Senate

Explanatory Memorandum

(Circulated by the Minister representing the Treasurer, Senator the Hon. Sir Kenneth Anderson, K.B.E.)

INCOME TAX ASSESSMENT BILL (NO. 3) 1972

Main Features

The proposals in this Bill are outlined below.

Rebate of tax on inter-company dividends (Clauses 3, 4, 9, 10, 11 and 12)

The deductions allowable to a company in receipt of dividends and other income are, to an appropriate extent, to be offset against dividends in calculating its rebate entitlement in cases where non-dividend income has been "manufactured" by the exercise of options governing the valuation of trading stock or where dividends have been received in a dividend-stripping operation.

Public company subsidiaries (Clauses 5, 6, 8 and 12)

A private company may either make a sufficient distribution of its income to shareholders, within a prescribed period, or pay additional tax on the amount by which it fails to make a sufficient distribution. A public company is not subject to these requirements. Under the proposals in the Bill, a company which would be unable to qualify as a public company in its own right (and thereby avoid the requirement to make a sufficient distribution of its income) will not acquire public status as a subsidiary of a public company if arrangements have been made which ensure that the private company interests still retain, or can acquire, effective ownership or control of it, or if it is managed and controlled, to an inappropriate degree, in the interests of persons or companies other than public companies.

Certain dividends paid by private companies (Clause 7)

Where dividends are paid by a private company to another company in exchange for a premium paid on shares in the private company, the dividends are to be disregarded in determining whether the private company has made a sufficient distribution of its income to shareholders in ascertaining the liability for additional tax on undistributed income.

The various clauses of the Bill are explained in the notes that follow.

Notes on Clauses

Clause 1: Short title and citation.

This clause formally provides for the short title and citation of the amending Act and of the Principal Act as amended.

Clause 2: Commencement.

Section 5(1A.) of the Acts Interpretation Act 1901-1966 provides that every Act shall come into operation on the twenty-eighth day after the day on which the Act receives the Royal Assent unless the contrary intention appears in the Act.

Clause 2 proposes that the amending Act shall come into operation on the day on which it receives the Royal Assent.

Clause 3: Rebate on dividends.

Clause 4: Rebate on dividends paid as part of dividend-stripping operation.

Introductory Note.

A resident company is entitled to a rebate of tax on dividends ascertained by applying its average rate of tax to the part of the dividends included in its taxable income. In the case of dividends received by one private company from another, the recipient company is entitled as of right only to one-half of the normal rebate but the Commissioner is empowered to allow a further rebate (effectively allowing the rebate in full) in appropriate circumstances.

In calculating the part of any dividends included in a company's taxable income for rebate purposes, deductions can, in practice, be taken into account only if they are directly related to dividend income.

This situation may provide a company whose total dividends exceed its taxable income with an opportunity to increase its taxable income, by adjustment of the valuation of its trading stock on hand at the end of a year of income, without attracting tax at general rates on the whole of the increase in its income. To the extent that income "manufactured" in this way is not subject to tax, the company can expect to avoid tax on a corresponding amount of income derived when the revalued stock is eventually sold.

The limited range of deductions which are able to be applied against dividend income in calculating the rebate of tax also provides a means by which tax can be avoided on non-dividend income by a company engaging in dividend-stripping arrangements with another company.

In its simplest form, a dividend-stripping operation involves the purchase by a share-trading company of shares in another company which has accumulated profits. A payment of a dividend is then made to the share-trading company which, in effect, wholly or substantially recoups its outlay on purchase of the shares that are then resold for a reduced price or are retained at a reduced value for income tax purposes.

Although, in a commercial sense, the share-trading company may make an overall profit on the transaction, no part of the deduction allowable for the cost price of the shares can be set off against dividend income to determine the part of the dividends included in taxable income on which the rebate is allowable. The result is that, while the dividends are effectively freed from tax by the rebate, the deduction allowed for the cost of acquiring the shares is applied against non-dividend income which thereby escapes full tax.

Broadly, the amendments now proposed are designed to withdraw the unintended benefits that can be obtained from the rebate on inter-company dividends by means of either of the arrangements described above.

Clause 3:

This clause proposes amendments to section 46 of the Principal Act, the provision which authorises rebates of tax on inter-company dividends. Some of these amendments are associated with a separate proposal (clause 4) to incorporate in the Principal Act a new provision, section 46A, to deal exclusively with rebates on dividends arising from dividend-stripping operations. The determination of rebates on all other dividends received by resident companies will continue to be governed by section 46.

Paragraph (a) of clause 3 will insert in section 46 a new sub-section, sub-section (1A.), which will ensure that a dividend subject to rebate under proposed section 46A will not also attract a rebate under section 46.

Paragraphs (b) and (c) of clause 3 will insert the words "of the year of income" in four appropriate places in existing sub-section (7.) of the section. These proposed additions are drafting refinements which do not affect the present operation of the provision which specifies the way in which the part of any dividends included in the taxable income of a company is to be ascertained for rebate purposes.

