Department (If Treasury and Finance Foreword InApril 1995, the Commonwealth, State and Territory governments signed three interrelated agreements which collectively underpin National Competition Policy (NCP). The Victorian Government is committed to the ongoing implementation of NCP in a considered and responsible manner. This means that public interest considerations should betaken intoaccount explicitly in any Government decisions onthe implementation of NCP. Under the Competition Principles Agreement. Victoria is obliged to apply competitive neutrality policy and principles to all significant business activities undertaken bygovernment agencies and local governments. The Victorian Government will fulfil this obligation and also meet its wider responsibility to the community byrequiring competitive neutrality beapplied only where it is in the public interest to do so. ( Competitive Neutrality Policy Victoria (CN Policy) sets outthe newVictorian approach to competitive neutrality. Competitive neutrality involves achieving a fair market environment by removing or offsetting any competitive advantages or disadvantages dueto public ownership of the government business. However, competitive neutrality does not override the range of social, environmental, economic and regional responsibilities of Government agencies, which mustbetaken intoaccount in determining whether the application of CN Policy is inthe public interest. The application of CN Policy can improve the accountability and transparency of Government agencies when engaging in a range of commercial activities. This will improve the ability of agencies to deliver key outcomes in an efficient and effective manner. Business confidence and investment should also improve as private sector firms compete on a more equal footing with government agencies. This Guide has been prepared to assist agencies to implement the policy outlined in CN Policy, released in 2000. The Guide updates the previous version released in May1997 and should be read in conjunction with the newCN Policy. Competitive neutrality also applies in local government butcouncils will apply it in anoperating environment provided bythe BestValue Principles (BVP) as . set out in the Local Government Act 1989 A separate guide will be developed, in consultation with the sector, to assist councils to apply competitive neutrality withinthe BVP context. These guidelines will bedeveloped afterthe Minister for Local Government releases the BVP framework.. CN Policy recognises that Government agencies and local governments have responsibility for achieving anarray of social, environmental, economic and regional objectives. Inapplying competitive neutrality, agencies and local government first determine whether a business activity is "significant" or not. Following this step, an agency or local government considers the costsand benefits of introducing a competitiveneutrality measure. If the benefits are greater than costs, agencies or local government would then need to consider whether implementation of a competitive neutrality measure is in the public interest. A public interest test provides a means bywhich the objectives of competitive neutrality can bebalanced with the key priorities and public policy objectives of the government agency such asthose considered under BVP in local government. A public interest test is introduced under the CN Policy framework, Many of the updates in this Guide reflect issues raised bystakeholders that have applied CN Policy. In particular, the Guide has been simplified with practical stepbystepinstructions onhowto make particular competitive neutrality cost adjustments, These adjustments need to beundertaken only afterthe government agency or local government has considered the steps outlined above. The Guide will be updated over timeto reflect changes in taxation, regulatory and institutional factors that impact onthe application of competitive neutrality, I commend this Guide to you as an important aid to ensure that the Government's competitive neutrality pricing principles aretranslated into effective and practical implementation strategies. Ian Little Secretary Department of Treasury andFinance Table of Contents Foreword Table of Contents Chapter 1: Overview 1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Scope and purpose of the guide What is competitive neutralityandwhy is it important? Competitive neutrality in the localgovernment environment Policy implementation What is a "significant " business activity? Assessment of benefitsand costs of introducing a competitiveneutrality measure The publicinterest test Competitive NeutralityComplaints Unit 1 1 2 2 3 4 5 7 9 Chapter 2: Implementation of Competitively Neutral Pricing Principles 2.1 2.2 Defining the output Calculate the competitively neutral cost of the output 2.2. 1 Adopting a costing methodology 2.2.2 Calculate the actual costs incurred in producing this output 2.2.3 Add competitiveadvantages 2.2.4 Subtract competitive disadvantages Settingthe competitively neutral price Applying the publicinterest test 2.4.1 Identification ofpolicy objectives 2.4.2 Competitively neutralprice and public policy objectives 2.4.3 Alternativesto meet the policy objective 9 10 10 11 12 12 13 14 14 14 15 19 2.3 2.4 Chapter 3: Making CostAdjustments 3.1 Competitive neutralityadvantages 3.1. 1 Actual cost ofproducing output 3.1.2 Goodsand Services Tax and wholesalesales tax 3.1.3 Stamp duties 3.1.4 Costof capital 3.1.5 Landtax 3.1.6 Localgovernmentrates 3.1.7 FinancialInstitutionsDuty (FlO) and debits tax 3.1.8 Pay-rolltax 3.1.9 Accident compensation levy (WorkCover insurance) 3.1.10 Advantages in borrowing funds and exemptionfrom the Financial Accommodation Levy(FAL) 3.1.11 Additional private sector regulations or requirements 3.1.12 Free or below-cost accessto corporate overheads Disadvantages 3.2.1 Superannuation 3.2.2 Government awards 3.2.3 Inheritedhigher cost structure 3.2. 4 Accountabilitycosts and legislativeand regulatoryrestrictions 19 19 19 20 20 22 22 22 23 23 23 24 24 3.2 24 25 25 25 26 Chapter 4: Case Study 27 4.1 Hypothetical example of the application of competitively neutral pricing principles 27 4.7.7 The output 4.7.2 Calculate the actual costs incurred inproducing this output Potential advantages 27 27 28 4.7.3 Exemption from sales tax 4.7.4 Exemption from stamp duties 4.7.5 Cost of capital 4.7.6 Exemptionfrom land tax 4. 7. 7 Exemption from local government rates 4.7.8 Exemptions from FlD anddebits tax 4.7.9 Pay-roll tax 4.7.70 Accident compensation levy (WorkCover insurance) 4.7.77 Other potential advantages Potential disadvantages 28 28 29 29 30 30 30 30 30 31 4.7.72 4.7.73 4.7.74 4.7.75 Glossary Superannuation Accountabilitycosts Netacfjustment to totalcost Competitively neutral pricing 31 31 32 32 33 Appendices Appendix 1: NationalIndirectTax Reform 3S A7.7 A New Tax System A7.2 Other implementation issues relating to the New Tax System Appendix 2: Appendix 3: Appendix 4: Appendix S: Appendix 6: Appendix 7: Appendix 8: Appendix 9: Rate of Return SalesTax Land Tax Local Government Rates StampDuties Financial Institutions Duty DebitTax Pay-Roil Tax 35 36 37 38 39 40 41 42 43 44 Appendix 10: Freeor Below-Cost AccessToCorporate Overheads Appendix 11: Superannuation Appendix 12: OtherCompetitive Advantages And Disadvantages 46 47 48 A72. 7Accident compensation levy (WorkCover Insurance) A72 Advantages in borrowing funds andexemption from the .2 Financial Accommodation Levy A72 Additional public orprivate sector regulations orrequirements .3 Appendix 13: SpecificCompetitive Neutrality Issues 48 48 49 50 A73.7 Contracts pre-dating CN policy extending beyond 7July 7997 A73.2 Use of avoidable cost methodology A73.3 Exclusive use of government advertising media A73.4 Commercial-in-confidence 50 50 51 51 Overview 1.1 Scope andPurpose or the Guide This Guide. which accompanies the new Competitive Neutrality Policy Victoria (CN Policy), has been developed to assist government departments, agencies and local government entities in:' • meeting the documentation and evidentiary requirements of the new policy oncompetitive neutrality; and adopting anappropriate competitiveneutrality measure. Inparticular, calculating the competitively neutral costadjustments to derive the appropriate full costbase for setting the price of a relevant good or service. This Guide focuses on full costreflective pricing as the primary toolfor implementing competitive neutrality astheother two structural responses namely corporatisation and commercialisation are less frequently used. Guidelines on howto implement corporatisation and commercialisation have been set outin other Victorian Treasury publications such as Assessing Corporatisation Proposals andImplementing Corporatisation Proposals (1997). 1.2 What is competitive neutrality andwhy is it important? Under Clause 3(1) of the Competition Principles Agreement, theobjective of competitive neutrality is... "theelimination of resource allocation distortions arising out of the public ownership of entities engaged in significant business activities: Government business should not enjoy any net competitive advantage simply as a result of theirpublic sector ownership. These principles only apply to the business activities of publicly owned entities, notto the nonbusiness, non-profit activities of these entities." It is common for private businesses (including both for profit and not-ror profitentities) to coexist with government businesses in a variety of markets. They donot always compete on equal terms. Such inequalities arisefrom a variety of circumstances and it is the goal of CN Policy to offset these where appropriate. The inequalities of concern arise from differences intax treatment. differences in the need to provide a return oninvestment, and related costadvantages ordisadvantages which might impact onthe prices that are set bygovernment businesses. The aim of CN Policy is to account for these differences in such a waythatwhere governments undertake significant business activities in markets, they dosoona fair and equitable basis. CN Policy measures are designed to achieve a fairmarket environment without interfering with theinnate differences in size, assets, skills and organisational culture which are inherent in a mixed economy. Differences in workforce skills, equipment and managerial competence, which contribute to differing efficiency across organisations, are notthe concern of CN Policy. Competitive neutrality can benefit allVictorians by enhancing the confidence of business to make decisions on investments in the State and private decisions asto whatto buy and sell. • The Guide is intended to serve asa "howto" manual onthe practical steps that agencies should take in making full costcalculations. The elements of the costadjustments are current at the date of publication. Agencies should beaware, however, that thenature of these adjustments will vary with changes in the scope of therecognised or allowable competitive advantages and disadvantages. Agencies should also note that the introduction of the Goods and Services Tax (GSn on1 July2000 and the concurrent abolition of wholesale sales taxhas simplified some of the steps in making full costcalculations. (However, a methodology, to be applied in relation to assets purchased pre1 July2000, has been retained in this Guide for the calculation of adjustments involving wholesale sales tax. See Appendices 1 and 3). 1 For ease of exposition, the terms "government agency" or "agency" will be usedinterchange ably throughoul this Guide to reFer to a Go vernment Department a publicsectoragency or a local governm entity. . ent Box 1.1: Implementation of competitive neutrality Corporatisation OJ U c:: OJ Commercialisation clear delmeation of commercial and non-commercial aetrvities ~ => === separate accounting for an clearly defined fina ncial rep ortmg requirements funding of non-commercialactivities .8 u Vl OJ .... OJ CT > o §. 'iii c:: OJ separation of regulatory tun ctlons from commercial activ ities appropriat return onassets used inthe commercial activity e application of taxequivalent regime d t guarant e fees e arrangements forallocation of profits fromcommercial ac nvitles * Cl -= t; '" Full CostReflective Pricing actual costs competitive neutral costs 1.3 Competitive neutrality in the local government environment 1.4 Policy implementation For local government the Best Value Principles (BVP) asset out inthe Local Government Act 7989 provides the operating environment in which the application of CN Policy mustbeconsidered. When applyingBVP councils should incorporate competitiveneutrality requirements in a common process. Decisions oncompetitive neutrality must be documented in a manner sufficient to satisfythe accountability and transparency expectedunder both BVP and CN Policy. Separate guidelines will be developed to assistcouncils to apply CN Policy within a BVP context. Implementation of the CN Policyhas been streamlined intothree simple steps: • Government departments, agencies and local governments are responsible for determining, on a case bycase basis, whether its business activity is "significant " in the relevant market and therefore subject to the policy. Where the business activity in questionfalls within the scope of the policy, the responsible government agency should then weigh up the expected benefits and costs of introducing an appropriate measure to achieve competitive neutrality. The relevant measures include corporatisation, commercialisation or full cost reflective pricing (see Box 1.1). This Guide deals only with the measure of most common application, namely full cost reflective pricing. • • Once the government agency has concluded that the expected benefits of introducing the relevant competitive neutrality measure outweigh the costs, it should thenconsider whether implementation of that measure is in the public interest. This public interest test provides a means by which the objectives of competitive neutrality can be balanced with the key priorities and public policy objectives of Government. The "relevant market" can normally be identified on the basis of the competing goods or services (le, substitutes) which could reasonably beused interchangeably by mostcustomers or consumers. In addition to this, the relevant market may also be identified in terms of the geographic area or areas in which sellers of a good or service operate and to which consumers can practically turnfor the good or service in question. The question of whether a business activity is significant or not in the relevant market can only be determined ona case-by-case basis. Some of the factors which could be considered in this regard include: • • • • the size of the relevant business activity in relation to the size of the relevant market; the influence or competitive impact of the business activity in the relevant market; the resources the business activity commands and the effectof poor performance; and whether the costs of providing thegoods or services by the entityarebeing predominantly met by users. The last two steps arenot necessarily sequential and may be interactive dependingon the nature of the business. The CN Policy emphasises documentation and public availability of decisions taken through open and consultative processes. This is to ensure that a government agency's deliberations with respect to policy implementation aretransparent and accessible to all Victorians. It also helps to facilitate the taskof assessing CN Policy compliance in the event of an investigation triggered bya complaint. 