Chapter 3 - Issues in relation to Schedules 1 and 2
Schedule 1—Small business capital gains tax concessions
3.1
The committee received a submission and accompanying paper in relation
to Schedule 1 from Dr Mark Burton at the Law School, University of Canberra.[1]
Dr Burton argues in his paper that small business tax concessions are
being made and regularly increased with minimal impartial and credible critical
scrutiny as to the effectiveness of the program. Specifically in relation to
the small business capital gains tax concessions, he states that:
...in the absence of publicly available data as to the
beneficiaries of these captial gains concessions, and the use to which the
benefit of the concessions is put, it is impossible to assess the merits of the
concessions.[2]
3.2
Although Dr Burton's paper does not specifically addresss Schedule 1 of
the bill, he expressed concern about the proposed extension of the small
business CGT concessions:
It is with considerable concern that I see that the Australian
government proposes to expend a further $100 million dollars without,
apparently, undertaking any credible study justifying such expenditure. I also
note the compressed timeframe allowed for scrutiny of this proposed measure.
Both aspects of the process by which this measure has arisen give great cause
for concern if Australia is, truly, to achieve a minimum standard of public
accountability.[3]
Schedule 2—Exemptions from interest withholding tax
3.3
Four of the five submissions received by the committee expressed
concerns about the amendments in Schedule 2 of the bill. The Australian
Financial Markets Association (AFMA) asserts, for example, that the amendments
will 'reverse the interest withholding tax relief granted to certain
non-debenture debt interests by the Government in 2005 and enable the
introduction of regulations to potentially curtail the availability of the
exemption for certain debentures previously eligible for relief.'[4]
3.4
The importance of Interest Withholding Tax (IWT) exemptions was
highlighted by the AFMA which notes in its submission that the gradual
extension of IWT relief over the last decade 'has benefited Australian
consumers and business by providing a broader range of cost effective finance
and it has assisted the development of our financial markets.'[5]
3.5
Specifically, several submissions focused on the effect of the changes
on the syndicated loan market. As described by the Reserve Bank,[6]
the borrowing requirements of businesses are sometimes beyond the funding and
credit risk capacity of single lenders. As a result, some loans are arranged as
syndicates with the funds jointly provided by two or more lenders. Though there
is a single loan agreement, each participant to a syndicated loan maintains a
separate claim on, and bears the credit risk for, the portion of the loan that
it has provided. The amounts of such loans are typically large and the
syndicated loan market in Australia has expanded rapidly in recent years. The
broadening of the IWT exemptions following the amendments to the Income Tax
Assessment Act 1936 (ITAA) in 2005, allowed syndicated loans that called on
international funds to attract the IWT exemptions in sections 128F and 128FA of
the Act.
3.6
Some submitters now hold concerns that Schedule 2 of the bill will
reverse the existing situation and will 'prejudice the ability of Australian
firms to participate in the syndicated loan market'[7]
because without the IWT exemption, Australian borrowers will be forced to pay
more for the cost of capital as non-resident lenders will charge higher rates
on loans to compensate for IWT.
3.7
The amendments in Schedule 2 introduce regulation making powers into
sections 128F and 128FA. These powers will allow the Minister to specify the
debt interests that will fall under the exemption from IWT in the
sections, as well as the circumstances under which the interest paid by a
company or trustee will not qualify for the exemptions. Submissions
generally opposed this approach. The concerns fall into the following
categories and these will be considered below:
- the appropriateness of utilising regulations rather than
including the provisions in the Act itself;
- the uncertainty created by the chosen mechanisms;
- the retrospective effect of the provisions; and
- the possibility that certain debentures might be denied the IWT
exemption by regulation.
