ACTING CHAIR (Senator Watson) —We are here today to take evidence relating to the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002. The bill was referred to the committee following a report of the Selection of Bills Committee presented on 18 September 2002. The committee is required to report by Tuesday, 22 October 2002, but it has agreed to bring forward the reporting date to this Friday, 18 October. The committee is to hear evidence today from a number of businesses and organisations and from officers from the Treasury and the Australian Taxation Office. I thank you all for making yourselves available at such short notice.

Before we commence taking evidence, I will reinforce for the record that all witnesses appearing before the committee are protected by parliamentary privilege with respect to the evidence provided. Parliamentary privilege refers to the special rights and immunities attached to the parliament or to its members and others necessary for the discharge of parliamentary functions without obstruction or fear of prosecution. Any act by any person which operates to the disadvantage of a witness on account of evidence given by that witness before this committee is treated as a breach of privilege. These privileges are intended to protect witnesses. I must also remind you, however, that the giving of false or misleading evidence to the committee may constitute a contempt of the Senate.

The hearing will commence with a roundtable discussion comprising three sections. We will start with consolidation, move on to the general value-shifting regime and conclude with demergers. Committee members may direct a question to a specific witness or ask a general question to which anybody at the table is invited to respond. At the end of each section, I will invite a general summary of views, and you should limit your statements to just a few minutes. This roundtable discussion will be followed by the attendance of officers from Treasury and the ATO to give evidence. It is a public hearing and you are welcome to stay to hear this evidence. Is there any particular statement that anybody would like to make briefly before we proceed to questioning?

Mr Morgan —I record that I am now representing the Law Council of Australia, at least to the extent that I am authorised from time to time.

Senator CONROY —I would like to start with the issue of compliance costs under the new consolidations regime. Mr Drenth, I note that the Corporate Tax Association believes that implementing consolidation will involve a considerable up-front cost for the corporate community. Could you expand on that for the committee. What are the main components of these costs?

Mr Drenth —The process of moving from the existing tax system to consolidations involves quite a major exercise because it is necessary to rejig the existing system, which looks at separate legal entities, into treating a 100 per cent owned group as if it were a single entity. To do that we need to eliminate the separate equity interests that exist at the different layers of the corporate group. In what we call the transitional consolidation process, where existing groups decide to move from the previous system to consolidations, a complex series of steps have to be followed. They involve valuations which will take some costs and expense, and a certain amount of what you might call tax archaeology. Depending still on how some of the details of these rules are finally worked out with Treasury and the tax office, some groups are going to have to go back many years to look at what dividends they paid out and to whom and to see what specific adjustments they might have to make before they can, as we say, push down the cost of equity into the individual assets. Once you are in there, our take on it is that life will be simpler and it will be a lot easier to reorganise your corporate group, if you feel you need to do that for commercial reasons, but to get in there is going to take a bit of effort.

Senator CONROY —In your experience what are the reasons why you would restructure your corporate group? Give us a few examples of what the issues are.

Mr Drenth —In a lot of cases corporate groups will tend to grow like Topsy because of a series of acquisitions. I have seen spider webs of literally hundreds of separate subsidiaries that have arisen as a result of these transactions over many years. Sometimes particular structures would have been adopted some years ago, perhaps for stamp duty purposes or for income tax purposes, for reasons that are no longer relevant—a structure which made commercial sense 10 or 15 years ago just does not any more. There are an awful lot of costs involved just in looking after these hundreds of companies and it sometimes makes sense to collapse 150 companies into 30 or 40. It does achieve long-term savings.

Senator CONROY —Mr Drum, I understand that there is also an issue of interest for CPA Australia. I note that, as a conservative estimate, you consider:

... that even the most simple corporate groups will incur compliance costs in the order of $20,000 to $30,000 to consolidate.

Could you expand on the main components for the committee?

Mr Drum —In our written submission of 8 October we gave an example in the appendix that works through the various components of an example of the consolidation process. We have a CPA board tax practice committee, of which Mr Thring, who is with me today, is the chairman. The feedback that I have been getting from that national committee is that this is the typical cost that a family group or a small to medium group will face to work through the exercise to determine whether or not they need to consolidate. As you can see, the particular example works out to about $25,000. Again, for the record, the feedback from our members is that it costs between $25,000 to $30,000 to work through the exercise on whether or not you should consolidate. The answer at the end of the day might be no, you should not, but you still have to do the work to determine what best suits your group.

Senator WEBBER —Can you give me an indication—just roughly—of how many groups would have to go through that exercise?

Mr Drum —I am sorry, I do not have details on that. There has been some conjecture about this ever since the consolidation regime was proposed under the RBT. Discussions have been around perhaps 10,000 entities that might fall within the consolidation regime, but of those 10,000 entities I still could not hazard an estimate as to the number of groups that might represent ultimately. So I do not know whether we have—

Senator WEBBER —Anyone else?

Mr Stolarek —Consolidation is relevant only where there are at least two companies—in the Australian context, where there is a subsidiary company sitting below a parent company— otherwise the entities are currently ineligible to consolidate. That means that we are not likely to have consolidation affecting the corner grocer in the same way that the BAS problems affected the taxpayer community, but many groups out there will have an array of companies floating around the place. It is hard to speculate on numbers, but it is important that we are aware that it is not going to affect individuals and single-company family structures—that is not the way consolidation is devised.

The observation about the costing is probably quite right: where there are groups of companies, the analysis of the entry of consolidation will involve that level of cost. It is worth noting, however, that a lot of that cost comes out of the design of the consolidation measures. It is fair to say that they have been devised by the drafters with a very high regard for integrity from the viewpoint of the revenue. There are a lot of requirements and a lot of steps designed principally to ensure that the revenue—the government and the tax office—has a level of assurance about the tax outcomes that are going to arise.

Senator CONROY —What would be a reasonable level of compliance cost?

Mr Mansell —I have just recently started—I was actually doing the job in a corporate two months ago. The cost that we were looking at—and we are talking about a large listed organisation—was up to around $50,000 or $100,000 because we had a large group of companies, but I would not imagine that you could do the process for less than $10,000 if you are talking about a series of companies with a number of assets in those companies. It would have to be a very simple structure with very few assets in it to cost less than $10,000.

Mr Stolarek —The proposition with consolidation, and this is why one has many people in business wanting to approach consolidation, is that once the transition costs are moved through—it is like the valley of death that the light horsemen charged through—and you are in consolidation, as Mr Drenth outlined, the benefit for a corporate group is that you can streamline a group. You can do away with the many companies that serve no particular useful purpose and you can focus a group into one entity without having the problems that the current tax law gives you about different complicated tax outcomes for every company and complexities that often make it impossible to streamline a group. So the compliance cost is not insignificant, but it can also be seen on the part of business as, if you will, the entry price into an environment that does enable you to collapse and compress your group and generate long-term savings in compliance because there will be fewer tax returns and fewer administrative requirements. It front-ends that entire process.

Senator MURRAY —Does that up-front cost result in tax deductions?

Mr Stolarek —That is a good point. We believe that it ought to be tax deductible—it is a cost that comes out of the tax system—but there may well be merit, as there was in relation to GST, in having a clear, unambiguous section on that. But we believe that one can get there under the current regime. To date no tax office guidance has been provided. It is a good question. If there is not an unambiguous—

ACTING CHAIR —Would it be regarded as a restructuring cost?

Mr Drenth —We would regard it as the cost of complying with your tax affairs, Senator, and that is deductible under a specific provision.

ACTING CHAIR —We might ask the tax office when they come along.

Senator MURRAY —But because it is an election, it might not be.

Mr Drenth —There are all kinds of elections under the act. There is no system that forces you to sort out the costs of what relates to what is electable and what is not. It is just part of the costs of managing your tax affairs.

Mr Mansell —It probably would not fall into the definition of restructure because you are not actually changing the legal structure of the entity. All you are doing is having a deemed creation of one entity for tax purposes. So it probably does not even fall within the definition of a—

Senator MURRAY —But what happens if you have a look at it and decide not to proceed—and you cannot decide whether you would or would not proceed until you have had a look at it? I can see that if you decide to proceed it would be a restructuring provision. If you don't decide to proceed, how would that be tax deductible? Aren't you examining it from a point of view of an opportunity? What I see here—and as I heard Mr Stolarek say—is that there is an economic opportunity and for that reason I think it is good legislation. You encourage efficiencies and so on. But if you examine an issue from the point of view of an economic opportunity and you decide not to proceed with it, I would assume your tax status would be a bit vague. I would not assume you could automatically deduct it. You are more expert in that than I am but—

Mr Drenth —There certainly are some areas where there is a bit of doubt at the margin. But there are still some black holes left in the tax system and, as you might be aware, the Minister for Revenue and Assistant Treasurer did make a public statement recently to the effect—and this was at the same time that the TVM method was laid to rest—that the government would entertain case-by-case relief for remaining black hole expenditure from now on. I understand there is a process under way to work out how that is to be done. We certainly support—

Senator MURRAY —But in summary, are you unequivocal that, even if you do not proceed with a restructure, once you have done the analysis it would still be tax deductible?

Mr Drenth —If you are looking at the question of whether or not consolidation was for you then my view about that—and my colleagues or the tax office might want to correct me—is that that would simply be part of the cost of managing your tax affairs.

ACTING CHAIR —We can appreciate the initial compliance and the necessary arrangements but once you go down the track you said there could be some refinements to the business structure itself. It is that second tier that I think we now need a clarification on as to whether doing away with certain entities or changing the nature of the entities or merging them et cetera is going to come within it. We can appreciate the tax deductibility of the up-front high cost but what about taking advantage of the opportunity by restructuring?

Mr Morgan —I had a look at this recently and I think the black hole problem has been remedied in part by the new division 40 provisions. I think there is a five-year straight line write-off for restructuring costs under those—I cannot remember the exact section.

Mr Mansell —It is 40-880. Originally, when it first came out under Ralph, we were told that it was going to cover all of the black hole expenses that ever existed. Unfortunately it is very limited to only the change in the structure. There still is the question of whether you go and look at changing a structure and then decide not do it and whether you can actually get that—the same question but a step down. There is still the question of whether you can actually use 40-880 to claim the deduction. So there still may be some black holes there.

ACTING CHAIR —Can you identify those black holes?

Mr Mansell —The example in case is when I get asked by my CFO to look at the possibility of a restructure. I come up with the concept of the restructure and then, due to some other commercial reason, we decide not to actually do the restructure. The section says you get a five-year deduction for restructure costs. I have not actually done a restructure so do I fall within the definition of 40-880? I may have planned for one; I may have spent money on getting advice on one, but I have never actually done it.

Mr Morgan —It is curious, isn't it? The same provision offers a write-off for takeovers that do not happen, but maybe not for restructures that do not.

Senator CONROY —I wanted to come back to the question I asked. Mr Mansell indicated that it would be almost impossible to do with less than $10,000. The figure we are talking about is between $20,000 and $30,000—$25,000 I think you said. It does not seem to be that far apart. I appreciate that if in the end you do not go anywhere then that is a sunk cost. But I would put that down to due diligence on anything, whether it was a takeover or a consolidation. I am just trying to get a sense of what you believe is a reasonable level of compliance cost to meet with this.

Mr Drum —I guess that depends on the taxpayer and the group in many ways. For example, we have just come through, as everyone would appreciate, enormous tax reform and some people have had enough of change and some people particularly have had enough of spending money on something that has no long-term advantage for them. To go through an exercise to determine that they do not have to do it is something that they would prefer not to spend money on. You really have to go through the exercise to determine whether it applies to you and whether it is going to be suitable or not. What is being indicated from our members and our committees is that there is a high degree of resentment out there and there seems to be a low level of uptake from potential groups that may or may not be beneficiaries or losers. The consolidation regime may or may not apply to them but there is a low uptake of people wanting the work done to determine whether it is going to be good or bad for them. This is going to have some long-term impacts. Transitional periods come and go and these people may not have consolidated when they should have and may not have taken advantage of the transitional period. As I said, it will depend on the taxpayer as to what is the right amount to determine whether this is good or not. There is a high level of resentment about any compliance cost. It has been described in some instances as `choice at the end of a barrel of a gun'—not really a choice. You are forced to consolidate because you lose the previous system benefits.

