Taxation issues and related matters
There were a number of issues raised during the inquiry relating to
current taxation arrangements that restrict competition in the banking industry
and possible changes to taxation arrangements that could promote greater
competition. These include interest withholding tax, tax concessions on
interest from household saving, GST input taxing, franking credits, debt
write-offs, the Libor cap, Retirement Savings Accounts, First Home Saver
Accounts and proposals to increase taxes on banking.
Interest withholding tax
Interest withholding tax (IWT) is levied on interest paid to a
ING Bank regard IWT as one of the four key barriers to competition.
It is of relevance to foreign bank subsidiaries (but not branches). Its
abolition was recommended by the Henry Tax Review and the Johnson report.
The Government announced changes to IWT in the 2010-11 Budget:
The tax on borrowings by local financial intermediaries from
their overseas parents will drop, from 10 per cent to 7.5 percent from 1 July
2013 and to 5 per cent from 1 July 2014;
The tax on borrowings by any Australian branch of a foreign bank
from its overseas head office will drop from 5 per cent to 2.5 per cent from 1
July 2013 and then be abolished from 1 July 2014; and
The tax applying to any financial institution that borrows from offshore
retail deposits which they on-lend in Australia will be cut from 10 per cent to
7.5 per cent from 1 July 2013 and then to 5 per cent from 1 July 2014.
Treasury explained the justification:
The benefits of the phase down are that it will: help support
banking competition; reduce the extent to which financial institutions make
funding choices based on tax rather than commercial considerations; and further
develop Australia as a regional financial centre.
ING Bank believe IWT should be cut further:
In Australia, we have nearly twice as much in loans as we do
in savings. That is pretty consistent for the Australian industry...Elsewhere
there is typically an excess of savings over loans. Most European countries and
the North American countries have an excess of savings over loans. What we as a
group would like to be able to do is take some of that excess and bring it to
Australia and put it into Australian mortgages, because across the world
Australian mortgages are now recognised as a very attractive investment...For our
whole group, that makes a lot of sense because we are not going out to the
markets and borrowing money to fund mortgages; we are taking it from related
companies. It makes a lot of sense for the bank here in Australia and it means
that, in the end, we will fund more Australian mortgages. What stops us from
doing that is interest withholding tax.
The Australian Bankers' Association claim that:
...these reforms [abolishing IWT] would promote more efficient
capital flows, cheaper cost of funds, greater diversification of funding
sources for Australia’s banks (not just Australian major banks, but potentially
Australian regional banks) and provide potential benefits for bank liquidity
and lower interest rates for Australian borrowers.... It should be noted that the
Government will broadly recoup lost IWT revenue from increased company tax
earnings. The ABA notes that this reform provides opportunities for banks to
diversify their funding sources, contribute to more efficient global capital
flows and promote Australia as a financial services centre, especially in the
Asked about the cost involved, Treasury replied:
If IWT for financial institutions were to be removed with
effect from 1 July 2011 (apart from IWT on non-resident retail deposits), it
would result in an additional cost to revenue in the order of $750 million over
the forward estimates.
The Committee agrees with Treasury's argument for reducing IWT. The same
reasoning, however, argues that rather than just phasing it down, it would be
better to abolish it immediately. Treasury's estimates of the first round cost
overstate the ultimate cost as the reform generates increased trading and
employment in the finance sector and these costs should be outweighed by the
benefits to other sectors from greater competition and narrower interest
The Committee recommends that interest withholding tax be abolished as
budgetary circumstances permit to increase the ability of foreign banks to
compete in the Australian market.
Tax concessions on deposit interest income
The Henry Review found that real returns on ADI deposit accounts were
subject to high rates of marginal tax:
Interest has the least favourable tax treatment. The entire
return, including inflationary gains, is included annually in taxable income,
generating an effective marginal tax rate on the real return greater than the
statutory marginal personal tax rate.
The Government announced in the 2010-11 Budget a 50 per cent tax
discount on up to $1,000 of interest earned by individuals, to commence on 1
July 2011. The measure was later delayed to July 2012 and the cap lowered to
$500 for the first year.