Paragraph (d) of clause 3 will insert a new sub-section, sub-section(7A.),to prevent misuse of the rebate by the manufacture of income through the options available under the trading stock provisions of the Principal Act.

Broadly stated, section 28 of the Act provides for any variation between the opening and closing values of a taxpayer's trading stock to be brought to account in arriving at the taxable income for the year concerned. Sub-section (1.) of section 31 allows the taxpayer to choose, in relation to each article of trading stock (other than livestock), whether the value at which it is taken into account at the end of the year is its cost price, market selling value or the price at which it can be replaced.

The proposed sub-section (7A.) will come into operation where a company has exercised an option available to it under section 31(1.) so that an article of trading stock is taken into account at the end of a year of income at a higher value than would otherwise have applied and it is evident that the option was exercised in that way for the purpose of increasing the company's entitlement to a rebate under section 46. In these circumstances, the sub-section will limit the rebate to the amount that would have been allowable if the option had been exercised so as to place the lowest of the available values on the article of trading stock.

Sub-section (7A.) will apply in the determination of rebates in assessments for the 1971-72 year of income and for subsequent years (Clause 12).

Paragraph (e) of clause 3 will amend sub-section (8.) of section 46 (which provides that a shareholder is not entitled to a rebate on dividends received from a co-operative company) to specify that the rebate to which the sub-section refers is a rebate under section 46. It is a drafting measure consequential upon the proposed incorporation of section 46A into the Assessment Act.

Clause 4:

This clause will insert in the Principal Act a new section, section 46A, to govern the determination of rebates on dividends arising out of dividend-stripping operations, the general nature of which has been explained above. The proposed section follows the general lines of section 46 but contains some variations specifically directed against dividend-stripping situations.

Sub-section (1.) of section 46A marks out the area of application of the section. It is to apply to a dividend paid after 31 August 1971 (the day on which it was announced that the Government intended to introduce amending measures) where the payment of the dividend arose from the carrying out of an operation that the Commissioner is satisfied was by way of dividend-stripping. The determination of rebates on dividends not arising from dividend-stripping will continue to be governed by section 46.

Sub-section (2.) ensures that an operation cannot be treated as dividend stripping unless the shareholder company which is entitled to a rebate on the relevant dividend is also actually or effectively entitled to a deduction for the cost of acquiring its shares in the dividend-paying company. The two entitlements are, of course, a major incentive for a company performing a dividend strip.

Sub-section (3.) states matters which, in a case otherwise potentially within the scope of the section, the Commissioner is required to consider when forming an opinion as to whether a dividend arises out of an operation that constitutes dividend stripping. In broad terms, these matters are -

(a)

whether, in effect, the receipt of dividends on the shares amounts to a recoupment of the price paid for the shares;

(b)

whether the value of the shares is substantially reduced after acquisition by the shareholder and, if so, whether the reduction is wholly or mainly attributable to dividends received;

(c)

whether there are special conditions associated with the shareholder's dividend rights which virtually fix the amount that he is to receive as dividends; and

(d)

any other relevant matters.

The sub-section thus directs the Commissioner to consider features common to dividend stripping as the term is ordinarily understood. These features do not exist in normal commercial transactions, e.g., in the purchase in the ordinary way of shares cum div. and the subsequent sale of those shares.

Sub-section (4.) explains the meaning of the expression "private company dividends" as used in the section and is in similar terms to sub-section (1.) of section 46.

Sub-section (5.) authorises, subject to other provisions of the section, the allowance of rebates to resident companies in receipt of a dividend to which the section applies. Broadly stated, it provides for the rebates to be determined by applying the average rate of tax payable by the shareholder to the net income derived from dividends by the shareholder unless the shareholder is a private company in receipt of private company dividends. In this event the average rate of tax is to be applied only to one-half of the net income derived from private company dividends and to the net income derived from other dividends. The provision corresponds with sub-section (2.) of section 46 except that different expressions have been used to identify the amounts to which the average rates of tax are to be applied.

Sub-section (6.) authorises the Commissioner to allow a resident private company a further rebate determined by applying the average rate of tax to one-half of the net income derived from private company dividends (effectively thus allowing a full rebate) where he is satisfied as to certain matters. The sub-section substantially corresponds with sub-section (3.) of section 46.

Sub-section (7.) authorises the withdrawal, in circumstances such as where later-established facts do not support understandings accepted at the time an assessment had been made, of a further rebate that has been allowed to a private company pursuant to the preceding sub-section. This provision is a repetition of sub-section (4.) of section 46.

Sub-section (8.) prescribes, for the purposes of the calculations required by sub-sections (5.) and (6.), the method of determining the average rate of tax payable by the shareholder. This provision corresponds with sub-section (6.) of section 46.

