House of Representatives

Income Tax Assessment Amendment Bill (No. 2) 1978

Income Tax Assessment Amendment Act (No. 2) 1978

Second Reading Speech

Mr Howard (Bennelong-Treasurer) (8.53)-I move:

That the Bill be now read a second time.

The Bill that I now bring before the House contains further measures to counter tax avoidance and to improve the equity and balance of the income tax system. It also contains legislation designed to encourage investors to put capital into the production of Australian films. Honourable members will recall that just two months ago I introduced a number of major amendments directed against prevailing tax avoidance practices. I spoke then in a general way about the problems that are posed by tax avoidance arrangements and I have since had occasion to put the Government's position on the matter and to underline the seriousness of our intent to strike these arrangements down. I shall, however, speak first about the policy initiative concerning capital investment in Australian films.

Capital Investment in Australian Film Rights

The proposal to change the income tax law in this respect was foreshadowed in the policy speech for the last general elections delivered on 21 November 1977 and the key points of the changes were outlined in a statement that the Minister for Home Affairs (Mr Ellicott) and I released on 27 April last. Underlying the proposed changes is a belief that if investors could deduct their capital investment in Australian film rights over two years instead of, as at present, over a much longer period of up to 25 years, there would be greater investment by Australians in the production of Australian films. There are obvious tax benefits in a quick write-off of capital costs and, when this new concession is taken together with other assistance such as that provided through the Australian Film Commission, the Government can justly claim to be lending significant support to the Australian film industry and to all engaged in it.

The concession for capital investment in Australian film rights will be implemented by amendments to the provisions of the income tax law that have, since 1956, allowed otherwise non-deductible capital costs of acquiring industrial property rights used in the production of assessable income to be written off over specified periods. For copyrights, which are the relevant property in this context, the costs have been subject to a tax write-off over 25 years, or any lesser period for which the rights subsist or are held. The amendments now proposed will-in relation to rights in Australian films first used for income producing purposes after 21 November 1977- substitute two years for 25 years as the basic write-off period. The longer period will, however, remain for those who wish to use it.

The Minister for Home Affairs will have the responsibility of determining which films are to be classed as 'Australian films'. The Bill proposes that an Australian film will be one that the Minister certifies has been, or is to be, made wholly or substantially in Australia and is a film with a significant Australian content. It will also include a film that the Minister certifies has been, or is to be, made under an agreement between government authorities of Australia and another country. The Bill contains extensive guidelines for the determination of when a film has a significant Australian content. In amending the relevant provisions, it is necessary also to guard against their misuse for tax avoidance purposes and the Bill contains measures to that end, effective after 27 April 1978, the date on which the amendments were foreshadowed. The anti-avoidance measures are directed against arrangements to secure excessive deductions by inflating the cost of rights or by deflating their sale price when they are disposed of.

Current Year Losses

In terms of space-43 of its 68 pages-the present Bill is mainly devoted to amendments dealing with current year losses that I announced in this House on 7 April when introducing the Income Tax Assessment Amendment Bill 1978 and h that are now expressed to be effective as from that date. Honourable members will recall from my earlier speech that these amendments are to employ and adapt the well-settled principles governing the deductibility by companies of losses sustained in prior years. In the relatively uncomplicated case, the adaptation will mean that, where there is a point within a year of income at which there has been a more than 50 per cent change in beneficial ownership of the company as at the beginning of the year, the net losses sustained by the company in the period before the change will not be available to be offset against the net income of the period after the disqualifying change, unless the company has carried on throughout that income period the same business as it carried on immediately before the change. Similar principles are to apply where an income period of a year precedes a loss period of the same year.

The point of these amendments, as of the provisions governing deductibility of prior year losses, is to prevent income earned by a company under the proprietorship of one set of shareholders being diminished for tax purposes by losses sustained under the proprietorship of a different group of people. The proposed amendments are undoubtedly complex. This is due to the effort that has been made to spell out, in the great variety of factual situations that can exist in practice, how the current year losses provisions are to operate and to guard against the new provisions being themselves made the subject of tax avoidance arrangements.

