Pre Budget Submission Australian Financial Markets Association

Transcription

1 31 January 2013 Mr Bill Brummit Budget Policy Division Department of the Treasury Langton Crescent PARKES ACT Dear Mr Brummit Pre Budget Submission The Australian Financial Markets Association (AFMA) represents the interests of over 130 participants in Australia's wholesale banking and financial markets. Our members include Australian and foreign owned banks, securities companies, treasury corporations, traders across a wide range of markets and industry service providers. Our members are the major providers of services to Australian businesses and retail investors who use the financial markets. In making its submission with respect to the Federal Budget, AFMA is mindful of the fiscal challenges presented by the current global economic climate and the associated downward pressure on government revenues. Accordingly, the issues raised in our submission are those that AFMA believes will stimulate economic activity of Australian enterprises operating in the financial sector without being significantly detrimental to revenue. AFMA is mindful of the need to improve the effectiveness of the financial sector while meeting the Government s strong commitment to fiscal discipline. As foreshadowed in the Johnson Report 1, financial markets and particularly debt securities markets (such as corporate bond markets) are becoming systemically more important than previously. Banks will be increasingly constrained in their capacity to leverage their balance sheets to comply with enhanced regulatory capital and liquidity requirements. Accordingly, it is our view that Treasury policy generally, and the Budget specifically, should reflect the current economic and financial climate and ensure that reforms that are undertaken promote the efficiency and competitiveness of the Australian financial markets. 1 Australia as a Financial Centre Australian Financial Markets Association ABN Level 3, Plaza Building, 95 Pitt Street GPO Box 3655 Sydney NSW 2001 Tel: Fax: info@afma.com.au Web:

2 Our submission is structured in two sections: the first addresses those issues that have arisen in the past twelve months, while the second provides an opportunity to reiterate issues that have been raised in prior submissions that continue to be a priority for AFMA members and remain outstanding. Thank you for the opportunity to contribute to the Government s consideration of matters that should be addressed in the Budget. We would be happy to discuss any of the matters that we have raised in this submission. Yours sincerely David Lynch Executive Director Page 2 of 12

3 1. New issues arising for Alignment of Regulatory and Tax Policies for Central Clearing Subsequent to commitments made by the G 20 nations 2 in 2009 to implement reforms to improve the transparency of over the counter (OTC) derivatives markets, steps have been undertaken leading to centralised clearing of OTC derivatives. In the US, this forms part of the Dodd Frank Act regulatory reforms and, in Australia, it forms part of the work program of the Council of Financial Regulators (COFR). The practical effect of the move towards the centralised clearing of OTC derivatives is that payments that have traditionally been made to OTC counterparties are being made to Central Clearing Parties (CCP) who act in a principal capacity on both sides of an OTC transaction. Further, under a centralised clearing model, increased collateral requirements are imposed on the parties to the derivatives transaction, with such collateral taking the form of Initial Margin, Variation Margin and Price Alignment Interest (PAI). COFR considers the OTC market for Australian dollar interest rate swaps to be systemically important within Australia. However, it is noted that, at the time of writing, there is no resident CCP for OTC swaps in Australia. Consequently, for swap transactions that are centrally cleared, the implementation of the G 20 reforms has resulted in payments out of Australia. PAI is calculated on the mark to market adjustments of the swaps to reflect a daily compensation or cost for excess or insufficient collateral. A party that held a shortfall of collateral due to an adverse mark to market movement will pay PAI in respect of that shortfall. For centrally cleared transactions, an Australian party to a transaction with a shortfall of collateral will be obliged to pay PAI to the non resident CCP. It is AFMA s view that such a payment may attract the imposition of Australian Interest Withholding Tax (IWT). The imposition of IWT on a transaction merely by virtue of the fact that the transaction was centrally cleared would, in AFMA s view, be an unintended consequence of the implementation of the G 20 reforms. Moreover, this consequence does not arise in key global jurisdictions, like the US, UK and Singapore. Under existing industry practice, such as that enshrined in market standard ISDA documentation, the burden of the withholding tax would fall on the Australian party by requiring that party to gross up the PAI payment to remove the burden of the IWT on the payee. However, the imposition of withholding tax will affect the pricing of the transaction and may result in rendering Australian parties uncompetitive, thereby significantly impacting the profitability of Australian enterprises that currently undertake such transactions. This would have an adverse impact on the current tax revenue base. 2 South Africa, United States, Canada, Mexico, Brazil, Argentina, China, Japan, South Korea, India, Indonesia, Russia, Turkey, European Union, Germany, France, United Kingdom, Italy, Saudi Arabia and Australia Page 3 of 12

