Second Reading Speechby the Treasurer, The Hon. John Howard, M.P.
This Bill to amend the income tax law will introduce measures to counter tax avoidance and give effect to a number of Government policy initiatives that have already been announced.
These policy initiatives include the new concession to allow shareholders a rebate of tax for share capital subscribed to companies engaged in off-shore petroleum exploration and development activities. The 1977-78 budget decision to liberalise the income tax deductions for gifts of works of art and comparable property to Public Libraries, Galleries and Museums will also be given effect by the Bill.
The measures against tax avoidance are wide ranging and are an important step in our programme to strike down tax avoidance arrangements.
As a Government, we simply cannot accept a situation where the actions of a few can jeopardise the well-being of us all. Not only do these practices make the Government's basic task of economic management more difficult, but they can seriously jeopardise our programme of tax reform designed to reduce the overall burden of taxation. Furthermore, it is particularly unfair when, in many cases, the persons involved in these schemes are the ones best able financially to accept their tax liabilities.
It would be idle to imagine that tax avoidance in all its forms will ever cease. There is a flourishing tax avoidance industry in all corners of the world and plenty of talent available to devise schemes of avoidance. It has long been recognised that it is reasonable for taxpayers to so organise their affairs as to minimise liability for taxation. However, the Government believes that some techniques of tax avoidance are so blatant, contrived and artificial as to go beyond the bounds of reasonableness.
There may be no absolute community standards by which particular forms of tax avoidance may be judged. I would not pretend to be able to offer a complete definition. I do, however, assert that some of the schemes which have been practised, and are the subject of this Bill, are clearly at odds with the general welfare of the community.
It does no credit to those concerned to be involved in a scheme where of $10,000 claimed as a deductible gift, just $120 is enjoyed by the charity concerned, with the promoter of the scheme benefiting to the extent of almost $1,400.
Nor, I think, would it be regarded generally as reasonable tax planning for a group of people to contrive, through trading in and dividend stripping of shares, to transform what is undoubtedly a profit of $5,000 into a deductible loss for tax purposes of $970,000.
Taxpayers and their advisers do have a responsibility as to the lengths they go in exercising legal means of minimising tax payments.
Against this general background, I turn now to the anti-avoidance amendments that are a feature of this Bill. The matters covered under this head are schemes involving the creation of tax losses through the issue and subsequent sale of bonus shares, abuse of the gift provisions, creation of artificial share trading losses, dividend stripping, artificial acquisition of "primary producer" status for averaging purposes and steps to avoid tax on undistributed income and tax on dividends.
The amendment relating to bonus shares has been made necessary by the legal interpretation applied in the well-known Curran case.
The essential elements of the Curran schemes are that taxpayers who seek to be treated as share traders can artificially create a tax deductible loss which can then be offset against their normal taxable income. For example, a person may pay $190,000 for shares with a face value of $10,000 and, after accumulated profits attaching to those shares have been capitalised by the issue of bonus shares to a face value of $190,000, the total parcel of shares is sold for $195,000. Under a Curran scheme the person claims to have incurred a loss of $185,000, whilst in commercial terms, a profit of $5,000 has in fact been made.
These schemes can be used to create whatever loss is required by a taxpayer to completely eliminate tax liability.
The Bill does not disturb the rules that an individual shareholder who is issued with non-redeemable bonus shares paid up out of capital profits is not taxed in respect of the receipt of those bonus shares, or that a resident company is not taxed in respect of any bonus share issued to it. The amendment proposed in the Bill will mean that in calculating the taxable profit or loss on disposal of shares by a share trader, the only cost attributed to a bonus share, where the shareholder is not taxable in respect of its receipt, will be the part of the cost of the original shares that is fairly attributable to the bonus shares.
Mr Speaker, I draw particular attention to one aspect of the amendment in relation to bonus shares, namely, that the amendment will apply to bonus shares allotted after the budget date of 16 August, 1977.
The Government has decided to adopt this application date because of the extreme gravity of the situation involving bonus share schemes. Precise quantification cannot be made, but all the indications available to the Government are that hundreds of millions of dollars of revenue would be lost if the amendment were confined to bonus shares allotted after today. Not only would many high income earners be freed from tax in 1977-78, a number would not pay tax for years into the future because of large carry-forward losses they have sought to create by schemes of this kind.