Much of what is in the measures stems from the necessity to modify provisions of the Income Tax Assessment Act that are constructed for application to a year of income as a whole so that they can be applied to separate periods that make up a year. Moreover, the measures must be capable of effecting this modification where a company that has suffered a disqualifying change in shareholdings gets its income or deductions via a partnership or its income through a trust. Of course, the legislation has to comprehend situations where there is more than one disqualifying change in shareholdings in the course of a year and a mixture of loss and income periods.

Dividend Stripping

Here too, I refer honourable members to what I have said on earlier occasions-in this instance in my second reading speech on 7 April last and in a subsequent statement that I released on 7 May. The proposed amendment under this head is yet another legislative attempt to prevent companies that engage in dividend stripping from achieving double benefits. The double benefit, where it arises, is represented by the freedom from tax of the stripping dividend conferred by the rebate on inter-corporate dividends plus a deduction for the loss on the sale of the stripped shares after their value has been reduced by payment of the dividend.

A provision was enacted in 1972 with the purpose of eliminating this double benefit. It specifies that only so much of a dividend received in a straight-forward dividend stripping operation as exceeds the cost to the stripping company of the shares to be stripped may qualify for rebate. That provision is now being amended, effective from 7 May 1978, to make it applicable where a third company, or a trust, is interposed between the company to be stripped and the stripper. The cost of the shares or interests in the interposed company or trust will be offset against the amount of stripping dividend otherwise eligible for rebate. Also effective from 7 May 1978 will be an amendment to the new anti-stripping provisions being introduced by the Bill brought down in April. These new provisions strike at the practices whereby a company receives the stripping dividend but an associated entity suffers the paper 'loss' on the purchase and sale of the shares to be stripped. Whilst they guard against a company being interposed between the company to be stripped and the stripper, they do not cater for similar interposition of trusts. That gap now is being closed.

Branch Profits Tax

The Government also proposes by this Bill to give form to the proposed branch profits tax on the taxable income of non-resident companies that was foreshadowed in a statement to the House by the Minister Assisting the Treasurer (Mr Viner) on 4 November 1977. As indicated then, there is a lack of balance in our tax system as between foreign companies that carry on business in Australia through a subsidiary company incorporated or otherwise resident here, and those that conduct their business through a branch of a company resident, for tax purposes, in another country. In each case, taxable income is computed in the same way and bears the same rate of company tax-now 46 per cent-but whilst the profit remittances of the subsidiary bear dividend withholding tax, there is no further tax in respect of 'remittances' of branch profits to head office or of dividends paid to foreign shareholders out of those remittances. The additional tax proposed to be levied on taxable income of non-resident companies is being introduced to redress this lack of balance. It will be at the rate of 5 per cent of the taxable income of the branch. The tax is being levied in this form because it is impracticable to impose a tax on 'remittances' of branch profits.

In striking a branch profits tax rate of 5 per cent of taxable income, the Government has aimed to achieve, as closely as is practicable, a reasonable balance in the Australian tax liabilities attaching to profits of foreign-owned subsidiaries and branches, bearing in mind that, in both cases, the companies are likely to plough back some of their profits into further developments in Australia. In last year's announcement of the branch profits tax, it was indicated that the tax would not fall on dividend income of branches, nor would it apply to film royalties, shipping profits or insurance premiums taxed under special provisions. These exclusions are made by the Bill. Representations made to the Government since the time of that announcement have led to one additional exclusion. This concerns the profits of non-resident life assurance companies that are allocated towards bonuses and other payments due to Australian policy holders. The Government has accepted the point that, if the tax were placed on these profits, it would effectively be borne by Australian policy holders and not, as intended, by the company or its overseas shareholders, if any. The Government has decided that the tax will apply to that part of the 1977-78 tax year falling after 4 November 1977, and to subsequent years. Although the branch profits tax takes the form of a rate increase, it is in essence a new tax. Hence it would be inappropriate to make it retrospective in effect by applying it to the full 1977-78 tax year. Before concluding my remarks on this subject, I mention that, whilst the basic application of the branch profits tax is provided for in this Bill, the Income Tax (Non-Resident Companies) Bill 1978 that I shall shortly introduce will formally declare the rate of the tax.

