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Exposure drafts of the legislation to implement the Carbon Pollution Reduction Scheme

CHAIR —I welcome Mr White and Mr Henderson from the Institute of Chartered Accountants in Australia. Would you like to make an opening statement?

Mr White —Yes, thank you. Good morning. Thank you for the opportunity for Mr Henderson and me to appear before the committee to provide our observations and comments. I do refer to our submission that we sent yesterday, which has hopefully made its way to you. With the tight time frames, hopefully we have been able to meet your expectations. I will not necessarily go into a lot of detail which is already covered in the submission, but there are some aspects I would like to briefly raise. I should indicate that Mr Henderson is actually a senior tax partner at KPMG but is with me today as the chair of the institute’s tax committee dealing with the energy trading schemes. It is really through how this committee works with us at the institute that we are able to draw on the knowledge of our wide membership and that has informed our submissions to date. Relating directly to the exposure drafts of the legislation, I would like to point to a number of aspects that are examples of our views.

Firstly, guiding our comments and analysis on the aspects of the legislation has been our tax policy aims of neutrality, fairness and simplicity. In some senses those are fairly great goals, and we try to balance each of those as we draw our views. But we do have some concerns about the application of what are seen to be the normal GST rules to CPRS transactions. We believe that this approach will create some uncertainty and complexity for business taxpayers, particularly relating to exports, imports and registered emissions units.

Secondly, we see that there should be some form of alignment of the income tax treatment of free permits between the emissions intensive trade exposed industries and non-EITE taxpayers. I draw particular reference to what are seen to be  the strongly affected industries—that is, the coal power generators.

Thirdly, the tax accounting for registered emissions units is, in our view, inflexible, particularly with reference to what is seen to be the rolling balance method and the valuation basis of FIFO—first-in first-out—basis evaluation, which is seen as restrictive. This is really a focus we bring in terms of the compliance and burden to business. We also see that there is some clarity required for businesses that they will be entitled to the tax deductions for the purchase of emission units that are surrendered for purposes such as abatement—that is, as being good corporate citizens.

Finally, I would also like to bring to the committee’s attention—and this is outside the tax aspects I have just covered—that the institute has been fairly heavily involved to date with the Department of Climate Change  regarding the external audit. The National Greenhouse and Energy Reporting Act and the CPRS are the underpinnings of the market based solution to achieving reductions in carbon pollution. For this solution to work, it is acknowledged that there needs to be reliable investment grade financial information. For this information to be of appropriate quality, we are of the view that there needs to be appropriate independent external assurance. We have to date provided the DCC with components of the best practice assurance model to assist with preparing the draft regulations to deal with this requirement. We are very keen to assist the DCC with producing appropriate guidance because, at the end of the day, we need to make sure that in introducing this system there is appropriate independent assurance. That is important in terms of timing because, from an assurance perspective, there needs to be quite an introduction of the rules and requirements to provide these services.

CHAIR —Thank you, Mr White. You have raised several issues. But, in your view, are businesses overall ready to undertake operating in the CPRS?

Mr White —I will make an initial reflection and pass to Mr Henderson, who is perhaps a bit closer to that aspect of business. When we reflect over recent years, businesses in Australia have had to adapt to a number of changes—I am talking about the introduction of a GST, Y2K, and the introduction of international financial reporting standards. One could argue that this is another layer which they will get used to introducing. Time frames are always going to be important, and the aspect that they are probably most engaged with is trying, as quickly as possible, to get clarity around how things will work.

CHAIR —By clarity you mean including the regulations that you are advising on.

Mr White —Yes.

Mr Henderson —I will add to that. We have here the design of tax legislation at the same time as the legislation for the actual policy it is aligned with. We think that is good, but it also creates challenges because we are trying to understand the legislation around the policy to ensure that tax rules will work properly in practice to allow fairness, neutrality and simplicity.

Senator BUSHBY —You were talking about clarity around how things will work. How important is it to get the design right from a tax perspective? What are the consequences?

Mr Henderson —It is very important from day one—there is a standing start—and also before day one so people can plan for the start of the CPRS system. The two main strands of tax are income tax and GST. Let me start with GST. It is important that systems are in place, particularly in the trading area—and we are not talking about one type of trading; we are talking about trading on the spot markets and the trading of derivatives. Currently, systems are not set up to deal with taxable GST supplies in trading systems, and so people would need time to be able to deal with that—and people are seeing complexity with that. From the income tax point of view, again people are making decisions as we approach a start date, and business is absolutely interested in certainty around how these tax rules will apply from day one.

