Chapter 4
Schedule 3 - Depreciation of plant previously owned by an exempt entity.
4.1 On 4 August 1997 the Federal Treasurer announced details of proposed
changes to the tax depreciation rules for privatisation transactions.
The government argued that the legislative changes were necessary as the
States were going through a phase of privatising businesses and because
they were exempt from federal taxes they were disinterested in the termination
value of the depreciable assets.
4.2 The Australian Council for Infrastructure Development (AusCID) is
concerned that the proposed amendments in Schedule 3 (Schedule 10 in the
previous bill) would discourage private investment in public infrastructure
projects. They understood from earlier announcements by the Treasurer
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
owner. [1]
4.3 The provisions of the Bill seek to clawback depreciation on the disposal
of an asset previously purchased from a tax-exempt entity. AusCID and
other witnesses argued that this is totally unfair and would be a financially
ruinous outcome for an investor who in most cases had incurred an economic
loss. AusCID provided the following example to illustrate their concern:
An investor purchases an asset from a state government for $1 billion
which has a notional tax written down value (NWDV) of $500 million. After
five years the taxpayer on-sells the asset for $900 million with a NWDV
of $400 million. Under schedule 10 the original investor will now be assessed
on the difference between $900 million and $400 million ie $500 million.
The original investor will now have to pay tax on a notional profit of
$500 million, when actually they had suffered an economic loss of $100
million.
4.4 AusCID contended that the above scenario also applies equally to
assets that are on-sold for a profit. If the same asset was sold for $1.2
billion the investor would have to pay tax on $800 million even though
the economic profit was only $200 million. In both cases the tax regime
proposed by the bill would act as a enormous transaction cost, restricting,
if not all together preventing the on-sale of assets in the future.
4.5 AusCID consider the policy motivation behind the proposed amendment
to the bill:
…was nothing other than an attempt by the federal government to
extract additional tax revenue from the state government privitisations.
[2]
4.6 AusCID believe that the major losers would be the state governments
or other tax-exempt entities as private investors will pay less because
they will value the asset on an after-tax basis and this view is supported
by the submissions from the state treasury departments.
4.7 In a supplementary submission AusCID argued for the use of the “tainting”
rule rather than the “balancing adjustment” rule. [3]
AusCID and some of its members favour the “tainting” rule and
believe it should be possible for a mechanism to be inserted into the
law to ensure compliance with a “tainting” rule. In support
of its proposition AusCID cited D.43 in respect of income producing buildings
and D.330 in respect of the purchase of mining rights.
4.8 AusCID expressed the concern that
.. the division 58 proposal, which is the only matter in TLAB 4 that
we wish to address, appears to be designed more to suit ATO administrative
convenience than to reflect commercial realities operating in the market.
Furthermore, it proposes a more complex solution to the issue of the depreciation
treatment of formerly tax exempt assets and thereby, we believe, cuts
across one of the key principles which is driving the Ralph review of
business taxation, which is, of course, to achieve greater simplicity.
In view of this Ralph process, we believe it would be better to delay
implementation pending consideration of the recommendations which may
flow from the review of business taxation, and then move to a solution
which is consistent with the outcomes of that inquiry. [4]
4.9 At the 29 April hearings Mr Michael Frazer of Arthur Anderson supported
AusCID's position:
Given the current state of the legislation and that it is still in a
proposed form, it is difficult to give hard, practical information. Clearly,
it had to be considered in various transactions—in particular, in
the Victorian privatisations. From our firm's own experience, the proposed
division 58 is causing some concern from the point of view of bidders
in that it is an entirely different regime from the standard depreciation
rules. It is inconsistent with some of the points coming out of the Ralph
report.
One of the points raised by AusCID was that there should potentially
be a deferment of proposed division 58 to see what the final outcome of
the Ralph report actually is. Our firm agrees with this because the current
drafting of division 58 is inconsistent with the proposals currently coming
out of the Ralph report.
Picking up the other major point from AusCID, which was on the nature
of this balancing charge, I think the submission has raised the point
that there are basically two alternatives: either a balancing charge or
a tainting approach. As I said before, there is no hard statistical information,
but it is fair to say that the balancing charge approach is clearly an
impediment to a purchaser refinancing those assets. That is one of the
reasons AusCID is proposing that a tainting approach is preferable. [5]
4.10 The Queensland Treasury believes that the proposed legislation is
inappropriate for state governments and provided the following example
to demonstrate the regressive nature of Division 58 [6]:
Power Corporation has owned and operated power stations for a number
of years. One of these power stations is sold to the private sector for
$500 million on 30 June 2000. The power station in question cost $300
million to construct and construction was completed and the asset ready
for use as at 30 June 1990. As at the date of sale the asset had a current
book value of $450 million (which reflected the notional written down
value of its Pre Audited Book Value) and a notional tax written down value
based on original cost of $200 million.
