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Australia’s investment challenge in wake of 2018 US tax reform

Philip Bazel and Jack Mintz

A policy paper commissioned by the Minerals Council of Australia MARCH 2018

Australia’s investment challenge in wake of 2018 US tax reform

Philip Bazel is a Research Associate at the School of Public Policy, University of Calgary. Mr Bazel has also played a role in a number of projects consulting for both governments and private organisations in the area of taxation and public finance.

Jack Mintz is the President’s Fellow at the University of Calgary’s School of Public Policy focusing on tax, urban and financial market regulatory policy programs. Dr Mintz was appointed the Palmer Chair and founding Director of the School of Public Policy from 1 January 2008 to 30 June 2015. He was recently awarded the Order of Canada for his fiscal advice given to governments internationally and at home. This includes leading a study of corporate tax reform in Canada as Chair of the Federal Government’s Technical Committee on Business Taxation in 1996 and 1997.

The Minerals Council of Australia is the peak national body representing Australia’s exploration, mining and minerals processing industry, nationally and internationally, in its contribution to sustainable economic and social development.

This publication is part of the overall program of the MCA, as endorsed by its Board of Directors, but does not necessarily reflect the views of individual members of the Board.

Minerals Council of AustraliaLevel 3, 44 Sydney Ave, Forrest ACT 2603 (PO Box 4497, Kingston ACT Australia 2604)P. + 61 2 6233 0600 | F. + 61 2 6233 0699 www.minerals.org.au | [email protected]

Copyright © 2018 Minerals Council of Australia. All rights reserved. Apart from any use permitted under the Copyright Act 1968 and subsequent amendments, no part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the publisher and copyright holders.

Contents

Executive summary 4

1 Why Australia needs company tax reform 6

2 Australia’s investment climate and how taxes play a role 9

3 How does Australia rank? 13

4 What is happening elsewhere? 18

Conclusion 22

Data appendix 24

Endnotes 25

Charts and tables

Chart 1 Foreign direct inflows and private capital formation as share of GDP 9Chart 2 Resource, manufacturing and service sector investment as a share of GDP 10Chart 3 Australia’s private investment as share of GDP compared to selected OECD countries 10Chart 4 Foreign direct investment inflows as share of private capital formation 11Chart 5 Australia’s METR relative to country groupings 13Chart 6 Marginal effective tax rates by country 14Chart 7 Central and sub-national statutory company income tax rates by country 16Chart 8 Decomposition of METR by country 17

Table 1 METRs in Australia for company tax reductions 8Table 2 METRs and country data 24

Box 1 United States tax reform 20

4 Minerals Council of Australia

Given the size of the United States’ economy – roughly one-fifth of world GDP – US tax reform has an enormous effect on worldwide company decisions and tax policy reforms by individual countries.

Executive summary

US tax reform will not only have implications for Australia’s ability to compete for multinational investment, but the positive flow-on effects of investment: technology, jobs and tax revenues.

As we stated in last year’s 2017 report on the prospects for US tax reform at that time:

US tax reform would dramatically result in Australia having a much higher tax burden on investment compared to the United States, a reversal of the past two decades. It will be a policy development of significant importance to those countries that are trading partners with the United States.1

Contrary to many predictions, the US government adopted as of 1 January 2018 its first major tax reform since 1986.2 While personal tax rates have been reduced, it is business tax reforms that were most innovative.

For decades, most companies with US operations would try to keep profits out of and costs in the United States to reduce worldwide taxes. Following the 1 January 2018 tax reforms, companies with US operations are re-evaluating supply chains, investment plans and financing with the aim to shift investment and profits to the US and interest expenses and general administrative expenses to affiliates in other countries.

This shift in strategic planning is due to five major provisions in the US reforms:

• A 14-point reduction in the federal company income tax rate to 21 per cent as well as the elimination of the minimum company tax rate

•The adoption of a dividend exemption system similar to Australia for foreign source income, enabling US parents to bring money home

•The expensing of investments in machinery just at the time that companies are looking to adopt new technologies such as digitisation, artificial intelligence, robotics and big data

• Various tightening provisions especially with respect to interest deductions and losses

• Incentives to hold intangible income in the US rather than other countries (e.g. intellectual property, marketing and mining intangible income).

Overall, the US is reducing its company income tax rate (including GDP-weighted state income taxes) from 39.2 to 26.6 per cent. Its effective tax rate on capital is dramatically declining from 34.6 to 18.9 per cent (with state income taxes likely to be reformed in the coming year). The US is now much more tax-attractive for investment, encouraging companies to re-evaluate their global and regional supply chains.

5Australia’s investment challenge in wake of 2018 US tax reform

These changes will prompt other countries, especially those most exposed to US trade and investment, to respond with their own tax reforms in the coming year as they did in 1986. While 2017 was a relatively quiet year, France and Belgium announced late in the year major company income tax reforms that would stage company tax rate reductions in the next several years. India reformed its VAT to eliminate most sales taxes on capital and intermediate inputs. Most other tax changes were of a technical nature. This will change in 2018 as many countries are already looking to reform their business taxes to make them more competitive.

Australia should not be left out in the cold. At this point, Australia is ill-prepared to deal with the global implications of the US tax reform. Its company income tax rate at 30 per cent has been unchanged for almost two decades and is now 9th highest of 43 countries surveyed in this report (4th highest of 34 OECD countries, tied with Mexico).

Its company income tax rate is 3.3 points higher than the US and is also higher than the weighted average company tax rates for the G7, G20 and OECD countries by wide margins.

With planned reforms in France and Belgium, Australia will have the second highest company income tax rate by 2020 among OECD countries.

Taking into account company income taxes (rates and cost provisions), stamp duties and other capital-related taxes, Australia’s marginal effective tax rate (METR) – the effective tax burden on new investments – is 28.4 per cent, now almost ten points higher than in the United States.

