Like it or not, Federal Government taxation policy is perhaps the key factor in the shaping of Australia’s wine industry. With the Henry review on Australian taxation being progressively leaked, the wine industry anxiously awaits some determination on its tax-related fate. Jeremy Oliver, one of Australia’s leading wine writers and a close observer of the industry for more than 25 years, believes there is a sensible course for Government and industry to follow, although he doesn’t believe for a moment that his opinion will be universally popular!The wires have been buzzing with poor research and misinformation concerning the future possibilities surrounding the likely tax change facing the Australian wine industry. Even the Sydney Morning Herald has tried twice and failed to get its facts in order. So perhaps it’s time for a straightforward examination of the possible scenarios.Other than the mandatory 10% GST, the overwhelming majority of Australian wineries do not ultimately pay tax on the sales of their product. In fact, about 95% of all wine tax collected and retained in Australia is paid by just 40 or so wineries, leaving around 2,400 entirely in the clear, a position that would be the envy of most businesses. It’s hardly surprising that those who do pay tax feel they’re being unfairly disadvantaged.Making a bad mistake even worseAt issue here is the so-called Wine Equalisation Tax or WET, which was introduced with the GST to ensure that the total tax take by Government from wine remained constant throughout the process of tax reform. However, it soon became clear that this 29% tax on wholesale value, which is imposed after the GST, collected $90 million too much. So the wine industry lobbied the Federal Government to give some back, the Government agreed and the WET rebate was born. If ever there was a case of one mistake grossly compounding another, this was it.Initially, the Federal Government offered from October 1, 2004 a rebate worth a potential $290,000 to the producer for its first $1 million worth of direct sales from the winery. In May 2006 this was adjusted upwards to the first $1.74 million of sales at wholesale, worth up to $500,000 each year to the producer. It’s sad but entirely accurate that the financial fate of most small and small-ish Australian wineries, numbering many, many hundreds, hangs on this lifeline. So, to be perfectly clear, the overwhelming majority of Australian wineries survive financially today only because of a tax rebate because of a mistake made by Treasury. Is this the sort of fiscal foundation that an industry should be built upon?Directly arising from this artificial financial base are several nonsensical outcomes. Firstly, wineries are able to sell their entire production at reduced cost knowing the half million-dollar rebate will follow in full once they achieve $1.74 million in sales at wholesale. In other words, there is a significant incentive for producers to cut their price to retailers to cost and even below to so they can pick up their tax rebate at the end of the year. Consequently, the medium-sized to large wineries with significant investments in Australian wine are forced to reduce the price of their own wines simply to compete with most of their competitors, the very same people who are only able to survive on the basis of a tax rebate. Furthermore, they have to reduce the price of their wines to compete against the ‘retail exclusive’ brands that have emerged in recent years, most of which owe their entire existence to a rorting of the WET rebate system. More on that shortly.If you thought the Australian wine industry was a level playing field, it’s time to think again. The application of the WET tax and its rebate is an artificial means of shaping the market and its value. It’s also shaping the evolution of the market, or more precisely, the lack of it.A handbrake on business evolutionAustralia, like several other large wine producing countries, has an oversupply. Ours is estimated to be more than 100 million cases and large enough to require the removal of between 25,000 and 40,000 ha of vines, depending on who you’re talking to. The wine industry, usually populated by the happiest and cheeriest of souls, is in a very troubled place. Its three main wine markets Ð Australia, the UK and the US Ð are a disaster zone for most wineries, and our three largest makers Ð Foster’s, Constellation Wines Australia and Pernod Ricard Pacific Ð are all struggling to achieve a meaningful return on investment. Small producers are struggling to get access to market. Non-contracted grape growers are slashing their wrists and those with contracts are spending all their free time pouring through their fine print. Usually, in situations like this, companies will merge together through a Darwinian sort of a process that enables one strong company to reach critical mass through the purchase of others. Yet, it’s actually quite hard to remember when one winery last bought another. There is but a single reason why dozens of mooted purchases have not taken place Ð the WET rebate. This only applies once to a single producer, regardless of the number of brands it might own. So, added to the purchase cost of any winery in Australia today is the value of its WET rebate, a cost you pay every year. So, if Winery A bought Winery B, which had wholesale sales of more than $1.74 million, it would effectively be penalised against its competitors by $500,000 EACH AND EVERY YEAR. Little wonder that wineries are not consolidating at all.Rorting the rebateThree years ago, the Federal Government returned $90 million in WET rebates. Yet for the year ending 2009, the Australian Taxation Office (ATO) collected $907 million in WET and gave back a staggering $200 million in rebates, an increase in $110 million in that short time. Has the wine trade more than doubled its size in this time? Not a chance! So what happened instead? Not only is the WET rebate being thoroughly rorted by Australian wine retailers and wine producers, but winemakers across the pond in New Zealand are dipping in as well.A wine producer creates a new brand and registers that brand as a winery. It then partners with a retailer with whom it enters into an