Bills Digest No. 164   1998-99 A New Tax System (Commonwealth-State Financial Arrangements) Bill 1999

Numerical Index | Alphabetical Index

WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History
Purpose
Background
Main Provisions
Concluding Comments
Attachment A: Locking in the GST Rate
Endnotes
Contact Officer & Copyright Details

Passage History

Date Introduced: 24 March 1999

House: House of Representatives

Portfolio: Treasury

Commencement: This Act commences on the later of the day on which it receives the Royal Assent or the day after last day on which the following Acts receive the Royal Assent:

• the A New Tax System (Goods and Services Tax) Act 1999;
• the A New Tax System (Goods and Services Tax Imposition-Customs) Act 1999;
• the A New Tax System (Goods and Services Tax Imposition-Excise) Act 1999;
• the A New Tax System (Goods and Services Tax Imposition-General) Act 1999;
• the A New Tax System (Goods and Services Tax Administration) Act 1999.

Proposed subclause 2(2) provides that to remove doubt, this Act does not commence until all of the above Acts have received the Royal Assent.

 

Purpose

This Bill and its companion A New Tax System (Commonwealth-State Financial Arrangements - Consequential Provisions) Bill 1999 seek to replace the general revenue grants - that the Commonwealth provides the States and Territories under the States Grants (General Purposes) Act 1994 - with the revenue from the proposed goods and services tax (GST). The Commonwealth is guaranteeing the States all revenues from the GST in exchange for the States abolishing a number of taxes and accepting additional responsibilities, including for financial assistance to local government now provided under the Local Government (Financial Assistance) Act 1995.

The Agreement on Principles for the Reform of Commonwealth-State Financial Relations (Agreement on Principles) - endorsed by heads of Governments at the Special Premiers' Conference on 13 November 1998 - envisages that the States and Territories will repeal a range of taxes and agree not to reintroduce them or similar taxes in the future. The target dates for the repeal of these taxes are:

• Bed taxes, from 1 July 2000;
• Financial Institutions Duty, from 1 January 2001;
• Debits tax, from 1 January 2001;
• Stamp duties on: marketable securities; business conveyances (other than real property); leases; mortgages, debentures, bonds and other loan securities; credit arrangements, instalment purchase arrangements and rental arrangements; and on cheques, bills of exchange and promissory notes, from 1 July 2001(1).

The Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations (the Intergovernmental Agreement) signed on 9 April 1999, gives effect to the intent of the Agreement on Principles.

The reader is referred to the Bills Digest on the A New Tax System (Commonwealth-State Financial Arrangements - Consequential Provisions) Bill 1999 which provides for the repeal of the States Grants (General Purposes) Act 1994 and the Local Government (Financial Assistance) Act 1995.

The Bill discussed in the present Digest includes measures for the following main purposes.

• Part 2 of the Bill sets out the procedure for changing the rate and base of the GST.
• Division 1 of Part 3 of the Bill sets out the basis for the distribution of the GST revenue to the States. (Proposed clause 4 defines State to include the Australian Capital Territory and the Northern Territory.) The States can use the GST revenue for any purpose.
• Division 2 of Part 3 of the Bill provides for making the following additional payments to the States:
• Franchise fees windfall tax reimbursement payments; and
• Competition Agreement payments.
• Division 3 of Part 3 of the Bill sets out the role of the Treasurer in making advance payments to a State for a GST year offsetting overpayments and underpayments in a particular year and in fixing amounts and timing of payments of financial assistance to a State.
• Part 4 of the Bill deals with appropriations for the purpose of making payments to the States.

There are also measures in Schedule 1 of the Bill for the transitional years, which commence on 1 July 2000 and 1 July 2001. These two years are referred to as the transitional GST years in proposed clause 4 of the Bill. There is provision to extend the transitional measures to a later year that may be prescribed by regulations.

Background

Implementing A New Tax System

The Bill is one of a package of 31 Bills(2) that was introduced into the House of Representatives to give effect to the Government's proposals of 13 August 1998 for a new tax system, which includes the introduction of a GST. The outlines of the Government's proposals were contained in the policy document Tax Reform: not a new tax, a new tax system: The Howard Government's Plan for a New Tax System,(3) which will be referred to as the A New Tax System (ANTS) in this Digest. An Overview of ANTS and further details of the proposals were contained in Fact Sheets, all of which are available in the Government's Tax Reform Website: http://www.taxreform.gov.au

Proposed clause 1-3 of the A New Tax System (Goods and Services Tax) Bill 1998 (the GST Bill) provides that the Commonwealth will introduce further legislation to give effect to the Agreement on Principles. In the Second Reading Speech on the GST Bill, the Treasurer stated that the Government proposes to enact the whole package by the end of the 1998-99 financial year and that when the package is enacted, Australia will have a new tax system from 1 July 2000.(4) The Prime Minister also stated in Parliament that further tranches of legislation will be introduced early in 1999 to implement the new tax system.(5)

Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations of 9 April 1999

It will be necessary to read this Bill in conjunction with the Intergovernmental Agreement, as Clause 4 of the Agreement provides that the Commonwealth will attach the Agreement as a schedule to A New Tax System (Commonwealth-State Financial Arrangements) Act 1999. The Intergovernmental Agreement is not part of the Bill at present and will probably be included by an amendment to the Bill shortly.

Clause 4 of the Intergovernmental Agreement states:

There is no indication from the Intergovernmental Agreement what form the legislation to be passed by the States and Territories must take.

The Intergovernmental Agreement also provides for the establishment of a Ministerial Council to oversee the operation of the Agreement. Its functions include the oversight of the operation of the GST and approving changes to the GST base (Clause 42). The membership of the Ministerial Council will comprise the Treasurer of the Commonwealth and the Treasurers of the States and Territories (Clause 41).

The Intergovernmental Agreement further provides for the establishment of a GST Administration Sub-Committee comprising Commonwealth, State and Territory officials to monitor the operation of the GST, make recommendations regarding possible changes to the GST base and rate and to monitor the Australian Taxation Office's performance in GST administration (Clause 46). The Commonwealth Treasury will chair the GST Administration Sub-Committee (Clause F7 of Appendix F to the Agreement).

