House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon. John Howard, M.P.)

General Outline

Introductory note

This memorandum contains explanations designed to provide a guide to the legislation prepared to give effect to company tax recoupment measures first foreshadowed in Ministerial statements of 25 July 1982 and 17 August 1982.

A package of Bills to achieve this broad purpose, but limited to former owners of the companies concerned, was introduced into the House of Representatives on 23 September 1982, at which time it was indicated that there would be further provisions to make promoters of pre-tax profit stripping schemes also liable to recoupment tax.

The Bills that are the subject of this memorandum represent the legislation introduced on 23 September 1982, extended to include promoters, and varied in some respects to effect technical and certain other changes in the originally-introduced measures. An associated measure, the Income Tax Assessment Amendment (Additional Tax) Bill 1982 deals with penalties for late payment of income tax and is explained in the explanatory memorandum prepared to cover the Bills introduced on 23 September 1982.

There are four Bills for the purpose of recouping evaded company tax:

•

The Taxation (Unpaid Company Tax) Assessment Bill 1982 which sets out the basic conditions of liability and contains necessary machinery measures.

•

The Taxation (Unpaid Company Tax - Vendors) Bill 1982 is a "Rates" Bill which formally imposes on vendor shareholders and other former owners of stripped companies a tax of the amount established by the first Bill.

•

The Taxation (Unpaid Company Tax - Promoters) Bill 1982 is also a "Rates" Bill formally imposing recoupment tax on promoters of pre-tax profit stripping schemes and their associates.

•

The Taxation (Unpaid Company Tax) (Consequential Amendments) Bill 1982 makes changes to several other Acts consequent upon the first Bill.

TAXATION (UNPAID COMPANY TAX) ASSESSMENT BILL 1982

General outline

This Bill will:

•

define the parameters of liability to recoupment tax of vendor-shareholders and other former owners of shares in companies that were stripped of pre-tax profits and thus evaded company tax (including undistributed profits tax) on those profits;

•

provide the mechanism for determining which former-owners are to be liable for this vendors recoupment tax and the measure of that liability;

•

provide a right of election so that shareholders in a company that has been stripped of its pre-tax profits will be (if the election is made) able to be assessed on sufficient dividend income to eliminate the liability of the company to undistributed profits tax and thus to recoupment tax on that undistributed profits tax;

•

similarly define the basis of liability to promoters recoupment tax of persons instrumental in stripping companies of pre-tax profits, and their associates;

•

require payment of additional tax for late payment of recoupment tax at the rate of 20% per annum where the recoupment tax is not paid within 30 days of service of a notice of assessment of that recoupment tax, or such extended time as the Commissioner of Taxation allows;

•

enable former owners of the companies to make arrangements with the Commissioner of Taxation for early payment of the amount of the evaded company tax;

•

require the Commissioner to re-issue notices of assessment on a stripped company to representative former owners and allow those former owners, through a nominated person, to exercise those rights of objection and appeal against the assessment that the company could have exercised;

•

render void arrangements entered into after 25 July 1982 which have the dominant purpose and the effect of directly or indirectly defeating, evading or avoiding a person's liability to pay recoupment tax.

Broad outline

As indicated above, the Taxation (Unpaid Company Tax) Assessment Bill is the main Bill in a package of 4 Bills, designed to recover from vendor-shareholders and other former owners of companies stripped of pre-tax profits, and from scheme promoters and their associates, the tax evaded by those companies.

This Bill contains provisions delineating the liability to a recoupment tax of persons who, directly or indirectly, owned shares in companies that were subject to stripping procedures that rendered them unable to meet a company tax liability that was actual or contingent at the date these persons ceased to so own their shares.

Similarly, the basis of liability to recoupment tax of the "promoter" group is spelt out in the legislation.

Included in the company tax that will be the subject of the recoupment will be tax on taxable income of the company, undistributed profits tax payable by the company and unpaid penalty tax imposed on the company for late payment of these taxes, measured only from 30 days after the date on which former owners are notified of the company's tax liability.