Private Companies in Liquidation

I come now to measures designed to meet representations from the liquidators of private companies that the undistributed profits tax provisions of the income tax law are so structured as to cause unreasonable delay in the final winding up of private companies in liquidation. An example may be the best way of illustrating the point. Let us say that a private company has earned a taxable income in the first four months of an income year and its liquidator wishes to make an immediate distribution of the income to shareholders, and to wind the company up. The problem is that he must wait six months until May of the income year to effect the distribution because only the dividends paid in the prescribed period of 12 months commencing two months before the end of the income year can be taken into account for undistributed profits tax purposes in relation to the year. To overcome the difficulty, liquidators in this situation will be o enabled by the Bill to make a qualifying distribution to shareholders before the commencement of the prescribed period.

That completes my remarks at this stage on the main features of the present Bill. All of its provisions will, as usual, be explained in a comprehensive explanatory memorandum. It has not, however, been practicable to complete the memorandum in time for introduction of the Bill. It will be made available to honourable members shortly. I mention at this point that, as might be expected, the Government will not be seeking passage of this Bill until the Budget sittings. Given the complexity of much of it, I think that there should be ample opportunity for interested people to examine it and comment on its technical features. These will, in any event, be subject to review by officials during the recess. The Government plans to bring still further income tax amendments before the Parliament early in the Budget sittings. It seems appropriate that honourable members and others who wish to study the present Bill during the recess should also have notice of other proposals that the Government will later be asking the Parliament to adopt. In addition to the measures I now proceed to outline, these later changes will include the legislation against avoidance through pre-paid interest, pre-paid rent and similar schemes that I spoke of in a statement on 19 April 1978.

Foreign Tax Credit System

The point has been made that recent tax measures by the Government are hasty improvisations and that the Government ought to be bringing forward remedial legislation of a more general kind. This is an option open to the Government and one that will, as evidenced by the significant changes I now outline, be exercised. These changes concern the income that Australian residents-people and companies- derive from sources in another country. Shortly stated, it is proposed to tax this income, subject to credit for the foreign tax that has been paid on it. When the Commonwealth income tax was introduced, it was on the basis that Australian residents were taxable only on income from within Australia. Over the years, there has been a movement to make foreign-source income of Australians taxable, but it remains the fundamental position that Australian residents are not taxed on significant categories of overseas income.

The position is in fact a hotchpotch. As a result of amendments made in 1941 and 1947, Australian resident individuals are taxed here on dividends from overseas, credit being allowed against the Australian tax for any foreign tax imposed on the dividends. But, because the rebate on inter-corporate dividends applies to dividends from overseas as well as to dividends from within Australia, foreign dividends received by Australian companies are tax-free in Australia, and this is so even if both the dividends and the profits out of which they are paid are not taxed in the overseas country of source. Another rule introduced in 1967 applies to interest and royalties from another country on which foreign tax is limited by a double taxation agreement. These are taxable in Australia, subject to credit for the foreign tax. The credit system of relief applies also to income, other than salaries and wages, from Papua New Guinea. All other foreign source income of Australian residents is exempt from Australian tax if it is subject to tax, no matter how negligible, in the country from which it is derived.

The Government considers that such outdated, and inconsistent rules cannot be retained. The fact that major elements of the foreign source income of Australians are not taxable in Australia seriously prejudices the equity of the tax system. Two Australians with the same total income can pay markedly different amounts of tax because one gets his income from Australia and the other from overseas. There may even be an incentive for the diversion of economic activity away from Australia to places where the level of tax is lower than it is in Australia. Most t significantly, the present rules lend themselves to tax avoidance through the diversion of income to low-tax or no-tax countries. The Asprey Committee has recommended that Australia introduce a credit system of taxing foreign source income of Australian residents, and this lines up with the practice of most major developed countries. Accordingly, with effect from the beginning of years of income or substituted accounting periods commencing on or after 1 July 1978 the basic rule will be that all foreign source income of Australian resident people and companies will be taxable in Australia. However, the Australian tax on that income will be reduced by credit for foreign tax according to rules that I shall later outline.

