Notes for the Minister's Second Reading Speech
The purpose of this Bill is to give effect to amendments to the income tax law made necessary by decisions of the High Court. These decisions have shown weaknesses in the present law of which taxpayers have been taking advantage to avoid - quite legally - large amounts of tax which, in accordance with the policy of the legislation as approved by the Parliament, it was intended they should pay.
The Bill is an important one, dealing in part with the most difficult question of providing effective legislative tests which separate the genuine public company from the ostensible public company for taxation purposes.
Before amending legislation in 1964, based on the recommendations of the Commonwealth Committee on Taxation 1959-1961, there had been considerable legal tax avoidance through essentially private companies masquerading as public companies. The 1964 amendments were intended to put an end to this. Unfortunately, as the High Court has pointed out, those amendments left a real gap which has been used to obtain the same kind of unintended tax advantages for private companies as were available before the amendments were made. In broad terms, the general aim of the arrangements is to ensure that the trading profits of private companies remain taxed at the lower rate applicable to those companies but that the profits are distributed as dividends to companies that are public in a narrowly technical sense so that there is no incidence of undistributed profits tax or personal tax on shareholders in respect of the dividends. The arrangements strike at the very basis of our company tax system as it was intended by the legislature to apply. Moreover, they are highly artificial and serve no purpose other than tax avoidance.
One type of scheme was dealt with by the High Court in the case of Casuarina Pty. Ltd. and ruled legally effective. Another type is known as the "chain-of-ten" scheme and is equally effective. Each type requires co-operation between genuine public companies and private companies so that, with the help of the public companies, the private companies can pay dividends to a company which is technically a subsidiary of a public company - and therefore itself a public company - for tax purposes. Of course the arrangements also ensure that the dividends effectively remain the exclusive property of the private company interests except, perhaps, to a very small extent which is a recompense or fee to the public company for its assistance.
In the Casuarina arrangement, the whole essence of the matter is that at the end of the year of income the company receiving private company dividends meets all the technical tests of a subsidiary of a public company. That is to say, at that time more than 50 per cent of the capital, voting power and the rights to dividends and other distributions are in the hands of a public company shareholder. There co-exist, however, counter-vailing devices which ensure that any attempt by the public company shareholder to exercise its ostensible rights can easily be defeated by the private company interests so that the public company rights are, in fact, worthless. These devices include such things as the use of shares redeemable at the instance of the private company interests only, but there are many ways in which the desired effects can be achieved.
The "chain-of-ten" scheme takes advantage of the fact that, under the present law, a sub-subsidiary of a public company, no matter how remote from the head or parent company, must be treated as a public company. If a company is owned as to more than 50 per cent by a public company, and its voting power is controlled by the same company, it is treated as a subsidiary of that public company. If it, in turn, has the same measure of ownership and control in another company, that other company is also treated as a subsidiary and so on. In a typical chain a public company listed on the stock exchange provides a specially established company with subsidiary status and this subsidiary sets up a chain of ten other sub-subsidiaries below it. The tenth and last sub-subsidiary is the company to which the private company profits are distributed as dividends. The public company interests could force re-distribution of these dividends along the chain - against the wishes of the private company interests. This is unlikely, however, because there is a 49 per cent private company ownership of each link in the chain which would result, for example, in only $119 out of $100,000 of private company profits finding its way to the listed public company at the top of the chain. The balance would all go to the private company interests.
The Government has decided that, in the face of these arrangements, in all their complexity and their shades of organisational and factual differences one from the other, the best plan was to define primarily as a subsidiary of a public company one that is, at all times during the year of income, beneficially owned, in the fullest sense of those words, as to 100 per cent by a genuine public company (including a subsidiary which, on these tests, is itself a public company). This the Bill proposes to do. The Bill also proposes that a company which does not meet the 100 per cent test will not be treated as a subsidiary of a public company unless, at all times during the year of income, it is owned as to more than 50 per cent and its voting power is controlled, again in the fullest sense, by a public company listed on the stock exchange. Both direct and indirect interests will be taken into account for these purposes.
These are necessarily stringent tests. As a safety valve against their applying inappropriately, a dispensing discretion vested in the Commissioner by the present law to treat a company as public when, for one reason or another, it fails to meet all the technical tests but should reasonably be treated as public, will remain. This is not a new administrative discretion, but one that has operated satisfactorily for some years now.
The tests - stringent as they are on the face of it - could still be met and provide no more than a facade behind which the company is managed or conducted so as to render the public shareholding worthless or virtually so. Directors representing private interests, for example, could have the power to do this. This is a substantial difficulty which it has not been found possible to overcome both positively and comprehensively. The legislation therefore permits the Commissioner to deny public status to a company when, having regard to specified matters relevant to the determination and set out in much detail, he is satisfied that the company's affairs are being conducted to this end.
