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Tuesday, 13 October 1970

Mr GARLAND (Curtin) - I propose to take up in the course of my remarks the points the honourable member for Melbourne Ports (Mr Crean) has just made, but before 1 do that I will give an outline of the main features of this Bill dealing with convertible notes. As has been mentioned, the distinction we are drawing here affects the deductibility of interest payable on convertible notes by companies which can convert them in due course to equity shares and which thereupon will pay dividends. Of course, those dividends are not deductible for income tax purposes.

Dr Gun - We are talking about company taxation.

Mr GARLAND - Yes. I am talking about the deductibility of interest on convertible notes which is a deduction in the accounts of a company and therefore results in less company income tax - primary tax - being paid to Commonwealth revenue. As has been said, in 1960 all this interest was deductible without hindrance. There were no hedges at all. The result was that many companies availed themselves of this opportunity, particularly in 1959 and 1960, and perhaps 99 per cent of those issues were devised purely for the purpose of obtaining the income tax deduction. They were convertible note issues which amounted to deferred equity share issues. The Government announced at that time, when incidentally other measures were taken in what is now known as the credit squeeze, that it would make a change, but it made the distinction that this would be a change to the permanent law and not simply a temporary measure. These measures were introduced into this House on 15th November 1960. What was then happening was legal avoidance of company income tax which was costing the revenue substantial amounts.

The opinion of the Government was that little or nothing was being received in the national interest in exchange.

So a review has been held, as set out in the second reading speech, in order to devise means whereby advantages which did accrue from such an allowance could be obtained without, on the other hand, allowing easy exploitation. Criteria have been set in this Bill to cover issues of convertible notes, which normally would be issues of debentures and which in a given time would be convertible to ordinary shares, when substantial reasons can be given for such issues in the public interest.

The reasons are twofold. Firstly, there are many genuine cases when a company can start a business, or some new aspect of its operations, with good prospects but without a prospect of being able to service, in the early period and perhaps early years, dividends on the new capital as equity shares. If a company issues convertible notes in the early years, cheaper money is often available because it is more attractive to investors to be able to place it. The company can give better conditions for such an issue knowing that it will receive a deduction for the interest payable on those notes during their currency. When they become shares, as I said previously, the dividends payable to shareholders will not be deductible. There are a number of such companies which develop the resources of this country. Much of the development of this kind is slow and the profits are some years in coming. Yet those companies normally would rely on loan funds rather than equity in the form of debentures in order to finance their operations.

The second reason for requiring such legislation - I mention this now because the earlier speaker in this debate, the honourable member for Melbourne Ports mentioned, somewhat darkly, that there were pressures on the Government - is that if you make it more attractive for investors in Australia to make such investments you will minimise - this is the point I have to meet - the amount of foreign capital that will come into Australia in the form of certain investments. This will allow not significantly more but a little more Australian participation because it would be a more favourable investment. I take it that it is common ground that Australia needs investment from overseas in such large quantities because we do not have the capital here to put into projects which open up our resources. The Government and honourable members on the Government side of the chamber would take the view that the cost being paid at present for this overseas capital is justifiable in the overall interest. At the same time that investment must be paid for by way of royalties, dividends and interest and the cost must be minimised at every opportunity.

Thus this legislation will be a complementary part of the legislation passed by this House in connection with the setting up of the Australian Industry Development Corporation. It also complements the overseas borrowing guide lines announced recently in this House. It is part of the Government's policy aimed at trying to minimise the cost of the overseas investment which we regard as fundamental to the development of Australia's resources.

Those are the two principal reasons. The convertible notes which will be issued as a result of this legislation would be, in most cases, fixed interest investment that would exist anyway. Therefore, what the Government is doing will enable a structure whereby companies can convert ultimately to equity capital the loan funds which otherwise would have remained as debentures and been repaid on maturity or renewed, if that were possible in the finance market of that day.

We are dealing, as has been said, with questions of judgment and policy. No black and white decisions are to be made in this area. This matter is not entirely clear; these complicated matters never are. The more I sit in this chamber the more it seems to me that fewer and fewer political questions can be determined clearly in one direction or another. At least this amendment to the Income Tax Assessment Act will give a clear indication to the Commissioner of Taxation of how he should apply the law. In itself that is a commendable thing. It does not leave to him or to anyone else a discretion as to what ought to be done, or what is a good thing or what ought to be a charge on the revenue, as he is allowed in other areas. It makes quite clear how he should apply the law, what interest will be deductible and what will be nondeductible. As has been said, certain fences have been erected here. In other words, attempts have been made to minimise the types of issue on which such convertible notes can be made.

I mention them briefly because they are contained in the documentation. Firstly, these options which are to be held by the convertible note holders are to be real options. They are to be at the opinion of the note holder. He can, if he wishes, not exercise the option and take the cash, which would place him in the position of the genuine debenture holder, a note holder. If he wishes he may take that cash back, which would be the position in the case of a debenture which did not have a convertible option. So he has a real choice. 1 refer not to the company but to the note holder.