As the Bill deals with disparate measures in the various Parts and the Schedule, the Background to the measures in each Part and the Schedule will be dealt with together with the Main Provisions for the convenience of the reader.

Main Provisions

Part 2 - Changing the rate and base of the GST

Background

The Explanatory Memorandum states that the provisions in Part 2 of the Bill are designed to 'lock-in' the GST rate and base with the objective of addressing community concerns that the Commonwealth could unilaterally increase GST revenues in the future by increasing the GST rate and base.(6)

The Explanatory Memorandum adds that, consistent with the approach set out in the Government's tax reform package and endorsed in the Agreement on Principles, the Bill provides that the rate of GST and, in most cases, the GST base, are not to be changed unless all States, Territories and the Commonwealth agree to the change.(7)

The Intergovernmental Agreement deals with the management of the GST rate and base in Clauses 31 to 36.

What are the provisions in the Bill for changing the rate and base of the GST?

Proposed subclause 10(1) provides that the 'rate of the GST and the GST base are not to be changed unless each State agrees to the change.'

Proposed Clause 11 provides that the rate of the GST is the rate of the tax specified at 10 per cent in the following Acts:

• the A New Tax System (Goods and Services Tax Imposition-Customs) Act 1999;
• the A New Tax System (Goods and Services Tax Imposition-Excise) Act 1999;
• the A New Tax System (Goods and Services Tax Imposition-General) Act 1999.

Proposed Clause 4 defines the expression 'GST Imposition Acts' to mean the above Acts. The reader is referred to the Bills Digests on the Bills relevant to the above Acts for explanations of the imposition of the GST at 10 per cent on imports, and where the tax on goods would amount to an excise and on goods and services generally.

Clause 31 of the Intergovernmental Agreement deals with the management of the GST rate. It provides that after the introduction of the GST, a proposal to vary the 10 per cent rate of GST will require:

Conditions (ii) and (iii) are the usual conditions that apply to any changes to Commonwealth tax rates. However, condition (i) is contained in proposed subclause 10(1) of the Bill, which requires the unanimous support of the State and Territory Governments for changes to the rate and base of the GST to take effect.

There is no indication from the Intergovernmental Agreement whether the legislation contemplated by clause 31 will require the approval of each State parliament to change the rate and base of GST or only that of the Executive Government of each State. Certain important legal issues pertaining to the constitutionality of the condition imposed by proposed subclause 10(1) arise for consideration.

2. Are the provisions of proposed subclause 10(1) part of the Imposition Acts?

3. To what extent will the Commonwealth be bound by the provisions of A New Tax System (Commonwealth-State Financial Arrangements) Act 1999 and the Intergovernmental Agreement to retain the rate of GST at 10 per cent in each of the GST Imposition Acts should any State or States not agree to a change in the rate?

These issues and the possible outcomes are discussed in the following paragraphs. The legal position regarding the second question is considerably clearer than that regarding the first.

Is proposed subclause 10(1) a law imposing taxation and if so what are the constitutional consequences?

If proposed subclause 10(1) is a law imposing taxation, section 55 of the Constitution will render ineffective all the other provisions in the Bill.

Section 55 of the Constitution states:

The High Court has set down a number of criteria for deciding what constitutes a 'law imposing taxation' for the purposes of section 55. Lane's(8) summary of the relevant criteria includes the following.

• The 'law imposing taxation' is a law or one provision of an Act that creates the very liability to tax. There is no doubt that the Imposition Acts will establish the liability to the GST at the rate of 10%. The question to be determined is whether the provision in proposed subclause 10(1) additionally creates liability to the GST as it sets out conditions under which that rate could be changed.
• A 'law imposing taxation' may include conditions; for example a tax is imposed on condition that a Minister is satisfied of such-and-such. Lane cites the case of Nott Bros & Co Ltd v Buckley (1925)(9) (Nott) in taking the view that a law imposing taxation may include conditions. In this case the Customs Tariff (Industries Preservation) Act 1921-1922 (Cth) included a condition that the Minister should first conduct an investigation and thereafter specify the goods to which the tax imposed by section 8 of that Act shall apply.

If a law imposing taxation may include conditions, does a law which sets out conditions for changing the rate come, for constitutional purposes, under the umbrella of a 'law imposing taxation'. If it does proposed subclause 10(1) is a law imposing taxation under section 55 of the Constitution. In that case, the other provisions in the Bill would have no effect. The other significant provisions in the Bill which may be invalidated are those dealing with changing the base of the GST, the distribution of the GST revenue to the States by way of grants and the appropriation made to effect the distributions.

However, if the terms of proposed subclause 10(1) dealing with the conditions for changing the rate of GST were incorporated into the Imposition Bills, the risk of having the other provisions of the Bill being declared invalid would be avoided.

The above discussion is based on the premise that the condition included in proposed subclause 10(1) requiring each State to agree to any change in the rate and base of GST is by itself a valid condition binding on the Commonwealth Parliament. This question is considered in the following paragraph and it would appear for the reasons mentioned in that paragraph, that the veto given to the States to prevent any change in the rate of GST and the GST base may be of no avail, as it may be unconstitutional. If that were the case, the requirement that each State should agree to the change in the rate of GST in proposed subclause 10(1) would not be a condition for the imposition of the GST.

This may also apply to the requirement in proposed subclause 10(3) that later changes to the GST base of an administrative nature must be approved by a majority of the Commonwealth and the States. In that case Part 2 would be of no avail and the rest of the provisions in the Bill would be valid on the assumption that Part2 is severable from the rest of the Bill.

Is proposed clause 10 requiring the agreement of each State to a change in the rate and base of GST binding on the Commonwealth Parliament?

As indicated earlier, the Explanatory Memorandum states that the provisions in Part 2 of the Bill, which include proposed clause 10, are designed to 'lock-in' the GST rate and base, with the objective of addressing community concerns that the Commonwealth could unilaterally increase GST revenues in the future by increasing the GST rate and base.(10)

It was also noted that the Intergovernmental Agreement, in clauses 31 and 36, confirms the above arrangements for varying the rate and base of GST. Clause 4 of the Agreement provides that the Commonwealth will attach the Agreement as a schedule to A New Tax System (Commonwealth-State Financial Arrangements) Act 1999.

