayments of the debt that are themselves directly or indirectly limited recourse debts (effectively any refinancing of a limited recourse debt) or, (b) by any payment from the proceeds of the sale of the financed property.
  • In effect, though the debt has been actually repaid, it is deemed not to have been repaid and the proposed section applies. AusCID would like a clarification on the policy behind these measures. The measure in (a) makes no distinction between a genuine market-based refinancing and an indefinite inter-company interest free loan. The inequity in measure (b) is self-evident.
  • The section does not even appear to allow discretion for the Commissioner to apply it only in appropriate circumstances.
  • Majority of privately financed infrastructure uses limited recourse debt, often on fairly unfavourable terms during and just after construction until refinancing can be based on better business conditions post "ramp-up"
  • This provision is therefore particularly unreasonable in the context of an emerging business sector based on privately financed infrastructure development.

Conclusion

AusCID submits that these proposed amendments discourage development of public infrastructure through private investment either by rendering unworkable otherwise legitimate financing arrangements or by introducing uncertainty, higher costs and outright uncommerciality.

Although initially, many investments proposals may generate early tax losses, when looked at from a "whole of project" perspective, they generate overall revenue benefits through later taxation payments. Business investment is driven by the prospect of profits (which will be taxed).

To create an environment conducive to greater investment, fundamental to economic growth and job creation, it is imperative that tax legislation aim at encouraging rather than impeding business investment opportunities.

 

RBT Appendix B

 

AusCID

 

 

 

REFORMING SECTION 51AD

OF THE

AUSTRALIAN INCOME TAX ASSESSMENT ACT

 

 

 

A Submission

by the

Australian Council for Infrastructure Development

December 1998

 

 

AusCID

REFORMING SECTION 51AD

OF THE

AUSTRALIAN INCOME TAX ASSESSMENT ACT

A Submission

by the

Australian Council for Infrastructure Development

December 1998

Executive Summary

For some time, Section 51AD of the Australian Income Tax Assessment Act has been a source of considerable difficulty, delay, frustration and unnecessary cost to private infrastructure investment in Australia, consuming extensive resources, serving little useful public policy purpose and raising no government revenue.

Government actions to encourage private sector investment and remove real impediments to investment will minimise the impact of the coming post-Olympics construction downturn and maximise employment.

S.51AD was devised in the early 1980’s, an era where there was no private ownership and little private management of infrastructure in Australia. Deals involving the private sector could automatically be assumed to be tax-driven transactions with the private sector merely pretending to ownership. Anti-avoidance laws at the time were generally ineffective.

Times have changed. The problems with S.51AD in an era of increasing private sector investment in infrastructure are twofold. Its application is too broad and the consequences of its breach too severe.

The reforms recommended by AusCID in this submission are directed to redressing these two features of the legislation.

Accordingly, we suggest that S.51AD be repealed so as to allow (an amended) Division 16D to apply.

However, D.16D is itself in need of two significant amendments.

 

(i) Limit the "control" test.

As is apparent from the case studies described in this submission, the current "control" test is far too wide. We suggest that D.16D be amended to:

  • abolish the "use" test;
  • restrict the "control of use" test to a "substantial control of use" test; and
  • define "substantial control" to be an exclusive concept such that only one party can be deemed to be a substantial controller of a given asset at any given point in time. This definition should contain a provision to the effect that a tax-exempt authority will be deemed not to have substantial control if the private sector owner or associate assumes the majority of material risks of the project.

Amendments of this kind will ensure that D.16D does not apply to projects where the government’s powers of control are merely incidental.

(ii) Amend the definition of "qualifying arrangement".

D.16D’s definition of "qualifying arrangements" deviates from the accounting definition of "finance leases". Most operating leases (other than those with very short terms) are deemed to be "qualifying arrangements" for the purposes of D.16D.