Mr Morgan —It is an offer you cannot afford to refuse.

Senator CONROY —I am interested in this issue of the slow uptake. Can you expand? When you say `slow uptake of the 100 per cent possible', is it one per cent, is it 30 per cent? What is your anecdotal feel for it?

Mr Drum —I cannot give you an anecdotal feel for it. Part of the slow uptake, though, is generally because we do not have legislation passed yet. There is a degree of resistance to being able to onsell, if you like, as a public practitioner, a service that people may or may not need. Similarly, Mr Mansell or perhaps Mr Drenth talked about the tax value method before. It was very hard to convince a client that you needed to be aware of and start taking into account what tax value method may or may not mean for you when it was really only a working party with a long way to go before it actually got to a commencement date.

Here we have something that is much more real. We have a commencement date. We have a number of bills out on this but it has not passed and the level of uptake is certainly influenced by that. We were supportive of transitional rules, particularly for smalls and small-mediums—tomorrow's leaders, if you like—because we think that in that gestation period they are the beneficiaries of the work that the largers—the top 300 publicly listed companies—will have to do in the meantime and are working on at the moment. We still think that, at the end of the day, it is not actually a choice. You consolidate, and a lot of these people will be consolidating. We hope they can make the timeframe because you are pulling the rug from underneath them by withdrawing the old system completely. Our submission is really about running contemporaneous systems on into the future and making the consolidation regime truly a regime that is based on choice.

ACTING CHAIR —Is that the general view of the roundtable members?

Mr Stolarek —I note that the Institute of Chartered Accountants recommends an extension of the existing grouping concessions for at least one year by way of a parallel system, and in our submission we at Ernst and Young have supported that also. The plain fact is that consolidation is a very large task. Consolidation requires not only the policy settings, which have been undertaken, and the guidelines—the rules are clear conceptually now—but also the minutiae of the law to be properly harmonised and integrated. That is why there is an acceptance that consolidation requires the two bills that are with the Senate and the third bill that was introduced recently. There will be inevitable administrative resolution and finetuning. This is not going to mean big policy changes but that all of the minutiae of the law will be resolved.

One can understand then that practitioners responsible for smaller groups and smaller et cetera—practitioners generally—would prefer to see the complete shape of the law before they commence their process of becoming involved with it. At the smaller business level, practitioners will have less time; they will have clients who are more sensitive to the fees and they will perhaps have clients for whom the real economic benefits will be less immediate. For that reason, a staged implementation has a lot of merit to ensure that larger companies and their advisers can resolve the issues and then have the system operating smoothly. The issue then is what is the transition for smaller business.

Mr Mansell —The CPA and us have come to the same conclusion but through different methods. Our submission referred to just the extension of that one year, but sending the transition one year further for SMEs—small-medium enterprises—whereas the CPA have suggested continuing that on indefinitely and hopefully the benefits will encourage SMEs to come into consolidation in future. Our concern is that our members are saying that they do not think they will have the time to do everything they will have to do. By giving these small, medium and large distinctions they can make sure their large clients are up and ready for the first transitional date and then start working on the second lot of their clients.

ACTING CHAIR —What are the views of the other members of the roundtable?

Mr Timmers —There are probably about four or five things I would mention at this stage. In relation to the slow uptake, that is not an unusual experience. We saw that through the GST implementation—that until the Senate passed the bill the button did not get pushed at all, certainly in the small-medium enterprise segment. That is what we are experiencing yet again with consolidation. We are ready for the horses to run free, so to speak, at this stage. There is no doubt that there are significant costs in transitioning into consolidation, but there are extreme costs in the current system with loss transfer notices, potential GST on loss transfer notices—if bill No. 3 goes through that might be relieved—and cost base setting adjustments, if there are assets moving within a group or there are loss transfers happening. All of those things cost extraordinary amounts of money so, partly relating to Senator Conroy's question—

ACTING CHAIR —Be specific: what about the SMEs then? Do you favour the SMEs, a staged approach?

Mr Timmers —We might recall also that consolidation was deferred already by one year— a bit over 18 months ago, I suppose it was now—for those sorts of issues. It is true that, until the bill passes, the SMEs probably will not start to move towards a system. At our end of the market, the Corporate Tax Association members, those who are going to go into consolidation are probably quite keen to blaze the trail there and for others to learn from that experience. Lastly, the thing I would note is that in an overall package sense the Ralph proposals were intended to be revenue neutral but we have been paying for consolidation through the loss of accelerated depreciation already for over 12 months. Business is already paying for all of these measures but not yet getting the benefits of consolidation. In that respect, I would recommend against a further deferral. Although, for those who would like to opt out for the time being through a dual system, that is worth consideration, but we would still impose on you the need to get in there because we are paying for it already.

Mr Drum —I just want to make a point of clarification. Our organisation is not proposing a deferral of the commencement of consolidation. We are saying, `Yes, commence it for those who want to get into it; that is fine with us,' and we have those members as well. We are running a fine line here between members who want their consolidation and the group that are saying, `This is not for us.' We do not think it is going to provide any long-term benefit. It is not a pure choice and therefore we are supportive of running it contemporaneously— maintaining the old system while having a consolidation regime that is based on true choice going into the future. We are not saying that we should delay the introduction of consolidation.

Mr Drenth —It is an important distinction. Mr Drum wants an indefinite carve-out and Mr Mansell wants more time. We represent the larger corporates, so we would not die in the ditch for it. Thinking about the issue more broadly, you would have to ask—and I think Mr Drum is spot on; a lot of his practitioner members are not going to be very keen on consolidation at any time—what the driver really is for forcing them into it against their will. I do not see the revenue concerns as being a strong driver at that end of the market. We have raised this issue in the past with ATO and Treasury officials and their preference, understandably, is not to have two systems running side by side because there is complexity. Maybe people switch from one to the other if you have a carve-out, depending on size. I would not have thought that those things could not be managed. From where I am sitting, I can see a backlash coming from Mr Drum's members—the accounting practitioners, who are under a lot of pressure already—not until about December 2003, when all the chickens will come home to roost and will be asking Mr Drum and other people what they have got them into.

Mr Morgan —I do not think the Law Council strictly has a position yet, but so far as I can hazard a guess, the way they would go would support a dual system indefinitely.

ACTING CHAIR —So we now have, basically, the Institute of Chartered Accountants with the dual system for 12 months. Is that right, Mr Mansell?

Mr Mansell —For 24 months in that it pseudo exists currently for 12 but going for an extra 12.

ACTING CHAIR —And then we have the CPAs suggesting an indefinite period, which the Corporate Tax Association of Australia would have some problem with.

Mr Drenth —We would support the carve-out which Mr Drum is advocating. Even though our own members will take it up, we can see their problems and I do not really see a strong revenue driver to push them into it.

ACTING CHAIR —Views on the right?

Mr Collins —I agree with Frank in that there would be no objection to having a carve-out in an ongoing sense. Again, I would be more interested in the position for large corporates and just to get the legislation finalised.

Senator CONROY —Mr Drum, are you saying that small business in particular are not that excited or interested in this at the moment? Is that suggesting that large business is the main beneficiary of this bill? I am trying to get a sense of what you are saying.

Mr Drum —What I am saying is essentially that we believe that for large businesses they can potentially see greater ongoing benefit of the consolidation regime. For very small businesses, as Mr Stolarek has already pointed out, they do not even enter into the equation because they will not be consolidateable groups. But in between there is a range of family groups, non-listed companies and private companies—all types of things—that may not be beneficiaries of this but they seem to be forced into consolidation for future eventualities, just in case this will be important further down the track. I think that that reason alone is not a good enough reason to force people into something that may provide no long-term benefit and, in fact, is detrimental in the year they go into it because of the compliance costs.

Mr Timmers —It is not just a question for big business equals consolidation. My rough understanding is that there are about 1,000 large groups that comprise the large business and international segment within the ATO, which accounts for quite a number of corporates. So putting everything else aside, nonetheless if the ATO were to receive one cheque for tax payment for each economic group separately, the administration from their perspective would be much more streamlined as well. So there is quite a lot in it for the administration at the ATO and government level as well.

ACTING CHAIR —We have to also think of the taxpayers.

Mr Timmers —The entire community would greatly support a less expensive compliance system.

Senator CONROY —Mr Drum, could you expand on the issues around the transition into the system and being forced into the system? I have my small business hat on, so I am particularly interested in the concerns that you have in this area.

Mr Drum —In our submission of 8 October, we outlined a number of specific concerns for small and medium enterprises. We have already referred to the complexity in particular. Our submission talks about the fact that the consolidation legislation is necessarily complex, because it is really imposing a tax fiction. One consolidated taxpayer is being placed over commercial reality—a group of entities. The legislation is not complete. It was 403 pages long at last count, and there are 600-odd pages of explanatory memoranda. It is quite complex. Complexity leads to compliance costs. Many studies done around the world indicate that compliance costs are felt more at the small and medium end of the spectrum than at the large end, and small and medium business are less able to readily absorb these compliance costs. I think that that has been on the record, particularly since the GST came in. There have been many discussions.

Senator CONROY —Recently the debate over the choice of funds legislation highlighted that point.

Mr Drum —Certainly.

Senator CONROY —I highlighted that point as well. Mr Timmers, you mentioned the middle sector. How many entities do you see in there?

Mr Timmers —That is well outside of my jurisdiction.

Senator CONROY —It is just that you were describing it. I was hoping that you might be able to be a bit more descriptive.

Mr Timmers —Perhaps later on this evening others will be able to answer that question.

Mr Stolarek —It is worth noting that, while some small and medium businesses initially might not find a lot of benefit in consolidation, the economic outcomes of consolidation—that is to say, the opportunity for pushing down the purchase price of an acquisition into the underlying assets—will mean that over time people will tend to come into consolidation. For example, if I were conducting an engineering business today and I grew my business by acquiring a new company that was also conducting engineering activities, and if I paid goodwill and appreciated value for the new company, under consolidation my company would be able to push down the value of that purchase into the underlying assets and have that recorded for tax purposes in the underlying assets instead of being required to maintain this continued company with its own set of tax values and the assets with another set of tax values. You will probably find that, over the years to come, whenever a small or medium business goes out and purchases another company, its adviser will have to seriously think about consolidation to give a better economic outcome to its clients. Over time, you would expect that the acquisitive, fast growing businesses will benefit from the economic neutrality that consolidation gives them. Over time, even small business will come into consolidation where their clients are growing.

Senator CONROY —Mr Drum, are you as optimistic as Mr Stolarek?

Mr Drum —I do not know whether `optimistic' is the word that I would use but, getting back to our point that there is no choice here, ultimately, or inevitably, groups will be forced to consolidate. There may be long-term benefits, but we also have groups in Australia that are known—perhaps not affectionately—as `go nowhere businesses'. They are not going to be the leaders of tomorrow. They are going to be forced into consolidating when there is no long-term benefit for them, because of the loss of the intercompany dividend rebate grouping, the CGT grouping and the other provisions that are being withdrawn. Again, Tony's point is quite relevant. Some people will be long-term beneficiaries of consolidation, based on what we have seen. However, there are a group out there that will not be, and they resent the compliance costs imposed upon them because it is not true choice.

Senator CONROY —I am presuming you have raised these issues with Treasury and the ATO as well. What was their reaction?

