Notes for Second Reading Speechdelivered by the Treasurer, Sir Arthur Fadden. 18th. September, 1952.
The provisions of this Bill are designed to give effect to income tax adjustments outlined in the course of my Budget Speech.
Foremost in importance is the proposed simplified plan for the taxation of the undistributed incomes of private companies.
When explaining the resolution dealing with rates of income tax and social services contribution, I made reference to difficulties which had been encountered almost from the inception of income tax in securing a basis which would at once reasonably protect the revenue and allow development margins for private companies.
The existing basis of taxing undistributed incomes was first evolved in 1934 but it has undergone almost continual adjustment since that time. In the process, complexity has been added to complexity until to-day the whole system of private company taxation is, of its very nature, cumbersome, extremely difficult of administration, does not provide adequate protection of the revenue and does not give satisfaction to the companies to which it applies.
The difficulties of the system are intensified by the inherent need to recognize that, practically without exception, companies must retain some of their profits for consolidation and development of their businesses.
The utmost difficulty has been experienced by successive Governments in securing a proper balance between a fair compensation to the revenue for the loss occasioned by the non-distribution of profits to shareholders and a just provision of retention allowances, free of undistributed income tax, to enable the reasonable development of company businesses. Difficulty has also been experienced in combating schemes of tax avoidance, of extraordinary variety and ingenuity, devised by companies to exploit defects in the system.
As a result the legislation has become most unstable. The view of the Government is that taxing legislation which is so unstable is self-evidently unsound and renders unduly difficult the management and control of those companies that fall under the ever-changing laws.
Accordingly, the Government has given particular consideration to a plan of private company taxation that might be expected to overcome many of the defects of the present law, particularly in regard to complexity, whilst providing some degree of stability in the future.
In the present Bill, therefore, the Government, having regard to the proved short-comings of the existing system, invites the endorsement of the Parliament to proposals founded on an entirely new approach to the problems of private company taxation.
In the sense that the departure from the present system is almost complete, the proposals are radical, but they are based, in principle, on the unanimous recommendations of members of the Commonwealth Committee on Taxation.
Honourable Members have already had the advantage of reading the very full report of the Committee on Reference No. 15, the Taxation of Companies Private and Non-Private and their Shareholders - which I tabled in this House on 12th August last.
The outstanding feature of the proposed method of private company taxation is its relative simplicity by comparison with the present system. While I do not seek to persuade the House that the full meaning and implications of all the provisions of the proposed legislation are to be gained from a cursory reading of the Bill, I do suggest that, having regard to the problems that have to be surmounted, the proposals are as simple as the subject matter allows.
Under the proposed system, graduated and, I believe, proper retention allowances are provided. The retention allowance is the income that a private company may retain and use in its business free of any impost other than the basic company rate of tax, but which income becomes subject to tax if subsequently distributed.
The present scale of retention allowances begins with 50% of the first Pd1,000 of income, and the percentage of retention descends in an irregular pattern upon each additional Pd1,000 of income until 10% is reached on the excess over Pd10,000.
The permitted retention at Pd6,000 of income at present is Pd2,050, or 34.16% of the total income, and is considered reasonable. Above that amount of income it has been necessary to liberalise the allowance to achieve balance, and it has, therefore, been decided to increase the percentage retention to all income in excess of Pd6,000 to a flat 25%.
The enlarged scale of retention will provide for all the reasonable requirements of companies by re-investment of profits in their businesses and should ensure that tax on undistributed income will not impair the development and financial stability of any private company.
If a private company chooses to withhold from distribution to its shareholders profits in excess of these increased retention allowances, the excess will be subject to tax at the rate of 10/- in the Pd. in lieu of the rate ascertained by assuming a notional dividend in the hands of shareholders.
The substitution of a flat rate of tax for the individual shareholders' graduated rates is a major step in the direction of simplification. Private companies, which may become liable to the tax, will no longer experience the irritating delays in ascertaining their full tax liabilities. These delays are unavoidable under the existing system.
