House of Representatives

Income Tax Assessment Bill 1938

Income Tax Assessment Act 1938

Explanatory Memorandum

(Circulated by the Treasurer, the Honourable R. G. Casey.)
A Bill for an Act to amend the Income Tax Assessment Act 1936-1937
Explanatory Memorandum showing the amendments proposed to be made to the Income Tax Assessment Act 1936-1937.

Ed. Note

The original document included both the explanatory notes and the text of the related legislation. In the electronic copy, only the explanatory notes and headings of the related legislation have been retained.

Notes on Clauses

Clause 2.-officers to observe secrecy.

Section 16 of the Principal Act is designed to ensure that officers will maintain secrecy regarding the affairs of taxpayers.

The section provides, however, that information may be communicated by the taxation authorities to the several other authorities stated in the section. It is proposed to include the National Insurance Commission amongst the authorities to which taxation information may be communicated.

The administration of the National Health and Pensions Insurance legislation will be assisted if permission is given for taxation information to be supplied to the Commission in the same manner as taxation information is made available to the Commissioner of Pensions when the occasion requires it.

The National Insurance Commissioners and their officers, in common with other authorities to whom taxation information may be communicated, are subject to the same obligation to maintain secrecy as are taxation officers.

Clause 3.-exemptions.

This exemption was first granted in 1923 in order to assist and encourage the development of the Northern Territory of Australia. The period of exemption, which has been extended from time to time, expired with the assessments for last year. The Government has decided to extend the exemption for a further ten years following upon its consideration of the Report of the Board of Inquiry appointed to inquire into the land and land industries of the Northern Territory.

Clause 4.-ex-Australian profits.

Where profits are derived partly in and partly out of Australia, the Commissioner has the power to determine what part is Australian profit.

The question whether the whole or any part of any profit is derived from sources in Australia is a question of fact which may be decided only upon a consideration of all the circumstances relating to the business operations of each taxpayer.

Under the present provisions of Section 42 a regulation may prescribe or the Commissioner may determine that part only of the relevant profit is derived from sources in Australia even although the facts of the case may be such that the whole of the profit has been derived from sources in Australia.

Under Section 42, if amended as proposed, a regulation may prescribe or a determination may be made by the Commissioner that the whole or any part of any profit has been derived from sources in Australia.

Clause 5.-dividends.

The object of Section 44 (2) (b) (i) is to exempt from income tax in the hands of the recipient shareholders those dividends paid by a company wholly and exclusively out of exempt net profits derived by the company from sources outside Australia.

There is a weakness in Section 44 (2) (b) (i), however, which enables companies to declare and pay dividends wholly and exclusively out of gross exempt income derived from sources outside Australia. For the purpose of so doing, the expenses of earning the gross exempt ex-Australian income are improperly charged against Australian assessable income. The following example illustrates the weakness in the provision.

Income and Expenses of company-

  Australia. Exempt ex-Australia. (Great Britain). Total.
Pd Pd Pd
Gross Income - 15,000 - 5,000 - 20,000
Expenditure - 12,000 - 4,000 - 16,000
  Net Profit - 3,000 - 1,000 - 4,000

For dividend purposes the company attributes Pd3,000 of its ex-Australian expenditure to Australian income (although the Pd3,000 does not relate in any way to the Australian income). The accounts would then be as follows :-

  Australia. Exempt ex-Australia. Total.
Pd Pd Pd
Gross Income - 15,000 - 5,000 - 20,000
Expenditure - 15,000 - 1,000 - 16,000
  Net Profit - - - 4,000 - 4,000

The company then declares a dividend of Pd4,000 wholly and exclusively out of exempt ex-Australian income and that dividend is exempt from income tax in the hands of the shareholders of the company.

So far as the assessment of the company itself is concerned, it would be taxed on Pd3,000 in Australia and Pd1,000 in Great Britain.

But by adopting the practice illustrated above, companies are securing for their shareholders exemption from income tax on dividends far in excess of that contemplated by Section 44 (2) (b) (i) of the Act.

The substitution for Section 44 (2) (b) (i) of the paragraph now proposed will have the effect of limiting the fund from which exempt dividends may be paid to the amount of exempt income derived from sources outside Australia less the losses and outgoings incurred in gaining or producing that exempt income.

Section 44 (2) (b) (iv) is being deleted as the provisions became inoperative as from 1st July, 1936.

The exemption from tax of income derived from the working of a mining property referred to in Section 44 (2) (c) is provided by Section 23 (o) which reads :-

23. The following income shall be exempt from income tax:-

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

(o) the income derived by a person from the working of a mining property in Australia or in the Territory of New Guinea principally for the purpose of obtaining gold, or gold and copper, provided that in this case the value of the output of gold is not less than forty per centum of the total value of the output of the mine;

A company deriving assessable income as well as the exempt income referred to in Section 44 (2) (c) may declare and pay dividends out of the gross exempt income after charging against the assessable income the expenses incurred in gaining or producing the exempt income.