Sub-section (9.) prescribes, again for the purposes of the calculations required by sub-sections (5.) and (6.), the method of determining "the net income derived from dividends by a shareholder" and "the net income derived from private company dividends by a shareholder". The sub-section provides for the setting off against dividends (those arising from dividend-stripping operations) included in the assessable income of the shareholder, the deductions allowable to the shareholder under the Act in respect of those dividends, in order to arrive at the net income derived from dividends by the shareholder. To the extent that any of those deductions may be attributed to private company dividends (those arising from dividend-stripping operations) included in the assessable income of the shareholder, they are to be set off against those dividends in order to arrive at the net income derived from private company dividends by the shareholder. This provision is the counterpart of sub-section (7.) of section 46 which uses different expressions but performs the same function.

Sub-section (10.) spells out the deductions, or parts of deductions, that are to be regarded for the purposes of the preceding sub-section as being deductions allowed or allowable to the shareholding company in respect of the dividends included in its assessable income. These are the deductions, or parts of deductions, that may be set off against the dividends to arrive at the amount, if any, subject to rebate under section 46A.

The sub-section, in effect, authorises the setting-off of deductions which relate exclusively to the relevant dividends and of so much of any other deductions as the Commissioner is satisfied it is reasonable to attribute to those dividends. The usual provisions will apply under which there will be a right of appeal to a Taxation Board of Review where a company is dissatisfied with the Commissioner's exercise of the discretion under this sub-section. With the support of other provisions, the sub-section is designed to ensure that, in particular, deductions relating to the purchase of the shares acquired for dividend-stripping purposes may be set off, in whole or in part, against the dividends in determining the level of rebate allowable.

The deductions to which the Commissioner may give his consideration are not limited to those allowable for the particular year during which the relevant dividends are derived or to those which have specific relationships with those dividends. Deductions allowable for other years, and those which have a common relevance to dividends and other income, or are not specifically related to any particular income or class of income, will also qualify for consideration.

Sub-section (10.) has no counterpart in section 46.

Sub-sections (11.) and (12.) are designed to bring within the operation of section 46A a dividend received by a company from a dividend-stripping operation where the shares on which the dividend has been paid are not treated as trading stock of the company concerned.

A company engaged in a business of share dealing would generally be entitled to a deduction for the purchase price of shares in the year during which they were acquired. If the acquisition was associated with dividend-stripping, it would be that deduction which the Commissioner would take into consideration in applying sub-section (10.).

On the other hand, a company not engaged in a business of share dealing would not generally be entitled to a deduction for the purchase price of the shares acquired by it. If the shares were purchased and subsequently sold as part of a profit making scheme, the purchase price would be taken into account in arriving at the profit or loss to be included as assessable income or allowed as a deduction, as the case may be. There are other circumstances where only the net results of a company's share transactions are taken into assessable income or allowed as deductions.

Sub-sections (11.) and (12.) provide that, where cases fall within the latter category, expenditure incurred in acquiring the shares, and other expenditure taken into account in ascertaining the amount of the overall profit or the loss on the transactions, shall be deemed to be an allowable deduction. As a consequence, the Commissioner will be able to take the cost of acquiring shares into consideration in these cases, just as he would be able to do when determining the rebate entitlements of share dealing companies, if the shares were acquired in the course of a dividend-stripping operation.

Sub-section (13.) is designed to remove any restrictive effect that section 50 of the Assessment Act might otherwise have on the operation of section 46A. Section 50 prescribes the order in which deductions are to be made from various classes of income and has operated to limit the types and amounts of deductions available for set-off against dividends in determining rebate entitlements. Sub-section (13.) will ensure that the determination of the levels of rebates to be allowed under section 46A in dividend-stripping situations will not be affected by the terms of section 50.

Sub-section (14.) will make clear the power of the Commissioner to amend assessments for certain purposes associated with the operation of section 46A. Paragraph (a), which is the counterpart of sub-section (5.) of section 46, authorises an amendment of an assessment, within three years after the date on which the tax became due and payable under the assessment, to allow a further rebate to a private company if it appears that the rebate should have been allowed. Within the same time limit, an assessment may also be amended to disallow a rebate that had been allowed if it is later found that the further rebate should not have been allowed in the assessment concerned. Paragraph (b) authorises an amendment of an assessment at any time to adjust a rebate by reference to deductions allowable in a subsequent year that are attributable to the dividends on which the rebate had been originally allowed.

Sub-section (15.) provides that dividends received from a company that is a co-operative company within the meaning of Division 9 of Part III. of the Assessment Act are ineligible for rebate. Such companies are entitled to deductions in respect of dividends distributed to their shareholders and thus enjoy freedom from tax on equivalent amounts of their assessable incomes. The provision is the counterpart of sub-section (8.) of section 46.

By sub-section (16.), the operation of section 46A is made subject to the provisions of section 116A of the Principal Act. In its present form section 116A places an upper limit on the rebates allowable under section 46 on dividends received by life assurance companies that do not satisfy certain tests. By clause 9 of this Bill it is proposed to amend section 116A so that rebates allowable under section 46A will also be subject to the limitation. Sub-section (16.) is the counterpart of sub-section (9.) of section 46.

Clause 5: Interpretation.

Clause 6: Private companies.

