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Submission No. 70 Back to full list of submissions
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12 January 1999

The Secretary
Review of Business Taxation
Department of the Treasury
Parkes Place
CANBERRA ACT 2600

Dear Sir

REVIEW OF BUSINESS TAXATION - SUBMISSION TO THE FIRST DISCUSSION PAPER, A STRONG FOUNDATION

 

1. Introduction

The Minerals Council of Australia appreciates the opportunity to provide a submission to the Review of Business Taxation’s first discussion paper - A Strong Foundation. The Minerals Council has welcomed the Government’s initiative to reform and modernise the Australian taxation system. The Minerals Council is an active member of the Business Coalition for Tax Reform (BCTR) and supports the general views put forward to the Review in the BCTR submission of December 1998.

The Minerals Council is the national body representing the Australian exploration, mining and minerals processing industry. The industry is a key contributor to Australia’s economic and trade performance. The industry has important linkages with the engineering, construction, services and manufacturing sectors.

The mining and minerals processing industry:

  • directly contributes approximately $30 billion to gross domestic product and makes a large indirect contribution;
  • is responsible for about 250,000 jobs in Australia (directly and indirectly);
  • represents 20 percent of total business investment in Australia;
  • spends over $12 billion a year within Australia on goods and services input; and
  • generates about 37 percent of total Australian merchandise exports.

Members of the Council are responsible for around 90 percent of Australia’s mineral production.

This submission addresses matters raised in the Review’s first discussion paper and does not attempt to reiterate positions adequately addressed in the BCTR Submission.

The broad objectives for Tax Reform and the Foundation principles for reform are supported as a framework for consideration of the more specific principles applicable to business taxation.

  1. The scope of the Review
  2. The terms of reference for the Review impose a revenue neutrality constraint. The Minerals Council considers this constraint as unduly limiting the consideration of longer-term benefits of tax reform and additional revenues arising from economic growth. Such a constraint limits the Review to a more narrowly based examination of what trade-offs are necessary between the existing taxation expenditures and a lower corporate tax rate. In effect, to achieve the objective of a 30 percent corporate tax rate some 80 percent of identified tax expenditures would need to be withdrawn to provide revenue neutrality. The Review will need to carefully consider the effects of such an outcome, and indeed, whether such an outcome is appropriate.

    The Council supports the BCTR’s recommendation that this constraint be considered a longer-term objective, and one which does not discourage or disadvantage short term investment in capital goods that produce higher rates of longer-term economic growth.

    The Minerals Council recognises the constraints of the Review but considers the apparent rejection of consideration of an expenditure-based business taxation system at odds with the general direction of taxation reform which is placing more emphasis on expenditure based (GST) than direct income collections from individuals. This is addressed in more detail later in the submission.

  3. Importance of tax reform to the minerals industry

Australian minerals companies are becoming more globally orientated. Reasons include:

  • a market requirement to be internationally competitive;
  • a number of developing countries that are relatively under explored and / or highly prospective are opening up to international investment;
  • better financial returns on investment now achievable elsewhere;
  • increased access to international capital;
  • perceptions of increasing sovereign risk in Australia in relation to project approvals and financial arrangements; and
  • a need to ensure adequate supply of minerals reserves.

Australia is recognised as having one of the most complex and outdated tax regimes in the developed world. The growing dependence on narrowly based indirect taxes, particularly input taxes on mineral production, significantly reduces the ability for companies to compete against other mineral exporters who can either obtain border-relief from domestic taxes or receive tax advantages not available to Australian producers.

Tax reform offers an opportunity to establish a more internationally competitive investment regime for minerals projects. Increasing globalisation means that industry (and the long-term investment dollars) will respond to project and market opportunities wherever they arise. It is crucial that Australia’s investment regime is globally competitive.

  1. Principles for an efficient and fair tax system

The purpose of taxation primarily is to raise revenue to finance government expenditure at the lowest economic cost - that is, the cost to the overall performance of the economy -while helping to meet the government’s equity objectives. Three interrelated concerns arise:

  • the overall burden of taxation;
  • the economic distortions which the tax system creates; and
  • the costs of complying with the tax rules.

The Productivity Commission identified the following three principles as key criteria by which tax systems should be evaluated. These are:

  • efficiency: An efficient tax system will minimise distortions to pre-tax patterns of production and consumption (ie minimise ‘dead weight loss’) and be as neutral as possible in its effects on private incentives and business decision-making.
  • equity: An equitable tax system spreads the burden of tax fairly over all taxpayers. It should incorporate concepts of horizontal and vertical equity (similar treatment of taxpayers in similar economic circumstances with those who are financially better off paying a greater share of the burden than those who are worse off).
  • simplicity: A simple tax system is one that is easily understood and applied. As such, a simple system will improve certainty and minimise administrative and compliance (including transaction) costs.

In addition to these principles, the efficacy of various tax reform proposals should be evaluated in terms of their ability to achieve:

  • no taxation of business inputs;
  • improved growth, employment and savings;
  • revenue adequacy and address the Commonwealth/State ‘vertical fiscal imbalance’ (VFI) problem;
  • minimisation of incentives for tax avoidance and evasion; and
  • minimisation of the sovereign risk of tax arrangements (ie certainty and system stability).
  1. Policy design principles

The Council supports the views on the Policy Principles contained in the BCTR Submission.

5.1 Comprehensive business Income as the tax base

Comprehensive income is defined as the sum over an annual period, of the taxpayer’s current revenue less current costs, plus the net change in the value of the taxpayer’s assets and liabilities. This approach raises a number of issues.

