Speech - Speech to AFR Infrastructure Summit [15/08/2002]
Speech to AFR Infrastructure Summit
Thursday 15 August 2002
9am - Hilton on the Park - Melbourne
Senator the Hon Helen Coonan
Minister for Revenue and Assistant Treasurer
Introduction
Thank you for inviting me to speak with you this morning. The National Infrastructure
Summit represents an ideal opportunity for industry representatives to
come together to discuss the range of critical issues facing this sector
of the economy.
The interaction with various Government representatives also provides an important
gateway for the exchange of ideas.
It can help us to gain a greater insight into the needs and issues facing the
industry, but also to work through solutions with many of the industry's key
stakeholders.
As the Minister for Revenue and Assistant Treasurer, I have a particular interest
in the role that infrastructure plays in the development of our economy. I also
obviously have an interest in the taxation aspects of the industry.
It probably goes without saying that adequate infrastructure is vital to the
ongoing growth of the Australian economy.
The taxation system also has an important part to play in ensuring that the
appropriate environment exists for investment in infrastructure as well as more
broadly across the economy.
Today I would like to cover two main areas. The first is the taxation issues
associated with private financing arrangements (or Public -Private Partnerships),
and the second is the broader range of taxation reform issues relating to infrastructure
provision.
However before I delve into these taxation aspects, it's worth taking a moment
to talk about the infrastructure investment climate that we have witnessed to
date in the Australian economy.
Infrastructure Investment in Australia
When talking about national infrastructure, it's important to remember that
definitions can vary greatly. Infrastructure is a very broad concept, and can
cover a range of categories from economic infrastructure through to human capital
infrastructure.
Looking at some of the broad indicators, Australia's investment in economic
and social infrastructure in 2001-02 amounted to 35 billion dollars. This included
27 billion dollars on economic infrastructure and 8 billion on social infrastructure.
The private sector component of Australia's infrastructure investment currently
stands at around 14.5 billion dollars annually. What's interesting here though
is the significant increase in the private sector share throughout the 1990s.
The private sector share increased from less than 25 per cent in the early
1990s to around 40 per cent today.
Overall, infrastructure investment as a proportion of economic activity has
been broadly constant since the early 1990s. The increased private sector share
has offset a decline in direct public investment.
As most of you here would appreciate, public infrastructure investment is overwhelmingly
a State and Territory responsibility, with only around 30 per cent of public
infrastructure investment being made at the Commonwealth level.
On the private investment side, there has been a significant increase through
Build-Own-Operate and Transfer, or BOOT Projects.
Since the Sydney Harbour Tunnel BOOT project which commenced in 1986, there
has been around 17 billion dollars worth of BOOT - or public and private partnership
type projects undertaken.
These PPP type projects have involved tollways, rail links, water treatment
plants, prisons and hospitals.
However, the growth in PPP projects does not account for the bulk of the increase
in private sector infrastructure investment. Instead, the majority of this growth
has been through purely private companies.
Significant levels of privatisations in recent years have of course moved many
areas of infrastructure investment into the private sector.
However, private sector infrastructure investment has also increased significantly
in communications, rising to 6 billion dollars worth of investment in 2000-01.
This has been supplemented by a further 3 billion dollars worth of investment
by Telstra.
Increased private provision of infrastructure has of course been an international
phenomenon. As many of you know, the United Kingdom has been active in adopting
and encouraging private financing arrangements, through its Private Financing
Initiative (PFI).
However, it is worth noting that the level of PFI infrastructure investment
in the UK if translated to Australia, is not that significant in terms of the
total level of infrastructure investment.
The UK's PFI initiative when adjusted for Australian economic activity, would
still only represent around 5 per cent of our current overall levels of infrastructure
investment.
An equivalent PFI initiative in Australia would represent only 1.9 billion
dollars when compared to our total infrastructure spending of 35 billion dollars.
This is not to say that private financing arrangements do not have an important
role to play, it's just that we need to keep it in context as only one aspect
of the overall infrastructure investment picture.
PPP Policy Principles
Before I turn to the taxation aspects of PPP arrangements, it is important
to consider some of the underlying policy issues relating to PPPs. A closer
look at the UK experience is also worth examining.
