House of Representatives

Income Tax Laws Amendment Bill (No. 2) 1981

Income Tax Laws Amendment Act (No. 2) 1981

Second Reading Speech

by the Treasurer, the Hon. John Howard, M.P.

It is with some satisfaction that I place before the Parliament the results of much careful and difficult work carried out to establish appropriate provisions to deal in a general way with the sort of artificial schemes of tax avoidance with which of recent times we have become only too familiar.

In short, this Bill proposes new general anti-avoidance measures to replace Section 260 of the Income Tax Assessment Act.

As I shall explain in more detail later, the measures in the Bill are designed to operate against avoidance schemes of a blatant, artificial or contrived kind and to have an impact in respect of both domestic and international transactions.

In the international area, however, even more is needed by way of a general legislative response to problems of avoidance of Australian tax.

Later in this speech I will be setting out in some detail changes that the Government will be proposing to Section 136 of the Income Tax Assessment Act which is, of course, the provision dealing generally with avoidance in international business and transactions.

Honourable Members will be aware that for some time now the Government has been actively carrying through processes to design provisions to overcome the limitations on the scope of Section 260 that have been revealed by a series of court decisions.

In view of the special nature of this task, the processes have not been confined to the work carried out by officials, but have extended to taking advice from senior private counsel and from the Taxation Advisory Committee.

This external advice along with contributions from the Government Members' Taxation Committee have played a significant part in determining the final form of the Bill and I wish to place on record my appreciation, and the Government's appreciation, of the contributions that have been made.

And I think it is appropriate on this occasion to say that the Bill substantially accords with advice coming to the Governmet from both official and non-official sources.

Mr Speaker, it is the belief of the Government that there is a wide Community consensus that Australia must have an effective general anti-avoidance provision.

There is widespread abhorrence of blatant tax avoidance of the kind that we have recently experienced.

It distorts in a most unacceptable way the relative burdens of tax that are borne by different sectors of the community.

In pursuing the Government's firm resolve to counter this kind of activity we have, over the past 3 years or so, introduced a series of specific, yet complex, anti-avoidance measures.

That has been a necessary response in the circumstances, but unless something is done along general lines there is a very real danger that our income tax legislation will become so voluminous and so complicated as to be virtually incomprehensible.

I do not say that the measures in this Bill will provide a cure-all in respect of all future avoidance arrangements.

The problems inherent in expressing solutions in a general, but controlled, way may mean that there will be tax-avoidance arrangements contrived in the future that escape being struck down by the new measures.

As to that, let me say simply that the Government will, where necessary, follow up this measure with whatever further action may be appropriate in the circumstances.

What is it that general anti-avoidance provisions should aim to achieve? Few people have faced up squarely to that question.

This Government has faced up to it, and also to the probably even more difficult problem of finding the legal language in which to express the conclusions reached about desired policy objectives.

We are acutely aware that the term "tax avoidance" means different things to different people.

Reasonable men and women are bound to differ on this crucial question and on the subsidiary matter of the appropriate tests for determining what behaviour a general anti-avoidance provision ougto to proscribe.

The proposed provisions - embodied in a new Part IVA of the Income Tax Assessment Act - seek to give effect to a policy that such measures ought to strike down blatant, artificial or contrived arrangements, but not cast unnecessary inhibitions on normal commercial transactions by which taxpayer legitimately take advantage of opportunities available for the arrangement of their affairs.

For example, a husband and wife who choose to run a business as partners will need have no fear of having their arrangements affected by part IVA.

There will be no question, either, of the new provisions impeding a parent who wishes to pass to a spouse or to children the use and enjoyment of some income-producing assets.

Some writers on the subject suggest that tax avoidance involves conduct entered into for the sole or dominant purpose of obtaining a particular tax advantage.

That description could be expected to cover the types of tax avoidance that, again using the language of social or political debate, are blatant, artificial or contrived, and which are indeed intended to be covered by this Bill.

