AELA – Annual Review 2006
The Australian Leasing Market:
Current Activity and Prospects The Taxation Framework:
Leasing and Tax Benefit Transfer
Leasing Tax Guidelines
Leverage Leasing and Leasing to Government and
Tax Incentives and Disincentives
Goods and Services Tax
Review of Business Taxation
Stamp Duty Rewrite
IGA 2005 Review of State Taxation Lease Training and Education:
AELA/Amembal Australian Leasing School
Annual AELA Leasing and Equipment Finance Conference
Leasing Technical Conference
Credit Skills Workshops
Other Association Activities and Issues:
Accounting for Leases
Anti-Money Laundering Reform
Chattel Encumbrance Registers
Consumer Credit Code
Lease and Equipment Finance Statistics
Lender Liability – Environmental Penalties and Remediation
Personal Property Securities Reform
Privacy and Credit Reporting
Privacy: Private Sector Extension
Product Liability, Environmental Laws,
Occupational Health and Safety, and Surrogacy
Trucking and Transport Issues
Used Vehicle Imports
AELA Formation and Structure
AELA Code of Practice
The AELA Council
AELA Chairmen and Current Year Council Membership
AELA Members and Representatives
Australian Equipment Lessors Association
ABN 19 054 908 520
John Bills, B.Ec.
Ron Hardaker, B.Com. (Hons) Administration Manager:
Economic & Statistical Analyst: Simon Payet, BA, MBC
Legal and Regulatory Reference Group:
Steve Edwards, Dip.Law (BAB) Helen Gordon, LL.B, GDLP Catherine Shand, LL.B, M.Com David Thorpe, B.Ec. (Hons), FCPA Level 7, 34 Hunter Street SYDNEY 2000 Australia
GPO Box 1595
SYDNEY 2001 Australia
Telephone: (02) 9231 5479 Facsimile: (02) 9232 5647 (International Access 61-2) Website: www.aela.asn.au ISSN-1031-6817, December 2006
Annual Review 2005/2006
AELA is the national association for the equipment leasing and financing industry. AELA’s 100 members encompass more than 90 percent of leasing activity in Australia.
With lease and equipment finance facilitating around 40 percent of the nation’s equipment capital
expenditure, the industry is vitally involved in the equipping of Australia’s productive base.
This Review covers developments and issues affecting lease and equipment finance markets over the year .
On behalf of members of the Australian Equipment Lessors Association it is my pleasure to report on the activities of our association during my period as Chairman. Since AELA’s formation in 1986, we have represented all major participants in the equipment finance industry in Australia. The association is not institutionally-based; membership includes financiers, large banks, regional banks, vendors, investment banks, lease packagers, lease brokers through their associations, and as associate members, service providers to the industry including law and accounting firms, actuarial firms and systems suppliers. AELA’s primary role is to assist its members in managing the regulatory environment in which they operate. The Australian financial system has undergone substantial reform in recent years, and whilst in one sense the market has become deregulated, this description more accurately reflects a movement away from direct controls to market-based regulation. In the broader sense however, it is unfortunate to conclude that the quantum of regulation continues to grow.
But within this complex regulatory framework, it is most pleasing to report on a number of favourable outcomes in the equipment finance industry which go against the trend. Most notably, all States and Territories have now agreed a timetable for the abolition of stamp duties on equipment finance, a major micro-economic reform, for which the Commonwealth and the States are to be congratulated. In a similar vein, in recent years we have witnessed the abolition of out-dated hire purchase legislation. These developments illustrate that industry and governments can work productively to ensure that the regulatory framework is dynamic and responsive to the needs of participants.
There is no escaping the fact that meaningful reforms do take a long time. That is the nature of the environment in which we operate, and successes of this significance serve to remind us that focused and determined approaches by an industry group, together with a necessary degree of patience, will achieve meaningful reforms.
Although monetary policy in Australia has been conducted for several years with remarkable stability, at the time of writing we had experienced three interest rate increases of 25 basis points over 2006. Reflecting fifteen years of continuous economic expansion, the equipment finance industry has maintained very solid business levels over 2006, and the interest rate increases have not to-date significantly impacted on business conditions.
