Chapter 3 - Issues in relation to Schedules 1, 4, 8 and 10
Schedule 1—Distributions to entities connected with a private company
3.1
The committee did not take oral evidence on Schedule 1 of the bill.
However, it notes support for the measures in this Schedule from the Taxation
Institute of Australia. In a media release on 6 December 2006, the Vice-President of the Institute, Mr Peter Moltoni, welcomed the
Government’s decision to adopt 'our recommendation' to stop the automatic
debiting of a private company’s franking account when a deemed dividend arises.
He claimed that the decision to repeal section 108 of the ITAA shows that the Government
is 'serious about continuing real tax reform for small business'. Mr Moltoni
also noted that giving the Commissioner of Taxation the discretion to disregard
a deemed dividend 'will go a long way to restoring equity and the Government is
to be commended'.[1]
Schedule 4—Taxation of superannuation death benefits to non-dependants
Submissions
3.2
Two submissions were received in relation to this schedule. The first,
from the United Firefighters Union, argued that the benefit should be extended
to the dependents of other workers who die on the job each year. The Union
argued that this would include, but not necessarily be limited to, emergency
services workers.
3.3
The second submission, from the Association of Superannuation Funds of
Australia (ASFA), indicated that ASFA does not oppose the measure. ASFA, like
the Firefighters, appears to be focussing on a wider group of workers. ASFA pointed
out that under the recent simplified superannuation changes, there are
differing rates of tax depending on whether a superannuation death benefit is
paid to a dependant or a non-dependant, even when the deceased member is aged
over 60. ASFA argued that there should be consistency of taxation for the
benefits of deceased super fund members aged 60 and over.
3.4
Some committee members, while emphasising that they did not wish to
denigrate in any way the risks faced by the defence forces and police, queried
why these benefits were not being extended to other emergency services
personnel. The example of fire fighters sent to other countries to assist in
fire emergencies was noted, and Treasury representatives were asked whether
they had looked at the costs of extending the measure to other groups. Treasury
representatives advised that they had not done so, because this is a policy
issue.[2]
3.5
The committee did not explore the ASFA submission with Treasury
representatives, but notes that the policy underlying the schedule is targeted
at specific groups and does not have wider application. As such, it is not an
appropriate vehicle for considering ASFA's argument.
Schedule 8—Forestry managed investment schemes
The plantation timber industry's
position on the bill
3.6
The committee received a joint submission on Schedule 8 from the
National Association of Forest Industries, Tree Plantations Australia, Treefarm
Investment Managers Australia and the Australian Plantation Products and Paper
Industry Council. These groups support the legislation, arguing that it
resolves 'ten years of instability and uncertainty about the future ongoing
taxation arrangements for retail forestry'.[3]
3.7
The joint submission argued that the forestry managed investment market
is highly sensitive to policy change and investor confidence. In this context, it
emphasised the importance of the bill in terms of removing:
- the sunset clause on the existing 12 month prepayment rule. This
rule allows a plantation manager a maximum of 12 months to carry out 'seasonally
dependant agronomic activities' for which the grower has paid and claimed the
business tax deduction. Under the sunset clause, this rule was to terminate in
July 2008;[4]
- the requirement to test whether investors are 'carrying on a
business'; and
- the tax impediment in tax ruling TR 2000/8 to the secondary
market trading of interests in forestry managed investment schemes.[5]
3.8
The submission also outlined some of the technical and timing issues
that Treasury and ATO officials had to consider in developing the legislation.
In particular, it noted the Government's 'surprise intention' to implement the
legislation as of 1 July 2007 rather than at 30 June 2008, when the 12 month prepayment rule is due to expire. Under the transitional arrangements, the
existing regime will continue to be available past 1 July 2007 to enable industry and the ATO to 'bed down' the ATO's new guidelines and procedures. The
submission described this decision as 'sensible and necessary'.[6]
3.9
The joint submission stated that the plantation timber industry's
consistent position on the issue of the forestry managed investment scheme tax
regime has been to remove the sunset clause and the impediment to secondary
market trading. The industry proposed to government that a specific deduction be
created under section 8-5 of the ITAA 1997; government proposed a '70 per cent
test' in place of its initial proposal of a dollar value cap on first-year. The
submission noted that this approach introduces additional compliance and
record-keeping requirements for companies, taxpayers and the regulator.