It is 7th highest of 43 countries and 4th highest of OECD countries. While mining effective tax rates will be updated at a later time, our analysis

has suggested that Australia taxes mining more heavily than other comparable countries.

If Australia were doing well with private investment, perhaps its tax disadvantage would not be much of a concern. However, private capital formation as a share of GDP has been declining since 2015, in part reflecting the commodity market downturn.

Australia has been especially weak in attracting manufacturing and service investment, making this study’s estimated tax burdens on capital particularly relevant. For this reason, we examine a few potential reforms that could be considered by Australia that would improve both growth and competitiveness.

Company tax reform has been debated in Australia for many years, especially since the 2009 Henry Report which concluded that the company income tax rate should be reduced from 30 to 25 per cent.3 Various arguments have been made in opposition to company income tax reform, some of which are debatable if not outright wrong. These shall be discussed later in the report.

This report begins with a discussion of why Australia needs company tax reform, the investment climate in Australia and the extent to which taxation affects investment decisions. We then provide a comparison of Australia’s tax burden on investment compared to other countries. This is followed by a discussion of implications of US tax reform for policy reforms. The analysis concludes with a discussion of potential reforms.

With planned reforms in France and Belgium, Australia will have the second highest company

income tax rates by 2020.


1Why Australia needs company tax reform

The benefits of a more tax-attractive investment climate

Economic growth enables people to earn more income and reduces the incidence of job losses. The public also benefits from stronger growth as governments have better fiscal capacity and can rely less on debt finance to fund public services.

Economic growth depends on a variety of factors of which tax policy is one. When governments particularly rely on distortive taxation, it makes it harder to achieve growth. For Australia, several reasons can be invoked in favour of a reduction in company tax.

Economic cost of business taxes

Company income taxes are especially harmful to the economy since they discourage private sector investment that is crucial to growth. Company income taxation tends to distort the allocation of capital across industries and assets and result in loss of tax revenues as companies shift profits to other jurisdictions even if they do not change location decisions for investment.

The highest economic cost of taxation is associated with company income taxation as shown by most international studies including a comprehensive one published by Treasury in Australia.4 The Treasury study showed that each dollar of company income tax raised results in an additional economic cost of 50 cents, making the total incremental cost $1.50 for raising a dollar of revenue – the second-highest of all taxes. In comparison, consistent with international studies, a consumption tax like the GST is much less distortive with an incremental economic cost of $1.19 cents, while municipal property taxes have the least cost.

Stamp duties or transfer taxes, especially on commercial property, also impose high economic costs on an economy by increasing the cost of supplying infrastructure, housing and other urban projects.5 The Treasury study quoted above estimates the incremental cost of raising one dollar of stamp duties to be $1.72 cents, the highest of all taxes. Stamp duties encourage a lock-in effect whereby owners are less willing to sell their property to avoid triggering additional transfer taxes. Moreover, transfer taxes on the resale of commercial property are highly distortionary since it is not easy to identify a change in ownership given the joint ownership of property through corporations, trusts and partnerships and the ability of companies to avoid the tax altogether.

Income gain to workers

Not only is it better to rely less on distortive taxes, but workers could also benefit through higher incomes. People, not companies, bear the burden of the taxes paid by companies. Any taxes on large businesses in a small open economy like Australia will result in higher prices on consumer goods and/or lower real wages paid to workers and rents to landowners, generally contributing to a less progressive tax structure.

Therefore, lower company taxes allow higher compensation paid to workers and lower prices for consumer goods, both of which directly contribute to a higher living standard. Reducing the tax cost to business will help increase the nation’s well-being in the long run. A recent Canadian study has shown that company income taxes are largely borne by labour.6

It is sometimes argued that company income tax reductions, whether through rate reductions or capital incentives, favour investors in oligopolistic industries that earn profits in excess of competitive rates of return.


This argument is incorrect for two reasons. It first presumes that the company income tax falls primarily on investors and not consumers or workers. Yet theory suggests that the incidence of a business tax in imperfectly competitive markets cannot be predicted with the possibility of the tax being fully shifted forward to consumers anyway.

Second, the best instrument to reduce oligopolistic behaviour is competition policy, not taxation. In fact, a company tax can aggravate the loss to consumers from oligopolistic behaviour by reducing output and thereby forcing consumer prices up further than warranted.

Australia and its trading partners will be responding to US tax reform

Many US trading partners will need to respond to the US tax reforms in some fashion. Countries should be concerned with their ability to compete for private investment, which is critical to economic growth.

They will also worry about a loss in company income tax revenues due to potential losses in investment and base erosion, since many companies with US operations will shift costs out of the US to affiliates in other countries.

Australia could consider three types of company income tax reforms. First, it could reduce company income tax rates by 5 points as proposed by the government. Second, it could adopt temporary incentives for investment in certain types of capital such as machinery as in the United States with some limits on interest deductibility. Third, it could adopt some base-broadening policies to further protect the Australian tax base from erosion, although Australia already has rules limiting interest deductions for outbound and inbound investments and a neutral treatment of costs at the business level.

Lower company taxes allow higher compensation paid to workers and lower prices for consumer goods, both of which directly contribute to a higher living standard.


To examine the impact of taxation arrangements on business investment, we calculate business taxes as a share of the pre-tax income for marginal projects: the marginal effective tax rate (METR). Marginal projects are particularly relevant in determining how tax arrangements affect business investment decisions. Our calculations of METRs include company income taxes at national and sub-national government levels (both tax rates and provisions related to income and costs) along with a range of capital, asset-based and transfer taxes.

This analysis shows Australia’s METR in 2018 stands at 28.4 per cent – higher than the average METR across the G7, G20 and OECD groupings of economies. Australia’s tax competitiveness has deteriorated since 2010 when its METR was in line with those of large advanced economies (see pages 13-17 below).

