The Uncomfortable Truth about Taxation and Investment: Why investors can no longer turn a blind eye on tax

This week Burger King announced it would acquire Canadian coffee chain Tim Hortons and would move its headquarters to Canada. The move sparked outrage including from Democrat Senator Sherrod Brown who called for a boycott of the chain. Missing from the debate was the voice of investors.

The concern about Burger King’s merger with Tim Hortons is not about burgers and coffee. It is all about tax. This week’s Rolling Stone article The Biggest Tax Scam Ever summarised the issue. “A loophole in American tax law permits companies with just 20 percent foreign ownership to reincorporate abroad, which means that if a big U.S. firm acquires a smaller company located in a tax haven, it can then “invert” – that is, become a subsidiary of its foreign-based affiliate – and kiss a huge share of its IRS obligations goodbye.”

The Burger King deal is the latest case of corporate taxation minimisation that has earned the ire of the US President Obama who stated earlier this year, “Even as corporate profits are higher than ever, there’s a small but growing group of big corporations that are fleeing the country to get out of paying taxes. They’re technically renouncing their U.S. citizenship, they’re declaring their base someplace else even though most of their operations are here. You know some people are calling these companies ‘corporate deserters.’”

According to Rolling Stone, taxation inversion is only one example of corporation focus to reduce taxation. “Profits were up $93 billion last year – to a high of $2.1 trillion, according to the Commerce Department. Yet corporate tax payments actually fell last year by more than $15 billion.” Corporate profits and corporate taxation collections are now trending in opposite directions.

The issue of corporate taxation is a global issue. In Australia the taxation paid by companies including Google and Apple has attracted attention of parliamentarians with questions as to why Google’s total tax paid last year was only $466,802.

As Marc Gunther, the Guardian’s Editor at Large of Guardian Sustainable Business says, “Something’s clearly fishy here – how else could a place like Bermuda with a GDP of $6 billion, be a place where US businesses report $94 billion in earnings?”

Investors have been noticeably silent in this debate. The uncomfortable truth for investors is that they have the ability to gain in the short term if a company reduces its taxation bill. Should investors be advocating for reform, even if there is a short term impact on company profitability?

To answer this it is worth gazing into the crystal ball to consider how the debate on corporate taxation will progress. The one certainty in politics is that for every action there is always a reaction.

Governments will consider reforms to corporate taxation because they have to. They simply cannot afford to lose revenue from their budgets at a time when their fiscal position is so tight – and will only become tighter as the looming demographic bills for health and pensions become due.

But governments will also be constrained politically by their electorates who are finding that, whatever their sphere of work, pay increases are difficult to obtain, and cost of living pressure will mean corporate taxation will come to be seen as all about fairness and equity.

It is not a question of whether governments will act, but how.

The question for investors is what should their role be in the debate on taxation. The way governments shape taxation systems has significant implications for inequality, for capital formation and for economic development – all of which ultimately impact on long term investment.

Because taxation ultimately influences long term investment returns, investors need to develop and advocate positions, not just on corporate tax, but on the whole taxation system.

Long term investors can no longer afford to be silent on tax.


The Biggest Tax Scam Ever

Ending the race to the bottom: why responsible companies should pay taxes

Is the Burger King-Tim Hortons Deal About More Than Taxes?

Refugees and Investment: Creating Connections

On Tuesday 19th August, Australia for UNHCR hosted its first Melbourne fundraising luncheon. Representatives from the finance sector including many superannuation funds raised funds to respond to key humanitarian crises in Syria, South Sudan and the Central African Republic.

One of the highlights of the luncheon was the chance to hear the story of Garang M. Dut, a Sudanese refugee who was born in Southern Sudan in 1987. Garang ultimately spent most of his childhood in refugee camps including the Kakuma Refugee camp in remote Kenya.

Garang learnt to write in dirt in an open field in 40°C temperatures. His intellectual capacity shone through even in this harsh environment as he topped his classes, being rewarded with additional pencils and writing materials. In 2005, Garang arrived in Australia and went to school at Sunshine Secondary College where he finished second in Year 12, narrowly missing out on his ambition to study medicine. Not to be daunted, Garang studied Biomedical Science at Monash University, recently transferring to Melbourne University where he will soon graduate as a doctor of medicine.

Garang’s story is one that has been repeated by migrants to Australia, who through competence and persistence have achieved incredible outcomes against incredible odds. One of the questions from talking to Garang is what role the finance sector can play supporting refugees?

One of the things that we know is that when refugees leave their home country they do not extinguish their links. We also know that countries that are impacted by conflict can achieve peace.