It should not be thought that this flat rate of tax will necessarily preclude private companies from gaining the use of profits over and above the permitted retention allowance which the directors feel should be retained. As the Commonwealth Committee on Taxation has pointed out so plainly, arrangements may be made for shareholders to re-invest with the company the residue of the dividends after payment of tax. In fact, many private companies have been following this practice for some years past.
If, however, any private company deliberately retains income in excess of the retention allowance, it may reasonably be assumed to be converting that income into capital which becomes part of the permanent capital structure of the company and that it does not contemplate the distribution of the taxed fund to its shareholders.
If it should do so, however, it is proposed that there should be no abatement in the shareholders' assessments on account of the tax paid by the company.
One of the most fruitful sources of complexity and dispute is the present system of identifying and rebating to shareholders the tax payable on dividends distributed out of funds which have borne undistributed income tax.
It is confidently expected that, under the proposed system, private companies will distribute their income up to the permitted retention allowances so that no question of rebate will again arise.
Perhaps I should here deal with the persistent claims that are made to the effect that Australian taxation of companies and shareholders is a form of iniquitous double taxation which imposes a far greater burden on company profits than do the system of other countries.
These claims are usually associated with a contention that a rebate of the company tax should be allowed to the shareholders when tax is being levied on the dividends they receive to prevent an undue proportion of the earnings of companies being absorbed by tax. It is not unusual for the claims to be made that most other countries do not subject company profits to tax more than once.
In any discussion of these problems it should not be overlooked that an examination of any particular form of taxation, in isolation from the general fiscal system of any country, may present a misleading picture.
But, for what it is worth, a comparison of the taxation of Australian companies and their shareholders with similar taxation in the major English speaking countries, even though the systems may differ, need not be avoided.
In Australia, public companies will, in this financial year, be required to pay tax at 7/- in the Pd on the first Pd5,000 of taxable income and 9/- on the balance. The shareholders pay tax at the graduated personal rates on the dividends distributed to them out of those profits.
In the United Kingdom, the standard rate of tax for companies and individuals alike is 9/6 in the Pd. In addition, every company pays 4/6d. in the Pd on its distributed profits, and may pay as much as 3/- in the Pd beyond that, by way of excess profits tax. In short, for every pound of its distributed profit, the company must pay at least 14/- and it may, be reason of excess profits tax, pay considerably more.
It is true that dividends paid by companies resident in the United Kingdom are not subject to ordinary income tax in the shareholders' hands, but where a shareholder's income, including the dividends, exceeds Pd2,000, sur-tax is payable. The rate of sur-tax may be as high as 10/- in the Pd.
In New Zealand the rate of income tax and social security charge payable by companies ranges from 4/3d. in the Pd to 11/- in the Pd, according to the company's income. The maximum rate is payable where the company's income is Pd7,950 or more, so that, in practice, a relatively small proportion of company profits is taxed at a rate of less than 11/- in the Pd.
Whilst dividends are not directly subject to New Zealand tax in a shareholder's hands, they are taken into account in determining the graduated rate of tax payable on any other income derived by him. This, of course, can have an appreciable effect on the overall tax payable by the shareholder.
In Canada, the standard rates of income tax payable by corporations are 22% on the first $10,000 of taxable profit and 52% on the excess. Shareholders pay tax at a graduated rate on dividends received by them, and the only rebate allowed against that tax is 10% of the dividend. As the Canadian rate of tax on the highest brackets of income earned by individuals is 86%, the effective rate of tax on dividends may be as high as 76%, or, converted to its Australian equivalent, more than 15/- in the Pd.
The United States recognizes fully the principle that the profits earned by a company and a distribution of those profits received by a shareholder are distinct subjects of taxation. As in the Australian system, company profits are taxed, and a separate tax is imposed on dividends received by the shareholders.
