House of Representatives

Income Tax and Social Services Contribution Assessment Bill (No. 3) 1964

Income Tax and Social Services Contribution Assessment Act (No. 3) 1964

the Treasurer's Second Reading Speech

By this Bill it is proposed to amend the Income Tax and Social Services Contribution Assessment Act in a number of important respects. Most of the proposed amendments arise out of the Government's consideration of the report of the Ligertwood Committee on Taxation in relation to tax avoidance. The subjects covered are companies, leases, trusts and partnerships, superannuation funds and alienations of income.

The measures proposed by the Bill are complex but so are the situations with which they deal. Complex situations will usually demand complex measures.

Every effort has been made to avoid unnecessary complexities in the proposed legislation, but I am sure all honorable members will agree that it would be foolish to sacrifice effective tax reforms at the altar of simplicity. Anyone who has even a nodding acquaintance with modern intricate business and family arrangements in the realm of income tax, or with the income tax laws of other countries that have resulted from these arrangements, would concede that, in this day and age, effective income tax legislation must necessarily take account of a very wide variety of circumstances.

I would point out, too, that people who have not gone to the trouble of complicating their business or family arrangements for tax purposes will not generally be affected by the measures proposed in this Bill.

From time to time the Government has been subjected to criticism for what has been called delay in acting on these aspects of the report of the Ligertwood Committee. The truth is, of course, that many of the recommendations of the Committee have already been implemented. Most of these favoured taxpayers.

The action now arising out of the report has not been delayed in any avoidable way. The Government has for some time been conscious of the need for reforms in our tax structure. That is why it set up the Ligertwood Committee. As I have said on other occasions, however, the Committee's report raised very complex issues and, in dealing with it, the Government has been anxious to ensure that these received the most mature consideration. The Government has also been desirous that the utmost care should be taken to avoid, as far as possible, any measures that would bear inequitably on particular taxpayers.

The measures proposed by the Bill, while broadly based on recommendations of the Ligertwood Committee, do not follow those recommendations in all respects. Some modifications of, and even total departures from the recommendations, have for a variety of reasons been found either necessary or desirable.

Nevertheless, I say very positively, that in its consideration of what should be done in the various areas of tax avoidance to which the Committee directed its attention, the Government has found the report of immense value. It has provided an invaluable guide which, as I think everyone will agree, has fully justified the Government's decision to set up the Committee.

In the course of my remarks on the different matters to which the Bill relates I shall try to indicate, in a very broad and brief way, where the Government proposes substantial departures from, or modifications of, the Committee's recommendations, and the reasons why these changes are proposed. The necessity for some of them has been found in situations that have arisen since the Committee made its report and which, of course, the Committee had no opportunity to consider.

I shall begin my remarks on the specific provisions of the Bill with the provisions that deal with companies. For many years now the income tax law has defined companies that are private companies for the purposes of that law. Companies that do not fall within this present definition are public companies for income tax purposes. Private companies are, in the broadest sense, companies that are controlled by a small number of persons. They pay company tax at a lower rate than public companies, but are liable for an additional tax on undistributed profits that is determined after allowance for income tax payable and a permitted scale of profit retention. Following the Ligertwood Committee's report, the Government increased the permitted scale of profit retention in 1963. The rate of undistributed profits tax is 10/- in the Pd1.

In the face of tax avoidance devices that came to its notice, the Ligertwood Committee regarded the present definition of private company as inadequate. It thought a better course would be to define a public company, and it recommended that the definition should contain a number of tests which it specified. Companies not meeting these tests would then, with certain exceptions, be regarded as private companies.

It is proposed by the Bill to adopt the main features of this recommendation. The basic requirement for public company status proposed by the Committee is that the shares of the company (other than preference shares) be on the official list of a stock exchange. This is proposed to be incorporated in the law, no association with supplementary tests much on the lines of what the Committee proposed, though not as elaborate in some respects.

Speaking in the most general way, it is proposed that a company will be classified as a public company if the ordinary shares issued by the company are, at the end of the relevant year of income, listed on a stock exchange and if, throughout the year, twenty or fewer persons did not own three-fourths of the paid-up capital (other than preferred capital), or did not control three-fourths of the voting power, or would not be entitled to three-fourths of distributions made by the company.

One important modification of the Ligertwood Committee's recommendation lies in the test concerning capital, voting power and distributions. The Committee proposed that the proportion of two-thirds should apply. The Government has decided to retain the less onerous proportion of three-fourths which has proved adequate in the present law.