exclusive arrangement, sells more than $1.74 million at wholesale rates, and then pings the Australian taxpayer for $500,000! Easy Ð just ask the number of New Zealanders who have figured it out! There are roughly 650 wineries listed in New Zealand, a number that has doubled in the past 2-3 years. Hmmm!This is far from the only reason why Kiwi sauvignon blanc dominates our retail market, but it’s undeniably a factor. And how do we know that wineries from Chile and the US are not about to claim? Like New Zealand, these countries have FTAs with Australia and the door is wide open. Despite the fact they’re not wineries, estimates suggest that retailers have taken the most of the increase in WET rebates Ð to the tune of about $50 million per year. How do they do that? They invoice their wine-producing partners (Australian or Kiwi) for an allocation of ‘marketing expenses’, which typically accounts for about half the value of the WET rebate, that’s how. Simple.All considered, it is easy to put a case that the current ad valorum system of wine tax in Australia favours cheap wines and cheap imports, which are rapidly growing in the Australian market and stealing market share from local producers. It supports an industry on the basis of a tax rebate and actively counters natural expansion of businesses. It also penalises more expensive bottled wines, the only possible saviour of Australia’s wine exporting reputation. Is this the sort of tax system the wine industry needs in 2010? Let’s explore some of the alternatives.A fixed flat tax for all alcoholic beveragesA single, flat tax for all alcoholic beverages, which is reportedly recommended in the Government’s still un-released Henry review, would be nothing less than an unmitigated social disaster. Support this concept if you want prices of spirits and alcopops to plummet, if you would like the prices of cask wines to more than double, and the price of bottled wines up to a price of nearly $18 to increase marginally. A bottle of wine that today costs $18 would be just $5 less than a bottle of spirit that today costs $35, instead of being $17 less as it is today. Support this concept, then, if you’re deeply committed to seeing more binge drinking amongst our youth and the more socially vulnerable. Thankfully, this notion is not being taken seriously in Government circles and is so deeply flawed that it doesn’t merit any further attention. A graded volumetric tax based on alcoholic strengthThe concept here is that wine would be given a series of stepped tax rates depending on alcoholic strength. For example, it would be taxed at x% if it was 9% or higher, y% if 12% or higher, z% if 15% or higher, and so on. Aside from the fact that Australia would become the only country in the world whose wine tax is based on alcoholic strength, this notion would make the ATO the most important influence on Australian grape growing and winemaking, which is something I believe the Federal Government has no interest whatsoever in seeing happen.Let me explain. Using the tax gradations suggested in the example above, in any given season a winemaker whose shiraz is typically 14% alcohol by volume might end up with a wine at 15% for a number of reasons that could encompass seasonal conditions, machinery breaking down, a winemaking experiment or even an outright mistake. Whatever the cause, the wine would be taxed more. Would the wine producer be able to ask the retailers to accept and pass on an increase in price for this single aberrant vintage? Not in this lifetime.The same would happen if the same winemaker was thinking about leaving the grapes out on the vine for longer than usual to acquire the same intensity of flavour expected by his or her customers. This could push the wine up to 15% alcohol and beyond, into the next tax bracket. As just discussed, this would cost the winemaker money in tax, which he or she cannot afford. So no, the grapes will be picked at the usual level of sugar (which equates to the usual level of alcohol after fermentation) to ensure the wine remains at the usual level of tax. But will the wine attain its usual level of quality? Not this time, it won’t. In this example, the ATO has directly influenced the quality of an Australian wine by determining when fruit is harvested, and this would happen all the time under these tax conditions.It is simply not possible in this scenario to set the incremental steps of alcoholic strength and tax rate correctly to account for all circumstances in wine production, which are subject to forces of a natural kind as well as those of the ATO.And there’s another issue here. The alcoholic strength of a wine in a bottle can change with time. Alcohol can evaporate out of bottles, and in the bottle it combines with acids to produce esters, which is a part of the reason a wine changes its character over time. Fortified wines in wooden casks can reduce in alcoholic strength from 0.2 to 0.3% a year. So how is a Government going to tax a wine that is kept in a winery, in bottle or cask, for several years before it is sold? What happens if nature dictates that a wine’s alcoholic strength falls from one ATO tax level to another between making and selling?This concept creates more layers of detail, confusion and complexity, it increases the paperwork burden on wine producers and from a production perspective, a wine’s alcohol band becomes as important as its regionality and variety. These are issues the wine industry neither needs, nor is equipped to deal with.An excise on wineExcise was initiated to regulate and protect a small number of spirit producers. It was never intended to become a means of collecting taxation from 2400-plus wineries. An explanation of excise by Rob Preece published online by the University of Canberra’s Centre for Customs and Excise Studies says the Australian excise licensing system ‘places considerable onus on the applicant to demonstrate that they are a bona-fide business with the full set of resources and skills for dealing in excisable goods.’ It adds: ‘Further, that both the business and key personnel have sound compliance records in all taxation matters, and that there are no other aspects that put the excise revenue being generated by the business at risk of not being paid or being paid late.’It is estimated that it would take around two years to implement a national wine excise tax, at a cost of tens of millions of dollars to the industry. If the Government were to follow a similar system for wine that applies to spirits, the wine industry would be submerged beneath a tidal wave of record taking and new responsibilities for reporting. Wineries would require bonded and non-bonded areas, and all stock movements between would have to be monitored. Imagine how this would affect a winemaker only using some, not all of the contents of a wine barrel when making a blend for sale Ð the confusion would be stupendous. The same wineries that now struggle with quarterly WET and GST returns would be required to report every week on stock movements, in addition to monthly reports for wine duty. It would be an expensive, time-consuming, non-productive nightmare. Strangely, though, some wineries actually embrace this concept. They obviously haven’t studied it in any detail.A flat wine volume tax on top of GSTWhatever new system of taxation is imposed on the wine industry, it will need to maintain existing revenues to Government Ð that much is certain. If a flat wholesale tax of $1.41 per litre was to be applied to existing wine sales in Australia, that would be achieved, provided current volumes of sales were maintained. A flat wine tax based on volume will clearly disadvantage wine sold in larger format packages such as four-litre casks. Anything that does this can be expected to reduce cask wine sales, since a four-litre pack now selling for $12.54 at retail would increase to $17.81. If one assumes a 20% decrease in volume sales of cask wine as a result, wine sales are reduced by 26 million litres, and the Government gets less tax. By increasing the volume tax to $1.47 per litre, tax revenue is equalised.Implementation of this concept would dramatically change the environment in which wine is grown, made and sold in this country. At the stroke of a pen, all the inconsistencies, illogicalities and the outright rorting of the WET system and its exemptions would be removed. Australian taxpayers would no longer be supporting competitive imports. Instead of the current artificial incentive to make cheaper wine sold in larger formats, Australian winegrowers will be encouraged to make better wine, the sale of which could actually make them profitable, or at least, sustainable without a handout from the taxpayer. Australian winemakers would be rewarded by making wines of higher price and quality. Our wine industry desperately needs this sort of incentive and reward to restore confidence and profitability.If this concept were implemented, wines currently priced below about $8.50 per 750 ml bottle would become slightly more expensive, while those priced above this mark could in fact become cheaper, if their makers and marketers wanted them to. However, only the blindest of optimists would expect prices to plummet with this change, since it is widely understood that the market interprets any fall in a wine’s retail price as a downward realignment of its true value.Instead, wine producers are far more likely to increase the wholesale prices of their wines priced above $8.50 per 750 ml bottle to maintain current retail prices. In doing so, they would actually make more money at wholesale than before, although the smaller guys wouldn’t be getting back their WET rebate. The Government would therefore make more money through an increased value of GST per bottle at wholesale, a bonus to the ATO estimated at around $50 million.A producer currently selling a wine at $35 retail that chooses to maintain this same retail price after this suggested change in taxation would receive an additional $4.62 (at wholesale) per bottle. This would go a long way towards offsetting the fact that it would no longer be receiving a WET rebate. Furthermore, the producer would receive this additional income at the time of sale, rather than through the existing once-per-year rebate payment. And if the producer’s wholesale sales exceed $1.74 million, they’re still able to keep all this amount.It’s possible that some producers would not do as well in this environment, especially the ultra-small ones unable to achieve high prices for their wines and those whose prices are presently kept artificially low in a bid to extract the full WET rebate. But a level playing field would be created for all wine producers, all of whom would pay some tax. It’s worth remembering that the WET rebate only existed to cover up for a mistake. No Government of any persuasion has ever held a policy position that small wineries should not pay tax. Government does however retain an option to assist small wineries by instigating a form of cellar door tax deduction as a regional tourism rebate.A flat volume tax of this kind would for the first time in years give medium-sized to large wine companies the chance to make a reasonable return on investment in quality wine. By increasing the cost of cask wines, it should have a positive effect on the levels of wine-related alcohol abuse. It would create genuine fiscal sustainability for those producers able to create a market for quality wine, either large or small. It would also generate the same tax return per bottle at wholesale for domestic and imported wines. It would end the WET rorting, worth a bare minimum of $50 million per year to the ATO.It’s really that bad right nowI’ll bet you didn’t know that for every bottle of wine that sells at retail for $25 today, about $10 finds its way back to the Government through WET, GST and a range of other company and business taxes. That’s a bigger margin, by far, than the retailer, the wholesaler and especially the producer, whose actual profit is a mere 50 cents for that bottle, according to modelling by Deloitte Touche Tohmasu. So Government presently pockets twenty times more than the producer, for a net investment of absolutely nothing at all. That is neither fair, reasonable nor is it sustainable. The sooner the system is changed to a flat volume tax, the better off will be the good ship Australian wine, and all but a small number of who sail aboard her.