It is proposed to consider the extent to which the Commonwealth will be bound by the above provisions of the Act as well as the Intergovernmental Agreement.

The question is best dealt with by considering the consequences of the Commonwealth increasing in the year 2002 the rate of GST by a hypothetical GST Amendment Act 2002 (the Amendment Act 2002) without obtaining the unanimous agreement of all the States. There would be two aspects of inconsistencies of laws to be considered.

The first aspect of inconsistency is that the Amendment Act 2002 would be inconsistent with A New Tax System (Commonwealth-State Financial Arrangements) Act 1999, another Commonwealth Act, in that the increase in the GST rate does not comply with the provisions of section 10 as the unanimous agreement of all the States to an increase in the GST rate has not been obtained. We then have the case of two Commonwealth laws differing in time which are inconsistent and where the intention to contradict the terms of section 10 is evident in the later Amendment Act 2002 by the mere act of increasing the rate of GST without the unanimous consent of all the States. The rule, to resolve the question of Commonwealth laws that are inconsistent when they differ in time, is that the later law prevails if the intention to contradict the earlier law is plain. Lane(11) explains the reason behind this rule as follows.

Lane cites the following dicta from the decision of McHugh J in Chu Kheng Lim v Immigration Minister (1992)(12) to support the above conclusion.

Thus the Amendment Act 2002 would prevail over section 10, notwithstanding that the unanimous consent of all the States to the increase in the GST rate has not been received.

A Research Note 'Locking in the GST Rate' by George Williams prepared for the Department of the Parliamentary Library considers the issues involved in attempting to require the consent of the States to changes in the GST rate and base. This Research Note makes the point that it would be unconstitutional for the Commonwealth Parliament to require the consent of the States and Territories before making a change to the GST rate.

The second aspect of the inconsistency is that the Amendment Act 2002 would be inconsistent with the Acts of the States that do not agree with the GST rate increase. This inconsistency is resolved by section 109 of the Constitution, which states:

It is thus clear that the Amendment Act 2002 of the Commonwealth increasing the rate of GST would prevail over an Act of a State Parliament. Lane emphasises the automatic nature of the operation of section 109 to render an inconsistent State law inoperative.

Thus a Commonwealth Act which increases the rate of GST would automatically override section 10 of the A New Tax System (Commonwealth-State Financial Arrangements) Act 1999 and any State Act, although all the States may not have agreed to the increase in the rate of GST.

The question arises what, if any, is the binding nature of the Intergovernmental Agreement and the requirement in clause 31 not to increase the rate of GST without the unanimous consent of all the States. It was noted earlier that the Intergovernmental Agreement will be incorporated into the A New Tax System (Commonwealth-State Financial Arrangements) Act 1999. The subsequent Commonwealth Amendment Act 2002 which increases the rate of GST notwithstanding the provisions of section 10 would not only prevail over section 10 but also clause 31 of the Intergovernmental Agreement, which is incorporated into the A New Tax System (Commonwealth-State Financial Arrangements) Act 1999.

Further, it was mentioned above that section 1 of the Constitution precludes the Commonwealth Parliament vesting legislative power or a right of veto in any other body or person, such as the States or Territories(15). Thus on this argument the Commonwealth cannot bind itself not to increase the rate of GST if the unanimous agreement of the States is not available as that would be unconstitutional and would amount to giving the States the right of veto. Thus, proposed clause 10 may not be valid if its provisions give the States a veto over the right of the Commonwealth to increase the rate of GST where this is considered necessary for the peace, order, and good government of the Commonwealth under section 51(ii) of the Constitution.

Professor George Winterton, in a paper titled Can the Commonwealth Parliament Enact "Manner and Form" Legislation? takes the view that the Commonwealth Parliament is not empowered to include an additional element to the present legislative process such as requiring the consent of another body.

Thus proposed subclause 10(1) of the Bill which provides 'The rate of the GST, and the GST base, are not to be changed unless each State agrees to the change'. could only give the States a veto power by a constitutional amendment following the procedure in section 128 of the Constitution. Until that process is gone through, that provision would be of no effect and the Commonwealth Parliament would be able to vary the rate and base of GST without the consent of the States.

This would apply equally to the provision in proposed subclause 10(3), which states that '...later changes to the GST base can be made if they are approved by a majority of the Commonwealth and the States.'

Thus the provisions in proposed clause 10, requiring the consent of the States to vary the rate of GST and the base of GST, would not be binding on the Commonwealth Parliament and there would be nothing to preclude the Commonwealth Parliament from unilaterally changing the rate of GST and the GST base.

What is the base of GST?

The Bill does not define the 'GST base' and it must therefore be given the ordinary meaning as can be gathered from the scheme for the imposition of the GST in the package of Bills that directly or indirectly affect its imposition. The term 'GST base' has also an economic connotation in that it is the base from which taxation revenue will be raised to replace a range of Commonwealth and State taxes.

The Explanatory Memorandum to A New Tax System (Goods and Services Tax) Bill 1998 in its Executive Summary gives a succinct summary of the operation of the GST which will assist in appreciating what the GST base means. The relevant extract from the Explanatory Memorandum is given below(17).

As the Bill does not define the GST base, we cannot be sure what a change in the base would involve and when the agreement of the States and Territories would be necessary. The exact definition of the base is likely to need amendment from time to time.

Generally the GST base is:

2. consumption goods-that is goods and services sold for final consumption by private individuals in Australia (other than GST-free and input taxed goods and services), plus

3. inputs into input taxed goods and services whether destined for consumption or otherwise.

However, in a good number of cases, additional criteria have been introduced to define what is inside and outside the GST base. Already we can identify areas where ambiguities may need to be addressed in the future.

Financial services are input taxed which means they are not included in the GST base but some inputs into financial services are included. For example, if a bank outsources its computing, those computing services will attract the GST. Where a financial institution makes a specific charge for a service such as financial advice, that service would attract the GST.