The standard rate of United States income tax payable by corporations is 30% on the first $25,000 of taxable profit and 52% of the balance. In addition, an excess profits tax is imposed, and the total levy for ordinary tax and excess profits tax may absorb as much as 70% of the company's profits.
Dividends are subject to United States tax in the hands of individual shareholders without the allowance of any rebate.
From what I have said, it will be clear that, in none of the countries mentioned, is full credit given in the assessment of an individual shareholder upon dividends received by him for tax paid by the company upon profits out of which the dividends are distributed.
It is necessary to bear in mind, moreover, that the higher the rate of tax payable by the company, the lower is the proportion of profits available for distribution. As the rate of company tax in Australia is, generally speaking, lower than in any other important English-speaking country, Australian companies are in a position to distribute correspondingly larger amounts by way of dividends to their shareholders.
Another and perhaps more cogent reason why rebates of the primary tax paid by companies should not be allowed against the tax paid on dividends is that, in all transactions in shares since 1940, the price of those shares has been determined by the parties having regard to the expected net return to the investor in dividends after payment of tax. If that net return were to be increased by granting a tax rebate on the dividend, shareholders as a class would gain a further benefit from the enhanced market value of their shares - an advantage not enjoyed by investors in Commonwealth loans or any other form of security.
I should emphasise that, although rebates of primary tax and the proposed flat rate on the undistributed income of private companies are not to be allowed, the freedom from tax of dividends paid out of 1950/1951 and previous incomes which have borne tax at shareholders' rates will be continued for a period of five years.
Private companies are thus afforded the opportunity, until 31st. December, 1957, of distributing to their shareholders dividends out of funds which have borne undistributed income tax calculated at the shareholders' individual graduated rates which will be tax-free in the shareholders' hands.
Acceptance of the new plan of private company taxation represents an important step towards simplification both in law and practice.
I have said that because of the liberal provision of retention allowances, on the one hand, and the ability of private companies to arrange for the continued use by way of loan or re-investment of distributed profits, private companies will be enabled to place themselves entirely outside the field of undistributed income tax. If these expectations are realised, Australia will have found a method of providing a practical and equitable solution to taxing problems that have caused concern to the legislators of this and other countries over many years.
A most important amendment proposed in this Bill is the allowance, for the first time in the history of Commonwealth income tax, of a concessional deduction in respect of expenses incurred by parents in educating families. Having regard to the ever-increasing costs of education, this concession will represent a very acceptable and practical form of taxation relief at the present time.
Taxpayers will be allowed a deduction as from 1st. July, 1952, of amounts paid to schools, colleges or universities for the full-time education of dependent children under the age of twenty-one years. The allowance will be subject to a maximum deduction of Pd50 for each child.
The allowance will include tuition fees, board, text books and extras, so long as the amounts claimed have been paid directly to the educational institution in connection with the full-time education of the child. It would not be practicable to allow a deduction for casual payments made otherwise than to an institution providing full-time education, even although those payments may relate to the child's education.
However, the Government has paid particular attention to the claims of parents who live in isolated areas or whose children are unable to receive a normal education because of physical handicaps. To meet these special cases, it is proposed to extend the concessional allowance to payments which are made to tutors or governesses for the full-time education of children. This allowance also will be subject to the general maximum annual deduction of Pd50 for each child.
I have great pleasure in announcing this concession to a most worthy cause.
A number of the proposals in this Bill are designed to implement recommendations by the Commonwealth Committee on Taxation for the removal of anomalies from existing legislation.
One of these proposals is that which relates to the taxation of goodwill associated with leasehold business premises. The Taxation Committee has expressed the opinion that the provision relating to goodwill probably has caused more dissatisfaction and confusion than any other provision in the income tax law.
Taxation of amounts received in connection with leasehold transactions is based on the assumption that lease premiums, although they have some of the attributes of capital, are in reality no more than commuted rent or rent paid in advance. On this principle, deductions are allowed in the assessments of persons paying lease premiums, and, correspondingly, the premiums are included in the assessable income of the persons receiving such amounts.
