ACTING CHAIR (Senator Sherry) —Welcome. I invite you to make some introductory remarks about your submission and then the committee will ask questions.

Mr Taylor —Thank you to the committee for giving us this opportunity to outline our concerns with the government's proposed tax reforms. As we explained in our submission, the GST will cause a dramatic increase in credit union costs. The proportionate increase in costs for credit unions will be substantially higher than that incurred by our major competitors—the banks. Unless remedial measures are taken, credit unions will cease to be a competitive force in the financial services market.

Before explaining the precise impact of the GST on credit unions, I would like to make some brief comments about the operations and structure of the credit union industry. Understanding this structure is pivotal to understanding why the GST as currently proposed will have such a serious adverse impact on our industry. There are 237 credit unions, all of which are, by any measure, small financial institutions. In aggregate, however, these credit unions have combined assets of $19 billion, which makes them larger than most Australian banks, larger than the building society industry and larger than the mortgage originators.

Viewing the credit union industry in this collective way is important for a number of reasons. Firstly, it is a reminder that credit unions are a significant competitive influence in the Australian financial system. Secondly, it reminds us that a substantial proportion of adult Australians—3.5 million, in fact—elect to use credit unions for their financial needs. Thirdly, it emphasises the cooperative structure of the credit union industry.

Credit unions have grown strongly in recent years amidst a very cluttered and competitive financial system. They have grown because there has been a need and indeed a preference for their services as a genuine alternative to the major banks. They have also grown because they have done things differently with an emphasis on personal service and customer needs rather than on profit. However, credit unions have only been able to compete and therefore grow because they have aggregated their resources to maximise economies of scale. As stand-alone institutions, credit unions would not have the capacity to compete with the major banks. They would not be able to provide the full range of financial services or offer them at a competitive price.

CUSCAL, which is the major national credit union body, is owned by credit unions and was established for the sole purpose of assisting credit unions to provide competitively priced services to their customers. It must be emphasised that this structure is not unique to Australia. It exists all over the world in countries with credit unions and cooperative banks. This structure exists because it is the only way that 237 small institutions can derive sufficient critical mass and operational efficiencies to compete with the major banks. It is a delivery structure built on cooperation and the sharing of resources. It enables credit unions to meet the needs of local communities while also being part of a large, sophisticated national support structure.

In its proposed form, the GST will impact unfairly on credit unions and will reduce competition in the Australian financial system. Our submission explains why this is so, offers some potential solutions to overcome these problems and, above all, emphasises that we are seeking solutions which are entirely consistent with the government's objectives for tax reform and competition in the finance sector. I would like to briefly summarise the size and nature of the problem faced by credit unions.

While there are varying community views on the merits of a GST, few would dispute that one of its major benefits is the removal of taxes from business. This significant benefit, however, will not be enjoyed by Australia's credit unions. The absence of such a benefit for credit unions is a direct result of the government's decision to input tax financial services. Without appropriate remedial measures, the input taxing of financial services will re-create and indeed exacerbate all of the well-known deficiencies of the existing indirect tax system. In particular, input taxing will increase, not reduce, the level of taxation borne by credit unions. It will significantly increase the level of hidden or embedded taxation in the price of financial services. It will impact unfairly and disproportionately on smaller financial service providers. It will undermine efficiencies which credit unions currently derive from outsourcing and aggregation and it will impede competition in the Australian financial system. These adverse outcomes run directly counter to the government's tax reform objectives.

If you provide financial services, you will be required to pay GST on your inputs but you will not be able to deduct this tax cost from GST collected from your customers. It follows that, if the cost of your business inputs increases, in this case because of a new tax, then one of two things will happen: either you will increase the price of your services in order to retain your previous profit margin or you will reduce your profits. If all financial services providers incurred the same proportionate increase in costs as a result of the GST, then there would be a uniform increase in prices or decrease in profits, but this is not what will occur. Rather, credit unions will incur a proportionately much higher increase in costs than their competitors, the banks. This is because the GST will only be added to an input cost where the input is supplied to the financial service provider from another taxpaying entity.