4 AFMA, together with the Australian Bankers Association, are shortly to provide a detailed submission on this interest withholding tax consequences arising from the requirement to post collateral to non resident clearing parties to Treasury. In the view of the AFMA membership, it is crucial that Treasury address this issue as a matter of priority FATCA Commitment to Intergovernmental Agreement On 7 November 2012, the Treasurer announced that Australia had commenced formal discussions for an intergovernmental agreement with the United States to minimise the impact for Australians of the United States Foreign Account Tax Compliance Act (FATCA) in Australia. 3 This was a very welcome announcement for AFMA members given the benefits arising under the Model I Intergovernmental Agreement (which is expected to be the model of agreement that Australia will pursue) when compared to FATCA compliance under the FATCA Regulations. Financial institutions have incurred, and continue to incur, significant costs in preparing to comply with the FATCA requirements. As Treasury has previously been advised, the processes that Australian financial institutions will implement to comply with FATCA will differ significantly depending on whether the institutions are operating under an Intergovernmental Agreement or the FATCA Regulations, especially for multinational financial institutions that are headquartered in Australia. U.S. Treasury officials have stated publicly that a financial institution in a particular jurisdiction may only rely on the government of that jurisdiction implementing an Intergovernmental Agreement where that agreement is signed. That is, Australian financial institutions are able to place appropriate reliance in shaping their response to FATCA based on an Intergovernmental Agreement as opposed to the FATCA Regulations where the Australian Government has signed such an Agreement, even if the implementing local legislation remains unenacted. On 17 January 2013, the US Treasury released the final FATCA regulations. While these regulations have addressed a number of issues that were raised in respect of the draft regulations, there remain significant benefits associated with the Intergovernmental Agreement approach to FATCA compliance. Such benefits in the Model I Intergovernmental Agreement include: The ability to effectively exclude Australian complying superannuation entities from all of the FATCA requirements; The provision of an enduring quarantining mechanism for Australian headquartered financial institutions in respect of affiliates located in jurisdictions that cannot comply with FATCA due to conflict of laws issues; and 3 Australia and the US commence discussions on Foreign Account Tax Compliance Act, 7 November 2012 Page 4 of 12

5 Closer alignment to existing Anti Money Laundering/Know Your Customer protocols and threshholds, thereby minimising the operational impact of FATCA compliance. Accordingly, AFMA reiterates its view that Australia should pursue a Model I Intergovernmental Agreement. As FATCA will be operative for Australian financial institutions from 1 January 2014, with registration required beforehand (by October 2013), such an Agreement should be signed as soon as possible Monthly PAYG for Large Companies In its Mid Year Economic and Fiscal Outlook (MYEFO), the Federal Government announced a proposal to compel large companies (defined as companies with an annual turnover in excess of $20 million) to make Pay As You Go (PAYG) income tax instalments monthly. This is opposed to the current practice of quarterly instalments. The proposed implementation of this measure would commence: From January 1, 2014 for companies with an annual turnover equal to or greater than $1 billion; From January 1, 2015 for companies with an annual turnover equal to or greater than $100 million; and From January 1, 2016 for companies with an annual turnover equal to or greater than $20 million. In its MYEFO, Treasury forecasts that this measure would yield the following revenue increases over the forward estimates period: $5.5 billion; $1.6 billion; and $1.2 billion. Importantly, as noted in the MYEFO, the revenue increases arising from the implementation of this measure are determined on an underlying cash basis. 4 It is AFMA s view that any material benefit arising from the implementation of monthly PAYG instalments for large companies arises only in respect of the underlying cash balance and not the fiscal balance, to the extent that the fiscal balance is determined on an accruals basis. Such a benefit to the underlying cash balance arises as the proposed measure serves to effectively bring forward fourteen months of PAYG instalments into the twelve month period in terms of cash receipts for the first year of implementation for each group of companies. The benefit can, therefore, be quantified as the time value of the government having the use of the PAYG instalments either two months or one month early. 4 Mid Year Economic and Fiscal Outlook, p12 Page 5 of 12

