The Senate

Income Tax Assessment Amendment Bill (No. 4) 1978

Income Tax Assessment Amendment Act (No. 4) 1978

Second Reading Speech

by the Minister for Education, Senator the Hon. J.L. Carrick

The Bill that I now bring before the Senate 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 Senators will recall that earlier this year the Government 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 the Government has subsequently further demonstrated, by the steps it has taken, 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 elections delivered on 21 November 1977, and the key points of the changes were outlined in a statement that the Minister for Home Affairs and the Treasurer 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 2 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 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 2 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 - 47 of its 72 pages - the present Bill is mainly devoted to amendments dealing with current year losses that were announced by the Treasurer on 7 April when introducing the Income Tax Assessment Amendment Bill 1978, and that are now expressed to be effective as from that date.

Honourable Senators will know from that 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 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. And, 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 Senators to what has been said on earlier occasions - in this instance in my Second Reading Speech on 11 May last and in a statement that the Treasurer 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 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. While 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 is now 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 ministerial statement 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 while 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 such a company. I mention that the tax is being levied in this form because it is impracticable to impose a tax on "remittances" of branch profits. I also observe that while the term "branch profits tax" is used as a matter of convenience, the tax is to apply whether or not there is a branch in Australia, but subject to the exclusions that I will mention in a moment.

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 non-resident companies, 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 while 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 4 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 6 months until May of the income year to effect the distribution because only the dividends paid in the prescribed period of 12 months commencing 2 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 enabled by the Bill to make a qualifying distribution to shareholders before the commencement of the prescribed period.

Mr President, that completes my remarks at this stage on the main features of the present Bill. All of its provisions are explained in a comprehensive explanatory memorandum and in a supplementary memorandum that has been prepared to explain a number of technical amendments proposed by the Government in the House of Representatives, and which were adopted by it.

The original memorandum, when read with the supplementary document, explains the Bill in the form now before the Senate.

I commend the Bill to Honourable Senators.