Many Australians travel and work overseas for relatively short periods. As often as not, the level of the foreign tax is about the same as the Australian tax, before credit, that would be payable on the income if it were taxed here. Whether or not that is so, the Government feels that it would impose unnecessary complexity and difficulty on ordinary salary and wage earners to require that their foreign salaries and wages be dealt with under the credit system. At the same time, it is necessary to guard against avoidance practices that would remain if the existing exemption for foreign source salaries and wages were to be fully retained. Accordingly, it is proposed that foreign source salaries and wages which are taxed in the country of source will continue to be exempted up to a maximum of $10,000 per annum, Amounts in excess of this will be subject to Australian tax, with credit being available for the foreign tax paid on the excess. The exempted amount will be taken into account for the purpose of determining the rate of tax applicable to the taxpayer's assessable income.

To return to the main features of the proposed credit system, a credit will be allowed for a tax imposed at one or another government level in the country in which the income is derived if the tax is one comparable with the Australian income tax. The foreign tax must have been paid and must, ordinarily, be a tax for which the taxpayer was personally liable. Credit will, however, be allowed for tax paid on a person's income by another person, such as an agent or trustee.

As is the case under credit systems generally, the credit for foreign tax paid in respect of a year will be limited to the Australian Tax on the foreign source income of the year and for this purpose the Government proposes to adopt the most generous of available methods by calculating the limitation on the basis of the aggregate foreign-source income of the taxpayer.

Dividends received from abroad by Australian companies deserve a special word. The basic rule will be that once such dividends are made effectively taxable by withdrawal from them of the rebate on inter-corporate dividends, a credit will be allowed for any foreign dividend withholding or other tax paid on them. In addition, a credit for the underlying company tax on the profits out of which the dividends are paid will, on what is known as a 'gross-up' basis, be allowed to Australian companies that have a more than portfolio investment in a foreign company. This credit will provide a direct recognition of the payment of any foreign company tax on those profits and will, at base, be allowed where the Australian company has a direct 10 per cent or greater shareholding in the foreign company.

The credit for 'underlying' tax will be extended beyond the underlying tax paid by the foreign company in which the Australian company has a direct 10 per cent or greater interest to include such tax paid by a foreign company one further stage removed, if the Australian company has, through the first tier company, at least a 10 per cent shareholding interest in the further company. To guard against avoidance, the relevant 10 per cent or greater shareholding must have been held for at least 12 months prior to the date of declaration of the dividend for a credit for underlying tax in respect of that dividend to be allowed.

There will, of course, be a number of more technical features of the credit system and, unfortunately, there will be both a need for further safeguards against avoidance as well as a degree of complexity in the legislation necessary to implement it. The Government does not shrink from that, having regard to the greater good that will come from the system's contribution towards tax equity and the reduction in avenues for avoidance. We are announcing our proposals at this stage so that taxpayers concerned will have an opportunity to plan for the pending introduction of the credit system.

Foreign Source Income of Trusts for Australians

I refer now to another structural change that has as its principal purpose the prevention of tax avoidance by the use of trusts through which to derive foreign-source income. As the law stands, Australian residents can defer, or even escape altogether, the payment of tax on foreign source income of trusts accumulated for their benefit. The present situation, which the Asprey Committee has described as 'unacceptable', results from a High Court decision some years ago to the effect that the trust provisions of the income tax law have application only to Australian-source income of trusts. Until recently, the decision had not given concern. However, because of the tax avoidance possibilities and the plain interest of tax advisers in avoidance through international activities, the Government has decided that corrective measures must now be taken.

The scheme of the amending legislation is to be very close to that recommended by the Asprey Committee. Under it, the existing trust provisions will be extended to the foreign source income of trusts that qualify as Australian resident trusts and also to the share of foreign source income of non-resident trusts to which an Australian resident beneficiary is presently entitled. The effect of the rules relating to resident trusts will be that, generally, the world income of such trusts, like the world income of resident individuals, will be liable to tax in Australia, either in the hands of the beneficiaries or the trustee. Income will be treated as taxable under the trust provisions to the beneficiaries or the trustee according to whether, under the trust deed or for other reasons, beneficiaries are presently entitled to the income. A resident trust is to be one of which at least one trustee is a resident, or which is managed and controlled in Australia.