6 Implementation of the Government s proposal will significantly increase the compliance costs for affected companies and focus the energies of employees in those companies on non revenue generating activities. Further, the proposal will impact on cash flows for business with requirements to amend budgets and projections. It is AFMA s submission that such detrimental impacts significantly outweigh the fiscal benefit arising to government from the implementation of the measure. Accordingly, AFMA submits that the current system of quarterly PAYG instalments for large companies be maintained. Page 6 of 12

7 2. Previously Raised Issues that Remain Outstanding 2.1. LIBOR Cap The tax deductibility of interest paid by a foreign bank branch on funds borrowed from its parent is capped at an amount not exceeding the London Interbank Offered Rate (LIBOR). The LIBOR cap unnecessarily inhibits the flow of capital into Australia through foreign bank branches and, therefore, increases pressure on the availability and cost of credit to Australian business. Recognising its cost to the economy and its impact on our international competitiveness, the Johnson Report recommended the abolition of the LIBOR cap. The LIBOR cap is defective tax policy because it conflicts with internationally accepted transfer pricing norms that rely on arm s length pricing. It also has serious technical flaws; notably because it is not a representative funding rate for individual banks or for funding at a maturity greater than twelve months. In addition to improved international competitiveness, AFMA has identified significant economic benefits from the abolition of the LIBOR cap including: Greater competition in banking, with significant benefits for Australian business, particularly through reduced borrowing costs and more borrowing options; Increased diversification in the banking and financial markets, which are more concentrated, post the GFC would reduce systemic risk over time; Enhanced policy consistency including a reduced cost for foreign bank branches in meeting the Basel 3 liquidity rules being implemented by APRA. Removal of the cap is exactly the sort of measure that would fit within the Government s banking competition and growth strategy. AFMA believes the Government should announce the abolition of the LIBOR cap in the Budget, if not before then. We expect there would be a net benefit to tax revenue taking account of these effects and the amount of tax currently collected through the LIBOR cap. AFMA notes that the Board of Taxation conducted a review in late 2012 regarding tax arrangements applying to permanent establishments and is due to report to Treasury by 30 April This review included in its terms of reference consideration as to the continued appropriateness of the LIBOR Cap. AFMA provided a submission to the Board of Taxation and reiterates its stance in that submission that the LIBOR cap is defective tax policy and should be abolished Interest Withholding Tax The Government announced on 23 November 2011 that it will defer the phasing down of IWT paid by financial institutions by one year. The deferral means that: Page 7 of 12

