Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon. John Howard, M.P.)
This clause will incorporate into the Principal Act additional provisions to counter schemes for tax avoidance that fall within two general categories.
Under one category of schemes, the most common of which are known as "pre-paid interest" and "pre-paid rent" schemes, a taxpayer incurs and pre-pays a liability for interest, rent or other outgoings of a tax deductible nature.
Under the pre-paid interest schemes, a taxpayer seeks to obtain a deduction for an amount far in excess of his net outlay in what is essentially a transaction arranged to manufacture a tax deduction. This is because payment of the interest for which a deduction is sought gives rise to a corresponding reduction in the amount of loan moneys that are effectively to be repaid.
Under the pre-paid rent schemes, a taxpayer seeks to obtain a deduction, in the form of rent, for the major part of the cost of a capital item such as a building for which no tax deduction is available if acquired by a straight forward purchase.
The new provisions are directed to ensuring that no deductions will be allowable in respect of expenditure incurred under such schemes where the expenditure is incurred after 19 April 1978, the date on which the amendments were announced.
Schemes within the other category involve arrangements between associated parties for the purpose of securing that one party will obtain a deduction while the other party will not bear tax on a matching amount in the same year of income. The associated parties thus aim to defer income tax liabilities.
The new provisions, to be effective from 20 April 1978, will deal with schemes of this nature in two ways. In cases involving outgoings in respect of the future provision of goods or services, a deduction is to be available in a particular year of income only for so much of the particular outgoing as is reasonable having regard to the extent to which goods or services were provided in that year. In other cases, the level of a deduction in a particular year of income is to be limited to any amount actually paid in that year.
The broad policy underlying the income tax law is that residents are liable to tax on income from all sources, whether in or out of Australia, at the time that it is derived, but subject to measures to prevent double taxation of foreign source income that has been taxed abroad.
However, in Union Fidelity Trustee Co. of Australia Ltd v. F.C. of T. (1969) 119 C.L.R. 177, the High Court held that, in calculating the net income of a trust estate for the purposes of Division 6 of Part III of the Principal Act (the part of the Act dealing with the taxation of trustees and beneficiaries), only income from sources in Australia could be taken into account. Income of a trust estate from foreign sources could not be taxed under that Division as it was derived, but only at the time when a resident beneficiary received the income (section 26(b)). An effect of the decision was that foreign source income could be accumulated by Australian residents in a trust without liability for Australian tax unless and until the trust income was distributed to a resident beneficiary.
To overcome the effects of the decision, the Bill proposes three main changes.
In consequence of one of them, an Australian resident beneficiary will be taxed under Division 6 on trust income to which he is presently entitled, whether the income has a source in Australia or overseas (clause 12) and the trustee will be taxed on such income where the resident beneficiary presently entitled to the income is under some legal disability, such as being a minor (clause 13). To this end, clause 11 will require that the "net income" of a trust estate be calculated on the same basis as if it were the income of a resident individual.
A second major proposed change concerns circumstances in which there is income of a trust estate to which beneficiaries are not presently entitled. It is necessary to tax the trustee on this "accumulating income" to which no beneficiary is presently entitled, if tax is to be obtained each year as income is derived. But under the High Court interpretation of the existing law, the trustee is only taxed on such accumulating income which has an Australian source. To bring foreign source accumulating income to tax as it is derived, the Bill first contains a definition of a "resident trust estate" - that is, a trust estate with a resident trustee or with its central management and control in Australia at any time during the year of income (clause 11, proposed section 95(2)). The next step is to tax the trustee of a resident trust estate on income to which no beneficiary is presently entitled, whether the income comes from Australian or foreign sources, and regardless of the residence of the ultimate beneficiaries (clauses 14 and 15). There will be no effective change to the present law under which a non-resident trustee is subject to tax on accumulating income from sources in Australia, although the rule is to be spelt out more fully in clauses 14 and 15.
