Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon. John Howard, M.P.)
This Bill will introduce into the income tax law general anti-avoidance provisions to replace section 260 of the Income Tax Assessment Act 1936 (the "Principal Act"). Section 260 has appeared in the Principal Act in an unchanged form, as set out below, since 1936 and had appeared in Commonwealth income tax laws in virtually the same form prior to that time.
"260. Every contract, agreement, or arrangement made or entered into, orally or in writing, whether before or after the commencement of this Act, shall so far as it has or purports to have the purpose or effect of in any way, directly or indirectly -
- altering the incidence of any income tax;
- relieving any person from liability to pay any income tax or make any return;
- defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or
- preventing the operation of this Act in any respect,
be absolutely void, as against the Commissioner, or in regard to any proceeding under this Act, but without prejudice to such validity as it may have in any other respect or for any other purpose."
The literal terms of section 260 may suggest that it has a wide ambit. However, as early as 1921, in referring to the then equivalent of section 260, the Chief Justice of the High Court observed:
- "The section, if construed literally, would extend to every transaction whether voluntary or for value which had the effect of reducing the income of any taxpayer; but in my opinion its provisions are intended to and do extend to cover cases in which the transaction in question, if recognised as valid, would enable the taxpayer to avoid payment of income tax on what is really and in truth his income. It does not extend to the case of a bona fide disposition by virtue of which the right to receive income arising from a source which theretofore belonged to the taxpayer is transferred to and vested in some other person.".
In following a course of interpretation which starts from a position that the section is not to be read literally, the courts have reached a point where, as expressed by a Justice of the High Court in 1977, "... the very restricted operation conceded to section 260 by the course of judicial decision and the generality of the language in which the section is expressed stand in high contrast ...".
Four broad categories of limitation on the scope of section 260, as exposed by judicial decisions, can be identified:
- The "choice principle" is an interpretative rule according to which section 260 will not apply to deny to taxpayers a right of choice of the form of transaction to achieve a result if the Principal Act itself lays open to them that form of transaction. To do so does not alter the incidence of tax and this is so notwithstanding that the transaction in question is explicable only by reference to a desire to attract the operation of a particular provision of the Act and so achieve a reduction in liability to tax below what it would have been if that course had not been taken.
- The section is expressed in such a way that the purposes or motives of the persons entering into an arrangement are not to be enquired into in deciding whether the section applies to the arrangement. Rather, the "purpose" of an arrangement is to be tested only by examining the effect of the arrangement itself.
- It is unclear whether an arrangement to which the section is found to apply must be treated as wholly void or whether it can be treated as only partly void, i.e., to the extent necessary to eliminate the sought-after tax benefit.
- The section does not, once it has done its job of voiding an arrangement, provide a power to reconstruct what was done, so as to arrive at a taxable situation.
The proposed new Part IVA, which this Bill will insert into the Principal Act, is designed to overcome these difficulties and provide - with paramount force in the income tax law - an effective general measure against those tax avoidance arrangements that - inexact though the words be in legal terms - are blatant, artificial or contrived. In other words, the new provisions are designed to apply where, on an objective view of the particular arrangement and its surrounding circumstances, it would be concluded that the arrangement was entered into for the sole or dominant purpose of obtaining a tax deduction or having an amount left out of assessable income.
That test for application of the new provisions is intended to have the effect that arrangements of a normal business or family kind, including those of a tax planning nature, will be beyond the scope of Part IVA.
In this respect, Part IVA may be seen as effectuating in general anti-avoidance provisions of the income tax law a position akin to that which appears to emerge from the decision of the Privy Council in Newton v. Federal Commissioner of Taxation (1958) 98 CLR 1. The essence of the views expressed in that case was that a tax avoidance situation covered by section 260 exists only if it can be predicated from looking at an arrangement that it was implemented in that particular way so as to avoid tax.
In coming to a conclusion about the application of Part IVA in particular situations, it will be necessary to examine all relevant external evidence of the purposes for which a person entered into an arrangement and carried it out in the way it was carried out. The manner in which the scheme was entered into, its form and substance, timing aspects, its practical results, including changes in the financial positions of the taxpayer and connected persons and the nature of those connections (e.g., business, family) are all to be considered.
It will be necessary, if Part IVA is to apply, that a taxpayer has obtained a "tax benefit". A tax benefit will have been obtained by a taxpayer in connection with a scheme if, after applying the other provisions of the Principal Act to the taxpayer, either an amount is not included in assessable income of the taxpayer that might reasonably be expected to have been included if the scheme had not been entered into, or a deduction is allowable to the taxpayer the whole or a part of which might reasonably be expected not to have been allowable if the scheme had not been entered into.