A great case study is Rwanda, a country that was racked by genocide exactly 20 years ago. Today the country is climbing up indexes that measure development and social progress. Yes, the country undoubtedly still has problems, but it is developing economically, including an emerging finance sector. An example is that this week Rwanda raised a 5 year local currency bond worth $21.87 million that will help to build the nation’s infrastructure.

The interesting thing is how Rwanda’s Diaspora is supporting the economic development of the country. The year before the Rwandan genocide remittances to the country amounted to around $12M. The country is now receiving on an annual basis around $76M a year. The flow of capital is consistent and likely to continue to grow over time.

The question is what can be done to support the remittances for refugees? There are a couple of things that can be done.

The first is to make refugee remittances tax effective by allowing tax deductions. This seems an obvious thing to do. The sacrifice that refugees make to send home is significant and should be recognised as part of a nation’s aid budget.

The second thing that can be done is to make remittances efficient by supporting the development of financial institutions that operate on a not for profit basis. There are financial institutions that do a good job of getting money to people in remote areas but their fees are expensive, and this is ultimately a transaction cost that is an impediment to economic development. The World Bank has established an international database of remittance prices that is aiming to provide disclosure of remittance fees. This is a good initiative but it does seem that the finance sector could intervene through its community investment programs to establish an impact investment that cut the cost of transacting. There are a number of exciting initiatives developing including using Facebook to facilitate transfers. With US $414 billion of remittances to developing countries on an annual basis, reducing transaction costs can make a material impact on economic development.

A third area where the finance sector can make a material contribution is by supporting greater linkages between Less Developed Countries (LDC) and the finance sector. Academic research has demonstrated that there is a clear link between the development of a nation’s finance sector and poverty alleviation. And yet little is done from an aid perspective to support the development of finance skills in LDCs.

A lot of work has been done in LDCs to develop market structures including stock exchanges. There are for instance around 34 separate stock exchanges in Africa. One thing that the finance sector could do is to support the development of finance sector skills by providing education for market regulators. This in turn would build confidence of investors to enter LDC capital markets.

The Australian Government is currently seeking to establish a new Colombo Plan that would provide education as a way of contributing to aid. It would make sense if the revised Colombo Plan had a focus on building finance skills to enable nations to develop their own capital markets.

Superannuation is a long term investment and therefore thinking long term should be something we are comfortable doing. Just as Rwanda is emerging from chaos, so ultimately with the right support could Sudan. In another twenty years it could well be that Australian superannuation funds are investing in Sudan, developing the country’s rich environmental and mineral resources.

But to make that happen, we need to be prepared to broaden our horizon today.

To donate to UNHCR go to:

Challenging The Attack on Growth Assets

It is perhaps advisable in life not to take on academics as the one thing that they do well is to argue. However the time has come for a stronger defence of the role of growth assets in investment portfolios.

My focus is a paper by professors Geoffrey Kingston and Lance Fisher from the Department of Economics at Macquarie University entitled “Down the retirement risk zone with gun and camera.” I have attached a link to the paper and recent trade press articles at the end of this blog.

Kingston and Fisher’s paper consider retirement risks and considers issues such as sequencing risk. Their core argument is that superannuation investors should reduce exposure to growth assets. They state:

We argue that sequencing risk has largely been a consequence of the dominant strategy for allocating assets in superannuation accounts. That strategy is aggressive constant-mix: allocate a high and stable share of the portfolio to growth assets. Almost all Australian providers have stubbornly adhered to aggressive constant-mix, despite the lingering fallout from 2008. That aggressive constant-mix is the industry standard is no coincidence. Superannuation balances typically peak in the neighbourhood of retirement, and the fees charged by fund managers are usually higher for growth assets than interest-bearing ones. So providers profit from aggressive constant-mix. Strong vertical integration of the Australian personal finance industry implies that financial planners typically benefit as well. And trustees enjoy a quiet life when people of different ages in the same workplace see the same superannuation returns when they compare annual statements.

If we didn’t get the message that the superannuation industry is not behaving responsibly then the authors drive the point home stating that “it is time that Australian practice shifted away from mindless constant-mix. Responsibility rests with the industry, ASIC, APRA and individual households.”

The first point is that by putting growth and defensive assets in a bucket is problematic. The superannuation industry has done a good job of educating consumers that fixed interest and bonds are defensive investments whilst shares are growth assets. However the superannuation industry itself has moved away from a simple classification of risk with the Standard Risk Measure providing guidance for how risk should be classified.