The legislation specifies that while financial services such as stock broking, superannuation and the like would be exempt, legal, accounting and like services would not be exempt. That of course creates a powerful incentive for lawyers, accountants etc to provide services that look as much like financial services as possible. Where charges can be shifted between other services and financial services, there would be an incentive to load the charges onto financial services rather than non-exempt services. In the stock broking industry, there has been a trend towards charging separately for pure broking services as distinct from the research brokers provide. The likelihood that charges for research would attract the GST may arrest the trend for separating brokers' services.

In a similar way while education is GST free, the tuck shop is not. It may be possible that some schools will get around that by including food and similar goods in annual fees.

As the legislation is currently drafted, buying and selling futures, options and other derivatives(18) over gold would not attract the GST since they are financial transactions. However, buying and selling actual gold would attract the GST (unless the seller is a refiner or registered dealer). It is likely that the introduction of the GST in this way would stimulate the invention of other derivatives that would be close substitutes for owning the physical asset.

The above are just possibilities and they would not appear to be insurmountable. The point is that additional action in the future is likely to address the blurry edges of the GST base. A literal reading of the Bill suggests that each such amendment would require the agreement of the States or at least a majority of the Commonwealth and States.

Part 3 - Grants to the States

Background

Commonwealth assistance to the States and vertical fiscal imbalance

Australia has the largest degree of 'vertical' fiscal imbalance of any federal country, that is, disparities between the power to raise revenue and spend at different levels of government. The amount of own-source revenue the Commonwealth raises exceeds considerably its own-purpose outlays, whereas the States' own-purpose outlays exceed the amount they raise in own-source revenue. For example, in 1997-98, the Commonwealth's own-purpose revenue exceeded its own-purpose outlays by more than a quarter; in contrast, the States' own-source revenue was equivalent to only 63 per cent of their own-purpose outlays. The Commonwealth provides assistance to the States and Territories partly to offset this imbalance. The most important factor underlying the differences in Commonwealth and State revenue raising and expenditure responsibilities relates to taxation, and results primarily from the introduction of uniform Commonwealth income taxation in 1942.(19)

The States are very dependent upon the Commonwealth for revenue. Overall, Commonwealth assistance accounts for around 42 per cent of State and Territory revenues, although the degree of dependence varies among the States and from year-to-year.

General revenue assistance

Currently, the main forms of assistance to the States are general revenue assistance and Specific Purpose Payments (SPPs).(20) General revenue assistance is 'untied'; that is, the States are not required to spend the assistance for specified purposes. Under clause 6 of the Intergovernmental Agreement, GST revenue will also be untied. In 1998-99, general revenue assistance is expected to account for around 53 per cent of total payments to the States and SPPs for around 47 per cent. The Bill does not change SPPs. Clause 5 of the Intergovernmental Agreement states that the Commonwealth "has no intention of cutting aggregate SPPs as part of the reform process".(21)

Financial assistance grants

Financial assistance grants (FAGs) account for more than 95 per cent of general revenue assistance (the other forms of general revenue assistance are Special Revenue Assistance and National Competition Payments, which are not changed by the Bill). FAGs are paid under the authority of the States Grants (General Purposes) Act 1994. The level of FAGs is indexed to movements in the consumer price index and in accordance with population projections. The indexation of FAGs is guaranteed on a rolling three-year basis. The Commonwealth has undertaken to maintain FAGs in real per capita terms in 1998-99, and to extend the real per capita guarantee to 2000-01. The payment of FAGs will cease on 1 July 2000 under the Bill.

Horizontal fiscal equalisation

General revenue assistance is largely distributed on the basis of the principle of horizontal fiscal equalisation. As applied by the Commonwealth Grants Commission (CGC), this seeks to ensure that State governments receive funding from the Commonwealth such that, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency, each would have the capacity to provide services at the same standard(22). To implement this principle, the CGC annually calculates per capita relativities, and applies them to the FAGs (and to health care grants, which the Commonwealth pays to the States under the Australian Health Care Agreements, to assist with the provision of public hospital services free-of-charge to eligible persons). The CGC's most recent (five-year basis) estimate of the relativities is in Table 1.

Table 1: General revenue and health care grant relativities: five-year basis

New South Wales	0.90032
Victoria	0.86273
Queensland	1.00775
Western Australia	0.94035
South Australia	1.20764
Tasmania	1.61001
Australian Capital Territory	1.10358
Northern Territory	4.84095
Australia	1.00000

Source: Commonwealth Grants Commission, Report on General Grant Relativities 1999, Volume 1. Main report.

Table 1 shows that, in general, New South Wales, Victoria and Western Australia have the greatest capacity to provide services to their populations.

The application of the fiscal equalisation principle results in the general revenue and health care grants being distributed unequally, in per capita terms, because States have different capacities to raise revenue and different per capita expenditure requirements to provide the same level of services. This is illustrated in Table 2.

Table 2: Effect of fiscal equalisation on the distribution of FAGs and health care grants 1998-99

	Distribution using CGC relativities		Distribution on an equal per capita basis		Difference in distribution
	(1)		(2)		(1)-(2)
	$m	%	$m	%	$m
NSW	6546	29.7	7467	33.8	-920
VIC	4814	21.8	5474	24.8	-660
QLD	4174	18.9	4089	18.5	85
WA	2117	9.6	2157	9.8	-40
SA	2131	9.7	1746	7.9	385
TAS	855	3.9	552	2.5	303
ACT	345	1.6	363	1.6	-18
NT	1091	4.9	227	1.0	865
Total	22074	100.0	22074	100.0

Source: Federal Financial Relations 1998-99, Budget Paper No. 3, page 18.

Table 2 shows that if FAGs and health care grants were distributed on an equal per capita basis and not on CGC relativities, NSW, Victoria, Western Australia and the ACT would be better off.

Proposed clause 9 of the Bill provides that the relativities factor for a State for a GST year is to be determined in writing by the Treasurer after consulting each of the States. However, under clause 7 of the Intergovernmental Agreement, the Commonwealth and the States agreed that "the Commonwealth will distribute GST revenue grants among the States and Territories in accordance with horizontal fiscal equalisation principles...".

Changes to State taxation powers and expenditure responsibilities

A condition of the Commonwealth's proposal to pass GST revenue to the States is that they undertake some additional expenditure responsibilities(23). The most important change to expenditure is that the States take responsibility from the Commonwealth, from 1 July 2000, for the payment of general revenue grants to local government.