Mr White —I will add to that. At the highest level it is important to get the starting point correct because, as Mr Henderson has indicated, there is a compliance cost. We are changing systems, but our experience has been that in the introduction of different types of legislation there is also a component around training as well. So the better that you can line up compliance and training, and everything else, to start with, the more effective it will be at commencement.

Senator BUSHBY —I have clearly identified issues. I presume you have been through the exposure draft legislation in detail?

Mr Henderson —I would say we have gone into the tax rules very much in detail, but to a lesser extent the other.

Senator BUSHBY —The bits are okay? The wider tax?

Mr Henderson —Yes.

Senator BUSHBY —Also, a lot of it is to be dealt with in regulation, which I imagine you will be waiting to have a good look at when it comes out.

Mr Henderson —Yes.

Senator BUSHBY —Having looked at those tax bits of the draft legislation, presumably you have identified issues. That is what your submission deals with—the technical issues that the exposure draft raises in your mind in dealing with it from a tax perspective.

Mr Henderson —Correct.

Mr White —When we use that phrase ‘the technical issues’, it is drawing back as well to those principles that I mentioned—neutrality, fairness and simplicity.

Senator BUSHBY —Yes. So some of the issues that you raise may apply to neutrality, some to fairness and certainly some to simplicity, which I think you have already—

Mr White —Yes, and some across all three. It is a bit of a balance there.

Senator BUSHBY —And how fundamental are the issues that you have identified? Are they serious or are they minor things that will just be an annoyance to people?

Mr Henderson —You can probably talk about the fact that simplicity, in some sense, can be an annoyance or become a big impediment. But what does an area such as neutrality mean? It means that a company would do something because of the tax reasons and not because of the policy reasons for climate change abatement. We are concerned that if a company has a trigger point for tax which is different from the abatement date of their permits, which happens here, they will be taxed at the end of the tax year and, in the following December, when they abate their credits, they can be taxed at year end even though they abate those credits after year end. We are seeing some aspects like that. We think that will be the major timing impact.

Senator BUSHBY —That raises fairness issues.

Mr Henderson —Yes, there are fairness issues. There are other examples, such as taxpayers who may find they have a taxation point when they do not realise the sale of a permit and they need to sell that permit to fund the tax liability, or they might just sell a permit at a time that is not related to their climate change objectives.

Senator BUSHBY —Have these issues only become apparent with the actual drafting of the exposure legislation, or are they issues that were apparent earlier in the green and white papers?

Mr Henderson —We picked up some aspects around that from the white paper in December, but there were other aspects, such as the FIFO valuation method, which we saw for the first time in the exposure draft. That was a particular surprise to people.

Senator BUSHBY —Presumably you made representations to the government on the ones that were apparent in the white paper, but they have still flowed through to the exposure draft?

Mr White —That is right. The submission you have there includes our prior submission. We have tracked within our current submission issues that still prevail from our earlier comments.

Mr Henderson —We will make a formal submission to Treasury and to the Department of Climate Change and Water in response to the ED, but we bring to the attention of senators that some of the aspects of this legislation are unduly protective of the revenue and unduly restrictive.

Senator BUSHBY —My next question was going to be about what revenue impacts your recommendations would have. You say that they are being unduly protective. In saying that do you mean that the revenue would not be impacted as much as they think it will be?

Mr Henderson —I will give you an example. We were told that the rigidity of some of the rules around valuation is because the drafters of the legislation fear that there would be abuse, and they perceive that certain taxpayers could hoard permits on a low base with a low cost to be sold some time in the future to ‘avoid tax’. Our response is that, therefore, all taxpayers and all businesses with no intention of any tax avoidance will be saddled with a very burdensome series of rules. So there are perceived theoretical fears of tax minimisation, which we are not aware of, and therefore these rules are very strict. It is like using a sledgehammer to crack a walnut.

Senator CAMERON —When you say all taxpayers, are you talking about the 1,000 entities that are covered by this or about all taxpayers in general?