However, it concluded that:
...the Bill that has resulted from Treasury's consultation
process...strikes a workable balance of fulfilling the Government's diverse
policy objectives...without imposing an administrative burden that the parties
will find unacceptable in order to achieve these outcomes.[7]
Treasury's response
3.10
Mr Blair Comley, General Manager of the Business Tax Division in
Treasury, told the committee that the 70 per cent figure:
...was a policy decision made by government. It reflected a
balance between the desire to have investment funds directed into the forestry
industry and a concern about excessive fees, commissions and other things that
were not flowing into forestry.[8]
Committee comment
3.11
The committee supports the amendments in Schedule 8 of the bill. They
are consistent with government's strategic plans for the forestry industry as
established in the 1997 strategy, Plantations for Australia: the 2020 Vision.
Schedule 10—Distributions to foreign residents from managed investment
trusts
Submissions
3.12
Of the 11 submissions received by the committee, six commented on Schedule
10 and all made the same point: that to implement a withholding tax at the 30
per cent company tax rate will be a disincentive to foreign investors,
notwithstanding the ability of the investor to claim various deductions. They contend
that similar tax arrangements in other countries only attract a 15 per cent tax
rate or less. The following is a typical comment:
The Investment and Financial Services Association (IFSA) submits
that Australia needs a withholding tax regime, which is both competitive and
removes the need for complex administration... IFSA advocates the introduction of
a flat and final withholding tax at the rate of 12.5 per cent.
Our nearest neighbours, and competitors, have far more
competitive rates of withholding: Japan has a withholding tax rate of 7 per
cent on REITs (Real Estate Investment Trusts) (and 0 per cent for super funds),
Singapore imposes 0 per cent for individuals and 10 per cent for other
investors and Hong Kong has an effective rate of 15 per cent on REITs, as does
the US.
The proposed 30 per cent rate is not final and, in addition to
the compliance burden for Australian fund managers, permits the investor to
offset it with deductions. After these deductions, the same net Australian tax
cost as a reduced flat rate could be produced.
However, many non-resident investors in Australian funds are
large institutions (eg pension funds), who are only concerned with obtaining
the best return for their investors.
They are interested in the headline rate, as well as minimising
any compliance costs. If they need to lodge an Australian tax return, and
obtain a refund, when they could simply invest in a jurisdiction like Hong Kong,
they will – even if the rate is ultimately the same... Australian managed funds
are concerned that, if the present system is not changed, it will be a major
deterrent to offshore investment.[9]
3.13
IFSA also raised concerns about various aspects of administrations
including the definitions of 'managed unit trust' and 'intermediary', as well
as compliance costs and under distributions of funds.
Public hearing
3.14
Both the Property Council of Australia (PCA), and the Investment and
Financial Services Association (IFSA) attended the 1 June 2007 hearing and reiterated their fundamental argument; namely, that a withholding tax levied at the
company rate of 30 per cent was a disincentive to foreign investors regardless
of the various deductions that may be claimed to offset it.