Value for money for taxpayers represents the core focus of the Commonwealth's
PPP principles. The detail of these principles were released by the Minister
for Finance and Administration in October 2001.
Value for money refers to comparing the costs of private financing proposals
against a neutral benchmark, called the Public Sector Comparator. For the Commonwealth,
this comparator is developed by the relevant public sector agency -and its advisers
- in consultation with the Department of Finance.
The Comparator needs to reflect the most efficient public sector delivery option
that is likely to be achieved for the relevant project.
The Commonwealth's principles centre on the value for money that a project
delivers in terms of its whole-of-life costs, within a whole of government framework.
Value for money is assessed in terms of the overall impact on the Commonwealth,
including the benefits to the Government of transferring risk to the private
sector
Each project therefore needs to be considered on its individual merits. More
importantly, the contracts need to be watertight and enforced to ensure any
gains are realised.
As a recent article in the Economist magazine pointed out, the UK's bail-out
of its private sector partner in its railway sector PFI, have caused the public
to question whether risks are truly passed to the private sector.
The Minister for Finance and Administration recently indicated that there currently
appear to be limited opportunities for the use of private financing at the Commonwealth
level.
However in saying that, it is important to emphasise that individual proposals
will continue to be evaluated on the basis of their ability to offer value for
money to the Commonwealth.
As my colleague, the Minister for Industry, Tourism and Resources outlined
yesterday, in May 2002, the Minister for Transport and Regional Services indicated
that the Government will be developing a new transport infrastructure plan -Auslink.
This is a plan to reform Australia's land transport arrangements. The Government
will be releasing a discussion paper - a Green paper - in relation to AusLink
later this year. It will establish the basis for developing a formal statement
of Government policy in May 2003.
Under the proposed AusLink plan the Minister emphasised that proposals for
PPP arrangements would be given equal treatment with other project bids to advance
the plan's strategic land transport infrastructure priorities.
It must be said though that the main opportunities for private financing in
Australia reside with the State and Territory governments They will of course
be pursuing infrastructure investment opportunities based on their own PPP policies
and priorities.
However, in all cases, Governments will be mindful of the fact that while PPP
arrangements can be a useful tool, they do set up a future set of obligations
to service payments streams that are similar to the costs associated with publicly
financed projects.
It's for this reason that we need to be careful that we don't accept overly
simplistic assertions that the use of private financing is a sure fire way to
enable Governments to expand their spending on infrastructure.
As I mentioned, projects will still need to be carefully assessed, case by
case, and any efficiencies that can be gained through the involvement of the
private sector need to be fully and carefully explored.
PPP Experience in the UK
Looking further afield, there does appear to be a consensus developing in the
UK that would suggest that the UK's private financing initiative has had a somewhat
mixed experience.
Some of the more recent reviews and commentary would support the view that
adopting private financing arrangements needs to be considered on a case by
case basis.
While an earlier study by Arthur Andersen in 2000 for the UK Treasury - estimated
value for money savings compared with public projects of around 17 per cent
- more recent studies have not been so definitive.
Studies by the UK Institute of Public Policy Research -the IPPR- and the National
Audit Office, pointed to results that showed efficiency gains in some prison
and road projects in the order of 10 per cent.
However the savings were much smaller in the case of hospitals and schools,
with value for money savings measures estimating gains in the order of 3 per cent.
Numbers at this level begin to look less convincing - at least at a general
level. We know that a key element in these comparisons is the method by which
we value future costs and benefits in today's terms.
If we set a high discount rate when making these comparisons, the results tend
to be more favourable to the private financing option when compared to traditional
financing methods.
For example, the IPPR noted that reducing the chosen discount rate by 1 per
cent, would increase the cost of a typical PFI project by around 5 per cent
over its lifetime, when compared to the publicly financed project.
There has been significant debate about the choice of the most appropriate
discount rate. The UK initially used relatively high discount rates in their
project assessments, but in a recent consultation paper, the UK Treasury proposed
a reduction in the discount rate from 6 per cent to 3.5 per cent.
As an offset to the lower discount rate, the UK Treasury also outlined that
the tendency to be over-optimistic in estimating costs associated with public
projects should be addressed directly rather than (as previously) through using
a higher discount rate.