Local government assistance

The Commonwealth has provided general purpose assistance to local governments since 1974-75. Under current arrangements, this takes the forms of local government FAGs and untied road funding. This assistance is paid under the Local Government (Financial Assistance) Act 1995 as a SPP 'through' the States (i.e. payment is made on the condition that the funds are passed on to local governments). Under that Act, the Treasurer is responsible for determining the annual increase in Commonwealth general purpose assistance. The Act provides for general purpose assistance to be increased by an escalation factor, which reflects the underlying movement in general revenue assistance provided to the States. The escalation factor reflects the percentage increase in the States' FAGs pool in the current year. That, in turn, reflects indexation for population growth and the consumer price index.

Under clauses 14 and 15 and Appendix D of the Intergovernmental Agreement, the States have agreed to make general purpose assistance payments to local government from 1 July 2000. The States are to maintain the level of this assistance in real per capita terms.

Abolition of some State Taxes

As noted, a condition of the Commonwealth's proposal to pass GST revenue to the States is that they abolish some taxes.(24) In general, these taxes are inefficient and difficult to administer.(25)

Main provisions

GST revenue grants

Proposed Clause 12 provides that each State is entitled to payment by way of financial assistance of a grant worked out using the following formula.

Each of the terms used in the above formula is defined in the Bill.

The formula is very similar to that in section 9 of the States Grants (General Purposes) Act 1994, except that GST Revenue replaces the following product:

ie. (BAA x IF x PF)

where

"BAA" (base assistance amount) means the base assistance amount set out in the applicable Schedule;

"IF" (index factor) means the index factor for the grant year;

"PF" (population factor) means the population factor for the grant year.

Basically the GST revenue replaces the indexation factor, based on CPI and population growth, applied to the previous year's grant. It assumes that GST revenue will reflect these changes.

The Commonwealth has in addition guaranteed minimum amounts under the transitional arrangements in Schedule 1 of the Bill. The transitional arrangements are contained in clauses 9 to 13 and Appendix C of the Intergovernmental Agreement. In essence, the Commonwealth has guaranteed that no State will be worse off in financial terms and, if necessary, will make transitional assistance payments to ensure this outcome. The determination of whether a State is entitled to additional funding requires the estimation of its guaranteed minimum amount. This amount takes account of the revenue the States will forego - mainly Financial Assistance Grants and business franchise fees - and the additional expenditure responsibilities the States will assume, including payments to first home owners and local governments.

Schedule 1 of the Bill contains provisions that apply for the first three GST years and other years that may be prescribed. Chapter 3 of the Explanatory Memorandum gives a detailed explanation of the transitional arrangements.

Franchise fees windfall tax reimbursement payments

The Franchise Fees Windfall Tax (Collection) Act 1997 (26)(the Windfall Tax Collection Act) is part of a package of nine Commonwealth Acts dealing with the consequences of the High Court's landmark 4:3 decision on 5 August 1997 in Ha & Another v State of New South Wales & Others and Walter Hammond & Associates Pty Limited v State of New South Wales and Others (Ha and Hammond)(27). Prior to the decision in Ha and Hammond the High Court had been divided in its approach to the definition of 'duties of excise'. Initially such duties were confined to taxes on the production or manufacture of goods. This definition was gradually extended to include taxes on goods imposed at any point in the distribution process. Over time the Court came to accept that exceptions should be made for taxes on alcohol, tobacco and petrol, and hence the States have been permitted to tax these goods using the backdating device in Dennis Hotels Pty Ltd v Victoria (1959-1960)(28). In Dennis Hotels the High Court accepted in a 4:3 decision, that a licence fee calculated by reference to the value of alcohol purchased for sale in the previous year, referred to as the backdating device, was not an excise. This backdating device has been upheld in Dickenson's Arcade v Tasmania (1974) 130 CLR 177, in relation to tobacco, and in HC Sleigh Ltd v South Australia (1977) 136 CLR 475, in relation to petrol, and was at issue in Ha and Hammond. The majority decision in Ha and Hammond removes, for the purposes of section 90, the special status accorded to tobacco, alcohol and petrol under previous decisions of the High Court based on the interpretation of section 90 of the Constitution.

Their Honours stated:

[D]uties of excise are taxes on the production, manufacture, sale or distribution of goods, whether of foreign or domestic origin. Duties of excise are inland taxes in contradistinction from duties of customs which are taxes on the importation of goods. Both are taxes on goods, that is to say, they are taxes on some step taken in dealing with goods(29).

Importantly, particularly for State revenues, the majority continued:

[I]t is unnecessary to consider whether a tax on the consumption of goods would be classified as a duty of excise(30) .

The Windfall Tax Collection Act in effect honours the undertakings made by the Treasurer on 6 August 1997 in response to a unanimous request from the States and Territories that:

• the Commonwealth use its taxing powers to collect revenues formerly levied under State franchise laws which the High Court had held either to be invalid or constitutionally doubtful;
• the Commonwealth will protect the States and Territories against any actions brought by persons seeking a refund for payments made under the (now invalid) State franchise laws prior to 5 August 1997; and
• legislation be enacted to give effect to the above 'safety net' measures in the Commonwealth Parliament as a matter of urgency(31).

Section 51(ii) of the Australian Constitution gives the Commonwealth power over taxation but provides that Commonwealth taxes may not discriminate between States or parts of States. Hence, in replacing the various State business franchise fees (taxes), the Commonwealth can only impose a uniform rate of tax across the country. Given variations in the rate and structure of franchise fee regimes formerly operating in each jurisdiction, some of what the Commonwealth has called the 'safety net rates' levied by the Commonwealth will be higher than some of the franchise fees in some of the States and Territories.

Currently, the franchise fees windfall tax reimbursement payments are made under section 11B of the States Grants (General Purposes) Act 1994 (Cth) and Item 6 of Schedule 5 to that Act. With the repeal of the States Grants (General Purposes) Act 1994 (Cth) by proposed Item 4 of Schedule 2 of the A New Tax System (Commonwealth-State Financial Arrangements - Consequential Provisions) Bill 1999, proposed clause 13 will provide for the continuation of these payments.

