Ladies and Gentlemen,
It is a great pleasure for me to deliver the opening address for this very timely Summit on Corporate Governance.
Corporate governance
I think its undeniable that the issue of corporate governance and its regulation is one of the most important policy challenges facing governments, business, investors and regulators today.
The quality of corporate governance plays a key role in determining the competitiveness and dynamism of corporations and their markets which, in turn, impact on domestic and global economies.
That said, corporate governance is not a new issue. The definition of a corporation, coined by the US satirist Ambrose Bierce, as "an ingenious device for attaining individual profit without individual responsibility" indicates that concerns about corporate governance have been around for some time.
However, recent corporate failures such as Enron and Worldcom in the United States, and HIH and OneTel in Australia have severely tested investor trust in the conduct of company executives, auditors and directors. As a result, greater attention is being given to the importance of accountability and transparency in the management of corporations.
In developing a best practice corporate governance framework the ASX Corporate Governance Council has noted that good corporate governance must protect the rights of shareholders, recognise public interests and ensure timely and accurate disclosure of material matters concerning the corporation. However, good corporate governance practices may vary from corporation to corporation necessitating a significant degree of self assessment.
Plato observed that "Good people do not need laws to tell them to act responsibly, while bad people will find a way around the law".
This truth has been recognised by this Government when framing its response to corporate governance concerns and the Prime Minister has succinctly noted: "You cannot legislate for integrity".
The Government's challenge is therefore to:
- ensure there is a proper framework to address systemic failures that are identified; and
- identify and tackle impediments to good corporate governance.
This framework needs to be attuned to business practices and the needs of the Australian community. The regulatory response should encourage competition and growth, and protect investors and market participants without stifling innovation or wealth creation.
Clearly corporate governance is not just an issue for Government. It is also an important issue for the business community, the professions and consumers. In fact, while governments play a central role in shaping the regulatory framework, the main responsibility for corporate governance lies with corporations themselves.
Shareholder activism, in particular, is a major force in improving corporate governance. A rapid expansion in the domestic and global share owning population has driven unprecedented power transition to shareholders which will have far-reaching and ongoing consequences for governance.
A global phenomenon bearing on shareholder activism is the rise of pension funds as institutional shareholders. Their rise is driven by the need to fund the retirement of ageing societies. In the US and UK pension funds have become key players in the drive for improved corporate governance as a means of improving investor returns. For example, the California Public Employees Retirement System (CALPERS), the largest public retirement system in the US, has for some time taken a role as a "watchdog" over corporate governance. As shareholders grapple with corporate governance issues they are also adopting systems for monitoring and rating corporate governance. Institutional shareholders can thereby assume the role of an effective corporate governance monitor.
Government's framework for regulatory reform
This Government has a proven track record of providing regulatory frameworks that support key objectives of business and the wider community. We have demonstrated our ability to deal with these important policy challenges by:
- successfully managing an economy that has not only weathered a downturn in global economies but continues to outperform other industrialised economies;
- We have undertaken an unprecedented level of business tax reform and are committed to maintaining its momentum; and
- We are progressively modernising and improving elements of Australia's corporate governance framework through the Corporate Law Economic Reform Program - CLERP.
In addition, the Government is also focussing closely on corporate governance in the public arena.
The performance of statutory authorities and office holders is critical for business and the overall health of the Australian economy. This is particularly the case in the areas of taxation and regulation, where businesses have the right to expect the highest levels of efficiency, fairness and transparency in their dealings with Government.
The Prime Minister has therefore recently announced details of a review into the corporate governance of Commonwealth statutory authorities and office holders.
The objective of the review is to improve the performance of statutory authorities and office holders and their accountability frameworks. It is intended to ensure government practices and structures in statutory authorities continue to reflect the highest standards of transparency, fairness and efficiency.
My focus today is on the role of tax changes in supporting economic performance and good corporate governance. The Government is also seeking to provide specifically targeted measures to support good corporate governance and my colleague Senator Campbell, the Parliamentary Secretary to the Treasurer, will discuss these specific measures in his speech tomorrow.
Australia's economic performance
While the Australian economy is facing a range of external challenges, to date it has exhibited remarkable resilience in the face of these challenges.. It is an uncertain time internationally. But the ongoing strength of our economy is something about which Australia can be proud.
While most indicators point to a continuation of buoyant domestic demand in Australia, a number of risks surround the outlook and it is important to guard against complacency. In particular, the devastating impact of the drought will hurt farm production and incomes while putting downward pressure on overall growth.
In all these circumstances, particularly in the slower growth economies such as the United States, the focus will continue to be directed towards improving structural arrangements in legal and regulatory frameworks, to help underpin confidence, sustain growth rates in the future and to best place Australia to take competitive advantage internationally.