1.5 What is a "significant" business activity? Consistent with the Competition Principles Agreement (CPA), CN Policy applies only to the significant business activities of publicly owned entities, and not to the non-business, non-profit activities of those entities. Activitieswhich do not result in the sale of a good or provisionof a service - either directly to a purchaser or through anarms length contract with another partyor parties should not be regarded as "business activities." The CPA does not provide a definition of "significant business activities". For the purpose of CN Policy, the concept of "significance" is predicated onthe importance of competition in the relevant market. In determining whether its business activity is significant or not, an agency should assess - on a case-by-case basis - the nature and extentof the relevant market aswell asthe probable nature and extent of the competition withinthat market. An activity should not be regarded assignificant or insignificant solely because of its size relative to the overall size of the government business. A government agency should document its determination asto whether a business activity is, or is not, within the scope of CN Policy. This documentation should be defensible and will be subject to scrutiny in the event that an investigation is triggered bya complaint. Agencies and local governments should consult the Competitive Neutrality Complaints Unit located in , the Department of Treasury and Finance, if they require assistance in thisregard. 1.6 Assessment of benefits and costsof introducing a competitive neutrality measure For the purpose of CN Policy. anassessment of the potential costsof applying competitiveneutrality measures should include. butis not limited to: • • legislativeand regulatory amendment; obtaining information and undertaking analysis to assess appropriate levels for tax equivalents, debtguarantee fees or pricing principles; and administrationof tax equivalent and debt guarantee frameworks. Following a determination bya government agency that anactivity is "significant", it should consider the expected benefits and costs of introducing an appropriate competitive neutrality measure. The decision to implement any specific competitive neutrality measure depends, in the first instance. onthe expected benefits outweighing the expected costs. The CPA only requires governments to implement competitive neutrality measures "to the extent that the benefits to berealised from implementation outweigh the costs." For the purpose of CN Policy. anassessment of the potential benefits of applying competitiveneutrality measures should include, but is not limited to. the matters outlined below: • increased market contestability which enables competition in the markets that have been traditionally dominated bypublic sector businesses. Such contestability produces incentives for businesses to lowerprices and provide greater choice for consumers; improved performance of government businesses in comparison with competitors. Competitive neutrality increases the incentives forthe business to operate efficiently thereby encouraging betteruse of the community's scarce resources; and owner governments can better clarify noncommercial objectives, and thereby determine whether the business is effectively meeting these objectives. • These aremainly what mightbegenerically termed "transaction costs" and arise directly from. or are associated with. theprocess of implementing competitive neutrality measures. Competitive neutrality measures need not be applied in situations where costs exceed benefits, that is, whenthe stream of competitive costs incurred over time is greater than the corresponding stream of benefits accrued over the same period. After examining competitive neutrality costing and assessing net financial benefits of a competitive neutrality measure, the government agency will need to undertake a publicinterest testif it considers that another policy objective or objectives of Government would becompromised bythe implementation of a competitive neutrality measure. In general. the costs of implementing competitive neutrality measures are more immediate. faced by the public business itself and more measurable. The benefits. which tend to accrue over the medium to longer term and diffuse across the community asa whole, areless easily quantified. It is important that any comparison of costs and benefits is undertaken on the same basis. This can bedone byamortising costs over the period for which the benefits are expected to accrue. or converting boththe cost and benefit streams to theircurrent values sothat theycan becompared properly. In this regard, the costs of implementation in mostcases are likely to be small relative to overall expenditures relating to the significant business activity. The cost-benefit assessment should be documented and made available in the event that an investigation is triggered bya complaint. • • Inevaluating the beneficial impact of competitive neutrality measures. it is important to remember that the benefits from greater competition will generally arise year afteryear sothat there is a stream of benefits which mustbeconsidered. For this reason they may be more difficult to establish than arecosts. 1.7 The Public InterestTest Once a government agency or local government has determined that theactivity in question is subject to CN Policy and the expected benefits of introducing the relevant competitive neutrality measure outweigh thecosts, it would then need to consider whether implementation of the measure is in the public interest. The CN Policy recognises that government agencies and local governments have responsibility for achieving anarray of social, environmental, economic and regional objectives. Government agencies should conduct a pUblic interest test to ensure that CN Policy is implemented responsibly and sensitively, byincorporating recognition of these other public policy objectives, The CPA provides some guidance onthe matters whichmay betaken intoaccount in assessing whether the introduction of competitive neutrality measures is in the public interest. These include: • • • government legislation and policies relating to ecologically sustainable development; social welfare and equity considerations, including community service obligations; government legislation and policies relating to matters such asoccupational health and safety, industrial relations and access and equity; economic and regional development, including employment and investment growth; the interests of consumers generally or a class of consumers; thecompetitiveness of Australian business; and theefficient allocation of resources, It is important to note thatthis is anopen-ended list sothat other relevant matters may be considered asappropriate. These may include, for example: • local or regional policies relating to economic and business development. employment, quality of goods and services, including timeliness of supply; impact onthe local or regional community; and impact ontheState and national economies, if any. • • Inaddition, other considerations made bya council during the implementation of its Best Value program in accordance with the Local Government Act 1989 may berelevant. Where a government agency considers that the implementation of a competitive neutrality measure would compromise other public policy objectives, it will need to conduct a public interest test in order to demonstrate the case fornotimplementing the measure in question, If implementation of a competitive neutrality measure is shown to be not in the public interest, then the business activity in question - such asa childcare centre - is exempt from CN Policy. To satisfy the formal requirements of CN Policy, the test should, at a minimum: 1. Clearly identify the public policy objective(s) for thegovernment business undertaking. These policy objectives refer to those which are promulgated orendorsed byGovernment. a Minister or a local government body. Supporting documentation could be in theform of anofficial policy statement inthe business plan of a government agency or aformal resolution of a local government. (See also section 2.4 .1 .) • • • • Box 1.2: Example of application of Competitive Neutrality PolicyVictoria Background A government agency owns and operates a fitness and swrn centre. Activities at thecentre include gymnasium services and access to the swimmingpool The purpose of the facilities is to provide the general public with user pays fitness activities. Also as partof the government's occupational health and safety objectives, thecentre provdes govemment employees with similar services. Recently the government agency considered whether It should continue provdinq services at thiscentre or sell the facilities to theprivate sector. Aspartof the decision making process, the government agency considered theapplication of Competitive Neutrality Policy Vtctoaa. The following is a summary of thegovernment agency's consideration of competitive neutrality principles. Significant business actillir}' The fitness and sWim centre is very popular With the local community WIth visitation rates Increasing. It is located close to government omces and a major shopping complex. At present nosimilar facilitiesexist withina 12 kmradius. The government agencyhas invited expressions of interest homtheprivate sector to build, ownand operate similar facilities. The costs of proViding theservices arebeing predominantly met byusers of the centre. The government agency has determined thatthe fitness and swim centre is a "significant business activity". Costing and pricing The government agency has adopted the fully distributed costing methodology to determine prices. This method ensures that the direct, indirect and competitively neutral costs are factored Intothe full costbase. Prices are setto recover competitively neutral costs over the medium to long term. Public intere st test Bemg located close to newgrowth suburbs, demand for services at the fitness and swim centre is expected to increase. The government agency is keen for the services to continue. Also, to maximise benefits to thecommunity thegovernment agency has undertaken to minimise price increases that may result from anincrease in demand for services at thecentre. 2. Demonstrate thatachievement of the stated policyobjective(s) would bejeopardised ifthe particular competitive neutrality measure under consideration wasimplemented. The relevant competitive neutrality measures include corporatisation, commercialisation and full cost reflective pricing. (See section 2.4.2 for further discussion.) 1.8 Competitive Neutrality Complaints Unit 3. Determine thebestavailable means of achieving theoverall policyoqjectives, including an assessment of alternative approaches. In undertaking this aspect of the test, the government business should identfy other i means of achieving the overall policy objectives (including those pertaining to competitive neutrality); and assess the relative merits of the alternative approaches. The determination of the bestavailable means mayinvolve a qualitative assessment of the priorities assigned to - and byimplication, the trade-offs arising from - the competing policy objectives. (See section 2.4.3) Under CN Policy, the public interest test should be undertaken in consultation with the affected community through anopen and transparent process. The government agency is bestplaced to determine, ona case-by-case basis,the level, nature or scope of the consultation having regard to the complexity of the issues and the impact on the community. In local government, council's consultation in relation to public interest maybe incorporated in consultation processes undertaken for Best Value purposes. At the conclusion of the consultation, the processes and outcomes of the public interest test should bedocumented and made publicly available. Information that is commercial-in-confidence may beexcluded, provided a statement specifying reasons to support the claim is noted in the public documentation. (See Appendix 13.4 for discussion of commercial-in-confidence.) Inorder to respond to concerns arising in relation to competitive neutrality and its application, the Victorian Government has set upthe Competitive Neutrality Complaints Unit(theComplaints Unit) so that it can make sure that government businesses compete fairly with private businesses. The Complaints Unitis required to investigate all complaints fairly, independently and rigorously and present a findingonthe basis of the bestavailable information. The Complaints Unitwill discuss complaints with complainants (affected persons or businesses) and in the first instance suggest a direct approach to the government agency to resolve the issue. If the mattercannot be resolved and a complaint is lodged in writing, the Complaints Unitwill consult with bothparties and assess whether the government agency does have an unfair advantage impacting onthe complainant. Complaints will be assessed in accordance with the CN Policy. When a complaint is received, the Complaints Unit will seek verification from the government business asto its compliance with the CN Policy. Where a formal investigation is necessary, the government business and the responsible government department and/or local government will be notified of the investigation. The onus is on the government business subject to a complaint to demonstrate compliance with CN Policy. Relevant documentation mustbemade available to the Complaints Unit, to either verify or assess the extentto which the government business has complied with CN Policy. For local government it is expected that application of the BVP will incorporate the necessary auditable documentation to meetthis need. If a complainant or government business believes that the Complaints Unithas overlooked a pieceof information relevant to the investigation, theymay write to the Complaints Unit and request further consideration of the issue. The Complaints Unitwill investigate further where newfacts, or information relevant to the inquiry, arebrought to its attention. Ig j" t .. There is nofeefor lodging complaints and, where possible, the Complaints Unit will seek to finalise complaint investigations within eight weeks of receipt of a written complaint. When an investigation is finalised, the Complaints Unit will notify the complainant, the subject of the allegation and the responsible government department or local government of thefindings of the investigation. and provide each with a copy of the preliminary investigation report. Subject to any comments received and further investigation required, the report will befinalised and may recommend. where needed, a change of action in thegovernment agency's business. The Complaints Unitwill liaise with the complainant, and the subject of the allegation, asto whether theyconsider any information to becommercial-inconfidence (see appendix 13.4). Investigation reports completed bythe Complaints Unit will then be made publicly available on the Unit's website: www.vic.gov.aulncp/cn_findings.htm Where non-compliance with the CN Policy is established, the Complaints Unitwill notify the relevant Departmental Secretary. or the Chief Executive Officer, of this finding and the actions which the government business should take to comply with the CN Policy. Three months afterthe investigation is finalised, the Complaints Unitwill request writtenadvice asto progress on compliance. The Complaints Unitwill notrecommend any compensation. The Complaints Unit does not assess anti-competitive behaviour that is already covered by the Trade Practices Act/Competition Code of Victoria. The Complaints Unitwill investigate complaints from an affected person or business aswell as from industry or community groups. The Complaints Unit will document all conversations and meetings relevant to the inquiry. All documentation received and created bythe Complaints Unitis subject to the normal operation of the Freedom of Information (FOI) Act 7982 (Vic). The Competitive NeutralityComplaints Unit Department of Treasury and Finance 1 Treasury Place Melbourne 3002 Tel: 96512148 Fax: 96515575 Email: cncu@dtf.vic.gov.au Implementation of Competitively Neutral Pricing Principles Implementation of Competitively Neutral Pricing Principles The intention of competitively neutral costing and pricing is to offsetany net competitive advantages arising from public ownership thata government business may enjoy, thereby ensuring thatresource allocationdecisions aremade on thebasis of comprehensiveand accurate costing. For the purpose of eN Policy, thekey requirement of full cost-retlective pricing is that government agencies should aim to recover thefull costs of their whole business activity over themedium to long term . 