Mr Drum —We have discussed them and we have been involved in the consultative process since its inception. I think the main thrust of the arguments that have been put to us is the fact that they were not keen on running contemporaneous systems. They thought it would be good to have a shut off and then have a new system going forward. Really, we have put these arguments before and that is where they have stopped. That is evidenced in the bills and EMs as they finally came out.

Senator CONROY —You raised the issue of a small business threshold. What would be the threshold? What sort of threshold are you looking at? How many small businesses do you think will be affected by this legislation and will qualify for the exemption? Where do you set it?

Mr Drum —In our submission, we say that a relevant threshold would be either a $50 million group turnover test or a $20 million group net asset test. We do not do economic modelling, so we do not have statistics. Similarly, one of the earlier questions was how many people, entities or groups do we think there will be. We do not know. What we really want to do is open up the debate. The work needs to be done so we can see what pool of entities is out there. We have suggested one or other of those two tests. It might be another test and we would be happy to enter into discussions on that.

Senator CONROY —Do you have any view at all on what the middle sector is which I asked Mr Timmers about?

Mr Drum —How big it is?

Senator CONROY —Yes.

Mr Drum —Not really. That gets back to the original question again: what is this amorphous blob, `the group'? We really do not know. I would expect Treasury would have a better idea of that—

Senator CONROY —We will get around to asking them.

Mr Drum —than we would.

Senator CONROY —You might want to watch.

Mr Drum —Thank you.

Senator CONROY —If I could then move on to a number of submissions that highlight a further raft—

ACTING CHAIR —Before we go on to that, has the Board of Taxation looked at this issue, Mr Drum?

Mr Drum —No, not to my knowledge.

Senator CONROY —Be afraid! Be very afraid! A number of the submissions highlight a further raft of technical issues with the consolidation legislation—as listed, for example, in appendix 1 of the Ernst and Young submission. Rather than taking up the time of the committee by going through the minutia of these technical issues, I suggest that we deal with those in a procedural manner—and what I mean by that is we have highlighted particular concerns. Can you let the committee have an update on how Treasury and the ATO have been dealing with those issues? Rather than getting into it—because I am sure that would take us many hours—are there any outstanding issues that you feel are not currently covered in the ongoing process with the Treasurer and the ATO? If so, what are they? I will move on to tax sharing, the same business test and the timing issue for the deduction that you have raised, but are there any other issues?

Mr Stolarek —Not to my knowledge. The consultative process which the government has been running on consolidation has been of a high quality. It has been subject to confidentiality requirements of government, which means that, of necessity, we are limited in the extent to which we can openly and transparently consult at large. But the consultative process involves a number of people—it would be in excess of 20 practitioners—and there is a very good process for escalating issues as they arise. To my knowledge, they are receiving attention and are being managed in a project management way. So, to my knowledge, no issues have been rejected out of hand or are not receiving attention.

Senator CONROY —Does anyone else want to say anything?

Mr Morgan —I have made three technical submissions and none of them have received any acknowledgment. Out of fairness, only one of them was made to the tax office a couple of months ago, but I think it is the most serious and it concerns the provision in schedule 7 in this bill. What Mr Stolarek says is no doubt true: if you do not have access to that consultation regime, then the means of access is far more problematic. I attempted to escalate the point about section 701-35—the proposed transitional provision in the act—by speaking to someone on the design committee, getting a name in the tax office and emailing them. I have received no confirmation, so I was pleased that this committee came along as a means of airing that. The other two submissions have been made far more recently and the tax office or the design group has not had the same opportunity. I tested one of them, again indirectly, through a member of the design team. I found that the answer I got back was not completely correct. I sought to re-engage those gentlemen and had no means of contacting them because my contact through the design committee had gone on leave for two weeks. Again, I was pleased to have the committee as a place to leave these submissions. So there can be a black hole in a consultation process, depending on where you sit.

Senator CONROY —And you are not part of the formal process of the Law Council?

Mr Morgan —They are saying, `Doesn't Ray Conwell represent the Law Council?' Perhaps that is right.

Mr Stolarek —My apologies, Senator. I am not involved in the management of the consultative process; I am merely a participant representing the Institute of Chartered Accountants. My understanding is that most of the professional bodies, if not all, are represented. Mr Morgan's point does highlight the fact that there is a tension. Because of the confidentiality requirements, there is a problem in having a transparent discussion about the consultative process.

Mr Morgan —To get on the design team, I think you needed to be able to commit two whole days a week for two or three months at the time. You had to be sponsored by a firm that was prepared to make that kind of commitment.

Senator CONROY —Could I just clarify, Mr Stolarek, whether you said there is a confidentiality issue about the process.

Mr Stolarek —No, about the content.

Senator CONROY —Mr Morgan, have you had any other satisfaction since it became clear that you were going to be presenting to this committee?

Mr Morgan —No.

Senator CONROY —There has been no further contact?

Mr Morgan —No.

Senator CONROY —Given I do not know who is involved in the consultation, I would like to refer you to someone in the room, but it is a secret.

Mr Drenth —I think the external members of the joint design team—

Senator CONROY —All known to each other, are they?

Mr Drenth —There is a secret handshake, I believe.

Senator CONROY —It is a secret and we are not allowed to mention it.

Mr Drenth —Their identities are reasonably well known in the tax community. Mr Morgan does raise a difficulty that comes out of a process that is subject to confidentiality, so in that respect it is not completely transparent. However, there are times—

Senator CONROY —So you would describe that as completely opaque?

Mr Drenth —You could.

Senator CONROY —I certainly would because I am not in it.

Mr Drenth —However, let me say, although the external members who are part of the joint design team have signed confidentiality undertakings, there are sometimes issues that arise when we will say to the Treasury or ATO person we are dealing with, `Is it all right if I run this by three or four of my members who would be able to comment on it?' They are always quite happy for that to happen and we get a few other people to sign up on that particular issue so that we are able to canvass things a bit more widely. In relation to Mr Morgan's experience of someone being on leave, that is unfortunate. But I am aware of other people who are not part of the joint design team who have been able to penetrate the Treasury and ATO firewalls to actually talk to people and get answers.

Senator CONROY —Mr Morgan, if I could just say that we will do our best to raise your concerns with the Treasury and ATO people. I am sure they will be eagerly wanting to make a response when they come to the table.

Mr Morgan —Thank you. Another practitioner, as recently as a couple of hours ago, said to me, `Yes, that section is a dog. It really needs fixing.'

Senator CONROY —We will don asbestos clothes and try to breach some firewalls for you later! The good news is, given Mr Stolarek's answer, that you are happy that all your issues are being addressed—and I guess I should open it up to anyone else who wanted to raise something about tax-sharing, same business or timing. Unless someone has a concern that these are not being addressed, I am happy to skip over that and save us all time.

Mr Morgan —Can I make one more process observation, which I have put in the submission. Yes, of course, there will be technical issues; yes, we will have to keep at them. We need to keep doing that after the last piece of legislation hits the parliament and is passed. I think there needs to be a shakedown period and some resources devoted to fixing the inevitable problems, which has not been hallmark of our introduction of new and complex legislation.

Senator MURRAY —Don't you think that reinforces Mr Drum's point? To some extent, the big firms can cope with subsequent technical adjustments, but small firms, I would have thought, benefit from the refinements once practical experience is felt. From a perspective of ease of administration, wouldn't small and medium businesses benefit from a delay?

Mr Morgan —Certainly they would. I think small businesses, by having the existing system taken away from them, are having to take a good deal on faith—if they are to be forced into the new system.

Senator CONROY —That sounds familiar.

ACTING CHAIR —What did Ralph have to say about the exclusion of small consolidations as suggested by the CPA?

Mr Mansell —I do not think it was proposed; I think what was proposed was—

ACTING CHAIR —All in.

Mr Mansell —All in, that is right. I do not think it was proposed that there would be contemporaneous systems running in perpetuity either.

Senator MURRAY —`All in' does not preclude a two-phased approach—big first, small later.

Mr Drum —No, it certainly does not, and I think we have some of that already. In fact, recent changes—I think announced around federal budget night—actually enable a transitional or a phased-in period. Our friends at the Institute of Chartered Accountants are suggesting an extension of that, if indeed we do not have an SME carve-out, as we suggest.

Senator CONROY —I have a few short questions about the proposed new value-shifting regime. I understand a number of the submissions criticise—

ACTING CHAIR —We are moving to a new topic then, aren't we? Is there anything further that people wanted to talk about on consolidation?

Senator CONROY —Yes, I am sorry. If people want to raise anything else on compliance, please jump in?

Mr Drenth —On compliance or on consolidations altogether?

ACTING CHAIR —We are moving from consolidation to value shifting, aren't we?

Senator CONROY —Did you want to raise something?

Mr Drenth —We had a lot of content in our submission on revenue matters, because we realise that was a concern of the non-government senators before, and those issues have been raised in the House as well. Our view of this is that, over the medium term, these measures are more likely to be revenue positive—maybe moderately so—than a cost to the revenue. The information is in our submission, so if there are no questions, I am happy to move on.

Senator MURRAY —Is that over the same time period as the government outline? I think on consolidations they said there would be a $1 billion revenue cost over, effectively, four financial years.

Mr Drenth —Yes, we have discussed that.

Senator MURRAY —Do you take the view that revenue positiveness will occur within those four financial years?

Mr Drenth —We have discussed this with government officials, and we do not see eye to eye on their revenue estimates. Their position is that that $1.1 billion or so represents the improved uses of losses over time. It is difficult for anyone to speak about this with any certainty. What we say is based on what we are hearing from our members, so that is perhaps a micro approach and it may not be wholly representative. My guess is that government officials are operating more at a macro level. But our view is that where we are now will broadly replicate what the current system does, particularly in relation to this mechanism of available fraction for loss entities, and we are not going to have the tax system haemorrhaging through losses being used up with gay abandon.

Senator MURRAY —I must tell you that my own instinct has always been that the economic efficiencies and benefits of consolidation would be matched on the revenue side by revenue recovery, not revenue loss.

Mr Drenth —You have asked about the budget period, Senator. Our position is that, perhaps going out a little bit from there, we will see a positive impact on the revenue because there will effectively be depreciation recapture, where you sell your company group to somebody else and, instead of being able to choose to sell shares rather than assets, you still sell the shares but the tax system treats you as if you sold the assets. That effectively gives you a depreciation recoupment through the tax system by building back up the cost base of your shares through your depreciated assets.

Senator MURRAY —So short- to medium-term loss and medium- to long-term gain from the revenue side—is that what you are saying?

Mr Drenth —In the short to medium term, it is lineball—and that is just a hunch, I have to admit. In the medium to longer term, the revenue impact would be somewhat positive in our view.

Senator CONROY —Do you think all your members are supporting an increase in tax laws?

Mr Drenth —Depending on how the revenue turns out, we might be able to knock a point or two off the corporate rates.

ACTING CHAIR —We will now move to value shifting.

Senator CONROY —I understand that a number of submissions criticise the proposed value-shifting regime on the grounds of complexity and the high compliance costs. Mr Mansell, perhaps you would like to expand on the concerns raised in this regard in your submission. Have you had representations on this issue from your members? What are their particular areas of concern?

Mr Mansell —Recently we ran a CPE seminar on value shifting. At the end of it, there was a line of people standing in front of the speaker wanting to know how they could actually handle this. I was at the ATO's communication and education forum on Friday and they were saying, `What you should be getting out to your members is how to avoid this so that it does not apply—that is, make sure you do everything at arm's length so that it does not apply, because you do not want your members having to read the legislation. There are 120 pages of legislation and 180 pages of EM.' So the ATO are telling us, `Tell your members just the exemptions so that they can avoid the legislation—so they do not have to go into it.' It seems to be ridiculous.

Senator CONROY —Do you know if that is a record, having the EM longer than the bill?

Mr Mansell —It could possibly be!