In deciding that this amendment should apply after 16 August 1977 the Government recognises that retrospectivity is involved. On this occasion we make no apology for acting retrospectively to protect the public revenue.
Generally, the Government has supported the view that the rights of taxpayers under existing legislation should not be altered retrospectively. However, the Government believes that whilst it is generally the case that the public interest can best be served by not applying tax legislation retrospectively, on this occasion the public interest requires a departure from this general practice. The Government's decision reflects its view that the abuse represented by the Curran type schemes is so blatant and of such a magnitude that it constitutes a serious detriment to the general body of taxpayers.
The Government also had in mind that it was doubtful whether any person entering into a Curran scheme in recent months could genuinely have believed that there was no risk that his or her enjoyment of the benefits of the scheme would remain totally immune from retrospective legislation. This is especially so in light of the clear warning against tax avoidance given in last year's budget speech. In fact, some promoters of these schemes have offered "money-back guarantees" in the event of the schemes being retrospectively struck down.
It is important to emphasise that the amendment will not be retrospective to earlier financial years. The effect is that losses generated by allotments of shares under Curran schemes from and after 17 August 1977 will be denied deductibility against income earned during this and subsequent financial years.
The abuses of the gift provisions against which this part of the Bill is directed all have the common feature that the donor seeking a deduction for a gift to one of the funds or institutions referred to in the gift provisions of the law does not, when the reality of the situation is laid bare, really make a gift of anything like the amount or value for which a deduction is claimed. Correspondingly, the charity does not enjoy anything like the full amount or value of the ostensible gift.
Under one gift scheme the donor seeks a deduction for a $10,000 gift that is made to an institution, $1,500 of the amount coming out of his or her own funds and the balance of $8,500 being lent by the promoters of the scheme. The institution, pursuant to an overall arrangement, pays the promoters a procuration fee of 98.8 per cent of the gift, leaving it with $120 out of the $10,000. The procuration fee puts the promoters in funds not only for their $8,500 loan to the donor, but provides them with a substantial fee. In practical terms, the donor does not have to repay the $8,500 loan.
In further schemes of the same kind the gift to the charity is a note or debenture which, despite the claim for a deduction of its face value, is rendered almost worthless by subsequent, pre-arranged, changes in its terms and conditions. The charity receives cash from the sale of the note or debenture at its reduced value, and the diminution in value accrues to the donor or his associates.
Plainly, the Commissioner of Taxation is resisting claims through these shoddy schemes for deduction, made under the law as it stands. However, as the courts may find that the nominal rather than the real gift is deductible, the Government proposes to put the matter beyond doubt in relation to gifts made after today.
I stress that the amendments will deny any deduction for a future gift only when made in tax avoidance circumstances of the broad kind I have just referred to. Genuine gifts made in ordinary circumstances to the funds and institutions concerned will not be affected.
A closely related exploitation of the gift provisions is also being dealt with in the Bill. This concerns practices whereby a donor gives a work of art, or money to buy a work of art, on the condition or understanding that the donor or a relative or other associate may have possession of the work. Generally, there will be no deduction for gifts of this kind made after today. However, if the gift is one that qualifies under the liberalised provisions to which I will refer later, a reduced deduction will be allowable. In such cases the deduction will reflect the full value of the work as discounted for the benefit that flows from retaining possession and enjoyment of it.
The Bill further provides that, where there is an arrangement that the donee will use a gift to acquire property from the donor or an associate, there will be no deduction.
Share trading losses
The Bill has the broad objective of preventing deduction of "manufactured" or artificial losses from trading in shares, by enabling the taxable profit or loss to be calculated on the basis of the commercial realities of the transactions concerned.
Honourable Members will recall that amendments were made last year to counter avoidance schemes in which elections were lodged under Section 36A of the Income Tax Assessment Act so as to create artificial share trading losses. The measures now brought before the Parliament supplement the earlier amendments.