It is also worth noting that some of the gains that have been captured in the
UK through the use of private financing partnerships, have been due to factors
that Australia has already taken on board.
In general, Australia's public procurement policies have been more advanced
than the UK in terms of taking advantage of some of the key efficiency tools
that form part of the private financing initiatives.
The main factor here has been Australia's early adoption of competitive tendering
into the design and construction of infrastructure.
The IPPR noted that a large driver of the projected efficiency gains from PFIs
in the Arthur Andersen study in the UK were due to the transfer of construction
risk.
As many of you know, competitive tendering of design and construction is already
a key feature of investment in areas such as the National Highway System. Nevertheless,
we should always be looking for ways to add to these gains.
Looking beyond these underlying policy debates about discount rates and other
mechanisms for extracting efficiency gains, we should continue to ensure that
whatever delivery mechanism is chosen, taxation should not be a key factor.
PPPs and Taxation
The Government has on many occasions demonstrated its total commitment to delivering
an efficient, fair and equitable taxation system. We are always working to ensure
that Australia's taxation arrangements operate to maximise economic efficiency.
Part of the solution is to put in place a tax system which has a broad base,
helping to reduce distortions - and seeking to ensure that complexity and compliance
costs are minimised.
It's for this reason that the Government has not, as a general rule, been inclined
to impose highly specialised taxation arrangements just on account of the characteristics
of one particular sector of the economy.
That said, it has sometimes been argued that infrastructure faces a tax disadvantage
because tax losses may not be able to be accessed for stand alone infrastructure
projects.
This was the basis on which the infrastructure bonds scheme was introduced
in 1992.
While I can appreciate how some of these arguments arise, it is true to say
that PPPs and other infrastructure projects are generally tax advantaged investments,
because taxable income is deferred relative to economic income.
The highly geared nature of most infrastructure projects also means that tax
advantages are generated through the long periods of tax losses. This can persist
for quite some time before a project becomes tax positive.
The losses can be accessed through a variety of means, and Treasury estimates
suggest that the tax advantages of PPPs can be in the order of up to 5 per cent
of the value of the project's assets.
While the tax advantages attaching to PPPs will obviously vary, it's interesting
to note that while the Commonwealth does consider these costs in our assessment
of PPP projects, to date appraisers in the UK have not done likewise.
However the Commonwealth does not expect State Governments to also include
the potential tax cost of PPPs in their own value for money assessments. Instead,
it is the Commonwealth's responsibility to establish the tax law that governs
such arrangements.
As you can imagine, most people tend to have more than a passing interest in
the tax laws that are established. Indeed some people derive great delight in
obtaining a favourable outcome from our tax laws.
I noticed an amusing quote the other day which highlighted this very point.
The quote, by a Mr F.J Raymond, was that `next to being shot at and missed,
nothing is quite as satisfying as an income tax refund'. I'm sure many people
here would agree.
While I have no intention of shooting at anyone here, let alone missing them,
I do want to point out that the Government is focussing on certain reforms,
in particular, section 51AD and Division 16D, which relate to tax exempt leasing
and PPP type arrangements.
Reform of section 51AD/Division 16D
The Government accepts that the current section 51AD is no longer appropriate.
As many practitioners in the audience today will no doubt already know, section
51AD denies deductions for taxpayers in leasing and similar arrangements involving
the use of non-recourse finance.
In relation to tax exempts, it applies where the assets are leased to or effectively
controlled by the tax exempt entity.
I am fully conscious of the problems that this provision can impose. The section
is quite draconian in cases where it is applied - although it should be said
instances of its application are not that common.
It inappropriately focuses on an effective control test. The time associated
with obtaining favourable rulings also adds to the uncertainty faced by business.
It's for these reasons that the Government is committed to change the law.
The way forward will be to structure a replacement to section 51AD and the associated
16D for tax exempt entities. It would be based around the operation of a risk
test rather than the current control test.
In acknowledging that there is a need to address section 51AD, the Government
considers that there is still a continuing need for a provision akin to Division
16D, because PPP and lease arrangements remain tax advantaged.
As many of you know, Division 16D treats finance leases and similar arrangements
with tax exempt entities - which do not predominantly involve non-recourse finance
- as the provision of a loan. In doing this it seeks to remove tax advantages
associated with such private financing arrangements.