The banks do not regard this as going far enough:
While this reform will address some of the tax anomalies
between interest bearing investments and other investments or asset classes
(including shares, managed investments, property), it has been proposed in a
manner that only applies in a limited way. In the absence of further reform,
this is unlikely to provide tax incentives adequate enough to significantly
influence consumers’ savings and investment decisions, and therefore is
unlikely to substantially shift the pool of domestic savings towards interest
...there are also some other opportunities to support
competition through taxation reform to increase or eliminate the cap on
concessional taxation treatment for bank deposits—where, currently, above the
cap, depositors pay tax on the inflation component of their return...
Taking an illustrative interest rate of 5 per cent, a depositor would
need a deposit of $20,000 to gain the full benefit from the concession. Only
about a tenth of household deposits are held in amounts of over $20,000.
The banks called for the concession to be brought forward and/or the cap
...by accelerating the introduction of the tax discount and
removing the proposed $20,000 threshold for individuals to receive a 50% tax
discount, this reform would address the imbalances within the current tax
arrangements for deposits and provide an incentive for individuals to increase
their savings using deposit accounts.
...we recommend that the Government reconsider its decision to
delay the implementation of this tax concession on savings.
The Committee notes with approval that households have been saving more
in recent years. This prudence should be encouraged. As well as giving
households healthier balance sheets, encouraging savings in bank deposits would
provide a more stable source of funds for banks and reduce their reliance on
The Committee notes the Henry Review's conclusions about the high
marginal tax rates on the real return on bank deposits which makes it harder
for ADIs to compete for household savings. The tax concessions for bank
deposits are a step in the right direction but do not go far enough.
The Committee recommends the taxation arrangements applied to bank
deposits and mutual ADI deposits should be reviewed by the inquiry into the
GST input taxing
GST input taxing refers to situations where there is no tax payable on
the supply of input-taxed goods, but the tax previously paid in the supply
chain is not refunded.
The Henry Review observed that GST 'input taxation' of financial
services advantages larger, vertically integrated companies. Many small credit
unions rely on the industry body to provide services such as government and
regulator relations, media representation, regulatory compliance systems and
support, legal advice, business advisory services, research and market
intelligence and systems to fight fraud and financial crime.
Abacus claim that:
Credit unions and building societies rely on outsourcing to
obtain economies of scale and therefore carry a heavier GST burden than the
This problem has been partly addressed by GST reduced input tax credits,
but these refer only to credit unions not to mutual building societies.
The Committee notes the concerns raised that the GST input taxing
arrangements disadvantage mutual ADIs. It did not receive sufficient evidence
to come to a definitive conclusion on this matter.
The Committee recommends that the Government require Treasury to
review the GST input tax arrangements for mutual financial intermediaries
having regard to the comments in the Henry Tax Review.
Franking credits arose from the introduction of dividend imputation.
They are an 'organisation's share of tax paid by a company on the profits from
which the organisation's dividends or distributions are paid'.
Abacus note that while banks make a return to their shareholders in the
form of dividends, mutuals make a return to their 'shareholders' (who are also
their customers) in the form of lower loan interest rates, higher rates on
deposits, low or no fees and better service. This places them at a competitive
disadvantage in being unable to make use of franking credits:
Mutual ADIs pay company tax just like listed banks but
mutuals do not have the same capacity to distribute franking credits.
One building society added that the stockpile of unusable franking
credits could make it more vulnerable to takeover:
These accumulated franking credits could be used against a
mutual ADI in the event of a predatory takeover attempt by a listed entity.
Such a predator could offer to pay a dividend that incorporates Heritage’s
accumulated franking credits as an incentive to encourage members to accept
their unsolicited offer of acquisition. In real terms this enables a predator
to use the funds of members to help finance an attempted takeover.
Abacus go on to suggest Treasury explore some way of allowing mutuals to
distribute a kind of franking credit.
An alternative is to:
...lower the amount of tax customer-owned financial
institutions are required to pay by the equivalent amount of the franking
Asked about Abacus' comment, Treasury replied:
Credit unions and mutual building societies that pay company
tax and distribute profits to members can choose to have the same access to
franking credits as other taxpayers (including banks). Credit unions and
building societies that are liable to pay company tax are taxed as co-operative
companies. The income tax law was amended in 2003...to make it easier for
co-operative companies that distribute profits to members to frank those distributions.