Inclusion of matters in regulations
rather than in the Act
3.8
The Australian Banking Association (ABA) considers that the matters in
question go to the heart of the operation of section 128F and such substantive
issues must be included in the primary legislation.[8]
Specifically, as regards items 4 and 7 which allow for exclusions from the IWT
exemptions to be made in 'prescribed circumstances', the ABA insists that this
should be done in the principal Act:
Measures of this nature can have effectively retrospective
operation. The proper application of the rule of law, and the protection of Australia’s
reputation in international financial markets, demands that any withdrawal of a
tax concession should occur via amendment to the primary legislation, with full
Parliamentary consideration.[9]
3.9
Additionally, as a practical matter, the ABA suggests that developing
and promulgating tax regulations is often a drawn out exercise and the length
of the process and consequent uncertainty would be an unreasonable imposition
on Australian and foreign market participants.[10]
3.10
The Institute of Chartered Accountants in Australia (ICAA) went further
and disputed whether there is a need for a regulation making power at all. The
ICAA attributed the motivation for the proposed changes to apparent Treasury
and Australian Taxation Office (ATO) concern that 'interest on some term
deposits and other standard bank accounts...might qualify for the IWT exemption
inappropriately.'[11]
However, according to the ICAA, there are more efficient ways of excluding such
deposits from the exemption; and that it is ‘not aware of any other financial
instruments in respect of which the ATO and Treasury have similar concerns’.
The ICAA concluded that accordingly, there is no need for any other exclusions,
and no need for a power to make regulations to exclude particular instruments.[12]
3.11
Questioned about why particular instruments were to be included or
excluded via the regulation power instead of via legislative amendment,
Treasury and ATO officers said that this approach provides the Government with
the flexibility to address developments in the market place.[13]
The committee notes that the regulation power does allow the Government to
respond to a fast evolving market considerably more quickly than would be the
case if developments were addressed via legislation.
3.12
Treasury officers also assured the committee that it was not the
Government's intention at this time to put forward regulations using the
exclusion power.[14]
This power is intended to be a reserve power to be used only if there is
evidence of systemic attempts to broaden the types of instruments eligible for
the IWT exemption beyond those intended in the policy.
Uncertainty
3.13
The regulations are not currently available in draft form and so it is
unclear what debenture and debt interests will be excluded from and entitled to
the IWT exemption in comparison to the current situation. The AFMA suggests
that a taxpayer in the course of preparing a financing arrangement that is a
debenture cannot be certain that the arrangement will not be prescribed by a
regulation.[15]
It argues that such a scenario will create uncertainty and generate additional
compliance costs which, contrary to the statement in the Explanatory Memorandum,
will not be 'negligible'. The AFMA suggests that these concerns are exacerbated
by the absence of clear principles to govern the application of the regulations
to particular arrangements.
3.14
The mechanisms chosen in the bill were also cited in submissions as
creating uncertainty. The ABA takes issue with the continued reliance on the
'somewhat ill-defined and archaic description of a “debenture”' as a means to
identify debt interests that are entitled to IWT exemption.[16]
The AFMA considers that the approach in the bill would undermine the principle
of tax neutrality across economically similar products that is a feature of the
current law.[17]
Businesses borrowing in the wholesale markets can avail of a
range of facilities without incurring a withholding tax liability. At present,
it is not necessary to utilise one debt instrument in preference to another
that is in substance the same, but is more convenient or incurs lower
transaction costs, because the withholding tax outcome is different. Similarly,
lenders apply the same internal credit policies and management procedures to
debt interests that are in substance the same.[18]
3.15
The Asia Pacific Loan Market Association (APLMA), which endorsed the ABA
submission, also submitted that its major concern was in relation to the
uncertainty that the bill has caused in respect of the syndicated loans market.[19]
3.16
The ICAA also addressed the issue of uncertainty, telling the committee
that this arises partly out of how the legislation is drafted, and partly out
of the regulation power. Mr Duncan Baxter of the ICAA said that there is
concern within the industry that because of the way the amendments have been
drafted, there is the potential to exclude almost any form of debt interest.[20]
The ICAA representatives said that they preferred the use of legislation rather
than regulation because of the level of certainty provided.[21]
3.17
The ABA and the AFMA suggest that a preferable mechanism to achieve the
aim of preserving the tax system integrity would be to utilise what the ABA
terms a 'negative list'.[22]
This approach would recast the provisions in the bill so that regulations are
used only to exclude specified arrangements or debt interests that would create
a risk to the tax revenue.
3.18
Mr Tony Burke, Director, ABA told the committee that the ABA had put
forward suggested amendments for the Treasury to consider in place of the
approach in the bill.[23]
He said that the ABA's suggested amendments directly target the concerns of the
Treasury and ATO and removed the regulatory risk problem that is of concern to
the market.