If you provide the service yourself in-house, then no tax will be added. If you are a small entity like a credit union, which, of necessity, must source most of its inputs from external suppliers like CUSCAL, then you will incur a major increase in tax costs. This input taxing approach turns a GST into a tax on business. More particularly, it becomes a tax on outsourcing and cooperation. It is a tax which will fall disproportionately on credit unions which, in order to be efficient and competitive, have sourced their supplies from cooperative service organisations like CUSCAL. The fact that input taxing will have these adverse effects is well established both by independent commentators and by official reports from countries with VAT systems.

The government's own modelling, however, forecasts that the proposed tax changes would produce a net reduction in costs for the finance industry including credit unions. While there do appear to be some reasons why the government modelling did not anticipate the dramatic adverse impact of the GST on credit unions, it is only through a detailed analysis of actual credit union accounts that the real impact of the tax changes can be seen.

As explained in our submission, we commissioned Price Waterhouse Coopers to conduct this detailed examination of credit union balance sheets. The PWC analysis shows that the extra tax burden from the GST will be three to four times the value of savings from the removal of other taxes. The difference is an estimated $40 million cost increase for the credit union industry per annum. This represents around one-third of the total surplus or profit for the industry in 1997-98.

Since the entire surplus of credit unions is retained for prudential purposes to meet capital ratios, this cost increase simply cannot be absorbed through reduced profits. Credit unions could seek to increase their fees or interest rates to cover this extra tax, but this would render them uncompetitive as banks will not incur the same proportionate increase in costs. If credit unions cannot reduce their profits to offset this additional tax burden but also cannot increase their prices, then what is the future of the industry? This is a question which we hope we will not need to answer for it was clearly not the government's intention to increase credit unions' costs, nor to create a new competitive impediment which will reverse the community benefits of the much heralded Wallis reforms. It is in this sense that we can only conclude that the adverse impact of the tax on credit unions is an unintended consequence of the tax package.

The amendments sought by CUSCAL as outlined in our submission are designed to address this unintended consequence. We are seeking two particular amendments. Firstly, and consistent with the approach adopted in Canada, we are seeking recognition for the unique cooperative structure of the credit union industry. Under the Canadian approach, services provided to credit unions by their collective support organisations do not attract GST. The Canadian government justified this policy on the basis that the taxation of such services would be discriminatory and would undermine competition in the Canadian financial system. The same logic applies in Australia. Secondly, we are seeking minor changes to the definition of financial services so that credit unions' outsourced supplies will attract the same tax treatment as supplies sourced in-house by banks.

I must emphasise that these changes should not be viewed as concessions for credit unions. Rather they will help achieve a competitively neutral tax system under which the impact of the GST on credit unions will be comparable to that on banks. In seeking this outcome we have drawn on the experiences of overseas countries with similar credit union systems and similar tax regimes. The legislative changes sought by CUSCAL are straightforward, are based on established overseas precedent and will redress the competitive inequalities in the proposed legislation.

In conclusion, we believe that our recommended amendments will improve the policy integrity of the tax package. They will enable credit unions to continue providing much needed consumer choice and competition in Australia's financial system, which was the primary objective of the government's Wallis reforms.

ACTING CHAIR —Thank you. Is there anything you would like to add, Mr Lawler?

Mr Lawler —No.

Senator GIBSON —I guess the first point I should make is that it is true, isn't it, that the government has been good to your industry in recent times in giving you access to the cheque system and also to the national prudential scheme, to make it a more level playing field with the banks? You did have a disadvantage previously.

Mr Taylor —That is quite right. In fact, the credit union industry has struggled for many years to remove a whole raft of impediments, some arising from the regulatory structure, some arising from particular laws like the Cheques and Payment Orders Act. The current government has been very supportive in its reforms to those areas. It has justified those reforms on the basis of improving competition in the finance sector. Indeed, one of its often repeated comments is that the four pillars policy will not be removed until such time as the extra competition by credit unions and others flows through to the system. This is precisely why we find it a little odd that such a dramatic adverse impact would be permitted, which really turns the clock back on all of those reforms that the government has put in place.

Senator GIBSON —Going on to what you propose, that is, the grouping provisions a la Canada, if that was done specifically for credit unions wouldn't that put you at an advantage relative to small banks? As you know, a lot of the banks do outsource a lot now, particularly the smaller banks. Would they thereby be disadvantaged relative to the advantage that this provision would apply to you?

