Australia and the world: how we’re now doing for capital what tariffs did for goods

Today’s column in the AFR.

Exporting Australian Funds Management

As the AFR reported late last week, a small new front is opening up in the election at least at the big end of town: Turning Australia into a funds management hub for the region. Its a worthy aspiration. But realising it will take a greater sense of urgency than weve shown so far.

We could start by learning some lessons from history.

With compulsory super having filled its coffers, Australias funds management industry is, remarkably, the fourth largest in the world. Its sophisticated and competitive. But our success carries eerie similarities with Australian manufacturing in the 1960s.

Back then, and despite the protection they received, our manufacturers were sophisticated and competitive, at least by the standards of the region. But while countries in Asia were busily redirecting their considerable energies from import replacement to export, we sat pat in a cocoon of complacency.

Werent things going along pretty nicely?

Why was export promotion so much more successful than import replacement? In fact the pioneers of this model of development only stumbled upon it in their endeavours to ration foreign exchange. But at least in hindsight, the answer is simple. Domestic markets are small. Export markets are big. Domestic markets are cheaper to get into, but theyre quickly saturated.

If you can develop some genuine edge offshore, youre in the big time.

Sadly, on scales both grand and small, were now doing with capital what tariffs did for goods. Dividend imputation is a grand scheme to rebate company tax to Australian shareholders. It makes perfect sense from the perspective of allocating domestic capital, but it costs a cool $20b in revenue! It turns Australian companies away from investing offshore because offshore income cant fund the franked dividends that their Australian shareholders crave.

And it massively constrains our ability to attract foreign investment.

If we copied Hong Kong and did without dividend imputation we’d be within a whisker of their (17.5%) company tax rate! If you were disgorging $20b of tax revenue and wanted to maximise investment in Australia, to whom would give the money? Australian shareholders or the other 97 per cent of global capital owners?

Similar misplaced priorities impede funds management exports more directly. Of the $1.3 trillion dollars Australian funds manage, just three per cent is foreigners money an embarrassment compared with competitors Singapore, Hong Kong, Ireland and Luxembourg and just about every major funds management hub.

The Opposition set the pace in its recent Budget reply promising to reduce and simplify withholding tax on Australian fund distributions to foreigners. Because this change mostly benefits property trusts, some of its effect will be to simply drive up land prices. But it will also fund useful property development.

The real prize is managing more global investments on behalf of foreign investors. But today those foreign investors face inadvertent Australian tax liabilities.

To its credit the Government has steadily worked on these problems. But its shown little urgency. Because tax law is so complex and because more general domestic tax avoidance issues are almost invariably involved, progress is slow. Loose ends remain.

While they do, any serious investment in Australian global fund management capability for export simply decamps most often to Dublin. Ireland specialises in the game, not just with the worlds lowest developed country corporate tax rate but by reacting quickly to the industries tax and regulatory needs.

With the Opposition making the running, the Government is planning some quick announcements for the election. The policies it announces will be half-hearted (if generally worthwhile), well overdue and cobbled together in haste. Sound familiar?

Tax on Australian investment trusts is governed by Division 6C of the Tax Act. Dating back to the 1930s, it is complex and hedged through with anti-avoidance provisions that make perfect sense if your focus is cooling the ardour of the more adventurous domestic family trust accountants.

But its a nightmare for a ten billion dollar global trust.

The industry has proposed a separate tax regime for managed investments like the Americans have, not to win any favours the reform should be revenue neutral but to permit codification, clarification and certainty.

The economic gains from such a regime would grow over time as it became easier to deal with anomalies and meet competitive challenges and opportunities as they arose without concern for flow on effects elsewhere in domestic tax law.

The industry regards the situation as urgent.

But the issues are eye-glazingly complex. And in that situation its difficult for the industry to gain champions within the bureaucracy, whose resources are constrained and whose mindset is, understandably, sceptical of industries arguing for special treatment.

In that context, the absence of strong Government leadership has seen things drift. The industry submitted detailed requests for a separate tax regime in March 2006!

Fortunately, the whiff of electoral grapeshot is beginning to concentrate politicians minds wonderfully.

Better late than never!