23G – Tax Exemption Gained & Lost

The Australian customer owned banking sector has had many internal debates and private meetings with politicians regarding taxation at state and federal level. Famously, Australian credit unions were granted an income tax exemption in 1974 only to have it revoked in 1995.

A 2018 article in American Banker compared the history of taxation of credit unions in America with those of comparable institutions around the world. It noted that “Credit unions in the U.S. have successfully defended efforts — both in Congress and in the courts — to keep their exemption to federal taxes.

“But the battle extends well beyond this country, and elsewhere, credit unions haven’t been so fortunate. From Canada to Eastern Europe to Australia, the credit union movement’s tax exemption has been under fire”.

The article also refers to research conducted by the World Council of Credit Unions (WOCCU) that reveals about 70% of the world’s credit unions are like those in America and do not pay corporate income tax at the national or federal level.

When the Australian Federation of Credit Union Leagues (AFCUL) formerly set forth its major goals in 1968, “fight state and federal taxes hindering credit union development” and “fight legislation harming credit unions” were two of seven proposed goals.

Dermot Ryan, President of AFCUL and experienced credit union operator, was a significant champion of the tax emption cause and he led AFCUL’s participation in two unsuccessful attempts at gaining tax emption at state level in NSW and South Australia.  Both campaigns went to the High Court – the first lost on a technicality and the second lost because the “mutuality principle” was said not to have been met in the required circumstances to grant a tax exemption under the legal definition.

In 1970, Ryan made a famous trip to Canberra and met with the federal ALP leadership group, including opposition leader Gough Whitlam, and extracted a promise from them to exempt credit unions from federal income tax in 1970 should they win the 1972 election. Whitlam wrote the following in a letter to Ryan:

On behalf of the Federal Parliamentary Labor Party I am happy to repeat the undertaking I gave the federation … A Federal Labor Government will also make the income of credit unions exempt from income tax.

Having won the election, the new government made good on their promise. Speaking at the AFCUL AGM in March 1974, Federal Treasurer Frank Crean said:

I am pleased to be able to announce the government’s decision to introduce legislation to amend the Income Tax Law to exempt from income tax interest received by credit unions from the members, to take effect in relation to income earned during the 1973-1974 income year … That will mean that only income earned from ‘outside’ investments will continue to be assessable as by far the largest part of interest received is on borrowings by members. The result of this concession will be to leave most credit unions either free from income tax altogether or with a relatively small annual income tax liability derived from outside investments.

The resultant Financial Corporations Act of 1974 required credit unions to register as a Non-Bank Financial Institution (NBFI) if assets surpassed $1 million. While some in the movement were concerned about excess government control most considered it a boon.

What the Labor government of 1974 gave, the Labor government of 1995 took away when it abolished the relevant tax exemption under Section 23 of the Income Taxation Act. Banks lobbied for the change to create a “level playing field”.  It was a time of financial “deregulation” and “economic rationalism”. Some could see the upside of the new era. The new regulation meant credit unions could now offer many of the products and services that they couldn’t before and therefore offer a more competitive suite of financial products.

At the time the 23G legislation was amended Cuscal was the peak body for the Australian credit union movement and they were unequivocal on the matter. Cuscal’s National Bulletin of 31 August 1993 is titled, “Urgent! Immediate Action Needed to Fight 23G Removal”. In part it reads:

Our negotiations with government and the Democrats have reached a critical phase. A number of credit unions have contacted their local MPs and demanded the tax be overturned.

But we need to provide the politicians in Canberra with compelling evidence that credit unions, individually and as a movement, reject this tax.

There is no time to lose. Over the next 24 hours we urge your credit union, its directors and members to swamp politicians with telephone calls and faxes demanding that 23G stay in force.

By October 1993, Cuscal was mourning the loss of the income tax emption as evidenced by the title of the National Bulletin of 26 October 1993, “Credit Union Taxation – Vale 23G”. This is not to say that Cuscal was wedded to the status quo and offered alternatives to the legislation as presented that would in their opinion see credit unions pay their fair share of tax while not being unfairly rendered less competitive.

The new legislation allowed small credit unions with assets under $30 million to retain the tax emption but Cuscal argued the tax emption limited to small credit unions offered them a perverse incentive not to grow.

Cuscal’s preferred amendment to the legislation was:

Exempting from income tax the first one percent return on assets, thereby ensuring capital growth sufficient to support reasonable asset growth, but taxing all income thereafter at the full corporate rate;

In a variation of the first proposal, linking the exemption threshold to capital adequacy rather than return on assets; and

Forfeiting the benefit of s.23G but then paying tax at a permanently reduced rate (as in Canada). Of course, these concessional arrangements inevitably lapse in time.

In the above American Banker article, Michael Edwards, Vice President of Advocacy and General Counsel for WOCCU, gave his opinion on the effect of the  tax changes:

The Australian credit unions and other mutual depository institutions, such as mutual banks and building societies, have not grown very much in recent years in large part because it is difficult to build retained earnings when the institution has to pay taxes with its earnings rather than retain them.

Below are videos of the Senate Standing Committee – Finance and Public Administration October 1993 – hearing into the revoking of credit unions’ federal income tax exemption under Section 23G of the Income Taxation Act. Includes evidence presented by Cuscal representatives Graham Loughlin and David Taylor as well as Mike Ahern from the National Credit Union Association.