3.15
IFSA claimed that reducing the rate to 15 per cent or below would
increase the industry’s economic capacity and Australia's Gross Domestic
Product. They also argued that increasing the attractiveness of Australian
property trusts would attract capital inflows and assist in maintaining low
domestic interest rates. Mr Richard Gilbert told the committee that:
...the relevant point for domestic housing, residential, is that
we need in this country as much capital as we can get in order to keep that
interest differential down. If we do not get that right, rates could be
affected upwards.[10]
3.16
The witnesses claimed that the 30 per cent 'headline' rate has a strong
deterrent effect on potential investors into the Australian managed funds and
property markets. This in turn would reduce the global competitiveness of
Australian property trusts. Mr Robin Speed, Chairman of Speed and Stracey
Lawyers, who has direct dealings with international investors, stated in
response to a question for the committee that:
The person on the other side of the phone cannot understand the
30 percent rate.... It has a dramatic chilling effect on any investment into Australia.[11]
3.17
Moreover, representatives from both organisations claimed that the
administrative burden to lodge an Australian tax return in order to recoup part
of their 30 per cent tax was likely to be a serious disincentive for investors.
Overseas investors do not want the complication of doing this, and
historically, very few of them do.
3.18
The IFSA and PCA representatives also argued that while a higher
withholding tax rate had been a disincentive in the past, this was like to
become worse in the future. Mr Trevor Cooke argued that the international funds
market was dynamic, and that new entrants into the market such as Germany, China
and possibly even India would make attracting foreign investment even more
competitive.
I think it is also important to recognise the changing nature of
the investment landscape since 2003—in particular, sitting here in 2007 and
looking forward to 2010. There is a worldwide structural oversupply of capital
to meet the existing stock that is available for investment. There is a
worldwide hunt for investment stock, and Australians have been at the forefront
of that. But investors are being presented with a substantially increased
choice, because other nations have embraced a weak regime—and I have mentioned
the UK, Germany, Italy, Japan, Singapore, Hong Kong, Korea and others—while at
the same time imposing lower tax rates on it. So, yes, the point is taken that
foreign investors had limited choice, but they have increasingly had more
choice. The other way of looking at it is that, since 2003, they have had more
choice as to where they are going—and that will continue to be the case.[12]
The point we are trying to make is that that landscape is
rapidly evolving. Whether or not we are able to retain the competitive
advantage that we have built up over a period of time will in large part be
driven by the taxation rate that applies to the investor. That is why
withholding tax for foreign investors on Australian sourced income becomes an
important component of that... our position will be substantially eroded and our
ability to compete internationally will be eroded. The message that a headline
rate of 30 per cent sends—the signal that it sends to an investor, irrespective
of their ability to structure in—will dampen our competitiveness.[13]
Gearing of foreign investments in Australia
3.19
Mr Speed criticised the bill for legislating a headline withholding rate
of tax rather than a final and flat withholding rate of tax. He told the
committee that all other countries had opted for a final withholding tax of 15
per cent or less, with no scope for deductions.[14] Mr Speed
told the committee that the effect of the high headline rate was that large
foreign pension funds seeking to invest in Australia are deterred, given they
most do not pay tax and that other countries have significantly lower
withholding tax rates.
3.20
Mr Speed noted that, in theory, the large foreign pension funds are able
to gear their investment at 75 per cent under Australia's thin capitalisation
rules.[15]
He added that 'rationally, you would expect them to gear'.[16] Mr Trevor
Cooke, Executive Director of the Capital Markets Division of the Property Council
of Australia told the committee that on the advice of the major investment
houses in Australia, 'no one was not gearing'.[17] However,
Mr Speed could not provide any indication of the extent to which foreign funds
are currently gearing, and explained that this data would not be forthcoming
for 'at least another three or four years'.[18]
3.21
However, the broader point emphasised by Mr Speed was that investors
will not lodge an Australian tax return and claim deductions on the 30 per cent
headline rate through gearing. He explained that 'whilst it may seem odd, the
truth is that they [the foreign investors] do not want to do it [gear]. It is
an administrative problem for them and they will not do it'.[19]
Mr Richard Gilbert, Chief Executive Officer of the Investment and Financial
Services Association, agreed that deductions on the 30 per cent headline rate
are 'messy, complex and not attractive to overseas investors'.[20]
These investors prefer to pay the final tax rate as they do in other countries.