For many years past, this treatment has been extended, by statutory definition, to amounts paid and received for the purchase and sale of goodwill attached to leasehold premises.
Whatever theoretical justification may be found for this basis of assessing consideration for goodwill, there is no doubt that it has given rise to a great deal of resentment because, to many vendors of goodwill, it has seemed to be the levy of income tax upon a capital receipt.
Moreover, the application of the legislative provisions relating to goodwill has proved difficult to administer in practice. As I have already mentioned, consideration for goodwill is taxable only where it is attached to leased premises, that is, where it is local goodwill. It is often very difficult to determine whether goodwill is local or personal.
It is clearly in the interests of the purchaser of goodwill to establish that the consideration he has paid should be treated as a premium because, under present practices, he gets a deduction of the amount paid spread over the term of his lease. The vendor naturally seeks to demonstrate that it should not be so treated because then he is not taxed on the amount received. This conflict of interests has led to numerous appeals being lodged against the assessments of one or other of the parties to sales of goodwill.
To overcome these difficulties, it is proposed that, as a general rule, consideration for goodwill should be excluded from the lease provisions of the income tax law. The effect of this exclusion will be to exempt the vendor from taxation on the sale price of goodwill, but, conversely, the person paying the consideration will not be allowed a deduction of that amount.
This amendment will apply to consideration payable in transactions made after 31st. December, 1952.
However, parties to transactions after that date may deem it advantageous that consideration payable for goodwill should be treated as a lease premium, as under the present law. Upon unanimous agreement to that effect,duly notified to the Commissioner of Taxation, those parties may preserve the present basis of assessment whereby the vendor is taxed and the purchaser is allowed a deduction in respect of the consideration for the goodwill.
It may be asked why the operation of this proposed amendment is being deferred until the New Year. The Government's reply is that it has an obligation to both of the parties to transactions of the nature I have described. From what has been mentioned already, it is apparent that those interests may be diametrically opposed.
Because of this conflict of interests, it is considered essential that reasonable notice should be given of the proposed amendment so that prospective vendors and purchasers and their taxation advisers may have every opportunity of becoming familiar with the new provisions.
It would be quite impracticable to apply the amendments to past transactions. Even if it were possible to undo something already accomplished by agreement, retrospective application of the law would mean that vendors would have to persuade purchasers to forgo deductions to which they are entitled. It is most unlikely that purchasers would enter into arrangements of this nature.
During the last Session of Parliament, Honourable Members had before them the Government's proposals for granting deferment of the tax liability of primary producers because of a reduction in income, and the Government's measure to reduce the burden of taxation on insurance moneys received upon the loss of live stock through bushfires, floods, etc.
On that occasion, I promised, on behalf of the Government, to examine the claims of primary producers who are exposed to a heavy burden of taxation upon receipts arising from forced sales of live stock due to loss of fodder through bushfires and drought conditions. This examination has been completed, and I am happy to announce that it has been found practicable to grant relief, not only in those cases, but also in cases where pasture or fodder is destroyed by floods.
Beginning with the income year 1951-52, the primary producer will, in all these cases, be given the opportunity, upon submission of evidence of the facts, of electing to include in his taxation return for the year in which the forced sale occurs only one-fifth of the resulting profit. One-fifth of that profit will then be included in his assessment for each of the next four succeeding years.
Another proposal in this Bill which will be of particular interest to primary producers is the provision concerning partnership transactions involving trading stock. I need not remind Honourable Members that trading stock, for the purposes of income tax, includes live stock.
For some years it has been open to doubt whether a transfer of interests in partnership assets including live stock and other forms of trading stock amounted to a disposal of that stock. Acting upon legal advice that such a transfer was, in effect, a constructive disposal, the Commissioner of Taxation has, in many of these cases, assessed the transferors on the market selling value of the live stock and allowed the transferees a corresponding deduction.
Whilst this interpretation was favorable to the transferees, it was unacceptable in some cases to partners who became liable to tax on what was, in substance, an unrealised profit.