Mr Taylor —The structure of the credit union industry and its delivery of services to customers are unique in Australia. It is a cooperative, mutual industry in which the delivery of services occurs through individual credit unions and all of the back office work and supplies are done through their support organisations. That is a mutual structure which exists all over the world: in Europe through their corporate banks, in Canada where the credit unions are almost identical in size and penetration to those Australia. So we are really asking the government and the committee to recognise the importance of that structure for providing competition. There aren't any other institutions, whether regional banks or anyone else, that operate on that basis, that actually own their own collective support structures through which they receive services.

Senator GIBSON —You are still having negotiations with the government, aren't you?

Mr Taylor —That is right; we are. In fact, we have been discussing these concerns with the government now for eight to 10 months, since our initial submission on the legislation well before we actually had legislation. We are now continuing our private bilateral discussions with Treasury and the Treasurer's office.

Senator MURRAY —If you did not get your recommendations accepted, would you support the government's tax package overall?

Mr Taylor —The impact we are talking about here on credit unions is not one at the margin. This is not a matter of credit union services going up marginally or down marginally; this is a series of tax changes which fundamentally undermine the structure that has been put in place by credit unions for the delivery of services. Whatever else is in the tax package is irrelevant to the credit union industry by comparison to this specific change. So I guess in short the answer to that is no. Our members, 237 credit unions, on behalf of

their 3.5 million members, would not have access to the sorts of services they have now from a credit union if changes are not made.

Senator MURRAY —The government has made the point, and the committee accepts, that it is all or nothing; it has to be the acceptance of the total package. Moving on from that, have you identified how different or how similar the credit union structure is in Australia to other OECD countries that have taken on a GST or VAT system? You have mentioned Canada, but have you done an overall appraisal?

Mr Taylor —Yes, we have. The fact is that credit unions are very strong in the United States, where of course there is no federal GST system, though we have spoken to them about the impact of some similar state taxes of a much lesser order. In Europe the term `credit union' is not used. They refer to themselves as cooperative banks, but they have the same mutual structure. VAT is not charged on exchanges within the cooperative banking groups, whether in France, Germany, Scandinavia or any other OECD country. In Canada, however, they do use the term `credit unions'. They have a structure which is as good as identical to ours in terms of structure and their market penetration and share of the industry are very much the same. We did look to them as a very good example because that was the most recent introduction of a GST or VAT in a country which had a very similar credit union industry. So we have looked at other countries. Canada is the best example only because that is the place where the credit unions are most similar.

Senator MURRAY —My understanding of the government's decisions on ANTS concerning the financial services and banking industry is that they have very much drawn on international experience to devise their system. In doing so have they in fact neglected to carry through international practice on credit unions or cooperative mutual banking services?

Mr Taylor —Certainly they have, in our view. There is no other country in the world that we are aware of where there is a VAT system which has the effect on credit unions or cooperative banks, as the case may be, that this proposal will have. There are basically two reasons for that. One is because of the absence here of any recognition of the grouping of these mutual entities, and the other is because the definition of financial services here is far narrower than it is anywhere in the EEC, where of course the VAT regimes are now synchronised, with similar exemptions and similar lists of financial services, and in Canada. The definition of financial services here is very restrictive, so that services provided in-house by banks are free from the GST net and if provided by a credit union sourced through someone else they are not. I will give one very brief example of that, only because it is one that the government itself uses in its explanatory memorandum. That concerns a valuation service. If a bank provides you with a loan but also provides you with a valuation service, there is no GST because the valuation is done by the bank. But if the credit union provides you with a loan and the valuation is done by CUSCAL, because CUSCAL provides that valuation service for credit unions, then there is GST. It is the same service, it may be the same potential customer, but a different price.

Senator MURRAY —But if the bank went outside for a valuation that valuation would carry GST, wouldn't it?

Mr Taylor —That is right. But as you look at the structure of the credit union industry—as we indicated in the diagram on page 12 of the submission—and you look at what banks provide in-house, that covers all of the big ticket items which, for credit unions, are sourced externally. The banks have a choice. Some banks might choose to outsource some functions, but they have a choice. Credit unions, at the size they are—237 of them—can only provide their services on this cooperative basis. That is the way the industry has always been structured.