Schemes of this kind are very involved. They require a number of intricate and contrived steps. Under one scheme, a partnership of taxpayers buys shares to which there are attached very substantial undistributed profits in liquid form, usually cash in the bank. The partnership is a share trading one, which means that its taxable profits or losses from share trading are allocated to the partners and are reflected in their individual assessments. Although the shares that the partnership buys would be very valuable to it if they were purchased in a straight-forward manner, the partnership in fact pays only a nominal amount, as it is part of the pre-arranged plan that the company concerned will issue special-class shares to an associate of the promoter from which the partnership bought the shares and will pay its previously undistributed profits as a dividend to that associate.
For example, a partnership buys shares for $25,000 that are worth $1 million and the dividend that is paid on the special-class shares is $970,000. The partnership then sells the stripped shares for $30,000 making a commercial profit of $5,000. It claims, however, a loss of $970,000 on the basis that a provision of the law deems the partnership to have acquired the shares for their then basic value of $1 million.
Another variant of the scheme relies on the general deduction provisions of the law. A share trading partnership buys shares for $1 million which it later sells for only $30,000, because the worth of the shares has been stripped away by payment of a dividend of $970,000 to another company. The dividend cannot effectively be taxed in the hands of the recipient company because that company is a straw company and has no realisable assets after the scheme is carried out. The partners claim for tax purposes to deduct the $970,000 loss but, and here is the point, they do not in reality have to bear the loss or any part of it. This is because the partnership has been lent money to acquire the shares under an arrangement whereby the loan is in fact not repaid. In the jargon of the trade, the loan is collapsible.
Mr Speaker, schemes of this kind have not been tested before the courts. I expect that this will happen in due course because the Commissioner of Taxation will be vigorously resisting them. However, the Government proposes to put the matter beyond doubt for relevant acquisitions of shares taking place after today.
In this avoidance scheme a company buys shares in a company with accumulated profits; strips these profits by way of dividend and subsequently sells the stripped shares, thus recouping itself for the initial share purchase.
In 1972 the law was amended to prevent a company from both deducting the apparent loss on sale of the shares and being allowed an intercorporate dividend rebate on the full amount of the dividend paid. Those amendments limited the rebate to the net amount of the dividend after offsetting the cost of the shares and any other deductions associated with the dividend.
Dividend strippers have found a way around the 1972 amendments. While one company receives the stripping dividend, it is an associated company or trust that incurs the apparent loss. In these circumstances there is no basis in the present law for offsetting the cost of the shares against the rebatable dividends.
To overturn this variation of the scheme it is necessary to provide that, where a company receives a dividend in the course of a stripping scheme, and it is a part of the scheme that an associate takes the apparent loss on the sale of the shares, the company that receives the dividend is not to be allowed any rebate in respect of the dividend. This amendment will apply to dividends declared after today.
A private company is liable to tax on its undistributed profits if it does not pay sufficient dividends to its shareholders. In respect of business profits, a private company is allowed to retain 60 per cent of its profits after company tax, and is required to pay the balance as dividends to its shareholders if it is not to pay the undistributed profits tax.
Under one current scheme of avoidance, the payment of dividends to shareholders is illusory. The company does pay or credit dividends to a shareholder but is not put out of funds by doing so. One re-imbursement technique is for the shareholders concerned to put broadly equivalent funds into the company, for example, by subscribing for redeemable preference shares that, after payment of a once-and-for-all dividend, carry virtually no rights. The shareholder receiving the dividend is not taxed on it because the special class shares are sold at a loss which is offset against the dividend.
Under another technique, dividends are credited to a shareholder but the amount is not actually paid to the shareholder but is used to pay up an almost worthless share or debenture. The shareholder in this scheme is an institution whose income is exempt from tax and a small fee is paid for its services.
Dividends declared after today under schemes of this kind will not be taken into account for purposes of tax on undistributed income.
Abuse of Averaging Provisions
A decision of the High Court given at the end of last year has made it necessary to amend the law so that the averaging system applicable to primary producers is not available to people who have no real stake in a primary production business and have become a beneficiary in a primary production trust simply to gain the benefits of tax averaging.
The averaging system is applicable to taxpayers who directly or as a beneficiary of a trust carry on a primary production business.
The court case arose out of an avoidance scheme by which thousands of beneficiaries were each given a $1 share of income from a primary production trust. The court held, in a test case, that one of these beneficiaries thereby qualified for tax averaging for his entire income.