But it is also apt to describe other arrangements, including some family arrangements, which are beyond the appropriate scope of general anti-avoidance measures and ought, if need be, to be dealt with by specific measures.

In order to confine the scope of the proposed provisions to schemes of the "blatant" or "paper" variety, the measures in this Bill are expressed so as to render ineffective a scheme whereby a tax benefit is obtained and an objective examination, having regard to the scheme itself and to its surrounding circumstances and practical results, leads to the conclusion that the scheme was entered into for the sole or dominant purpose of obtaining a tax benefit.

Certainly, different approaches might have been taken.

The Government tried many of them in the course of developing this Bill.

One possibility considered was to adopt the language of the priy. council in the well-known decision in Newton's case, and, positive tests of inclusion having been expressed, make the new provisions inapplicable to schemes entered into in the course of "ordinary business or family dealing". It has been decided, however, that the better test of what is "blatant", "contrived" or "artificial" is the positive one that has been adopted.

That test seems best to capture the essence of the views expressed by the privy council which, in fact, characterized and "ordinary business or family dealing" as representing a situation other than one of which it can be predicated that it was implemented in the particular way so as to avoid tax.

I have already said that one of the conditions for the application of the new part IVA is to be that a taxpayer has obtained what the Bill terms a "tax benefit".

Such a benefit will have been obtained if, after all other provisions of the income tax law have been applied, an amount is not included in a taxpayer's assessable income that might reasonably be expected to have been included if the scheme had not been entered into.

The other form of tax benefit covered by the Bill concerns an amount that, again after all other provisions have been applied, is an allowable deduction to a taxpayer, but is one the whole or a part of which might reasonably be expected not to have been allowable if the scheme had not been entered into.

This approach - of specifying in the new provisions what constitutes a tax benefit and that the relevant purpose for application of the provisions is one of obtaining such a benefit - should help to eliminate some of the uncertainties associated with the use in Section 260 of less precise expressions.

That Section uses phrases that speak of "altering the incidence of any income tax" and "defeating, evading or avoiding any duty or liability imposed on any person by this Act".

These very wide, but uncertain, expressions appear to have ben at the root of the development by the courts of the so-called "choice principle", a rule of interpretation which, together with other established defects, has greatly limited the scope of Section 260.

There are two other significant limitations on the effectiveness of Section 260 which the new part can be expected to remove.

The present Section does not permit the purposes of the persons entering into an arrangement to be enquired into, except by reference to the effect of the arrangement itself.

Moreover, it does not provide a power or procedure, once an arrangement is struck down, to reconstruct a taxable situation.

As to these points, I have already mentioned that, under the provisions of this Bill, an enquiry must be made, on objective grounds, into the purpose of a person who entered into the arrangement.

The "reconstruction" problem is to be overcome by an express provision for the cancellation of a tax benefit obtained under a scheme to which the part applies.

Authority will be given to the Commissioner of Taxation to eliminate the benefit in an appropriate way.

In other words, the Commissioner will be specifically authorised to disallow the whole or an appropriate part of a deduction or to include in assessable income an omitted amount.

This method of eliminating the sought-after benefit, or part of it, is designed also to remove another uncertainty which surrounded the application of Section 260.

It was unclear whether an arrangement to which that Section applied had to be treated as wholly void or could be treated as only partly void as against the Commissioner.

I draw to the attention of honourable members that Part IVA contains a supplementary code applicable to schemes that are commonly called dividend stripping - and to similar schemes - under which shareholders in effect receive company profits in a tax-free form, in substitution for taxable dividends.

The reason for such specially-tailored provisions within the nwe general measures is to be found in particular features of such schemes when viewed in the context of the structure it has been necessary to give to the basic provisions of Part IVA.

It is this.

When profits have been accumulating in a company, possibly for extended periods, there will be no clear answer to the question whether those profits might reasonably be expected to have been distributed as dividends if the scheme had not been entered into.

As often as not, that expectation could not be established to exist.