The relevant purpose, already referred to, that is to be enquired into is a purpose of obtaining a tax benefit, in the sense just mentioned. Specification of what constitutes a tax benefit and that the relevant purpose is one of obtaining such a benefit is designed to eliminate the uncertainties associated with the use in section 260 of less precise expressions, e.g., "altering the incidence of any income tax" and "defeating, evading or avoiding any duty or liability imposed on any person by this Act" and which appear to be at the root of the development by the courts of the "choice principle" (limitation (a) referred to earlier).
So far as limitation (b) is concerned, the approach taken in proposed Part IVA aims to improve upon section 260, as interpreted, in two ways. Firstly, it will enable an enquiry into whether the new provisions are applicable to go beyond the effect of the arrangement itself. Secondly, it will require a wider enquiry directed to finding, on objective grounds, what was the purpose of a person who entered into the arrangement.
These various features are to be found in proposed sections 177A, 177B, 177C and 177D. Those provisions will, as a matter of law, determine whether Part IVA applies to a particular arrangement. Where it does, section 177F becomes relevant.
Part IVA will have within it, in section 177E, a supplementary code to deal with dividend-stripping schemes of tax avoidance and certain variations on such schemes, the effect of which is to place company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends. Section 177E is designed against the background that, while such schemes are of the general kind to which preceding provisions of Part IVA are to apply, it may not always be able to be concluded that, if the scheme had not been entered into, the relevant dividends would have been (or might reasonably be expected to have been) included in assessable income : the company may simply have retained the profits for the time being.
In schemes of this kind, arrangements are generally made to convert into cash the assets of the company to be stripped and, following the sale by shareholders of their shares in the company for a capital sum, subsequent trans-actions ensure either that the purchaser is reimbursed for the price of the shares in the form of a dividend or other payment from the company or that an entity which has a close association with the shareholder obtains the enjoyment of property of the company in one form or another. These transactions are structured so that profits thus effectively stripped from the company do not bear tax.
Section 177E will treat such schemes as schemes to which the Part applies so that, for example, a shareholder who disposes of his or her shares in the context of a dividend-stripping scheme will be treated as having obtained a "tax benefit" of the amount which the person would have derived as a dividend had the company paid as a dividend the amount of company profits that are represented in the property of the company that is stripped from it under the scheme.
Where on the application of either the general provisions of Part IVA or the more specific provisions of section 177E it is found that a tax benefit has been obtained, the Commissioner of Taxation will be authorised, under section 177F, to cancel the whole or (if the circumstances warrant it) a part of the tax benefit and, if it is fair and reasonable to do so, to effect corresponding tax adjustments in favour of the taxpayer or other persons concerned. In this way the particular "non-taxable" position sought for by the arrangement is annihilated and a "taxable" situation appropriate to the case is reconstructed. These procedures aim to overcome limitations (c) and (d), noted above, on the scope of the existing section 260.
Decisions by the Commissioner about the application of Part IVA will of course be subject to the usual rights of objection, review by an independent Taxation Board of Review and appeal to a court.
In ascertaining whether a tax benefit has arisen under a particular scheme, the other provisions of the Principal Act apart from Part IVA are first to be applied. This means, for example, that if a specific anti-avoidance provision has applied to take away a tax advantage sought to be achieved under a scheme there will be no room for Part IVA to apply to that scheme.
Another situation in which a tax benefit will not arise for examination under Part IVA is where a reduction in tax liability follows from the mere making of a declaration, election or selection, the giving of a notice or the exercising of an option expressly provided for by the Principal Act. Nor is the deduction available for investment in Income Equalisation Deposits to be within the purview of Part IVA.
Where an assessment which takes into account a determination under section 177F to cancel an amount of tax benefit is made, the taxpayer whose liability to tax is thereby increased will also be liable to pay an amount of additional tax. As is the case under the existing sub-section 226(2) of the Act when income is omitted or deductions are claimed in excess of expenditure incurred, the additional tax is to be expressed as an amount equal to double the amount of tax avoided. Any such statutory additional tax will be subject to a power of remission by the Commissioner and subject also to a power of review by a Taxation Board of Review, on a basis comparable with that applicable in relation to other amounts of additional tax imposed by existing sub-section 226(2).
An assessment may be amended within 6 years for the purposes of giving effect to a determination by the Commissioner to cancel a tax benefit, and may be amended without time limit for the purposes of making a complementary adjustment in favour of a taxpayer.
Part IVA is to apply only to schemes that are entered into after the date of introduction of the Bill into Parliament and section 260 is to be made inapplicable to arrangements entered into after that date.
Where, if Part IVA had applied to schemes entered into before that date, a tax benefit would have been cancelled, the amount of that benefit is not to be eligible for inclusion in a carry-forward loss deductible against income of the 1980-81 income year, or any later year, and there are also measures to counter any arrangements made, before the 1980-81 year ends, to side-step this limitation.
The provisions of the Bill are explained in more detail in the notes that follow.