The body of this Review covers the activities of AELA in detail. In reviewing the recent year, a number of major achievements and activities stand out:
– agreement by all States and Territories on a timetable for the abolition of stamp duties on equipment finance;
– consultations with Commonwealth Treasury seeking the exclusion of leasing from the proposed Taxation of Financial Arrangements regime;
– participation in reform of the tax framework governing leasing to tax exempts;
– consultations with the Tax Office to achieve more realistic ‘safeharbour’ residual values in leases;
– continuing input to the Tax Office on GST and hire purchase apportionment;
– initial consideration of GST zero-rating of business-to-business financial services; – liaison with the Tax Office on GST adjustment arising from hire purchase default terminations; – participation in the development of a Personal Property Securities regime in Australia, to cover all non-real estate assets;
– detailed consultations on the introduction of Australia’s new anti-money laundering regime;
– involvement with governments on the emerging regulatory framework for finance brokers; – the 12th Annual AELA Leasing and Equipment Finance Conference, held in November 2005; – the AELA Credit Skills Course, held in Sydney and Melbourne in May 2006;
– the AELA/Amembal Australian Leasing School, held in Sydney and Melbourne in September 2006.
AELA members look forward with confidence to the year ahead. There is some uncertainty as to the necessity for further interest rate rises, but in any event such increases would be unlikely to be of the magnitude of past years, and are not likely to reduce business confidence significantly. AELA remains a very cohesive association, and membership has never been stronger. We look forward to maintaining a constructive relationship with governments around Australia, to both propose and respond to regulatory initiatives in a thoughtful and constructive manner. I would like to thank all members for their involvement and support of our association, and the AELA Council, which provides experienced and insightful guidance.
Finally, my past year as Chairman has been both a privilege and a pleasure. My sincere thanks go to Council members for their strong support over the year. We must also recognise the dedicated and professional service provided to the association by directors Ron Hardaker and John Bills, together with Connie Sison and the whole Directorate team. Their continuing efforts, over many years, are reflected in the strong association we now have, and the high regard the association enjoys with governments and regulators throughout Australia.
The Australian Leasing Market
Lease finance in Australia is a mature financial product having been offered as part of a portfolio of financing techniques for over five decades. The predominant lessor groups are finance companies and banks; lessees include all private and public industry sectors with around 20% of the economy’s capital equipment being
leased. Leasing and other equipment finance offered by members together account for around 40% of equipment capital expenditure.
While the concept of leasing plant and machinery was not unknown pre-1950 in Australia, its relatively large-scale use and acceptance is a phenomenon of the last 50 years.
The wider use was pioneered by finance companies in the late 1950s and early 1960s. Since that time most financial institutions have moved to include leasing in their product range.
Lease finance utilisation rose strongly as the acceptance of the philosophy of leasing broke down earlier attitudes against this non-equity form of financing. The current level of utilisation reflects this wide acceptance.
Generally speaking leasing is offered as part of a range of financing products. This allows its particular merits vis-a-vis other finance methods to be weighed and tailored to the customer’s particular needs and financial position.
Applicants can usually choose between a number of sources including financiers/lessors with whom they have an existing relationship, those which may be offering leasing at the point of sale and those independently operating in the market. Lease packagers are involved in structuring some of the more complex transactions. Lease brokers also play a role in promoting the product.
In terms of general market functioning, leases are written for most capital equipment items (provided they are used for commercial purposes) and for periods ranging between two and five years; implicit rates are competitive and are usually fixed for the period of the lease. Providing the commercial use test is met, lessees claim the full amount of the lease rentals as a tax deduction; the lessor, as owner, usually claims the depreciation and any investment incentives – the latter in the case of the Investment Allowance (when
applicable) can be claimed by either the lessee or the lessor as appropriate, with leasing’s tax benefit transfer capacity reflecting the incentive of the Allowance in the amount of the lease rentals. Until mid-1990 lessors may have elected to tax account and price on the finance or receivables method (i.e. on the implicit interest income stream); IT2594 however removed this election ability. Equipment acquisitions better priced through financing via the finance method (i.e. longer depreciating items of plant), are now in many instances financed via commercial hire-purchase or chattel mortgage.
There can be no option during the lease contract to purchase the leased goods at the end of the term. The lessee may however release the goods at the end or make an offer for them. In any event the finance lease will provide for the lessee to indemnify the lessor for any loss on sale for less than the residual value; this provision aims at ensuring that the lessee properly maintains and uses the equipment and, from a pricing point of view, keeps any equipment technological risk implicit in the credit risk.