It is axiomatic that good corporate governance includes managing risk in respect of taxation. However, in the Enron case it appears a lack of corporate governance and tax minimisation practices went hand in hand. The company reported profits of around $1.8 billion in the five years leading up to the collapse but paid no corporate income taxes in four of those five years despite reporting an accounting profit in each of those years. While much of the creative accounting practices are alleged to involve the use of off-balance sheet special purpose entiteis to hide debt, it appears that much of the reduction in tax may have been due to tax benefits from stock options and the use of subsidiaries in tax havens.
It is therefore important that our taxation system must be seen to be operating fairly, efficiently and transparently. It should provide certainty and generate compliance costs that reflect proportionately the risks to revenue. Importantly, taxpayers must feel that all are paying their fair share and there is equity in the system.
TAX CHANGES AND ECONOMIC PERFORMANCE
It is also important that our tax system continually responds to emerging global trends, particularly:
- the continuing integration of national economies and the increasing mobility of capital and skilled labour; and
- the increasing importance to Australian companies of both foreign shareholders and foreign source income.
Australia's strong economic performance has been underpinned by tax reform policies introduced by the Howard Government . These measures have provided long term structural benefits to the economy that ensure Australia can now boast a stable economic environment conducive to longer-term productive investment.
Over the last three years this Government has introduced the most comprehensive and successful tax reform in Australian history. The trilogy of indirect, personal and business tax reforms has ensured Australia now has a more efficient, internationally competitive and robust taxation system.
Business tax reform has broadened the business tax base by removing tax concessions such as accelerated depreciation, with the savings used to reduce the company tax rate and allow for capital gains tax reforms.
The cut in the corporate tax rate has meant the rate of 36 per cent of 2 years ago has fallen to an internationally competitive rate of 30 per cent.
Capital gains tax reforms have halved the CGT rate for individual investors and trusts and exempted one third of the gain for superannuation funds. The Government has also provided capital gains tax scrip-for-scrip relief on mergers, and tax relief for demergers.
The new venture capital tax concessions also ensure we have a worlds best practice tax vehicle to encourage additional offshore investment in Australian venture capital.
We have introduced a uniform capital allowance regime to streamline the tax treatment of depreciating assets and recognise a number of blackhole expenses. The introduction of statutory effective life caps for a number of major assets of large and economically significant industries ensures these industries remain internationally competitive and that Australia's depreciation regime does not discourage investment in large infrastructure assets.
We have introduced a new consolidation regime for wholly owned company groups, designed to improve commercial flexibility, reduce compliance costs, and structurally address integrity issues arising from the current tax treatment of corporate groups.
Further business tax reform
The Government remains committed to maintaining the momentum of business tax reform and building on the reforms already in place.
Just as corporate governance is not an end in itself but is an important element in our international competitiveness, another critical issue in that global context is the way in which, and the extent to which, we tax foreign investment in Australia and the foreign earnings of Australian companies.
The reduction in the corporate tax rate; revised tax treaty arrangements with the United States and others planned with key trading partners such as the UK and Germany, together with other recent tax reforms have provided a firm foundation for our tax competitiveness with most other industrialised countries.
The Government is also undertaking a review of Australia's international tax arrangements to ensure they do not impede Australian companies from expanding offshore and to understand how they affect holding companies and conduit holdings being located in Australia. In the context of good corporate governance it has been suggested that Australia's corporate residency rules inhibit Australian companies from placing Australian based executives on the boards of foreign subsidiaries. The review is examining this issue.
The review concentrates on at least four principal areas:
- the Dividend imputation system's treatment of foreign source income;
- the foreign source income rules;
- the treatment of "conduit income," that is foreign source income that flows through an Australian entity to a non-resident investor; and
- high level policy aspects and processes of our Double Tax Agreements.
The taxation treatment of foreign expatriates also is an important issue for consideration. The Government has recently reintroduced legislation into Parliament to remove tax impediments to expatriates relocating to Australia and assist business in attracting skilled expatriate employees. It was disappointing that the Opposition rejected these measures in June but it is hoped that they can yet be convinced that it is essential to remove unfair taxes on foreigners posted to Australia by their firms to grow the Australian business, provide better products and enrich skills in this country.
We have confirmed our election commitment to consult widely with key stakeholders in this review. The Board of Taxation is currently reviewing business submissions as part of this consultation process and will report to Government on outcomes by the end of this year.
The complexity of our tax system
Another important tax policy relevant to our global competitiveness and economic prosperity is the compliance costs associated with our tax laws.
The Government has therefore taken steps to ensure the development of tax policy also conforms to the type of regulatory framework I mentioned earlier -one attuned to business practice and the needs of the community.
These reforms are directed towards enhancing community consultation in the development of tax laws and changing the accountability for tax legislation design from the ATO to Treasury. They act to ensure that tax legislation accurately reflects policy intent.
The Board of Taxation also has a vital and ongoing role to play in ensuring our tax legislation is operating as intended and managing the consultative process on proposed tax policy initiatives.
However, the complexity in our tax laws is not just an unintended by-product of cumulative tax changes. Commercial transactions are highly complex and the tax rules that deal with them reflect that. This is amply demonstrated by the recent consolidation legislation which is undeniably lengthy but which has been developed in close consultation with business.