Mr Henderson —I will be more specific on that point: it is taxpayers who will be trading or holding CPRS units, which would go beyond 1,000 because of the counterparties, the banks and other people trading in the market, as well as other companies which choose to buy CPRS units for carbon-neutral projects.

Senator CAMERON —But that is not every taxpayer by any stretch of the imagination.

Mr Henderson —It is not every taxpayer, correct.

Senator BUSHBY —It is every taxpayer who has an obligation. Making the changes that you refer to may have some revenue impacts, presumably you would concede that, but you think they are being overly protective in that sense. The whole point of this legislation is not to raise revenue; it is to try to put in place a structure that will encourage Australians and provide a market-based incentive for Australia to move from a carbon based economy to one that is less carbon based. Would the recommendations you are making be likely to have any effect on participant behaviour which would undermine the overall objective? For example, you have talked about hoarding carbon credits. Is there anything in there, other than revenue, that would actually undermine the objective?

Mr Henderson —The only comment I would make relates to the GST. The fact that we have confusion about how imports and exports are treated might impact the participation of international trade. We are hearing that from business.

Senator BUSHBY —With what consequence? How would that play out?

Mr Henderson —In terms of trading in an Australian scheme as opposed to trading in another scheme?

Senator BUSHBY —Yes.

Mr Henderson —If there is uncertainty around the GST taxation and there are other choices people might choose to trade elsewhere, so it might impact the volume in the market.

Senator BUSHBY —So they might trade outside Australia rather than in Australia?

Mr Henderson —Yes.

Mr White —Yes, particularly around the capital inflows into Australia as well.

Senator BUSHBY —Which would probably undermine the overall effectiveness of the scheme if it were left as it was?

Mr Henderson —I think ‘efficiency’ is probably more accurate, rather than the overall effectiveness.

Senator BUSHBY —Okay, the efficiency of the overall scheme. So in that sense if your recommendations were adopted or looked into they might actually improve the scheme?

Mr Henderson —Correct.

Mr White —In terms of the efficiency that is right. I do not believe that, besides the one that Mr Henderson has raised, there are implications in what we are talking through here in terms of the behaviour, so what else would happen other than the efficiency.

Senator FURNER —It is apparent that businesses will build their systems to deal with the carbon reporting and compliance as a result of the CPRS. There will be a lot of work for lawyers and accountants in that field. Do you think that will be reduced once companies have had their systems bedded down?

Mr White —Now this is more from the accountant’s perspective. Experience has shown with other major projects, where other pieces of legislation have been introduced, that there is an initial component of training and system changes and that after a period of time—and it depends on the complexity of what is being introduced—all that becomes more a part of business as usual rather than a special resource demand within the organisation. You would find some degree of decrease in cost over time as well. How much that would be from the initial investments would depend a little bit on the complexity of and the challenges of what is being introduced. We have certainly seen that in other aspects.

Senator FURNER —What was your experience throughout the introduction of the GST of the effects on businesses given that there will be two different levels of impact through the CPRS and the GST arrangements in terms of employment?

Mr Henderson —I concur that it was similar to that. There was a big ramp-up, just as people are now immediately affected both on the trading side and on the side of the covered entities that are working now. They have to be working now. They expect that to go right through past the start date and then it will drop off.

Mr White —There will be components relating to ongoing costs as well. In my opening comments, I made reference to the assurance of the underlying audit requirement. That would be a requirement that in effect would need to be ongoing. One might suggest that perhaps as the audit profession and the accountants involved in this all learn how to put this in place, while that might be a bit of a stronger cost initially with the introduction, it might be reduced down although not significantly over time, but there would be a reduction as it became part of that business as usual. It would be an ongoing cost as well.

Senator FURNER —Do you have any idea of the time frame of any of that slight reduction?

Mr White —Time frames are always a little challenging on this. If I looked across at something like the introduction of IFRS, that was probably a three-year period before things had really started to settle down.

Mr Henderson —You do expect it to go possibly a year after the start date, because you do get the laggards who are catching up as well.

Mr White —The challenge at times is that you think something is about to get bedded in but there are further changes or other drivers change and therefore it gathers a little bit more momentum as well.

Senator FURNER —This morning we heard from Mr Paul Curnow from Baker and McKenzie. He was giving evidence that the obligation transfer number is an innovative feature of the Australian scheme that other countries can learn from. Do you agree with that? How will it increase flexibility for businesses?