Competition Agreement payments

Under the Agreement to Implement the National Competition Policy concluded at the April 1995 Council of Australian Governments (COAG), States are eligible for three tranches of ongoing National Competition Payments (NCPs). This is subject to the States complying with the conditions set out in the Agreement. The NCPs commenced in July 1997 at an annual level of $200 million and are scheduled to increase to $400 million and $600 million in July 1999 and July 2001 respectively in 1994-95 prices.

Currently, the payments are made as general purpose payments under section 12A of the States Grants (General Purposes) Act 1994 and Item 8 of Schedule 5 of that Act. With the repeal of the States Grants (General Purposes) Act 1994 (Cth) by proposed Item 4 of Schedule 2 of the A New Tax System (Commonwealth-State Financial Arrangements - Consequential Provisions) Bill 1999, proposed clause 14 will provide for these payments.

What are the constitutional powers which will enable the Commonwealth to distribute the entire GST revenue to the States and Territories under certain conditions?

Section 96 of the Constitution provides that 'the Parliament may grant financial assistance to any State on such terms and conditions as the Parliament thinks fit'. It is therefore well within the constitutional power of the Commonwealth to distribute to the States the entire GST revenue for each GST year as financial assistance subject to conditions.

Lumb and Moens summarise the ambit of the grants power under section 96 as follows.

In South Australia v Commonwealth (1942)(33) (the First Uniform Tax Case) the High Court recognised the right of the Commonwealth to provide grants to the States conditional on the abstention of the States from imposing their own income taxes.

The majority of the High Court upheld the validity of the legislation, drawing a distinction between a coercive law which would fall outside section 96, and a law which offers financial inducements to a State not to exercise its powers in a particular way. Thus section 96 grants must not be made under a coercive law of the Commonwealth. What appears to be prohibited is legal compulsion which is different from a very attractive inducement which the States are likely to accept for economic and or political reasons. The test would appear to be the freedom available to the States to decline the offer of grants by the Commonwealth. Latham CJ in the First Uniform Tax Case met the argument that the distinction was blurry as follows.

In Victoria v The Commonwealth (1957) (35)(the Second Uniform Tax Case) the validity of sections 5 and 11 of the States Grants(Tax Reimbursement) Act 1946-48 were challenged. Section 5 provided that in respect of any year in which the Treasurer is satisfied that a State has not imposed a tax upon incomes there shall be paid an amount calculated in accordance with the provisions of the Act. Section 11 provided that if a State has received advances of a grant during a financial year and before the end of that year seeks to raise additional revenue by imposing an income tax, that State must refund the advances. It was held by the whole Court that the States Grants(Tax Reimbursement) Act 1946-48 was a valid enactment on the basis that section 96 empowers the Commonwealth Parliament to grant financial assistance to any State on such terms and conditions as it thinks fit.

Thus Latham CJ in the First Uniform Tax Case made the point that the State Grants (Income Tax Reimbursement) Act 1942 (Cth) did not require the State or the State Parliament to abdicate or purport to abdicate its power to impose taxes upon income. Although obiter, the point was made that in any event a State Parliament could not bind itself or its successors not to impose taxes upon incomes in the future.

If the Intergovernmental Agreement is incorporated into the Bill the question will arise whether the terms of subclause 5(vi) are coercive or not. In addition there arises the question whether the Intergovernmental Agreement compels the Parliaments of the States to bind themselves and their successors to cease applying certain taxes and not to reintroduce them. These questions are considered in the following paragraph.

What are the conditions attached to the distribution of the GST revenue to the States and Territories and are they enforceable?

Part 3 of the Bill is titled - Grants to the States and Division 1 is titled GST revenue grants. Proposed clause 12 provides for the entire GST revenue for a GST year to be paid to each State as financial assistance on the basis of a formula set out therein. The State hospital grant for each State is to be determined under the measures in proposed clause 6 and these grants are not connected with the GST revenue raised for a GST year. There are no conditions set out in Part 3 of the Bill for the Commonwealth to make GST revenue grants to the States.

Part 2 of the Bill requires the agreement of each State to any change in the rate of GST and the GST base. Apart from the question of the validity of Part 2 discussed above, its terms are not open to the construction that it is coercive on the States to agree to changes in the rate and base of GST that may be suggested by the Commonwealth from time to time. It may be said that the terms of Part 2 far from being coercive offer the political and economic attraction to the States to agree to increases in the rate of GST as they would be the main beneficiaries of additional GST revenues. To that extent Part 2, if valid, would satisfy the test suggested by Latham CJ mentioned in the previous paragraph for offering a financial inducement which is not a coercive condition.

Clause 4 of the Intergovernmental Agreement states that the Commonwealth will attach the Agreement as a schedule to the A New Tax System (Commonwealth-State Financial Arrangements) Act 1999. As mentioned earlier it will be necessary to amend the Bill to incorporate the Intergovernmental Agreement and make its terms and conditions apply to the making of GST revenue grants.

However, clause 4 adds that the Commonwealth will use its best endeavours to ensure the Act will require compliance with the Agreement and the States and Territories will use their best endeavours to ensure their legislation will require compliance with the Agreement. It would appear that Clause 4 gives the Intergovernmental Agreement the character of a Memorandum of Understanding by accepting that there are limitations of a political nature in giving effect to its terms.

Subclause 5(vi) and Appendix A of the Intergovernmental Agreement list the range of taxes that the States and Territories have agreed to cease to apply from certain dates and not to reintroduce them or similar taxes in the future. Subclause 5(vi) would appear to be subject to the reservation in Clause 4 of the Intergovernmental Agreement which only requires the States and Territories to 'use their best endeavours to ensure their legislation will require compliance with the Agreement'.

It may therefore be argued that the Intergovernmental Agreement is not coercive in the manner suggested in Latham CJ's test in the First Uniform Tax Case referred to above. Further, the Intergovernmental Agreement having the character of a Memorandum of Understanding the question of enforceability may not arise because it is essentially an agreement governing sharing of revenues subject to further negotiation between the Executive Government of the Commonwealth and the Executive Governments of the States in a federation.