In the early years most leases were motor vehicle-related and even today around one half of lease volumes is for motor cars, trucks, vans, motor buses and coaches; aircraft, ships and heavy earthmoving vehicles comprise another sizeable end-use, and in recent years EDP and office equipment have grown strongly. For most part, the national taxation system has been relatively neutral as between the various financing options with each alternative able to compete on the basis of its appropriateness and flexibility for the particular investment and financing need. Paradoxically the long history and high utilisation of leasing in
Australia has often led to a misunderstanding of its attributes; the 1985 Government White Paper on Tax Reform, for example, tended to incorrectly characterise leasing as merely a form of tax shelter. In terms of taxation, leasing captures and crystallises taxation deductions and incentives available within the system and within government policy, focusing their effect on the area where it will have the most impact: reduced cash outflow for the lessee. When Government inquiries urge action to develop ‘sunrise’ industries
or to smooth the restructuring of other sectors or industries, it is ironic that the financing technique best suited to achieving both these objects (i.e. leasing), can be inappropriately and disparagingly described as ‘tax shelter’.
A business just starting out or one in the process of restructuring is unlikely to be generating current year taxable income. In these circumstances tax deductions for depreciation or investment incentives do not achieve their desired policy effect – rather they simply add to carry-forward losses. Through leasing, the
lessor can claim these deductions against its taxable income, crystallise the benefit and pass it on to the lessee in the form of the tangible incentive of reduced cash repayments.
Unfortunately, the aggregation of such deductions in the books of a relatively few lessors can be misunderstood and can result in the contemplation of restrictions. This occurred in the area of financing unit trusts for property and construction projects when the Tax Commissioner issued tax ruling IT2512 which restricted the ability of such trusts to transfer the benefit of certain deductions. The broader question of tax benefit transfer was also raised in the debate which surrounded the ruling; equipment leasing was however exempted from the Government’s general policy to restrict such tax effective financing. The rationality of this exception was highlighted in the Bureau of Industry Economics’ paper ‘Tax Losses and Tax Benefit Transfer.’
Leasing is an essential financing tool for a dynamic and competitive economy. If from time-to-time a new application or lease product development tests the legislative or taxation framework, this should be seen as a healthy and necessary sign of an innovative financial system. An on-going role for groups such as AELA is to ensure that policy or administrative responses proceed on an informed basis with due regard to any wider consequences. This role has been to the fore, for example, as consideration of the 1999 Review of Business Taxation recommendations has proceeded.
A development in the lease market over the years has been the offering of variously structured operating leases. These were in part a response to the Australian Accounting Standard for Leases (AASB 117) which requires lessees, for corporate disclosure purposes, to capitalise their finance leases onto their balance sheets; operating lease commitments on the other hand, are expensed in the usual way and need only be disclosed by way of footnote to the published accounts.
Initially demand for the operating lease product was limited to the larger corporations and companies with overseas, especially US parents. Over the years this has changed, with a wider spectrum of private and public sector lessees now utilising the product.
From a lessor viewpoint, for the lessor to retain the advantages and disadvantages of economic ownership of the equipment (as the Standard requires of an operating lease) it is necessary to be confident that the value of the equipment when returned by the lessee will achieve a resale price which is predictable. This ‘equipment’ risk is reduced where there is a sufficiently deep second hand market for the particular equipment to allow reliance on reasonable estimates of sale values. Given the general lack of depth of Australian equipment markets (compared, say to the US or Europe), operating leases to-date have been largely limited to motor vehicles, computers and multi-purpose industrial equipment (e.g. forklifts). As the same resale market questions will affect residual value insurance premiums, such insurance can be expensive especially for specialised equipment. The more recent experience of minimal inflation and the WST/GST switch, add further elements of risk to this area.