The company would thereby obtain for its shareholders an exemption from income tax greater than the exemption intended to be given by Section 44 (2) (c).

The paragraph which it is proposed to substitute for Section 44 (2) (c) will remove the weakness in the present law.

The opportunity has been taken to give a clear expression in the paragraph to the exemption from income tax of dividends paid by a company wholly and exclusively out of exempt dividends which it has received from a company carrying on gold-mining operations. When the exemption of of gold-mining profits and of dividends was incorporated in the law in 1924 it was intended that the exemption should extend to dividends paid by a company out of dividends which it had received from a company which had earned the exempt profits. Doubt has been expressed, however, as to whether the enactment of 1924 and its re-expression in the 1936 Act had the effect of giving to a shareholder the full exemption that was intended. Any ambiguity in this section of the law is removed in the proposed new provision.

Exemption from income tax is conditioned on the dividends being paid wholly and exclusively out of exempt income. This requirement brings the exemption into alignment with the other dividend exemption provisions of the Act.

Clause 6.-deductions in case of composite incomes.

Following a recommendation by the Royal Commission on Taxation (1932-1934) Section 50 was inserted in the Act to simplify the method to be adopted in determining the classes of income from which deductions were to be allowed.

The section is defective, however, in this respect that a deduction may in part directly relate to one or more of these classes of income, but the deduction as a whole does not directly relate to any one class of income. There is in the law no power of apportionment so as to attribute to a particular class of income the part of the deduction which directly relates to that class.

A consequence of this construction of the law is that that part of a deduction which directly relates to a dividend income, or property income other than dividends, is attributed to personal exertion income, resulting in the payment of tax at the higher rate applicable to property income as compared with the rate on personal exertion income.

The following example illustrates the defect in the present law :-

A taxpayer's total income is Pd3,500, comprised of Pd1,000 salary, Pd2,000 interest from mortgages and Pd500 dividends on shares in a company.

From the total assessable amount of Pd3,500 there is deductible State income and special taxes aggregating Pd450, of which Pd150 directly relates to salary, Pd280 to interest and Pd20 to dividends.

If the porportions of the total amount of Pd450 were deducted from the respective classes of income to which they relate the taxpayer's assessment would be as follows :-

  Personal Exertion. Property.  
Interest. Dividend. Total.
Pd Pd Pd Pd
Assessable Income 1,000 2,000 500 3,500
Deductions 150 280 20 450
Taxable Income 850 1,720 480 3,050
Rate of Tax 20.546d. 43.718d. 43.718d. -
Pd s. d. Pd s. d. Pd s. d. Pd s. d.
Amount of Tax 72 15 4 313 6 3 87 8 9 473 10 4
Rebate of Tax on Dividends- Pd480 at 13.8d. in Pd 27 12 0
Net Amount of Tax - - - 445 18 4

The present law requires, however, that as the whole of the deduction of Pd450 does not relate directly to income from dividends, or to income from property other than dividends, it shall be deducted from income from personal exertion and the taxpayer is assessable as follows :--

  Personal Exertion. Property.  
Interest. Dividend. Total.
Pd Pd Pd Pd
Assessable Income 1,000 2,000 500 3,500
Deductions 450 - - 450
Taxable Income 550 2,000 500 3,050
Rate of Tax 20.546d. 43.718d. 43.718d. -
Pd s. d. Pd s. d. Pd s. d. Pd s. d.
Amount of Tax 47 1 8 364 6 4 91 11 7 502 19 7
Rebate of Tax on Dividends-Pd500 at 13.8d. in Pd - 28 15 0
Net Amount of Tax - - - 474 4 7

The proposed amendment will give to the section the full effect which was intended. It will provide that a part of a deduction which directly relates to a class of income shall be deducted from that class of income.

Clause 7.-expenditure pursuant to franchise.

This clause is designed to provide for the allowance of an annual deduction to an owner of a franchise to recoup to him expenditure which he is required by the franchise to incur on assets which in due course become the property of the authority granting the franchise, and in respect of which no compensation is payable.

In Queensland, franchises have been given to companies to construct a toll bridge and a toll highway. Under Queensland taxation law, provision is made for the allowance of an annual deduction to recoup expenditure made by the taxpayer before any profits or income derived from the venture is taxed.

In an ascertainment of the annual net income which is derived by an owner of a franchise, an annual allowance should be made in respect of the amount expended on the franchise undertaking so that at the expiration of the period of the franchise the amount of the expenditure will have been recouped to the taxpayer. There is, however, in the present law no provision whereby such a deduction may be allowed.