The Bill will also impose additional penalty tax at the rate of 20 per cent per annum on any recoupment tax assessed under the proposed law that is not paid by the due date for payment of the tax. That penalty tax will be capable of remission by the Commissioner of Taxation only in restricted circumstances. Special arrangements for time to pay, without penalty, are also provided for.

In addition, the Bill contains provisions to render void any arrangement, or transfer of property, occurring after the date of the Ministerial announcement foreshadowing this legislation - 25 July 1982 - that has the dominant purpose and the effect of enabling a person, who will be liable to recoupment tax under the Bill, to escape payment of that tax.

In order to recover from former owners of shares in stripped companies and from promoters and their associates the tax evaded by those companies it is necessary for constitutional reasons for the Bills to impose a tax on the persons concerned. The tax on former owners is to be imposed by one Rates Bill as a "vendors recoupment tax" and by a further Rates Bill the tax on promoters and their associates is to be imposed as "promoters recoupment tax".

The legislation will apply to schemes entered into before 4 December 1980, that being the date that is the commencement date of the Crimes (Taxation Offences) Act 1980. In order to make the legislation apply only from a time shortly before these schemes came to be practised on a wide scale, the Bill is expressed to apply to schemes entered into on or after 1 January 1972.

A typical scheme of pre-tax company profit stripping would ordinarily involve a sale of all (in isolated cases practically all) of the shares in a company (the "target company") which had successfully traded for a substantial part of the income year and which had, up until the implementation of the scheme, current year profits on which a contingent company tax liability existed. In addition, if the target company concerned was a private company for income tax purposes it would in due course become liable to pay undistributed profits tax in the event that it failed to pay a dividend of a specified proportion of its profits within 10 months after the end of the income year.

The trading activities of the target company would first have been transferred to another entity (company or trust) controlled by the former owners of the company and the target company's assets reduced to cash or other liquid form. It would be a condition of the scheme promoter that all liabilities of the company except its actual or contingent tax liabilities be paid or indemnified by the vendor-shareholder.

The former owners of the company would be paid a price for their shares that was fixed on the basis of the value of the company's assets, not taking into account the contingent tax liability on company profits. This capital sum would however have been reduced to reflect the fee charged by the promoter or other stripper.

By further processes the target company would be stripped of its liquid assets (e.g., by the making of a loan that could not be repaid) and thus rendered incapable of meeting the company tax liability in due course assessed to it. It is this unpaid company tax that is the subject of the Bill.

There were yet other situations in which the ownership of companies was sold and the companies rendered incapable of paying their income tax.

In some of these the sale of shares in a holding company would carry the ownership of one or more subsidiary companies, one or more of which was stripped of funds and rendered incapable of paying legally payable company tax. In situations involving more complex company structures, the entire ownership of a company that was later stripped was transferred by selling shares either in it and in other companies through which the company to be stripped was owned or in other companies which through various inter-company shareholdings owned the target company.

Some companies that were stripped of untaxed current year profits were also stripped of profits of a prior year that had not borne the company tax legally payable on those profits.

Yet again, some companies that had current year profits were, after the sale of their shares, put into a scheme which is found to be unsuccessful in its purpose of creating deductions that would eliminate the company tax liability that had accrued to the date of sale. Once the scheme is found not to be effective, so that company tax is payable, and the scheme is one that could not reasonably be expected to have achieved its purpose, is connected with a stripping of the company that has rendered it unable to pay tax or has a purpose of so stripping it, the case is also one of pre-tax profit stripping.

For all these situations, the legislation proposes the creation of liabilities to recoupment tax on "vendors" and "promoters". The liability on each group is independent of the other, except that the legislation is so structured that a payment of promoters recoupment tax will have the effect of reducing the amount of unpaid company tax that is the basis for the recoupment tax liability of vendors.