Mr Plummer —No.

Senator CONROY —No? I will defer to Mr Plummer's much superior knowledge!

Mr Mansell —The concern goes to the extreme where I know that, in one of the big four, the person who was nominated for running the training on this spent 156 hours—they keep records of all the time they spend—preparing for the training, and at the end he still was not confident that he knew enough to run the training program if people asked him questions. The legislation seems to have missed the principle approach. It is not written using the same techniques that we have seen since the 1997 act came out. It is just difficult to read.

ACTING CHAIR —Why is that—because it based on a principles approach?

Mr Mansell —It does not seem to have that principles approach. You do not seem to be able to pull out the major principles. It seems to have been: `We've thought of another thing we need to close up, so we'll just close it up in this section. Oh, and here's another arm where there's possibly some value shifting; we'll close it up here.' So it is difficult to find the issues in the legislation.

ACTING CHAIR —So it is basically anti-avoidance stuff.

Mr Mansell —That is the second concern that I have. We believe most of the legislation would actually fall within the general anti-avoidance legislation.

Senator CONROY —Part 4A.

Mr Mansell —Yes, part 4A. There is no need to have much of the legislation. I know it specifically says that this is not designed to capture situations where there is a tax benefit intent.

Senator CONROY —How many successful prosecutions have there been under part 4A? It is now up to one.

Mr Mansell —A few more, but not many.

Mr Drenth —There is quite a number of cases where the commissioner has got up or the taxpayer has had a pyrrhic victory. Goodness only knows how many people have rolled over on a part 4A assessment. There are a lot more than one, Senator.

Mr Mansell —Part 4A does drive a lot of tax practitioners. There are a lot of things that we do not advise or people do not do because of part 4A, even though there has not been the judicial use of it.

Mr Morgan —Let us not forget that these provisions only extend and replace three divisions in the existing act which are already targeted at that sort of thing, and one could say better targeted. They do not catch everything, but they were not designed to. They were meant to catch the worst things. They operate more on an exception basis, which is why people can live with them. What is wrong with these provisions is that they are yet another example of a law that covers everything first and then finds its form in the exemptions. The decks are particularly littered now with that kind of thing; we do not need another one.

My submission, which the Law Council supports, is that we invite the senators of this committee first and then the full Senate to be suspicious of anything that has not been through the Board of Taxation. We now have that forum to assess major pieces of legislation. We think this is a major piece of legislation. With the de facto effect of bringing in a transfer pricing regime domestically, that qualifies as a major piece of legislation. The track record of things which Treasury have suggested as necessary or worth while, which have survived that excessive discipline by being publicly exposed and assessed in a neutral way, is not good. We have had entity taxation and then the tax value method fall by the wayside when subjected to that discipline and we simply invite this major piece of legislation not to be pushed through without subjecting it to that sort of testing.

Senator CONROY —We probably have to take issue with you and say that we treat the Board of Taxation with suspicion.

Mr Morgan —Everybody is entitled to their view.

Senator CONROY —Absolutely.

Senator MURRAY —Acting Chair, the summary of what Mr Morgan has said is that he would want delay to the bill.

ACTING CHAIR —The tax value—

Mr Morgan —I think the relevant divisions are easily excised so that the balance of the bill could go forward, and that would be the Law Council's submission.

Senator MURRAY —Is that view shared or opposed?

Mr Drenth —These are anti-avoidance and/or integrity measures, Senator. So when you ask a group of people representing taxpayers whether we would like to have it, it is difficult to become enthusiastic.

Senator CONROY —The Board of Taxation did a great job on integrity issues to do with trusts.

Mr Drenth —I believe that job is not finished yet.

Senator MURRAY —The benefit of a roundtable discussion is to elicit guidance for the Senate to decide how it is going to deal with legislation. Taking off your self-interest hat where you can, I wonder whether that attitude is supported or opposed.

Mr Drenth —We are not sanguine about another set of integrity measures. At a conceptual level, you can see that not having these measures would leave scope for loss duplication outside of consolidated groups. The consolidation regime pushes large groups into consolidations—they really have no choice once the transitional period is up—but in relation to non-wholly-owned groups, there will still be the possibility of shifting value out of one company into another. You can then sell the loss company and retain the gain company. Depending on how many shadows you want to jump at, you can see a need for these rules. Also, to be fair, I expect that our colleagues in the tax office may have seen examples of people driving these things rather hard, although, as Mr Morgan says, some of these more contrived exercises in value shifting could perhaps be tackled under part 4A.

Having said all that, we do think that, in some respects, these measures are an improvement over the existing value shifting rules, which no-one pays as much attention to as they should. The existing value shifting rules come in when there is a value shift of a dollar. These provisions have thresholds and carve-outs which do make them more workable than they might otherwise be. Whether you really need to have that final plank in your integrity structure is really a matter of judgment for the government and, ultimately, the parliament, but we are not asking for these measures.

Senator CONROY —That is probably all I have got on that section, so I will move on to demergers, unless anybody wants to raise any other issues.

Mr Mansell —Can I add one thing on general value shifting?

Senator CONROY —Yes, please.

Mr Mansell —All the large businesses will fall into consolidations, and general value shifting will have a very limited scope for them except when there is that one company just outside that has not been able to consolidate. It is really going to affect small to medium general value shifting. The institute's concern is about having legislation that is as intricate and as detailed as this having to be analysed by the tax agent who works in a shop above another shop and who has his 700 clients; it is not legislation that the lower end members are going to be able to pick up and run with. When the tax experts have trouble working out what it means for the large corporates, I do not think it is possible for where it is really going to hit hard—small and medium—to use this legislation. It is not practical for them to understand it as it stands.

ACTING CHAIR —There is a practical problem, though, because if you can foresee a problem and you do not have to comply for a few years you will take what advantage you can by value shifting in the meantime.

Mr Mansell —The institute's submission is that we go ahead with the legislation as it stands under the assumption that we will look at rewriting the legislation, bringing it back to that principled approach. We agree with the concept fully; we just do not think that in its current form that concept is clearly enunciated.

Senator MURRAY —Would it be your intention then that the Senate or the government refer the passed bill back to the Board of Taxation with that specific brief?

Mr Mansell —That would be one method that would be possible. The Board of Taxation may be looking at it more in the conceptual phase as well, so it may not be something that the Board of Taxation wants to take on, if it is just a mere rewrite of the concept.

Senator MURRAY —But what you are outlining is in fact concept, because what you are outlining is that you wish to return to looking at it, in the Ralph language, on a `principles' base and limiting the number of prescriptive provisions, in a sense broadening the provisions but limiting the number of black letter provisions. I would have thought that that would be more a role for the Board of Taxation—or, as it was, the tax office legislation council—than a role for Treasury to look at it in detail once it has gone through that process.

Mr Mansell —I fully understand what you are saying. We do not have a preference—well, we do have some preference—of who looks at it as long as someone does. We see that there is a need for this legislation; we just do not think that in its current form it is correct, and someone—we do not have a suggested person—

Senator CONROY —Committee, parliament—something the public can be involved in and have a look at. Mr Drum, do you share Mr Mansell's concerns about the impact here in terms of small business copping it in the neck again?

Mr Drum —Yes, I think that is quite correct. We would agree with everything that Mr Mansell has said. We made a written submission on general value shifting rules. Our key point is that we acknowledge the need for legislative reform but we remain concerned about the complexity, which has already been borne out in the previous discussions of the general value shifting provisions, and the increased compliance costs particularly for small to medium enterprises, and we believe that the rules need to be modified to ameliorate the compliance costs for taxpayers.

We have made a number of recommendations in our paper for changes that we think would help ameliorate those compliance costs and also address some of the anomalies that have already been mentioned in discussions here this afternoon. They include changes to the application date. We have got a bit of a choice in respect of transitional period and consolidation at the moment, but we have got a drop-dead start date for general value shifting, and we think that, if you are not going to determine that you are going to consolidate until 1 July 2003, then general value shifting perhaps should apply from the time you elect to consolidate rather than from just 1 July 2002.

There is also an exclusion in the bill for certain small to medium enterprises in respect of indirect value shifting, but there is no similar exception to direct value shifting. We think that might be a bit heavy handed. The point has already been made that we have had part 4A, the general antiavoidance provision that would apply in many of these types of cases. We think that is something that needs to be looked at. There are a number of other recommendations in our written submission about market value, common ownership test and a control test for discretionary trusts. I do not know whether we have got time to go through them all in detail.

Mr Plummer —I think it is an interesting result that within this same bill the consolidation measures and the demerger measures are, we are hearing, receiving significant support from the business community, subject to certain comments around the edges of those measures, and then we have the value shifting provisions—which are an integrity, avoidance set of provisions—contained within this bill. Having noted that, I would like to stress a comment that has already been made—that is, that we would only be suggesting that the value shifting measures be referred back to the Board of Taxation for further review if they can be excised from this bill, because would certainly not want to hold up the progress of this bill containing the consolidation and the demerger measures.

Senator CONROY —I am happy to move on to demergers if everyone else is finished on that. I would like to start the discussion of demergers measures by focusing on the main extensions beyond the Ralph review recommendations in this area. As you would know, the proposed measure allows relief for non-widely held entities and their members whereas the original Ralph recommendation was for recommended relief for members of widely held entities only. I understand from the explanatory memorandum that relief is being restricted for non-widely held entities due to integrity concerns. Many of the submissions were very quick to reassure us on this point that the extension to non-widely held entities would not compromise the integrity of the tax system. Would someone just like to help the committee out and take us through what has changed since Ralph to make us think that this extension is not a risk? He seemed to think there was a risk to revenue. Does someone want to help us out and explain to us why he was wrong?

Mr Plummer —I am not sure that Ralph actually identified there being a risk to revenue in relation to non-widely held entities. I think that the consultation process of simply looking at the benefits and the objectives of demerger provisions saw that these provisions should apply to as wide a base of companies as possible. To the extent that demergers and their benefits are going to benefit the economy in terms of achieving more efficient corporate structures, then I suppose it begs the question: why not have those measures made available to as broad a base as possible?

The concerns in relation to any revenue leakage, I think, are more than adequately covered through the very, to some extent, broad and onerous conditions that must be satisfied to qualify to obtain this relief. I think any demerger that actually makes it through those set of qualifying conditions is going to be a genuine demerger and the benefits of that demerger are going to be beneficial to the economy at large. I think that is the thinking that took the recommendation that Ralph made to the result that we now have.

Senator CONROY —Maths, for a start, suggests that when something is restricted to a group this large—and Hansard cannot record how wide my hands are at the moment—then it is going to cost X, and if it is wider it is going to cost X plus. The explanatory memorandum goes to great lengths to point out that this is an integrity issue in terms of the tax base.

Mr Plummer —Genuine demergers are not going to have a negative revenue impact. Demergers that would otherwise give rise to a significant tax cost are simply not going to go ahead in the absence of these provisions.

Senator WEBBER —Is it not possible, therefore, that if you widen the base you are more likely to have non-genuine demergers?

Mr Plummer —I agree.

Senator WEBBER —And, therefore, you are going to put the revenue base at risk.

Mr Plummer —That is why there are the conditions to qualify for demerger and, to some extent, there is a level of discretion built into these provisions for the tax office to review a specific set of circumstances and to deny, for example, providing a positive tax office ruling or giving clearance in relation to a demerger they see as not being genuine. As I said, to the extent that a demerger can qualify for each of the conditions under these rules, they will all be genuine demergers.

Senator CONROY —You have described these eligibility conditions as `broad and onerous' yet you are saying that they achieve an integrity result.