3.19
Treasury officers confirmed that the Government was considering the ABA's
proposed amendments.[24]
Retrospectivity
3.20
The amendments limiting eligible debt interests to non-debenture debt
interest that are non-equity shares will apply to debt interests issued on or
after 7 December 2006 (which was the day on which the bill was introduced into
the House of Representatives). Contrary to the statement in the Explanatory
Memorandum that the amendments will have no financial impact, several submissions
assert that the bill will be retrospective and will effectively impose costs
via interest withholding tax 'gross up' clauses on Australian borrowers who
negotiated loan arrangements in good faith based on current law.[25]
3.21
Submissions suggest that certain syndicated loan facilities in particular
may be affected by the legislation with retrospective effect. Those facilities
that were arranged prior to 7 December 2006 but which would have amounts drawn
down after that date, would be affected by any regulations that were formulated
to exclude them from the IWT exemption.
3.22
The APLMA was amongst those who contended that the date of effect
amounted to retrospective effect in respect of ‘drawdowns on pre 7 December 2007 128F compliant facilities’.[26]
3.23
The ICAA did not describe the proposed changes as being retrospective,
but did make similar points to the other submissions in relation to interests
that issuers may not have issued but to which they were nonetheless committed.
The ICAA noted that the proposed transitional rules only preserve the existing
treatment for interests issued as at the operative date, but submitted that
this should be extended to include interests and facilities to which the issuer
was committed as at that date.[27]
3.24
The ICAA argued that there is a need to ensure that the transitional
rules preserve the existing treatment for a range of circumstances including:
- debt interests to which an issuer was already committed but had
not yet issued any interests;
- staggered draw-downs already partly issued;
- redraws;
- rollovers;
- novations; and
- facilities issued that are varied after the operative date.[28]
3.25
Treasury officers advised the committee that it was not the intention in
the legislation to unwind currently accepted practices.[29]
Rather, the legislation, including the regulation making power, was developed
to re-affirm the Government's policy in relation to the instruments intended to
be eligible for the IWT exemption. The legislation also responds to
'interpretive pressure' to broaden the exemption to other products, such as
certificates of deposit to be made available to the retail market.
Potential exclusion of debentures
from the IWT exemption
3.26
The ICAA noted that the regulation making power would extend to
debentures as well as other debt interests. It submitted that there is ‘no
policy need to suddenly exclude particular debentures from the exemption’.[30]
3.27
Treasury officers emphasised that there was no intention at the present
time to use the regulation making power to exclude existing arrangements.[31]
Committee comments
3.28
The committee notes evidence received that the introduction of the bill
has given rise to a degree of uncertainty in relation to whether some
debentures and other debt instruments will be excluded from current IWT
exemptions. Industry concern is focussed in particular on whether syndicated
loans will continue to qualify for the IWT exemption, although there are also
broader concerns about other products. These concerns originate from the
relatively broad powers in the bill allowing debt instruments to be either
included or excluded from IWT exemption, and from the absence of detail in
relation to the regulations.
3.29
The committee also notes concerns about transitional arrangements and
the implications of the commencement date for the legislation on instruments
such as staggered loans only partially issued, redraws, rollover loans and
other loan facilities varied after the operative date.
3.30
The Treasury has explained that this legislation is intended to
re-affirm the Government's policy in relation to the instruments intended to be
eligible for the IWT exemption and to respond to 'interpretive pressure' to
broaden the exemption to other products. It is not intended to unwind currently
accepted practices. As such, it does not appear that concerns about
transitional arrangements or the future exemption of products such as
syndicated loans are well founded.
3.31
Nonetheless, the committee considers that it would be desirable for the
Government to re-examine the issue of transitional arrangements, to ensure that
appropriate grandfathering arrangements are in place. The committee also
considers it desirable for the Government to respond to concerns raised about
the future status of syndicated loans.
3.32
The ABA has put forward amendments for the Government's consideration as
an alternative to the approach in the bill. The ICAA has also made direct
representations to the Government in relation to its concerns. The Government
is yet to respond to the ABA's proposed amendments or to the ICAA's
representations.
Recommendation 1
3.33
The committee recommends that the Senate pass the bill.
Senator the Hon Michael Ronaldson
Chair
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