The Senate

Income Tax Assessment Bill (No. 4) 1967

Income Tax Assessment Act (No. 4) 1967

Notes for the Minister's Second Reading Speech

This Bill will make some important amendments to the Income Tax Assessment Act.

The main parts of the Bill concern our taxation of interest and dividends going out of Australia to non-residents and income derived by our own residents from investments in overseas companies. The Bill also proposes some important changes in the provisions governing the taxing of distributions made by companies.

I turn firstly to the proposed withholding tax on interest paid to persons who are not residents of Australia. The Bill will implement the Government's decision to introduce this tax which was announced in a statement by the Treasurer on 4th May last.

Without going over again in detail the reasons that prompted the Government's decision, I recall to honourable senators two of the principal factors we considered.

One is that interest paid by companies to non-residents is, at present, subject to Australian tax at a rate of 42.5 per cent of the gross amount unless steps are taken to avoid the tax. I stress the word gross; no allowance is made for expenses incurred in gaining the interest. The rate is high in itself and generally much higher than other countries see fit to impose. The tax is, in fact, so severe that it induces overseas lenders to avoid it if they can. This leads to the second factor, which is that our law contains provisions which clearly permit arrangements to be made to avoid the special tax. I emphasise that these statutory provisions are quite explicit and people who have taken advantage of them had a perfect right to do so. The position that results from all this is far from satisfactory.

In reviewing the situation, the Government set itself the aim of introducing a withholding tax that would ensure that a reasonable contribution to Australian tax revenue is made by overseas lenders in relation to interest drawn from Australia. We wanted to see a relatively simple method of collection of the tax. At the same time, full regard was had to the effectsan withholding tax might have on the availability and cost of overseas capital to Australian borrowers.

It is proposed that the rate of the withholding tax will be 10 per cent of the gross interest, and that it will be a final tax. Interest subject to withholding tax will not, in any circumstances, be taxed on the ordinary assessment basis. The withholding tax on interest will come into operation in respect of interest paid on or after 1st January 1968. It will usually apply to interest paid by Australian residents to non-residents, except to the extent that the interest is attributable to a business carried on by the Australian resident outside Australia. It will also apply to interest paid by a non-resident to another non-resident to the extent that the interest is attributable to a business carried on in Australia by the non-resident who pays it. Interest paid by the Commonwealth or a State will generally be within its scope.

Some interest received by non-residents will not, however, be subject to withholding tax and will continue to be taxed on the ordinary assessment basis at the appropriate general rate. In this category is interest derived by a non-resident in carrying on business in Australia through a branch, e.g., a non-resident bank. Government loan interest on securities issued before 1st January 1968 and in respect of which the special rebate of 10 per cent of the interest is available will also continue to be taxed by assessment. So too will residents of the external territories.

Certain interest will be exempt from withholding tax and will not be taxed on any other basis. Here I point particularly to cases in which a resident company had negotiated, or was negotiating, a loan before 4th May, 1967 on terms which bind it to pay interest free of any deduction. Under the statutory provisions I mentioned earlier, no Australian tax would be payable under the present law in these circumstances and it is not proposed to disturb the basis of these contracts.

Also to be exempt from the tax are foreign superannuation funds, charities and similar bodies if the income is exempt from tax in the home country of the particular body. The exemption of interest paid on external Government loans will not be affected by the legislation.

To maintain consistency with the interest withholding tax an amendment is proposed to the dividend withholding tax that has operated since 1960. This is that Australian dividends received by foreign superannuation funds, charities and similar bodies will be exempt from dividend withholding tax only if tet dividends are also exempt from tax in the country where the organization is a resident for tax purposes.

I turn now to features of the Bill that are designed to clarify the taxation position of an Australian resident who receives a dividend from an overseas company, but does not receive it as a shareholder in the company. He may, for example, beneficially own shares which are registered in the name of a trustee or some other person.

In general, Australian taxpayers are relieved from double tax on foreign dividends by means of a credit system. This means that if a resident shareholder derives dividends from a foreign source he is subject to Australian tax on the dividends but receives a credit against his Australian tax for foreign tax on the dividend for which he is personally liable. On the other hand, other types of foreign income derived by a resident are exempt from Australian tax if they are subject to tax in the country where the income has its source.

The amendment proposed will declare in explicit terms that Australian residents who beneficially derive foreign dividends, but are not themselves shareholders in the foreign company, are to be taxed on the dividends and allowed credit for foreign tax, in the same way as Australians who have direct holdings in foreign companies.

Other major proposals in the Bill concern distributions by companies. One deals with distributions made in association with a reduction in paid-up capital, another with distributions in the course of what can be described as an informal liquidation of a company.

I speak first about distributions in association with a reduction of capital. For more than a quarter of a century our taxation law has, in broad terms, treated as dividends, and therefore as income subject to tax in shareholders' hands, any distribution made by a company as a going concern, other than a return of paid-up capital. A majority decision of the High Court has in recent years, however, interpreted the law to mean that it is not effective to tax amounts paid to shareholders when a company reduces its capital even though those amounts are greatly in excess of actual paid-up capital returned. This means that a company can, by concerted action involving some reduction of its capital, pay to shareholders in a tax-free form profits which would be subject to tax in the shareholders' hands if distributed by way of a conventional dividend.

The Government considers that this situation constitutes a real threat to revenue and to the basic general principles on which the taxation law is based. The position also gives an unwarranted advantage to shareholders in companies in a position to execute this type of plan as against companies not so fortunately placed. The Bill therefore proposes to remedy the technical deficiency in the law.

The Bill provides that a distribution made in consequence of a reduction of paid-up capital will be subject to tax to the extent that it exceeds the sum of the reduction in nominln paid-up capital and any distribution out of share premium account.

As to liquidations, the position is that distributions made by a liquidator in the course of a formal liquidation are taxable in the hands of shareholders to the extent that they are made out of income. Shareholders wishing to wind up a company sometimes do not have it formally liquidated but merely take possession of the company's tangible assets, collect and retain debts due to it and discharge debts due by it and then treat the company as wound up. Where this is done, distributions made out of income of the company are not taxable although they would be if made in the course of a formal liquidation.

The Bill proposes that distributions made in these informal liquidations will in future be taxed in the same way as distributions in an orthodox liquidation.

Other proposed amendments in the Bill are of a relatively minor nature. At present, grants made by the United States Educational Foundation in Australia are specifically exempt from tax. This organization has been superseded by the Australian-American Educational Foundation and the Bill will ensure that grants made by the new body will also be exempt from tax.

The final amendment is a matter of machinery. Since 1922 the income tax law has set a limit on the amount to be appropriated for salaries and allowances of members of the Taxation Boards of Review. This has occasioned frequent amendments to the Act and is out of line with more modern legislation on statutory bodies. The Bill will therefore omit the limitation. This action will not, of course, affect the administrative procedure for determining salaries of members of the Boards which will continue to be determined by the Governor-General on recommendations by Cabinet.

The Bill is explained in more detail in an explanatory memorandum available to Honourable Senators and I do not propose to go into any further detail at this stage.

I commend the Bill to the Senate.