The deduction now proposed to be allowed is analogous to that provided for in the Act in respect of improvements made under covenant on leasehold property.

Clause 8.-gifts and contributions.

This is a drafting amendment to give clearer expression to the intention of the section.

The purpose of Section 78 (2) was to limit the deduction in respect of gifts of property (other than money) to property purchased by the taxpayer within twelve months preceding the making of the gift and to ensure that the deduction allowable would be no greater than the sum paid by the taxpayer for the gift.

It has been found in practice that the expression "gift in kind" in Section 78 (2) does not embrace all kinds of property other than money. The limitations provided at present by Section 78 (2) apply to donors of personal property but not to donors of real property.

The amendments which it is now proposed should be made to Section 78 will remove this anomaly from the provision.

Clause 9.-concessional deductions.

The object of the amendment to Section 79 (a) is to provide a deduction for a widow similar to that allowed to a widower.

The addition of sub-clause (e) (iii) to Section 79 will give a deduction to employees in respect of their contributions, both compulsory and voluntary, under the National Health and Pensions Insurance Scheme. Contributions by employees to the Queensland Unemployment Insurance Fund and similar funds will also be allowable deductions in the assessments of the employees.

The Queensland Unemployment Insurance Fund is a fund created by Act of Parliament of that State to provide for the insurance of unemployed workers and for other auxiliary purposes. Contributions to the fund are made compulsorily by both employers and employees.

So far as contributions by an employer to these funds are concerned, the present provisions of the law permit of the deduction of his contributions in respect of employees who are engaged in producing his assessable income. Deduction is not allowed (nor is it proposed to make such a deduction allowable) to an employer for his contributions to the scheme in respect of employees who are not engaged in producing his assessable income, e.g., private and domestic employees.

Clause 10.-definitions-leases.

Provision is made in the Principal Act for the inclusion in the assessable income of a taxpayer of any consideration received by him for or in connexion with the assignment by him of a lease. The law provides also for the allowance of an annual deduction to the purchaser in respect of the consideration which he has paid for the assignment of the lease to him.

From the income which is included in the assessment of a taxpayer who assigns a lease, there is deducted the purchase price of the lease (less the total of the annual deductions which have been allowed to him in respect of that purchase price). The net effect is that a taxpayer who assigns a lease is assessed on the profit which he makes or is allowed a deduction of the loss which he sustains on the purchase and sale of the lease.

In some cases, however, leases have been assigned together with other assets in consideration of a lump sum payment which is not allocated in the agreement of sale or in any other document to the several assets sold.

There is at present no provision in the law to authorize, in such cases, the allocation to the lease of portion of the total consideration for the assets assigned. Consequently, the profit which the vendor may have derived or the loss which he may have made on the purchase and sale of the lease cannot be taken into account in the ascertainment of his taxable income. In addition, the purchaser of the lease is deprived of the annual deduction in respect of so much of the total payment made by him as represents consideration for the assignment of the lease to him.

The proposed amendment will enable the Commissioner to allocate a fair and reasonable amount to a lease which has been sold together with other assets for a lump sum which has not been allocated to the various assets sold. The Commissioner's discretion will be subject to reference to the Board of Review if the taxpayer is dissatisfied with the Commissioner's determination.

Clause 11.-partner not in receipt or control of share.

One of the schemes devised by taxpayers to avoid or reduce the total amount of tax payable by them is the creation of fictitious partnerships.

The intention of Section 94 was that, in calculating the amount of tax payable by the partnership, the share of the partner who has not the real and effective control and disposal of his share of the net income of the partnership, should be added to the income of the partner who has (or divided amongst the partners who have) the real and effective control and disposal of that share.

It has been found in practice, however, that Section 94 has not the full effect that was intended.

Section 94 in its present form requires that the amount of tax payable by the partnership shall be calculated on the basis that the share of the partner, who has not the real and effective control and disposal of his share of the net income of the partnership, has been divided between and added to the assessable income of the other partners, even though some of those partners do not have the real and effective control and disposal of that share.

The proposed amendment will give the intended effect to Section 94 (1) by empowering the Commissioner to assess to the partnership the full amount of tax, by attributing the income in question to the partner or partners only who have the real and effective control of it.

Clause 12.-definitions-private companies.

The Principal Act contains special provisions that if a private company does not make a sufficient distribution of its income, it shall be liable to pay the additional tax which its shareholders would have had to pay if the amount of the insufficiency had been distributed to its shareholders.

The distributable income of a private company for the purpose of the provisions is the taxable income of the company less the taxes described in paragraph (a) above.

But the special provisions have been found to operate inequitably in the case of a private company which carries on business operations in and ex-Australia, and which derived a profit from its Australian operations but sustained a loss on its ex-Australian operations, the net result of the company's trading for the year being a loss.