Some organizations that are companies for income tax purposes, such as clubs and government-controlled bodies, will not need to satisfy the proposed tests to qualify as public companies. Neither will subsidiaries of public companies. In addition, it is proposed that, where the proposed tests can be shown to operate inappropriately to deny public status to a company, the Commissioner of Taxation will be able to classify the company as a public company.

I will now go on to interlocked private companies. The Ligertwood Committee gave consideration to the avoidance of tax by interlocked groups of private companies that circulate dividends among the members of the group. This is done to avoid tax on undistributed profits. It can be done because all dividends paid to a resident company are, in effect, tax-free in the hands of the company, by virtue of a rebate of tax that is applied to them.

The Committee recommended that the rebate on dividends received by any company from a private company should be reduced by 15 per cent. It considered that this would discourage the circulation of undistributed profits among members of a group of private companies, because the income would be whittled away in tax as each successive distribution was made year by year.

The Government has concluded, after looking at the matter from all angles, that the Committee's proposal would operate harshly in some cases and not provide a sufficient deterrent to tax avoidance in others. We recognise, also, that not all groups of private companies exist for tax avoidance purposes and that, in some cases, no reduction of the rebate would be warranted. But it is necessary, nevertheless, to provide a substantial deterrent to such tax avoidance practices. In the end, the Government has decided that the rebate should, in relation to private companies but not public companies that receive dividends from other private companies, be reduced to half the present level, but that the Commissioner of Taxation should be authorised to allow a full rebate where he is satisfied that this is justified by the circumstances of the case. This is broadly the basis of the provisions embodied in the Bill.

The third matter concerning companies dealt with in the Bill is the traffic in shares in companies that have accumulated substantial losses.

A loss incurred by a taxpayer in one year may be carried forward as a deduction for income tax purposes against income of the taxpayer of a succeeding year. The maximum period of the carry-forward is seven years. These provisions of the law are equitable and it is not proposed to alter them as they apply in the great majority of cases.

One has only had to follow the financial pages of the daily press to discover that, in some circumstances, these provisions give to shares of a company with accumulated losses a value that is attributable to the taxation saving that attaches to the potential deductions. Income diverted by a profitable public company to another public company with accumulated losses escapes taxation until the losses have been absorbed, even though all the shares in the loss company have changed hands and are owned by quite different people from those who owned them when the losses were incurred.

There are certain provisions in the law which were intended to prohibit a deduction for losses incurred in earlier years by a private company if, broadly speaking, more than 75% of the shares in the company had changed hands in the meantime. These provisions have proved ineffective. The Ligertwood Committee considered them and, in view of their ineffectiveness in most cases and inappropriate effects in others, recommended their repeal. But the Committee also said that another approach would be to tighten up the provisions and apply them alike to public and private companies. That is the course the Government proposes in this Bill. The opportunity will also be taken to remove some unnecessarily irritating effects which the provisions have had in the past.

In the very broadest terms, it is proposed that, in future, losses of a previous year will not be allowed as deductions against the income of a year of income of any company, unless there is found to be, during both years, a beneficial ownership by the same shareholders of shares in the company that carry at least 40 per cent of the voting and dividend rights and 40 per cent of entitlements to distributions of capital in the event of the company being wound up or reducing its capital.

The next matter to which I would refer is the income tax treatment of lease transactions.

The Ligertwood Committee drew attention to complexities in the lease provisions of the present law and to tax avoidance practices that they permit and that are being extensively adopted.

The basic principle of the present law in relation to capital premiums paid for leases is that the recipient is taxed and the payer is allowed deductions spread over the unexpired term of the lease at the time the premium is paid.

The procedure followed in relation to the capital cost of improvements made on leasehold property by a lessee is, however, different. If the improvements are made under covenant or with the written consent of the lessor the expenditure is deductible by the lessee over the period that the lease has to run. The lessor is, however, taxed on only a proportion of the estimated value of the improvements as at the end of the lease.

For improvements not made under covenant or with written consent, no deduction is permitted in the first instance, but by the simple device of, for example, surrendering the lease to a related company or individual the whole of the expenditure on the improvements becomes deductible. The value of the improvements is not taxed at all to the lessor.

The inconsistencies apparent from these simple examples are increased if the lessor is a government authority or an exempt institution. In such cases, since no tax is assessed to the lessor, the tax value of deductions allowed to the lessee are never counter-balanced by tax received from the lessor.