They are investing much larger sums in other countries where they do not have
to structure their affairs, and are therefore reluctant to gear the relatively
small sums they might invest in the Australian real estate market.[21]
3.22
Mr Speed told the committee that there is therefore a legitimate debate
about the extent to which companies are going to gear. In theory, through
gearing, foreign companies investing in Australia can easily reduce their
withholding tax rate to 12 per cent 'without being aggressive'.[22]
However, industry representatives apparently dismiss the likelihood that
companies will gear and contend that the combination of a high headline rate, no
final flat rate in Australia, and perceived administrative difficulties with
gearing is enough to cause potential foreign investors in Australia to look
elsewhere.
IFSA's proposal
3.23
Submissions received prior to the public hearing proposed various rates,
between 12.5 and 15 per cent. However, at the public hearing, the PCA and IFSA presented
to the committee an alternative, compromise proposal that foreign investors in
Australian funds receive the same tax treatment as Australian would receive
when they invest in those overseas countries' funds.
We believe it would uphold the Australian sense of balance and
fairness—that is, it has parity, mutuality and reciprocity. The third point,
which I think is critical, is that this is something which the board of tax
suggested in its report.[23]
They recommended:
...residents of a foreign country who are investors in Australian
managed trusts will be reduced on a reciprocal basis to the same as that
foreign country's tax treatment of Australian residents who invest in its
managed investment funds.[24]
Treasury response to submissions
and evidence
3.24
At the commencement of the public hearing, the Treasury representative
reiterated the objectives of the amendments in this schedule, which were to
simplify and strengthen the existing withholding tax arrangements:
...the objective of this schedule is to simplify and streamline
the existing withholding tax arrangements. It does replace multiple regimes and
multiple rates with a more efficient collection mechanism regime and a single
rate. The object is one of simplifying and providing more certainty and
reducing compliance costs.[25]
3.25
Treasury representatives pointed out that taxation is only one factor in
influencing whether the Australian managed investment trust market is
competitive internationally, and investors would look at a range of factors
including the after tax rate of return and the strength of the economy, not
just the tax rate:
...it does not simply come down to tax. Looking at the reports
from the retail investment trusts—the world reports that the accounting
companies put out—in terms of rates of return, in Australia in 2006 the return
was about 18.5 per cent. It was the third highest. As I recall, South Africa
and New Zealand were relatively very small. Part of the attractiveness of
investing in retail property trusts in Australia is the overall rate of return,
the overall performance, the overall performance of the economy et cetera.
Investors would take into account the after-tax rate of return, not simply the
tax rate. That applies when looking at any type of international
competitiveness. You are looking at a range of factors.[26]
3.26
Treasury representatives questioned the alleged deterrent effect of a 30
per cent withholding tax rate on foreign investment, noting that while there
had been difficulties with collection, similar and higher rates (in the range
29 to 45 per cent), have been in place for some years, and during this period, inflows
of foreign capital investment into Australian property trusts had been
substantial. Mr Callaghan pointed out that '...in that assessment of how
competitive the rate is you can look at the evidence that is occurring now'.[27]
3.27
Treasury representatives also questioned whether the 30 per cent rate is
uncompetitive against international rates, stating that a number of other
countries had rates that were similar, although rates may be lower where a
double tax treaty is in place:
Just commenting on the international comparisons, I think what
has been quoted this morning is 15 per cent. Looking at different structures
overseas, you are not always comparing like with like. We have different
organisational structures, different regulatory structures. When we look at the
withholding tax arrangements we find that in Canada there is a 25 per cent
withholding tax on foreign distributions but it is reduced in double tax
treaties, generally down to 15 per cent. In the United States there is a 30 per
cent withholding tax on distributions from estate investment trusts but it is
reduced to 15 per cent for portfolio investments under its double tax treaties;
so they start off much higher. Similarly, in Korea there is a 27.5 per cent
withholding tax but they reduce it down in their double tax treaties. Japan has