8 The rate of IWT for foreign bank branches which borrow from their overseas head office will fall from 5 per cent to 2.5 per cent in , and to zero in ; The rate of IWT for other financial institutions which borrow from foreign financial institutions, and financial institutions which borrow from offshore retail deposits, will fall from 10 per cent to 7.5 per cent in , and to 5 per cent in This decision defers the boost to banking competition that the Government promised through this measure, and reduces the expected downward pressure on loan margins. When it occurs, the IWT reduction will improve banks access to cost effective funding from overseas sources and enable them to better contain the higher cost of financial intermediation from the global banking reforms. Australia s policy commitments at the G 20 Summit in Seoul in 2010 included the announced tax reforms to support further competition from foreign financial institutions in the domestic market and support the flow of credit to the private sector. Both the Henry tax review and the Johnson Report on Australia as a financial centre recommended the abolition of IWT for financial institutions because this would benefit the Australian economy. AFMA requests that the Government should take the necessary steps to ensure that the legislation required to implement the amendments is enacted in the 2013 calendar year. This would provide requisite certainty to foster Australia as a financial services centre and enable financial institutions to build in the change in their forward business planning with greater certainty Tax Black Hole for Retail Investors An expense in relation to an income earning activity that is not recognised for tax purposes (e.g. a deduction, depreciation or inclusion in capital gains tax cost base) is referred to as a tax black hole. It is widely accepted that a tax black hole is a sign of a deficiency in the efficiency and fairness of our tax system. AFMA s pre Budget submission in February 2010 asked the Government to introduce a solution in the Budget for a tax black hole that penalises retail investors. In short, the tax black hole in question exists in relation to non deductible interest on an investment where a capital gain is not achieved when the investment is realised, which could adversely affect many retail investors in commonly offered financial products. In response, the Assistant Treasurer advised that the Government had considered AFMA s proposal in framing its Budget but would not proceed with it at that stage due to other priorities. He went on to say that the Government may be in a position to consider AFMA s proposal further in the future. We continue to believe it would be timely for the Government to address this issue as a matter of urgency as: Page 8 of 12

9 There is no obvious public policy reason why a tax attribute should not arise in the circumstances considered here and change is required to produce a reasonable and fair outcome for investors; Financial market and economic conditions continue to be challenging for retail investors; and The issue has already been set aside for three years and, even if a decision is announced in the Budget to make the necessary change, it is unlikely that legislation would be in place before the end of the year Capital Protected Borrowings Capital protected products include protected equity loans and instalment warrants. They are an efficient investment tool for retail investors, including many retirees, to manage their financial risk and grow their wealth in a prudent way by investing in the Australian economy. Schedule 2 of the Tax Laws Amendment (2010 Measures No. 5) Act 2011 (TLAB5) reduced the benchmark rate for the tax deductibility on interest on capital protected borrowings to the indicator home loan rate plus 100 basis points. AFMA advised the Senate Economics Legislation Committee in its inquiry into the related Bill that this level is not a fair reflection of the borrowing costs for investors and it would continue to stymie the market s ability to meet their needs in a cost effective way. The data show our concerns were valid and investors have lost access to cost effective capital protection at the very time that market volatility places a premium on this. Table 1, set out below, highlights the inefficiencies associated with the reduction of the benchmark rate as set out in TLAB5, namely: i. Volume A continuous decline in market size since the Government announced a greatly reduced benchmark rate in the May 2008 Budget, with total capital protected borrowing amounts in September 2012 exhibiting a reduction of approximately 80% from of the peak (December 2007); and Price The non deductibility penalty has increased, as illustrated by the increase in the spread between the Margin Lending Rate and the Home Loan Rate between (average spread of 85 90bbps) to 2012 (spread of approximately bps). Page 9 of 12

10 Table 1 Capital Protected Borrowing ($mn) Interest Rates (Margin Lending v Home Loan) AFMA recommended to the Senate Committee that the benchmark rate should be set at the mid point between the indicator rates for housing loans and personal unsecured variable rate loans. We ask the Government to acknowledge the problem and make this change in the Budget. Given the impact of the tax measure in reducing economic activity, there are reasonable grounds to believe that this change would be revenue positive. This would provide a stable and workable solution that protects tax revenue, enable investors to go about their business in a prudent manner and reduce the likelihood of inadvertent impacts on business Traditional Instalment Warrants On 10 March 2010, Assistant Treasurer, Nick Sherry, announced that the Government intended to introduce legislation to amend the income tax rules for 'traditional instalment warrants. In effect, the changes would provide certainty about the lookthrough treatment of these instruments. On 17 January 2011, the Assistant Treasurer, Bill Shorten announced that the Government would extend the proposed income tax look through treatment to cover instalment warrants and receipts over direct and indirect interests in listed securities, as well as unlisted securities in widely held entities and bundles of these assets. Given that more than two years has passed since this announcement without any further action, we continue to encourage the Government to make the necessary policy and drafting resources available to complete this process and provide the desired legal certainty as soon as possible. Page 10 of 12