To avoid hardship in these cases, it is proposed to give the parties to such transfers of interests an opportunity of determining their respective tax liabilities. In effect, they will be given a right of election, so long as they unanimously agree among themselves, whether tax shall be payable on the unrealised profits or whether the liability should be deferred until an actual sale of the transferred stock takes place.
This right of election will apply, not only to transfers in current and future years, but also retrospectively to 1st. July, 1950. By agreeing unanimously to exercise their right of election, partners who have been taxed on unrealised profits deemed to have arisen from transfers of interests effected after that date will have the opportunity of being re-assessed on the new alternative basis.
Reference has already been made in this House by the Minister for Territories to the Government's future taxation policy in relation to income derived in the Northern Territory. Provisions designed to give effect to this policy are included in the present Bill.
As the general outline of the Government's proposals has already been made public, it is not my purpose on this occasion to do more than recapitulate the essential features of the proposed amendments.
Honourable Members are aware that, for many years, income from primary production, mining and fisheries in the Northern Territory has been entirely tax-free if earned by a resident of the Territory. That exemption expired on the 30th June, 1952.
This Government proposes tax concessions which should provide an effective stimulus to the re-investment in the Northern Territory of profits derived from primary production in the Territory.
The concessions to which I refer will enable primary producers in the Northern Territory to write off over a period of five years, by way of deductions from assessable income, the cost of plant and machinery purchased by them after 30th June, 1952. Moreover, in regard to structural improvements completed after that date, the primary producer will have the option of deducting the full cost in the year of completion, or of writing off that cost over a period of five years in the same manner as the cost of plant and machinery.
The Government's proposals include special provisions designed to cushion the transition from tax freedom to tax liability. By reason of these special provisions, primary producers and persons engaged in mining in the Northern Territory will be relieved of the full burden of taxation in the years immediately following the termination of the exemption. Particulars of the proposed concessions will be given in an explanatory memorandum to be circulated for the information of Honourable Members in a few days' time.
RETIRING ALLOWANCES AND PENSION FUNDS.
As I have already indicated, several of the provisions in this Bill are designed to give legislative effect to recommendations of the Commonwealth Committee on Taxation. One group of these provisions relates to the taxation of retiring allowances, the deduction of contributions by employers and others to employees' pension funds and the exemption of income of funds established to provide retirement benefits for self-employed persons.
With regard to the taxation of retiring allowances, Honourable Members are, no doubt, aware that where such allowances are paid in a lump sum, only five per cent of the amount received is included in the assessable income of the recipient.
It has become evident in recent years that undue advantage has been taken of this concession. Tax has been avoided by payment of large amounts which purport to be retiring allowances but which are, in effect, deferred remuneration for past services or advance payments of future pensions.
To close this avenue of tax avoidance, it is proposed to limit the concessional basis of taxation to retiring allowances which are reasonable in amount having regard to the length of the employee's service and the value of his services as measured by his remuneration.
The determination of what is a reasonable amount will not be left to the discretion of the Commissioner of Taxation or any other authority. The basis of limitation will be written into the law itself.
Shortly stated, the concessional basis of assessment on five per cent only of retiring allowance will be restricted to an amount equivalent to three years' salary for forty years of service. In the case of longer or shorter periods of service, the amount subject to the concession will be proportionately greater or smaller. This means, approximately, that four weeks' salary for every year of service will be regarded as a reasonable lump sum retiring allowance of which only five per cent will be subject to income tax.
There will be an overall maximum of Pd10,000, however, to which the concessional basis of assessment is to apply. Where the lump sum retiring allowance is Pd10,000 or more, the tax-free proportion may be as high as Pd9,500 but no higher.
Even in these days, the receipt of a retiring allowance of Pd9,500, undiminished by any levy of taxation, cannot be regarded as a trifling concession. If an employee retires at the age of 65 years and receives such an amount, it would enable him to purchase a life annuity of between Pd850 and Pd900.