When this equipment resale value risk is added to the credit/client risk (i.e. will the lessee meet the
commitments) and indeed the manufacturer and goods risk (i.e. will the manufacturer/supplier continue to provide servicing, will the goods prove reliable), it is obvious that compared with a traditional finance lease, operating leases are more complex. Any legislative or other regulatory measure which results in a move to operating leases out of balance with the market’s capacity to cover underlying equipment risk will have
prudential consequences, as well as forcing that risk, currently implicit in a finance lease, to be explicitly priced in the operating lease. Nonetheless given current writing levels it would appear that these problems are being addressed and the product advanced, with many lessors specialising in this market segment. The introduction of GST on 1 July 2000 added somewhat to the complexity of leasing and equipment finance transactions, but at the same time this framework has provided a fair degree of flexibility in meeting the needs of customers. More recently, the introduction in June 2003 of proposed Division 250 to replace the existing framework governing leasing to tax preferred entities focused attention on the appropriate income tax treatment for leases to tax exempts. In a similar vein, the 2006 proposals for the introduction of a new regime for the Taxation of Financial Arrangements (TOFA), has focused this attention on leasing to taxables. The detail of these developments is covered elsewhere in this Review, but it is important to note that for leasing to continue to provide a dynamic and creative solution to the equipment finance needs of businesses, it cannot be placed within the conventional homogeneous ‘sale and loan’ approach. The proposal to introduce the Tax Value Method for determining taxable income could have had important implications for the equipment finance industry, and AELA was one of the many groups that welcomed the Government’s decision not to proceed.
Current Activity and Prospects
The Australian equipment finance market continued to experience robust conditions in 2005-2006. Strong business levels have been a feature of the Industry since the early 1990s, apart from a temporary hiatus during the period of the introduction of GST in 2000.
In the recent period there has been some discrepancy between the Australian Bureau of Statistics (ABS) equipment finance collection, and the statistics collected internally by AELA from members. It would appear that the ABS statistics have been somewhat understating equipment finance activity, and AELA has been attempting to reconcile the two statistical sources. Whilst there is greater consistency between these two sources from the second half of 2005, the ABS series may still be somewhat understating business volumes. AELA members provide four basic products to fund the purchase of capital equipment: finance lease, operating lease, hire purchase and chattel mortgage. The ABS provides separate series for finance and operating leases, whereas hire purchase and chattel mortgage are included within the one category, classified as ‘non-lease equipment finance’. The trends in this broad mix are not only affected by economic conditions but also by Government policy, with the latter particularly evident in recent times. The introduction of GST produced a significant shift away from finance leases and initially to hire purchase, as the transitional GST arrangements did not apply to hire purchase. This trend has been followed by a move away from hire purchase to chattel mortgage and leasing, caused by an inappropriate GST outcome in relation to hire purchase contracts entered into by cash basis taxpayers. As from 1 January 2005, the Commissioner of Taxation’s revised effective life determinations for trucks and like assets has translated into unrealistically
high ‘safeharbour’ residual values in leases for these assets, resulting in a shift away from leasing to the provision of hire purchase and chattel mortgage products for these transactions. As detailed in this Review, these tax issues are the subject of ongoing discussions with Treasury and the Tax Office. Besides GST and income tax, differences between the States in the scope and rate of stamp duty have caused distortion in the product mix. However, as also outlined elsewhere in this Review all jurisdictions have now announced a timetable for the abolition of these duties, and accordingly it is pleasing to report that in the not too distant future, stamp duty distortions will no longer exist in the equipment finance market.
The impact of these influences on the composition of equipment finance business has been quite dramatic. Since 2000 total lease business has declined from 60% to around 35%, hire purchase has declined from 40% to 30%, and from very little chattel mortgage business only five year ago it now makes up 35% of the total.
The ABS statistics show total equipment finance volumes of $29.4 billion in 2005-2006, an increase of 28% on the previous financial year; by way of comparison, the AELA figures show a year-on-year growth of 10%. Total Motor Vehicle volumes have stabilized at around $1100 million per month ($13.5 billion per annum). However, the ABS figures show a very large increase in the General Equipment category, which is where AELA believes there has been under-reporting of activity from around the end of 2002. Monthly volumes for this category (including Other Transport Equipment) dropped from $900 million in late 2002 to $800 million in 2003-2004, but from mid-2005 have jumped up sharply to $1350 million per month, equivalent to some $16.5 billion per annum. This increased business is being conducted mainly by way of hire purchase and chattel mortgage, and accordingly the non-lease volumes are running at around $1600 million per month ($19 billion per annum), up from $1050 million per month until mid-2005. The leasing volumes have increased slightly over this time, from $800 million to around $900 million per month ($11 billion per annum). In 2005-2006, motor accounted for 45% of total equipment finance volume, other transport equipment for 6%, and general equipment for 49%. The ABS provides a break down of these broad asset classes only for leasing, and these statistics show that new cars accounted for 67% of motor vehicle leasing, used cars for 11%, new trucks 16%, used trucks 4% and other vehicles 2%; the trend over recent years has been for new vehicle leasing to expand at the expense of used vehicles. The general equipment category continued to be dominated by EDP equipment (32%) and office machines (19%), with general equipment rising strongly in 2005-2006 to make up 25%.