Where this is so - and despite the fact that the company had been stripped of profits - the result under the basic provisions would be that there is technically no "tax benefit" obtained.

Dividend stripping cannot be allowed to escape the new provisions on a technicality of this kind.

In the simpler schemes of dividend stripping, assets of a company are generally converted into cash, the shareholders sell their shares for a capital sum and the purchaser arranges for the profits of the company to be stripped by way of a tax-free dividend or other payment from the company.

The purchaser is thus reimbursed for the price of the shares, while the former owners have effectively obtained the accumulated profits of the company in a tax-free form.

Other schemes of a dividend stripping kind involve the sale of shares in "current year profit" companies.

Both kinds of scheme are within the supplementary code.

The dividend stripping provisions will treat a shareholder who disposes of his or her shares in the context of one of these schemes as having obtained a tax benefit of the amount which he or she would have derived as a dividend if the profits stripped under the scheme had been paid as a dividend.

A tax benefit so obtained will be subject to the new general provisions for cancellation of tax benefits that I have described.

Where a tax benefit has been cancelled under Part IVA, the Commissioner of Taxation will be empowered to effect correspondig adjustments to reduce the tax liability of others affected by the arrangements, if it is fair and reasonable in the circumstances to do so.

Another key part of the legislation covers the imposition of statutory additional tax on taxpayers whose future schemes are struck down by Part IVA.

Bearing in mind that the Part is concerned with blatant, contrived and artificial schemes, the Government has concluded that taxpayers who, in the face of it, wish to persist with such schemes should be exposed to something more than only the tax they seek to avoid.

We have seen it as highly relevant that a taxpayer who omits assessable income from a return, or who claims deductions in excess of expenditure actually incurred, is liable to statutory additional tax of twice the tax avoided.

Accordingly, a taxpayer to whom the new Part applies will be liable by statute to pay an amount of additional tax equal to double the tax sought to be avoided.

As under the existing provisions, however, that amount will be subject to remission by the Commissioner of Taxation and his decision will similarly, on objection by the taxpayer, be open to review by one of the Independent Taxation Boards of Review.

I add the observation that, in the absence of these penalty provisions, taxpayers would have the "odds to nothing" in participating in future avoidance schemes and in risking the application of Part IVA.

The provisions of Part IVA as a whole will operate with paramount force in the income tax law, but only in relation to schemes entered into after today.

However, in line with settled policy in relation to anti-avoidance legislation, carry-forward losses resulting from schemes that have already been entered into will not be available for deduction against income of the 1980-81 or any later year.

In harmony with the rules for application of Part IVA, Section 260 is being made inapplicable to arrangements entered into after today.

There are, of course, other things of note about the Bill but thee are covered by the comprehensive explanatory memorandum available to Honourable Members and I think it is not necessary for me to speak about them at this stage.

I do, however, want to touch on just one point.

This is that the Bill indicates specifically that a tax benefit cannot arise in respect of the deduction available for deposits made under the Income Equalization Deposits Scheme, and that the mere making of an election or the giving of a notice specifically provided for in the Act will not be affected by Part IVA.

I note these things as a prelude to my response to concern that I can foresee being expressed in some quarters that taxpayers who simply take advantage of certain incentives in the law will find themselves at risk under Part IVA.

Other critics of the Bill will, no doubt, say that arrangements that survive the application of specific anti-avoidance provisions inserted to support particular provisions are in double jeopardy in then having to face and survive the paramount general provisions.

I make no apology for the approach adopted in the Bill.

But I do assert that taxpayers who simply take advantage of concessions for the purposes for which they were put in the law cannot and will not be affected by the new provisions.

Specifically, for example, Part IVA will not deny to people who simply respond to our concessions for investment in Australian films the benefit of the tax advantages that are part of those concessions.

But I think it incontrovertible that blatant misuse of those and other "incentive" concessions ought to be within the scope of Part IVA.