It is proposed by the Bill that the amendments I have so far described should basically apply so that, if the corporate arrangements had been finalised by the necessary issue of shares, etc., before 29 April 1971, the artificial subsidiary will remain a public company for the 1970/71 income year by satisfying the existing tests of a public company subsidiary. For subsequent years, however, that company, in common with all other companies seeking public company subsidiary status, will need to comply with the tests that are proposed in this Bill. Where the corporate arrangements had not been finalised until after 28 April 1971, it is proposed that the company be treated as a private company for 1970/71 unless, of course, it meets the new tests in relation to that year. These commencement provisions are consistent with the Treasurer's announcement on the matter on 28 April 1971.
The income year 1971/72 is, therefore, the year for which, in the generality of cases the new tests, required to be met at all times during the year, will apply. Most of that year has already elapsed. In recognition of this, a special transitional provision is proposed whereby a company will, with an exception I shall shortly mention, be taken to have met the tests at all times during 1971/72 if it meets them at all times during the part of that year commencing no later than one month after the date of Royal Assent. The exception is the case of the company which has performed the public company part in a tax avoidance arrangement of the kind against which the legislation is directed and which received private company dividends after 28 April 1971 and in the period of 1971/72 prior to its compliance with the new tests.
A transitional provision that applied only for the 1971/72 year would not meet the position of a company which, because of an irregular accounting period, may have already commenced its 1972/73 year of income. Accordingly, the transitional provision, and the exception to it that I have mentioned, are designed so as to apply to both the 1971/72 and 1972/73 income years should this prove necessary.
Where a company remains a public company for the income year 1970/71, distributions made to it by a private company up to the end of that year will be treated as dividends paid to a public company. However, it is proposed by the Bill that any such distributions made after 28 April 1971, and before the end of the recipient company's 1970/71 income year, will not be capable of giving rise to an excess distribution to be carried forward by the private company into future years. In other words, a company will not be permitted to generate an excess distribution through excessive dividends declared under the tax avoiding arrangement in the closing stages of 1970/71, and after the Treasurer's announcement of the proposed amendments.
The Bill also proposes an amendment to deal with another and different arrangement which involves avoidance of undistributed profits tax without actual distribution of profits. Under this scheme a private company issues shares to another company in return for a premium equal to the dividends the private company is able to declare. It is proposed that a dividend paid in these circumstances is not to be taken into account in determining whether the paying company has made a sufficient distribution of its profits. This amendment will apply in relation to dividends paid after 9 December 1971, the date on which the Bill was introduced into the House of Representatives.
As foreshadowed by the Treasurer's announcement of 31 August 1971, the Bill also proposes amendments to deal with dividend-stripping arrangements which take advantage of the way in which the law at present requires the tax rebate on inter- company dividends to be calculated. It is proposed that the amendments will operate in relation to dividends arising out of an arrangement which the Commissioner of Taxation is satisfied is by way of dividend-stripping. The Commissioner is directed to consider, in forming his opinion, matters which are characteristic of dividend-stripping as the term is commonly understood in professional and financial circles here and in the United Kingdom. Principally, these are the effective recoupment of the purchase price of shares through the receipt of a dividend and a diminution in the value of the shares by reason of the declaration of the dividend.
This amendment will apply to dividends paid after 31 August 1971 and, in broad terms, will permit the amount of dividends subject to rebate to be ascertained by reference to all losses and outgoings incurred in relation to the dividend- stripping arrangement as a whole.
In his announcement of 31 August 1971 the Treasurer pointed out that, because of the dividend rebate provisions, a company can effectively receive other kinds of income tax-free. In addition to the dividend stripping arrangement a recognised way of doing this is for a share trading company to take advantage of the trading stock and dividend rebate provisions of the income tax law, operating in combination, so as to reduce tax on share trading profits. I point out that this is a device which is not available to all companies. It depends very much on the particular circumstances of a company whether an unintended tax benefit can be had from resorting to it.
The Bill proposes that where the purpose of a valuation of trading stock is to obtain this tax advantage the rebate allowable to the company is to be calculated as though, instead of the valuation of stock adopted by it, the lowest valuation that it could lawfully have chosen had been adopted. This amendment will apply in relation to assessments for the income year 1971/72 and subsequent years.
A number of the provisions - unavoidably and, I think, quite appropriately - turn primarily upon the Commissioner of taxation being satisfied as to certain matters. Specific guidelines are, where practicable, provided for the Commissioner to consider in the formulation of an opinion. If a taxpayer is not satisfied with the opinion formed by the Commissioner on the facts of a particular case, the usual rights of objection and appeal against the Commissioner's decision will, of course, be available to contest the correctness of the Commissioner's decision.
A memorandum explaining technical features of the Bill is being made available for the use of Honourable Senators.
I commend the Bill to the Senate.