The Australian Energy Regulator (AER) recently announced a review on how much estimated tax it will allocate when making revenue decisions for network businesses.[1] This is, in part, a recognition that network costs have been the key driver of rising electricity prices over the last decade or so.[2] As part of that review, AER has released an issues paper for consultation. We summarise this below.

electricity prices

By Dr Drew Donnelly, Regulatory Specialist, Compliance Quarter

Estimate of tax payments

When setting revenue allowances for network businesses (i.e. deciding how much revenue monopoly distributors are allowed to make), the AER estimates expected tax payments for electricity and gas distributors. By reviewing the current approach to estimating tax, the end result may change the total revenue allowance for network businesses, and thereby contribute to bringing down energy prices.

The estimated tax payment is combined with other calculations in AER’s ‘building block’ approach to its revenue determinations including:

  • return on capital (compensating investors for the opportunity cost of funds invested in the business);
  • return of capital (depreciation, to return the initial investment to investors over time);
  • operating expenditure (covering the day-to-day costs of maintaining the network and running the business).

Differences between estimated tax allowance and actual tax paid

Advice from the Australian Tax Office (ATO) suggests that tax is being over-estimated (i.e. network businesses), particularly for privately-owned network businesses.[3] Possible causes identified by ATO include:

  • Ownership structure. Some structures attract a lower statutory tax rate (e.g. 15%) but the tax is being estimated by AER at the corporate rate (30 per cent);
  • High gearing. Some network businesses might be highly geared (greater than 60 per cent), compared to the benchmark (60 per cent) which means a higher interest expense, and lower taxable income than on AER’s model;
  • Some network businesses may use diminishing value depreciation for tax purposes, and thereby front-load depreciation compared to the straight-line model used by AER;
  • Self-assessed shorter asset lives. This makes the depreciation expense higher than in the AER model;
  • Low-value pools. Network businesses may aggregate assets worth less than $1000 and then rapidly depreciate them, meaning a greater depreciation expense than on the AER model;
  • Prior tax losses not accounted for on the AER model.

AER asks a range of questions, including:

  • Are there other publicly available sources that provide tax data for the regulated networks?
  • Of the available data sources, which are the most appropriate for the purposes of the AER’s review?
  • What information would the AER need to obtain on actual tax payments in order to inform this review and any potential adjustments to the regulatory treatment of taxation?
  • Are there other potential drivers that could cause the difference (between expected tax costs and actual tax paid) identified by ATO?
  • How should we assess the materiality of the potential drivers?
  • Which of these potential drivers should be the focus for the AER’s review?

The issues paper is available at https://www.aer.gov.au/networks-pipelines/guidelines-schemes-models-reviews/review-of-regulatory-tax-approach-2018

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[1] See https://www.aer.gov.au/networks-pipelines/guidelines-schemes-models-reviews/review-of-regulatory-tax-approach-2.

[2] E.g. see https://www.accc.gov.au/publications/accc-retail-electricity-pricing-inquiry-preliminary-report.

[3] See https://www.aer.gov.au/system/files/ATO%20note%20to%20AER%20-%20Comparison%20of%20regulatory%20tax%20allowances%20and%20tax%20paid%20-%2010%20April%202018.PDF.

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