The point is that what are considered defensive investments such as bonds can be risky, whilst so called growth assets such as shares can have low volatility.

No one would think of Greek sovereign bonds as having low risk. Similarly there are companies such as Coca Cola that are less risky than other equity investments.

The other point is to understand growth and defensive investments in an Australian context.

One of the things that has always been said to me is that equity portfolios are managed differently to fixed interest portfolios. In order to achieve the desired risk and return objective from an equity portfolio a relatively small number of stocks are required. By contrast because fixed interest investments have a cap on their returns, but still have the capacity to lose capital, to deliver the desired risk and return objective it is necessary to invest in a breadth of investments. Fixed interest portfolios typically have a larger number of investments.

This represents the problem in the Australian context. The structure of the Australian capital market is that we have a small number of very large companies, and a large number of very small companies. The superannuation industry has already collectively reached the point where it will be necessary to invest more offshore as the local market is unable to absorb the flow of super contributions.

There has been a lot of discussion about the need to develop a corporate bond market in Australia. Whilst I would expect that the Australian market would evolve over time, if Australian superannuation funds shifted their investment strategies as Kingston and Fisher are advocating, the result would be that superannuation capital would flow offshore in order to find the diversity of fixed interest investments that would be required. That would require superannuation investors to increase the hedging of their portfolios in order to manage one of the major risks to capital; currency risk.

One of the questions for investors approaching retirement is volatility. Inflection Point Capital Management is looking at whether it is possible to achieve a lower volatility portfolio by investing in a portfolio of quality stocks. Inflection Point Capital’s methodology looks not only at environmental, social and governance factors as an indication of management quality, but factors such as innovation and agility. One of the things that we understand is that the world in the future will be volatile. A confluence of megatrends from climate change through to digital disruption and demographics will shape our society in coming decades. The companies that understand and adapt to their environment will also be those that are likely to provide investors with lower volatility.

Managing retirement risk is an issue that will impact on all western societies. Answers lie, not necessarily in investing in defensive investments, but considering new ways of investing.


Recent Trade Press on the Kingston and Fisher paper:

Geoffrey Kingston and Lance Fisher, Down the retirement risk zone with gun and camera, Department of Economics at Macquarie University, CIFR WORKING PAPER NO. 005/2014
MARCH 2014
See and

Investment in Australian Agriculture

Presentation to Victorian Farmers Federation Conference

Gordon Noble
Managing Director
Inflection Point Capital Management

Delivered 12 June 2014

Today I will focus on the role that Australian superannuation funds can play investing in agriculture. But before I do that I will briefly talk about why I am here today and the perspective that I bring.

Inflection Point Capital Management is a new boutique investment firm that has its operations in London and Paris. We have established a joint venture with a French fund management group La Francais which is in turn owned by a French cooperative bank.

Our focus is the impact that environmental, social and governance issues can have on investment returns. We have established our own five factor model which analyses the innovation and agility of companies that we invest in based on our strategically aware investment methodology.

Basically what we believe is that the companies to invest in are those that understand the world we live in and actively seek to respond to change.

One of the things that we pay very close attention to is mega trends.
In terms of the farm sector the megatrends that are of particular focus are:
• Food security
• Urbanisation
• Rise of developing world
• Obesity in developed world
• Climate change

Each of these megatrends will shape agriculture investment in the coming decades and are already influencing investments of major pension funds globally.

Food Security: the global food security crisis in 2007-2008 has left the developing world focused on food security. As global population increases from 7 billion where it is today to 9 billion by 2050 there will simply be more people to feed. The demand for food commodities will encourage investment but we are also likely to see more regulation of trading to prevent speculation.

Urbanisation: Over the next 15 years alone an additional 1.4 billion people will move to urban centres. One of the positives of urbanisation is that it supports development of super markets and more sophisticated transport logistics for food.

Rise of the Developing World: The rise of China, Africa and Latin America will create a new middle class that will consume more protein. Much protein production will be domestically focused but will require massive amounts of feed that provide growing market opportunities.

Obesity in the developed world: Whilst the developing world is focused on feeding itself and protein we will see much more focus on health in the developed world. It is estimated that there are 400 million obese people in the world. The health cost of obesity will lead to changes in the way we all eat which will in turn support new markets.

Climate change: From an investment perspective climate change will lead to a focus on diversity of investment from a geographical and crop perspective. It will also encourage greater investment in infrastructure such as irrigation and dams. Investors when assessing farmland investments will look for established infrastructure that will reduce volatility of returns.

In terms of investment in farmland there is no shortage of capital that is looking to invest.