In relation to "vendors", the Bill proposes the creation of a series of levels of liability to vendors recoupment tax - a liability at primary level on each person (other than a bare trustee) who was a vendor-shareholder of shares in a stripped company or, where the vendor was a bare trustee, the owner of them under the trust, and to the extent necessary a series of further levels for persons who were at the time of sale of the stripped company beneficially entitled directly or indirectly to capital rights in a primary level company or trust. A liability at a level below the primary level will not arise unless for some reason (e.g., the primary level liability falls on a company that has been wound up) a primary level liability to the vendors recoupment tax will not be met or it would be inappropriate in the particular circumstances to expect it to be paid.

By clause 5 a liability for recoupment tax at the first level - primary level - will arise where (to take the simple case):

•

shares in a company carrying more than 90 per cent of the voting power in the company were sold, whether in Australia or outside Australia, on or after 1 January 1972 and before 4 December 1980 (i.e., before the commencement of the Crimes (Taxation Offences) Act 1980);

•

the total consideration for the sale of the shares in the company exceeded the net assets of the company after taking into consideration any actual or contingent company tax liability (but not penalty taxes) covering periods up to the time of sale of the shares;

•

an assessment has been made of the company tax payable by the target company, any objection against that assessment has been finalised and there is no outstanding dispute in relation to the company tax;

•

the company tax (including late payment penalty) remains unpaid as a result of an arrangement or transaction; and

•

the company did not after the sale carry on the same business it had carried on before the sale.

A liability to recoupment tax would not however arise if the case is one where after the sale of the shares the company unsuccessfully entered into a scheme to eliminate its tax liability, the scheme is one that (objectively viewed) could reasonably have been expected to be efficacious, it was not part of the arrangement that rendered the company unable to pay its tax and there was no purpose of stripping in the arrangement.

Where the various conditions are all met each direct shareholder in the target company, or a shareowner holding shares via a nominee who sold his or her shares, will, by clause 8, become liable to pay a recoupment tax equal to a proportion of the unpaid company tax ascertained by reference to the proportion of his or her consideration for the sale of the shares to the total consideration for all the shares.

The measures, suitably adapted, will also apply where shares in a holding company or holding companies were sold so that not only the holding company(ies) but also its subsidiaries were stripped of pre-tax profits, and in this case the tests outlined above will apply after aggregating the net assets and tax liabilities of the holding company(ies) and the subsidiary companies. Similarly, they will apply where a target company had been owned through a more complex series of shareholdings and the sale of the company was accomplished by selling shares in a number of companies, including the target company.

If a company had traded for a period and a provision for the company tax for the period had been raised in the company's accounts it sometimes happened that the vendor-shareholders received a price for their shares that was diminished by the amount of the provision and by an additional fee for the promoter. In that simple case, the legislation will not apply - the consideration for the shares did not exceed the company's net assets after taking into consideration the company tax liability (paragraph 5(1)(d)).

If, however, the case was one where the promoter took from the vendors the amount of the tax provision for a completed year, but left the vendors to enjoy the bulk of the benefits of the unpaid company tax for the next year, the test in paragraph 5(1)(d) could be satisfied in relation to the entire scheme, and in relation to the unpaid tax of both years. In line with the outcome in the given simple case, sub-clause 5(4) will permit the Commissioner to free the vendors from the recoupment liability in relation to the first of these two years.

Sub-clause 5(4) and its counterpart sub-clause 6(18) will also authorise the Commissioner to free a person from a liability for vendors recoupment tax where that person's liability would be less than $100 and it would not be appropriate to seek to recover the tax.

A person who holds shares as a bare trustee (i.e., as a nominee) will not be liable for vendors recoupment tax, but a person on whose behalf those shares are held will become liable as if that person were the holder of the shares that were sold.

Where a person has died before an assessment of recoupment tax is made in respect of that person there will be no liability for recoupment tax passed on to that person's dependants or beneficiaries under a will. However, if a person dies after a recoupment tax assessment has been made on him or her, the Commissioner will be authorised to recover that tax out of that person's estate.

Where the allocation of the unpaid company tax at the primary level is to individuals no further tracing of liability for the recoupment tax will be necessary. Liability will rest with the vendors who benefited as vendor-shareholders (or beneficiaries under a bare trust) from the evasion of company tax.