Secondly, the option itself must not be for longer than the term of the loan. The first 2 years of the term of the loan is the maximum time which will be allowed as the period in which the note holder cannot exercise the option. That is a period which might be called the 'maximum no option period'. That period will be set by the conditions of the issue. After that 2-year period he has a right to exercise it at any time up to within 12 months - and that again is the maximum period so it could be a lesser period - before the maturity of the loan. The option period itself must not be for longer than 10 years. The 10-year period again has been regarded, as a matter of judgment, as the period within which any undertaking ought to have reached profitability, and so it will be necessary under the terms that the company offers for the option and the period to have then come to an end, the loans to be repayable or to be converted into equity shares, whichever the note holder wishes.

In the case of Australian note holders the term must be less than 7 years because that is regarded as a fair period in the case of a note holder who may be an investor without particular knowledge and probably without particular technical, managerial and entrepreneurial knowledge in the activities of the company concerned. That would be a period which would allow him time to make an assessment as to whether or not he should exercise this option. The Government is not concerned with the judgment formed by overseas investors and it therefore has not put that restriction on an overseas investor. This is an assistance to Australian investors and note holders and not a barrier - and I will deal with this matter later - which would help overseas investors. Also for Australian investors the issue must provide fixed terms and conditions at the beginning of the issue. These terms and conditions are not allowed to be changed. Of course if they were changed during the period of the loan the right to make a tax deduction would not exist. Therefore the advantage of the issue would go. For Australians the terms must remain fixed, though not for overseas investors. They may wish to enter into such an investment with the knowledge that the terms can be varied. They often are in international money markets. Frequently a loan is raised with a condition contingent upon international money market, some fixed market agreed upon and stated, varying up or down - and these days it always seems to be upwards. If such a variation occurred it would not affect the deductibility in Australia to overseas investors but it would certainly take away the deductibility if such a variation were made as against the Australian note holders. Those conditions which are made have been made in the interests of Australian investors. So one cannot turn around and say that this is a help to overseas investors. It is not really a tax matter for them. It is a matter of providing a safeguard to Australian investors which is not given to foreign investors.

These options can be for new shares or for issued shares and can be in a variety of ways. The last main criterion is that the price at which the convertible notes are converted to shares must not be less than 90 per cent of market price or par or, alternatively, at valuation. A structure is set out for valuing in different circumstances. The procedure is there. These valuations are a minimum only. That criterion is to prevent any inducement or advantage being given on the option being taken up so that it is known from the beginning, in fairly precise terms, exactly what the value will be at the time the option is taken up. That full disclosure is very much in the interest of investors. The scheme is to come into operation by application after assent to this Bill. The matter is a relatively complex one, although perhaps not as complex when the Bill is read and the documents are considered for a while.

I think it is comforting to note that although opposing the Bill members of the Opposition are not moving an amendment for the setting up of a committee to inquire into these matters. The moving of such amendments has become a joke. Time and time again the Opposition's lack of precise criticism has been converted to a plea for the setting up of a committee to inquire into matters, but which would only delay the passage of the Bill. It has been said that the matters contained in the Bill have been overdone. I submit that that has not been determined yet. In 1960 the Government and, I think, all people believed that too much advantage was being taken of the existing law, which meant a loss to the revenue of a substantial amount of tax. Steps were taken to make the interest non-deductible. Until very recently that situation continued. Until this legislation has been in operation for a while, it will not be possible to see how many companies avail themselves of the structure. In future it may be necessary to restrict it a little further. It may be possible to open it a little further. I suggest that that will need testing.

The honourable member for Melbourne Ports made some criticisms of the Bill. His first point that there was not time for representations to be made is perhaps a little thin because, as we see from the Notice Paper, under item 7, this Bill has been in the House since 27th August. It is now 13th October. Prior to 27th August a statement was made: it was well known roughly what the criteria being presented tonight would be. The honourable member mentioned that in former times what went on was regarded as a bit of a racket. I have alluded to the revenue loss. He said that it was difficult to know what was right or wrong. I suggest that the principle in this Bill is that the Government is prepared to allow deductibility within certain criteria, provided that the economy and public interest receive some advantage. I have advanced reasons for this. Allowing companies, within certain conditions, to receive cheaper money and providing a small advantage for Australian participation where there otherwise might have been foreign participation are most substantial advantages which have been given and which compensate and justify the proposition as it is in the Bill. I do not think one can reasonably say, as the honourable member did. that overall the Bill can be regarded as bad rather than as good. That was bis phrase. I noted it. I have tried to point out that it will mean, particularly in the area of Australian participation, a small advantage to us. It is not a question of its giving foreign investors any advantage. Surely they will be in a rather similar position.

Debate interrupted.

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