Introductory Note.

The income tax law draws distinctions between public companies - very broadly, those in which there is substantial public interest - and private companies. For income tax purposes, section 103A of the Principal Act describes in detail a public company and defines a private company as one which is not a public company.

A public company bears tax on its income at rates higher than those applying to private companies but is not required to distribute any part of its profits to shareholders. A private company, on the other hand, is liable for additional tax, at a rate of 50 per cent, if it fails to distribute an appropriate proportion of its profits within a prescribed period.

The requirement that private company profits be distributed to individual shareholders (in whose hands they would be taxed at the progressive personal rates) can be avoided by the payment of dividends to a public company, since the rebate of tax on inter-company dividends would effectively free the recipient company of tax on the profits distributed to it in the form of dividends.

For income tax purposes, a public company includes a public company subsidiary as defined by section 103A of the Principal Act. The definition can, however, be exploited by the payment of dividends by a private company to another company which, although qualifying as a public company subsidiary under the tests laid down in the present law, is, for all practical purposes, owned or controlled by the individuals who own the private company.

The main purpose underlying the amendments to the Principal Act proposed by clauses 5 and 6 of the Bill is to strengthen the conditions under which a company will be accepted as a subsidiary of a public company.

Under the present law, a company is a subsidiary of a public company in relation to a particular year of income if, at the end of that year, one or more companies that are public companies for income tax purposes (but which are not non-profit companies) beneficially own more than one-half of the paid-up capital of the subsidiary and have rights to more than one-half of the voting power, dividends and distributions of capital.

A "parent" public company for this purpose may be either a company listed on a stock exchange or a co-operative company, provided it satisfies what may be called the 75/20 test, that is, the test that more than 75 per cent of the paid-up capital and of voting and dividend rights in the company are in the hands of more than 20 persons at all times during the income year. Safeguarding provisions are included to meet the possibility that arrangements are in existence whereby the rights of the shareholders in a listed company or a co-operative company may be varied either during or after the year of income with the result that the 75/20 test would no longer be satisfied.

Other classes of parent companies may also pass on subsidiary status. These are public companies for income tax purposes which are not required to satisfy either the stock exchange listing test or the 75/20 test -

(a)

a mutual life assurance company;

(b)

a friendly society dispensary;

(c)

a body (other than a company) constituted by a law of the Commonwealth and established for public purposes;

(d)

a company in which a Government or a body established for public purposes has a controlling interest; and, most significantly,

(e)

a subsidiary of a public company.

The Commissioner is empowered, where he considers it reasonable, to treat as a public company any company which for one reason or another may fail to satisfy the prescribed requirements of public status.

Under the more stringent tests now proposed, a company will be a public company subsidiary if at all times during the year of income -

(a)

one or more public companies (but not including a non-profit company, a public company subsidiary that is less than wholly-owned by public companies or a wholly-owned subsidiary that balances on a date different from its public company parent) beneficially own all of the shares in the subsidiary and have indefeasible rights to the whole of voting power, dividends and capital distributions; or

(b)

one or more listed companies (i.e., a company listed on a stock exchange that also satisfies the 75/20 tests relating to paid-up capital, dividends and voting power), directly or indirectly, own more than one-half of the shares and have indefeasible rights to control the voting power and to receive, directly or indirectly, more than one-half of the subsidiary company's dividends and capital distributions.

As a necessary safeguard against potential tax avoidance through well-concealed arrangements or understandings, a company is to be denied public subsidiary status where the Commissioner, having regard to specified criteria and despite an apparent compliance with the shareholder's rights' test, is of the opinion that the "subsidiary" is being managed or conducted in the interests of persons other than the public company parent and at the expense of that parent's 100 per cent or other majority interest in the subsidiary, as the case may be. An opinion formed by the Commissioner will, as is usual, be subject to review by a Taxation Board of Review.

The existing discretionary power of the Commissioner will be available to treat as a public company any public company subsidiary that may fail to meet the new tests of public company subsidiary status but should nevertheless reasonably be treated as having that status.

Clause 5:

Paragraph (a) of clause 5 inserts in section 103 of the Principal Act a definition of "the relevant holding company or holding companies" to facilitate reference to the particular classes of public company that may confer the status of a public company subsidiary on another company which is either wholly-owned with the parent and subsidiary companies having identical accounting periods (proposed sub-section (4.)) or, in other cases, in which there is ownership of shares carrying rights to more than one-half of the voting power, dividends and capital (proposed sub-section (4B.)). The respective parent companies are defined as those described in sub-sections (4.) and (4B.) of section 103A.

Paragraph (b) of clause 5 is complementary to the amendments in clauses 7 and 8(a) of the Bill. These relate to dividend and share-premium exchanges and are explained in pages 16 to 18 of this memorandum. The effect of paragraph (b) will be to exclude such a dividend from the dividends which are deducted from a private company's "distributable income" to ascertain whether there is an "undistributed amount" on which the private company would be liable to pay undistributed income tax.