That will also be the case where the person who is allocated a recoupment tax liability at the primary level is a company or trust that is still owned by the people who were owners at the time control of the relevant target company was sold to the promoter or other stripper - so long, of course, as the company or trust still exists and has funds to pay its share of the recoupment tax.

Where that is not so, a further process of tracing may be necessary. As soon as such further tracing reaches an individual, it will stop, but would as necessary correspondingly continue to and through successive companies and trusts.

There are three triggers for tracing from the primary to the next level and, as required, successively to further levels. These are, very broadly, that the company or trustee to which recoupment liability has been allocated or traced -

(a)

no longer exists (sub-clause 6(1));

(b)

now has different shareholders or beneficiaries as a consequence of sales of shares or beneficial interests (sub-clause 6(2));

(c)

is unlikely to pay all of its share of the evaded tax (sub-clause 6(3)).

Once the need to trace liability from a company or trust has thus been established, the fundamental rule for tracing to shareholders and beneficiaries is on the basis of respective firm rights to a capital distribution from the company, or to a distribution of trust corpus, normally as viewed at the time of sale of the target company concerned.

In some cases, e.g., in the case of a discretionary trust, persons will have received capital distributions in situations where it could not be said that at the time of sale they had a firm right to that distribution. For such cases the legislation treats the actual receipt of capital or of corpus as having been received pursuant to right.

There are yet further situations where persons have received moneys as a consequence of a sale of shares in a target company (stripped of its pre-tax profits), but have not done so either in pursuance of rights to capital or corpus or in the form of a formal distribution of capital. For example, a recipient trust may have been stripped of funds by the making of loans so structured that they are not intended to be, and in a practical sense are not capable of being, repaid. The Bill treats persons who have thus effectively received moneys originating in a target company as having received, pursuant to right, a distribution of capital or corpus.

Should the application of these tracing rules result in the allocation to a person of a recoupment tax liability that is so far removed from practical realities that it would not be appropriate to pursue the person for the recoupment tax amount the Commissioner will be empowered (sub-clause 6(18)) to refrain from action accordingly.

If, after an assessment for vendors recoupment tax is made, the whole or a part of the underlying basic company tax (tax on taxable income and undistributed profits tax) is paid, the payment of that company tax will reduce any recoupment tax that is payable (clause 9). Similarly, if an amount of recoupment tax is paid at the primary level that payment will be reflected through reduction of the recoupment tax payable at a later level and vice-versa.

By sub-clause 9(7) a payment of promoters recoupment tax will be taken as a payment of basic company tax, and this will have the consequence of reducing the amount of vendors recoupment tax that is payable.

Turning to the basis for ascertainment of promoters recoupment tax, the persons who will be liable to recoupment tax as promoters are those who purchased shares from vendor shareholders or, for the more usual situation where the purchaser was a company or trustee, were shareholders or directors of the purchasing company, beneficiaries or trustees of the purchasing trust, directors of a purchasing corporate trustee, or were legal or beneficial owners through one or more further companies or trusts in a chain of ownership extending behind the purchasing company or trust.

Also to be treated as promoters for purposes of the promoters recoupment tax are those persons, companies and trustees (and similarly persons connected with or behind them) that acted as agent for the purchaser of the shares or as broker. On the same basis, the legislation will include persons in the "promoter" class where they are associates of a purchaser and gave financial assistance in the purchase of the shares (or, in the sense indicated, are connected with or behind them).

These tests aim to include as "promoters" those who, in the popular sense, were promoters of schemes to strip companies of pre-tax profits, and those closely connected with them in terms of ownership rights. For the same general purpose, a person who stripped moneys from a company or trust that is in the promoters class by way of loans that had the real character of distributions of income or capital will be treated as a "promoter" by being treated as a shareholder or beneficiary of the company or trust.