Plainly, that is not a situation in which averaging should apply. Our proposed amendment is confined in scope to the special provision applicable to beneficiaries in primary production trusts. If the beneficiary's share of income of a year is $1,040 or more, the law will apply as it does now. If, however, the beneficiary's share falls short of this figure, averaging will not apply unless the Commissioner of Taxation is satisfied that the beneficiary's interest was not acquired primarily for the purpose of attracting the averaging provisions.
Beneficiaries in primary production trusts of the traditional kind will not be affected by the amendment.
Where it is applicable in relation to avoidance schemes of the kind I have outlined, the amendment will apply in the determination of averaging entitlements in 1978-79 and, for people who enter into such schemes after today, in the current financial year.
Mr Speaker, that completes my outline at this stage of the principal anti-avoidance measures contained in this Bill. Those measures are not the sum total of the response that we intend to make to prevent tax avoidance practices. Other amendments are in course of drafting and will be introduced at the earliest practicable time.
Let me now turn to the other measures contained in this Bill.
Expenditure Pursuant to Franchise
The Bill contains provisions to withdraw the deduction for capital expenditure on a revenue-earning facility erected pursuant to a Government or public authority franchise.
The provision in question was enacted some years ago to cater for circumstances not commonly encountered. At the time, leaseholders were entitled to deductions for capital expenditure on leasehold improvements. It was therefore appropriate that where a taxpayer was granted a right by a Government authority to construct and maintain an undertaking of public utility, and to earn revenue from it, the taxpayer could deduct over the life of the franchise the capital costs incurred in the project.
However, the law was amended in 1964 to withdraw the deduction available to lessees for the cost of leasehold improvements. It is now anomalous that taxpayers who can arrange to be franchise holders can deduct costs not deductible to taxpayers who build on leasehold or freehold land. The deduction for franchise holders is being withdrawn in relation to capital expenditure on franchises granted after today.
On 24 August last year the Deputy Prime Minister announced in this House a number of decisions made by the Government after considering ways of assisting the development of gas fields on the north-west shelf. The decisions included the provision of three very important taxation concessions.
Two of these, the general extension by two years of the 20 per cent phase of the investment allowance and the inclusion in allowable capital expenditure of the cost of natural gas liquefaction plant, have already been carried into legislation.
The third concession is the shareholder rebate scheme. By this Bill, shareholders who, after 24 August 1977, subscribe share capital to a company holding a registered interest in an offshore licence or permit, will be eligible for a tax rebate. The rebate is only available when the company lodges a declaration with the Commissioner of taxation that the moneys are ear-marked for expenditure on exploration or development of an off-shore petroleum field.
A Corollary of this will be that the company will forgo its own right to deductions for the expenditure under the petroleum mining provisions of the Income Tax Law. The scheme therefore permits the transfer of tax allowances for eligible expenditure from a petroleum mining company to its shareholders.
The Bill puts into effect the policy decision outlined in the earlier statement by the Deputy Prime Minister. The new scheme draws very much on the earlier concession under section 77D of The Income Tax Assessment Act under which shareholders were allowed deductions for capital subscribed to mining companies.
However, experience with taht conession led to the government's decision to provide strengthened safeguards against exploitation of the new concession when no real contribution to exploration or development is made.
Liberalisation of Gift Provisions
It was announced in the last budget speech that there would be a liberalisation of the gift provisions of the Income Tax Law as they apply to gifts of works of art and comparable property to public libraries, art galleries and museums. The Bill implements that undertaking effective from 1 January, 1978, and for a trial period of three years.
At present, the deduction for gifts of property to specified funds and institutions is limited to property purchased by the donor within the preceding twelve months, and to the lesser of its current value and its cost to the donor.
The Government considers that there should be some changes in these rules to encourage people owning significant works of art or other items of cultural property to donate them for public display.
Details of the Government's policy are contained in a statement by the Minister for home affairs on 30 December, 1977.
The essence of the trial scheme, however, is that a taxpayer will be eligible for a deduction for property that has been held for any length of time and, in general, the deduction will be an amount equal to the market value of the property. Claims for deductions will need to be supported by valuations from approved valuers and a committee established with the co-operation of the New South Wales and Victorian Governments will approve valuers for this purpose.