To ensure that D.16D only applies to leases which are, in substance, loans we recommend that D.16D be amended to:

  • convert the present 90% nominal test into a 90% present value test;
  • ensure that the definition of future cash flows excludes repairs and maintenance expenditure; and
  • ensure that the definition of future cash flows excludes payments which are subject to genuine commercial risk: i.e. payments which are contingent on market patronage or market prices.

Amendments of this kind will ensure that D.16D applies only to transactions which are, in substance, financing transactions and not to genuine operating leases or projects which involve a genuine transfer of commercial risk to the private sector.

 

 

 

 

AusCID

REFORMING SECTION 51AD

OF THE

AUSTRALIAN INCOME TAX ASSESSMENT ACT

 

A Submission

by the

Australian Council for Infrastructure Development

December 1998

Introduction

For well over a decade, Section 51AD of the Australian Income Tax Assessment Act has been a source of considerable difficulty, delay, frustration and unnecessary cost to private infrastructure investment in Australia.

Administration of S.51AD has consumed extensive resources, served little useful public policy purpose and raised no government revenue.

The Australian Council for Infrastructure Development (AusCID), representing 55 organisations (list attached) owning or supporting greater private sector involvement in public infrastructure, considers that the spirit of effective competition reform calls for a close review of the policy foundations of legislation and administrative practice which, in the opinion of its members, deter the introduction of competition to the market and no longer serve the public good.

In the Council’s opinion, S.51AD falls into this policy and legislative category. AusCID therefore welcomes this opportunity to submit its views to Australian governments on this important issue.

Attention to S.51AD and the dilemma it creates for project definition, structuring and delivery will enhance Australia’s attractiveness for private investment in major infrastructure projects while also encouraging smaller projects, particularly in regions, where the economic and job creation impacts can be magnified. Such action will also address a key limitation to the creation of effective public-private partnerships which more effectively share risk according to capacity to bear.

There are clear signs that the infrastructure and Olympics-driven construction boom in NSW is flattening out and will move into reverse gear after 2000. Non-residential commencements are likely to grow by only 1% over the next two years after a 12% rise in 1996/97. Engineering construction is expected to slump to levels not experienced for nearly 10 years, with NSW activity post-2000 expected to run more than 20% below the 1998/99 peak. (Building Australia, May 1998, quoting BIS Shrapnel).

Government actions to encourage private sector investment and remove real impediments to investment will minimise the impact of this downturn and maximise employment.

The most trying of these impediments affecting private sector investment in Australia’s infrastructure is S.51AD of the Income Tax Assessment Act 1936.

S.51AD unnecessarily delays projects, adds significant costs and reduces the community benefit from major private sector investment in infrastructure.

 

Why S.51AD was introduced

Australia’s tax laws contain provisions designed to prevent the abuse of tax concessions intended to encourage investment by taxpayers in productive assets. The Fraser Government in the early 1980’s introduced S.51AD when John Howard was Treasurer. It was an anti-avoidance measure aimed at preventing "inappropriate" use of tax incentives designed to encourage investment in plant and machinery.

The particular transaction which reputedly led to the introduction of S.51AD was a leveraged lease involving the Eraring power station (electricity generation being at that time an exclusively Government activity). The effect of the lease was that private sector lessors could claim tax incentives as the owners of such assets even though they assumed no real risks of ownership. Essentially these structures were simply loans to State Governments.

 

Why S.51AD has outlived its usefulness

S.51AD was devised in an era where there was no private ownership of infrastructure in Australia and, what is more, virtually no private management of this infrastructure. Government was assumed to be the "natural owner" of infrastructure assets and any other arrangements involving the private sector could automatically be assumed to be "shams": tax-driven transactions in which the private sector merely pretended to ownership. Furthermore anti-avoidance laws at the time were generally found to be ineffective. Times have changed.