Mr Plummer —Yes—`onerous' in that there is a list of specific conditions that a corporate group needs to pass before they will qualify for demerger, things such as ownership criteria, looking at the ownership before and after the demerger, and factors such as foreign ownership in the group which is being demerged. It is onerous in that respect, in terms of there being a list of quite specific tests. In addition, there are quite broad elements where the tax office has quite significant leeway, such as the integrity measures relating to what will be a dividend and what might be a deemed dividend. There is quite a level of flexibility in there for the tax office to look at a particular demerger that they do not like, one that does not, for example, pass the smell test, and say that they are not happy with that. In that respect, there are those two elements which will very much protect the revenue from non-genuine demergers.

Senator CONROY —Notwithstanding that you have talked about how the current `broad and onerous' conditions deliver genuine demergers, in your submission you argue for a further widening on top of what we already have. Is that right?

Mr Plummer —Yes, that is correct—again, for the same reason: that the rules which are built into these provisions which you must satisfy even if you are a listed company, which is to some extent a smaller list than if you are a non-listed company, are sufficient to provide protection for the revenue such that those rules that apply for listed companies should be broadened to apply for the entire base.

Senator CONROY —Can you explain to the committee the practical impact of the rule regarding removing the maximum cap of a 20 per cent interest in the head entity of an unlisted company or trust?

Mr Plummer —It basically means that at the moment if you have a group and the parent, so-called, of that group has a corporate shareholder that owns more than 20 per cent of that group, then that group of itself will not qualify under these rules for a demerger, unless they are listed. There is an exclusion in there for listed groups. For non-listed groups, if you have a 20 per cent shareholder that is a company in your group, then you will not qualify for demerger at all under these rules.

Mr Timmers —I understood that the 20 per cent holding rule, as it formerly was, would have meant that to have effected the provisions you would have had to have demerged the leaving entity, if you would like to call it that, to the shareholders of that 20 per cent entity above you and therefore not distribute any of the shares to your, say, 80 per cent shareholders. Clearly, that was not what was intended; it was a technical glitch. That is why that rule has been overwritten—to make sure that the shares in the leaving entity end up in the hands of the right shareholders.

Mr Stolarek —I would support the proposition made earlier—it is contained in our submission as well—that the demerger rules do contain some measures that could merit some adjustments. Concerning the 20 per cent rule, while one can understand why there was a policy rationale. Ideally a demerger should happen only if the top company has natural shareholders or a spread of shareholders rather than being merely a subsidiary of a parent company. The problem with the 20 per cent rule is that it means that any company that is not publicly listed, in which a shareholder which is another company holds more than 20 per cent of its shares, is unable to demerge anything. So the 20 per cent rule, in our submission as well, is one of the issues around demergers that needs to be refined and can sensibly be refined. We also are strongly supportive of the measure. We think that it works satisfactorily for listed public companies at the moment. For that reason, we at Ernst and Young would like to see the bill passed, but we see that there will be some opportunity for finetuning of the detail of the policy because there are measures like this 20 per cent where one would say that it does not perform any useful function and could be removed and adjusted in due course.

Mr Thring —To address the first issue you raised about why this is being extended to non-widely held, I think the reason for that recommendation of Ralph's was that this is very closely aligned to the scrip-for-scrip rollover provisions. Originally it was designed as a sister provision but was probably an afterthought rather than the primary one. The scrip-for-scrip rollover involved effectively a cost base uplift to the company acquiring. Demergers do not involve that because that involves allocation of the cost base between your existing shares. So there is no actual cost base uplift. The integrity measure issues are not as great on the CGT side as perhaps they were on the scrip for scrip. I also note that the scrip-for-scrip rollover, which Ralph did recommend only for widely held, has been extended to non-widely helds. The reasons that were given are in our paper. I think it would be anomalous if we were to have a scrip-for-scrip system running which was a different size to that on which the demerger provisions run. They really should be working the same playing field. For that reason we support, on equity grounds as much as anything else, the inclusion of demergers for non-widely helds.

Mr Poulos —To expand further as to why it is necessary to remove the anomaly in the current bill regarding non-widely helds or non-listed companies, most of our major trading partners—other than New Zealand, which does not have CGT and does not need demerger relief—have much broader demerger relief. It is recognised that a lot of innovation and a lot of growth in an economy is actually generated from the non-listed sector. I will give you an example. You might have a small unlisted biotech company owned by a couple of researchers and a venture capitalist, say, and that company discovers a new drug or a new line of research that could give rise to tremendous commercial potential, but for commercial reasons—such as fear of litigation or some other exposure, whether it be FDA scrutiny or litigation in the US— it might be appropriate to spin off that new discovery back up to the shareholder level so that the existing business is not tainted or threatened by that new promising business, which really can prosper to its maximum potential only if it is spun off. Typically in unlisted companies— whether they be small, medium or large—you will see that tremendous potential.

Australia has moved a long way to try to foster innovation through a number of programs and measures to support venture capital. Extending demerger relief to the non-listed sector is really part and parcel of those reforms and one that is very important. Notwithstanding that we have had a technology correction in recent years, there are still thousands of start-up companies and early technology companies that, going forward, will realise their potential, to a degree, by benefiting from demerger relief. So, as much as the current bill allows listed companies to demerge—and it is critical to make sure that that demerger relief is legislated as soon as possible to mitigate the costs already being borne by listed companies that are being frustrated by delays in the legislation—it is important for the Senate to ensure that the non-listed sector also ultimately receives the benefit of the relief and, in due course, the legislation is revisited to deal with this very gaping hole.

ACTING CHAIR —That is very important for research in emerging companies. Can you explain just what relief overseas taxation regimes provide in relation to the issue you have just mentioned?

Mr Poulos —The three critical taxes that arise in a demerger are CGT at the shareholder level—there are also revenue taxes at the shareholder level which are not dealt with in this legislation, unfortunately—CGT at the corporate level and dividend relief. Demerger relief models typically take account of all of those reliefs. Merely dealing with one does not constitute demerger relief, because a demerge will typically give rise to those three lots of taxing provisions. So you need to hit the whole three.

ACTING CHAIR —But how do other tax jurisdictions handle this research and technology spin-off to the shareholder level?

Mr Poulos —They have general demerger relief so that companies of different industry classification and different size can demerge. The various models all have their own rules for qualifying and their own integrity measures and so forth. I think the model we have come up with in Australia is a good model, by and large.

ACTING CHAIR —But at the same time you are suggesting that it could restrict the development of research and development in this country, because of the tax impositions. Is that the point you are making?

Mr Poulos —No, it restricts R&D insofar as only listed companies, in the main, can benefit from demerger relief.

ACTING CHAIR —Yes, but we want to be able to split off their successful, innovative subsidiary and provide those benefits back to the shareholders. That is the scenario. I am asking: how do other tax jurisdictions provide an appropriate tax mechanism to enable that to happen?

Mr Poulos —They do it in the same way we are proposing to do it for listed companies, but they do not close it off to listed companies alone. We are closing it off to listed companies and non-listed companies that, by virtue of chance, do not have a greater than 20 per cent shareholder. I would imagine that most unlisted groups do have a greater than 20 per cent corporate or trust shareholder.

Mr Stolarek —To address and amplify Mr Poulos's response—and to address Senator Conroy's query as well—at the moment the best position under the demerger law is for widely held entities and listed public companies et cetera. To be widely held and listed, one has to have, broadly, 300 diversified shareholders. The issue is, if we look at the reality of business, the private equity market and the way that businesses are formed in Australia, there are many businesses that do not have 300 shareholders and that are not wholly owned by one listed public company or a subsidiary of one listed public company. If you have a business that has been established through a limited take-up of equity by, say, half a dozen companies, which may be a mixture of public and private companies—we will call this business a non-widely held company—and if one of the shareholders of that non-widely held company happens to have more than a 20 per cent shareholding then that non-widely held substantial business activity is prevented from accessing the demerger concession.

This addresses Senator Conroy's point as to why the concession moved from the silence of the Ralph review. The Ralph review did not call for a prohibition. I think it was actually more silent in this area. What we can see is that the non-widely held sector of this economy speaks not just for private companies that are owned by one family and so on where one might have one's view about the integrity issues involved but also for some very substantial businesses that might have very substantial shareholdings but do not happen to be listed.

Senator CONROY —Mr Poulos and you are making a good case for the non-widely held company. You have made reference then to potential—if I could describe them as this—non-genuine cases. How do we open one part up to the genuines and not let the non-genuines get access?

Mr Thring —That is already catered for in legislation because section 45B is a very broad vision. It effectively says that, if you have a more than incidental purpose, in doing your demerger, of providing a dividend benefit, the whole value of your company, potentially, can be treated as a dividend—and it is a more than incidental purpose, which is something that is more than fortuitous. That would mean that any person who had a less than genuine arrangement—in other words, who did not have a commercial purpose to do the demerger— and where there was some tax mischief would be running a very extreme risk if they had not cleared it with the tax office. I know some tax practitioners have complained about this provision—that it effectively requires you to go to the tax office before you can do a demerger. To that extent it does effectively put a great amount of integrity into the system— the fact that there is this potential sword of Damocles hanging over your head.

Senator CONROY —In terms of trusts and distributions, there have been a lot of those cases in the courts—testing a genuine one and a non-genuine one.

Mr Thring —Demergers?

Senator CONROY —Distributions and trusts.

Mr Mansell —The beauty of this situation is that you would be negligent as a tax practitioner not to have got ATO approval. So before you actually do the demerger you have to go to the ATO and say, `I want to treat this 65 per cent as a dividend; 35 per cent as a return of capital.' The ATO are going to have a chance to really look at every single one and make a call on whether they think 45B will apply or not.

Senator WEBBER —If we impose that on these smaller entities, the non-listed ones, aren't they all going to whinge about the compliance cost of having to get an ATO ruling before they demerge. You are saying open it up but—

Mr Drenth —We are probably not talking about a couple of companies worth under $100,000; we are talking about businesses that would be worth a few million dollars.

Senator WEBBER —But it is not cheap to get an ATO ruling on something as complex as that, is it—in terms of the advice that is required?

Mr Drenth —No-one is going to volunteer to shell out thousands of dollars on advice. The proposed transaction would need to be of a certain critical size for it to be worth contemplating in the first place, and that is what you have to pay to get into the system.

Senator WEBBER —But that is arguing against what Mr Poulos was talking about in his theoretical example. I could not see that company having access to that amount of money, yet we are saying we want them to be able to access the system.

Mr Plummer —I think what we are talking about here is not an annual compliance cost; we are talking about a major restructuring of an existing group. When it comes to those one-off type significant transactions then whoever it is that is entering into something like that is going to want to get a reasonable degree of professional advice and ATO to sign off. In those scenarios they are going to bear that cost.

Senator MURRAY —If I may interrupt, my understanding is that the number of companies which would find demerger commercially attractive, as distinct from tax attractive if you allowed that—which I think would be massive—is likely to be very low, whether it is in the large business sector or the small and medium business sectors. I cannot envisage that many situations of demergers being attractive. Why would that be so?

Mr Poulos —I can understand one getting that impression from reading the press, when there have been, say, a handful of very high profile mergers in the listed sector. But, equally, I can look across my firm's client base of small, medium and large—

Senator MURRAY —How many have you got on there, as an example?

Mr Poulos —Of this type? I have had comments from dozens—

Senator MURRAY —No, I mean if you had a 10,000 client base, how many would you say would find demerger attractive?

Mr Poulos —Over the course of their evolution, which would be over a number of years, I would say that there will be quite a few—several.

Senator MURRAY —But that is the point I make. I speak to you as somebody who has been in business for most of his life. I cannot recall situations where, as a businessperson, demerger would have arisen much. I would assume, if you are talking about millions of businesses, demerger as a commercially attractive proposition, not as a tax effective proposition, that would have numbered in the thousands rather than anything more. That is just my assumption. Therefore, I cannot see why there would be a major issue with the legislation extending itself fairly widely, because I cannot see that many people taking it up providing you restrict the tax effective side of it.