Income flowing to a resident beneficiary from accumulated foreign source trust income not taxed in Australia while accumulating, for example, such income derived by a foreign trust, will be taxed in the hands of beneficiaries when received by them. Appropriate anti-avoidance rules will prevent beneficiaries escaping tax on a technicality that the amount or benefit is not received as income. In keeping with the basic principle of taxing non-residents only on Australian source income, a non-resident beneficiary presently entitled to foreign source income of a resident trust will not be taxed on it. In addition, provision will be made to refund the appropriate amount of Australian tax paid on accumulated foreign source income of a resident trust which is ultimately distributed to a beneficiary who is beneficially entitled to it and who, when the income was derived by the trust, was not a resident of Australia. Appropriate credit will be given under the new foreign tax credit system for foreign tax paid on foreign source income which is taxed in Australia to a trustee or beneficiary. As an aid to administration, a trust carrying on business in Australia or deriving income here from property and which does not have a resident trustee is to be required to have a public officer in Australia responsible for ensuring observance of the trust's taxation obligations, in the same way as a company.

I add that the partnership provisions of the income tax law are to be amended so as to remove any possible doubt arising from the court decision to which I have referred as to their application to partnership income from sources out of Australia. These amendments to the trust and partnership provisions of the income tax law will apply to the 1978-79 and subsequent years of income. I commend the present Bill and the Government's plans for future tax reform of a most important kind to the House.

Debate (on motion by Mr Willis) adjourned.

Debate resumed from 8 June, on motion by Mr Howard:

That the Bill be now read a second time.


Honourable members will recall that, in introducing this Bill on 8 June 1978, I said in my second reading speech that because of the complexity of much of the Bill, I considered that ample time should be given to interested parties to examine and comment on it. I said also that officials would be reviewing its technical features. These amendments arise from that process. Although there are in number 43 amendments to the Bill, they are closely inter-related and all are of a technical nature. Almost all of the amendments relate to the 'current year losses' provisions. Honourable members will recall that the current year losses provisions were introduced as a measure to counter the avoidance of tax by trafficking in current year company losses. The point of the measure, as of the provisions governing deductibility of prior year losses, is to prevent income earned by a company under the proprietorship of one set of shareholders being diminished for tax purposes by losses sustained under the proprietorship of a different group of people. The provisions employ and adapt the well-settled principles of the prior year loss provisions.

I draw particular attention to amendment No. 2. This relates to a company to which the proposed current year losses provisions apply and which is involved in a dividend stripping operation. As indicated in the special note on page 58 of the explanatory memorandum on the Bill, the provisions of the Bill are deficient in dealing with these cases. The trouble is that the Bill was intended, in 'current year loss' situations, to apply the same rules for setting deductions against dividends subject to rebate as apply in situations where the current year losses provisions are not applicable. It failed to do this. The amendment is directed to correcting this deficiency. If it went uncorrected there could be the paradoxical situation that legislation introduced to prevent tax avoidance through acquiring current year losses could aid and encourage avoidance through dividend stripping.

I mention also that amendments Nos 20 to 22 propose to replace references to the 'holding' of shares with references to the 'beneficial ownership' of shares. This amendment was foreshadowed in a statement I made on 28 July 1978 and will ensure that the 'continuity of ownership' tests in the current year losses provisions follow those already contained in the prior year losses provisions. Because of the subsequent introduction and passage of the Bills giving effect to Budget income tax measures, and introduction of the Income Tax Assessment Amendment Bill (No.3) 1978, it has been necessary to re-number this Bill as the Income Tax Assessment Amendment Bill (No.4) 1978.

These and all the other amendments are explained in a supplementary explanatory memorandum that is being circulated, and because of their technical nature I think that it is not necessary for me to speak at further length at this time. I commend the amendments to the Committee.