Senator MURRAY —I might have missed this in your submission or your remarks: have you put a revenue cost to the government of your proposals? Is there a figure that you know it would cost them?

Mr Taylor —This is an interesting question because it raises the whole issue of the government's own projections and forecasts for the impact on the financial services industry. The government have stated publicly and to us in discussions that they did not predict an increase in costs for the financial services industry, whether it be for banks or for credit unions.

Senator MURRAY —Sorry, I think you are misunderstanding my question. If they were to change their system to what you want, what would be the revenue cost to government, not the cost to your own industry?

Mr Taylor —I was just clarifying that, compared to the government's forecast of a reduction in costs, there would be no change because all we are doing is actually restoring what was intended out of this package. Clearly, if the changes that we are recommending are put in place, there would be some forgone revenue as a result of us paying less GST.

Senator MURRAY —Do you know how much?

Mr Taylor —We have estimated that the additional impact of the GST on the industry is about $40 million per annum. We are seeking to remove as much of that as possible, so you could say $40 million.

Senator SHERRY —I am continuing from the point Senator Murray raised. Looking at the ANTS document, under `Cost effects by industry' it has banking minus $670 million and then it has the non-bank finance minus $80 million. Are you included in the non-bank finance sector?

Mr Taylor —Yes, we are—along with merchant banks, money market dealers, finance companies and a whole lot of others.

Senator SHERRY —There is obviously a lot of difference between minus $80 million, and whatever your share is purported to be, and a plus $40 million increase in cost. Can you explain how that has happened?

Mr Taylor —This is the question that we have been trying to explore with the government, with Treasury. What we can say is that the modelling that was done by the Treasury was at a very macro level. They were utilising the ABS input/output tables. At the end of the

day, the modelling analysis that was done really got nowhere near a micro-analysis of the credit union industry, as we see even from the category used—`Impact on non-bank finance', assessed through the Treasury model to be a reduction in costs of $80 million. But that includes merchant banks, money market dealers and finance companies, none of which are structured anything like the credit union movement.

It could well be the case that there are some cost reductions there. What we have done is take actual accounts—this is not modelling per se—actual credit union figures for 1997-98 and have Price Waterhouse do the analysis. They have assessed the tax on every expenditure and revenue item. So it is, in a sense, not modelling; these were our actual accounts and this is the extra tax.

Senator SHERRY —This is the real world.

Mr Taylor —Yes.

Senator SHERRY —You have talked about the $40 million cost increase and you have said in your introductory remarks, if I have quoted you correctly, that credit unions will cease to be a competitive force. Why can't you simply put up the price of your services?

Mr Taylor —If we could do that—while that would be a bad outcome for consumers—we probably would not be here today. If the impact of this tax were proportionately the same on banks as on us and everyone put up their prices, it would effectively be the same as, for example, a rise in official interest rates. Official interest rates go up, everyone bears the same cost and prices go up for consumers. But, as we have explained, the impact is proportionately different for credit unions—significantly so. That is because of the large degree of outsourcing, which I have mentioned; but it is also because credit unions focus on the household needs of consumers, household financial services. So they provide hardly any taxable supplies; in the Price Waterhouse analysis it is about three per cent. So, whereas banks can recoup some of their GST cost on their taxable supplies, credit unions cannot.

Thirdly, credit unions provide no zero rated activities. Banks get zero rating of their money market, forex dealings and overseas supplies, overseas services. Credit unions do not have overseas supplies, they do not delve in the forex markets, so they do not have anything that is zero rated and therefore they cannot offset their tax costs through zero rating rebates.

Senator SHERRY —I am aware that in recent times, particularly with some banks closing branches in areas of regional Australia, some credit unions have filled some of that gap. They have gone into regional areas that the banks have vacated. What will be the impact of this $40 million impost on rural and regional areas? I come from Tasmania—I do not know whether you are familiar with the state—and it is highly decentralised. What would the impact be on rural and regional areas in particular?