The Bill also introduces a deduction for gifts to the Australiana Fund. This fund is set up to facilitate the making of gifts of cash and works of art, including furnishings, for the fitting out of Government House, Admiralty House, The Lodge and Kirribilli House. Gifts to this fund will be allowed on the same extended basis as proposed for gifts to public libraries, art galleries and museums.
I mention here that the Bill brings up to date the gift provisions as they apply to gifts to the Northern Territory and Australian capital Territory National Trusts. The Northern Territory body has been re-constituted and the Australian Capital Territory body has been made a separate entity, instead of being a branch of the New South Wales trust. The amendment means that gifts to the national trust of each state and internal territory will be tax deductible.
Isolated Children's Allowance
Another change to be made by the Bill will benefit taxpayers who have dependent children for whom payments are made under the isolated children's education assistance scheme. In 1973 these payments were made exempt from tax in the hands of the recipients. However, they continued to constitute separate net income of the children for purposes of calculating entitlement to the zone allowance and other rebates. That can have the effect of reducing rebates available to the parents of the children and the Bill provides that the allowances are not to be taken into account as from 1 July 1977.
Vocational Training Scheme
Payments under the former regular servicemen's vocational training scheme are also dealt with by the Bill. These payments are akin to payments under the N.E.A.T. scheme which were made subject to Income Tax in 1975. Payments under the vocational training scheme are correspondingly being made taxable with effect from the scheme's commencement on 1 February 1978.
Current Year Losses
There is yet another area of avoidance that it has not been practicable to make the subject of proposals in this Bill, but which is of such importance that the Government has decided to announce amendments effective as from today. The term "current year losses" is a convenient shorthand description of it.
Honourable members will know that the law contains a number of highly complicated provisions developed over the years to counter equally complicated arrangements for trafficking in tax deductible losses incurred by companies in prior years. In essence, a company may not deduct against income of a year a business loss incurred in a prior year unless throughout both years either the same persons beneficially owned more than 50 per cent of shareholders' dividend, voting and capital rights, or the company carried on the same business after a disqualifying change in shareholdings as it carried on before the change.
The essence of current schemes is that losses incurred by a company while under the ownership of one set of shareholders are sought to be offset against profits earned in the same year under another set of owners.
The arrangements have two basic forms. In one type, a company that has in the early part of an income year traded unprofitably is sold to a new group of shareholders who in the second part of the year inject into the company income that is offset by the losses of the early part of the year.
The other form is the reverse of this. A company that has traded profitably in the early part of a year is sold to another group who create artificial losses. These losses are set against the income earned by the company in the early part of the year under the original proprietorship. Honourable members may have noticed heavy advertising in the press of schemes of this kind.
The principles governing deduction of prio-year losses being a settled part of the law, the Government sees no reason why the same principles should not be applied to govern the deduction of current year losses. We propose that the law be amended accordingly.
The new provisions will work along the following lines. The existing provisions of the law for determining whether there has been a sufficient continuity of ownership will be applied. If there is a disqualifying change in ownership, the new provisions will not apply if the company satisfies the "same business" test that now applies in respect of prior year losses.
Where, however, the company fails both tests, its taxable income of the year will be calculated by treating the two parts of the income year, as if they were separate years. Where these separate calculations show a taxable income in one part of the year and a net loss in the other, the amount of the loss will not be offset against the profit.
The proposed legislation will apply the same principles where there is more than one disqualifying change in the course of the year.
The proposed "current year losses" amendments will be applicable in all situations where a disqualifying change in ownership occurs after today.
Mr speaker, the Bill also contains some other more technical amendments of a significant kind, notably those dealing with transfer of mining capital expenditure deductions from companies to their shareholders, aspects of the anti- dividend stripping provisions and the averaging system for primary producers as it applies in the context of the new standard rate personal tax system.
All the provisions of the Bill are explained in the usual explanatory memorandum that is being circulated to honourable members. Due to the complex technical nature of the Legislation the Government does not intend to resume the second reading debate for at least a few weeks to allow adequate opportunity for comment on the technical aspects of the Bill.
I commend the Bill to the House.