a seven per cent rate but it is scheduled to increase to 15 per cent after 1 April 2008. It only applies to listed property trusts. For unlisted property trusts it
is 20 per cent. In Singapore, listed REIT is subject to 10 per cent, but this
is temporary; it is scheduled to return to 20 per cent on 18 February 2010. So I think we have to be careful of these international comparisons.[28]
3.28
The rate in Japan also varies in accordance with whether the property
trust is listed or unlisted, and in some circumstances where investments are
substantial, can be as high as 30 percent:
On 1 April 2007 it was only a temporary seven per cent. It is
going to 15 per cent on 1 April 2008. As I say, it only applies to listed
property trusts. For unlisted trusts it is 20 per cent. Like all things, in the
case of Japan if a foreign investor owns more than five per cent of a listed
REIT then any capital gain is subject to Japanese tax at 30 per cent.[29]
3.29
Treasury also advised the committee that the withholding tax only
applies to returns on Australian real property, a mature market, 70 per cent of
which is already securitised. As a result of this market maturity, the focus of
activity for Australian managed investment trusts is now overseas, and returns
from investments overseas flowing through Australian managed investment trusts
to foreign investors are not subject to the tax.[30]
3.30
Responding to questions from committee members about what the cost to
revenue would be if the proposed withholding tax rate was reduced to 15 per
cent, Treasury said that the cost would be $100 million, without allowance for
gearing by investors.[31]
Committee comments
3.31
The main question for the committee in consideration of this schedule was
whether the implementation of a headline withholding tax rate of 30 percent
would adversely affect the global competitiveness of Australia's managed investment
trust market, as has been argued in most of the submissions made to the
committee's inquiry.
3.32
The committee notes the evidence from IFSA, the Property Council and
others that other countries have lower rates. However, on the basis of evidence
from Treasury representatives, it is not correct that similar headline rates do
not exist elsewhere, even though these may be reduced substantially where
double tax treaties are in place.
3.33
The committee agrees with Treasury's assessment that headline rates of
tax alone are not going to be the sole determinant of overseas investment
decisions. Investors will undoubtedly be interested in the after tax rate of
return, but they will also be concerned about economic stability and
management, and Australia is widely acknowledged as being a safe place to
invest.
3.34
It is also important to note that this tax does not apply to returns
from investments overseas flowing through Australian managed investment trusts
to foreign investors. It applies only to returns on Australian real property.
As several witnesses noted, the Australian real property market is mature, and
70 per cent is already securitised. Treasury told the committee that the
property trusts have indicated that it is difficult looking for expansion of
real property in Australia.[32]
Consequently, the focus of activity for Australian property trusts is now
overseas.
3.35
While an investment trust that has a mixture of Australian real property
and overseas assets may become exposed to some withholding tax even though most
of its assets may be overseas, it is only liable for the tax for that
proportion of the distribution from Australian real property assets.[33]
There are also options available using the demerger provisions to allow overseas
property investments to be split off from Australian real property investments and
therefore not subject to the tax. LPTs can also establish new trusts to attract
new investment and hold exclusively foreign assets. As such, the case is not
well made that this change would make the Australian property trust market
uncompetitive, even if the tax rate of 30 per cent was seen by some potential
investors as a potential deterrent.
3.36
While the committee considers that on balance, the 30 per cent rate is
unlikely to have the effects on market competitiveness that some have
predicted, nonetheless, it does not lightly dismiss the concerns expressed by
those who gave evidence in submissions and the hearing. The committee therefore
suggests that the government carefully monitor developments in the industry
following passage of the legislation.
3.37
The committee considers that the approach suggested by IFSA at the
public hearing has some merit, (see paragraph 3.23) but believes that this should
only be implemented through double tax treaties.
Recommendation 1
3.38
The committee recommends that when negotiating double taxation treaties,
the Government considers reciprocal withholding tax treatment for distributions
to foreign residents from managed investment trusts.
Recommendation 2
3.39
The committee recommends that the bill be passed.
Senator the Hon.
Michael Ronaldson
Chair
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