Equipment finance is provided to the broad range of Australian industry sectors. No one industry sector particularly dominates; the single largest are the Property and Business Services sector together with Finance and Insurance, accounting for 14% and 18% respectively. On a State/Territory basis, NSW accounts for 42%, Victoria for 23% and Queensland for 17%, so that the three eastern states and ACT made up 82% percent of total business. Looking ahead to 2007 notwithstanding the increases in interest rates over 2006, AELA members anticipate a continuation of solid business levels as the Australian economy continues to demonstrate robust health.
The Taxation Framework
Like all financial products leasing and other equipment finance operate within the framework provided by the Commonwealth, State and Territory Governments’ taxation statutes.
Over the past 40 years there has been a series of reports on and inquiries into various aspects of the Australian Taxation System. Some have set down principles which should underpin a better system (e.g. simplicity, efficiency, equity); some have dealt with changes necessary to address external factors (e.g. inflation), while others have attempted to set an agenda for overall change; similar reviews have taken place at the State level. In addition, other wider-ranging inquiries (e.g. the Campbell Financial System Report and the Wallis Financial System Inquiry) have made observations and recommendations concerning tax. Contemporaneously the various statutes have been continuously amended or added to, as governments have responded to social, fiscal and commercial developments.
Many changes have been made, and while AELA does not necessarily agree with all of them, it is fair to say that the general direction has been towards improvement. The framework itself however has become overburdened by continuous amendment, resulting in excessive complexity, increased scope for ‘unintended consequences’ and major distortions caused by the narrowness, overlap and economic shift in the various tax bases. Given the complexity of modern commercial transactions, this outcome while regrettable, is nonetheless understandable.
Within these developments, the Commonwealth Government has introduced a major tax reform program. The centrepiece was the 1997 Task Force on Taxation, which culminated in the 1 July 2000 commencement of the Goods and Services Tax (GST), which replaced the previous Wholesale Sales Tax (WST) regime and Financial Institutions Duty (from 1 July 2001) with a 10% GST coincident with a reduction in personal income tax. At the same time the Ralph Committee’s 1999 Review of Business Taxation (RBT) process was an attempt to deliver enduring tax simplification and a lower rate of company tax. The various issues for the industry arising from these are dealt with in the following sections, where relevant, and on a stand-alone basis at the end.
A role of bodies like AELA, has always been to assist members and other market participants with the interpretation of statute amendments, as well as to offer informed advice to governments on their drafting and revision. In the context of the major GST and RBT reforms, this role has been even more necessary and encompassing, with the following several key issues the subject of on-going focus.
Leasing and Tax Benefit Transfer
At the Commonwealth level the tax framework applies to leasing such that, provided the equipment is used for business purposes, the lessee claims the lease rental as a business running expense tax deduction. The lessor is generally tax-assessed on the basis that the capital item is being used to produce assessable income: taxable income therefore is lease rentals received less depreciation and any investment (dis)/incentives operating through the tax system and taking into account any balancing amounts (profit or loss on sale) at the end of the respective lease agreement.
For non-lease equipment finance on the other hand, the business borrower claims tax deductions for interest and depreciation and the financier is taxed on its interest income.
Around 20% of national private equipment capital expenditure is leased, with lease finance being widely used by all sectors of the economy. Another 20% or so is financed via chattel mortgage and hire purchase. Compared with such other financing techniques, leasing has a number of competitive features: the lack of equity outlay conserving the lessee’s cash resources; the ability to tailor lease rental schedules to seasonal
or irregular income streams; a lesser effect of the equipment utilisation decision on balance sheet ratios; the