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 privaterulings. 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.