Mr Poulos —I would agree that demergers may occur commercially in the thousands rather than in the millions. If we had viable businesses in the millions then I think we would all be very happy. The economy is that big and there are a number of enterprises there but the demergers are a fact of evolution, particularly in start-up, high-tech, knowledge based, innovative types of sectors of the economy that we would all like to see. It is a commercial development that is more likely to be a feature of the future than the past.

ACTING CHAIR —Would this be an impediment to new, innovative research and development type firms?

Mr Poulos —The tax arising on demergers is very much an impediment and demergers do not occur because of that tax cost, which gets back to—

Senator MURRAY —Presently.

Mr Poulos —Yes—which gets back to the whole issue of integrity and therefore integrity measures. Demergers do not get done.

ACTING CHAIR —But here is an occasion to provide them with a real opportunity to use Australia as a base, providing the integrity measures are satisfactory.

Mr Poulos —That is right.

Senator MURRAY —Which means its predominant purpose has to be commercial, not tax effective.

Mr Poulos —Exactly. And if it is not predominantly commercial then you are not going to get around the integrity measures in the current legislation.

Senator MURRAY —To return to the question asked by my senator colleague, with respect to the small business numbers, they are actually very difficult to get. The ABS says there are 1.1 million. The ATO, I think, registered 1.6 million or more—it might have been 1.8 million—ABNs as small business. Within that sector—the official classification—I just really cannot see demerger provisions arising to an extent.

Mr Mansell —Take the example of a family company in the case of a divorce. I think that is the current flavour of the month with demergers. People are talking about using demergers in that case where you have got a series of companies, a husband and a wife as the shareholders and you now want to split the companies up. Instead of having to go through the tax cost of demerging, that can now be achieved through this legislation here. That is the flavour that everyone is running around with at the moment. So I think it may apply to more companies than we think.

Senator MURRAY —So you mean almost in the estate planning side of it—for divorce or death, or that sort of thing?

Mr Mansell —That is something I had not thought of. I would have had the same thoughts that you did, until someone called me up and said, `Can I use it in this situation?'

Senator CONROY —You have not told Tony Abbott you are trying to facilitate divorce, have you?

Mr Mansell —Absolutely!

Senator MURRAY —Family values!

Senator CONROY —It would all be withdrawn tomorrow!

Mr Mansell —Again, that is why I think it is difficult to guess the situations it will be used in, until we have the opportunity to see how people will use it.

Senator MURRAY —That is helpful.

Mr Plummer —I think it is worth making the point, though, that nothing in these provisions is going to give businesses a beneficial tax result from actually doing a demerger. These provisions remove a tax cost of doing something which otherwise would be commercial. Only commercial reasons will drive businesses to undertake demergers.

Mr Collins —The Securities Institute submission has an interesting analysis done by Access Economics explaining that, overall, by providing this benefit, there will be a net benefit to the economy. I think that is an important point to remember. As Mr Plummer was saying, it is actually removing an impediment for some commercial transaction proceedings, which has an overall benefit.

Senator CONROY —Mr Drum, have you got a lot of divorces on the books?

Mr Drum —I am not sure about our divorce rate at the moment. I am also not the authority or our spokesperson on demergers. That is why I brought Mr Thring. I do not know whether I have much else to add to what I have heard in the discussions this afternoon.

Mr Thring —I do not think that example is limited to divorces. Take the example of the service station with the grocery store. If two partners decide they want to effectively split the business up—and there are still some issues around the integrity measure as to the extent it can be used to do that in a divorce setting, so it is not clear that that will actually achieve this; the ATO have yet to set out the guidelines of what is acceptable—with a CGT swapping of assets there will be some tax cost. Effectively there will be a split-up of the business between the two parties, to go their own way, which is just another illustration of the divorce example. So I guess those sorts of transactions are the ones which people are thinking about. The ATO have yet to respond on whether or not it is acceptable.

Senator CONROY —I will not mention it to Tony Abbott if you will not!

Mr Morley —If I could speak as someone who is anxious to use the legislation, I agree with Mr Collins that, if we demerge subsequent to the passing of the legislation, which I expect our shareholders would approve of, then I would expect that there would be changes in the portfolio holdings of the two different entities which come out of it. I would be quite confident that there would be revenue positive effects from the demerger legislation because, to the extent that you have different types of entities arising out of the original one, people will change their risk profiles.

I think the reasons for introducing the legislation and the improvement in the capital market have been very well expressed in the submissions and also in the oral presentations given today. But I would like to add my voice to saying that this legislation seems to be a lot less contentious than any of the other legislation. In spite of the fact that it may need some improvement or that there may be some desirable improvements, we would be very anxious to see it passed as a matter of urgency. We have been employing some very expensive advisers to get us to this stage, and I can assure you that the holding costs are very high. We would be very enthusiastic to see the bill passed in this session of parliament.

Senator CONROY —You are not reflecting on anyone in this room, are you?

Mr Morley —I will not mention names. If the bill were passed, we could then proceed towards a demerger by the end of this year.

ACTING CHAIR —We note the general anxiety to get the demergers.

Senator CONROY —This is a very well attended committee hearing for such a non-controversial bill, I must say! I have never seen such interest!

Mr Collins —I would like to support what Mr Morley was saying. I am here representing Incitec, which has also made a submission. Supporting what Mr Morley was saying, Incitec are a long way down the path to developing a proposal which hopefully demonstrates the benefits of demergers. It is permitting them to separate the chemicals and fertiliser business they operate to allow for rationalisation of the fertiliser industry. Having separated those businesses, there can then be a merger between Pivot and Incitec so we end up with a specialised fertiliser company and a separate chemicals company. Certainly, Incitec have been proceeding on the basis that the rules will be available from 1 July. They will have a shareholders meeting on 22 October, where the shareholders will be asked to vote on the demerger. The implementation of that will be necessarily subject to the legislation receiving royal assent.

I would like to echo the point that there a lots of other demergers that are not in the public domain. There are three or four that are talked about a lot and there are quite a few others that are still under wraps at the moment. Those you can see in the room and you read about in the press are good examples of the types of transactions that these rules will permit to proceed. At the moment the tax cost is too expensive. There is an enormous benefit to the economy in some of the synergies that can be brought out of these types of transactions.

Senator MURRAY —You will be pleased to know, from my perspective, that I have never understood why there would be objection to demerger provisions when, on a cross-party basis, the parliament has so assiduously made merger provisions far more efficient and productive. Senator Conroy and I have been at the heart of that and supported that fully. I see the demerger provisions as the other side of the same coin, providing the motivation is genuinely commercial. I understand your caution, but you are probably unnecessarily concerned that it will not get passed.

Mr Morley —Adding to what Mr Collins said, it is not so much that it will not be passed; it is when it will be passed that we are really keen on.

Senator MURRAY —If we could stop the buggers blowing up our citizens in Bali, we would be able to get on with business.

Senator CONROY —Can I just ask anyone who is involved in that little secret society you have chatting with Treasury what Treasury's views are on this issue?

Mr Timmers —On demergers?

Senator CONROY —On the issues that we have been kicking around here. Have you raised them with Treasury?

Mr Timmers —Yes, we have. It has been a terrific consultation process. It seems to be getting better every time we go through this cycle.

Senator CONROY —They have stopped fighting, have they?

Mr Timmers —The government's policy is to support demergers as complementary to scrip-for-scrip. Although, technically speaking, they are not identical. With scrip-for-scrip, you have shares in a company, which is being taken over by some other, and you end up with shares in that other company, including all of its assets, as well as the assets of the entity that you are giving up your shares in. In demergers the same economic interests end up in exactly the same hands, albeit by two streams of shares rather than one. A key point is that it is not an economic shift that is going on under a demerger. There is an economic shift that happens under scrip-for-scrip. Both of them are similar in the sense that there is no cash changing hands. So the poor shareholder, if they were assessed for tax, has the problem of where they get the cash from. They had shares; they still have shares but no cash to pay their tax liability, so it is very much the same. Where do Treasury stand? We have had very lengthy discussions with them, sticking to the Ralph proposals as much as we can. There are some areas where that does not happen to be the case currently.

Senator CONROY —I will narrow it down for you: the non-widely held entities and the 20 per cent rule.

ACTING CHAIR —That is where the problem areas are.

Mr Timmers —In our submission, we raised employee shares and equity interest. We will not go into that, because you are particularly interested in the 20 per cent rule. The rule decides to whose shareholders the distribution should be made or where the shares should rest. It is a mechanism to decide at which level the demerger can happen. It is a technical issue more than anything else. I do not see it as being highly controversial.

Senator CONROY —Are you making progress with Treasury?

Mr Timmers —Yes, absolutely.

Mr Thring —I think Treasury are taking that on board and are looking at it.

Mr Plummer —The impression that I got on that particular point was that they were not prepared to move on that 20 per cent rule and they had moved as far as they were going to in allowing that exclusion for listed entities. That was the compromise they were willing to accept, and they were not willing to accept—

Senator CONROY —Do you all attend the same meetings? I just got three different answers there, that was all.

Mr Thring —There was no meeting on this. They were one-on-one discussions.

Senator CONROY —Are you all talking to the same Treasury officials, then?

Mr Thring —We are.

Mr Plummer —This issue actually arose after the principal consultation meetings were over, so it has been discussed on a one-on-one basis.

Mr Poulos —To expand on that a bit, throughout the consultation process, which has gone on for about two years, it is fair to say that the feeling from Treasury and the tax office was that demerger relief should apply to non-widely helds as well. There was always a caveat that perhaps there may need to be some additional integrity measure, although it was never, ever made clear that there would actually be a need for an integrity measure and what form that integrity measure would take. Nobody could ever really put the finger on and identify what the mischief might be. This is just another example of being ultraconservative and ultraprotective in raising legislation. In Australia we try to chase every possible, conceivable dollar of tax revenue and end up with an extremely complicated tax system that is probably world's worst practice in terms of tax legislation.

Senator CONROY —We have just gone through a massive taxation simplification process!

Mr Drum —Yes!

Mr Poulos —I must have missed that one. What we are doing here, as a result of what appears to be paranoia, is cutting out for a massive section of the economy, including much of the innovative potential of the economy, the ability to access that demerger relief. That leaves us at a disadvantage relative to other dynamic economies around the world.

Senator MURRAY —Essentially you are saying that, if there are relatively few restraints on mergers, there should be relatively few restraints on demergers.

Mr Poulos —At the very least, if there is a case for additional restraint, let us establish that case and then frame an additional integrity measure. But there has not been a case established, and the cutting-out of the non-listed companies has effectively happened at the back end of a very productive consultation process and almost out of the blue. That is not good enough.

Senator CONROY —We will let Mr Wallis know your views.

ACTING CHAIR —Can we move to the employee share acquisition laws.

Senator CONROY —I would actually like to keep working through my sheet, if I could.

ACTING CHAIR —Have you got some further questions?

Senator CONROY —Yes. The second Ralph extension issue is that the proposed measure extends tax relief to the entity itself whereas Ralph recommended relief for members only. Many of the submissions have sought to reassure us on this point, this time on the basis that there is an underlying economic case for extending the relief to entities as well as members. I am intrigued: if there is such a basic economic case for the extension, why did Ralph get it so wrong? Can anyone help me with this?

Mr Thring —I do not know if Ralph got it wrong. Again, you have got to remember that the demerger relief did come out of the scrip-to-scrip and scrip-to-scrip is only between the shareholders. I have heard anecdotally that the demerger relief, which was thought about later in the piece in the scrip-to-scrip, was modelled having the same sort of thinking. They did not recommend against corporate relief; they simply had no recommendation either way. It could be that they simply did not address this issue rather than actually recommending against it.