A consequential amendment proposed is that if foreign-source accumulated income that has been taxed to the trustee of a resident trust estate is later distributed to a beneficiary who was a non-resident at the time the income was derived, the tax on that income is to be refunded on an application being made by the beneficiary (clause 16, proposed section 99D). This follows the policy of the income tax law that a non-resident is not liable to tax on ex-Australian source income.
The third major amendment proposed is designed to ensure that a resident beneficiary will be liable to tax on trust income paid or applied for his benefit and to which Division 6 has not previously applied (clause 16, proposed section 99B). Thus, an amount paid to an Australian resident beneficiary out of income from foreign sources that has been accumulated in a non-resident trust estate (and would not have been taxed while the income accumulated) will be taxed to the beneficiary under the rules proposed in the Bill (clause 16, proposed section 99C).
Other significant effects of these provisions of the Bill are -
- that a trust with a business in Australia or income from Australian property (except dividends or interest subject to withholding tax), which does not have a resident trustee, is to be required to appoint a resident public officer to ensure that the trust's taxation responsibilities are met (clause 21, proposed section 252A);
- to make it clear that the fact that trust income to which a beneficiary is presently entitled in a year of income is paid or applied for the benefit of a beneficiary during the year does not mean that the present entitlement provisions of Division 6 (section 97 or 98) do not apply to that income (clause 11, proposed section 95A).
These proposed amendments to the trust provisions are to apply to 1978-79 and later income years.
A non-resident beneficiary will continue to be taxed, as at present, on income from Australian sources to which he is presently entitled, except where the beneficiary is under a legal disability, when the trustee will be assessed on the income.
The trust provisions will continue to be subject to existing provisions giving relief from double taxation of foreign source income that has been taxed in the country of source.
As it could be argued that the reasoning of the Union Fidelity decision applies also to partnerships, it is proposed to clarify the law to ensure that income from foreign sources is included in calculating the net income of a partnership, and that a resident partner is liable to tax on his share of the partnership's world income, subject to the existing provisions giving relief from double taxation. A non-resident partner will continue to be liable to tax only on that part of his or her share of the partnership income that is attributable to sources in Australia.
The amendments are to apply to 1978-79 and later income years.
By this clause it is proposed to overcome certain tax avoidance arrangements designed to enable trading profits and other income derived by trusts to escape tax completely.
Section 97 of the Principal Act provides for a beneficiary who is presently entitled to a share of the income of a trust estate and not under any legal disability to be taxable in respect of that share. In those circumstances, the beneficiary's share of the trust income is included in his assessable income, and the trustee is not required to pay tax on the beneficiary's share. Where a trustee who has a discretion to pay or apply income for the benefit of specified beneficiaries, exercises the discretion in favour of a beneficiary, section 101 deems the beneficiary to be presently entitled to the amount paid or applied, and such an amount is also assessed to the beneficiary under section 97.
The particular tax avoidance arrangements rely on a nominal "beneficiary" being introduced into the trust and being made presently entitled to income of the trust, thus relieving the trustee of any tax liability in respect of the income. However, it is a feature of the arrangements that the introduced beneficiary also escapes tax by one means or another, e.g., as a tax-exempt body or organisation. This "beneficiary" retains only a minor portion of the trust income, while the group in whose favour the trust in substance exists effectively enjoys the major portion, but in a tax-free form. For example, a corresponding amount may be gifted to form the corpus of a further trust for the group's benefit.
The amendment proposed will look to the existence of an agreement or arrangement that is entered into otherwise than in the course of ordinary family or commercial dealing and under which present entitlement to a share of trust income is conferred on a beneficiary in return for the payment of money or the provision of benefits to some other person, company or trust. In those circumstances, the amendment will treat trust income dealt with under the "reimbursement agreement" as not being income to which any beneficiary is presently entitled but as having been accumulated by the trustee, who will then be liable to pay tax on the income under section 99A at the prescribed tax rate (61.5 per cent for 1978-79).
The amendment will apply to trust income paid to or applied on behalf of a beneficiary on or after 12 June 1978, being the date of the announcement to legislate against these schemes.
The following are notes on each of the clauses of the Bill.