2.1 Defining the output Output definition involves defining the good or service and specifying thecharacteristics and elements of that good orservicein such a wayas to enable appropriatecosting and identification of competitive advantages and disadvantages arising from government ownership. For example. where an activity is the subject of competitive tender, the tender briefshould define theoutput(s) being purchased. The procedure for competitively neutral costing and pricing is summarised in the following figure Define Outputs ." ... • • I •~- Set Price to Recover Net Competitively Neutral Cost Section 2.1 Section 2.2 Section 2.3 Box 2.1: Example of Grouped Outputs fducdtiOf! sector A TAFE College provides a range of vocational training courses related to the hospitality industry, These include food preparation, food service, tourism and hotel management. Other educational institutions also provide hospitality industry training services in competition with the TAFE College. Provided that as a whole, theCollege can recover the competitively neutral cost of providing services over the medium to long term, the College may pnce each course, or group of courses, to take into account factors such asdemand and competition. 2.2 Calculate the competitively neutral cost of the output Full cost-reflective pricing takes into account: • • • allof the costs that can beattributed to the provision of the good or service; thecostadvantages of public ownership; and thecostdisadvantages of public ownership. 2.2.1 Adopting a costing methodology The focus is onthe outputs of activity rather than on inputs or the processes associated with the activity. Outputs are the goods and services produced and delivered byan agency for customers outside the agency. Customers areany people, organisations or other departments external to the agency whopurchase, use or consume products or services provided by it. The following factors will assist indeveloping a clear description of the output: • • what is the purpose of providing the output? what is the context within which theoutput is used or consumed (relevant policy issues, government directives, standards or principles of operation)? howis the output measured and verified? if there is uncertainty, what is specifically excluded from the output? FUlly Distributed Cost - It is expected that fullcost attribution will beachieved using the FUlly Distributed Cost (FOC) method. This ensures that the direct. indirect and competitively neutral costs of producing an output arefactored intothe full costbase, Direct costs of production include wages and thecostof inputs. Indirect costs (overheads) are typically splitamong various commercial and/or non-commercial outputs and include electricity, information technology, building security, administration, personnel services and rent. These costs that areincurred in producing the output should therefore be taken intoaccount. Avoidable Cost - Ininstances where the primary activity of an agency is non-commercial, it may be appropriate to use Avoidable Cost (AC) methodology, Using this method, the agency need only consider the extra (direct) coststhat the agency could avoid if the activity in question was notundertaken, Inmany cases, the indirect costs of anagency will not beaffected bythe commercial activity of the agency, asoverhead costs would be incurred anyway. To the extent that indirect costs are affected bythe commercial activity these should betaken into account. • • Outputs of a particular agency may begrouped and it may be more practical to apply thesteps to a group of outputs, rather than many individual outputs. However, thefollowing criteria should be observed when grouping outputs, Output groups should have the following characteristics: • • • similar attributes; outputs with similar customers or categories of customers; and outputs contributing to a common service objective of the agency. Further, the only competitive neutrality adjustments that need to betaken intoaccount under the AC approach arethose adjustments which result in competitive advantages and disadvantages in the production of the commercial output. Box 2.2: Examples of competitive advantages Advantage Accident c.ompensation levy Capital financing Corporate overheads Description leviedonemployers to cover WorkCover expenses. Cheaper financing due to a lower risk premium where theagency is backed by an explir.it or implicit government guarantee. Access to various corporate overheads free of charge, Including office accommodation. pay-roll services, human resource services, marketing and ITservices. Reqmrement to earn a rate of return onfunds whichcould otherwise be used elsewhere. Levied onalldebits of not less than $1 to taxable accounts, A financial institution that receives money is liable to pay FlO inrespect of each receipt of money except where it is forthe credit of anexempt bank account. Annual tax based ontotalunimproved value of Victorian land owned bya taxpayer. Imposed on tend bylocal governments, leviedonfirms whose annual pay-roll is over $515.000. Outll:'5 arecharged ona number of transactions, including those involving tradeable instruments, property and hiring Cost of capital Oebits tax Financial Institutions Duty (FlO) Land tax local govemment rates and charges Pay-roll tax Stamp duty Note: Wholesale sales taxused to be levied on thewholesale costof certain goods. This taxwasabolished when theG ST was introduced on 1July2000. For calculations relating to pre GSTcastings refer to Appendix 3. Anagency mustbeable to demonstrate that its primary activity is clearly non-commercial and that its indirect costs are unaffected bythe activity in question. before it chooses to apply theAC approach, This may be achieved through a variety of means, such asa description inthe agency's annual report of its activities. or bya Minister ial Statement as to therole of thegovernment agency . Where there are noclear policy statements about the primary activity of the agency, the agency may use the AC approach if it can demonstrate that the substantialmajority of its outputs arefor noncommercial purposes.s Inmost cases, agencies will berequired to adopt the FOC approach to costng outputs, i 2.2.2 Calculate the actual costs incurred in producing this output. Where the FOe approach is beingused. agencies need to establish a fullcost base whichattributes allcosts incurred inthe production of the output. This isthe base to whichadjustments for competitiveadvantagesand disadvantages are made. If agency outputs are notfully costeda vital first step is to ascertain and allocate allrelevant costs and set upappropriate accounts. This needs to be done before proceeding to competitively neutral costing and pricing. The fullcost base will include: • • alldirect costs such as labour, materials and premises; indirect costs (overheads) such aspersonnel services, information technology support, administration; and depreciation of physical assets. .j I .5 ~ .. • '" .~ z '5 -8 .., 2 As a general rule.the agency will be required to demonstrate that a significantproportion or its outputsis non-commercial before the ~ '" g! .~ AC approach canbeused. The Competitive Neutrality Complaints Unitwill acceptevidence of inputuse (le what proportion of inputs areused in the non-commercial activity) or outputuse (iewhat proportion of outputs arenon-commercial. what proportion of patronage is non-commerc in deciding whetherthe FOC approach or the ACapproach is appropriate. ial) E o u 2.2.3 Add Competitive Advantages 3 2.2.4 Subtract Competitive Disadvantages To the fully costed base, agencies should add an amount calculated foreach identified competitive advantage relevant to theoutput. The principal competitive advantages which are likely to accrue as a result of government ownership are summarised in Box 2.2. Further detail is provided in Chapter 3.1. While theGuide covers most of the likely competitive advantages, agencies should review all of their activities and the markets they supply to identify further differences peculiar to theirown circumstances. The key criterion is whether the difference is solely due togovernment ownership of the public sector agency. Where a difference is identified which is partly due to government ownership and partly due to other factors, it is the part of thedifference which can beattributed to government ownership which is the competitive advantage to becosted. Box 2.3: Examples of competitive disadvantages If agencies consider thatthey are disadvantaged in their business activities byarrangements imposed on them bygovernment (forexample, accountability costs and private sector 'small business' exemption from pay-roll tax), they should give consideration to ways of directly removing or altering theparticular requirements. (For example this could beachieved byremoving exclusivity arrangements orconsidering alternative structural and ownership arrangements.) The key factor in assessing whether a disadvantage constitutes a competitive neutrality issue is that theconstraint (on theconduct of the public business) is externally imposed onthe agency and it exceeds that likely to befaced bya private sector business supplying the same goods or services. Disadvantage Descri/...tion Accountability costs Agency specnc requirements Corporate overheads Employment remuneration Greater accountability costs due to public sectorreportingand regulatory requirements. Compliance withCommonwealthand State legislation, requlations or directives. Limi1:ed flexibilityin reducing orrestructuring corporate overheads. Public sectorhas different employment and indus rial relations t requirements 3A separate adjustment to offset company income taxandcapital gains taxis not reco mmended. This advantage is betterdealt with throug the useor a before h -taxrate of return (Rerer to Chapter 3. Section 3.1 andAppendix 2). Becaus company inco tax is levied e me on profits thisadjustment canno be accurately calculated in most cases. Similarly. raetors such as the shareduseor capital with non. t commercial activitiesmeans that capital gains tax would bedifficult to calculate accurately . After consideration of these options if agencies believe theyface unavoidable cost disadvantages, these should beclearly identified and the magnitude of the costburden should be estimated for the purposes of determining net competitive advantage. Box 2.3 summarises some potential competitive disadvantages faced bygovernment agencies. Further detail is provided in Section 3.2. Once aninitial estimation and adjustment has been made, it is recommended that this adjustment. expressed asa percentage of total costs, be reapplied to total costs in subsequent periods, unless there is a significant change likely to have an impact on the estimatednet adjustment. For example, a significant change mightresultfrom a change in the recommended rateof return, a change in the valuation of assets, or a change in statutory rates of tax. This will need to bejudged bythe agency onthe basis of information obtained during the initial calculation. Aswell, agencies may develop shortcut approaches to estimating particular cost components. Therefore, anactual calculation may not be made in each case, but an estimated figure could bedetermined based on experience gained from making similar calculations elsewhere. Agencies mightbeable to determine from experience the proportion of expenditure associated with commercial projects that is likely to bespent on sales tax exempt goods, and accordingly develop a rule of thumb. Similarly, experience mightenable an agency to develop shortcuts in relation to estimating costs associated with transactions attracting stamp duty. The reasons for selection of any shortcuts should be documented, defensible and reviewed when appropriate. 2.3 Setting the Competitively Neutral Price Once the competitively neutral cost of an output has been determined, theagency must seta price forits output to ensure thatit fully recovers the competitively neutral cost over themedium to long term. Insetting the price forthe good or service in question, the government agency may have regard to a number of economic factors that include, but are not limited to: • • • the level of demand for the good or service; the level of competition between service providers; and short term pricing strategies involving the use of "loss leaders" or cross-subsidisation, subject to the prohibitions of certain pricing behaviour under the Trade Practices Act 7974. Where agencies areinvolved in producing a number of commercial outputs, it is the commercial operations asa whole which should achieve full costrecovery in the medium to long term: full costrecovery is not required for each output produced. Therefore, different commercial activities can cross subsidise each other, provided that revenue is noless than the total competitively neutral cost of allthe activities. 2.4 Applying the Public InterestTest 2.4.1 Identification of policy objectives In some situations, government maydirectan agency to provide a particular outputat less than full costrecovery in order to achieve a policy goal in the public interest. These goals can besocial, economic or distributional in nature. Inthese cases, it is not the intention of CN Policy to override these goals. Once a government agency has determined that the activity in question is subject to CN Policy and the expected benefits of introducing the relevant competitive neutrality measure outweigh the costs, it would then need to consider whether implementation of the measure is in the public interest. Where a department, agency or local government considers that the implementation of a competitive neutrality measure would compromise otherpublic policy objectives, it will need to conduct a public interest testin order to demonstrate the case for not implementing competitive neutrality measures. To satisfy the formal requirements of CN Policy, the test should, at a minimum, identify the (endorsed) policy objective{s), demonstrate the risk to that objective created bythe competitive neutrality measure and assess options to achieve overall policy objectives asdiscussed below. The agency mustclearly identify the policy objective{s) that is (are) to be achieved and demonstrate that the policy objective(s) has official endorsement. This evidentiary onus can be satisfied bydocuments showing the exercise of ministerial discretion, clear policy statements in annual reports, official directions or other public documents. It is not sufficient for the agency to merely state that it has engaged in a particular activity that happens to bein the public interest for a period of time. 2.4.2 Competitively neutral priceandpublic policy objectives The onus is onthe agency to demonstrate that the achievement of the stated policy objective{s) would bejeopardised if the particular competitive neutrality measure under consideration was implemented. The agency should provide evidence of the process used to assess that the competitive neutrality measure would jeopardise the stated public policy objective. For example, the agency mightshowthat the setting of a competitively neutral price over the medium or long term would not enable the agency to achieve a particular public policy objective due to reduced affordability amongst the targetclients. The policy mayfocus on a particular market sector and the specific features of that sector may require a higher quality of service than the private sector market would provide for the price. To demonstrate this, the agency mightestablish its actual costs and competitively neutral costs for a particular product or service thenexplore whether or not a pricing strategy to cover these costs can meetthe relevant objective(s). In some cases, the public policy objectives may be achieved at a competitively neutral price. Box 2.4: Example of TAFE Institute Pricing A TAFE Institute produces a training course fora competitiVely neutral costof $17.913. A 'break , even' feeof $1 .800 per student