The Committee recommended action that would have corrected some of the existing anomalies. Other anomalies would have remained untouched. The provisions necessary would have done nothing to remove present complexities and, in some respect,p especially in relation to some leases of indefinite duration, would have increased complexities in the law and practical difficulties for both taxpayers and the Taxation Administration. Even then, partial solutions only would have been provided for some of the problems.

The basic proposal in the Bill is that the lease provisions shall not apply in relation to lease transactions entered into in the future.

It is not proposed to alter the general effect of the present law in relation to lease transactions already entered into. Where an entitlement to a deduction now exists in connection with a transaction made in the past, the entitlement will not be withdrawn by reason of the proposed amendments.

An additional feature I should mention relates to premiums paid in respect of leases of property not producing assessable income, for example, a premium paid in lieu of rent for a lease of a residence.

In such circumstances, the premium is at present assessable income and neither the lessee nor any other person is entitled to a deduction for the premium. There are relatively few premiums paid in these circumstances but, with the introduction of the measures already mentioned, there will be an incentive for landlords of residences, and other properties not used by the occupier in producing assessable income, to seek the payment of a premium. As an inducement to tenants in a position to pay a premium in lieu of a periodical rent, the lessor could fix the premium at an amount that allowed himself and the lessee to share the tax saving between them. A safeguarding provision to prevent loss of revenue in these circumstances is, therefore, being made.

The next subject of the Bill to which I would refer is the matter of trusts.

For a long time now, a special basis of assessment has been authorised in relation to trusts for unmarried minor children of the settlor. The tax payable on this income is the same as though the income were derived by the settlor. The Ligertwood Committee noted that the present provisions have not functioned satisfactorily. It recommended that the provisions be widened in scope and that a tax of 10/- in the Pd be imposed on income of a trust if the deed authorises the settlor to vary its terms in favour of unmarried minor relatives.

In the light of current practices it is unlikely that implementation of this recommendation would achieve the objectives the Committee had in mind. It is by no means uncommon for several trusts - in some instances as many as 40 or 50 - to be created so as to accumulate income in such a way that the special basis of assessment does not apply. If the taxable income of the trust does not exceed Pd208 no tax at all is payable on the income accumulated, so the tendency is to create a multiplicity of trusts sufficient to ensure that none of them derives enough income to be taxed.

It is proposed by the Bill to provide for the imposition of a special rate of tax on the income of trusts to which no person has a present entitlement, that is, where income is being accumulated in the trust. The special rate, which will be formally declared by separate legislation at an appropriate time, is proposed to be 10/- in each Pd1 of income.

The Government is quite conscious, however, that it is not the purpose of all such trusts to avoid tax that woudm otherwise be payable. For this reason, the legislation will oblige the Commissioner to consider all relevant facts and authorise him not to apply the new provisions where it would be unreasonable to do so. The legislation will state various specific matters that the Commissioner must consider for this purpose.

The Ligertwood Committee also made recommendations concerning the taxation of a share of partnership income which a partner does not control. The Bill proposes measures arising out of these recommendations.

In broad terms, the Committee proposed that uncontrolled partnership income should be taxed to the partnership as though each of the other partners had received a share of it relative to his agreed share in partnership profits. It is not proposed to adopt this recommendation, principally for the reason that it could bear inequitably on some partners. Instead, it is proposed that the partner lacking control of the income shall be liable for tax on it. The income is to be taxed at the partner's personal rate of tax or 10/- in the Pd whichever is the higher. Separate legislation declaring the rate will be introduced at an appropriate time.

The Committee also thought that certain partners under 21 years of age should be deemed to lack control of their shares of partnership income. The Government considered that such a provision would be unduly onerous, particularly in farm partnerships. It proposes instead that partners under the age of 16 years shall be deemed to lack control. Allowance will, however, be made for the value of any services rendered by such a partner in producing the partnership's assessable income. No allowance will be made for interest on the partner's capital in the partnership. This would not only involve considerable complications but could lead to the purposes of the legislation being defeated by the accumulation of uncontrolled income in the partnership to provide the relevant partner's share of the capital of the partnership.

The Government envisages that there will be cases in which it would not be appropriate for the new provisions relating to partnerships to apply. Provision is being made for the Commissioner not to apply the new legislation in such cases.

Alienation of income, not accompanied by a transfer of the assets producing the income, is another matter dealt with in the Bill. The Ligertwood Committee recommended that income assigned in this way to a minor unmarried relative of a taxpayer should bear the tax it would have borne if the assignment had not been made.