As a result of those amendments, co-operative companies can choose to frank
distributions to members. Alternatively, they can make unfranked distributions
and obtain a deduction for amounts distributed to members. The effect of these
changes was to give co‑operative companies that distribute profits to
members the same access to franking credits as other companies (including
banks), while maintaining the long standing benefit of a deduction for
unfranked dividends. Where profits are not distributed to members due to legal,
practical or other reasons franking credits are retained in the co-operative.
If these franking credits were to be distributed to members (in the absence of
a dividend), co‑operative companies would obtain an advantage over other
All credit unions and building societies, except for a
handful of very small credit unions, are liable to pay company tax but Abacus
is unaware of any credit unions or building societies that are taxed as
co-operative companies. It is the case that credit unions and building
societies may be able to elect, from year to year, to be taxed as co-operative
companies, but to do so they would have to satisfy certain criteria. The fact
that most, if not all, credit unions and building societies do not elect to be
taxed as cooperative companies indicates there are significant barriers to
doing so. Despite paying company tax like our listed bank competitors, credit
unions and building societies are unable to provide franked returns to their
owners. For example, should a mutual choose to pay a cash dividend, the level
and type of dividend is tightly constrained by ASIC Regulatory Guide 147. The
result is that credit unions and building societies continue to accumulate
franking credits but cannot pass on the benefits.
The Committee agrees with the mutual ADIs that they are being
disadvantaged by the current arrangements governing franking credits.
The Committee recommends that the Government require Treasury to review
the treatment of building societies and credit unions in the franking credit
arrangements and report publicly on the advantages and disadvantages of various
A foreign bank drew attention to the foreign bank branch rules of the Income
Tax Assessment Act 1936, under which the tax deductibility of interest paid
by a branch on borrowings from its parent is limited to the London Interbank
Offered Rates (LIBOR). When funds are provided at a rate in excess of the
applicable LIBOR rate, the excess is denied a tax deduction:
In response to the GFC, banks have been had to seek longer
term funding (3 years or longer) throughout the last few years. This will
continue into the future as a consequence of current requirements by APRA as
well as their intended future adoption of the recently published Basel
liquidity pronouncements. LIBOR does not prescribe any rates for lending terms
of greater than 12 months. Hence, the tax deductibility of borrowing costs of
longer than 12 months is artificially capped at the LIBOR 12 month rate.
The ABA also supported this:
...removing the LIBOR cap on deductibility of interest paid on
branch/head office (which includes branch-branch) funding, this reform will
address tax constraints related to offshore borrowings. Under the foreign bank
branch rules of the income tax law, deductibility for interest paid by the
Australian branches of foreign banks on funds borrowed from their offshore
branches/head office is limited to the London Interbank Offered Rate (LIBOR).
Funds provided at a rate above LIBOR are denied a deduction for those amounts.
During the GFC, the difference between LIBOR and commercial rates significantly
widened. This reform would ensure that banks operating in Australia have access
to alternative funding sources at competitive rates.
Both the Johnson Report and the Henry Review recommended the abolition
of this cap.
The Committee recommends that the Government require Treasury to review
the abolition of the LIBOR cap to the tax deductibility of interest paid by a foreign
bank branch on borrowings from its parent bank.
Retirement Savings Accounts
Retirement Savings Accounts (RSAs) are a capital guaranteed product
offered by licensed ADIs, life insurance companies and prescribed financial
institutions for retirement savings as a low risk/low income accumulation
The Cooper Superannuation Review recommended they be phased out:
RSAs have generally not been a success because they are a
capital guaranteed product and there is currently no scope in the RSA framework
for adding a market‐linked investment where the risk
of loss is borne by the holder. RSAs are thus suitable only for individuals
with an extremely low risk tolerance, and are essentially unsuitable for much
of the accumulation phase of retirement saving.
Abacus takes issue with the Cooper Review's opinion that RSAs 'seem not
to meet the low-cost objective for which they were originally intended':
...in fact credit union RSAs are very low cost, with very few
fees and very low fees.