The apparent rejection of an expenditure-based business taxation system is at odds with the general direction of tax reform which is placing more emphasis on expenditure based GST than direct income tax collections from individuals. However, a change in the business tax system to an expenditure-based system would create a number of transitional problems and clearly would be difficult to achieve in the proposed time frame.

The use of a comprehensive income system for business taxation involves both operating revenues and revenues from investments for corporate entities. This approach is a significant departure from the principle of taxation of ultimate owners (individuals).

As a goods producer, issues for the minerals industry such as the taxation of financial arrangements as well as changes in the values of assets are significant. It is noted in the paper that the full imputation approach flagged in the Government’s tax reform package will need to be considered carefully recognising the identified difficulties with this approach for distorting investment flows between nationals of different countries. In addition, the ‘negating’ effect imputation can have on Government incentives delivered via the fiscal system needs to be borne in mind.

It is further noted that maintaining a yearly revaluation of assets will create significant compliance costs on the industry. This may well lead to the retention of a form of capital gains tax for those assets that are too costly or too difficult to revalue on an annual basis. An evaluation of these assets and an accounting profit and loss will be realised at the end of the economic life of the asset or some arbitrarily determined period. Alternatively a number of other asset classes will be able to be valued at the end of each annual period and/or tax period and brought to account as profit or loss in that period.

The paper notes that it will not treat profit and loss on changes and assets values symmetrically. Whereas profit will be brought in as taxable income, losses may be carried forward but will be only able to be carried forward at their nominal value combined with a quarantining of capital from revenue. This is recognised as a major non-neutrality in the system but justified by indicating that allowing the more generous treatment of losses would pose a significant threat to revenue.

This departure from the neutrality principle has a significant impact for long term capital investment. Ultimately the risk profile of competing investment opportunities will be effected by applying a non-neutral business tax regime to the treatment of losses and carry forward of losses.

5.2 Taxation of financial arrangements

The Council is particularly concerned that the Government proposes to apply accruals taxation methods to unrealised gains and losses on the financial transactions of minerals producers. Many commodity producers (including electricity and cotton as well as gold, copper and silver) carry out such transactions. They are undertaken as a matter of normal and accepted business practice to manage risk with regard to commodity prices and shifts in currency values through hedging and similar risk management strategies. They should be differentiated from trading activities where the primary business of the financial intermediary is to earn a profit as an arbitrager.

5.3 Fringe Benefits Tax

The Council supports the paper’s criticisms of the Fringe Benefits Tax (FBT) contained in paragraphs 2.20 - 2.22 of the discussion paper. FBT is an extremely complex tax and introduces very high compliance costs for industry. Significant simplification of the FBT system is required.

In addition, anomalies in the FBT system (such as the exemptions for some benefits provided by primary producers in remote areas being unavailable to minerals producers operating in the same area and seeking to provide the same benefits) can impose significant costs on effected businesses.

5.4 Tax expenditures as policy tools

The Minerals Council has serious concerns with some of the suggestions contained in paragraphs 2.29 - 2.31.

The minerals industry is characterised by high levels of capital investment and long lead times before the generation of sales income and production-dependent cash flows. It is one of Australia’s most capital-intensive industries and represents approximately $10 billion or over 20 percent of annual new business capital expenditure in Australia in recent years.

Any trade-off between the corporate tax rate and other business tax arrangements (such as generally applied ‘accelerated’ depreciation, mining capital provisions or the immediate deductibility of exploration expenditure) may have disproportionate effects on cash flows and the investment economics of project opportunities. This is particularly relevant for mineral projects where sales revenue per dollar of investment is very low relative to most industries. Clearly, depreciation rates in this context are crucial and changes directly impact project viability.

Exploration is clearly necessary to ensure continuing production in the minerals industry. The immediate deductibility of exploration expenditure acknowledges that such expenditure is an ongoing and necessary expense of a minerals company. The immediate deductibility has been supported consistently by independent reviews. These include those by the Asprey Committee and the former Industry Commission - which found it to be the least distorting tax treatment in terms of the efficient allocation of resources in the economy. The tax treatment also recognises the success rate in discovery is extremely low, reflecting the typically high technical and financial risks involved. Typically there will not be a successful mine resulting from most exploration expenditures.

The Council emphasises that it is the combination of all business tax rates and measures, and not just the corporate rate (or any other single tax measure) that is used in assessing project viability. The overall tax position in Australia relative to Australia’s competitors affects competitiveness and project viability.

5.4 Simplicity

The Council is concerned that the pursuit of simplicity should not be given prominence at the expense of economic growth, equity and international competitiveness. Certainty and clarity could be regarded as higher priorities than simplicity. Some comments at the consultative meetings have unduly focused on reducing the number of pages of the taxation legislation by up to 50 percent. While a worthwhile objective the actual legislation needs to remove uncertainty and confusion rather than increase uncertainty through this legislation.

5.5 Balanced taxation of international investment

There is a need to overhaul Australia’s double tax treaty system, including new relevant treaties and renegotiation of existing treaties (a particular issue in this context is the level of withholding taxes on inbound income flows). Australia has lagged behind many other countries in this area and, as both a capital importer and exporter, this has been to the detriment of Australian investors. The articulation of clear priorities and the development of an appropriate timetable would facilitate improvements in this area.

The Minerals Council of Australia would be pleased to discuss any of the matters raised above.

 

Yours sincerely

 

R C WELLS
EXECUTIVE DIRECTOR

RCW:DMD