Paragraph (b) will apply in relation to dividends paid after 9 December 1971, the date of introduction of the amending Bill.

Paragraph (c) of clause 5 inserts sub-sections (4.), (5.) and (6.) in section 103 of the Principal Act. These provisions define certain terms used in the proposed tests of a public company subsidiary.

Sub-section (4.) of section 103 defines the "listed company" which may confer public company subsidiary status under the new section 103A(4B.) on a company in which there is less than total ownership by a public company or companies or which, being wholly-owned, balances on a date different from its public company parent.

The listed company for this purpose will be a company that is a public company by virtue of the present section 103A(2.)(a), i.e., a company that is listed on a stock exchange on the last day of its year of income and which also satisfies the 75/20 test under section 103A(3.) of the Principal Act.

The new public company subsidiary tests are to be met at all times during the year of income. Sub-section (4.) of section 103 also ensures that, although the public company parent under the proposed section 103A(4B.) test is required to be listed on a stock exchange only on the last day of its income year, it can be treated for purposes of the test under the proposed section 103A(4B.) as having been a listed company at all times during any period of its subsidiary's income year if it is a public company by virtue of section 103A(2.)(a) for its own income year in which is included that period of the subsidiary's income year.

Sub-sections (5.) and (6.) of section 103 are drafting measures which extend any reference to a right, power, option, agreement or instrument in the public company subsidiary tests to include arrangements or understandings and to cover rights, etc. that are not legally enforceable.

Clause 6:

Sub-clause (1.) of clause 6 omits from section 103A of the Principal Act the existing sub-section (4.) which describes the circumstances in which a company is accepted as a subsidiary of a public company. Sub-clause (1.) also inserts new provisions in section 103A (sub-sections (4.) to (4E.)) to specify the new tests that are proposed to determine whether any company is a public company subsidiary for the 1971-72 income year and subsequent income years.

The new sub-section (4.) of section 103A provides the basic conditions to be met by a company to qualify as a subsidiary of a public company or companies by which it is wholly-owned.

Paragraph (a) of sub-section (4.) requires that all the shares in the subsidiary be beneficially owned at all times during its year of income by one or more companies that, with specified exceptions, qualify as public companies under the present law (section 103A(2.)). The classes of companies that so qualify are outlined at pages 9 and 10 of this memorandum.

Sub-paragraphs (i) and (ii) of paragraph (a) specify the exceptions mentioned. Sub-paragraph (i) excludes non-profit companies. Sub-paragraph (ii) excludes public company subsidiaries that either are not wholly-owned by public companies or, being wholly-owned, balance on dates different from their public company parents.

Paragraphs (b), (c) and (d) of sub-section (4.) provide safeguards against arrangements, etc. which could render ineffective the tests prescribed in paragraph (a).

Paragraph (b) will ensure that only companies which are wholly-owned by, and having identical accounting periods with, their public company parents qualify as public company subsidiaries under sub-section (4.). There could be scope to avoid this wholly-owned test where a company and its public company parent balance on different dates for income tax purposes.

Paragraph (c) requires that no person be in a position at any time during the income year to prevent the parent public company from exercising for its own benefit the whole of the voting power in the subsidiary or from receiving for its own benefit the whole of any dividends or distributions of capital that might be paid or made by its subsidiary during the income year.

Paragraph (d) complements paragraph (c). It requires that there be no agreement, arrangement or understanding in existence during the income year that could affect the voting power of the public company parent in its subsidiary after the income year or the rights of the parent company to dividends or distributions of capital that might be paid or made by its subsidiary after the income year.

Sub-section (4A.) specifies for the purposes of paragraphs (c) and (d) of sub-section (4.) the circumstances under which a person is to be regarded as being in a position at a particular time to affect the voting rights of the public company parent in relation to its subsidiary and its rights to dividends or capital distributions made by its subsidiary. It specifies for this purpose a person having at the particular time a right, power or option to acquire any of the parent company's rights in its subsidiary or to prevent the parent from exercising, for its own benefit, voting rights in the subsidiary or from receiving for its own benefit the whole of the subsidiary's dividends or capital distributions.

Sub-section (4B.) specifies the basic conditions under which a company that is not wholly-owned by a public company or companies or which, being wholly-owned, balances on a date different from its public company parent, may be treated as a public company subsidiary for income tax purposes in relation to a year of income.

Paragraph (a) of sub-section (4B.) requires the voting power of the subsidiary company to be controlled, or to be capable of being controlled, at all times during the year of income by one or more listed companies. (A listed company for this purpose is described at page 12 of this memorandum.) The control may be exercised directly by reason of the listed company beneficially owning shares in the subsidiary or indirectly through any companies, trustees or partnerships that may be interposed between the listed company and the subsidiary. Company A would be treated as directly controlling company B, and as indirectly controlling company C through company B where, for example, A beneficially owns shares controlling the voting rights in B and B beneficially owns shares controlling the voting rights in C.