We estimate the impact of reducing the company income tax rate by 5 points and expensing of machinery investments (100 per cent write-off) on marginal effective tax rates estimated in our model (Table 1), following the United States.7 A five-point reduction in the statutory rate to 25 per cent would result in a 4.1 point reduction in the marginal effective tax rate (METR) from 28.4 to 24.3 per cent and about the same for manufacturing and service sectors.

Expensing would be more dramatic, resulting in a further reduction in the METR by 12.8 percentage points to 11.5 per cent. Manufacturing would benefit more from expensing since machinery is intensively used in the sector, resulting an increase in the

dispersion of METRs between manufacturing and services from 0.3 to 1.6 percentage points.

The advantage of a company tax rate reduction is that it reduces economic costs by benefiting most the more heavily taxed assets and industries. A lower company income tax rate also counters base erosion, as companies will have less incentive to shift costs into Australia with a lower company income tax rate.

Capital expensing for machinery, especially with interest deductibility, is quite favourable to certain machinery-intensive sectors. It would encourage the early adoption of new technologies such as artificial intelligence and robotics. However, it would lead to more profitable companies paying no company income tax, thereby blunting the effectiveness of the incentive.

Unlike rate reductions, expensing does not counter potential base erosion, which will be more important to watch in the wake of US and trading partner tax reforms. Further, expensing creates a precedent whereby Australia in the past years has minimised tax preferences that favour some business activities over others – in other words, Australia has avoided picking winners over losers through the tax system, which itself improves productivity through better economic use of scarce capital resources.

Overall, a company income tax rate reduction should be a first priority as the best response to worldwide tax reforms in this coming year. Australia’s company income tax rate is now out of line with many countries and, being so high, will lead to increased base erosion in the wake of US tax reform.

Table 1 METRs in Australia for company tax reductions (%)

Overall Manufacturing Services Difference

Current system 28.4 28.6 28.3 0.3

25% tax rate 24.3 24.4 24.2 0.2

25% tax rate & machinery expensing 11.5 10.1 11.7 1.6

Source: School of Public Policy, University of Calgary


2Australia’s investment climate and how taxes play a role

In recent years, Australia’s investment climate has worsened somewhat, in part but not solely due to weakening commodity markets. Foreign direct investment that helps fund private investment has also been weak, raising competitive issues.

Australia’s weak investment performance

As shown in Chart 1, foreign direct investment inflows have slowed down since 2011, well before the commodity price bust, falling from 4.7 per cent to 3.5 per cent of GDP (with some improvement in 2016). Private capital formation peaked at a high of 23 per cent of GDP in 2013, falling to 21 per cent in 2016.

Breaking down private investment by sector

for 2005-15, it is clear that not only has resource investment declined but also manufacturing and service investment during the years 2005-15 (Chart 2). Manufacturing and services were almost 13 per cent of GDP in 2005, but have fallen below 10 per cent of GDP in 2015.

Resource investment ballooned during the heady years of 2007 to 2012, before declining thereafter to 7 per cent of GDP by 2015. On the other hand, manufacturing investment accounts for only 1 per cent of GDP, and service sector investments for 9 per cent of GDP.

Compared to other countries, Australia has benefited from large resource investments which account for 41 per cent of private investment during 2011-15 (Chart 3).

Chart 1 Foreign direct inflows and private capital formation as share of GDP 2008-2016

% GDP

25

20

15

10

5

0

Source: World Bank and Australian Bureau of Statistics

2008 2010 2012 20142009 2011 2013 2015 2016

GFCF private Foreign direct investment (net inflows)


Chart 2 Resource, manufacturing and service sector investments as a share of GDP 2005-2015

% GDP

20

18

16

14

12

10

8

6

4

2

0

Source: World Bank. Mining and quarrying includes oil and gas as well as minerals and quarrying sectors.

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Service sector Manufacturing Mining and quarrying

Chart 3 Australia’s private investment as share of GDP compared to selected OECD countries Averaged 2009-2015

% GDP

25

20

15

10

5

0

Source: World Bank

Service sector Manufacturing Mining and quarrying

Austra

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Czech

Rep

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Hungar

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Australia’s private investment is substantial at 17 per cent of GDP, which is less than France and Germany but more than Canada, the United Kingdom and the US.

However, excluding resource investments, Australian performance is weak with manufacturing and service investments only at 10 per cent of GDP – the third lowest of 19 countries (only Canada is lower).

Foreign direct investment plays an important role in financing Australia’s investment needs. During the period 2009-2015, foreign direct inflows were 11.3 per cent of private investment (Chart 4). Unsurprisingly, foreign direct investment is less prominent in Australia compared to small economies like Belgium, Estonia, Netherlands and Switzerland, which have used the tax system and financial regulations to attract financial and headquarter investments.

Australia is not as reliant on foreign direct investment inflows as resource-rich Chile, although it is more reliant than Canada.

How taxes influence investment

Several factors influence investment such as growth in demand for products: the business cycle, credit risk, regulations and – of interest to this study – taxation. While taxation is clearly not the only determinant of investment, it can make a difference in choosing projects.

Companies evaluate investment decisions according to whether they earn sufficient after-tax profits to cover their cost of capital. They also compare investment prospects across countries depending on after-tax profitability.

A company will choose to invest in those jurisdictions that provide the best after-tax returns. Taxes will play an important role, especially when jurisdictions are comparable in other factors such as political risk, infrastructure, cost of labour and growth prospects.

Compared to other OECD countries, Australia benefits from its rich resource endowments as well as its relatively close location to vibrant

Chart 4 Foreign direct investment inflows as share of private capital formation Averaged 2009-2015

%

40

35

30

25

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10

5

0

Austra

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Rep. o

f Kor

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Czech

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Portu

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Switzer

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Belgium

New Z

ealan

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SwedenIta

lyChil

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Icelan

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United

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Norway

Greec

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Turk

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Japan

Denm

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United

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Nethe

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Source: World Bank


Asian markets. Investment analysts would be hard-pressed to say Australia has significant advantages compared to other advanced countries in areas such as a skilled labour force, political risk and infrastructure.

