Experts call to delete tax on foreign deposits

David Murray’s financial system inquiry should push to remove withholding tax on non-residents’ deposits in Australian banks to help diversify the funding base of local banks and create more competition from foreign institutions.

Next week’s report from the inquiry should also drive the development of a corporate bond market, back the establishment of a multilateral framework to allow the cross-border marketing of investment funds in the Asian region, and recommend the Australian Securities Exchange should have its 15 per cent ownership limit reviewed, and its monopoly in clearing removed.

These views from the Australian Centre for Financial Studies are expressed in a research paper to be released on Wednesday, which examines the international links between financial markets. It is one of four papers it is releasing ahead of David Murray’s interim report next week.

International deposits comprise about $120 billion, or just 6 per cent of all bank liabilities, according to the ACFS.

Interest withholding tax denies Australian banks and other borrowers access to cost-effective funding, the Australian Bankers Association said in its submission to Murray.

The tax restricts the ability of banks – both Australian and international – to use foreign deposits to improve their liquidity and support their lending in the Australian market.

Outside some exemptions, the 10 per cent tax applies on the gross amount of interest paid by Australian borrowers to non-resident lenders.

Report authors Professor Deborah Ralston, executive director of the ACFS, and Martin Jenkinson, its research officer, find the tax also reduces the ability of international banks to compete in Australia, negatively impacting on competition in the banking sector.

Hong Kong, Singapore, the United States and Britain do not levy withholding taxes on non-resident deposits. The Johnson Report in 2009 and the Henry Tax Review in 2010 called for the government to reduce interest withholding tax.

The 2010-11 federal budget committed to phasing down the tax from 2013-14, but in late 2011 the date was deferred and the Abbott government said last year the phase-down of the tax would be discontinued.

Given the Coalition is planning a tax white paper later this year, the Murray inquiry’s terms of reference say it should “provide observations that could inform the tax white paper”.

The ACFS paper also calls for a financial system inquiry to support the Asia Region Funds Passport, a multilateral framework to allow local fund managers to manage Asian capital and Australian super to more easily invest in the Asian region.

The Financial Services Council has been pushing the passport at regional forums over the past year. Noting only 3.4 per cent of total funds being managed by Australian fund managers come from offshore (compared to 80 per cent in Singapore and 60 per cent in Hong Kong, the ACFS report says: “The potential benefits of increased international flows into Australian investment managers suggest that the implementation of the [passport] would be advantageous to the export of financial services.”

The ACFS also wants policies to assist the development of a more dynamic local corporate bond market, pointing to dangers of over-reliance on offshore funding. Professor Ralston and Mr Jenkinson find only 1 per cent of issued bonds in the Australian market are held by households; less than 1 per cent of Australian fixed interest securities are listed on the exchange; and 90 per cent of Australian non-financial corporate bonds are held by non-residents.

This is making it harder for the Australian financial system to manage longevity risk and is hampering the development of a deep annuities market in Australia.

But the report notes that encouraging the corporate sector to want to participate in a listed bond market is a big challenge.