The tax position with respect to the disposal would be represented as
follows:
In the absence of Division 58 (the current treatment)
For the State Trading Enterpise-
Tax on recouped depreciation ($300 - $200) million x 36% = $ 36 million
Capital Gains Tax ($500 - $350*) million x 36% = 54 million
Total Tax Equivalence on transaction = $ 90 million
(*indexed cost base for CGT purposes)
For the Purchaser-
The purchaser would have a cost base for taxation depreciation purposes
of $500 million.
Assuming Division 58 in its current format applies
For the State Trading Enterprise-
Tax on recouped depreciation ($300 - $200) million x 36% = $ 36 million
Capital Gains Tax ($500 - $350*) million x 36% = 54 million
Total Tax Equivalence on the transaction = $ 90 million
(*indexed cost base for CGT purposes)
In reality, Power Corporation would be required to substantially reduce
the sale price to compensate the purchaser for the effect of Division
58, which will lower the taxation depreciable cost base to the purchaser.
For the Purchaser-
The purchaser would have a cost base for taxation depreciation purposes
of either the notional tax written down value based on original cost or
notional tax written down pre-existing audited book value. In the example
specified, the purchaser could adopt either $200 million or $450 million
– both are significantly beneath market value, and are only available
if the sale occurs in the near term. Over time, both of these potential
reference values are written down at tax rates of depreciation, which
will only exacerbate the divergence between the opening values under proposed
Division 58 provisions and market values.
4.11 Queensland Treasury went on:
To add to the inequity of the situation if the private sector entity
on-sells the asset to another private sector entity the balancing charge
for the initial purchaser is calculated by using the taxation cost base
to that purchaser. If the power station used in the above example was
on-sold after a period of time for $500 million to another private sector
operator, the assessable Division 58 balancing charge would be $50 million
($500 - $450 million), yet the initial taxpayer has only recovered their
outlay. [7]
4.12 The Queensland Treasury questioned the need for the legislation
in the first place and asked why Part IVA could not be used to remedy
any mischief that the government perceived. If the legislation is necessary
they believed that the government should broaden the definition of Pre-Audited
Book Value (PABV) to and limit its scope to the initial policy announcement.
….if the legislation is needed, the definition of pre-audited book
value could be broadened to an approach which could proxy the market value
of assets without allowing any unnecessary freedom for people to creatively
account for asset values.
We think the scope of the legislation should be limited in accordance
with the initial policy pronouncement by the federal government. That
is assuming that the legislation is needed and that part IVA is somehow
deficient and cannot be used in this case. [8]
4.13 The Queensland Treasury provided additional information following
the public hearing on 5 August 1998 that rejected the government advice
to the Committee on the use of PABV and the scope of the legislation.
4.14 The Queensland Treasury stated the ATO's advice to the Committee
[9] had failed to mention the proposed legislation
only provided for the use of the PABV if the relevant balance sheet includes
the plant, the plant was not qualified in the auditor's report and the
audit report was signed prior to 4 August 1997. The Queensland Treasury
believes the current PABV is the best option for an investor as a PABV
frozen in time would create an artificially low figure as times goes by.
[10]
4.15 The Queensland Treasury stated that the impact of the proposed changes
is much broader than the Government's statement indicates [11]
and that foreshadowed in the Treasurer's press release of 4 August 1997.
In their opinion the bill covers the outsourced provision of government
functions such as car fleets, cleaning and printing services. They provided
the following example to illustrate their point:
If the Queensland government decided to put out to tender all the of
the state's future printing needs and decided to sell all the plant relating
to the existing printing service by auction, the legislation as it is
currently drafted would apply to all units of plant purchased by any business
wishing to claim depreciation on the plant for taxation purposes. [12]
4.16 Mr Green of Arthur Andersen stated the unintended consequence of
the bill demonstrated the lack of consultation in the drafting of these
measures. He noted two areas of concern. First, the proposal as it is
currently drafted favours non-resident purchasers of government owned
assets and would provide them with an economic gain that Australian residents
could not achieve and is clearly a matter of concern for the Australian
Industry.
…..the proposed depreciation cost limit on plant previously owned
by an exempt entity—the schedule 10 measures—tips the playing
field in favour of foreign investors who are typically able to take tax
deductions in their home jurisdictions for the full capital cost of acquiring
such assets. It is demonstrable that such foreign investors are able to
bid substantially more than Australian companies for these assets, thus
this bill would prevent Australian companies from bidding competitively
for business assets in their home territory. [13]
4.17 Second, the proposed treatment of hire purchase transactions as
notional or deemed sales and purchases will be taxed as revenue profits
when they would otherwise be non-taxable capital gains. This would result
in double taxation for the investor, once on the deemed sale and again
on the actual disposal of asset. The bill does not provide any protection
for an unsuspecting investor when such a situation arises. [14]
Government Response
4.18 The Government did not accept the view put forward in the submissions
and by the witnesses that the legislation on depreciation for tax exempt
entity assets that become taxable introduces an anomaly into the tax law.