Business taxation is a disadvantage for Australia, as shown below.

In this study, we measure the impact of taxation on new investment by calculating business taxes as a share of the pre-tax income for marginal projects: the marginal effective tax rate (METR).

As noted above, marginal projects are particularly relevant in determining how taxes affect investment decisions, since businesses invest in projects so long as they earn a return on capital that is sufficient to cover their total economic capital costs (depreciation, risk and financing) as well as taxes.

We include in our analysis central and sub-national company income taxes (rates and various provisions related to income and costs), sales taxes on capital purchases, asset-based taxes, stamp duties and other transfer taxes. The only levy not included in our analysis is municipal property taxes, since data are typically missing to estimate effective tax rates on real estate property, net of the value of municipal services.8

We have analysed the impact of our METR measures on manufacturing and service sector investments across OECD countries for the period 2005-15 and find that company taxes affect investment performance along with growth in demand, unemployment and credit risk.9

Other studies find that a 1 per cent increase in the METR-inclusive cost of capital causes investment to decline by 0.7 to 1.0 per cent.10 A survey on the relationship between taxes and foreign direct investment estimates that a one-point reduction in the company income tax rate results in an increase in foreign direct investment by 2.49 per cent.11

Those who argue that company taxation does not affect investment are simply wrong.

Those who argue company taxation does not affect investment are simply wrong. Company taxes affect investment performance along with growth in demand, unemployment and credit risk.


3How does Australia rank?

While Australia has stood still over the years, most countries on average have reduced company tax burdens on investment. In Chart 5, we compare Australia’s METR to the GDP-weighted and simple averages of various groupings of countries (G7, BRIC, G20 and OECD).

Australia’s METR in 2018 of 28.4 per cent is higher than G7, G20 and OECD averages, unlike 2010 when Australia was at least competitive against the average of large advanced economies.

Much of the change in the G7, G20 and OECD weighted averages is due to 2018 US tax reform that has resulted in a significant decline in the METR (see the Data Appendix for detailed METR calculations for manufacturing, services and the overall average by country).

Given the size of the US economy, it is not surprising that the G7 average has dropped dramatically to 25.5 per cent – more than three points below Australia.

Australia has the 7th highest tax burden on investment among 43 countries and 4th highest among OECD countries (Chart 6). Its METR is 9.5 points higher than that in the United States after that country’s tax reform. New Zealand is much more tax-competitive at a METR of 19.5 per cent compared to Australia.

In comparison to its Asian neighbours, Australia taxes investments more heavily than China (21.8 per cent) and Indonesia (21.9 per cent), although Australia remains competitive compared to India (50.2 per cent), Japan (39.5 per cent) and Korea (30.9 per cent).

Although it has a high tax burden on capital, India has sharply reduced its effective tax rate by almost 10 points with last year’s VAT reform that reduced sales tax on capital purchases (see Chart 6).

Chart 5 Australia’s METR relative to country groupings 2010 and 2018

%

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35

30

25

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15

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0Australia G7 w BRIC w G20 wG7* BRIC* G20* OECD* OECD w

Note: * signifies simple average and w signifies GDP-weighted averageSource: School of Public Policy, University of Calgary

28.328.431.0

26.6

34.5

25.5

39.6

34.733.1

29.0 28.9

26.1

32.6

25.9

19.318.2

30.4

23.7

2010 2018


Chart 6 Marginal effective tax rates by country 2018 and 2010

2018 2010

0 5 10 15 20 25 30 35 40 45 50 55 60 65

Source: School of Public Policy, University of Calgary.

India

Brazil

Japan

Belgium

France

South Korea

BRIC w

Australia

Russia

G20 w

Germany

G7 w

Colombia

Italy

Austria

Peru

United Kingdom

Indonesia

China

Norway

Canada

Netherlands

Portugal

New Zealand

Israel

Mexico

United States

Spain

Sweden

Luxembourg

Czech Republic

Denmark

South Africa

Slovak Republic

Ireland

Iceland

Greece

Hungary

Poland

Finland

Switzerland

Zambia

Estonia

Chile

Slovenia

Turkey

w = weighted average

%


Back in 2010, Australia was in a somewhat better position with a lower or similar tax burden on capital compared to large countries like India, France and Japan but also Russia, Germany, Spain and the United States (the US was 34.6 per cent in 2010).

On the other hand, Australia’s METR was substantially more than those of the Scandinavian economies, Canada, Mexico and many smaller economies.

The reason for Australia having a relatively high tax burden on investments is a result of its relatively high statutory company tax rate. Company income tax rates do not fully explain differences in tax burdens on investment by country: the correlation between our METR and company income tax rates is 47 per cent.

Still, the company income tax rate, including central and subnational rates, surtax rates and profit contribution rates play an important role in rankings. As shown in Chart 7, Australia’s company income tax rate is 9th highest of 43 countries and 4th highest of OECD countries, tied with Mexico. Given it is at the top of the ladder, Australia is more likely to attract costs resulting in base erosion due to its high company income tax rate.

Other sources of variation in tax burdens on investment arise from differences in the corporate tax provisions such as accelerated depreciation and investment allowances and the importance of other capital-related taxes.

Australia’s treatment of capital costs is not excessively generous and, unlike some Latin American companies such as Chile, profits are not indexed for inflation resulting in higher tax payments. Australia also has stamp duties of which the most important is a tax on real estate transfers.

As shown in Chart 8, stamp duties roughly account for 3.4 percentage points or 12 per cent of the 2018 METR. Company taxes alone take up most of the tax burden in Australia. Only in India do company income taxes impose a larger tax burden on capital compared to Australia (India also has a real estate transfer tax and capital tax).

New Zealand, on the other hand, has a lower company tax burden on investments (19.5 per cent) and no other taxes such as stamp duties.