In a two part article in the Melbourne University Law Review(37) Professor Cheryl Saunders examined the question whether conditions imposed on section 96 grants are enforceable in the Australian courts. Both private and public law models were examined and found to provide only partial answers to the legal problems created by these grants.

On the question of enforceability Professor Saunders stated:

Professor Saunders points out that enforcement could be carried out by the Commonwealth at the practical level by refusing to pay future grants if a condition is not met by a State. Conversely, enforcement by a State against the Commonwealth may be a pyrrhic victory if the sum recovered subsequently is set off against other payments. This explains why disputes are resolved at a political level and any Intergovernmental Agreement in practical terms is of short duration with annual revisions and the question of legal enforcement may rarely arise.

Concluding Comments

 Federalism up in Smoke? The High Court Decision on the State Tobacco Case

The High Court decision on 6 August 1997 in Ha and Hammond v NSW declared as invalid the imposition by NSW of franchise fees on tobacco under section 90 of the Constitution. This decision effectively declared all State business franchise fees to be constitutionally invalid. At that time it was anticipated that the invalidation of this substantial source of State revenue may be a catalyst for a further review of both Federal-State financial relations and the structure of taxation in Australia. The measures in the Bill may take Australia on the path to an even more highly centralised revenue collection system and aggravate the vertical fiscal imbalance with serious consequences for financial accountability. Denis James in a paper on Federalism up in Smoke? The High Court Decision in the State Tobacco Case(39). foreshadowed a major reform of consumption taxation:

Even before the 1997 High Court decision the Commonwealth with sole access to both the sales tax base and, since 1942, the income tax base, raised around 80 per cent of all tax revenue but was responsible for only 63 per cent of all expenditure. This imbalance, referred to as vertical fiscal imbalance, between the revenue resources available to each tier of government and their expenditure responsibilities was expected to be aggravated by the High Court decision and the temporary measures that were put in place for the Commonwealth to collect and distribute to the States the franchise fees that were declared to be unconstitutional.

The Windfall Tax measures that were put in place in late 1997, whereby the Commonwealth stepped in as a temporary measure to collect the taxes previously levied by the States, will cease to apply with the passage of the Bill. The Intergovernmental Agreement will result in the States ceasing to apply certain specified taxes in return for sharing the entire GST revenue without any Commonwealth control over its expenditure. These arrangements may require further review and reform in the interest of correcting the vertical fiscal imbalance and ensuring greater financial accountability to taxpayers.

Is there a need for a referendum to lock-in the procedure for participation of the States in varying the rate of GST?

The Explanatory Memorandum to the Bill, as indicated earlier, states that the provisions in Part 2 of the Bill are designed to 'lock-in' the GST rate and base, with the objective of addressing community concerns that the Commonwealth could unilaterally increase GST revenues in the future by increasing the GST rate and base.(40) There are doubts whether Part 2 is constitutional in that the States may have been given the power to veto Commonwealth legislation varying the rate of GST in contravention of section 1 of the Constitution. This section vests the legislative power of the Commonwealth in a Federal Parliament consisting of the Queen, a Senate, and a House of Representatives called the Parliament of the Commonwealth. If the States are to have a role as envisaged in Part 2 in the law making process of the Federal Parliament it may be necessary to amend the Constitution following the referendum procedure set out in section 128 of the Constitution. As the States are assured of all the GST revenue and any increase in the rate of GST will accrue to their benefit any constitutional change that approves of the procedure in Part 2 of the Bill would offer little assurance to the community that the GST rate has been effectively locked-in. If a role for the States is considered necessary the approval of all the State Parliaments, rather than the Executive Governments of the States, would assist in improving the fiscal responsibility of the States who will then share accountability for the expenditure of GST revenues which they have sanctioned together with the Commonwealth Parliament. This procedure too will require approval at a referendum.

Will the interest of fiscal responsibility of the States be better served by amendments to the Constitution to boost the taxation power of the States and redefine the grants power of the Commonwealth?

One option to redress the fiscal imbalance in the Federation might be a referendum to redistribute the power to raise revenue between the Commonwealth and the States. As mentioned earlier the High Court decision in Ha and Hammond v NSW has enhanced the Commonwealth's power to raise duties of excise at the expense of the States. The High Court in that case as well as in Capital Duplicators(41) did not find it necessary to decide the question whether a consumption tax was an excise. There are doubts whether the GST which is imposed on imports and at various stages of supplies until final consumption of goods is in fact an excise at all stages of its imposition. Section 90 which gives the Commonwealth its exclusive power to impose excise duties would not cover services and the GST on services would not be an excise. The Imposition Acts accept this uncertainty and impose the GST as a tax, excise and customs duty in three separate Acts.

An amendment to section 90 to remove these uncertainties may demarcate the Commonwealth and State areas of consumption taxation. The interest of fiscal responsibility requires the Parliament that raises revenue be accountable for its expenditure and vice versa. A clearer demarcation of the indirect taxation areas might assist in increasing Commonwealth and State Parliamentary accountability for revenue raised by respective Parliaments.

The need for reform of the grants power has also been highlighted in judicial dicta as well as by some commentators. Thus in the Second Uniform Tax Case Dixon CJ indicated that if the course of prior judicial decision had not given the Commonwealth the unlimited power to make grants on its terms, there was support to confine it to certain restricted situations where assistance was required by the States. His Honour stated:

It is appropriate that when redefining the taxation powers the amendment of the grants power on the above lines should be considered.