Persons liable as "promoters" will have a joint and several liability to pay promoters recoupment tax in respect of certain amounts of unpaid company tax, both primary tax on taxable income and undistributed profits tax. The basic tests for determining whether promoters are to be so liable are the same as those for determining whether vendor shareholders are to be liable for recoupment tax (tests based on purchase being substituted for tests based on sale), except that there is not to be in relation to promoters the "excess consideration" test (sale proceeds exceeding company net assets after taking into account any actual or contingent company tax liability).

The omission in relation to promoters of this test, along with further specific tests contained in the legislation will mean that the "promoters" group is to be liable to pay, as promoters recoupment tax -

(a)

20 per cent of the amount that "vendors" are liable to pay as vendors recoupment tax in any given case.

(b)

an amount equal to the whole of the evaded company tax in any case where vendors are not liable for recoupment tax because the whole amount of a company provision for tax was paid to the promoter; and

(c)

an amount equal to the whole of the evaded company tax in any case where the ratio of accumulated (taxed) profits to pre-tax profits in the stripped company is so high that the "excess consideration" test operates to exclude vendors from liability to recoupment tax.

In category (a) just outlined, the liability to promoters recoupment tax will be co-extensive (as to 20 per cent) with, and independent of, the liability to vendors recoupment tax in relation to the particular amount of unpaid company tax. However, there are provisions in the Bill (sub-clause 9(7)) under which any amount paid as promoters recoupment tax in relation to a particular company will, in relation to vendors recoupment tax, be taken as having been applied in reduction of the underlying unpaid company tax, with the consequence that the payment will operate to reduce the vendors recoupment tax liability accordingly.

The liability for promoters recoupment tax being a joint and several one of the members of the eligible promoters class it could occur that one or more of the members of the class is obliged to pay the recoupment tax that is the responsibility also of other members of the class. To enable the weight of the promoters recoupment tax to be appropriately shared amongst member of the class, clause 10 gives a member of an eligible promoters class a right of contribution against other members of the class in respect of promoters recoupment tax that he or she has paid. The right is to be exercised by suit in a court of competent jurisdication, which may order such sharing of the tax as appears to the court just and equitable.

A further provision in the Bill (clause 11) enables a person who would otherwise be treated as being in an eligible promoters class to seek from the Federal Court a declaration that it is not just and equitable that the person be so included. This relief could be sought either where the Commissioner of Taxation is seeking recovery of promoters recoupment tax from the person, or the person is the subject of an action for contribution brought by another member of the eligible promoters class.

If an amount of either vendors or promoters recoupment tax remains unpaid after the due date for payment (i.e., 30 days after issue of a notice of assessment), additional penalty tax at the rate of 20 per cent per annum will become payable. This additional tax will be capable of remission only in restricted circumstances such as where late payment of the recoupment tax is due to factors beyond the control of the taxpayer. If any payments of recoupment tax are made these will be applied in the first instance against this penalty tax (sub-clause 9(1)).

Under varying circumstances and conditions, there is provision under which former owners may, in a way that results in them not being liable to late payment penalties pay to the Commissioner amounts equal to some or all of the unpaid company tax, and in a way that does not reduce "promoters" liability to recoupment tax. In particular, if former owners choose not to contest liability, they may make arrangements with the Commissioner to pay over a period, normally of up to 12 months, the whole of a company's unpaid company tax, without attracting late payment penalty.

The legislation (clause 15) will enable the Commissioner to make an assessment of company tax against a company that has ceased to exist, e.g., where a company has been dissolved or deregistered, in which case the assessment notice is to be served on a representative group of pre-strip owners of the company.

By clause 18 of the Bill a company's assessment notice if not already issued or a copy of a notice of assessment previously served on a stripped company under the Income Tax Assessment Act will similarly be served on a representative group of pre-strip owners.

The representative group of former owners will be those people now living and whose whereabouts are known, and those companies that are still operative, who were shareholders (or owners under a bare trust of which the vendor shareholder was a trustee) being persons who are likely to have a recoupment tax liability. The representative group will also include up to 5 further former indirect owners of the company.

The representative group will be entitled to nominate a person who, on the basis of a majority decision of the group, will be able to exercise all the company's rights of objection and appeal against the company's assessment to primary company tax or undistributed profits tax.