Mr Henderson —Sorry, I did not quite catch that about his main statement.

Senator FURNER —It was that the obligation transfer number is an innovative feature of the Australian scheme that other countries can learn from.

Mr White —I cannot reflect on that.

Mr Henderson —I do not have a view.

Senator FURNER —Okay.

Senator XENOPHON —In your submission as to the green paper, you raise concerns about the tax treatment of free permits. How does the government’s draft legislation deal with that problem?

Mr Henderson —The government’s draft legislation, as announced in the white paper, has taken the approach of, firstly, taxing the free permits. But there is a mechanism for when that taxation point is recognised. The white paper does announce that the permits will be allocated over a number of a years rather than just one big lump sum, upfront amount. As explained in the white paper, that would ameliorate the impact of having just a whole lot of permits taxed in one year. That is contrary to many of the submissions which asked for industry assistance to be in a tax-free format. The ED, the exposure draft, has these permits taxed. There is a distinction between the trade exposed, the exporters, and the strongly affected, the coal power stations. The trade exposed, if they still hold onto the permits after the first year, can defer the taxing point until the year in which they surrender, whereas, if the coal power stations hold them at year end, they will be taxed on the value of that permit. That is one of those paper profit issues we have already mentioned. It is recognised as a paper profit when the permit is still held and could distort behaviour.

Senator XENOPHON —You do not think it is satisfactory or do you think the government’s approach in the exposure draft is satisfactory?

Mr Henderson —We have been getting resounding views from businesses in the submissions. The starting point would be to have tax-free permits similar to industry assistance provided to other industry sectors as in the past.

Senator XENOPHON —How come they have not done that yet?

Mr Henderson —It was not accepted in the white paper.

Mr White —There has not been an alignment between the EITE and the non-EITE taxpayers.

Senator XENOPHON —Just a couple of other things. In your green paper submission you noted the need for appropriate tax incentives to be included in the design of the scheme. What do you mean by that?

Mr Henderson —As part of the government’s policy our major aspect will be the development of low-emissions technologies and also abatement technologies such as carbon capture storage, which is the geosequestration of the CO2 in an underground reservoir. Very big capital projects will require significant investment in R&D and capital expenditure. The government has announced that this issue will be considered by the Henry review of the Australian tax system. In our submission, which was lodged yesterday to this committee, we pointed out that the reporting date for the Henry review is into the 2010 year. It is stated that they will be looking at incentives for low-emission technologies. What we would like to highlight for this committee’s consideration is that these incentives are seen as an important part of the Australian tax system to encourage investment and importation of capital, and we would like to see that these tax incentives are released, announced or developed in conjunction with the start date.

Senator XENOPHON —You prefer that the Henry review, insofar as it relates to its impact on the CPRS legislation, ought to be made public before the other aspects of the review?

Mr Henderson —I think we agree with that. We would like to see special fast-tracking of the incentives.

Mr White —There needs to be integration between the two.

Senator XENOPHON —Is that something you put to the Henry review, given your concerns?

Mr Henderson —Yes, we have.

Senator XENOPHON —Finally, in your green paper submission you raise concerns about the use of operational control as defined in the reporting legislation as the basis for setting liability. Have those concerns been dealt with in the context of this exposure draft? As I understand it, in your green paper submission, you raise concerns about the use of operational control, as defined in the National Greenhouse and Energy Reporting Act, as a basis for setting liability. Am I right about that? Is that premise correct?

Mr Henderson —Yes.

Senator XENOPHON —How have those concerns been dealt with in the context of the exposure draft?

Mr Henderson —In the tax rules the taxing point is measured at each year end on how many permits you hold and that will determine your taxing point. However, if you abate those permits after year end, at the reporting date, you will still be taxed. We requested that they recognise that covered entities have a liability which accrues over the course of that year and they should allow for the tax deduction to be recognised in that year.

Senator XENOPHON —Has that been done in the exposure draft?

Mr Henderson —No, it has not. We understand that New Zealand does allow an accrual of a deduction for covered entities, and we have discussed that and pointed that out.

Senator XENOPHON —You see that as a problem?

Mr Henderson —Yes, and a fairness issue.

Senator XENOPHON —Thank you.

Proceedings suspended from 12.19 pm to 1.29 pm