In the government's opinion the proposed changes remove an anomaly which
previously existed. The Assistant Treasurer, Senator the Hon. Rod Kemp
stated:
In the absence of an amendment, under existing taxation legislation,
taxpayers that acquire the depreciable assets of tax exempt entities receive
different taxation treatment, depending on how the sale is structured.
In the absence of an amendment, under the existing legislation, where
a tax exempt entity is sold—that is, a so-called entity sale—depreciable
assets that are held within that entity are depreciated for taxation purposes
on the basis of their notional written down value.
However, these rules can be circumvented by carving out assets of the
entity for separate sale—that is, a so-called asset sale—so
that the purchaser claims depreciation on the basis of the purchase price.
These circumstances provide scope for parties to structure a range of
significant taxation advantages. [15]
4.19 The government approach is to ensure that where an exempt owner
is disposing of a business or a business opportunity and its associated
assets, the depreciation to the first taxable holder of that business
and those assets is the same whether there is an entity sale or an asset
sale. [16]
4.20 The ATO advised the Committee in relation to Pre Audited Book Value
(PABV) the government has decided to go for the higher of the written
down values. This approach is the normal treatment on entity sales and
the much higher figure of the pre audited book value.
4.21 The provisions for example, do not apply when a government sells
office furniture but does apply when a government sells the asset together
with the business or a business opportunity.
The government has taken the view in structuring these provisions that
in effect the two cases of selling the entity that has the business and
the assets, or selling the assets separately and separately providing
the business or the business opportunity, should lead to the same depreciation
treatment in this specialised case where the assets were formerly held
by an exempt entity. [17]
4.22 Mr Hood, Assistant Commissioner, ATO, informed the Committee the
evidence submitted by the witnesses concentrated on what happens when
assets are sold in their own rights and ignored the part of the bill that
makes changes to the treatment of entity sales. Mr Hood added that the
government proposal would treat entity sales very generously through the
arrangement of the PABV as an opening value for depreciation purposes.
[18] In response to the Committee's question
why the price paid for an asset by an investor is being limited to the
PABV at a certain time and not the most recent value, Mr Hood said:
…. the government has simultaneously acted to go for the higher
of the written down values which is, after all, the normal tax treatment
on entity sales and what is the generally much higher figure of the prior
audited book value. Remember that this is not an artificial figure. These
prior audited book values are the figures which are being used, being
signed off by auditors and being used in audited accounts. They are not
artificially low, or there is no reason why they should be. There are
very good accounting reasons why they should not be artificially low.
[19]
4.23 Mr Hood advised the Committee that the provisions about asset sales
in schedule 10 (now schedule 3) only apply where assets are sold in the
context of making available a business or a business opportunity in association
with those assets. It would not apply if an exempt entity sold surplus
office furniture. [20]
4.24 At the 23 April Hearings Mr Hood advised:
The government's policy in division 58 has been to equalise those two
cases so that you get the same depreciation in both cases. The policy
of the government has also been to strike a depreciation basis compared
to what would otherwise obtain in taxpayer-to-taxpayer transactions which
is more generous than what you would get, taxpayer-to-taxpayer, on buying
an entity and, in some circumstances, potentially less generous than what
you might get on selling the assets separately from the business opportunities
with which they are associated.
The reason that the government took this course is that, in the case
of transactions between an exempt owner and a taxpayer, there are not
the self-regulating trade-offs between the owner and the purchaser which
effectively protect us against, for example, the misallocation of total
purchase price to one asset rather than another, to depreciable assets
rather than to goodwill, rather than to licences, rather than to rights
to operate, for example. Because of that concern, the measures are not
concerned with cases where assets are sold not associated with business
opportunities or rights. They are only concerned with the case which is
fundamentally the sale of the operation and the asset, or the potential
operation and the asset would be fairer. In those terms, this is obviously
not an issue which can be deferred for consideration to the Ralph committee.
[21]
Footnotes
[1] Submission No. 6, p. 58.
[2] Tabled document by AusCID titled `Hard Cases
Make Bad Law', p. 3.
[3] Submission No. 4 dated 12 April 1999.
[4] Evidence p. E 1.
[5] Evidence p. E 14.
[6] Submission No.15a, p. 7.
[7] Submission No.15a, p. 8.
[8] Evidence p. E 62.
[9] Evidence p. E 80.
[10] Supplementary Information provided by
the Queensland Treasury, dated 17 August 1998, p. 1.
[11] Evidence p. E 79.
[12] Supplementary Information provided by
the Queensland Treasury, dated 17 August 1998, p. 2.
[13] Evidence p. E 70.
[14] Evidence p. E 70.
[15] Evidence p. E 79
[16] Evidence p. E 79
[17] Evidence p. E 79
[18] Evidence p. E 79
[19] Evidence p. E 80
[20] Evidence p. E 79
[21] Evidence p. E 15.