A costly tax for Australian businesses

Many issues have been raised in all the debate on tax reform. Company tax reform discussions have focused on encouraging foreigners to invest in Australia. But what about addressing disincentives for Australian businesses investing offshore? This has been largely missed. Until now.

Filling this gap, ANZ Bank has just released an important report: Winning the Away Game. The report states that Australia and New Zealand impose a higher tax on businesses that invest offshore, compared to businesses that invest locally (an indirect result of the imputation systems in the two countries). None of the 12 other countries examined by ANZ (including the US, UK, Japan and China) have an extra impost on offshore investment. As a result, businesses in Australia (and New Zealand) are strongly discouraged from expanding overseas. In response, ANZ is recommending that a tax credit be provided to local shareholders to offset this bias.

But why should we care? Why do we need to encourage Australians to bypass investing in their own country? However, ANZ Bank is not proposing that there be incentives for Australian firms to expand offshore (although some may portray it as such). The report is instead recommending the removal of a tax distortion discouraging overseas expansion. And the proposal from ANZ would broadly mirror the foreign tax credits individuals receive when they directly invest overseas.

There is much to be said for the ANZ proposal. If Australian firms become more globally-focused, they will become less risky (as they reduce their exposure to Australia-specific risks). In addition, a disincentive for holding companies to be based in Australia will be removed; and there will be reduced incentives for globally expanding businesses to move offshore. Further, Australian firms will no longer forego worthwhile offshore investment opportunities for tax reasons. Finally, it will level the playing field between companies and individuals investing offshore.

These are all substantial benefits. Therefore, it is no wonder the Board of Taxation recommended the tax credit change in 2002-03; but ANZ notes no action was taken on this proposal.

Now ANZ has commissioned modelling showing the advantages are not just anecdotal: the economic benefits are estimated to be around $1bn per year more than the revenue cost (which is $1.75bn per year). The modelling also shows the existing distortion is one of the worst tax imposts. The adverse impacts on the economy are almost as high as stamp duty, the least efficient tax in the modelling, and well above the efficiency costs of personal tax and the GST.

While all taxes need some reform, a clear priority lies with reforming the least efficient ones. So addressing this distortion should be a priority.

However, there are caveats to this conclusion. Firstly, ANZ is obviously spruiking a proposal that is in its own interests, as it has substantial overseas operations and wants to expand. But this should not mean its research should be dismissed.

But more importantly, ANZ’s commissioned modelling assumes that if an Australian business switches investment from Australia to offshore, the lost Australian investment is fully replaced by foreigners investing in Australia (in technical terms, the modelling assumes perfect capital mobility).

This is unrealistic: the proposal may lead to lower domestic investment. Conversely, the model also excludes the dynamic benefits from Australian firms expanding offshore. It is hard to say whether these two omissions mean the benefits are overestimated or underestimated. So further modelling is warranted, including sensitivity analysis.

Finally, the proposal will have a substantial tax cost. But this shouldn’t rule it out of contention. Reducing or removing taxes that do most harm should be part of any tax reform package. The Centre for Independent Studies has made many suggestions for reducing Government spending which should help pay for that tax cost.

Regardless of these concerns, the research by ANZ Bank is a useful addition to the tax reform debate. Hopefully it will not be put in the ‘too hard’ basket along with many other useful reforms.

Michael Potter is a Research Fellow at the Centre for Independent Studies.