CPA Australia believes an essential feature of demerger relief is corporate relief. If you do not have it at the corporate level, there will be a lot of demergers which cannot happen because of the cost of the corporate doing it: the benefits of the merger could be simply wasted by the corporate tax paid at the corporate level—which essentially should be a deferral, because eventually it will be paid at the shareholder level.

Senator CONROY —Someone has suggested that, as part of Ralph's consideration of these issues, there were wins and losses, trade-offs, along the way in the final package that he proposed and that this was one of the bits of the package where some would be unhappy with one element and others would be happy with this other element. So it is a bit of a trade-off to leave it out. Now what seems to be happening is that you did not get everything you want through Ralph so you have just come back for a second bite.

Mr Thring —I could understand that if the Ralph report had actually recommended against or even commented on relief at the corporate level.

Senator CONROY —I have always found it not worth picking a fight, even if I oppose something and try to put forward something, if I do not need to—just do not talk about it rather than buy into the fight by saying, `Oh no, it's a shocker because it will be a terrible lack of integrity.' But I am a cynic.

Mr Thring —Yes. I have spoken to some people who were involved in the Ralph report and I do not understand that that was the process which was gone through. I would reiterate the point that it would in some circumstances make it very difficult for some corporates to actually do a demerger. I guess we would view it as a necessary feature of the demerger relief legislation because it would arbitrarily cut out some companies' wish to do the demerger.

Mr Poulos —Perhaps to expand on that, I would expect that most demergers would not proceed if you limited the relief to only taxation at the shareholder level. I think even a cursory analysis of what is required technically and a cursory analysis of what happens internationally in providing the demerger relief is that you do need to have the relief cut across the three key taxes—demerger, CGT at the shareholder level and, secondly, at the corporate level, and then dividend relief. Simply dealing with one does not deal with the issue. In the consultation process there was quite a lot of focus on going beyond the Ralph recommendation, and quite rightly so, by the ATO and Treasury. My perception was that that issue was clearly understood by the ATO and Treasury.

Senator CONROY —I must say that what I thought was clearly understood was when Ralph made his recommendations and the government approached the opposition and said, `Sign up for the package as it stands now because it is revenue neutral.' All of a sudden there seem to be these little holes.

Mr Poulos —I think in fairness to Ralph it dealt with hundreds of recommendations, and this appears to be one that really had not been given a lot of thought. In two pages you really cannot do justice to a topic of this type. It is apparent that the Ralph committee did not seek to look extensively at this issue. In terms of any trade-off, it is widely regarded in the profession that there is no trade-off when it comes to revenue cost or something like demergers simply because demerger relief removes impediments. It does not resolve any reduction in tax revenue because demergers do not happen where there are tax barriers. That is an internationally understood issue.

Mr Drenth —I really do not think that it would be fair to characterise it as a second bite of the cherry. The Ralph process, as good as it was, was not perfect in the sense that it was not really all that iterative. There were reports prepared by the committee which people responded to, generally in writing, and although there were some meetings the consultation process was not nearly the same as it is now where there are many meetings and we keep throwing issues back and forth at each other until we get a bit closer. I think also, as Mr Thring pointed out, the demergers part of the final Ralph report, while not quite an afterthought, did not purport to be a comprehensive analysis of what the system should look like. So I do not think it is wise to read that page and a half like the entrails of a chicken and see what it really means. I think Treasury and the ATO have sensibly moved beyond what a literal interpretation of it might tell you and have come up with something that really works.

Mr Collins —In the absence of that relief at the company level, you do not truly have demerger relief. The broad theory here is that the economic ownership of the assets is not changing. If you are a shareholder, it ends up, instead of owning one share, having two shares with exactly the same economic interest in two separated companies. The idea would be that that happens on a tax deferred basis. If tax has to be paid at the corporate level, that is not achieving the objective. Instead of having double taxation, you have single taxation. I reinforce the comment that has been made that it only makes sense if you have relief at the company level.

Senator MURRAY —If I understood Mr Morley correctly, he said that, as a result of demerger, the stock, the shares, become more tradeable and therefore released into the market with the taxation consequences, which is revenue positive—in other words, kind of a multiplier consequence. Is that what I understood you to say?

Mr Morley —Yes.

Senator MURRAY —The EM itself does not identify any revenue loss or gain from this exercise but Mr Morley is implying there will be an economic consequence which would deliver a revenue positive result. I would assume demergers result in more economic activity, so the general proposition would be easy to follow.

ACTING CHAIR —You do not demerge unless you are enhancing shareholder value. That is the whole purpose of it.

Senator MURRAY —Or tradability.

ACTING CHAIR —Once you dispose of the shares, you then pay a gain.

Senator MURRAY —Surely it improves tradability.

Mr Collins —I point out to the senators that the Securities Institute of Australia has quite a detailed submission that was done back in 1999, which was based on some work done by Access Economics. It demonstrates that, although the rules may have a revenue cost in the earlier years, overall they have a positive impact on revenue. Because of that, the unlocking of the synergies, the increase in share prices and therefore the increased collection of CGT, the company is generally being more profitable. I recommend that you have a read of it.

Senator CONROY —Since you mentioned CGT, I might move on to the next issue there. The third Ralph extension issue is the measure preserving pre-CGT status of assets where Ralph recommended that pre-CGT assets would be brought into the tax net. Many of the submissions have sought to reassure us again, this time on the basis that the policy intent should be that there are no CGT implications at the time of demerger. I am interested in your views as to why this was not done in the first place and why Ralph missed this. Can anyone provide any information on that? Was it potentially part of a balance that Mr Ralph was seeking to achieve at that point or is it another second bite at the cherry?

Mr Drenth —You have to ask how big the cherry is and whether it is worth upsetting the people who have still got it. I mean, 1985 is a long time ago. Even if that was not an issue, then conceptually—

Senator CONROY —Your job is not to try and provide hospitals and schools for the rest of the country; ours is.

Mr Drenth —But conceptually, if you hold a pre-CGT share in a company and you go through the demerger exercise and you are left with two shares instead of one, you have still got, we would argue, two pre-CGT economic interests. Why should your tax position be changed?

Mr Stolarek —In our submission, we noted that currently a company can engage in a CGT share split.

Senator CONROY —That was my next question. I was going to ask you to expand on that.

Mr Stolarek —That does not do the same thing as a demerger but that addresses that particular piece of it. A demerger is in truth, at the end of the day, a splitting of the company. The company might be undertaking two diversified activities, the market likes one not the other, the management of one does not operate well in the other activity and it is decided to really split the company totally and to distribute it to its shareholders. They are the key elements of a demerger at the company level.

Looking just at the shareholder, it is possible for a company currently to split its shares. For every share, a shareholder could receive three shares or for every share a shareholder would receive half a share in terms of capital restructures. The existing CGT rollover which enables such share subdivision to occur allows the pre-CGT status to carry over into the replacement shares. The key proposition is that the number of pre-CGT shares in the economy is progressively reducing with just the effluxion of time. But in the company sector, particularly in the widely held sector, there are still a lot of shareholders who have pre-CGT shares in their estate or whatever. Losing that pre-CGT concession would throw up a difficulty in implementing the mergers and I think, as most of the submissions have emphasised, the pre-CGT continuity is maintained in various pieces of the CGT law. It is a relic of the time of the introduction of the CGT law but certainly, as every year goes by, the number of pre-CGT shares or assets in this economy falls away. The preservation of that pre-CGT status I think we all saw as being consistent with the rest of the CGT law and the preservations elsewhere. One might say there is no greater or lesser basis for its preservation than there is in the remainder of the CGT law.

Senator CONROY —Even if it creates a whole extra layer of complexity by having two different rules? It is the sort of thing that people like you normally sit here and tell us is a bad thing and tell us we should not do.

Mr Stolarek —I understand, Senator Conroy, but what really happens is that one hopes that the merger law as it starts to operate will result ultimately in a shareholder who originally held shares in a company conducting activities A and B ending up at the end of the demerger with two lots of shares, A shares and B shares, and ideally those shares should have the same characteristics as they did previously. Then he or she can decide whether they want to sell A or B and pay the tax on that share without overlaying new lots of tax consequences over the top of the demerger. So the preservation of the pre-CGT years is, as it were, a way of keeping the noise or new complexity away from that split and enabling the split of the company to take place simply and cleanly and just break the company apart.

Senator CONROY —Do you remember I mentioned earlier that Ralph originally put up this package and the government reached an agreement with the opposition on the basis of revenue neutrality. Access Economics have costed this particular change at $160 million over the next four years. Have you any suggestions on how we make up the $160 million to stay revenue neutral? Put the tax rate back up to 31 per cent? Any takers?

Mr Drenth —Sorry, Senator, where did that come from?

Senator CONROY —Access Economics.

Mr Drenth —Was that to do with demergers?

Senator CONROY —No, CGT cost. The specific CGT measures that we are talking about.

Mr Drenth —Preserving the pre-CGT status of the demerged shares?

Senator CONROY —There must still be a few of those shares hiding out there somewhere.

Mr Drenth —It is hard to understand how it could be a cost. Without the demerger measures there would be no transactions, Senator. I do not know what instructions Access Economics were given or who they made the report to.

Mr Morgan —There would not be until they were traded again so it may not be in the area we are concerned about.

Senator CONROY —So there is no revenue gain by bringing them in then; is that what you are telling me? I cannot see why people are objecting if there is no revenue gain.

Mr Drenth —It depends on what Access Economics were asked to cost. If their starting proposition was that these shares would become post-CGT shares and you assume that they were sold within a year and made 100 per cent profit then you would come up with a theoretical revenue gain that would be lost by having these measures. But we would argue that would be comparing the outcome we are seeking with an outcome that is unfair. It is certainly not the government's position that has been locked in. It is always hard to know what you are comparing the thing with especially as things change over time.

Senator CONROY —Actually it was the government's position they locked in, just for the record. They signed an agreement with the Labor Party in writing from the federal Treasurer locking himself into a particular package.

Mr Drenth —I do not know where the $160 million fits in. That's all.

ACTING CHAIR —In terms of the non-widely-held, how many companies went down the demerger route on the basis of Senator Coonan's press release of 6 May 2002 only to find when the legislation subsequently came out that the non-widely-held were excluded? Did we have any situations where people proceeded on the basis of the press release?

Mr Plummer —There were no publicly announced transactions that I am aware of. There were certainly a lot of inquiries, from our client base in particular, in which those types of companies—the family companies and the high-tech type companies—raised the question, only to be told when we saw the provisions as they ended up that they would not qualify for that sort of relief.

ACTING CHAIR —So not much work was done on the basis of the press release.

Mr Thring —Just to clarify that: non-widely-helds are included; it is only this 20 per cent issue that causes a problem. There is an issue if non-widely-helds are deemed demerger, but non-widely-helds, prima facie, can do one. A lot of parties are interested in it but there are two issues: as we have suggested, people would be reluctant to do this without a tax office ruling, and you are not able to get a tax office ruling on this issue, effectively, until you have royal assent to the legislation. There have been a lot of inquiries, but I think people will be holding off until the legislation is passed so that they can get the proper clearances from the tax office.

Mr McGuigan —I would like to echo that. In fact, our board of directors are waiting for this legislation to pass before they can make any decision on our demerger. Again, a quick passage of the legislation is what we are looking for.

ACTING CHAIR —I probably need to declare an interest in this.

Senator CONROY —Do you have CSR shares?

ACTING CHAIR —Yes, a small one.

Mr McGuigan —You may have two shortly.

Senator CONROY —I would like to add one final issue in this area before we move on to employee share ownership. Mr Morgan, I understand from the Law Council of Australia submission that you are concerned about the role of the tax commissioner as a gatekeeper for virtually every demerger transaction by making the dividend relief dependent on `vague and unworkable tests'. Would you expand on that for us, please.