A general anti-avoidance provision would be of little worth if it could not be used to prevent the unintended exploitation of such concessions in the law, or to operate as a back-up to a specific anti-avoidance provision in circumstances where a taxpayer has tailored arrangements so that the provision is circumvented in form, but not in substance.

Finally, before turning to the subject of Section 136 I mention that it is the Government's wish that this important Bill be debated and passed by both Houses of the Parliament before the end of the current sittings.

I have indicated on a number of occasions in this House that proper time will be given, after exposure of the legislation, for comment by interested persons.

If it is to be dealt with before the winter recess, the time available for public comment is short, and shorter than I would have liked.

However, the alternative to debating the Bill immediately would be to defer its passage for some months and in all the circumstances that is an alternative which the Government believes is not an appropriate one.

We will of course welcome, and give careful attention to, constructive comments that persons and organisations care to put to us.

Shifting Income Abroad

Mr Speaker, I would like now to spell out what is involved in the Government's decision to introduce in the next sittings of the Parliament further anti-avoidance measures complementary to those I have just explained and which will deal with what might be described as the transfer pricing problem.

The further measures will apply in relation to income derived and expenses incurred after today.

I have previously informed the House that the existing section 136 - which was designed decades ago to deal with tax avoidance arrangements under which profits that should be taxed in Australia would be shifted out tax-free - was being reviewed because it was proving inadequate to meet modern conditions.

That point has been driven home by the decision of the High Court in the Commonwealth Aluminium Corporation case.

I have also said that decisions about section 136 would be made once the related redrafting of section 260 was completed.

Honourable Members who have been following my remarks today will appreciate that blatant tax avoidance arrangements, including those involving international transactions, will in future eb subject to Part IVA.

But there remains a significant area involving international tax avoidance which cannot feasibly be countered by the provisions of that part.

International tax avoidance involves transactions carried out wholly or partly overseas, where Australian taxation authorities lack powers to obtain information by which the purpose and effect of the transactions can be judged.

And there is also the point that, damaging as they are to the Australian revenue, international transfer pricing arrangements may be entered into for a complex mixture of tax and other reasons.

The fact, if it is one, that tax saving is not a key purpose of an arrangement or transaction is, however, no reason why we as a nation should not be in a position to counteract any potential losses of Australian tax inherent in it.

Other major countries have in recent times acted against the growing use of international arrangements that have a tax avoidance purpose or effect, especially those involving "transfer pricing".

Methods adopted by tax authorities to re-allocate profits on a more appropriate basis than pricing arrangements throw up are usually based on the internationally accepted "arm's length" principle, and this will form the foundation of our proposed new measures.

It is proposed that assessable income and allowable deductions will be calculated by reference to the price or amount which might have been expected to have been received or paid in any transaction affecting assessable income or allowable deductions, if that transaction had been one between parties who were not only completely independent of each other, but were also dealing with each other in an arm's length way.

This principle is in fact embodied in relevant provisions in all of Australia's double taxation agreements, and the existing section 136 has in practice been applied in broad reliance upon it.

However, as has been well publicised, one serious deficiency in tet existing section 136 was exposed by the High Court in the Commonwealth Aluminium Corporation case.

The proposed amendments to section 136 aim to remedy this defect.

Essentially, the new provisions will be applicable to transactions in respect of which the Commissioner of Taxation, having regard to any connection between the parties and to other relevant circumstances, is satisfied that any parties to the transaction were not dealing at arm's length with each other.

The provisions will thus be capable of application not only where the parties are associated in terms of ownership or control, but also where they in fact do not, in a transaction extending to this country, deal in an arm's length way with each other.

The new provisions will also be directed at overcoming other difficulties in the transfer pricing area.

For example, there may well be no basis available to the Commissioner on which to arrive at an "arm's length" price or amount.

This could arise in a monopoly situation, particularly in a vertically integrated industry, where there simply are no arm's length dealings with outside parties which would provide an arm's length benchmark.

Every one of Australia's double taxation agreements addresses this difficulty, which can also arise because of lack of sufficient information.

