Proposed wine equalisation tax (WET) rebate reform

Agribusiness

 Barrels of wine

 

Earlier this year we highlighted signs that the Australian wine industry, driven by a boost in export sales, was beginning to reverse the trend of the testing times that it has endured for so long.  However, with the Federal Government 2016/17 Budget measures regarding the taxation of wine, long time risks are re-emerging in the industry. With the re-elected Turnbull Government , the industry is nervously awaiting the final proposed changes and their impact. We consider below the previously announced changes.

The WET came into effect at the same time as the Goods and Services Tax (GST) in July 2000.  WET is a tax on the last wholesale sale of wine, calculated at 29 percent of the sale value and only applies to domestic sales, not export sales.  Within several years of its implementation, wine producers, particularly smaller producers in rural and regional Australia, were severely impacted and lobbied for a rebate of the WET payable on wine sales in order to create a level playing field.  Many of those wine producers have become reliant on the WET rebate for their ongoing profitability and viability thereby hiding potential inefficiencies in the production process.

For the past 12 years the rebate for producers has been up to $500,000 per annum and has led to widespread claims of rorting.  The Federal Government 2016/17 Budget measures have indicated tightening of the eligibility rules for the rebate.  Those measures include strengthening the definition of a producer to avoid the rebate being claimed multiple times by different entities and a requirement from 1 July 2019 for a producer to own a winery or have a long term lease over a winery to be eligible.  This last proposal is directed at “virtual wine producers” which have become more prevalent in the industry.

Arguably the most significant tax reform will be the reduction of the WET rebate cap from $500,000 to $350,000 on 1 July 2017 and down to $290,000 on 1 July 2018.  The current $500,000 WET rebate cap means that a wine producer’s first $1.7 million of sales per annum are effectively exempt from WET but this will reduce to $1.2 million in FY18 and $1.0 million in FY19.

In September 2016, the Federal Government released an Implementation Paper for further submission and comments including how wine should be packaged and branded, in order to prevent bulk and unbranded wine from benefiting from the WET rebate. The Implementation Paper is silent on any further changes to the above proposed caps on the rebate.

Given that nearly 2,000 of Australia’s 2,468 wine companies currently claim the rebate, a large proportion of producers and associated grape growers are likely to be impacted by the proposed changes.

The Treasury Discussion Paper supporting the 2016/17 Budget measures, argues that the WET rebate is distorting production patterns of wine by:

  • Preventing industry adjustment by allowing unviable / inefficient wine producers to continue to operate, resulting in an oversupply of wine grapes and wine;
  • Not incentivising businesses to exit the industry due to their reliance on income and cash flow, where an efficient market would require them to; and
  • Preventing market consolidation / economies of scale due to fragmented arrangements which are structured to maximise the WET rebate.

The rebate cap reduction is expected to severely impact small to medium wine producers, many of whom rely heavily on the rebate for their cash flow and profitability. These producers often operate at higher price points. The impact of the reduction in the WET rebate cap will have the greatest impact on the average cost of production.  By way of example, an eligible wine producer that sells 22,000 cases of wine at a wholesale price of $80 per dozen (excluding WET and GST) per annum, would be entitled to receive the full WET rebate cap of $500,000 per annum. However, when the rebate cap reduces to $290,000 on 1 July 2018, this same wine producer would need to find cost savings of $210,000 or $9.54 per dozen to maintain the same level of profitability. 

Larger wine producers with a greater focus on export sales will be less impacted by the proposed changes as will small niche producers (as distinct from ‘small to medium’ wine producers) who only sell branded products through cellar doors.

Small to medium wine companies, particularly those without production facilities and which focus their sales more on bulk and unbranded wine, will potentially be the hardest hit.  They argue that reduction of the WET rebate cap will lead to significant industry restructuring (one of the primary reasons the Federal Government is introducing the changes) and may result in business failure.  Exacerbating this point, as the announced changes currently stand, the subsidy paid to New Zealand winemakers has been left intact. This has long frustrated Australian wine producers who are vying for the same markets.

Five possible ways that wine producers may seek to overcome the reduction in the WET rebate cap are as follows:

1. Increase wine prices
Wine producers may try to pass on the reduction in WET rebate to retailers. However, this may result in loss of access to market, loss of contracts and / or
reduction in supply. Alternatively, a retailer may try to pass on price increases to the consumer, resulting in that price increase being rejected by the consumer and a change in consumer preferences.

2. Focus on exports
Wine producers may target export sales to supplement any loss of domestic and/or competitiveness as a result of the reduction in the WET rebate cap. However, that strategy has its own risks, including the costs and time taken to establish presence in those export markets.

3. Loss of employment
Wine producers may reduce their employee headcount in order to save costs. However, restructuring employment arrangements may crystallise significant redundancy costs. The producer may not have the capacity to fund these costs which may place significant strain on the wine producer’s cash flow and could result in business failure.

4. Reducing input costs
Wine producers may seek to reduce input costs. This may result in:

  • Vineyards not being adequately maintained, potentially resulting in a decline in grape and wine quality and grape yields;
  • Prices paid for grapes per tonne reducing, impacting the viability of marginal growers, who may choose to exit the industry;
  • Further pressure on wineries reliant on contract processing as their source of income, who are already suffering from a surplus of excess processing capacity; and
  • A compromise in the overall quality of the product by possibly using inferior production processes, including bottling.

5. Cuts to business investment
Wine producers may also cut their capital expenditure and research and development budgets. Both are important to the ongoing viability and success of the wine industry. This may place funding pressure on the Federal Government to increase grant funding to partially offset the additional WET that is forecast to be collected.

Conclusion

As the WET rebate cap is reduced, wine companies, particularly small to medium wine producers, are likely to experience pressure on their profitability and cash flow.  Given that the cuts to the rebate are designed to improve efficiency, there is a risk that those wine companies who do not act early by implementing efficiency measures and / or restructuring (which may include exiting the industry) will risk business failure.  Whether you are a wine producer, advisor or financier to a wine business impacted by the WET rebate reform, Ferrier Hodgson can help, having assisted wine businesses for 40 years by providing independent advice to stakeholders

 

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