In a similar way to corporate governance regulation, the design of tax legislation highlights tensions between principle-based law and "black letter" law.
Calls for "principles based drafting" to assist in simplification of legislation often conflict with requirements for certainty. However, there is a need to remove any bias towards tax laws with overly complex anti-avoidance or revenue protection provisions where they are at the expense of unreasonable compliance costs. The Review of International Taxation consultation paper highlights some possibilities to do just this while maintaining tax integrity in the controlled foreign corporation rules.
Tax changes and corporate governance
Tax reform measures rarely impacts directly on corporate governance. However, there has been some public discussion lately about whether the tax law impedes some aspects of good corporate governance. These concerns have been raised in relation to the tax implications of expensing share options.
Executive compensation
Director and executive remuneration has become the focus of increased public attention spurred on by controversy surrounding high termination payouts to outgoing executives and bonuses paid to executives of failing companies. Paul Anderson, ex CEO of BHP Billiton, recently observed that the world of finance had started to resemble the world of sports with "Star" CEOs being viewed as valuable as star athletes.
Expensing share options
While stock options may have a legitimate role in executive compensation, some argue they may have been overused because Board's considered them to be "free". This highlights the need to formally require companies to disclose and bring to account the extent to which they are rewarding senior executives with options and shares.
In the United States, both Government and the community are asking questions about the level and transparency of senior executive remuneration. This is partly due to the recent US experience where stock options may have provided incentives to executives to manage earnings to inflate share prices.
Results of a recent survey by Ernst & Young and Orient Capital concerning executive remuneration highlight Australian companies and their investors had very different views about what constitutes adequate and effective shareholder engagement on executive and Board remuneration issues.
While 89% of investors ranked the remuneration issue as of importance with nearly 50% dissatisfied with consultation levels on this issue only 12% of companies believed it important to consult with shareholders on remuneration issues.
In recognition of these concerns, the Government has responded in a measured and targeted manner to ensure that an appropriate financial reporting framework applies to companies across Australia. This includes the Government's announced CLERP 9 policy proposals on audit regulation and corporate disclosure.
These measures will be supplemented by the Australian Accounting Standards Board's release (and eventual adoption) of an International Accounting Standard on executive share based remuneration. The standard will help to more transparently divulge the nature and amount of executive remuneration by introducing the accounting requirement to expense share options. An exposure draft of the standard was released earlier this month with a final standard likely to be issued in late 2003.
The Government will be encouraging the adoption of this International Accounting Standard from 2005 by seeking to anticipate, as far as possible, any tax or regulatory consequences and ensure they are appropriately dealt with.
Share capital tainting
On the issue of expensing share options, the Government is fully aware of the possible adverse tax implications companies may face as a consequence of expensing share options. Under the share capital tainting rules in the tax law, a company's share capital account may be tainted if the expensing of the share options requires a corresponding increase in the company's share capital.
We will be taking any necessary steps to ensure that the share capital tainting rules, in particular, do not stand as an impediment to ensuring broader corporate governance objectives of increased transparency and accountability are met.
However, I am also aware that the share capital tainting rules are an integrity measure to prevent companies transferring profits and other amounts to share capital, then distributing it as preferentially taxed share capital. Therefore, in resolving this issue, I am conscious of the need to avoid opening loopholes in the tax laws. The Government will carefully consider any future amendment to the share capital tainting rules in this context.
I will make a further announcement on any amendments that may be required to the tax laws in due course.
Deductibility of share options
Another tax issue that has gained recent media and public attention is the tax deductibility of shares and options that are expensed.
Under the current income tax law there is no general deduction available for the granting of share options. The proposal to provide tax deductions for employee share options raises several complex tax issues that need to be carefully considered. For example, the normal basis for providing taxation deductions is that a business has incurred an economic loss or outgoing. The granting of share options would appear generally not to meet this criterion as it appears no economic loss is incurred when the options are granted.
The Government is still considering this issue. I can assure you that in considering this issue, any implications for corporate governance will be taken into account, including whether granting a tax deduction would in fact provide an incentive to issue options.
Conclusion
Results of a recent McKinsey & Company survey of over 200 institutional investors in the US indicated that:
- Corporate governance is on par with financial indicators when evaluating investment decisions; and
- Investors will pay a premium for companies with high corporate governance standards.
This indicates the importance of Australia maintaining our highly respected corporate governance framework. Supporting good corporate governance remains an important challenge for the Government - one the Government is well placed to achieve given our proven track record in formulating regulatory frameworks to support key business needs such as tax reform and sound economic management.
I began by stating that developing a proper framework to support good corporate governance is not just an issue for Government. I have heard it said that "Boards of directors are like subatomic particles - they behave differently when observed."1 The role of boards of directors is now clearly in the spotlight and must clearly focus on sustainable corporate governance measures.
Thank you.