Regrettably, adequate and reliable information may not always be supplied or be available to Australian authorities.

Accordingly, it is proposed to include in the new section a supplement to the arm's length principle.

Where, for the reasons mentioned, it is not practicable for the Commissioner to apply the "arm's length" principle, he will be empowered to assess tax on a taxable income of such amount as he determines to be appropriate in the circumstances.

Wide though such a power may appear to be, it is clear from Court and Taxation Board of Review decisions under the existing section 136 - which already contains such a power - that those tribunas would expect the Commissioner, as far as practicable in the circumstances, to work to a broad "arm's length" yardstick.

Boards of Review will have full power to review the Commissioner's decisions and to substitute their own opinion if they consider him to be wrong.

It is to be noted that the existing section 136 limits adjustments under it to the amount of the company's total receipts.

The new provision will not be confined in this way.

Although international tax avoidance commonly takes the form of manipulation of trading stock prices, any item of income or deduction is potentially open to abuse.

The new measures will therefore apply in relation to all of these items.

Thus, both business and non-business transactions, rent, royalties, interest and other income not clearly business proceeds will be within the purview of the re-vamped section 136.

Moreover, the new measures will permit the imputation of income where necessary to counteract avoidance, for example, in the case of an interest free loan by an Australian resident to an associate in a tax haven.

The measures may be applied to both residents and non-residents who are parties to an international transaction or series of transactions but they will not apply to any transaction solely within Australia between Australian residents.

Individuals, trustees and other entities as well as companies will be within the scope of the new provisions.

As is the case under the new Part IVA, the new section 136 will allow appropriate corresponding adjustments to be made by the Commissioner, in favour of the taxpayer or others affected by a profit shifting arrangement to which section 136 applies.

Effective measures to recast taxable income along the lines I have mentioned are a basic necessity.

But a deterrent is also needed.

In speaking about the new Part IVA I have indicated that a substantial statutory additional tax will, subject to the usual powers of remission, apply where an avoidance of tax is struke down under it.

For corresponding reasons, the Government believes that additional tax should be imposed by statute on taxpayers whose international profit shifting arrangements are negated by the new section 136.

However, the fact that Part IVA is to operate in relation to blatant schemes of avoidance, while the situations that fall within section 136 will not necessarily be as reprehensible, has led us to the conclusion that a differently-structured penalty tax should apply for section 136.

Our view is that a taxpayer whose international profit shifting arrangement is struck at under section 136 should, whether or not a relevant double taxation agreement also authorises recasting of the taxable income, be statutorily obliged to pay additional tax at the rate of 10 per cent per annum.

That additional tax could, of course, in appropriate cases be remitted in whole or in part by the Commissioner of Taxation.

At a more technical level, the proposed law will be structured to make it clear that, if application of the new measures results in an increase in tax paid under a previously issued assessment, credit is to be allowed against the increased tax for the tax paid by the taxpayer under the earlier assessment.

The new structure will also remove any doubt that prior year losses may appropriately be taken into account.

The amendments to section 136 are to apply to expenditure incurred, and to income derived or that might have been expected to have been derived, after today.

In this particular area, the Government considers that this purely prospective application of the new measures ought not to be modified so as to leave outside their scope arrangements entered into in the past.

There are transfer pricing arrangements between associated companies entered into in the past that still have many years to run.

It would be patently absurd if the future effects of these on taxable income were to be outside the scope of the new provision.f

Mr Speaker, the measures I have spoken about today are, by any test, significant ones.

Leaving aside those with an axe to grind, some people may be concerned about the breadth of the measures.

We will probably hear a lot about their "uncertainty".

To that I say that any problems of that kind are an inevitable outcome of the approach of tackling a widespread and intricate problem by provisions of a general kind.

I believe that the measures represent a sober, and appropriately restrained, response to a difficult problem and will be welcomed by all responsible members of the community.

I warmly commend the Bill to the House.