11 2.6. GST and Cross Border Transactions On February 15, 2011, the Assistant Treasurer, Mr Bill Shorten, released a discussion paper in relation to the proposed reforms regarding the application of GST to crossborder transactions. The release of this discussion paper followed the review of the Board of Taxation into the proposed reforms. The release from the Assistant Treasurer stated that the proposed reforms were to apply from 1 July 2012 and that there would be a further round of consultation in late AFMA provided a detailed submission to Treasury in relation to the proposed reforms in April 2011 where, broadly, it was submitted that the GST definition of permanent establishment be aligned to the definition for income tax. AFMA is not aware of any further developments on this issue. We believe that there are significant opportunities for meaningful reform in this area and recommend that the consultation process be re established as soon as practical Tax Black Hole Staff Termination Payments The government and the community expect companies to look after the welfare of their staff. The closure of a business can be a distressing time for employees and companies may endeavour to make redundancy payments in excess of minimum statutory entitlements to assist affected employees. The tax law should not inhibit employers who wish to help their staff in this way. However, staff termination payments made to employees upon the closure of a business may not always be tax deductible to the employer, creating a tax expenditure black hole. In technical terms, the problem arises from the interaction of s and s with s of the Income Tax Assessment Act 1936; the latter limits the tax deductibility of a pension, gratuity or retiring allowance paid to an employee. Taxation Ruling TR 2011/6 includes an example that explains ATO s view of the law: Example Company T made a payment to an employee in the form of a retiring allowance which meets the conditions for a deduction under section However, the payment resulted in the company making a loss for income tax purposes. Paragraph 26 55(1)(a) limits the deduction otherwise available under section if the deduction creates or increases a loss for income tax purposes. 2. As a result, the part of the payment to the employee that created the loss is not deductible under section As paragraph 26 55(1)(a) expressly prevents part of the payment being deductible under section 25 50, paragraph (5)(h) excludes that part of the payment from deductibility under section We believe this outcome conflicts with good tax and social policy. The Ralph Review of Business Taxation considered the tax policy issues and recommended that business Page 11 of 12

12 closure costs should be made deductible to eliminate a tax expenditure black hole. 5 Staff termination costs may be a significant component of the cost of winding up a business and they should be fully tax deductible. This outcome is also anomalous given the treatment of related expenditures (eg legal advice on a terminations payment is tax deductible). Staff termination payments arising in the normal course of winding up a business should be fully deductible. We ask the Government to clarify that its policy is that all bona fide staff termination payments are deductible and, if necessary, it should amend the law to provide the required certainty. If there is any concern about tax avoidance, then this should be dealt with separately. 3. Resourcing Policy Change and Tax Reform AFMA s Pre Budget Submission in respect of the Budget noted that government action on a number of the issues mentioned above is frustrated by insufficient resources being available in either or both of Treasury and the Office of Parliamentary Counsel to pursue them in a timely manner. That is, AFMA foreshadowed the emergence of bottlenecks in the legislative process. Our Pre Budget submission highlights just some of the bottlenecks that exist in the implementation of necessary reforms that promote economic activity, remove anomalous outcomes and foster Australia s competitiveness as a centre for financial services. These issues remain a significant priority for the AFMA membership and we again request that Treasury address these issues as a matter of urgency. On a related point, AFMA notes that the issuance by the Business Tax Working Group (the Working Group) of its final report regarding a possible reduction to the corporate tax rate in a revenue neutral fashion signalled the conclusion of the Working Group under its terms of reference. AFMA is firmly of the view that an appropriately resourced and qualified group focussing on tax reform can play a major role in ensuring that Australia strives to remain internationally competitive and address both revenue and economic challenges. AFMA agrees with the comment made by the Working Group in its final report, namely that tax reform should be seen as a continual process 6, and encourages Treasury to re constitute the Working Group and provide it with terms of reference that allow for issues of tax reform to be considered and prioritised in a meaningful way. 5 A Tax System Redesigned; recommendation Business Tax Working Group Final Report, para. 16 Page 12 of 12