based on10enrolments gives fullcost recovery 12 students enrol for the training course, If the traIning course in question was the only commercial output produced bythe Insttute. fees i would need to beset to achieve full costrecovery for the course over themedium to long term . However the Institute also produces a number of short courses which it sells Ina competitive market for around $120 perstudent. The Institute will therefore need to costthe short courses, taking account of the relevant competitiveneutrality adjustments. The costfor short courses is $12.000 after taking into account competitive neutrality adjustments. This IS based on anestimated enrolment of 100students. The Institute receives 75 en rolments forshot courses. The shortfall of $3.000 ($120 x 25students] with the shortcourses is met by the 2 additional enrolments in the trainingcourse ($1 .800x2 = $3,600). The Institute denves anoverall cost for the delivery of the bundle of trammq courses which constitutes the fullcostrecovery benchmarkwhich it should recover over the medium to long term. ThIS provides the Institute with flexibility to price aboveestimated costs for COUlseS or serviceswhere there is strong demand. and to reducepric esfor courses wheredemand IS lower. subject to the ovemonq requirement to cover the Institute'sfull costsacross its activities over the medium to long term. 2.4.3 Alternatives to meet the policy objective In cases where it is clear that the setting of a competitively neutral price cannot meet particular public policy requirements. agencies need to assess alternative ways of achieving these objectives to determine the best available means of achieving the overall policy objectives. The consideration of alternative options in a transparent manner has thepotential to improve the allocation of the scarce resources oftheagency and the community ingeneral. Alternative options to below full cost reflective pricing include: • rebates - whereby particular members of the community can claim a rebate when using a particular facility such asa local government pool; reduced rates andcharges - where a broad section of the community enjoys a particular activity which is also provided byprivate competitors inthe vicinity. a reduction in general government rates and charges will increase the purchasing power of consumers. This may make it feasible for them to afford to pay more to use a particular private facility, while being noworse off; and • provision of substitutable outputs - some outputs may becheaper to provide butjust as effectively meetthe particular public policy objective whichis in the public interest. • The analysis of these alternative options, including theoption of retaining a transparent public subsidy . should be undertaken in consultation with the community through anopen and transparent process. At the conclusion of the process. the conduct and outcomes of the public interest test should bedocumented and made publicly available. Informationthat is commercial-inconfidence may beexcluded, provided a statement specifying reasons to support theclaim is noted in the public documentation. (See example in Box 2.5) Box 2.5: Applying Competitive Neutrality Policy A number of government agencies havejolntly established d regional office facility that includes a conference facility. The departments share therentand overhead costs onthe basis of staffing levels and space, and the conference facility, wmch IS managed as a separate cost centre, is charged onthe basis of usage. The regional managers have been approached concerning community access to theconference facility for weekends and evenings when the facility is not used bythe government departments. The regional managers examine the issue of whether or notto charge and if so howmuch to charge. They realise that the suggested Inter estinthe use of the facility is such that it could be regarded asa significant businessand cornpennve neutrality issues must beconsidered. They decide to examine the options of charging ona fullcost and anavoidable cost basis. The rental onthefacility is covered bythe funding of thedepartments and would notbeaffected bythe additional use. However. the conference facility manager would be required to work additional hours to supervise the facility, includingaccess, operation of equipment and secunty. Utility COSt5 (such as power for heating and lighting) aswell asa proportion of maintenance and c1eeming would constitute avoldable costs. Inorder to determinethe mostappropriatepricing approach the reqional managers decide to consult with thecommunit y to ascertain the likely usage and capacity to pay. Following pubsc consultationthe regional managers find that there are three categoriesof potential users and two potentialcompetitors and a demand depending onfees whichwould have thefaCIlity in use 20eveningsand 10full weekend days. The user categories are: • • • some business related functions, where participants would be paying to attend; community groups which have been paying 3 minimal fee to use the church hall; and community groups whichhave nofinancial basis butwould value the ability to convene meetings and would clean upaftertheir functions. The second competitor is the local hotel, which has a smaller room used for meetings and pnvate functions suchaswedding receptions. The hotel has allowed some fee free access to its room where thegroup dines there aswell and is anxious notto lose catered functions to the conference facility. The regional managers establish a three-tier pnonqregime: fullcost, avomable costand fee free, with feefree access limited to demonstrably public interest use. To ensure thatthe facility is notcompeting unfairly With thehotel and thechurch, those categories of users which would normally pay forthe use of the church hall or thehotel venue will be charged either fullcostor avoidable costdepending onthecategory of users. Inaddition, the hotel will beallowed access to cater ona commercial basis for conference facility users. Further, efforts Will bemade to promote a coordinated partnership approach to the booking ofall three facilities. Inthis case the government agencieshave balanced the Issues of pUblic Interest and competitiveneutrality in making facilities accessible to thelocal community. The expected usage is such thatthe receipts from "fullcostpaYing use" and "avoidable costuse" will more than cover the avoidable costof totalexternal usage The agenciesare also ableto use the entrance foyer to publicise their programs, increasing public awareness to potentialclients. In summary, the following is a checklist to assist with the publicinterest testprocess: • Identify the policy objective(s) to beachieved and provide supportingdocumentation, such as a statement bya Minister or local government body. or official policy documents. Demonstrate that the achievement of the stated policy objective(s) would be jeopardised if the particular competitive neutrality measure under consideration was adopted. • Determine the bestavailable means of achieving the overall policy objectives, including anassessment of alternative approaches. Document the conduct and outcomes of the "public interest test" and make the documentation available to the public. Information that is commercial-in-confidence may be excluded. provided a statement specifying reasons to support theclaim is noted inthe public documentation. • • .j oS '5 t :3 E o 4l '" .~ z .~ L> .!l! ., ~ '" an Cost Adju tments Making Cost Adjustments This chapter outlines the steps necessary to make particular costadjustments. These cost adjustments are added to (subtracted from) thecostbase in arriving at a competitively neutral cost. A numerical example demonstrating these steps is outlined in Chapter 4. 3.1 Competitive neutrality advantages 3.1.1 Actual cost of producing output Calculation Stflll Identify goods purchased which would ordinarily besubject to sales tax. Only include those goods which would be subject to sales tax if purchased bya private sector business. Establish a common retail price for the goods. Where a government agency has purchased goods sales tax exempt, they are paying a retail price, where nosales tax was charged at thewholesale level. In most cases, this price will beless than a common retail price (which includes sales tax charged at the wholesale level). A common retail price for goods (where sales tax was paid at thewholesale level) can beascertained bythe following methods: • byconsulting a survey of retail prices; or • bygrossing upthe price which the government agency paid for the goods by 22 per cent. 4 ~ All costs attributable to producing the product or service are determined asa first step using either thefullydistributed cost (FOe) method or the avoidable cost (AC) method. This amount is referred to asthe cost base. This process should also involve determining thecostof capital for assets used in the production of thegood or service. These assets may have been purchased exempt from stamp dutyorsales tax and if so stamp dutyand wholesale sales tax adjustments mustbeadded to theasset costs and depreciated in arriving at the writtendown value of theassets. 3.1.2 Goods and Services Taxandwholesale salestax On 1 July2000 the Goods and Services Tax (GST) effectively replaced the wholesale sales tax. The GST is a value added tax on the consumption of most goods, services and property in Australia, including imports. The GST does not apply to exports of goods and services consumed outside Australia. See Appendix 1 for further details onthe GST. Note: Anadjustment for exemption from wholesale sales tax may apply forassets purchased prior to 1 July2000. The requirement for thisadjustment will progressively reduce as more assets are purchased under the Goods and Services Tax regime. Description Step 3 Deduct 10 per centfrom the common retail price. This calculation approximates the wholesale price forthe good including sales tax. ~ Calculate sales tax: sales tax = wholesale price including sales tax sales tax rate x :;-:--~:---:--~:1 plus sales taxrate As a general rule, most capital equipment would have been subject to 22 percent sales tax. Therefore, in mostcases: sales tax = wholesale price including sales tax x (22/122). Sales tax is an indirect tax previously imposed on thewholesale price of goods used asinputs (prior to 1 July2000) to produce the good orservice. 4 This can be donewherethe sales tax levied wouldhavebeen22 percent anda percentage mark-up fromthe wholesale levelto the retaillevelis assumed. ~ If the sales tax adjustment relates to a fixed capital asset (a non-current physical asset) then the sales tax amount should be added to the purchase price of the asset and then depreciated in line with the appropriate depreciation rates for that asset. Sales tax applying to consumables should beadded asan expense adjustment to the costbase. 3.1.4 Cost of capital Description The costof capital reflects theopportunity costof funds provided to government agencies. Government agencies areexpected to earn a rate of return to cover the opportunity cost of capital. It should benoted that capital markets generally use nominal rates. Any consideration of the Weighted Average Cost of Capital (WACe) relating to private sector usage. needs to bemade with the knowledge that any comparisons should bemade with dueconsiderationto differences in cash flows and the basis of the ratedetermination. Nominal rates require aftertax cash flows. CN Policy uses before tax cash flows, and hence. real rates asthe basis of the rate of return determination. The real (before tax)rate of return oncapital, based ona WACC for the purpose of competitive neutrality pricing, remains at 8 percent. Calculation Note: If the calculation of full costs includes an estimation of a commercial rent. noadjustment needs to be made for land or premises. The agency should provide anestimate of commercial rent. This can bedone through an examination of comparable rental properties, real estate documentation stating potential rental value of the premises or, should theycurrently pay rent. evidence that any existingrental contract is at arms length. Further information Refer to Appendix 3 for further information about sales tax rates that applied prior to the introduction of the GST on 1 July 2000. 3.1.3 Stamp duties Description A State Government tax imposed ona widevariety of transactions, including land transfers. leases of land. marketable securities and mortgages. Calculation Note: The stamp dutyadjustment is handled differently depending onwhether or not it relates to a non-current (depreciable) asset. Step 1 Identify transactions associated with the output that would bedutiable butfor the government exemption. 5rell1 Calculate the dutyapplicable to each transaction. Step 3 If the stamp dutyrelates to transactions involving a non-current physical asset, include the amount of the dutyin the cost of the asset forthe purposes of calculating depreciation and the written down value of the asset for the purpose of the cost of capital adjustment. Otherwise, add the estimated dutyto the other competitively neutral costadjustments to the cost base. Further information Refer to Appendix 6 for further information about stamp duty. ~ Calculate thetotalasset base. The total asset base is the sum of total current assets (eg working capital, debtors, stock) plus total non-current assets (eg written down value (WDV) of physical assets) owned and employed inthe production of relevant output, as shown diagrammically. Note: the WDV of physical assets should be adjusted for any stamp dutyand sales tax exemption. Identification of relevant assets Assets employed other than in relation to relevant output --Assets emiiioyed . in producing relevant output ~ Calculate that part of thetotal asset base used to produce the commercial proportion of the relevant output for which a competitively neutral price is required . This will involve multiplying the value of total assets bythe percentage use of these assets in producing the relevant output for which a competitively neutral price is required. Where a specific asset is used only forcommercial activity the value of this asset should beexcluded from proportional calculations and added in separately in full . If the totalassets are wholly used to produce the relevant commercial output, the rate of return percentage is applied to the whole base. Proportion of assets employed in non commercial production of relevant output Proportion of assets employed in producing commercial output Ste!l....4. Determinethe net costof capital adjustment. Subtract from the costof capital amount (calculated at Step 3) any costs already associated with the funds used to purchase assets. This includes any interest owing ona bank loan to purchase assets aswellasservicing costs arising from any government capital charge (such asa financial accommodation levy). Alternatively the costof assets purchased with a fully commercial loan can beexcluded from the asset base used for thecostof capital calculation. Sill!U. Calculate the costof capital amount. Multiply the relevant proportionof the total asset base bythereal costof capital for the current year. For thisexample, multiply the proportion of total assets (current plus fixed) by0.08 (8 per cent). Ste.R...5. Add thecalculated amount to the cost base. Further information Refer to Appendix 2 for further information about the costof capital. 3.1.5 Land tax Description An annual tax levied by the State Government. based onthe total unimproved value of all Victorian land owned bya taxpayer. Calculation Note If the calculationof full costs includes a : documented and defensible estimate of commercial rent, noadjustment needs to be made. Step 2 Obtain from the local government an estimate of the rates that would apply. ~ Assess rates apportioned to the premises used relevant to the business activity. Add the amount to the costbase. ~ Further information Refer to Appendix 5 for further information about local government rates. S!!m.l ~ Obtain a municipal valuation of the site value of therelevant land. Multiply the sitevalue by therelevant "equalisation factor" (ratio which reflects the change in land value since the last general valuation) to derive the unimproved value of land. Ascertain the percentage of land directly attributable to the relevant business activity. Using the land tax scales, calculate land tax which would beassessed on the land relevant to the business activity . 