Only in India do company income taxes impose a larger tax burden on capital compared to Australia.


Chart 7 Central and sub-national statutory company income tax rates by country 2018 and 2010

0 5 10 15 20 25 30 35 40



Note: Belgium’s recently announced reduction in its company income tax rate from 33.99 per cent to 29.58 per cent is not included in this chart.

2018 2010

%

Colombia

Zambia

India

France

Brazil

Belgium

Japan

Mexico

Australia

Germany

Portugal

Peru

Greece

South Africa

New Zealand

Italy

G7 w

Americas w

G20 w

South Korea

OECD w

Canada

United States

Luxembourg

Austria

Indonesia

China

Spain

Netherlands

Chile

Israel

Norway

Denmark

Sweden

Slovak Republic

Turkey

Finland

Russia

Iceland

Slovenia

United Kingdom

Poland

Czech Republic

Switzerland

Estonia

Ireland

Hungary


CIT Capital (Net wealth) Capital sales (Input) Capital transfer

Chart 8 Decomposition of METR by country 2018

0 5 10 15 20 25 30 35 40 45 50 55 60


Turkey

Slovenia

Chile

Estonia

Zambia

Switzerland

Finland

Poland

Hungary

Greece

Iceland

Ireland

Slovak Republic

South Africa

Denmark

Czech Republic

Luxembourg

Sweden

Spain

United States

Mexico

Israel

New Zealand

Portugal

Netherlands

Canada

Norway

China

Indonesia

United Kingdom

Peru

Austria

Italy

Colombia

Germany

Russia

Australia

South Korea

France

Belgium

Japan

Brazil

India

%

4.2

6.2

7.4

8.0

8.2

9.3

9.0

10.8

3.5 7.6

11.2

10.2

9.5

12.2

12.6

13.6

11.3

9.4

13.5

17.7

7.3

16.5

12.0

19.5

19.4

15.8

18.1

19.7

16.2

18.3

19.5

21.7

21.4

24.0

19.8

22.6

8.8

25.0

22.6

23.2

34.3

25.0

7.3

39.1

0.3

0.2

0.6

0.1

0.2

1.3

2.5

0.1

0.5

0.8

0.1

0.6

0.6

1.7

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3.1

5.7

3.2

1.7

0.7

11.4

2.4

7.3

4.3

3.1

3.6

3.5

2.9

3.4

3.2

3.4

8.3

18.1

2.5

3.17.1

14.5

4.4

23.47.5

6.7


4What is happening elsewhere?

While most of 2017 was calm in terms of tax reform, it ended with a splash with two G7 countries announcing major tax reforms: France (September 2017) and the United States (December 2017). Belgium also enacted company income tax reforms just before Christmas 2017.

On the other hand, Australia has stood still although a legislative proposal to reduce company income tax rates by five points is being debated in Australia at the time of writing.

Key company tax reforms for 2018 and beyond

Several countries have so far announced further rate reductions after 2017: the United Kingdom plans to reduce its corporate income tax rate to 17 per cent by 2020, Luxembourg to 18 per cent by 2018 and Norway to 22 per cent by 2018. Pakistan is also reducing its company tax rate in 2018 to 30 per cent in 2018.

Belgium is reducing its company income tax rate from 33.99 per cent 2017 to 25 per cent by 2020. This will put Australia near the top of all OECD countries, with the second-highest company income tax rate, tied with Mexico, by 2020.

As G7 countries, it is the French and US reforms that are most significant. France is staging reductions in the general company income tax rate from 33.33 per cent to 25 per cent, beginning in 2018 with a 28 per cent rate for businesses with less than €500,000 in profits followed by reductions in the top rate in 2019. By 2022, all companies will be taxed at the rate of 25 per cent. A 3 per cent profit distribution tax, found to be contrary to European law, is abolished as of 2018. Several other important changes were introduced including capital income being taxed at a flat 30 per cent rate for individuals and the abolition of the wealth tax in favour of a property tax. Payroll taxes are being reduced and an employment tax credit will be cancelled by 2019.

The US business tax reforms are the most extensive. These reforms are described in some detail in Box 1, with a focus on issues of particular relevance to Australia.


1. The US is now much more competitive than in the past for business investmentWith the reduction in the US company income tax rate and expensing, tax reform dramatically reduces the tax burden on capital in the United States. As shown below, the METR on US investment declines from 34.6 to 18.9 per cent in 2018. Various base-broadening provisions will increase the METR but impacts vary on a case-by-case basis.

For example, most companies will not be affected by the interest limitation rule prior to 2022 unless there is a downturn in the economy. However, it will become more meaningful after 2022 as many firms will have interest expenses in excess of 30 per cent of earnings before the deduction of interest (the METR rises to 22.4 per cent if companies cannot deduct all of their interest). It is possible that Congress may amend the rule at a later time.

2. US companies will shift cash to the United StatesUS multinationals will no longer have an incentive to keep profits in Australia. At present, US companies earned $20.3 billion in 2013 earnings and profits in Australia, of which they paid income taxes equal to $3.2 billion. In the past, a US company remitting income back to the United States would pay US tax with a credit for Australian withholding and company income tax. Given the high US company income tax rate, many US companies parked income abroad to avoid additional US taxes. This has now changed.

Even though a transition tax applies to post-1986 earnings and profits held at the end of 2017, dividends could be paid after 2017 without further US tax. US Treasury reports $60 billion in post-1986 earnings and profits held by US companies in Australian affiliates as of 2013. While not all past earnings and profits would be returned to the United States since they are invested in real assets, it is possible for US affiliates in Australia to increase third-party financing so that more cash can be transferred to the US parent.

With announced reforms in France and Belgium, Australia will have the second-highest company income tax rate in the OECD by 2020.


