House of Representatives

Income Tax Assessment Bill 1948

Income Tax Assessment Act 1948

Notes for the Minister's Second Reading Speech.

The provisions of this Bill to amend the Income Tax Assessment Act are mainly concerned with the incidence of taxation on private companies and their shareholders.

While it has been generally recognised and accepted that, in the interests of the protection of the revenue and in fairness to taxpayers generally, some special form of taxation on the undistributed profits of private companies is essential, the basis on which the tax should be levied has been the subject of controversy for many years. The present tax has been criticised on the score that it is unequal in its incidence, bearing too heavily on some private companies while favouring others.

The subject has received the consideration of the Government, and a plan, within the framework of the present law, has been formulated which, it is considered, will bring the measure of income tax payable by private companies and their shareholders into harmony with the liabilities of other taxpayers.

A matter of primary importance in connection with the Government's proposals is the criteria by reference to which the classification of private companies should be determined.

Under the present law, a private company may broadly be described as one which is controlled by or in the interests of seven or less persons.

The present definition of "private company" in the Income Tax Assessment Act has been examined by the High Court in recent years and, in the light of observations by the Court, it has become evident that some companies are outside the compass of the special taxing legislation, although these companies are essentially private in character.

In determining whether a company should be classed as a private company, a comparison may be made between the company and a partnership. In many instances, companies represent the incorporation of partnerships - the business of the company being conducted in exactly the same manner as by the partnership before incorporation.

The maximum number of members of a partnership permitted under State laws is twenty. If more than twenty persons desire to carry on business collectively, it is necessary for those persons to incorporate a company of which they are the shareholders. On this ground, there is reason for regarding any company comprised of twenty or less shareholders as being a private company.

Accordingly, the first branch of the proposed definition of "private company" includes a company all the issued shares of which are held by twenty or less persons.

In determining whether a company with more than twenty shareholders should be classified as private, the main factor to be taken into consideration is the number of persons who are capable of exercising control of the company, more particularly in respect of its dividend policy.

It is generally accepted that the dividend policy of a company in which the shares are held by the general public is not greatly affected by consideration of the amount of taxation that will be payable by individual shareholders. In any event, reliance can be placed on the influence of shareholders on the directorates of these companies to ensure that reasonable distributions of profits will be made.

The Government accordingly affirms the principle of the present law that the special taxation provisions should not apply to companies in which the public are substantially interested. These companies and subsidiaries of public companies are specifically excluded from the scope of private company taxation.

There are, however, many companies with more than twenty shareholders which are operated substantially in the interest of one person or in the interests of relatively few persons. In conformity with the principle on which the present definition is based, it is proposed that these companies should be taxed as private companies. The second branch of the definition will accordingly apply to a company which is capable of being controlled by not more than seven persons.

There are also companies which represent the incorporation of family groups. In these companies, it is usually found that, although the shareholders may be more than twenty in number, the real control of the companies, including their dividend policies, is allowed to be exercised by comparatively few persons. Members of a family ordinarily permit their voting power to be exercised by, or will themselves vote in accord with, the leading members of the family group.

Correspondingly, nominees exercise their voting power at the direction of their principals.

It is accordingly proposed in the third branch of the definition of a private company to retain the provision of the present law that a person and his relatives and nominees shall be regarded as one voting unit.

It is also proposed to alter the basis upon which, for taxing purposes, the distributable income of a private company is ascertained. Since the inception of the present system of taxation of the undistributed profits of private companies, those companies have been permitted to deduct payments of undistributed profits tax in the ascertainment of their distributable incomes.

This deduction has afforded a strong inducement to many private companies to refrain from distributing their profits within a reasonable period after closing their accounts for a year.

By so refraining from distribution, the companies incur liability to undistributed profits tax, which becomes a deductible amount in ascertaining the distributable income of the year in which the tax is paid. This deduction has proved to be the most fruitful source of inequality in the incidence of the tax on private companies generally and has conferred an undue advantage on large companies whose shareholders are in the higher income brackets.

Upon close examination, the Government has come to the conclusion that there is no sound principle on which the continuance of this deduction can be defended. It is a privilege conferred on private companies which is denied to individual taxpayers. Accordingly, the definition of "distributable income" is being altered to withdraw the deduction in assessments for the current financial year and future years representations that there is need for the conservation of private company profits to meet the contingencies of business and generally to preserve the structural stability of private companies and that such reserves should be free from undistributed profits tax.