Paragraph (b) adds to the voting rights required by paragraph (a) conditions relating to the listed company's interests in the dividends and capital distributions of the subsidiary. Paragraph (b) requires one or more listed companies to beneficially own shares at all times during the year of income that would entitle the listed company (or companies) to receive more than one-half of any dividends or capital distributions that may be paid or made by the subsidiary.

The listed company's entitlement to dividends and capital distributions may be direct by reason of its beneficial ownership of shares in the subsidiary. Alternatively, it may be an indirect beneficial interest through another company or companies interposed between the listed company and the subsidiary.

Where, for example, all shares carry equal dividend and capital distribution rights and listed company A beneficially owns 90 per cent of the shares in company B which, in turn, beneficially owns 70 per cent of the shares in company C, the direct beneficial interest of A in B is 90 per cent. The indirect beneficial interest of A in C is 63 per cent (

(90 per cent) * (70 per cent)


). For the purposes of paragraph (b), company A would be treated as entitled to 90 per cent of the dividends and capital distributions of company B and entitled to 63 per cent of the dividends and capital distributions of company C.

Paragraphs (c) and (d) of sub-section (4B.) perform a similar function in relation to a subsidiary under sub-section (4B.) as do paragraphs (c) and (d) of sub-section (4.) in relation to a subsidiary under sub-section (4.)

Paragraph (c) requires that no person be in a position during the year of income to prevent the listed company from exercising for its own benefit control of the voting power in the subsidiary or from receiving for its own benefit more than one-half of any dividends or capital distributions that might be paid or made by the subsidiary during the income year.

Paragraph (d) complements paragraph (c). It requires that there be no agreement, arrangement or understanding in existence during the income year that would affect rights of the listed company in the way described in paragraph (c) in relation to the voting power of the listed company in the subsidiary after the year of income or in relation to dividends or capital distributions that may be paid or made by the subsidiary after the income year.

Sub-section (4C.) applies in relation to the sub-section (4B.) test in the same way as sub-section (4A.) applies in relation to the sub-section (4.) test. It specifies, for the purposes of paragraphs (c) and (d) of sub-section (4B.), the circumstances under which a person is to be regarded as being in a position at a particular time during the income year to affect the rights of the listed company in relation to the voting power in the subsidiary and to its dividends or distributions of capital. The listed company's rights will be treated as capable of being affected by any person who, at the particular time, has a right, power or option to acquire any of those rights or to prevent the listed company from controlling the voting rights in the subsidiary for its own benefit or from receiving for its own benefit more than one-half of the subsidiary's dividends or capital distributions.

Sub-section (4D.) authorises the Commissioner to treat a company as not being a public company subsidiary where, although it has apparently complied with the shareholders' rights' test under sub-section (4.) or under sub-section (4B.), he is satisfied, nevertheless, that the "subsidiary" is not being managed or conducted in the respective interests of the public company parent to an appropriate extent. Where the Commissioner is of this opinion, the company, even though it may have complied technically with sub-section (4.) or sub-section (4B.), is not to be treated as a public company subsidiary.

A company dissatisfied with the exercise of the Commissioner's discretion will have the usual rights of objection and reference to a Taxation Board of Review.

Sub-section (4E.) specifies in paragraphs (a) to (g) criteria to be taken into account by the Commissioner in forming an opinion for the purposes of sub-section (4D.).

Briefly, the matters to be examined are -

(a)

whether the parent company's interests in its subsidiary were acquired in ordinary commercial dealings;

(b)

the provisions of the subsidiary company's memorandum and articles of association governing its management and conduct, appointment and removal of its directors, issue and redemption of its shares, variation of rights attaching to its shares, payment of dividends and use of its moneys;

(c)

the nature and extent of any existing arrangements affecting matters mentioned in (b) above;

(d)

whether the parent company's rights were exercised other than for its own benefit or were exercised at all;

(e)

the nature and source of the subsidiary's income and whether that income was derived in the course of ordinary commercial dealing;

(f)

the manner in which the subsidiary's moneys were applied or invested; and

(g)

the dividends paid by the subsidiary and the circumstances of such payments.

Paragraph (h) authorises the Commissioner to take into account, in addition to the matters specified in paragraphs (a) to (g), any other matters which are relevant to whether a particular "subsidiary"' is being managed or conducted without proper regard to the majority interest of its public company "parent".

Sub-clause (2.) of clause 6 is a machinery provision. It makes drafting changes to sub-sections (5.) and (6.) of section 103A of the Principal Act which are occasioned by the insertion in that section of the proposed sub-sections (4.) to (4E.).

With one exception which is explained in the notes relating to clause 12(2.) of this Bill, the new tests of a public company subsidiary will apply in assessments in respect of the 1971-72 income year and all subsequent income years.

Clause 7: Sufficient distribution.

Introductory Note.

Section 105A of the Principal Act provides that a private company will have made a sufficient distribution in relation to a year of income if it has, within a prescribed period of twelve months ending ten months after the end of that year, paid in dividends at least the amount by which the distributable income of the year (broadly its after-tax income) exceeds the proportion of its income specified as the retention allowance under section 105B. As mentioned earlier, a private company which fails to make a sufficient distribution is liable to additional tax on the undistributed amount.