In the absence of such a provision there would be scope for arrangements to
be unduly influenced by tax considerations.
In consultations with State Government officials and private sector participants,
this point has been accepted and there has been general agreement that the current
Division 16D needs to be improved.
On 14 May this year I announced that I expected legislation to be introduced
in the Autumn 2003 sittings to replace section 51AD and Division 16D. It is
expected that the changes will commence from 1 July 2003.
The Treasurer also announced on 2 May 2002 that responsibility for the design
of tax laws and regulations had been relocated from the ATO to the Treasury.
Following these announcements, a new team has been assembled in Treasury to
take the work forward. I understand that consultation with State Treasury officials
and the private sector will resume later this month.
This will help to address the concerns expressed in some quarters that the
development of reforms may not accommodate a proper whole of government perspective.
Bringing the issue more fully under Ministerial oversight will help in this
regard.
A central element of the proposed framework for a replacement to Division 16D
is for the tax treatment to be based in part around the extent of risk transfer
to the private sector.
One of the key issues that needs to be addressed is the design of this risk
test.
In consultations, this risk based framework has enjoyed significant support.
While this general support is welcomed, significant boundary and implementation
issues still need to be resolved.
It is currently proposed to have separate tests for leases and service contracts.
While the issues relating to leases are relatively straightforward - more difficult
issues arise in relation to the many PPP arrangements which are not leases but
service arrangements.
Although there is general agreement that the concept of risk transfer should
be central to any tax treatment, a challenge for the consultations will be to
establish a mechanism that can make such a risk test operational.
As always, I will be interested in seeking to deliver as simple and robust
a test as possible in order to address administration and compliance concerns.
While I have an interest in progressing these specific taxation issues, I also
want to reinforce today the Government's significant efforts to date in taxation
reform and infrastructure support.
General Tax Reforms and Infrastructure Investment
The past three years have of course seen one of the most substantial reforms
to the Australian tax system on record.
In relation to infrastructure provision, the cut in the company tax rate to
30 per cent has been incredibly significant. This rate is highly competitive
internationally.
While some have questioned the removal of accelerated depreciation, it is important
to look at the overall effects of tax reform taken as a whole.
A study by Econtech in 1999 showed that every major industry category which
covers infrastructure facilities, was expected to gain in terms of net output
from the combined impact of the tax reforms.
The Strategic Investment Coordination (SIC) process
While the business tax changes are important, in 1999, the Government recognised
the potential impact of removing accelerated depreciation on capital intensive
projects with long lives, and outlined that it would consider such projects
in the context of an expanded strategic investment co-ordination process.
In this regard, the Strategic Investment Coordination (SIC) process provides
for Commonwealth funding to assist particular projects, that might otherwise
not proceed.
The introduction of the Uniform Capital Allowance (UCA) System from 1 July
2001 has also provided significant benefits to infrastructure projects through
recognising previous blackhole expenditures and through the establishment of
project pools.
The Introduction of Statutory Effective Lives
On 14 May 2002 I announced that the Government would legislate to ensure that
depreciation deductions for a number of key asset classes remained appropriate
following the Tax Commissioner's review of effective lives.
The Government took a range of broader national interest concerns into account
in deciding on the appropriate statutory effective life cap.
The statutory caps included a general 15 year effective life for most oil and
gas production assets, and 20 years for gas transmission and distribution assets.
The new statutory effective life caps will provide certainty for the industries
concerned, and provide an appropriate balance between meeting the needs of those
industries as well as maintaining the integrity. of the effective life depreciation
system
CONCLUSION
In conclusion, the strong growth in private investment in infrastructure over
the 1990s reveals a healthy infrastructure investment climate in Australia.
The Governments taxation measures and recent reforms, as well as the proposed
reforms to section 51AD and Division 16D will help to sustain this favourable
climate well into the future.
While Albert Einstein was quoted as saying that he `never thought of the
future, because it would come soon enough', those of you in the infrastructure
industry know that we cannot be that relaxed about the future.
We need to plan for the needs of our community, and I hope that you all enjoy
the summit and take the opportunity to raise new ideas and options for consideration
by all stakeholders. I look forward to continuing my association with the infrastructure
industry.