Abacus argue that with only one bank having shown interest in providing
RSAs, it is an area where mutuals are filling a gap in the market and promoting
The Committee supports the retention of retirement savings accounts.
They offer mutual ADIs a useful avenue for competing with the banks.
First Home Saver Accounts
First Home Saver Accounts (FHSAs) were established in 2008 to assist first
home buyers save a deposit. An individual who makes a contribution of $5,500 to
their FHSA will be eligible for a Government contribution of $935 and FHSA
earnings are taxed at a concessional 15 per cent.
The Government estimated in 2008 that by 2012 they would hold savings of
$6,500 million, but by mid-2010 there was only $114 million in 22,600 accounts.
Only 19 ADIs offer the accounts.
It is generally thought that the reason they have not become more popular is
that they require savings to be locked up for four years.
Abacus suggest means by which competition in this part of the deposit
market could be invigorated:
We have no doubt that the key problem with FHSAs is the
four-year minimum qualifying period. The most consistent issue that appears in
feedback to Abacus from credit unions and building societies about FHSAs is
that the four-year ‘lock-up’ requirement is too long and is the single most
important disincentive for savers. Abacus recommends removal or reduction of
the period of time during which savings in FHSAs can’t be withdrawn. The
Government contribution is incentive enough to ensure that savers contribute
over a number of years. A minimum period is an unnecessary disincentive and
penalises savers who have the opportunity to buy a house within the ‘lock-up’
Given the purpose of the First Home Saver Accounts scheme, the Committee
regards it as appropriate for the savings to be locked up for four years.
The Committee recommends that the Government require Treasury to review
the operation of the First Home Savers Accounts scheme and report publicly on
the advantages and disadvantages of various options.
Increasing taxation on banking
As noted above, it is at least arguable that banks make larger profits
because of their market power and implicit or explicit government backing. This
has therefore led to calls for higher taxes to capture more of the excess
profits for the people:
...if the parliament is unable or unwilling to regulate to
drive either actual competitive outcomes or price restrictions, we should
consider a super profits tax on banks. We have just surveyed the public about
the upcoming tax summit next year, and 81 per cent of Australians support the
tax summit considering the introduction of a super profits tax on banks.
...banks make enormous profits not necessarily because they are
particularly good at what they do but because they have the privilege of owning
a bank license, have a large customer base and so have access to the clearing
system and the cheap funds as part of their role in the payments system.
... implicit Social Licence to operate as facilitators of
transactions, deposits and lending, should not be provided for free. The major
Banks can rely on support from the Government, including from a regulatory and
funding point of view...the implicit Social Licence held by the Major Banks
[should] be made explicit in a fee calculated as a percentage on assets (ie.
Loan portfolio), and paid by the Major Banks to the Government...a reasonable
level would be one (1) basis point, payable per annum on total assets, by
profitable Major Banks. For the Banks that are most profitable, measured in
terms of return on equity, a higher rate should apply.
Professor Buckley argues that the taxpayer should be compensated for the
support to banks that will not be allowed to fail:
Yet if Australian taxpayers are, in effect, standing behind
our banks, and the banks’ credibility in the marketplace is thereby
strengthened and their cost of funds correspondingly reduced (for which there
is considerable evidence), there is a very strong equity argument for a levy on
Other submitters opposed this suggestion:
Banks are not analogous to mining companies – they are not
depleting non‑renewable resources and should not have a super profits tax
imposed on them.
The fact that banks make large profits is another charge made
against them, but the question is, ‘Are these what are called “super profits”?’
This term was introduced in the discussion of the resources rental tax. Super
profits are profits above those necessary to keep the shareholders happy.
Economists also call super profits ‘rent’. Unfortunately, too many commentators
assume that any profits at all are super profits and should be taxed away,
taken away or regulated away.
The Committee notes that banks pay large amounts of company tax, which
rises as their profits increase. It does not support calls for increased
taxation on banks. Rather it wishes, through the earlier recommendations in
this report, to increase the amount of competition in banking which will drive
down bank profits to a normal level commensurate with their size and the
riskiness of their activities.
Senator David Bushby Senator
Chair, Banking Competition Sub-Committee
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