3.1.7 Financial Institutions Duty (FlO) and debits tax Description FlO is a State government tax levied onthe receipts of all financial institutions. Oebits tax is levied onall debits transactions of accounts with cheque-drawingor payment order facilities. Calculation For administrative simplicity the adjustments for FlO and debits tax can be combined into a single adjustment based on0.1 percentof sales revenue from the output. Step 1 Forecast likely sales revenue from output for the current period. This forecast can be based onthe revenue earned from the commercial output over the previous financial year. ~ StflL3. ~ ~ Add the amount to the cost base. Further information Refer to Appendix 4 for further information about land tax rates. 3.1.6 Local government rates Description Levied bylocal governments on land-holders within their municipalities. Calculation Note: If calculation of fullcosts includes a documented and defensible estimate of a commercial rent noadjustment needs to be made. Multiply the forecast by0.001 (0.1 percent). Step 3 Add the amount to the costbase. Further information Refer to Appendices 7 and 8 for further information about FlO and debits tax. S!!m.l Obtain the relevant municipal valuation used forratingpurposes for properties used in the business activity. 3.1.8 Pay-roll tax Description Levied by the State government onVictorian wages paid byan employer to its employees. Calculation Step 2 If the WorkCover insurance is paid bythe parent entity, add the relevant proportion of the levy to the costbase. Further Information Refer to Appendix 12 for further information about WorkCover insurance. 3.1.10 Advantages in borrowing funds and exemption from the Financial Accommodation Levy (FAL) Ste)l.1 Determine whether the agency's commercial activities areexempt from payrolltax. To determine whether or not it is exempt from pay-roll tax, anagency needs to calculate the total salaries of all personnel engaged in producing the commercial output. Where this is not possible, agencies need to make this calculation on a pro-rata basis, using the commercial output as a proportion of total output asa guide. Description Lower interest rates on loans obtained by government agencies which arenot obliged to pay the FAL. Calculation Step 1 Entities need to obtain anestimate of interest rates on borrowings by private sector businesses undertaking the same activity. This information should be used as a benchmark against which interest on their loans can be measured. The private sector rate may vary according to the nature and length of the loan. S1ep.1 If an adjustment is required (and the salaries paid total more than $515,000 per annum or $42,917 permonth), subtract $515,000 from the total salaries cost. Step 3 Multiply the difference by0.0575 (pay-roll tax rate). S1ellA Addthis amount to the cost base for a competitive advantage or subtract it from the cost base for a competitive disadvantage. S1ep.1 Subtract the public sector ratefrom the private sector rate. ~ Further information Refer to Appendix 9 for further information about pay-roll tax. 3.1.9 Accident compensation levy (WorkCover Insurance) Multiply the difference between the two rates by the size of the loan. This should provide the additional interest payment that the entitywould pay if it were a private sector business. Step4 Add this amount to the cost base. Further Information Refer to Appendix 12 for further information about this issue. Description WorkCover is compulsory insurance for injured workers, which mustbe taken out byall Victorian employers. Calculation Step 1 Does the commercial unit bear the levy or is it paid by the parent entity? I t . .~ ~ z s .., .! .~ ~ '" E- o u 3.1.11 Additional private sectorregulations or requirements 3.1.12 Freeor below-cost access to corporate overheads Description Regulations or requirements that apply to a private sector business but not its public sector equivalent carrying out the same activity. Calculation Note: This adjustment requires a comparison of compliance cost differences between the public and private sector in meeting regulatory requirements in a particular area. For example, more rigorous corporate governance requirements for the private businesses (such asunder the Corporations La!<1.? should becompared with equivalent corporate governance requirements for the public sector. Where public sector requirements are more rigorous than private sector requirements (forexample privacy requirements), theywill need to bethe subject of separate adjustments to reduce the costbase. Description A public sector business should take account of all the overhead costsinvolved in producing a good or service. Calculation - FUlly Distributed Costing (FDC) ~ Establish what the entityis currently paying in overhead costs to produce the output. Step 2 Calculate overheads for the output using the FOC approach.s Step 3 Subtract total in Step 1 from total in Step 2. This will give the difference between overhead costs apportioned across all commercial and non-commercial activities and the costs the entity is actually paying. ~ Add this amount to the cost base. Further Information Refer to discussion of FOC and AC methodologies in Chapter 2 and Appendix 10. 3.2 Disadvantages Stelll Identify any additional requirements for private sector competitors. Estimate the costof these requirements, considering costfactors such as labour and materials, accounting costs and broader corporate controls. Addthis amount to the cost base. S!mU Ste!ll Further Information Refer to Appendix 12 for further information about this issue. As a starting point, thereis a presumption in the costing guidelines that the public sector does not face conditions whichwould constitute a competitive disadvantage vis a vis a private sector competitor. For example it is arguable whether higher superannuation costs simply compensate for lowerpublic sectorsalaries. In effectthe government has to employ people in a competitive labour market, superannuation is partof the salary package, and thereis no reason to presume that the salary package is not competitive. Similarly, the extent of additional costs of accountability should becarefully assessed, as accountability requirements may beequivalent. Notwithstanding this presumption, the cost disadvantages faced maybe very real and agencies should set out clearly the basis for the determinations theymake. 5 Wherethe agency is making cost adjustments on an avoi able cost basis, theywill be required to accountfor the overheads if it is an d avoidable cost. 3.2.1 Superannuation 3.2.3 Inherited higher coststructure Description Superannuation includes a contribution paid by employers into a fund to providean income for workers aftertheir retirement. While the legal requirement for employer contributions is eight per centof anemployee's salary, some public sector employees receive higher levels of superannuation payments under defined benefit schemes. Calculation Description Government agencies which have recently been commercialised or corporatised may inherit higher or less efficient cost structures than their private sectorcounterparts. This disadvantage may persist for several years whilethe entity restructures and modifies its cost structure to reflect better that of its competitors. While this process is taking place, organisations may legitimately take this into account when determining competitively neutral pricing. The onus is on the entity to demonstrate how it is competitively disadvantaged asa result of a greater coststructure. This disadvantage will also include anagency's lack of flexibility in restructuring overheads compared to the private sector (forinstance a requirement that the commercial operations occur in a particular building for which overheads arehigh). Calculation SlliIll ~ Identify superannuation contributions to those employees on defined benefits schemes. Subtract fromthis total the equivalent of an eightpercent superannuation contribution (0.08 multiplied bythe relevant wages). Step 3 Subtract this amount from the cost base. Further Information Refer to Appendix 11 for further information on Superannuation. 3.2.2 Government awards Stf/l.1 Description A public agency mayfind that its wages and/or salariesare higher than the private sector competitor. However, this cost disadvantage can not bereflected in the competitively neutral price unless the employer can demonstrate that it is bound by law to paya higher award than the private sector. If it is simply industry practice for the public agency to payhigher wages, butthis is not reflected in award conditions, this is not considered to be a disadvantage accruing asa result of public ownership. Calculation Identify costs not borne bya private sector business in the same activity, and which aredirectly attributable to the inherited cost structure of the recently re-structured business. This mayinclude excess personnel or the useof larger commercial facilities than is necessary. Step 2 Calculate these additional costs taking into account factors such aslabour, mater ials, and overhead costs. ~ Deduct the total from the costbase. S!illU Identify statutory wages costsof those employees to whom the agency is required to pay a higher wageby law. Subtract fromthis total the award costs for equivalent private sector employees. Subtract this amount from the costbase. ~ Slim.l 3.2.4 Accountability costs and legislative and regulatory restrictions Description These costs may arise because government agencies face accountability or regulatory requirements not imposed on private sector competitors undertaking the same activity (eg. quarterly reporting to government). Calculation ~ Identify activities resulting from accountability. legislative or regulatory requirements, not borne by private sector businesses. ~ Determine the costof each of these activities, taking intoaccount factors such aslabour. overheads. materials and accountingcosts. thecostbase. ~ Deduct this total from C S udy Case Study 4.1 Hypothetical example of the application of competitively neutral pricingprinciples 4.1.2 Calculate the actualcosts incurred in producing this output A government agency controls and operates a fitness centre called Apollo. The principal purpose of the facility is to provide the general public with a range of user pays fitness activities (60 per cent). However, the centre is used to improve thefitness of government employees aspart of the government agency's occupational health and safety objectives (40percent). The activities provided at the centre are: • • gymnasium services - comprising weight training facilities and circuit classes; and aquatic activities - comprising access to the pool as well asswimming lessons. The government is required to use the FOe Approach to costing its outputs because the principal purpose of thefacility is commercial. The actual equivalent (pre-tax) costs incurred in operating the leisure centre for both commercial and non-commercial purposes are: • • • Electricity Wages Other expenses Bank loan interest onequipment Miscellaneous expenses* Depreciation Total Cost $9,600 $10,000 $72,500 $712,100 $20,000 $600,000 A private sector competitor operating a gymnasium facility has lodged a complaint with the CompetitiveNeutrality Complaints Unit that the government owned fitness centre has not applied competitively neutral pricing principles. 4.1.1 The output The commercial outputs of the leisure centre can begrouped intotwo broad output groups: gymnasium services and aquatic activities. [* The miscellaneous expenses include thelease of a carfor use by theleisure centre. If thecentre ownedthecarit would needto beincluded asan asset andadjustments made for costof capital and stamp duty. The details at 4.1.4 demonstrate the calculation of thestamp duty, which would affect the depreciation amount included asexpenses, ifthe vehicle was owned. The adjustment is notmade to thecostin this case asfor thepurpose of this example the vehicleis leased.] However, asonly 60 percentof the costs are incurred fora commercial purpose. the costof producing the commercial output is $427.260. Co!>t of producing commercial output is $427,260 Potential advantages 4.1.3 Exemption from sales tax 4.1.4 Exemption from stamp duties Note:Anadjustment forexemption from sales tax applies to allassets purchased prior to 1 July2000. The requirement forthisadjustment will progressively reduce as more assets are purchased under the Goods and Services Tax regime. ~ Note: For the purpose of thehypothetical example forApollo. the motor vehicle is leased at commercial rates and consequently noadjustment for stamp dutyis required. The calculation below is provided for agencies owning vehicles as depreciable assets. If themotor vehicle wasanasset. thegovernment agency would beexempt from stamp duty onthe motor vehicle used bythe leisure centre. Suppose thecentre changes its motor vehicle every 12 months. For the exemption. stamp duty ona car with a retail value of less than $35,000 is $5for each $200 or part thereof. The vehicle has a retail value of $25,000. Stamp duty onvehicle = $25.000/200 x $5 = $625. This amount of $625 should be capitalised anddepreciated with the asset. Calculate sales tax. Comment: The gym equipment. which would normally be subject to sales tax. waspurchased sales tax exempt for $200.000. S!!m1 Establish a common retail price forthe goods. Comment: The gym increases its purchase price by22 percent: $200.000 x 1.22 = $244.000 St!ml Deduct 10 per cent (estimated mark-up) from thecommon retail price: $244.000 - $24.400 = $219,600 ~ Calculate sales tax. Sales tax = wholesale price including sales tax sales taxrate x.,....-::"::""::-=--':"_-1 plus sales taxrate Sales tax = 22 $219.600 x 122 = $39.600 S1eR.5. This amount is added to the capital costof the equipment forthe purpose of calculating depreciation and cost of capital. The depreciation adjustment for the sale tax, using thesame basis asthe asset depreciation. for thecurrent period. would be$7.425. Sales tax adjustment amount is $39,600, with a depreciation adjustment of $7,425. 4.1.5 Costof capital The assets of the leisure centre are: • • • Land BUildings Gym equipment Add sales tax adjustment Less commercial loan component • Cash in the bank $500,000 (UCV) $500,000 (cost) $200,000 $39,600 ($80,000) (cost) $100,000 $500,000 $430,000 (WDV#) $112,500 (WDV#) $22.275 (WDV#) ($45,000) (WDV#) $100,000 (WDV# calculated using appropriate depreciation ratesfor the asset types, in this example over two years.) The centre has taken out a bank loan for the gym equipment of $80,000 at a commercial interest rateof 12 percent. As a consequence, the capital value of the equipment financed bythat loan should not be included in the cost of capital adjustment. (This capital value does not include any adjustment for sales tax.) This means that the written downvalue of the gym equipment forthe cost of capital adjustment reduces to $89,775. Step 1 Calculate the totalasset base. Comment: The total asset base after adjusting for sales tax is $1,339,600. After deducting commercially financed equipment, the relevant fixed asset base hasa written downvalue of $1,019.775 plus the workingcapital amount of $100,000. However, while only 60 percent of the fixed assets (land, building and equipment) has a commercial purpose, all of the cash in the bank is used asworking capital for commercial operation purposes. Sl.ep.J. Multiply the relevant proportion of the total asset base bythe cost of capital for the current year: $711,865 x 0.08 = $56,949 4.1.6 Exemption from land tax SleD Stell2 The sitevalue of land is $500 000 according to the local government. The "equalisation factor " asdetermined by Land Victoria is 1 therefore the unimproved value of land remains the same asthe site value as returned to local government at the lastgeneral valuation. attributable to relevant business activity. S1!m.1 60percentof the land is directly ~ The unimproved value of the land is greater than $85.000. therefore land tax will apply. (see Appendix 4 for current rates). The rate is: Slilp2 Calculate the portion of the total asset base used to produce the commercial output. $200 + 0.002 x$300,000 = $800. $1,019.775 (land, buildings and gym equipment) x 0.6 + $100,000 (cash in the bank) x 1 $611.865 + Therefore, the relevant adjustment for land tax directly attributable to the business activity is: $800 x0.6 = $480. Land tax adjustment is $480 $100,000 = $711 .865 Costof capitaladjustment is $56,949 6 Because cashin the backrelates solely to the commercial activities. 