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2010-05-25

John Ralph on the RSPT

Comments on John Ralph "Retrospective tax a risk to national sovereignty", 25/05/2010, http://www.theaustralian.com.au/news/opinion/retrospective-tax-a-risk-to-national-sovereignty/story-e6frg6zo-1225870760693

Now the PM, Treasurer, government ministers, as well as Treasury officials should take a note of what Ralph has to say on the RSPT, modelling assumptions and model logic.

The article is quoted as below for my future reference:

"HAVING retired from corporate life I am reluctant to become involved in the present debate about proposed tax measures, but I am perplexed about the apparent lack of understanding by the commonwealth government of the long-term damage they are about to inflict on the Australian community if the proposed resource super-profits tax is implemented as planned. Governments can increase or decrease tax rates and, while these changes will have an effect on future investment decisions, they do not affect the external perception of the nation's standing in relation to sovereign risk.
Prudent management will have assessed the sensitivity of a project's viability and attractiveness to a change in tax rates in making its investment decisions.
A decision to impose a 40 per cent tax rate on earnings above the bond rate will reduce future investment because of the substantive effect on projected after tax returns. Projects that promised to meet, or just exceed, the company's cost of capital without the new tax would not do so with the new tax, and so would not proceed. Only those projects with a very high projected return would proceed. A suggestion that an increase in taxation would result in an increase in investment could only be made by somebody not living in the real world.
If a computer model predicts this, then the assumptions on which the model is based need to be re-examined. As always with computers, remember GIGO (garbage in, garbage out).
There clearly seems to be a fundamental misunderstanding that the prospect of a refund of 40 per cent when a project fails or makes losses will make a project more financially attractive to undertake. The expected after tax return from a project being considered for investment will largely determine whether the project proceeds. Projects are not undertaken when losses or failure are expected. Knowing that part of a loss will be underwritten by government if the project fails, does not do anything to improve the after tax return when the project does not fail. Consequently, the imposition of the additional tax burden will reduce expected returns and, therefore, reduce investment at all levels in the industry.
There will, of course, be some offsets in the resulting lower value in the Australian dollar for exporters accounting and reporting in Australian dollars, but an increase in import costs, with implications for inflation.
An additional fallout that can be expected will be that a reduction in investment attractiveness will almost certainly result in a lower level of exploration activity. Why would companies be expected to retain a high commitment to exploration if there are likely to be fewer viable projects?
All of the above considerations relate to the fact that there will be consequences for investment and jobs from changes in tax arrangements. Provided it understands the implications, this is a matter for government to weigh up and decide if it wishes to trade off future investment and jobs in the mining and associated industries for an immediate increase in revenue.
The aspect of the proposed arrangements that is of most concern to me, however, and should be to most Australians, is the retrospective nature of the proposed tax in applying it to existing operations. This will heighten significantly the sovereign risk assessment of Australia when it comes to investment in, and lending to, Australian entities.
This changed assessment of risk will be priced into transactions and make borrowing more expensive for a country very dependent on foreign capital. This will affect all Australians. One only has to look at what is happening in Greece, admittedly a more extreme case, to appreciate how heightened sovereign risk increases borrowing costs and limits access to funds. The Hawke government clearly appreciated this issue of sovereign risk when it introduced the resource rent tax on petroleum, by not applying it retrospectively.
Whether an individual, a company or a country, reputations take a long time to build but they can be tarnished or destroyed in an instant and, once lost, take a long time to rebuild. If the sovereign risk assessment of Australia is downgraded from the strong position the nation has enjoyed for many decades, it will take a long time for this perception to change. The precedent will have been seen to have been set and investors and lenders will be questioning for some time where next may retrospectivity be applied? They will reflect this in their pricing decisions affecting Australia.
It is this risk to the nation's standing in relation to sovereign risk that concerns me most because of its long-term adverse implications for the Australian community."

John Ralph AC was formerly chief executive of CRA, a director of BHP Billiton and chairman of the Commonwealth Bank, former president of the Business Council of Australia and chairman of the Ralph report into corporate tax reform.

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