The US business tax reforms are dramatic. The key elements relevant to Australia are the following:

1. A reduction in the federal corporate income tax rate from 35 per cent to 21 per cent beginning 1 January 2018.

2. Expensing of investment in assets with a recovery of less than 20 years (primarily machinery and equipment) except for companies not subject to the interest limitation rule described below (construction, real estate and regulated public utilities). This is effectively an increase in bonus depreciation that was being phased out by 2020 (40 per cent in 2018 and 30 per cent in 2019). Expensing is to be phased out after 2022 by one-fifth each year (and therefore no longer available after 1 January 2027).

3. Research and development expenditures incurred in tax years after 2025 will be amortised over a 5-year period (15 years for expenditures attributable to research conducted outside the United States).

4. A general limitation on the deductibility of interest expense to be no more than 30 per cent of adjusted profits (regulated public utilities and finance would be largely exempt). The Act limits, until 1 January 2022, the deduction of net interest expense to 30 per cent of the business’s adjusted taxable income, not taking into account interest, depreciation, amortisation, depletion or net operating losses (disallowed amounts may be carried forward five tax years). After 2021, the limit will be based on 30 per cent of the business’s pre-tax earnings gross of interest (disallowed amounts may be carried forward indefinitely).

5. Limitation in the use of non-operating losses deductions to be no more than 80 per cent of profits.

6. The elimination of the corporate minimum tax rate as of 1 January 2018.

7. An exemption for dividends received from foreign affiliates with at least 10 per cent ownership by the US parent according to value (voting shares shall no longer be relevant in determining the ownership test). New anti-abuse rules are introduced.

8. As a transitional measure, existing foreign earnings accumulated abroad since 1986 would be subject to a mandatory toll (transitional tax) payable over 8 years: 15.5 per cent for earnings held in cash and 8 per cent for the remainder.

9. A tax on global intangible low-tax income (GILTI) earned by US affiliates offshore. GILTI is the excess of income over a deemed tangible income return, the latter measured as 10 per cent return on tangible assets and does not include passive income, foreign oil and gas income and certain related party payments. GILTI is taxed at a rate of 10.5 per cent until 1 January 2026 when it becomes 13.125 per cent thereafter. A tax credit is given for 80 per cent of foreign taxes without a carry back or forward to other years.

10. Domestic corporations are provided with a reduced tax rate on foreign-derived intangible income (FDII). The effective tax rates on FDII will therefore be equal to 13.125 per cent prior to 1 January 2026 and 16.406 per cent thereafter.

11. A base erosion and anti-abuse tax (BEAT) applies to foreign companies operating in the United States. The BEAT is a minimum tax of 10 per cent (later to be 12.5 per cent beginning 1 January 2026) on taxable income gross of base erosion payments (a one-point higher tax rate applies to registered security dealers). BEAT is levied on companies with deductions higher than 3 per cent of total deductions and for those with gross receipts of more than $500 million. The cost of goods sold and certain service cost deductions (such as those subject to no mark-up values) are not included as a disallowed deduction.

United States tax reform

Box 1


3. Domestic and foreign companies with operations in the US will look to shift profits into the United States and expenses to countries with high company income tax ratesCompanies with US operations will have an incentive to shift profits to the United States to reduce or avoid the impact of interest limitation and loss restrictions, the base erosion and anti-avoidance tax or simply to fund more activities in the United States.

There will also be an incentive to shift debt and general administrative expenses from the US to those entities in countries with relatively high company income tax rates and the absence of thin-capitalisation rules (Australia currently has limits on interest expenses for outbound and inbound investments).

4. There will be less incentive to hold intellectual property and other intangibles in foreign jurisdictions like AustraliaThe favourable treatment of intangible income in the United States, taxed at a rate of 13.125 per cent (not 21 per cent) and the new 10.5 per cent tax on foreign intangible income earned by US affiliates abroad will increase the incentive to shift intellectual property, marketing, mining and other intangible income to the United States especially for Australia that taxes such income at a rate of 30 per cent.

Companies are already looking to shift activities related to intangible income (such as sales forces and research and development) from high-tax countries to the United States.

US tax reform will undoubtedly put pressure on Australia to reform its tax system. The current proposal to lower the company income tax rate to 25 per cent from 30 per cent is timed well in the context of the US reform.

Companies are already looking to shift activities related to intangible income (such as sales forces and research and development) from high-tax countries to the United States.


Conclusion

Australia’s tax policies to attract investment are examined in this report in wake of US tax reform. US tax reform not only has implications for Australia’s ability to compete for multinational investment but the positive effects of that investment: technology, jobs and tax revenues.

If Australia was doing well with private investment, perhaps company tax reform would not be much of a concern. However, private capital formation as a share of GDP has been declining since 2015, in part reflecting the commodity market downturn.

Overall, the US is reducing its company income tax rate from 39.2 to 26.6 per cent. Its METR is dramatically declining from 34.6 to 18.9 per cent (with state income taxes likely to be reformed in the coming year). The US is now much more tax-attractive for investment.

These changes will prompt other countries, especially those most exposed to US trade and investment, to respond with their own tax reforms in the coming year as they did in 1986. While 2017 was a relatively quiet year, this will change in 2018 as many countries are already looking to reform their business tax systems to make them more competitive – and Australia should not be left out in the cold.

Australia, at this point, is ill-prepared to deal with the global implications of the US tax reform.

Its company income tax rate at 30 per cent has been unchanged for almost two decades and is now 9th highest of 43 countries surveyed in this report (4th highest of 34 OECD countries).

Its company income tax rate is 3.3 points higher than the United States and is also higher than the weighted average company tax rates for the G7, G20 and OECD countries by wide margins. With announced reforms in France and Belgium, Australia will have the second-highest company income tax rate.

Taking into account company income taxes (rates and cost provisions), stamp duties and other capital-related taxes, Australia’s effective tax burden on new investments is 28.4 per cent, now almost ten points higher than in the United States. It is 7th highest of 43 countries and 4th highest of OECD countries.