4.1.7 Exemption from local government rates 4.1.9 Pay-roll tax Step 1 The relevant capital improved value of the property (ie. premises and land) is $1 ,000,000 forrating purposes according to the local government. S!!m1 The local government rate is 0.008 times the value of the property per annum: 0.008 x$1 ,000,000 = Step 1 Because total annual salaries are greater than $515,000, pay-roll tax must bepaid. The total staffsalaries are $600,000. The amount on which pay-roil taxwould be payable is: $600,000 - $515,000 = $85,000 $8,000 S!lm2 Multiply thedifference by0.0575: $85,000 x0.0575 = $4,887.50 Pay-roll tax adjustment is $4,887.50 S1eJL3. The portion allocated to therelevant output is 60percent $8,000 x 0.6 = $4,800 Local Government ratesadjustment is $4,800 4.1.10 Accident Compensation Levy (WorkCover insurance) 4.1.8 Exemptions from FlOanddebits tax ,Srep.l Forecast likely sales revenue from output. The gym's revenue forthemost recent financial year was $450,000 and thisfigure can beused asa forecast forthecurrent period. Applying therule of thumb combining theadjustment for these two exemptions, 0.1 per centof sales revenue should be applied. Apollo has already paid a levy forWorkCover insurance. This is partof the"miscellaneous costs" category. 4.1.11 Other potential advantages Apollo estimates that it does not benefit from any requirements or regulations not shared byits private sector competitors, nor does it have access to free or below-cost overheads. S!!m1 Multiply theforecast by0.001 (0.1 per cent). FID and Debits tax amount is: $450,000 x 0.001 = $450 FlOanddebits tax adjustment is $450 Potential disadvantages • • Higher superannuation costs; and higher accountability costs. Step 3 The difference between the two is: $12.000 - $9,600 = $2,400 Step 4 Only 60 per centof this costis for commercial purposes. Therefore the adjustment is: As a starting point, there is a presumption in the costing guidelines thatthe public sector does not face conditions which would constitute a competitive disadvantage visa vis a private sector competitor. To the extent that costdisadvantages are identified, there is also anonus ontheagency to seek to minimise theadditional costs of public provision. Apollo will therefore need to: • • • establish a case that it does face higher costs solely due to government ownership; investigate arrangements forremoving the source of the high cost or ; if the costdisadvantage is unavoidable. estimate the magnitude of thecostburden to offsetagainst theestimated competitive advantages. $2,400 x0.6 = $1,440 Superannuationadjustment is· $1,440 4.1.13 Accountability costs S1eIl1 As a result of govemment requirements, Apollo must prepare a quarterly report for departmental compliance with the Financial Management Act. This is in addition to ordinary annual reporting requirements. This is nota costfaced byits private sector competitors. It takes theaccountant 5 hours to complete each quarterly report. The accountant's hourly pay is $25. Therefore, 20hours (5 hours x 4) is spent each year completing the report, a total of $500. Apollo estimates that each report also uses $25 of materials such as ink and paper SteJU 4.1.12 Superannuation Several employees (equivalent to 20 percentof salaries) receive anadditional two percent of their salary assuperannuation under a defined benefit scheme. (4 x$25 = $100). Therefore. the costof thisrequirement is: .s.tm2l Superannuation equivalent to 10 per cent of salary (rather than thestatutory 8 per cent) is paid on20per centof the total salary cost (ie. $600.000 x 0.2 = $120.000) . Therefore, the contribution to defined benefits schemes is: $500 + $100 = $600 Step 3 Only 60 per centof thisactivity is for commercial purposes. Therefore the relevant adjustment amount is: $600 x0.6 = $360 Accountability adjustment is • $360 ($120,000 x0.08) + ($120,000 x0.02) = $12,000. SteiL2. If Apollo contributed only thestatutory 8 percentto superannuation, the total would be: $120.000 x0.08 = $9.600 4.1.14 Net adjustment to total cost Box 4.1 Summary of Competitive NeutralityCost Adjuslments Netadjustment can be summarised as follows: Costof producingcommercial output Adjustments $427,260 .00 $ Depreciation onsales tax adjustment Exemption from stamp duties (*) Amount for costof capital Exemption from land tax Exemption from local government rates Exemption from FID and debits tax Exemption from pay-roll tax Additional superannuation costs Accountabilitycosts 7,425 56,949 480 4,800 450 4,887.50 (1,440) (360) $73,191 .50 5500,45 1.50 Net acijustment required Full competitiv(~/y neutral cost * Note: If themotor vehicle hadbeen anasset anamount of stamp duties not incurred dueto the exemptionwasestimated at $625. This amount wouldneedto be addedto the valuation of assets for depreciation purposes andwouldbe allocated to the cost of thecommercial output. The net competitive neutrality adjustment to costasa percentage of the full costbase is estimated to be 17 percent. 4.1.15 Competitively neutral pricing Under CN Policy. prices should reflect the full competitively neutral cost of producing a good or service. Currently. Apollo's income is $450,000. The competitively neutral cost of providing fitness services is $500.451 .50. Inthis example, Apollo has not fully implemented a competitively neutral price for its gym and pool facilities. To comply with CN Policy, the fitness centre will need to earn a further $50.451 .50. It is the choice of the management of Apollo centre onhow thismaybeachieved. Competitive neutrality requires that full costrecovery is achieved in aggregate on the pool and gym activities. For instance. it is acceptable for the centre to decide to provide aquatic activities at below cost, provided that the revenue from the gymnasium servicesis sufficient to cover bothits own competitively neutral cost aswell assufficient additional revenue to cover the competitively neutral cost of the aquatic activities. GLOSSARY Avoidable costs (AC): a costmethodology which can be used by non-commercial agencies, whereby only the incremental costs of producing anoutput areconsidered in establishing a competitively neutral cost base. Using this method, the agency generally need only consider the extra (direct) costs that the agency could avoid if the activity in question was not undertaken. (To the extentthat indirect costsareaffected bythe commercial activity these should be taken into account.) Competitive neutralitymeasure: a specific action to achieve competitive neutrality. These include corporatisation, commercialisation and full cost reflective pricing. Competitive NeutralityPolicy(CN Policy): a policy designed to offsetor remove anynet competitive advantages of publicly-owned businesses resulting from government ownership. Competitively neutralcost:the total cost of producing a good or service aftertaking into account competitive neutrality cost adjustments. Competitively neutralprice:the price set bya government-owned business for its outputs to recover fullythe competitively neutral cost over the medium to long-term. Current asset:anasset which is cash or can be readily converted to cash (eg. cash in bank, accounts receivable). Definedbenefitsscheme: the superannuation system under which the total benefit is related to factors such asyears of service and average salary. Payments under these schemes tendto have an accrual rate above that mandated bycurrent legislation. Direct costs of production: costs which can be directly and unequivocally attributed to anactivity. Fullydistributed costs (FDC): a costmethodology which ensures that the direct. indirectand competitively neutral costs of producing a good or service arefactored intothe cost base. Government business enterprise (GBE): a term used to describe any stand-alone business owned bygovernment at Commonwealth, StateITerritory or local level. Indirectcosts of production: costs which arenot directly attributable to a particular activity. These are often referred to asoverheads. Non current asset: anasset which is not readily converted to cash (eg. equipment, vehicles) . Opportunity cost: the return which could be gained byemploying resources in the nextbest alternative activity. Rateof return:(in this context) the percentage return required bygovernment on the total assets employed byanagency to undertake a business activity. Weighted AverageCost of Capital(WACC): the cost of funds to government agencies, which takes into account various classes of debtand equity capital. WACC takes intoaccount factors such as the appropriate return on debtand equity and a risk free rate of retum. Appendices National Indirect Tax Reform A1.1 A New TaxSystem Under national tax reform, a range of existing indirect taxes will bereplaced bya Goods and Services Tax (GST). This will have implications for competitive neutrality pricing. How will the GST work? The GST will bea multi-stage value added tax where tax is applied at each stage of the production chain. Government and businesses will beeligible to claim a rebate for the GST with the tax only "sticking" at the final point of sale to consumers.' The nature of taxreform The Commonwealth Government has proposed thatthe GST will replace the following taxes: • • • sales tax - from 1 July2000; Financial Institutions Duty - from 1 July2001; and stamp duties on marketable securities - from 1 July2001. The various state governments will also consider abolishing debits tax by1 July2005. The abolition of theremaining business stamp duties has been deferred. The phased nature of the abolition of these taxes will mean some of the competitive advantage of government entities will gradually decline from 1 July2000. This will bereflected in a reduction in the size of any competitive neutrality adjustments required bythe policy. Impact on competitive neutrality The main impact of national tax reform on competitive neutrality arises from theabolition of Sales Tax. Removal of thistax will significantly enhance competitive neutrality because the Sales Tax provides specific concessions to particular government organisations. These exemptions are described in Schedule 1 of the Sales Tax (Exemptions andClassifications) Act 1992 (see also Appendix 3). However, unlike the Sales Tax, the GST tax generally does not provide concessional treatment to particular entities engaged in creating commercial supplies. Rather, the nature of GST treatment will depend onwhether a supply is taxable, GST-free, or input taxed. Therefore, government agencies that are currently exempt from sales tax,will not beexempt from GST by virtue of their government ownership. BoxA1.1: Example ofthe GST For example: A timber merchant adds value of $1 00. Sells timber to a furniture maker for $110 (includIng 10 percentGST). The merchant remits $10to theATO The furniture maker claims aninput tax credit for $10. He adds $50invalue and sells it to a final consumer for $165 (including $15 GST). Heremits $15 to the ATO. There are three types of treatment of supplies under the GST: • taxable supplies - where GST is charged on supplies (eg sales), but inputtaxcredits are allowed for the GST on inputs used to make supplies. GST-free supplies - where GST is notcharged on sales of goods and services that are input GST-free. However, sellers of GST-free goods and services will not beentitled to claim input tax credits for any GST paid onbusiness purchases. input taxed supplies - where GST is not charged on sales of goods and services that are input taxed. However, the seller will not be entitled to claim input tax credits for GST paid on business purchases. • • 7 Refer to the Commonwealth Government's policy statement Tax Reform: Not a newtaxa newtaxsystem. August 1998. Transitional competitive advantages Over the phase-in period of the GST (2000-01 and 2001-02), there still may becases where the GST has competitiveneutrality implications. For example, under section 20 of A New Tax System (Goods andServices Tax Transition) Act 1999, there is to bea gradual phase in of input tax credits for motor vehicles. This means that for businesses: • • • noinput tax credits areallowed for motor vehicles purchased in the first year of the GST; 50 percentinputtax credits areallowed in the second year; and fullinput tax credits areallowed in the third year. Some of these government agencies may face higher GST compliance costs than competing private sector businesses which simply charge a uniform tax rateon alltheir sales and receive input tax credits ontheirpurchases. However, such costs are likely to beoffset bythe larger size of many government agencies. Further, for government agencies that engage in taxable and GST-free supplies there should beno additional compliance burdens onthe acquisition of business inputs." Even where the additional GST compliance costs areconsidered to be significant for the government agency, this is still not a competitivedisadvantage for the purposes of competitive neutrality adjustments. While a government agency may be obliged to provide particular services whicha private sector competitor does not, costs should be kept separate from the taxable activity which competes with the private sector. Accordingly, the government agency maychoose to consider appropriatestructural arrangements to ensure that GST compliance costs areable to beapportioned according to the nature of the activities. This provision is designed to reduce the incentive for entitiesto delay purchasing motorvehicles until after the GST start-date. However, where anentity wasable to purchase a motor vehicleSales Tax exempt. it will not be subject to this transitional provision. As a result. government agencies, which purchase motor vehicles Sales Tax exempt now, will beable to claim full inputtax credits for vehicles purchased immediately afterthe introduction of the GST. Competing private sector entities will have to wait for 2 years before theycan claim alltheirGST on purchased vehicles. This competitive advantage will accrue to government agencies that were previously exempt fromsales tax until 1 July 2002. A1.2 Otherimplementation issues relating to the New Tax System Cash flow Under the GST legislation, government businesses will be required to remit GST ona monthly basis if theirturnover is over $20 million. Competing private sector businesses with a turnover of between $50,000 and $20 million will be able to remitquarterly. This can provide the private business with a greater cash flow advantage, as theywill beable to hold GST collections for a greater period untilremittance to the Australian Taxation Office. This cash flow benefit increases with business interest rates in the economy. However, the potential disadvantage of monthly GST remittances stems from the size of the organisation. As it does not stem specifically from government ownership and it is not a competitive disadvantage from a competitive neutrality perspective, it should not betaken into account in making competitively neutral cost adjustments. Compliance costs Some government agencies will provide taxable and GST-free supplies following 1 July2000. Taxable supplies would include those supplies provided in competition (orpotential competition) with the private sector, whileGST-free supplies may include the provision of services such aswater and sewerage. 