Mr Morgan —Certainly. I was going to mention four points, of which that one was the third, and it might put things in perspective if I mention at least the first two to start with. I let some time pass because my comments were going to be of a slightly different pace and to a slightly different point from the others, concerning some matters of theory, and there are such weighty matters of practice on the table. The Law Council supports the prompt passage of the bill. The uncertainty created by the delay is really inimical to the idea of certainty that we have through rule of law, and there have been problems there. I think that is a reasonably obvious point. The second is that the Law Council would support the removal of the 20 per cent share block for unlisted companies; that seems to be confounding the commercial objects of the legislation.

Third, to get to your point, Senator Conroy, about the dividend relief, I think it is drawn up in a way that makes it, effectively, discretionary. I will amplify on that in a minute, but I think that having that relief as discretionary creates neither good law nor good administration. We would hope, again in the interests of rule by law, that the integrity of the legislation we have talked about at length can be found in provisions that can be interpreted and advised on without having to seek a ruling. Most of the deals that are in place and waiting to go are reconciled to the idea that they will have to go and get a ruling, so they want the legislation passed quickly so that it can be.

But you asked what the problem is with this. I think the taxpayers of Australia are entitled to be able to order their affairs with some reasonable certainty without having to go and ask for a ruling. That is not really the point of law and that is not really the point of taxation either. The detail that I am concerned about is that the test, in essence, in 45B is whether there is any purpose—more than an incidental one—to the transaction being taxed, or if it is any better than if you had got a dividend that was fully assessable. Usually, that will always be a part of the transaction—that is why the relief is there in the first place. In our submission, it creates an unworkably low threshold—a hair-trigger threshold—that sends people scurrying off to get the ruling, because in a matter of any consequence you can never be sure what you have got. How do you know whether your purpose is more than incidental or not? There is some law on that, but it is a very low threshold.

The second problem is that it leads to the test being administered on grounds that are an abstraction from that. In other words, the tax office has—perhaps even sensibly—its own rules in its mind about what is a bit rich and what is not. It administers this discretion that it has dealt itself into in a way that is abstracted from the test. It would not be possible to seek judicial review of the exercise of any powers there. If you wanted to appeal an adverse ruling, you would have to go back to the court and say, `My purposes were only incidental' whereas the tax office's administration of that power would have been on the mix of the capital component and the dividend component and whether in their estimate, after looking at everything, it was a bit too rich. Even though the system is working sensibly in some respects, it has just departed from what we normally look for in law. That is only our submission.

Senator CONROY —That was a pity. I was being reassured by some of the other witnesses' evidence that the tax commissioner being there to put a smell test over it was going to be a good way to ensure that it was a genuine demerger.

Mr Morgan —If that is the only way to get the relief up then so be it. As I said, our submission is of the theory that that was not originally what law was about and why we had it. It is a bit of a shame. I would have thought there was substantial integrity built into all the other tests, and we do not need to rely on that style of test remaining discretionary. For the moment, we need those people who thought that they would have this relief from 1 July to in fact have it, and we can clean up 20 per cent, discretionary tests and other things along the way. I just wanted to add my voice to that point being cleaned up one day as well.

Senator MURRAY —Do you think that is a transitional problem or a permanent problem? In other words, once tax officers have experienced a number of demergers and the market has experienced them, do you think the ground rules will be easier set? What you are itemising is a real concern if it is a permanent tax office habit—in other words, checking off every taxpayer's exercise.

Mr Morgan —I can only comment in this way: the dividend relief here has been made to piggyback on section 45B, which has been on the statute books now since, I think, about 1998 or 1999. They have been happy to keep the gatekeeper role for the transactions that that section in its current form affects, like share buybacks. The bottom line is that no share buyback of any consequence can be got away with without a ruling these days, because of the way the test works and is administered. If you ask any one of the other witnesses, they will say, `It is a problem. It is one that we have lived with, but it would be better if it were fixed, if we can think of the right words to fix it with.'

Mr Stolarek —To support Mr Morgan, in our submission we did note that there is a strong need for the tax office to provide guidance material around 45B. I think it is notable that the section is about a page and a half in the bill but in the explanatory memorandum there is really only a paragraph or two on it. As Mr Morgan notes, we all recognise that there needs to be integrity around any measures, for the reasons we have discussed previously, but there should be some clarification by way of a public ruling as to the way the ATO intends to interpret and apply 45B, otherwise there will be an inefficiency in the cost that is created every time people come along to the tax office to achieve a clearance. There is always a trade-off between whether or not one has the guidelines expressed statutorily, in which case the risk is that we will have very long legislation, or in a way that revolves around a discretion. But if there is a discretion on the part of the ATO, there is a need for the ATO to have clear guidance material available very quickly so that the community can understand what they are to make of the law.

Mr Morgan —Legislation can sometimes be short and still give some substantial clarification. For instance, part 4A talks about a dominant purpose and, whilst one is never entirely sure, that has been the subject of litigation, so we get a growing idea and that really reposes in one line. Part of the problem here is that the test is set unrealistically low so as to set a hair-trigger that then allows a discretion to be applied in an abstracted way and to not be reviewable anywhere.

Senator MURRAY —The nub of the proposition put by the two of you is that, if you are going to go to self-assessment, which is essentially what you are arguing for, in complicated cases you need a very detailed set of guidelines so that people will know against what they are being appraised. If you do not have that, the ATO are forced to assess it on a case by case basis and to build up the rules as they go along. My earlier question to you was: in the transitional process, whilst they are finding their feet as to the effects of the legislation in a marketplace as well as in a taxation sense, will it be necessary, before they devise rules, actually to have people come to them with a demerger proposition so that they begin to understand in greater detail what the consequences are?

Mr Thring —I think that is correct, because 45B was actually the gatekeeper for demergers which happened previously. We should always recall that several high-profile demergers have occurred, and they all sought 45B rulings. There was some practice and understanding coming out on 45B as it applies to the mergers. The ATO have indicated that they are going to do a 45B ruling. It is a question of when, but that practice and guidelines will come out eventually. I agree with John that it would be nice not to have 45B, but I seem to recall that 45B was to be a temporary measure before the profits first rule came in. The profits first rule is not going to come in, so in this situation you can have either a general principle based rule, as the tax office call it, or a very detailed mechanical rule like the profits first rule. I think in the interim we have to accept that 45B is there. It is the one that currently governs demergers—it has for the last three years—and, until we can develop a suitable rule, it is probably the one that has to be used at the moment.

Senator MURRAY —Practically speaking, unless you let people go away and do their own thing and then a few years later you whack them, which is highly undesirable, I cannot see how the tax office could deal with it in any other way than initially to review it on a case by case basis, provide the rulings, get the experience, then develop the guidelines and put it out for the general market. That is rather unpleasant for you two gentlemen because your companies are going to have to front up, but I cannot see another way to do it.

Mr Morley —We have been working with the tax office for some time on a draft ruling and we are quite satisfied with the process. We are waiting on the legislation.

Senator MURRAY —The point I make is that their experience with CSR and WMC will, I would have thought, in due course allow them to provide guidelines of general application as opposed to your specific circumstances.

Mr Morgan —There is probably good sense in what you say, and in practice we have no option anyway. That choice of mechanism was picked at a time when the tax office was trying to draft this within a very short time frame. Any change to 45B would require thought and they did not think they had that time then. I do not think we have any more now, but trying to fix it one way or another seems to me to be good in principle and I am glad to have had the discussion.

Mr Poulos —Certainly the US, the UK, Germany and Japan, amongst others, have been able to deal with the issue without needing a case-by-case tick-off on every transaction, so there are other ways of doing it. In the interests of time and getting the bill through, it is not something that can really be dealt with at this point in time, but we should not necessarily close our minds to the way we set up a framework of law. It would only take one or two personnel changes in a critical area of the ATO for a lot of that body of experience built up in relation to dealing with issues such as 45B to need to be recreated and started all over again.

Mr Morgan —I am sure the tax office can and probably will speak for themselves but, in a very early part of the consultation which I attended, someone said they were getting a bit sick and tired of being asked for a ruling every time a transaction was happening and were looking for a more streamlined kind of system of dividend relief. It seems that, in the time frame, they could not find one.

Mr Plummer —It may not have been the time factor. In fairness to the—

Senator CONROY —Thanks for that, Mr Morgan; you have got a debate going there. Has everyone finished on that issue—

Mr Morgan —I have one more point, which I am happy to make at any time that suits the committee.

Senator CONROY —Do it now.

Mr Morgan —It would be good to have equivalent stamp duty relief. I am all too aware that this is not the province of the Senate, or even of this parliament, but I will make a couple of comments nonetheless. We did manage, for instance, to get facilitatory state relief for a federal measure to do with the Managed Investments Act. It was perhaps a smaller matter than this, but there is some precedent for it. The federal government is not without powers of persuasion in this area, so I will turn to what the problem is so that it can be recorded and thought about. A substantial duty cost can prevent a demerger that should happen. There are two particular stamp duty problems. The first concerns what is generally called corporate reconstruction relief, which is relief for transfers within a group. That relief is not going to be effective here because we are talking about transfers outside the group, so the existing relief is inherently not going to be good enough.

A sort of second-layer or indirect effect is that the existing corporate reconstruction relief is quite patchy. It is not in every state and territory and it does not work the same way in every state and territory. In practice, demergers often involve a bit of setting up—a bit of restructuring within the group—before the spun-off entity is to be spun off. As I understand it, the lack of uniformity and extensiveness of the existing group relief is presenting that kind of second-layer problem. In other words, duty prohibitions on transfers within the group preparatory to demerger are a problem. I do not expect that that can be solved here today, but I want to record it.

ACTING CHAIR —We will note it in the report.

Senator CONROY —Mr Plummer, I am interested in the issue highlighted in the PWC submission regarding your treatment of employee share ownership plans. Can you expand on this for the committee? Do you consider this to be an unintended consequence of the measure? How would you suggest addressing it?

Mr Plummer —I certainly do not consider it unintended. This issue was raised, from the very beginning, throughout the consultation process. The tax office and Treasury teams that were dealing with the recommendations for drafting the legislation saw it as beyond the scope of their role, which was to deal with the income tax implications for the shareholders and the CGT implications but not to deal with the broader issue of employee share ownership schemes. So I do not believe it was unintended, but it is certainly an issue which should at some point be rectified, preferably with effect from the time these provisions have effect. If it is not rectified, employees will face a tax cost as a result of demergers, and they will face that tax cost without having realised any cash or made any realised profit as a result of the transaction.

Senator CONROY —Can you explain what categories of share ownership plans—for example, share option plans—you believe should be offered CGT relief?

Mr Plummer —It is any share, option or share entitlement that is subject to tax under the employer share provisions, which is division 13A. That group of shareholders is subject to tax under that set of provisions, rather than the ordinary income capital gains tax provisions which the demerger rules have dealt with and provided relief for. It is all those shareholders that are subject to tax under that particular division and that includes shares and options.

Senator CONROY —Do you have an estimate of the cost to revenue of your proposal?

Mr Plummer —No, I do not. Again, it is wrapped up to some extent in the cost to revenue of the demerger rules in general. If it is seen that the demerger rules will have a positive revenue impact, removing all tax barriers to a demerger would be seen as, overall, providing a positive revenue impact. This is certainly one tax impediment to a demerger.

Senator CONROY —Mr McGuigan, I understand you have an interest in this.

Mr McGuigan —Yes. We should also point out that Ralph did say that he would try to relieve all taxes in a demerger situation, and he did not split out in any way employees from that particular situation. If we stick with Ralph, being revenue neutral, there is no cost. It was built into it that relief should be granted for employees. The other issue is a management of people issue. There will be a lot disruption to employees in a demerger situation. It will be a very uncertain time for them, as we can all imagine. This is just another issue that they will have to deal with and another cost that they will have to pay when they have no cash to do so.

ACTING CHAIR —I thank the witness for appearing before the committee today.