Mr Taylor —Credit unions—or the industry as a whole—have endeavoured to move into as many rural and remote areas as possible as they have been vacated by banks. I think the latest figures are that we have established in the last two years 45 new operations in rural areas which otherwise had no financial service provider. I am sure it will be no surprise to anyone that those operations are not highly profitable—in fact, in their early stages many of

them are still running at a loss—but the credit unions are prepared to do that to provide a service. With support from the community, they think that these sorts of operations can at least break even.

Obviously, if you have a big increase in costs, if you cannot increase your prices and if you cannot reduce your profits—as I explained earlier—the only other thing you can do is try and reduce some costs or overheads elsewhere in your business. There is no doubt that some of those rural and remote area operations will be the first sets of services to be scrutinised if there is any need to reduce costs further.

Senator SHERRY —It seems to me that, if you wanted to design a system that put you at a competitive disadvantage vis-a-vis banks, this would do a good job of it.

Mr Taylor —I can only agree with that. It is of great concern to us that we have ended up with a system which will adversely impact on credit unions so greatly at a time when the government's other reforms have been removing competitive impediments. It is not that this is something that we have only realised at the last minute; from our first submission to the government on a GST, we have emphasised the potential disadvantages if they go down this route and we have given to them overseas experience where these problems have been avoided.

Senator SHERRY —So you have been ignored?

Mr Taylor —Our views have not been acknowledged through changes to the legislation at this point. It is true that this government, like its predecessor I might add, has been supportive of the credit union industry and we do not think the government wants to see a reduction in the competition that is being provided very strongly by credit unions.

CHAIR —I apologise for not being here when you commenced your evidence, Mr Taylor, and you may have covered this point. Credit unions, as I understand them, are effectively cooperative savings schemes that lend money at usually lower interest to their members. From a credit union point of view, do you have any idea of the socioeconomic group that we are talking about, the one that your members represent?

Mr Taylor —That is a very difficult question. I should perhaps preface the answer by making the observation that, when credit unions first evolved in Australia 50 years ago, they were very much providing services to low income earners—those who basically could not get finance from other sources. Part of the instigation to set them up was to prevent people getting bound up with high interest money lenders.

As those 50 years have passed there has, of course, been change and development. One of the particular things that caused credit unions to become more mainstream was the imposition of full corporate taxation in 1993. Credit unions used to be exempt from company tax; they now pay full tax. Once that was done it was necessary to be able to provide the full range of services. They have now done that. That has enabled them to compete. So, if you looked at the customer base now, you would find—although I do not have figures available—that the majority of credit union members are employed and probably in the

middle income range, if I could use that broad description. I think the very high income earners do not tend to use credit unions. It is focused in the middle income areas.

CHAIR —The interesting feature is, I think, that cooperative is still—

Mr Taylor —That is quite right—no external shareholders. All the reserves of the credit union are owned by the members and the profits of the credit union are only made to meet prudential requirements. We must meet the same prudential requirements as banks—the same capital requirements. Because we do not have capital coming in from external shareholders, we have got to get retained earnings to maintain that capital. That is when we refer to a profit figure in 1997-98 of, I think, $130 million across the industry. This $40 million is around a third of that. But we cannot reduce that. Those profits must be earned to meet prudential requirements.

CHAIR —Is the credit union movement growing? Are more people joining credit cooperatives?

Mr Taylor —Yes, they are. The credit union movement has grown very strongly. The current figure is 3.5 million members, and assets of $19 billion which have grown in the last four years from about $14 billion. They have also grown in areas of business where there has been a need. For instance, in the small business area there has been a particular lack of competition. Credit unions lending in small business areas increased by, I think, 35 per cent—of that order—in the last year. That is because of some of the reforms that the government has made to enable credit unions to provide the full range of services. So, yes, they are growing in assets and membership, and that is consistent with overseas trends where mutual banks—cooperative banks and credit unions—are achieving a higher share of the financial services market.

CHAIR —I suppose this is a philosophical question so I will not engage you on it. I am someone who is a strong supporter of cooperatives where people pool their resources to have greater control over their life and spending patterns. I think that is a good thing, whether it be grower cooperatives in rural Australia, whether it be credit union cooperatives or whatever else. I conclude by asking you this question. You have pointed in your submission and in your oral evidence to a competitive disadvantage that you will now face by virtue of the banks. Have you gone through the bills that we are inquiring into, and are you able to indicate to the committee—later, if you are not in a position to do it immediately—where you would think those bills would be better amended to reflect a balanced approach to all lenders and not an approach such as the one you complained about which disadvantages credit unions?