8 Refer to p. 6 of the Regulation Impact Statement for the introd uction of a Goods and Services Tax (Explanatory Memo randum f()(A New Tax System (Goods andServicesAct) 1999). Rate of Return The Department of Treasury and Finance is responsible for setting therate of return to apply to business activities of government agencies under the Victorian Government's CN Policy. The Department of Treasury and Finance advise thatthe approach to beadopted in calculating a rate of return for the purposes of competitive neutrality is to calculate a real before tax return based onthe WACC with reference to total assets. Rate The real (before tax) rateof return oncapital for the purpose of competitive neutrality pricing is currently 8 percent. Application The asset base to which the rate is to beapplied can bedefined as: • • total current assets (eg working capital, debtors, stock); plus totalnon-current assets (eg written down value of physical assets), owned and employed inthe production of the relevant output. To avoid double counting, it is important that the amount of any Government Financing Charge or other interest expense already allocated to an output isfirst deducted from the estimate of total cost, before the amount representing the rate of return is calculated. Valuation of assets The valuation of the non-current physical assets component of total assets, to which the rate of return is to apply should bethewrittendown replacement costin accordance with the 'Deprival Value Method'. For further explanation of the approach to valuation of assets refer to the Department of Treasury and Finance publication Recognition and Valuauon of Non-Current Physical Assets issued inJanuary 1995. Assistance can be obtained from the Budget and Financial Management Division of the Department of Treasury and Finance. Where lease, rentor hire options are pursued, the costof using the asset would normally be reflected inthe payments made to the owner of theassets and reflected asa direct costin calculating the full competitively neutral costof service delivery. Sales Tax Application Under national tax reform, thewholesales sales tax has been replaced bytheGoods and Services Tax (GST). Anadjustment for previous exemption from wholesale sales tax may apply for assets purchased prior to 1 July2000. The requirement for this adjustment will progressively reduce as more assets are purchased under the Goods and Services Tax regime. Wholesale sales tax wasa tax imposed bythe Commonwealth Government on goods imported into Australia and goods that weremanufactured and consumed in Australia . The taxwas imposed on the lastwholesale sale of goods going intouse forthefirst time in Australia. Sales taxwas imposed on 'assessable' goods which werethe SUbject of an 'assessable' dealing, unless an exemption applied. and hygiene products, books, magazines and newspapers and scientific and educational goods werealso exempt. Inrelation to the local government sector, exemption applied to goods used in a workand/or supply contract where ownership passed to the local government under the contract. For example in thefitting outof a local government occupied building or parts used in the repair of local government equipment or vehicles, Sales tax exemption didnot extend to machinery, equipment or tools, which werepurchased for use in carrying outlocal government contr actswhere the private contractor retained ownership. An exception existed in relation to earth moving contracts. Machinery, implements and apparatus, other than general purpose road vehicles, which were expected to be used mainly in earth moving contracts for governments forat least a periodof two years could be purchased free of sales tax. Exemptions The scheme of exemptions wascomplex. There werecategories of exemptions based on the use of the goods ('conditional' exemption) or the nature of the goods ('unconditional' exemption). The essential point is that, depending upon the circumstances, bothgovernment owned agencies and private sector businesses could obtainexemptions from salestax, Under Schedule 1 of the Sales Tax (Exemptions and Classifications) Act 7992, goods purchased for use bythe following entitieswereexempt from sales tax: • • • • public transport authorities (item 64); State Government bodies (items 126, 127 or 128); public hospitals (item 140); and local government bodies (item 127) ,9 Rates As at March 1997 rates of sales tax were: • • 12 per centfor household goods; 22percentfor non-luxury motor cars and other goods not covered by other rate categories (this is the 'general rate'); 41 per cent for alcoholic wines and 37 per cent for spirits, etc.; 32per cent for luxury goods (eg.jewellery, watches) [NB. F most schedule5 items, or excludingfur skins and somej ewellery, the sales tax rates reduced to 22 per centfrom 29 July1999]; and 22 per cent upto the luxury depreciation limit and 45 percent onthe balance for luxury motor vehicles, • • • Schedule 1 also exempted certain goods for use in business or industry (business inputs) relating to mining, primary production, manufacturing, transport, storage, research and development. Building materials, irrigation and watersupply materials, fuels, food and drink for human consumption, clothing and footwear, human health The category of purchases whichwas not exempt for private sector businesses which is most likely to be relevant for competitive neutrality is the category encompassing non-luxury 'motor vehicles' and 'other goods', This category had a tax rate of 22 per cent (the general rate). 9 Aruleof thumbis: jf a bodyis establishedby State legislation andthe Government hassomecontro overit. thenit is like to be l ly exempt from sales tax. This includes the following public bodies: libraries, museums. art galleries. fire brigades, harbouror marine boa rds, infant welfarebodies. Localgovernm bodi s include authorities established to carry out functions for local government. ent e Land Tax Application Land tax is an annual tax levied bythe State Government and is based onthe total unimproved value of all Victorian land owned bya taxpayer. The unimproved value of land isthe sitevalue provided bythe municipality multiplied bythe relevant "equalisation factor". The equalisation factor is a ratio supplied byLand Victoria whichreflects the average change in the value of land within the municipality from the timeof the lastgeneral valuation at a date setbythe Treasurer. For the 2000 assessment year, notax is payable ontotal land holdings of an unimproved value of less than Rates The scale of land tax in Victoria asat March 2000: Unimpmved land value Tax rates in 2000 $0- $84,999 $85,000• $'199,999 $200,000 . $539,999 $540,000· $674.999 $675,000 · $809.999 $810,000 - $1 ,079,000 Nil $85 plus 0.1% in excess over $85,000 $200 plus 0.2% of excess over$200,000 $880 plus 0.5% of excess over $540,000 $1 ,555 plus 1% of excess over$675,000 $2,905 plus 1.75%of excess over $810,000 $85,000. Exemptions Exemptions from land tax apply in relation to all Crown land, although where land is leased from the Crown, the lessee may beliable for land tax. Other specific exemptions are available forland vested in municipalities, public statutory authoritiesand, in some instances, for bodies providing or promoting outdoor sporting, recreation, cultural orsimilar outdoor activities. Note, certain specific public authorities (such as the Urban Land Authority) are notexempt. Please refer to the information provided onthe website of the State Revenue Office (www.sro.dtf.vic.gov.au) forfurther details. $1,080,000· $1,619,999 $7,630 plus 2.75% of excess over $1,080,000 $1,620,000 • $2,699,999 $22,480 pius 3% of excess over $1 ,620,000 $2,700,000and over $54,880 plus 5% of excess over $2,700,000 Comment Land tax does nothave to befactored intothe competitively neutral price where a government agency is paying full commercial rent. Local Government Rates Application Rates are levied by local governments on land holders withintheir municipalities. Rates Rates aredetermined by individual local governments. Exemptions Crown land and land used byState government and local government bodies is often exempt from rates and charges levied bylocal governments. The amount of rates levied depends onthe valuation of the land; charges relate to the provision of particular services bythe local government (for example, garbage collection). Comment A competitive neutrality adjustment does not have to be made where the government entityis paying commercial market rent. This is because the rent should embody the costs borne by the landowner, which include the costof rates. ., Stamp Duties Application Stamp duty is a Stategovernment tax levied under the Stamps Act 7958 and was traditionally imposed on documents necessary to evidence such things asshare and land transfers. However, in Victoria the regime now applies to a wide range of transactions which include; transfers of real property, leases of land, trusts, settlements, hiring of goods, mortgages, debentures and other securities, shares and other marketable securities, insurance and acquisitions of motor vehicles. Mortgages, bonds, debentures andcovenants: • • any mortgage by Her Majesty or various named government bodies; and anymortgage given for a religious, charitable or educational body or purpose. Rates Rates of stamp dutyaresmall percentages levied once-off on particular transactions. For example, the mostcommon rateof dutyfor a definite term lease exceeding $130 perannum is 60 cents per $100 or partthereof of the entire value of the lease. Exemptions Exemptions from stamp dutyin relation to most categories areavailable to public sector agencies. For example, specific exemptions areavailable in relation to particular transactions: Comment Under national tax reform, stamp duties on marketable securities quoted ona recognised stock exchange will beabolished from 1 July 2001. Conveyances ofrealproperty andland: • • • a grant of Crown land bythe Crown; transfers to the Crown or various named bodies; and transfers to or in trust for religious, charitable or educational bodies. Leases oragreement for lease: • • any lease granted to Her Majesty or various named government bodies; any lease granted or assigned to a municipality pursuant to powers conferred by Part XLA of the Local Government Act 7958; and any lease entered intofor a religious, charitable or educational purpose or body. • oS t s ':; .~ j .., Z .:l ~ .~ E o u OJ .~ Financial Institutions Duty Application The State Government under the Financial Institutions Duty Act 7982, levies Financial Institutions Duty (FlO) onthe receipts of financial institutions with annual deposits in excess of $5 million. Virtually allfinancial institutions directly pass onthe tax to theircustomers. Rates FlO is levied at the rate of 0.06percentwith a maximum dutyof $1 ,200perreceipt. Comment FlO is to be abolished following the introduction of the GST. It is expected to cease from 1 July 2001. Exemptions FlO is generally not payable onreceipts credited to exempt bank accounts. The following bodies can hold exempt bank accounts: • • • • • government departments; local government organisations; stateschools; public or non-profit hospitals; and charitable institutions (other than a tertiary educational institution). Debits Tax Application Debits tax applies to alldebittransactions to accounts with cheque drawing facilities. Debit transactions include direct debits and over-thecounter withdrawals, as well ascheque, EFTPOS and automatic tellermachine withdrawals. Financial institutions and account holders are jointly liable for debits tax, although it is usually passed on bythe financial institution to theaccount holder. The tax is levied perwithdrawal ona sliding scale, based onthe amount of the withdrawal. Rates Debit taxvaries according to the value of the debit to your account. The currentrates are: Notless than $1 but less than $100 Not less than $100 but less than $500 Not less than $500 but less than $5.000 Not less than $5,000 but less than $10.000 $0.30 $0.70 $1 .50 $300 $4.00 Exemptions Exemptions from debits tax areavailable in relation to accounts held bythe following: • • • • • • State government authorities; State government departments; local government bodies; public hospitals (and non-profit hospitals); universities, colleges and schools (including kindergartens) ; and charitable institutions. $'10,000 or more A general guide is that the rate is 0.04 per cent. Comment Followingthe introduction of theGST, debits taxis expected to cease from 1 July 2005. Exemptions do not apply where the sole or principal function of the account holder isto carry on an activity inthe nature of a business (whether ornot forprofit). The term "business" has been defined asa trade or comrnercial enterprise operating asa going concern. If an agency supplies goods to the public for payment. the agency may beregarded ascarrying onan activity in thenature of a business (except where an activityforms a minor or insignificant partof the function of the agency) . Pay-roil Tax Application Pay-roll tax is levied bythe State government under the Pay-roll Tax Act 7971. on theVictorian wages paid byan employer to its employees. A business is required to register and pay tax if it employs staff in Victoria and its total Australian wages exceed the general exemption level of $515,000over a financial year (or$42,917 permonth). For the purposes of the tax, the definitionof "wages' includes: • • • • • • • wages; salaries; remuneration; commissions; bonuses; allowances; fringe benefits, within the meaning of the Commonwealth Frnge Benefits Tax Assessment i Act 7986; employer (pre-tax) superannuation contributions; payments to some contractors (where a person is deemed to be an employee forthe purposes of the Pay-roll Tax Act) ; and remunerationpaid to company directors. • • • Exemptions Businesses whichfall under the following categories areexempt from pay-roll tax: • • • public and non-profit hospitals; non-profit. non-government schools providing education at or below secondary level; municipalities (withthe exceptionof wages paid to employees engaged in activites i specified under section 10(1 )(e) of the Pay-roll Tax Actor asdefined under section 9 Prescribed activities inthe Pay-roll Tax Regulations 7998.) (See Box A9.1); public benevolent institutions; charitable bodies (other than schools, educational institutions or instrumentalities of the State); and religious institutions. • • • Box A9.1: Activities of local government for which there is no pay-roil tax exemption Section 10(1 )(tl) of the Pay-roll Tax Act provides a general exemption to pay-roll tax with exceptions specifiedas: "(i) for or In connection with; or (ii) for or In connection with the construction of any bul ldinqs or the construction of any worksor the installationof plant machinery or equipment forusein or in connection , Withthe supply of electricity of gas watersupply, sewerage, me conduct of abattoirs, of public , markets. of parkingstations. of cemeteries, of crematoriums or of hostels or of anyother activity that is a prescribed activity". Other prescribed activitiesare set out under Section9 Prescribed activities in the Pay-roll Tax RegulatIons 1998. Section1OA of the Act states that the exemption does not apply to local govemment business entities unless the bod corporate is a wholly-owned subsidiary (within the meaningof the y Corporations law) of the local government. Therefore. if a local government conducts a commercial activity - suchasthe operationof a leisure centre - It will beexempt from pay-r oll tax ifit is wholly owned bythe local government. Inaddition, certain payments are not subject to pay-roll tax. These include: • • payments to mostapprentices and registered trainees; compensation payments to injured workers but not amounts paid in excess of the amounts prescribed ascompensation; some termination payments and payments made ascompensation for loss of employment; and payments to people on leave to work in the Defence Forces. Rates As of 1 July 1999, the rateof pay-roll tax in Victoria is 5.75 percent of pay-roll payments in excess of $515,000. Comment Competitive neutrality adjustments are still appropriate even where the