The problem with S.51AD can be simply stated:

  1. The potential scope of the provision is extremely broad. Application is essentially dependent on whether the Commissioner of Taxation considers that a government retains "control of the use" of the infrastructure asset. Since "control’ need only be potential, more than one party can be deemed to control the use of an asset. And given that governments often retain regulatory, coordination and safety functions in respect of major infrastructure assets, the ATO frequently forms a prima facie view that government control exists.
  2. The effect of its application, should it be established, is fatal. Under S.51AD, all income remains assessable but all deductions are disallowed. Since the outcome under such a scenario is almost certain bankruptcy, private sector parties will not proceed with a transaction until they have obtained ATO clearance.

ATO rulings typically take several months to obtain, by which time, finance commitments may be withdrawn and the transaction may not proceed. On other occasions, private consortia may decide not to bid at all because S.51AD uncertainty makes fund-raising untenable.

The rationale for this legislative excess is explicable only by reference to the history of the section.

The public policy assumptions behind the government ownership of public infrastructure have now been challenged, to a greater or lesser extent, by all Australian governments. So much so that, in 1998, in excess of $50 billion of Australian infrastructure is now in genuine private ownership and nearly $15 billion of new infrastructure has been or is being built, owned and operated by the private sector.

 

In other words, S.51AD belongs to a world which is now rapidly becoming extinct. Its raison d’être - to prevent government control of privately financed infrastructure assets - is now not only obsolete, but at cross-purposes with what various Federal and State governments are actively aiming to achieve.

Case studies

As discussed above, the wide "control" concept means that S.51AD has prima facie application to virtually all private infrastructure projects. This is so even though, overwhelmingly, these projects do not involve any tax mischief and have the support of the Federal Government.

The following list of projects is provided by way of illustration only because, as stated earlier, virtually every private infrastructure project is threatened by S.51AD.

 

NSW Southern Railway

Extreme difficulties were incurred in obtaining a positive binding tax ruling in respect of S.51AD for the Sydney Airport Link Project. An application was made for a streamlined ruling in early February 1995 but the response was not resolved until late May 1995. This resulted in considerable expense and a delay in project commencement.

The project involves the private sector effectively owning a number of railway stations and taking patronage risk in respect of commuter usage. The private sector is also fully responsible for the construction, operation and maintenance of these stations and there is no government contribution or underwriting.

Nevertheless, the ATO took the view, for some considerable time, that S.51AD should apply. The issue was only finally resolved after considerable discussions at the highest level with both the ATO and government.

 

Eastern Distributor

The Eastern Distributor is a $600m privately-financed toll road linking Sydney CBD with Kingsford Smith airport. The private sector accepted full commercial risk on the deal, including construction, operation, maintenance and patronage.

It was argued by the ATO that S.51AD applied because the NSW Roads and Traffic Authority retained control of traffic lights, median strips, maximum speeding limits and interconnecting roads - all of which dictate the extent and the flow of traffic on the motorway. This, it was argued, constituted de facto "control of the use" of the private toll road.

The ATO eventually abandoned this line of reasoning and the deal proceeded, but not without considerable expense and delay.

Collinsville power station

The Collinsville power station involved the refurbishment, ownership, financing and operation of a coal fired power station on a freehold site. Collinsville was then required to enter into an 18-year power purchase agreement with a Queensland government instrumentality.

The initial application for a S.51AD ruling was submitted in November 1995 and, in similar fashion to most projects, the ATO initially formed the view that S.51AD applied. After considerable delay - and at a cost in management time and legal fees estimated to be in excess of $200,000 - a positive ruling was finally advanced. By then however, the damage had already been done. The project failed to meet its scheduled opening date in early 1998 - a time when the State experienced brown-outs because of the lack of power station infrastructure.

The community costs of these brown-outs could have been avoided if the project had not been obstructed by the delays and distractions caused by the S.51AD process.

Phase 1 airports

Out of an abundance of caution, bidders in the first phase of the airport privatisation program sought rulings from the ATO that S.51AD did not apply. However, the initial view expressed by the ATO was that because the revenue from landing charges was "regulated", S.51AD would apply.

Following representations by the bidders to the Asset Sales Task Force and Federal Treasury, this view was reversed but it added considerable delay and uncertainty to the bid process.