Company tax reform has been debated in Australia for many years especially since the Henry Report in 2009, which concluded that the company income tax rate should be reduced from 30 to 25 per cent. No action was taken despite the sound arguments made in the Henry Report.

Action on company tax is now crucial for Australia as businesses reorder their supply chains in response to tax changes now being considered following US reforms.

Australia’s effective tax burden on new investments is

28.4 per cent, now almost ten points higher than in

the United States.

Data appendix

Table 2 METRs and country data By sector and country (%)

2018 2010 2018 2010 2018 2017

Australia 28.4 28.6 28.3 0.3 28.3 29.4 28.2 1.2 30.0 30.0 1.9 2.6 - 23.9 OptionalAustria 24.3 25.5 23.9 1.6 25.3 24.9 25.4 0.5 25.0 25.0 1.6 3.1 - 10.6 OptionalBelgium 34.3 34.6 34.3 0.3 11.3 10.8 11.4 0.6 34.0 34.0 1.4 7.0 - 32.9 LIFOCanada 20.9 16.3 22.5 6.2 20.8 15.0 24.1 9.1 26.8 29.4 2.0 4.0 - 55.0 FIFOChile 7.7 9.1 7.5 1.6 5.2 5.7 5.1 0.6 25.0 17.0 3.5 7.5 - 39.7 LIFOCzech Rep. 14.4 14.7 14.2 0.5 14.1 14.0 14.2 0.2 19.0 19.0 1.2 3.1 - 20.8 OptionalDenmark 14.1 16.7 13.6 3.1 17.2 18.5 17.0 1.5 22.0 25.0 0.9 5.1 - 22.7 FIFOEstonia 8.0 8.0 8.0 0.0 8.5 8.5 8.5 0.0 16.3 21.0 1.3 9.9 - 21.6 LIFOFinland 9.6 16.3 8.0 8.3 18.8 20.0 18.5 1.5 20.0 26.0 1.1 8.2 - 28.7 FIFOFrance 33.5 36.5 33.0 3.5 34.6 35.7 34.5 1.2 34.6 34.4 0.7 3.1 - 26.5 OptionalGermany 25.7 28.4 24.7 3.7 26.9 28.5 26.3 2.2 29.7 30.2 1.0 3.1 - 14.4 LIFOGreece 11.3 10.9 11.4 0.5 9.0 7.9 9.1 1.2 29.0 24.0 -0.7 5.3 - 39.2 LIFOHungary 11.1 12.6 10.6 2 14.1 14.7 14.0 0.7 9.0 19.0 1.5 3.3 - 48.1 OptionalIceland 11.5 9.1 12.1 3 10.6 7.0 11.4 4.4 20.0 18.0 2.9 3.3 - 30.5 FIFOIreland 12.0 11.7 12.1 0.4 15.3 14.3 15.7 1.4 12.5 12.5 0.4 2.0 - 12.4 FIFOIsrael 19.3 17.9 19.5 1.6 17.1 15.3 17.3 2.0 24.0 25.0 0.5 4.2 - 29.8 OptionalItaly 24.7 26.9 24.3 2.6 25.6 23.6 26.0 2.4 27.9 31.3 0.9 5.1 - 15.3 LIFOJapan 39.5 40.1 39.4 0.7 45.3 45.1 45.4 0.3 30.9 39.5 0.8 2.0 - 21.3 OptionalSouth Korea 30.9 34.6 29.1 5.5 29.5 31.1 28.7 2.4 27.5 24.2 1.3 2.6 - 20.1 LIFOLuxembourg 15.1 15.9 15.1 0.8 17.0 17.4 17.0 0.4 26.1 28.6 1.2 4.1 - 21.0 OptionalMexico 19.0 21.7 18.4 3.3 19.7 21.1 19.4 1.7 30.0 30.0 3.5 5.1 - 15.4 LIFONetherlands 20.1 19.6 20.2 0.6 21.2 19.8 21.4 1.6 25.0 25.5 1.8 2.9 - 20.9 OptionalNew Zealand 19.5 19.7 19.4 0.3 17.1 14.7 17.4 2.7 28.0 30.0 0.8 6.8 - 23.9 OptionalNorway 21.4 21.8 21.3 0.5 24.5 23.3 24.6 1.3 24.0 28.0 2.1 3.6 - 24.5 FIFOPoland 10.9 10.3 11.1 0.8 11.6 10.3 11.7 1.4 19.0 19.0 0.6 2.6 - 25.8 LIFOPortugal 20.0 18.7 20.3 1.6 20.3 17.9 20.8 2.9 29.5 29.0 1.4 2.2 - 19.8 OptionalSlovak Rep. 12.2 17.6 10.4 7.2 12.3 15.4 11.3 4.1 21.5 21.0 0.8 5.0 - 17.3 OptionalSlovenia 6.2 5.8 6.3 0.5 6.8 6.4 6.9 0.5 19.0 20.0 0.8 3.5 - 21.6 OptionalSpain 18.5 18.2 18.6 0.4 23.5 22.0 23.7 1.7 25.0 30.0 0.6 2.1 - 29.2 OptionalSweden 16.7 15.8 16.8 1 19.4 17.7 19.8 2.1 22.0 26.3 0.3 3.2 - 19.5 FIFOSwitzerland 9.5 9.3 9.5 0.2 15.4 14.4 15.6 1.2 17.8 21.2 -0.5 5.7 - 31.9 LIFOTurkey 5.9 7.4 5.5 1.9 7.2 6.3 7.4 1.1 20.0 20.0 8.1 12.5 - 48.8 OptionalUK 23.0 22.8 23.0 0.2 29.0 26.3 29.3 3.0 19.0 28.0 1.5 1.4 - 17.7 FIFOUS 18.9 15.3 20.4 5.1 34.6 32.1 36.0 3.9 26.6 39.2 2.0 4.0 - 11.7 Optional