As the Australian profit was wholly absorbed by the ex-Australian loss it was not possible for the company to make any distribution to its shareholders out of the Australian taxable income. Nevertheless, the private company was deemed under the special provisions to have made an insufficient distribution of its income of the year and was assessable accordingly to additional tax.

The proposed amendment will correct the inequitable operation of the private company provisions of the Act in cases such as that described.

Clause 13.-freights payable under certain agreements.

Under the present form of the law an overseas owner or charterer of a ship which takes passengers, cargo or mails from Australia to overseas ports, is assessable upon an assumed profit of 5 per cent. of the gross amount paid or payable in respect of the carriage of the passengers, cargo and mails.

The agreements specified in Section 7c of the Australian Industries Preservation Act 1906-1937, provide, inter alia, that in consideration of periodical sailings to be provided by the ship-owners and the carriage of goods of the shippers at agreed rates the shippers agree to ship exclusively by vessels owned by the ship-owners. The agreed rates are gross rates subject to rebates if the conditions of the agreements are fulfilled by the shippers.

The statutory taxable income of the ship-owner or charterer is calculated upon the basis of the net freight money retained by the owner or charterer out of the total amounts paid or payable in respect of the carriage of such cargo, after deducting from the gross amount the rebates allowed to the shippers of the cargo. An exception is in the case of contracts for the shipments of wool. The rebates in respect of wool are usually paid to the shipper, while the gross freights are usually paid by the consignee.

The proposed amendment will overcome the technicality in the law which prevents wool freights being accorded treatment similar to that given to freight money on other forms of cargo.

Clause 14.-reinsurance with non-resident.

Under the present provisions of the Commonwealth law an Australian insurer is assessable to income tax, as agent for each ex-Australian reinsurer, on the profit derived by the reinsurer from reinsurance premiums. The taxable income which is deemed to be derived by the reinsurer is 10 per cent. of the reinsurance premiums which he received, unless the actual profit or loss made by the reinsurer is established to the satisfaction of the Commissioner.

The ascertainment of the actual profit or loss made by the reinsurer on reinsurance business has been found to be of extreme complication, due, principally, to the necessity for an aggregation of all of the transactions of each reinsurer with all of those Australian insurers with whom reinsurance business is conducted.

The practical difficulties experienced by taxpayers and the Department in the application of these provisions may be obviated without loss of revenue, by excluding from the assessments of local insurers the reinsurance premiums paid to, and the recoveries received from, ex-Australian reinsurers. The full profit or loss arising from the risk insured will then be reflected in the assessment of the Australian insurer.

Clause 15.-penalty for unpaid tax.

The law places on a taxpayer a penalty calculated at 10 per cent. per annum on tax remaining unpaid after it has become due and payable.

Tax becomes due and payable sixty days after notice of assessment has been given to the taxpayer, but if that period is extended, the extended date becomes the date when the tax becomes due and payable. Any penalty for late payment is calculated as from the extended date.

Cases arise not infrequently where an amount of tax is not paid by the original due date and the Department is obliged to commence legal recovery action. The taxpayer often then applies for an extension of time to pay which is usually granted. But any such extension gives the taxpayer automatically a fresh due date for payment. In such cases the penalty which has accrued to the original due date lapses, though it is often considered just and proper that the penalty (or some part of it) should be charged for the default in payment and for the unnecessary trouble and expense the Department has been put to through the dilatory conduct of the taxpayer. The proposed amendment will authorize the imposition of the penalty which is appropriate to the circumstances of each case.

Clause 16.-persons leaving australia to obtain certificate.

The Principal Act requires that, before an authority to travel may be issued by the owner of a ship or aircraft to a person intending to leave Australia, that person must present a clearance certificate obtained from the Taxation Department.

It is considered undesirable that the departure from Australia of persons without means should be prevented. Frequently such prevention places an unnecessary charge upon the general community. It is proposed accordingly to extend the section to give the Commissioner power to issue clearance certificates in such cases.

It is also considered undesirable and unnecessary that the Taxation Department should disclose in any way the financial condition of a taxpayer by certifying that he is not liable to pay income tax, or that satisfactory arrangements for the payment of tax have been made, or that the tax is irrecoverable. It will suffice if the departmental certificate states that there is no objection for the purposes of the Act to the departure of the person from Australia.

Clause 17.-application of act.

This clause provides that the amendments proposed by this Bill, with the exception of Clause 14, shall apply to assessments beginning with the current financial year.

Clause 14, relating to reinsurances, will apply to assessments for the financial year 1936-37 and subsequent years.

The practical difficulties associated with Section 148 of the Principal Act are such that in may cases the Department has been unable to make assessments for the financial years 1936-37 and 1937-38. Hence the proposal for the retrospective operation of this clause which the insurance companies and the Commissioners generally desire.

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