 

Endnotes

2. Agreement on Principles for the Reform of Commonwealth-State Financial Relations of 13 November 1998; pp.2-3.

3. A list of the Bills is set out below:

   • A New Tax System (Aged Care Compensation Measures Legislation Amendment) Bill 1998,
   • A New Tax System (Australian Business Number Consequential Amendments) Bill 1998,
   • A New Tax System (Australian Business Number) Bill 1998,
   • A New Tax System (Bonuses for Older Australians) Bill 1998,
   • A New Tax System (Commonwealth-State Financial Arrangements) Bill 1999,
   • A New Tax System (Commonwealth-State Financial Arrangements- Consequential Provisions) Bill 1999,
   • A New Tax System (Compensation Measures Legislation Amendment) Bill 1998,
   • A New Tax System (End of Sales Tax) Bill 1998,
   • A New Tax System (Family Assistance) (Consequential and Related Measures) Bill (No. 1) 1999,
   • A New Tax System (Family Assistance) Bill 1999,
   • A New Tax System (Fringe Benefits Reporting) Bill 1998,
   • A New Tax System (Goods and Services Tax Administration) Bill 1998,
   • A New Tax System (Goods and Services Tax Imposition-Customs) Bill 1998,
   • A New Tax System (Goods and Services Tax Imposition-Excise) Bill 1998,
   • A New Tax System (Goods and Services Tax Imposition-General) Bill 1998,
   • A New Tax System (Goods and Services Tax Transition) Bill 1998,
   • A New Tax System (Goods and Services Tax) Bill 1998,
   • A New Tax System (Income Tax Laws Amendment) Bill 1998,
   • A New Tax System (Indirect Tax Administration) Bill 1999,
   • A New Tax System (Luxury Car Tax Imposition-Customs) Bill 1999,
   • A New Tax System (Luxury Car Tax Imposition-Excise) Bill 1999,
   • A New Tax System (Luxury Car Tax Imposition-General) Bill 1999,
   • A New Tax System (Luxury Car Tax) Bill 1999,
   • A New Tax System (Medicare Levy Surcharge-Fringe Benefits) Bill 1998,
   • A New Tax System (Personal Income Tax Cuts) Bill 1998,
   • A New Tax System (Trade Practices Amendment) Bill 1998,
   • A New Tax System (Wine Equalisation Tax and Luxury Car Tax Transition) Bill 1999,
   • A New Tax System (Wine Equalisation Tax Imposition-Customs) Bill 1999,
   • A New Tax System (Wine Equalisation Tax Imposition-Excise) Bill 1999,
   • A New Tax System (Wine Equalisation Tax Imposition-General) Bill 1999,
   • A New Tax System (Wine Equalisation Tax) Bill 1999.

4. Circulated by the Hon. Peter Costello MP, Treasurer of the Commonwealth of Australia (AGPS) August 1998.

5. Hansard, House of Representatives, 2 December 1998, p. 1087.

6. Hansard, House of Representatives, 3 December 1998, p. 1343.

7. Explanatory Memorandum to the A New Tax System (Commonwealth-State Financial Arrangements) Bill 1999; paragraph 2.4; p. 5.

8. Ibid., paragraph 2.2; p. 5.

9. Lane's Commentary on The Australian Constitution (Second Edition); p. 398.

10. 36 CLR 20, 25-26.

11. Explanatory Memorandum to the A New Tax System (Commonwealth-State Financial Arrangements) Bill 1999; paragraph 2.4; p. 5.

12. Lane's Commentary on The Australian Constitution (Second Edition); p. 767

13. 176 CLR 1 at pp. 74-75 where a 1992 Commonwealth Act pre-empted a 1986 Commonwealth Act.

14. Research Note on Locking in the Rate of GST by George Williams (9 February 1999); p. 2

15. Lane's Commentary on The Australian Constitution (Second Edition); p. 767.

16. Research Note on Locking in the Rate of GST by George Williams (9 February 1999); p. 2

17. (1980) 11Federal Law Review 167 at p. 192.

18. Explanatory Memorandum to the A New Tax System (Goods and Services Tax) Bill 1998; p. 6

19. A "derivative" is a financial claim which is derived from a physical or real asset.

20. For a history of Commonwealth assistance, see Department of the Parliamentary Library, Commonwealth Assistance to the States since 1976, Background Paper No. 5, 1997-98.

21. Details of assistance to the States can be found in Budget Paper No. 3.

22. See the Prime Minister's press release of 13 November 1998.

23. Commonwealth Grants Commission, Report of General Revenue Grant Relativities 1999, Volume 1, Main Report, page x.

24. The States will also compensate the Commonwealth for the costs of administering the GST; fund and administer a First Home Owners Scheme under which first home owners will be paid $7000; and retain some residual responsibilities for providing rebates to users of diesel for off-road purposes (the extent of these responsibilities is not yet clear).

25. The States are to abolish 'bed taxes', financial institutions duty, and debits taxes, and to remove stamp duty from: marketable securities; credit arrangements, instalment purchase agreements and rental (hiring) arrangements; leases; mortgages, debentures and other loan securities; cheques, bills of exchange and promissory notes; and business conveyances (other than on real property). The States will also reduce gambling taxes

26. Productivity Commission, Directions For State Tax Reform, June 1998.

27. The reader is referred to Bills Digest No. 23 of 1997-98 for further background information on the background to the Franchise Fees Windfall Tax (Collection) Act 1997.

28. 189 CLR 465

29. 104 CLR 529

30. 189 CLR 465 at p. 499.

31. Ibid.,

32. The impact of this decision on the revenue raising ability of the States and Territories is treated in detail in two IRS publications:

    • 'What is an excise duty? Ha and Hammond v NSW', Research Note, Number 1, August 1997; and
    • 'Federalism Up in Smoke? The High Court Decision on State Tobacco Tax', Current Issues Brief, No.1, 1997-98.

33. The Constitution of the Commonwealth of Australia (Annotated); Fifth Edition; R D Lumb and G A Moens; pp. 483- 484.

34. 65 CLR 373.

35. Ibid., p. 417

36. 99 CLR575

37. 65 CLR 373 at p. 416.

38. Towards A Theory for Section 96; Cheryl Saunders; Melbourne University Law Review Vol. 16(1) 1987; pp 1-31 and Vol 16(2) (1988); pp 699-724.

39. Ibid., p. 711

40. Current Issues Brief No. 1 1997-98; Department of the Parliamentary Library; p. ii.

41. Explanatory Memorandum to the A New Tax System (Commonwealth-State Financial Arrangements) Bill 1999; paragraph 2.4; p. 5.

42. Capital Duplicators Pty Ltd v Australian Capital Territory [No 2] (1993) 178 CLR 561

43. 99 CLR 575 at p. 609.

Go to Attachment A: 'Locking in the GST Rate'

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