Most people, among them employees on wages and persons in receipt of professional fees, are unable to transfer their income so as to avoid or reduce the tax liability on it. The use of assignments for tax purposes thus provides a sectional advantage for a relatively small proportion of taxpayers.

In the light of present practices the Committee's proposal would have a very limited effect. After the most careful consideration, the Government now proposes that a person who makes an assignment of income to another person, but retains the assets that produce the income, shall be taxed as though the assignment had not been made. The measures proposed by the Bill in this respect will, however, apply only to assignments that are, or may be, for a period of less than seven years and are made subsequently to today.

The Ligertwood Committee also made a number of recommendations concerning superannuation funds for employees. I shall first refer to deductions for contributions to these superannuation funds. In this respect, the measures proposed by the Bill broadly follow the plan outlined in general terms by the Committee. A great deal of technical and detailed elaboration of the Committee's broad outlines has, of course, been necessary.

Turning to the exemption from tax of the income of superannuation funds the Government has found that these funds fall into three broad classes. There is the traditional class of superannuation fund to which the employer contributes for the benefit of his employees. There is an intermediate class that often caters for the general public, whether employees or otherwise, and which, while serving a useful role in providing retirement benefits for people not able to participate in the traditional type of fund, is, nevertheless, to some extent, used to accumulate tax-free savings for contributors. And there is a third class which, though in the guise of superannuation funds, can only be viewed as means of accumulating tax-free savings.

As to the first class of fund, the Ligertwood Committee's broad proposals are being implemented by the Bill. The income of funds that fall within this class will, generally speaking, continue to be exempt from tax, provided the existing rules regarding investment in public securities are observed.

The Ligertwood Committee took the view that any superannuation fund that did not satisfy the tests it propounded should be taxed on its income to the extent that it exceeded the level of its income for the year ended 30th June, 1961. The Committee's proposal would, in the Government's view, operate over-severely on a fund established after 30th June, 1961, and, at the same time, disproportionately benefit a fund that had an unusually high income in 1961. The Government proposes by this Bill that a fund which does not meet the tests for full exemption will, in effect, be exempt on its income up to an amount equal to 5% of the cost of its assets, if it meets somewhat different tests to those proposed for funds that may be fully exempt. The Government takes the view that since the level of exemption is to be limited to 5% of cost of assets it should not apply the "30/20" investment rule to such funds.

The Ligertwood Committee also recommended that the exemption of income of any superannuation fund should not extend to dividends and, in certain circumstances, other income derived by the fund from a private company. As to private company dividends the Government considers a blanket withdrawal of the exemption too severe. It is proposed, instead, that each individual case should be examined on its merits by the Commissioner of Taxation to determine whether such dividends should be taxed in full in the hands of a trustee of a superannuation fund, irrespective of any exemption that would otherwise be available to the fund. Also to be taxed in full, irrespective of any exemption otherwise available, is income from a transaction by a superannuation fund with a person with whom the fund is not dealing at arm's length. Such income will be taxed in this way if it exceeds the amount that might have been expected to accrue to the fund from the same transaction with a person at arm's length.

It is not proposed to vary the rates of tax applicable to the investment income of traditional type funds that may be subject to tax only through failure to comply with the "30/20" investment rule. It is proposed that other funds that are partially exempt, and those that are not exempt at all, will pay 10/- in the Pd on income that is taxable. This rate is also to ee imposed on the income of any fund for employees that is to be taxed in full in the special circumstances to which I have already referred. The rate of tax for this purpose is being declared by another Bill which I will introduce later today.

The final matter covered by the Bill concerns payments by a taxpayer to his relatives. In broad terms, these are at present allowed as tax deductions only to the extent that they are reasonable in amount. It is proposed by the Bill to amend the law so that the same basic principles are, in specific terms, applicable to excessive payments by a partnership to a relative of a partner as are now applied to payments by a sole trader to his relatives. It is also proposed that any amount disallowed as a deduction in accordance with the provisions will in general not be taxable in the hands of the recipient.

Before concluding, I should say that, with two exceptions, the new law will operate for the first time in relation to assessments of the income year 1965-66. The amendments concerning leases will be effective as from tomorrow. The amendments relating to certain income of superannuation funds for employees that is derived from private company dividends or transactions not at arm's length will also be effective as from tomorrow. The amendments relating to alienations of income will only affect alienations made after today. Alienations made later in this financial year will be subject to assessment on the proposed new basis in the year 1965-66.

A memorandum, giving much more detailed explanations than I could hope to achieve in this introductory speech, is being made available to honorable members.

I commend the Bill to the House.