competitor is below the pay-roll tax threshold. This is not a potential difference arising from government ownership, but one of size of the organisation. • • As noted above. businesses have exemptionfor the first $515.000of annual pay-roll payments. Free or Below-Cost Access to Corporate Overheads Whether access to corporate overheads will bea competitive advantage to betaken intoaccount in establishing a competitively neutral cost for the commercial output will depend onwhether the Fully Distributed Cost (FOC) approach orthe Avoidable Cost (AC) methodology is used. If theentity is required to apply FOC in costing its commercial outputs, overhead costs will have to beapportioned between commercial and noncommercial outputs. However, whether overhead costs need to betaken intoaccount under the AC approach will depend onthe variability of the overhead cost. For example, assume theoverhead of electricity is fairly constant during theweek and an additional commercial activity which requires commercial space does not materially affect electricity consumption. If the entity is able to apply AC methodology, theelectricity costs are unlikely to be apportioned to theoutput. Therefore, not paying for theelectricity is nota commercial advantage asno adjustment is required under the AC approach. Incontrast, where the commercial activity requires the use of overheads which are variable - such as additional electricity on weekends - the variability of theoverheads may besufficiently significant for it to betaken intoaccount under theAC approach. However, overheads will berequired to betaken intoaccount in all cases under the FOC approach. Superannuation Superannuation is a contribution paid byemployers into a fund to providean income for workers after their retirement. Both private sector and puonc sector employers are nowrequired to pay the same compulsory superannuation contribution (eight percentof an employee's salary asof 1 July2000), asmandated under the CommonwealthSuperannuation Guarantee (Administration) Act 1992.10 However, some public sector employees receive higher levels of superannuation payments under defined benefit schemes (public sector superannuation schemes which preceded the implementation of the 1992 Act). The principal defined benefit schemes include the State Superannuation Fund at the State level and the Public Sector Superannuation Scheme and Commonwealth Superannuation Scheme at the Commonwealth level. There is an evidentiary onus onthe agency which claim a competitive disadvantage to demonstrate howthenature of their superannuation obligations exceed those in the private sector. Further, while additional superannuation requirements inthe public sector may bea legitimate competitive disadvantage, it should be recognised that superannuation is only one element of theoverall remuneration package. Accordingly, other aspects of government remuneration may constitute a competitive advantage to theagency - for example where government awards arelowe than private sector r awards or where government employees can lease Australian vehicles at concessional rates asa result of discounts given byvehicle manufacturers to government employees. These advantages may be thesubject of a separate competitiveneutrality ad justment. 10 Most publicsectorsuperannuation schemes wereexemptedfromthis requirement under the kt but under a Heads or Government Agreement entered into by StateandCommonwealth Governments in 1996. thepublic sectorcompleswith the major principles or the i legislation. induding thecompulsory contribution. Other Competitive Advantages and Disadvantages A12.1 Accident compensation levy (WorkCover Insurance) Any employer of workers in Victoria whose annual remuneration is $7.500or above musthave a WorkCover insurance policy. Employers mustpay a premium forthe policy to one of agents authorised bythe Victorian WorkCover Authority. In 1998-99, the average premium was 1.9percentof total remuneration. Individual WorkCover premiums depend on the size of the pay-roll, the industry risk. and theclaims costs of thepastyear plus estimated claims costs forthe coming year. While allpublic sector employers are required to have a WorkCover policy. the premium may be made either directly bythe entity in question, or on behalf of the entity byitssupervisory agency. WorkCover insurance will therefore be a potential competitive advantage where entities have not directly paid the premium. If entities donot normally receive fundingfrom the supervisory agency which has paid their premium, this may be a competitive advantage. Similarly, where entities doreceive funds from the supervisory agency which paid their premiums this may not bean advantage if the funds received have a component reduced to reflect theWorkCover insurance paid on theirbehalf. Additional information can beobtained through the Victorian WorkCover Authority: A12.2 Advantages in borrowing funds and exemption from the Financial Accommodation levy Government-owned entitiesmay beable to obtain loans at a more favourable interest rate because of theirownership status. The Financial Accommodation Levy (FAL) is paid by Government Business Enterprises (GBEs) to the Treasury Corporation of Victoria, through which borrowings are made. The FAL is intended to account for the difference between normal commercial interest rates paid by private businesses, and rates paid by GBEs who, by borrowing through the Treasury Corporation, have the benefit of a State Government guarantee ontheir loan. However. the FAL only applies to significant GBEs. Smaller entitiesarenot able to borrow through the Treasury Corporation. While this may not provide access to an explicit State Government guarantee on loans, their public ownership provides an implicit Government guarantee, including local government activities. This is generally reflected in advantageous interest rates compared to private sector businesses in the same activity. Level 24, 222Exhibition Street Melbourne VIC 3000 tel: (03) 9641 1555 fax: (03) 9641 1222 Email: info@worlccover.vic.gov.au A12.3 Additional public or private sector regulations or requirements • There may existparticular legislation or regulation for a specific activity thatapplies only to private sector businesses undertaking that activity. Complying with such regulation may impose costs that a public sector agency engaged inthe same activitydoes not incur. Conversely. the private sector may have a comparative advantage regarding other regulations where public sector requirements are more onerous. Agenciesare encouraged to review allaspects of theiractivitiesto determine all legislation/regulation that affects the same activities when carried outbya private sector business. Ifsuch a review identifies any legislation/regulation thatapplies to a private sector business. butnotto the government agency. the bestoption is theelimination of thedifference through amendment of the legislation. Until legislative amendment occurs, grounds for a competitiveneutrality acjjustment may exist. The adjustment for a competitive neutrality advantage requires identification of: • particular regulatory requirements which are more onerous forthe private sector than the public sector (such ascorporate governance requirements under the Corporations La~ ; and quantification of thedifferences in compliance costs between these requirements and the equivalent requirements faced bythepublic sector (such as those under the Financial Management Act7994). Conversely, where a competitive neutrality adjustment is sought for a regulatory requirement whichplaces the agency in a comparative disadvantage, theagency: • must demonstrate that regulatory requirements in a particular area - such as information controls under the Privacy Act 7988 - are more onerous relativeto therequirements faced by theprivate sector; and thatthese additional requirements have had a measurable imp onthe coststructure of the act government agency relative to equivalent private sector competitors. • Often, any decreasing costadjustment for a competitive disadvantage claimed bythe public sectoragency may bemore than offset byan increasingcostadjustment for a competitive advantage in another area. Specific Competitive Neutrality Issues Government agencies and complainants have raised a range of issues regarding the application of CN Policy. Many of these issues can be summarised as follows. A13.1 Contracts pre-dating CN Policy extending beyond 1 July 1997 Where a contract is nearing expiry, analternative approach is to renegotiatecompetitively neutral prices upon renewal of the contract. A13.2 Use of avoidable cost methodology The Government's competitively neutral pricing principles will continue to apply where a third party manages Government premises, for example under a management contract. Where thecontract formanagement was signed priorto theapplication of competitive neutrality policy (1 July1997), there will benobreach of competitive neutrality policy at the time of concluding thecontract. However, following theapplication of CN policy, the Government agency is obliged to apply the Government's policy insofarasit is capable of operation within theterms of the contract. For example, where a government agency has contracted outthe management of a government facility, thegovernment agency should - where possible - use existing contractual obligations to require thethird party to take into account competitively neutral costs of provision of service when setting fees and charges. Insome cases, government agencies may utilise assets inthe provision of goods and services which are notfor commercial return. This could occur where theoutput is consistent with a stated public policy objective of theentity. These assets may also beused for commercial purposes, in competition with the private sector. If a business unit can earn revenue to equal (or exceed) its avoidable costs, it will impose nocosts on the non-commercial agency inwhich it is housed. It will also begenerating a commercial return on its ownassets. Where non-commercial agencies have assets with spare capacity, the avoidable costmethod will allow such capacity to beused commercially, rather than potentially have it lieidle. Avoidable costcomprises: • the additional costto the parent agency of the business unitusing its resources (assets and overheads); and thecosts of resources used exclusively bythe business unit (inclUding capital costs)." • Box A13.1: Example of the application of avoidable cost methodology .! c i oS ~ 'S A hospital has a catering facility which is used to prepare and dis tribute food asa key part of the care of patients of the hospital. The catering facility IS consistent with the stated (and obvious) public policyobjective of prOViding recuperative care for patients. The facility also sells takeaway in competition with theprivate sector. The avoidable costmethodology would only require that pricing reflect avoidable costs, ie those costs which would nothave been incurred if takeaway food wasnot provided Asthe building and cooking faCility would have already existed to provd e patient food, a rateof return onthese assets does nothave to be taken into account in setting a competitively neutral price. Rather, the key incremental costs thathave to betaken into account are thecosts of food preparation. These include theadditional food and labour costs "- s '" zz '" ~ E .~ .~ <3 11 ReIer to thepaper bythe Commonwealth Competitive Neutrality Complaints Office (CeNO Research Paper). Cost Allocation and Prcing. October 1998, pp. 7 - 22. i A13.3 Exclusive useof government advertising media A13.4 Commercial-in-confidence Whether exclusiveuse of Government advertising media constitutes a competitive advantage stemming from Government ownership will depend on whether the restriction is consistent with normal commercial practices orwhether it stems from a regulatory advantage which theGovernment business has relative to its private sector competitors. Where advertising access, for example, is denied to competitors in a manner consistent with normal commercial practices, there is unlikely to bea breach of competitive neutrality pricing principles. For example, where a local government grants exclusive advertising in its general notices to local government owned organisations, thiswould be analogous to a business preventing competitors advertising in its internal newsletter. This situation can becontrasted with exclusive use of directional signage. Even where a Government owned entity has made payments forthe privilege of placing signage in a particular location- such asnear a footpath - the denial of this access to a private sector competitor will bea breach of CN Policy. This is because the local government is using its regulatory powers to provide local government owned facilities with exclusiveaccess to a particular advertising location. This therefore constitutes a regulatory advantage for competitive neutrality purposes. The materiality of such action will depend on the extent to which commercial payments are made by theentity for the right to advertise in such a location and the availability of substitutable locations in which the private sector competitor may advertise. A recent Public Accounts and Estimates Committee report (35th report to theParliament March 2000) found that commercial-in-confidence has been used too broadly bythe public sector asa means of preventing disclosure of a widerange of information. Victorian Civil and Administrative Tribunal (VCAT) - has assumed the external review function previously exercised bytheAdministrative Appeals Tribunal (MT) has an overriding discretion to grantaccess to most categories of exempt documents if it concludes thatthe public interest requires such disclosure. The eN Policy allows that information that is commercial-in-confidence may beexcluded, provided this is noted in the public documentation. However, use of thisexclusion must bebalanced with the public interest of disclosure and transparency. Consequently use of claims of commercial-in-confidence to prevent the disclosure of information must bejustified. (NB. Competitive Neutrality Complaints reports are notsubject to VCAT/MT review asthey do not constitute administrative decisions or determinations.) Ingeneral, it will beappropriate for agencies to withhold information onthe basis that its disclosure will harm their own affairs (as opposed to those of third parties) only where the information falls within the scope of section 34(4) of the Freedom of Information Act (FOI). This section requires that agencies must beable to demonstrate thatthe information contains: • • some trade secret; or in thecase of an agency engaged in trade and commerce information of a business, commercial or financial nature thatwould, if disclosed, expose it unreasonably to commercial disadvantage. Another provision of relevance is section 36(b) of the FOI Act. which exempts from disclosure documents containing instructions issued to, or provided for the use or guidance of, officers of an agency onthe procedures to befollowed in various processes including: • • • negotiation; the execution of contracts; and other similar activities relating to the financial, property or personnel management and assessment interests of the Crown or agency. The VCAT has evolved a broad test of public interest that attaches significance to the role of transparency in promoting public debate and participation. The test also upholds the need to ensure proper standards of public administration by facilitating the disclosure of documents that reveal evidence of iniquity or wrongdoing. Inthe lightof the strong policy reasons that favour the transparency of such information, the Committee expressed the viewthat "there should bea specific requirement for .... parties to identify those parts that areclaimed to beconfidential and to specify theirreasons for making such claims". Therefore for the purpose of competitive neutrality processes, information that is commercial-in-confidence may beexcluded, provided a statement specifying reasons to support the claim is noted in the public documentation. )