Powernet

Powernet is the recently privatised Victorian electricity transmission grid.

It was argued by the ATO that the ability of a state instrumentality to switch network connects in an electricity grid amounted to control by the State of the operation of poles and wires (owned by the private sector) that comprise that grid. S.51AD clearance was ultimately obtained but only after significant expense and delay.

 

Macarthur water treatment plant

After a protracted and costly negotiation with the ATO, and in an attempt to obtain S.51AD clearance, the private consortium which secured the Macarthur Water treatment plant agreed to contractual changes that were counterproductive to the State’s objective of reducing water usage and detrimental to both the state and the private sector.

 

Brisbane Airtrain

The Brisbane Airtrain Project is a private railway initiative which involves the private sector building, owning, operating and maintaining a rail link from Brisbane city to Brisbane airport. Full patronage risk is to be assumed by the private sector developers.

The initial application for a S.51AD ruling was lodged in October 1997. A ruling was not issued until May 1998. The significant management resources and third party legal costs incurred in obtaining this approval have been extensive. A QC had to be briefed and an opinion formed prior to a major review by an independent expert undertaken to confirm to the ATO that S.51AD did not apply. Most absurdly, the ATO required the Queensland Rail rolling stock be used for the Airtrain project and their drivers to be seconded for S.51AD not to apply.

 

Hydroelectric station

It has been asserted by the ATO that the ability of a state instrumentality to open and close the floodgates to a reservoir which held water that supplied a turbine-powered power station (operated by a private firm) amounted to state control of the day to day operation of that power station.

 

Bid for National Transmission Network

On current form, the ATO is almost certainly likely to provide an unfavourable S.51AD ruling on the grounds that part of the revenue from this asset is derived from the ABC. This is adding great uncertainty to the bid process.

 

Case studies conclusion

The common theme from the above experiences is that a vast amount of the community’s resources (both public and private) are being consumed in abstruse arguments over the meaning of "control". This is despite the fact that the economic risk allocation of these projects is totally commercial and far removed from the prototype transactions that S.51AD was designed to attack.

The wastefulness of this outcome from a public policy perspective is now painfully apparent to all objective participants in the process.

In this era of global capital markets, it is imperative that Australia’s tax legislation be tailored to achieve its objectives while at all times minimising commercial uncertainty and indiscriminate or haphazard application.

The unnecessary costs in terms of tax and legal advisers and senior management resources, which can be used more productively elsewhere, ought to be sufficient incentives for reform. But, even more compelling, is the cost to the community of delaying the delivery of vital infrastructure.

How many rail commuters will be inconvenienced in Brisbane because the Brisbane Air Train project was delayed by 6 months by S.51AD? How many road commuters will likewise be inconvenienced in Sydney because the Eastern Distributor will be delivered 6 months later than it could otherwise have been? How many power users in Queensland were inconvenienced by brown-outs that should never have occurred?

A nation that does not value the opportunity cost of its time is destined to fail as a premier world destination in what is an increasingly competitive international environment.

 

 

Recommendation for reform

It was mentioned at the outset that the problems with S.51AD are twofold. Its application is too broad and the consequences of its breach too severe. The reforms recommended by AusCID in this submission are directed to redressing these two features of the legislation.

In drafting our suggested solution, we have taken cognisance of the fact that Division 16D already exists and shares identical objectives to those of S.51AD.

Accordingly, we suggest that S.51AD be repealed so as to allow (an amended) Division 16D to apply.

The attraction of using Division 16D as the basis for our legislative solution is twofold:

(a) D.16D is more measured and more sensible legislation in terms of the consequences imposed in the event of contravention. Unlike S.51AD, it is not punitive. It taxes a transaction according to its substance, rather than its form. In other words, if a transaction is in substance a loan rather than a lease, then D.16D simply taxes it as such - no more and no less. The mischief, if any, is redressed without resort to the intimidatory prospect of bankruptcy and consequential loss of jobs and government revenue.