A company which fails to meet the proposed new tests of a public company subsidiary could technically satisfy the requirement to make a sufficient distribution of its profits through a device by which special class shares in that company were issued at a premium to a public company in pursuance of an arrangement under which amounts of the premium were to be paid over by the public company in exchange for roughly equivalent amounts of dividends to be declared and paid to it by the other company.

The public company would receive the dividends effectively tax-free because of the rebate of tax on inter-company dividends. The other company, while paying a dividend which would be taken into account in determining whether it had made a sufficient distribution of its profits for undistributed income tax purposes, would be reimbursed for the payment of the dividend by the share premium it received.

Clause 7 will insert sub-sections (3.) and (4.) in section 105A of the Principal Act as a safeguard against arrangements of this kind. These provisions will complement the amendments effected by clauses 5(b) and 8(a) of this Bill. Sub-section (3.) in conjunction with the amendment effected by clause 5(b), will ensure that dividends paid by a company in exchange for premiums on its shares are excluded from the calculation made to determine whether the company has made a sufficient distribution of its profits for undistributed income tax purposes.

Paragraph (a) of sub-section (3.) of section 105A will apply where the dividend is paid on the shares that were issued at a premium while paragraph (b) will apply where the dividend is not paid on the shares issued at a premium but is nevertheless paid to the owner of those shares in respect of other shares owned by that person.

Sub-section (4.) will make it clear that the operation of sub-section (3.) is not avoided by converting into stock the shares referred to in paragraph (a) or (b) of sub-section (3.).

Clauses 5(b), 7 and 8(a) will apply in relation to dividends paid after 9 December 1971.

Clause 8: Excess distributions carried forward.

Where dividends are paid by a private company in excess of the amount of a sufficient distribution of its profits in relation to an income year, the amount of the excess is deemed by section 106 of the Principal Act to be a dividend paid by that company that may be taken into account in determining whether the company has made a sufficient distribution of its profits in relation to the next income year for undistributed income tax purposes. Clause 8 will effect two amendments to section 106 each of which will have the effect of excluding certain dividends from the calculation of the amount of the excess distribution to which section 106 applies.

Paragraph (a) of clause 8 will amend sub-section (1.) of section 106 of the Principal Act. This amendment is complementary to the inclusion by clause 7 of the Bill of sub-sections (3.) and (4.) of section 105A in the Principal Act. The effect of the amendment made by the paragraph will be to exclude from the amount of any excess distribution to which section 106 applies, any dividend which is to be excluded by the proposed sub-sections (3.) and (4.) of section 105A from the determination of whether that company has made a sufficient distribution of its profits for undistributed income tax purposes.

As mentioned above, the proposed sub-sections (3.) and (4.) of section 105A will prevent any such dividend being so taken into account when it is paid. In addition to this, the amendment to be effected by clause 8(a) to section 106(1.) is necessary to prevent any such dividend being carried forward as an excess distribution to be taken into account for undistributed income tax purposes in respect of a later income year.

The amendment in paragraph (a) will apply in relation to dividends paid after 9 December 1971.

Paragraph (b) of clause 8 will insert a new provision, sub-section (4.), in section 106 of the Principal Act. This provision will exclude from a private company's excess distribution dividends paid by that company to an "artificial" public company subsidiary that fails to satisfy the proposed new tests as to public status for the 1971-72 income year.

Sub-section (4.) will apply to dividends paid during the 1970-71 income year of the subsidiary but after 28 April 1971 (i.e., after the date upon which the Government's intention to amend the existing tests of a public company subsidiary was announced).

This amendment is designed to prevent undue advantage being taken by a private company of the provisions of these amendments which will permit, with a few exceptions, "artificial" public company subsidiaries to be taxed under the existing law as public companies for the 1970-71 income year. A private company anticipating this concession could otherwise employ it to its advantage in relation to its liability for undistributed income tax in future years by paying as large a dividend as possible to the "artificial" public company subsidiary during the period that it continued to be accepted as a public company. But for proposed sub-section (4.), the excess distribution so produced would then be carried forward by the private company to be offset against profits of future years that otherwise would need to be distributed to its shareholders or bear the alternative undistributed income tax.

Dividends so paid, although excluded from any excess distribution that might otherwise be carried forward, will nevertheless be taken into account as dividends actually paid during the relevant prescribed periods when determining whether the private company has made a sufficient distribution of its income for undistributed income tax purposes.

Clause 9: Modification of sections 46 and 46A in relation to certain life assurance companies.

Section 116A of the Principal Act places an upper limit on rebates allowable under section 46 in respect of dividends from shares held as assets of the insurance funds of life assurance companies that do not maintain what is commonly known as the 30/20 ratio of investments in public securities.

Clause 9 will replace sub-section (1.) of section 116A with a provision taking a similar form but varied to ensure that the limitation will apply to rebates allowable under both section 46 and proposed section 46A.