The global understanding of the megatrends I have described has led pension funds to allocate investment to farmland. Funds that are investing include US TIAA-CREF, Swedish AP2 and AP3, Netherlands APG, Canada Pension Plan Investment Board and NZ Super.

We are already seeing some of the largest pension funds in the world look to Australia for investment in farmland attracted by our diversified climate, strong infrastructure and rule of law.

There are a small number of Australian superannuation funds that have invested in farmland but they have generally found it a difficult investment.

I would like to talk about why it is that Australian super funds find it difficult to invest in farmland, whilst pension funds around the world are increasingly interested in investing.

The answer relates to the superannuation system that we have created. Whilst you can’t get access to your superannuation until you retire, which may be 20 or 30 years away, we have established a system where we must manage investments on a short term basis.
The reason for this is choice of fund. We have the right to move our super from fund to fund, and to different investment choices within days. This has meant that the industry’s regulators have had to regulate the liquidity of superannuation fund investments.

Whilst superannuation funds are able to invest in illiquid assets they can only invest a small proportion of their total assets.

The challenge for farmland is that from the perspective of the way superannuation funds are regulated farmland is an illiquid asset.

Over the next couple of decades we will see superannuation system increase from $1.7 trillion to around $6 trillion. Over this time we will see the emergence of very large funds that will have capacity to invest in illiquid assets. The megatrends – which won’t go away – will provide strong incentives to invest in agribusiness. So the future conditions should favour farmland investment by superannuation funds. However we cannot take this for granted.

To encourage superannuation investment in farmland then there needs to be a focus on removing the impediments to investment – the chief of which is liquidity. The Prime Minister’s White Paper on Agriculture and the Financial System Inquiry may offer some options that can form a basis for future reform.

To conclude long term investors such as pension funds and superannuation funds are potentially great partners to invest in farmland. Long term investors are not looking to flip out of an investment to make a short term return. They are here for the long run and therefore have an interest in ensuring that farming is sustainable for generations to come.

Superannuation’s Licence to Operate

(First printed in ASFA Magazine June 2014)

Western Australia Premier Colin Barnett recently delivered a blunt speech to Western Australia’s booming gas and petroleum industry.

Barnett stated “I put it to you, it’s a hard narrative to sell to the community or a government that we are going to increase production of gas and we are going to export it and in the meantime gas supplies might be diminished and the domestic price will go up. I am a politician. I am pretty good at selling a story. I find that one tough to sell. You can’t say to people gas production is going up and by the way your supplies are going down and the price is going up. Stop reading American management books. Think a bit broader. The ultimate social licence is not what you may think it is.”

Barnett went on to state, “the ultimate [social] licence is getting agreement and alignment with both the national and state governments in Australia. That’s the licence that counts. That’s the one you must secure to develop Australia’s natural resources.”

Whilst focused on the gas industry, Barnett’s comments raise the question what does ‘licence to operate’ mean for the superannuation industry?

Social licence is at best a fuzzy term. Unlike our driving licence there is no grand department where companies and industries can line up to have their ‘social licence’ stamped and renewed. The best definition of social licence can be described as a stakeholder perception of the legitimacy of a project, a company or an industry. Using that definition the superannuation industry has a problem.

Over the last few years superannuation has taken a battering that shows no sign of abating. In the last months alone media commentators have lambasted Australia’s superannuation system and have gone as far as saying that superannuation has failed. How did we get here? More importantly what we can do about it?

A starting point is to understand why stakeholders may be criticizing super. Rather than jumping into a debate on fees, investment returns and customer service, let’s take a step back and look at the different groups of stakeholders that have a problem about super; members, government, civil society and business and try to understand what they are concerned about.

For superannuation members the challenge is that superannuation at its heart is a product that is based on an aspiration that life in the future can be better. Perhaps that is part of the problem. The promise that superannuation is holding out, to make the future better, may be in itself a source of stakeholder discontent. The problem with an aspirational product is that if the reality falls short of the objective then the customer is left more dissatisfied than if the product was just an everyday consumer good where there weren’t great expectations.

For twenty years following the introduction of the SG the superannuation industry didn’t have to worry too much about aspirations falling short. That was because most of the people in our system had not retired. For those that retired in the last 15 years they knew that they were late to super and therefore their expectations were lower. However as the baby boomers reach retirement we are dealing with a group that does have aspirational expectations in regards to their super. For Generation Y and Z, who are entering the workplace with the expectation that they will retire at 70 there is a cynical view as to whether a better future is possible at all.