(b) D.16D has been part of Australian tax law for over a decade and there is already a considerable body of literature regarding its likely ambit and application. By using it as the basis for our suggested reforms, we seek to avoid the uncertainty that will inevitably arise should S.51AD be replaced by a completely new provision.

However, D.16D is itself in need of two significant amendments.

(i) Limit the "control" test.

The objective of S.51AD and D.16D is to prevent the private sector from exploiting tax concessions without, in substance, accepting the substantial risks of ownership.

Conceptually therefore, the appropriate condition precedent ought not to be "control" of the asset by a tax-exempt authority, but rather a risk-based test designed to ascertain whether or not there has been a genuine transfer of risk to the private sector.

 

However, a prescriptive risk-based test would be complex to draft and potentially difficult to administer. The theoretical merit of this approach may therefore be more than outweighed by the uncertainty that it would generate.

On the other hand, as is apparent from the case studies above, the current "control" test is far too wide. We suggest that D.16D be amended to:

  • abolish the "use" test;
  • restrict the "control of use" test to a "substantial control of use" test; and
  • define "substantial control" to be an exclusive concept such that only one party can be deemed to be a substantial controller of a given asset at any given point in time. This definition should contain a provision to the effect that a tax-exempt authority will be deemed not to have substantial control if the private sector owner or associate assumes the majority of material risks of the project.

Amendments of this kind will ensure that D.16D does not apply to projects where the government’s powers of control are merely incidental, as for example with the Eastern Distributor and Brisbane Airtrain projects.

(ii) Amending the definition of "qualifying arrangement".

The introduction of D.16D was announced by the Treasurer on 15 May 1984 and the relevant press release notes that it was targeted at "ordinary finance leasing by governments and tax-exempt government authorities."

This statement was later reinforced by the Explanatory Memorandum:

"D.16D specifies a number of tests for determining whether an arrangement is a qualifying arrangement to which the Division applies. These tests broadly follow those developed for accounting and commercial purposes in identifying a finance lease."

However, D.16D’s definition of "qualifying arrangements" deviates in one material respect from the accounting definition of "finance leases".

Under accounting standards, a lease is considered a finance lease if the present value of the payments to be made by the lessee under the lease are greater than 90% of the fair value of the leased property at the time the lease was entered into. The corresponding test in D.16D is not a "present value" test: i.e. all that is required is that the sum of all nominal payments made under the lease exceed 90% of the fair value of the leased property.

 

The dilution of the 90% test is exacerbated by the fact that the D.16D test includes not only all lease payments but also any payments made for repairs and maintenance. As a result, most operating leases (other than those with very short terms) are deemed to be "qualifying arrangements" for the purposes of D.16D.

To ensure that D.16D only applies to leases which are, in substance, loans we recommend that D.16D be amended to:

  • convert the present 90% nominal test into a 90% present value test;
  • ensure that the definition of future cash flows excludes repairs and maintenance expenditure; and
  • ensure that the definition of future cash flows excludes payments which are subject to genuine commercial risk: i.e. payments which are contingent on market patronage or market prices.

Amendments of this kind will ensure that D.16D applies only to transactions which are, in substance, financing transactions and not to genuine operating leases or projects which involve a genuine transfer of commercial risk to the private sector.

 

Conclusion

In the early 1980’s when S.51AD was introduced, it was an appropriate legislative response. At that time, there was no private sector investment in roads, railways, ports, prisons, or power stations. The statutory draftsman did not - and did not need to - take care to protect bona fide cases of private sector investment in Australian infrastructure.

S.51AD has however failed to respond and adapt to the fundamental changes brought about by the Hilmer competition reforms. Today, S.51AD is nothing more than a dormant deal-killer - threatening, as it does, to delay or obstruct virtually every legitimate private sector investment in Australian infrastructure.

At a time when the demand for infrastructure in Australia constantly outstrips the community’s willingness to pay for it through increased taxation, we can ill-afford as a nation to be complacent about a provision that adds nothing to the integrity of our tax system but subtracts so much from its efficacy.