Mr Taylor —Yes, we have. Without going into it in detail, I think it is fair to say that the amendments that we have sought and which are outlined broadly in our submission—but are being discussed in more detail in direct discussions with the government—are very minor. We are talking about changes to the definition of financial services which itself can be changed by regulation. We are talking about adopting changes which are consistent with those that are well practised and well used overseas. So these are not dramatic amendments. They are ones which have precedent. They do not create major drafting problems. They do not undermine the policy adopted by the government. Financial services will still be input

taxed. We are just talking about changes at the margin of the definition but which will have a very substantial ameliorative effect on the credit union industry.

CHAIR —There is probably a follow-up then. You are in discussions with the government about whether the government will agree to these changes. At this stage those discussions are current, they are not resolved and there is no outcome. You, of course, participate in these hoping that you will persuade the government. In the event that you do not, would you be putting to the Senate that the Senate should make the changes?

Mr Taylor —We are participating in this inquiry because we need to bring before the proper processes established by the parliament the changes that we would like to see. We also recognise that the government is in a position itself to make those changes before they ever come before the parliament. If we had a preference we would rather see that; we would rather see this matter resolved amicably.

CHAIR —I realise that I am putting you on the spot, Mr Taylor.

Mr Taylor —The answer is yes. If we do not achieve the changes with the government, we would like to see the parliament make the changes.

CHAIR —Thank you.

Senator MURRAY —I have a question arising from your remarks in answers to questions from other senators. Other industries that have seen the downside of the package have spelt it out to us in terms of numbers of jobs that could be lost or numbers of businesses or organisations that could collapse. That is a reasonable way of outlining a downside. If this package goes through as it stands, is it possible that your industry will shrink in numbers either through merges or loss of operators? Will the smaller or more marginal people fall away? Will there be job losses if it goes through as it presently is?

Mr Taylor —We know that the impact on the industry, if there are no changes, will be substantial. It is difficult to say how long it will take before those extra cost increases lead to mergers of credit unions and job losses from that. It is hard to quantify that. We are also very conscious of the fact that credit unions, like all financial institutions, require public confidence. So we need to be careful about saying publicly what may happen to credit unions if these changes are not made. We have set out for the government and the committee the cost impact and, as I said in my opening remarks, we would rather not answer the question: what if there is no change? There is no doubt that the impact is so severe that the credit union industry would not continue in its current form.

Senator MURRAY —But you must appreciate that you need to be up-front with this committee because, if we go to the Senate and we do not know from you that the consequences will be job losses or merges or marginal operators closing down, then our basis for recommending to the Senate that they make amendments which the government refused to make is thereby weakened. However, if you are straightforward with the potential risks it enables a better evaluation by the committee as to whether it should recommend to the Senate a particular course of action.

Mr Taylor —We are trying to be straightforward. There will be credit unions that will not be able to continue. There will be job losses resulting from that. It is hard to quantify that. But the impact of this will be so severe that it is hard to imagine the credit union industry existing in anything like its current form if there are no changes. This is a $40 million per annum cost impact. The industry simply cannot absorb that.

Senator SHERRY —I have one last question which flows on from the announcement today by the Treasurer. I assume you do not know that in detail. Apparently the Treasurer has ruled out the taxation of the operation of cash management trusts by banks. That would seem to me to be conferring a significant advantage on banks vis-a-vis credit unions. I am not aware that credit unions operate cash management trusts. You might like to comment.

Mr Taylor —We do not manage them in the same way as banks, no. There are similar structures. I cannot really comment on the detail of that because I have not seen it. We have been participating in the Ralph review. I can say that credit unions, as I mentioned earlier, do now pay full company tax. We meet every impost the same as anyone else in the industry. We do not think that what we are seeking should be characterised as concessions. We do not think that there should be a new tax put in place which is designed to reduce the costs of business but which ends up increasing our costs substantially. We are looking at removing an anomaly, not providing a concession.

CHAIR —Thank you for your evidence today.

Proceedings suspended from 12.20 p.m. to 1.38 p.m.