24/08/2021 - 14:00

Adding value to defence objectives

24/08/2021 - 14:00

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Balancing offshore inputs with local participation in defence contracting is a challenge.

The view of Townsville from a Australian Army CH-47 Chinook. Photo: Sagi Biderman

Australian content is a permanent feature of defence, with the ‘AIC plan’ component of the requirements in defence tendering and contracts referring to Australian industry capability.

AIC can be a contentious issue, with risk, capability, national security, industry development, export potential, global supply chains, international diplomacy and government policy all tied to the topic.

It plays a critical role in how government dollars in defence are used to boost Australian industry.

The Australian government describes the AIC program as one that “encourages involvement of Australian industry in supply chains”.

It says the program aims to: provide merit-based opportunities for Australian business in Australia and overseas; influence global defence companies; facilitate the transfer of knowledge and intellectual property; and encourage investment in Australian industry.

The success of these aims draws attention to the definition of an ‘Australian company’. If the work is performed in Australia, with Australian employees and an Australian Business Number, the company is Australian.

This includes subsidiaries of overseas companies, which introduces several other complications that create considerable debate.

The defence supply chain is of critical importance, and it is easy to lose perspective when debating the AIC program. The capability provided to defence must be delivered to standard, on time, and on budget.

At the point of contracting, mitigating the risk on capability delivery and effectiveness is a real concern.

Proven international companies hold an advantage here. With a subsidiary registered in Australia, they meet the AIC program definition of ‘Australian’.

There are, however, other risks and consequences in this instance.

In a crisis, what is the control framework within that Australian subsidiary, and will it align with Australia’s national interests? This is addressed somewhat by the definition of the ‘sovereign industrial capability priorities’, defined by defence as: “Industrial capabilities considered critical to defence and for which Australia must have access to, or control over, the skills, technology, intellectual property, financial resources and infrastructure that underpin those capabilities.”

It has been a long-held personal belief that the definition of ‘Australian’ company should focus on the end-of-line beneficiaries, and that the taxation implications should be considered as part of the financial metrics in evaluating tender responses and supply chain engagement.

Assuming a 10 per cent profit margin on a $475 million acquisition contract, the difference between an Australian company by beneficiaries versus multinational subsidiary lies in the additional tax on the Australian shareholders.

In this example, the variance in value to the Commonwealth relative to the original revenue amount is 1.05 per cent ($4 million).

Using the same assumptions on a $20 million per annum sustainment contract, the variance is 1.55 per cent ($312,583 per annum).

The application of management fees, a multiplier effect, and reinvestment rates further exacerbate the potential variance.

Assuming a 25-year sustainment term, alongside the acquisition example, and applying reasonable positions on tax-effective strategies, the differences reach 2.01 per cent and 1.66 per cent.

The benefits of major multinationals cannot be ignored, however, and many wonderful contributors to Australian industry genuinely conduct themselves as Australian businesses.

If a subsidiary company offers broader industry a chance to compete for genuinely contestable work, employs Australians, invests in Australian capability development and training, participates in knowledge transfer, and connects local industry into global supply chain opportunities, then real Australian benefit is being delivered.

This is what gives rise to the debate around the AIC program. International subsidiaries that act in accordance with Australian intentions should be welcomed, and Australian beneficiary businesses also deserve their fair chance, while the Commonwealth understandably wants to de-risk capability and delivery.

Consideration must be given to the application of new financial metrics in the assessment of Australian businesses.

And perhaps what is lacking is a third definition of ‘company’, to be fair to both the participating multinational subsidiary and to the Australian-owned business, with tiered financial metrics applying to their evaluations within a tendered supply chain: international company, Australian subsidiary of foreign owned; and Australian owned to beneficiary level.

What is clear is that improvements have been made over the past two decades in accountability and participation in the AIC objectives by all involved. It is also true that international companies add great value to Australia, and that Australian companies continue to have value to add. To be fair to all, and to meet the objectives of defence, continued evolution is required. 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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