I am sure, therefore, that no unbiased person will find just grounds for complaint when an amount exceeding either Pd10,000 or the maximum retiring allowance calculated in accordance with the formula is required to bear the normal weight of taxation.
The Government has recognised, however, that retiring allowances paid before the introduction of this Bill would have been received in the belief and understanding that the income tax law as it stands at present would apply to those allowances. To obviate any hardship in such circumstances, it is proposed that the limitations I have mentioned should apply only to retiring allowances paid after today.
With regard to contributions to employees' pension funds, the present maximum deduction which is allowable to the employer in respect of any employee is Pd100 or five per cent of the employee's remuneration, whichever is the greater. A higher deduction may be allowed, however, if the Commissioner of Taxation is satisfied that the special circumstances of any case warrant such allowance.
In this Bill it is proposed to increase, as from 1st. July, 1952, the general maximum from Pd100 to Pd200 for each employee. Contributions up to this amount will be allowable as deductions to the employer, irrespective of the employee's rate of remuneration and independently of the exercise of any discretionary power by the Commissioner.
The Government has considered, also, ways and means of encouraging self-employed persons to establish pension funds for their mutual benefit.
It has been decided that the most appropriate means of achieving this objective would be to extend to the income of such funds the same freedom from tax as now applies to the income of employees' pension funds. An appropriate provision is accordingly included in this Bill.
A concessional deduction will be allowable to the contributors in respect of payments to funds of this nature. However, the aggregate deductions allowable to a contributor in respect of life insurance premiums, pension fund contributions and comparable payments made by him in any one year may not exceed the general maximum of Pd200.
In order to ensure that the proposed exemption will not open the door to schemes of tax avoidance, it is proposed to place upon the trustees of each fund the onus of demonstrating that the fund is a genuine one. It is hardly necessary for me to add that, if it is found that taxpayers seek to take unwarranted advantage of the concession, the Government may be obliged at some future date to consider whether further restrictions should be placed upon the operation of the concession or whether it should be withdrawn altogether.
Further proposals in this Bill are designed to effect minor changes in the Principal Act. No important principle is involved in these amendments. I suggest, therefore, that they may be more appropriately studied in the printed memorandum which, as is now customary, will be circulated among Honourable Members at an early date.
In the policy speech upon which this Government was elected, we undertook to rationalize the taxing laws of the Nation, to reduce the rates progressively, to simplify the enactments and to grant concessions in quarters where they were warranted.
I take the liberty of recording, for the information of Honourable Members, the following major reforms which have been effected during this Government's two years of office :-
The amalgamation of the two separate levies of income tax and social services contribution, with the consequent elimination of the confusion and complexity associated with the previous system.
The substitution of simple schedules of income tax rates for the previous complicated system of graduated rates, running into several decimal places.
The simplification of return forms, which, together with the improved rating schedule to which I have just referred, enables any taxpayer to calculate, with certainty, his own taxable income and the tax payable thereon.
The conversion of the basis of concessional allowances from rebates of tax to deductions from income, a reform of special benefit to the family man.
The rationalization of conditions attaching to the allowance of concessions for dependants - particularly in regard to parents and to student children up to 21 years of age.
The increase of the maximum concessional deductions allowable for medical, dental and funeral expenses and for such payments as life insurance premiums and superannuation fund contributions.
The introduction of an age allowance which confers upon older folk in the lower income groups a complete freedom from income tax and social services contribution.
Far-reaching concessions in the interests of primary producers - such as the special 20% depreciation allowance on plant installed and structural improvements effected up to 30th June, 1955, and the concessional treatment of insurance recoveries on live stock.
Last, but not least, the system of self-assessment of provisional tax introduced this year, which will have the effect of smoothing the incidence of income tax to the benefit of businessmen and primary producers.
I believe that when these major reforms are considered together with the major items I have explained tonight, all thinking persons will agree that the Government has fully and faithfully fulfilled its promises.
I commend the Bill to Honourable Members.