Clause 10: Rebates and provisional tax.

Section 121DD of the Principal Act provides, among other things, that the trustee of a superannuation fund is not entitled to a rebate as provided by section 46.

Clause 10 will amend section 121DD to make it clear that a company acting as trustee of a superannuation fund will not be entitled to the rebate of tax provided by the proposed section 46A.

Clause 11: Credit in respect of tax paid in Territory of Papua and New Guinea.

Section 160AF of the Principal Act provides that a resident of Australia whose assessable income includes income derived from sources in the Territory of Papua and New Guinea on which he has paid Territory income tax is entitled to a credit of the net Territory tax or the amount of Australian tax payable on the Territory-source income, whichever is the lesser. Sub-section (2.) lays down the manner in which the amount of Australian tax on the Territory-source income is to be ascertained, and requires that rebates which relate exclusively to the Territory-source income be deducted from a predetermined amount but that rebates under section 46 of the Principal Act are to be excluded from those which are to be so deducted.

Clause 11 will amend sub-section (2.) of section 160AF so that rebates under the proposed section 46A will also be excluded from those that are to be deducted in calculating the Australian tax payable on Territory-source income.

Clause 12: Application and transitional provisions.

Sub-clause (1.) of clause 12 specifies the assessments to which the provision to counter the use of inflated trading stock values to increase the rebate on inter-company dividends (clause 3(d)) and the new tests governing public company subsidiaries are to apply. Subject to the exception in sub-clause (2.) in relation to public company subsidiaries, these provisions are to apply in assessments in respect of the 1971-72 income year and all subsequent income years.

Sub-clause (2.) will first apply the new tests governing public company subsidiaries in respect of the 1970-71 income year to any "artificial" public company subsidiary where the necessary share allotments to set up the tax avoiding structure were finalised during the 1970-71 income year of the subsidiary but after 28 April 1971 (i.e., after the date on which the Government's intention to amend the public company subsidiary tests was announced).

An "artificial" public company subsidiary in respect of which all the necessary share allotments had been made before 29 April 1971 to finalise the tax avoiding structure will be treated as a public company for 1970-71.

Sub-clause (3.) is designed to enable a genuine public company subsidiary to be treated as a public company for 1971-72 (and for 1972-73 where this may be necessary for some companies that have adopted irregular accounting periods for income tax purposes) even though it does not satisfy the proposed new tests, as would be required otherwise, at all times during the relevant income year.

Subject to the exception in sub-clause (5.), any company which satisfies the new public company subsidiary tests from a date commencing not later than one month after the date of Royal Assent to these amendments is to be treated as having complied with those tests for the whole of 1971-72 (and for 1972-73 also in an appropriate case). In addition, there is the general discretion in section 103A(5.) of the Principal Act which authorises the Commissioner to treat a company as public if he considers it reasonable to do so.

Sub-clause (4.) is a drafting measure to ensure in the application of sub-clause (3.) that the period of the 1971-72 income year (and of the 1972-73 income year where applicable) during which the public company subsidiary tests are otherwise satisfied will be treated as a year of income in the consideration by the Commissioner under the proposed sub-sections (4D.) and (4E.) of section 103A of whether the "subsidiary" company has been managed or conducted during the year of income in a manner that is consistent with the ostensible majority interest of its public company parent.

Sub-clause (5.) will exclude from the operation of sub-clause (3.) for 1971-72 an "artificial" public company subsidiary which has received a dividend from a private company after 28 April 1971 and during that period of the 1971-72 income year in which the "artificial" subsidiary did not comply with the proposed new tests of a public company subsidiary. Sub-clause (3.) will not operate also for the 1972-73 income year of an "artificial" public company subsidiary which has received a dividend from a private company after 28 April 1971 and during that period of 1972-73 during which the subsidiary did not comply with the proposed new tests. It will be necessary for such a "subsidiary" to have complied with those new tests at all times during the 1971-72 or 1972-73 income year, as the case may be, if it is to be taxed as a public company in respect of the relevant year.

Sub-clauses (6.), (7.) and (8.) of clause 12 are drafting measures which define "the relevant period" of the 1971-72 and 1972-73 income years during which the proposed public company subsidiary tests are satisfied by a company that acquires public company subsidiary status for 1971-72 or 1972-73 by the operation of sub-clause (3.) of clause 12. The relevant period must be a period that commences on a date not later than the expiration of one month after the Royal Assent to these amendments.

The relevant period for the 1971-72 income year will end on the last day of that year where the period commences during 1971-72.

Where the relevant period commences during the 1972-73 income year, it will end on 1 December 1972 (the earliest irregular balancing date for the 1972-73 income year) for the purpose of applying sub-clause (3.) to the 1971-72 income year, and on the last day of the 1972-73 income year for the purpose of applying sub-clause (3.) to the 1972-73 income year.

Sub-clause (9.) specifies commencing dates that are related to the payment of certain dividends. These dates have been mentioned in the notes on the relevant clauses of the Bill.