While ensuring that the taxation payable by private companies will be commensurate with the tax payable by partners in a comparable partnership, it has been found possible to allow a measure of freedom from undistributed profits tax dependent on the level of the company's profit. The allowance will be on a graduated scale commencing at 30% on the first Pd2,000 of distributable income, 25% on the second Pd2,000, 20% on the third Pd2,000, 15% on the fourth Pd2,000 and 10% on the balance of the company's distributable income.

As an indication of the graduated scale of the allowance, a distributable income of Pd2,000 will be free from undistributed profits tax to the extent of Pd600, a distributable income of Pd8,000 will be free to the extent of Pd1,800 and, at the level of Pd40,000, the portion of the distributable income that will be free from undistributed profits tax will be Pd5,000.

The proposed allowance, and the withdrawal of the deduction to which I previously referred, will substantially restore the equitable balance of taxation as between private companies and, to a large extent, cause the measure of taxation payable by private companies and their shareholders to accord with the liabilities of other taxpayers.

The foregoing are the most important of the measures proposed by the Government for altering the incidence of tax on private companies, but there are some other proposals contained in the Bill which I think should be mentioned.

One of these proposals is designed to give a clear specification of the fund which is available to a private company for payment of tax-free dividends to its shareholders.

In this connection, I might explain to the House that, when a private company has paid tax on its undistributed profits, dividends paid wholly and exclusively out of the taxed fund are free from tax in the hands of the shareholders.

It is proposed to amend the law in conformity with the principle that the tax payable on profits is a charge against those profits. Only the balance of profits remaining after deduction of the taxation applicable thereto will be available to a company for distribution as tax free dividends to the shareholders.

The Bill also contains provisions that are designed to nullify devices that have been employed by some private companies to defeat the general intention of the present legislation.

Before leaving the subject of private company taxation, I should mention that the Bill provides for a measure of simplification in the assessments of the undistributed profits tax. For the purposes of these assessments, concessional rebates of tax in respect of dependants, etc. are to be disregarded, and the incomes of private company shareholders are to be treated as being derived wholly from property. These simplifications of the calculation will not materially affect the amounts of undistributed profits tax payable by private companies.

A clause in the Bill extends the concession granted in 1946 for the purpose of encouraging industrial experts to come to Australia in the interests of the development of our industries.

The 1946 provision granted immunity from Australian taxation in respect of the earnings of these experts during the first and second year of the visit to this country if their earnings were subject to tax in the country in which they were ordinarily resident.

It has now been found that the services of some of these experts in Australia will be required beyond the period of two years. In these cases, it is proposed that during the third and fourth years of a visit an expert will not be obliged to pay a measure of Australian taxation any greater than would be payable by him in his own country.

Another clause of the Bill modifies the taxability of allowances that are received by employees when they are obliged to work away from their home.

In 1945, a provision was included in the Income Tax Assessment Act, the effect of which was generally to cause taxation to be levied to the extent of 15/- per week on these allowances.

The sum of 15/- per week was at that time regarded as the general average of saving in the domestic budget of the employee.

However, it has been represented that, in many instances, industrial tribunals have taken into account the domestic saving when reaching a determination as to the rate of payment of the allowances. In these cases, where the allowance is paid in cash, it cannot fairly be said that there is any saving by the employee after he has met the expenses for which the allowance was granted. It is accordingly proposed that away-from-home allowances up to 50/- per week granted by industrial tribunals and paid in cash will be free from taxation.

In order to encourage donations by taxpayers to the United Nations Appeal for Children, the Government is including in the Bill a provision extending the concessional allowances to gifts to this Appeal.

In the interests of governmental administration, the secrecy provisions of the Act are being amended to authorise the Commissioner of Taxation to communicate essential information to the Director-General of Social Services and to the Universities Commission.

The opportunity has been taken to remove a misunderstanding in some quarters that social services contribution is a rebatable amount for income tax purposes. Clauses in the Bill clearly state that an income tax rebate is not allowable in respect of the contribution.

The Bill is particularly technical in its nature and in order that Honourable Members may better understand its provisions a memorandum explanatory of the clauses is being prepared and will be delivered to Honourable Members in the course of the next few days.

I commend the Bill to the House.