As announced on 17 August 1982, a right of election will be available to shareholders in a company who would be liable to be assessed to recoupment tax based on unpaid undistributed profits (Division 7) tax of the company. The election would, if practicable, be made by the former directors of the company or, failing that, the vendor-shareholders. They will be able to elect that the former owners be assessed on an amount of income equal to the dividend that the company would have needed to pay to eliminate the liability to undistributed profits tax (clause 16).

Where such an election is made and the Commissioner is satisfied that the persons concerned will pay tax on the amount to be included in their assessable incomes, the company's liability to Division 7 tax, and thus the shareholders' liability to recoupment tax in connection with that Division 7 liability, will be eliminated. Where a shareholder is a trustee of a trust estate, a further election will be available to treat the imputed dividend income of the trust estate under the earlier election as a distribution to the beneficiaries in the trust, which will be assessed to tax at the marginal rate applicable to those benficiaries (clause 17). A similar effect in relation to shareholders in a company will be able to be achieved by the application of existing provisions of the income tax law (sections 46(3) and 105AA).

In a practical sense persons who make elections under these provisions will do so only where a lower rate of tax is applicable to any imputed dividend and thus where elections would operate to the financial benefit of the former owners or beneficiaries in a trust that formerly owned shares in a company.

The proposed legislation also contains (clause 22) provisions - foreshadowed on 25 July 1982 - to render void arrangements entered into after that date which have the dominant purpose and the effect of directly or indirectly defeating, evading or avoiding a former owner's liability to pay recoupment tax. Where a scheme involves a transfer of, or diminution in the value of, any property of a person liable to pay vendors recoupment tax, that scheme will be void in any proceedings commenced by the Commissioner or by a liquidator or trustee in bankruptcy which are designed to recover the recoupment tax. A scheme of this nature entered into for the purpose of rendering a person unable to meet a potential liability to vendors recoupment tax will also be void if, at a later time, that person is assessed to pay recoupment tax and fails to pay that tax.

Corresponding provisions are to apply in relation to arrangements to avoid promoters recoupment tax.

Finally, the legislation will mean that a person who receives a notice of assessment to recoupment tax will not be entitled to go behind the company tax liability unless there have been exercised, in the circumstances allowed, rights of objection and appeal against the company assessment (clause 23). Once a company's liability to company tax is finalised, either by a failure to exercise rights of objection or by a determination of any objection and subsequent appeal against the company, that liability will be conclusive insofar as an assessment to recoupment tax is concerned.

TAXATION (UNPAID COMPANY TAX - VENDORS) BILL 1982

General outline

This Bill will formally impose on vendor shareholders and other former owners of stripped companies a tax on the vendors taxable amount (broadly the person's share of the unpaid company tax) ascertained under the Taxation (Unpaid Company Tax) Assessment Bill 1982. The tax will be an amount equal to that vendors taxable amount.

TAXATION (UNPAID COMPANY TAX - PROMOTERS) BILL 1982

General outline

This Bill will formally impose recoupment tax on persons who were promoters, or associates of promoters, of schemes to strip companies of pre-tax profits. The amount will be determined under the Taxation (Unpaid Company Tax) Assessment Bill 1982 and is there described as a promoters taxable amount (in general it will be 20 per cent of the unpaid company tax). The tax will be an amount equal to the promoters taxable amount.

TAXATION (UNPAID COMPANY TAX) (CONSEQUENTIAL AMENDMENTS) BILL 1982

General outline

This Bill will:

•

amend the Administrative Decisions (Judicial Review) Act 1977 to exclude from review under that Act decisions relating to the assessment of recoupment tax (which will be reviewable instead under the objection and appeal provisions of the income tax law).

•

amend several other taxation Acts to provide that a liquidator or receiver of a company that has a liability to recoupment tax is required in setting aside assets of the company to pay tax to take into account the liability to recoupment tax.

Against the above general background, the provisions of each Bill are, in the notes that follow, explained clause by clause.