The second key stakeholder is government. Superannuation has been cast as a two pillar relationship between member and fund. In fact it has always been a three pillar relationship – member, fund and government. There are many ways over the last twenty years that the Federal Government has demonstrated that they are a key part of the superannuation system. By and large however Governments have been a silent stakeholder. When economic times were good and the cost of superannuation on the Federal Budget was manageable, the Government largely left superannuation funds alone.

The future fiscal position for Government is not so rosy and will be a major reason why the Federal Government focuses on superannuation. Over the next two terms of parliament we can expect to see more focus in this area to make the system sustainable. To understand the reason why this will happen we need to unpack the Federal Budget. We know from the work of the Grattan Institute that the deterioration of the Government’s fiscal position is largely based in a blow out of health expenditure. As the Grattan state, the increase in government spending is driven above all by health spending, which in the past 10 years has risen by more than $40 billion a year in real terms. The cause is not the ageing population but the fact that people are seeing doctors more often, having more tests and operations, and taking more prescription drugs.

We have yet to feel the full impact of our aging population on the Government’s position. Over the next decade a significant portion of baby boomers will retire. By the time the baby boomers have left the work force we will see a permanent change in the structure of the proportion of workers supporting pensioners. This will further erode Government’s fiscal position as the full cost of pensions hits the Federal Budget.

Superannuation is one of the biggest expenses the Federal Government faces. There is a significant political debate about how Governments should handle this. One example is the debate about accessing the pension at 70. Whilst this doesn’t change the amount of money in an individual’s superannuation account for many Australians it will significantly change what they can do with that money. For those, including blue collar workers, that are unable to work until 70 due to physical health, the increase in access age will in reality mean that superannuation will be used to pre-fund retirement before accessing the pension at 70. Instead of super being a top up to the age pension it will be become a pre-funding account.

The age pension debate illustrates why the third major stakeholder, civil society, criticizes super. Superannuation is now in direct competition with other ways that government can spend money. In order to demonstrate why a particular way of spending money is desirable, it is necessary to demonstrate why government expenditure on super is not effective in meeting social goals.

The fourth area of criticism about super relates to the way super invests. When the Australian economy was strong and unemployment was trending downwards – which represents most of the history of the SG – the way in which super invested was largely ignored.

Whilst long predicted by economists it is now clear that the mining and resources boom is on the wane. As manufacturing industries contract there is understandably angst in the community about where jobs are going to come from.

Superannuation collectively is the biggest pie in the Australian economy. How superannuation funds invest will make a material difference to the way in which the economy develops. The Financial System Inquiry will focus on the role that superannuation plays in capital formation. Whatever the Inquiry concludes Australia’s political parties of all persuasions will increasingly focus on how superannuation invests.

To understand why this will happen, it is only necessary to go back to Colin Barnett’s comments at the start of this article. Barnett is right; politicians know how to sell a story. But what he doesn’t say is that they also know how to shift blame to someone else.

The best example of this is the banking industry which has a long history of being the scourge of politicians. In the late 1990’s the banking sector was on the front pages of papers on a regular basis as banks closed branches, increased bank fees and made record profits. There were numerous banking inquiries that provided ample opportunities for politicians to criticize banks. Labor at the time went so far as developing a banking social charter as a core part of its election commitments in the 2001 Federal Election.

One of the things that came out of the period that the banks were subject to public criticism was that the major banks all developed their own commitments to corporate social responsibility and sustainability. Compared to 13 years ago the banks are now regarded as leaders when it comes to sustainability and CSR. This is not to say the banks are perfect, but they have realized that the only way to address social licence issues is by focusing on the issues themselves.

This is also the answer for the superannuation industry. No amount of media campaigning will result in positive outcomes if the fundamental issues that are of concern to members, governments, civil society and business are not addressed. So, how do we start?

The first place to start is to acknowledge that superannuation, like other sectors of the economy, is subject to a social licence. We need to learn the lessons from those that have been here before. One of the lasting outcomes of the early campaigns against Nike and Shell was the development of sustainability reporting. A couple of funds in the superannuation industry have dipped their toes into this area but largely our industry has believed that CSR/ sustainability reporting is for others. It is not.

Sustainability reporting is not an end in itself. It must be back by real concrete work that seeks to address the issues that are of most concern to stakeholders.

The superannuation industry must be careful not to be complacent about its position in society. Social licence may be a fuzzy concept but it is real. We are entering an era of change where everything is up for grabs. When respected commentators say superannuation is failing we shouldn’t ignore them but take a good hard look at what we are doing to ensure that we retain our social licence in coming decades.