Brazil 40.0 22.5 43.2 20.7 44.4 22.5 48.3 25.8 34.0 34.0 7.2 4.1 - 11.7 OptionalChina 21.8 26.2 19.1 7.1 24.7 27.1 23.1 4.0 25.0 25.0 2.1 7.0 - 14.6 OptionalIndia 50.2 45.1 51.7 6.6 61.5 50.5 64.7 14.2 34.6 33.2 7.5 5.1 - 35.0 OptionalRussia 26.8 32.0 25.6 6.4 27.9 31.1 27.1 4.0 20.0 20.0 8.5 3.1 - 20.8 Optional

Argentina 35.2 48.8 31.6 17.2 31.7 36.2 30.5 5.7 35.0 35.0 16.3 4.1 - 11.7 LIFOBolivia 23.3 31.2 21.4 9.8 23.8 30.1 22.3 7.8 25.0 25.0 4.8 2.6 - 16.9 FIFOBotswana 17.0 18.2 16.9 1.3 19.2 13.6 19.7 6.1 22.0 24.1 4.9 2.5 - 24.5 OptionalBulgaria 8.0 7.7 8.1 0.4 6.0 6.0 6.0 0.0 10.0 10.0 0.3 4.0 - 30.2 OptionalChad 31.2 37.3 29.6 7.7 44.7 48.5 43.8 4.7 35.0 40.0 4.7 5.1 - 16.2 OptionalColombia 25.2 29.8 24.3 5.5 12.4 15.5 11.8 3.7 37.0 33.0 4.1 5.0 - 19.4 LIFOIndonesia 21.9 26.8 19.9 6.9 22.9 25.8 21.7 4.1 25.0 25.0 5.4 5.1 - 14.0 OptionalPeru 23.7 26.7 23.0 3.7 24.9 31.7 23.2 8.5 29.5 30.0 3.4 4.6 - 20.0 OptionalSouth Africa 12.7 15.9 12.1 3.8 14.2 15.6 14.0 1.6 28.0 28.0 5.7 5.0 - 25.0 OptionalZambia 8.9 18.0 7.8 10.2 9.4 15.2 8.7 6.5 35.0 35.0 10.0 5.1 - 47.3 Optional

G7 w 25.5 24.4 26.0 1.6 34.5 33.0 35.3 2.3 27.9 36.3BRIC w 29.0 28.8 28.0 0.8 33.1 30.0 33.1 3.1 27.2 27.0G20 w 25.9 25.5 25.8 0.3 32.6 31.1 33.1 2.0 27.6 32.8OECD w 23.7 23.1 24.0 0.9 30.4 29.3 31.0 1.7 27.0 33.5


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1 J Mintz, P Bazel, D Chen and D Crisan, With global company tax reform in the air, will Australia finally respond? Minerals Council of Australia, Canberra, March 2017.

2 For a lengthy discussion, see J Mintz, Global Implications of U.S. Tax Reform, January 2018, forthcoming CESIfo paper series.

3 Commonwealth of Australia, Australia’s Future Tax System (Henry Report), Canberra, December 2009.

4 ibid.5 Some recent international studies have

suggested that the transfer taxes have high economic costs, although none examine real estate impacts on commercial property. For example, Buettner estimates the welfare cost to be €1.67 in Germany (see T Buettner, Welfare Cost of the Real Estate Transfer Tax, CESifo Working Paper No. 6321, Munich, Germany, 2017). A Canadian study estimates a marginal cost of the Toronto land transfer tax to be $1.29, more than for a property tax increase (see B Dachis, G Durantan and M Turner, ’The effects of land transfer taxes on real estate markets: Evidence from a Natural Experiment in Toronto’, Journal of Economic Geography 12(2), pp. 327-54, 2012)

6 KJ McKenzie and E Ferede, ‘Who Pays the Corporate Income Tax? Insights from the Literature and Evidence for Canadian Provinces’, SPP Research Papers, 10(6), School of Public Policy, University of Calgary, 2017.

7 We are unable to provide revenue estimates for these policy reforms.

8 Our data is based on economic depreciation rates, capital structures (machinery, non-residential buildings, inventories and land) by industry using Canadian data. The cost of finance is based on the assumption that the average G7 investor holds bonds and equity such that the risk-adjusted after-personal tax returns on assets are the same. Nominal interest rates and the cost of equity financing is adjusted for country inflation rates. For a review of the methodology, see P Bazel and J Mintz, ‘2015 Tax Competitiveness Report: Canada is Losing its Attractiveness,’ SPP Research Papers, 9(37), School of Public Policy, University of Calgary, 2016.

9 Our preliminary results are similar to a number of studies – a 10 per cent increase in the effective tax rate on new investment (as provided in this paper) causes investment as a share of value-added to decline by roughly 2 per cent. See also P Bazel, J Mintz and A Thompson, ‘The 2017 Tax Competitiveness Report: The Calm Before the Storm’, SPP Research Papers, 11(17), School of Public Policy, University of Calgary, February 2018.

10 See M Parsons, ‘The Effect of Corporate Taxes on Canadian Investment: An Empirical Investigation’, Finance Canada, Working Paper 2008-01, Ottawa, 2008. In an earlier study using the estimates of our METRs, see M Krzepkowski, ‘Marginal versus Average Effective Tax Rates and Foreign Direct Investment’, in Three Essays on Investment and Taxation, University of Calgary, Calgary, 2013.

11 LP Feld and JH Heckemeyer, ‘FDI and Taxation: A Meta-Study’, Journal of Economic Surveys, 25(2) pp. 233-72, 2011.

Endnotes

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Minerals Council of Australia

Level 3, 44 Sydney Ave, Forrest ACT 2603 (PO Box 4497, Kingston ACT Australia 2604)P. + 61 2 6233 0600 | F. + 61 2 6233 0699 www.minerals.org.au | [email protected]

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