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Wednesday, 8 June 1994
Page: 1526


Senator HARRADINE (5.09 p.m.) —I would have been voting for the amendments relating to HECS had they been proposed; apparently they are not being proposed now. There is therefore no point in pursuing that matter. I would like to have incorporated into Hansard questions that I asked of the minister outside this chamber which were referred to the Taxation Office. Before I do so, I would like to express my appreciation for the minister's interest and for the work and attention that was given by the officers of the Taxation Office and the minister's office in responding to these questions. I seek leave to have the questions and the answers incorporated in the Hansard.

  Leave granted.

  The questions and answers read as follows

QUESTIONS ON TAXATION LAWS AMENDMENT BILL (NO. 2)

  1. What analysis has been undertaken of the impact of this kind of complex capital gains tax on the attractiveness of Australia as a regional headquarters for American or European companies investing in the Asia Pacific region?

  2. Bearing in mind the recent High Court examination of section 55 of the Constitution in the Mutual Pools Case, what advice has been received on the Constitutional validity of the Bill?

  In particular, how can it be said there is "one subject of taxation", namely a tax upon income, where:

  (a) people are being taxed on notional unrealised accruals on securities as though they are income which has come in? (Clause 10, proposed section 159GQ)

  (b) people are being taxed on a deemed capital gain when they have not sold any shares and the shares concerned have depreciated in value rather than been disposed of at a profit? (Clause 26, proposed section 160ZZRP(2))

  (c) people are being taxed on a deemed capital gain when under a declaration of a unit trust, there has been no change in the legal or beneficial ownership of an asset and no disposal of the asset? (Clause 30, proposed section 160M (3)(a), (3)(A), (4)(A))?

  3. In regard to the definition of "Controller" (Clause 26 proposed section 160ZZRN(1)(c) how can the Explanatory Memorandum be supported by the Act? Sub-section 160ZZRN(1)(c) defines a taxpayer as being a controller of a company if "the taxpayer controls the company". The word "control" is not defined. Parliament, taxpayers and the Courts are therefore entitled to assume it refers to the case law meaning and that control of a company is generally vested by the Articles of Association in the directors. But the Explanatory Memorandum purports to state in paragraph 5.37 that "if the taxpayer can, for example, control the appointment of directors of a company, the taxpayer will generally be taken to have de facto control of the company". How can that be so, if it is directors who have the control of the company and are answerable in law as fiduciaries for their exercise of that control? Given the refusal of the High Court in Hepples' Case to use the Explanatory Memorandum to fill in drafting omissions, what basis is there in the Act itself to support the interpretation of "control" asserted in the Explanatory Memorandum?

  4. Cannot the Bill's provisions on accruals assessability of securities be used to avoid interest withholding tax, since a deduction is given to an Australian issuer for a notional amount, without any provision to deem that to be in the nature of interest? Would any deeming provision declaring the notional amounts to be interest be invalid as being contrary to Australia's double tax treaties?

  5. Cannot the value shifting provisions be used to avoid tax by having a non-resident shareholder shift value into shares held by australians to increase their cost base? How can a capital gains tax liability be enforced against such a non-resident shareholder if it is a resident of certain treaty partners, where the treaty limits Australia's taxing rights as to capital gains? How can any capital gains tax liability be enforced against such a non-resident shareholder in any case, if it has no assets in Australia and the shares from which value has been shifted are subsequently worthless?

QUESTIONS ON TAXATION LAWS AMENDMENT BILL (NO. 2)

  1. What analysis has been undertaken of the impact of this kind of complex CGT on the attractiveness of Australia as a regional headquarters for American of European companies investing in the Asia Pacific region.

  Answer

  Foreign companies operating through regional headquarters in Australia to invest in the Asia Pacific region are generally subject to the taxation laws of Australia. Certain concessions applicable to them were announced in the Government's `Working Nation White Paper on Employment and Growth', released on 4 May 1994.

  Where a company transacts business on an arm's length basis the CGT provisions that apply are not complex. The so-called complex provisions are of an anti-avoidance character and would generally not have an adverse impact on genuine commercial transactions.

  In this context, the Government is of the view that the CGT provisions would not act as an impediment to the incorporation in Australia of regional headquarters.

QUESTION

  2. Bearing in mind the recent High Court examination of section 55 of the Constitution in the Mutual Pools Case, what advice has been received on the Constitutional validity of the Bill?

KEY POINTS

  The Mutual Pools Case, concerned the application of section 55 to a combination of an excise—a tax on goods—and a tax on land. It raised no new principles and so required no special advice for this Omnibus Taxation Laws Amendment Bill.

  No special advice on this particular Bill was sought, as it was considered that it fell entirely within the scope of existing High Court authority and the single subject of taxation dealt with by past and present income tax law.

  The suggestion that notional or unrealised accruals are a different subject of taxation to income was rejected in Harding v. Commissioner of Taxation (1917) 23 CLR 119.

  That case concerned the application of section 55 to the inclusion for income tax purposes of 5 per cent of the capital value of real property owned or held rent-free by a taxpayer for purposes of residence or enjoyment.

  This notional, hypothetical, unrealised, accruing benefit was held not to represent a separate subject of taxation.

  The test for deciding whether the subject of taxation imposed by an Act is single is now that stated in Harding's case, adopted by the majority judgement of the High Court in the Second Fringe Benefits Tax Case (1987) 163 CLR 329 and consistent with the views expressed by Sir Owen Dixon in Resch V. FC of T (1942) 66 CLR 198 (at 223).

  The question (in summary) is whether, looking at the subject of taxation dealt with as if it were a unit by Parliament, it can be fairly regarded as a unit in the aspect in which it is dealt with, or whether it consists of matters necessarily distinct and separate.

  The High Court will not resolve such a question against the Parliament's understanding, with the consequence that a statute is constitutionally invalid, unless the answer is clear.

  There are no potential problems with this Bill, under section 55 of the Constitution. Some of the suggested problems would require existing High Court authority to be overturned. All the suggested problems would entail findings that substantial parts of the present income tax law breach section 55 of the Constitution.

  The possibility of such problems would be inconsistent with past advice of the Attorney-General's Department on similar issues, and inconsistent with applicable reasoning of the High Court.

  3. In regard to the definition of `controller' (clause 26—proposed paragraph 160ZZRN(1)(c)), how can the Explanatory Memorandum be supported by the Act?

  Answer

  The term `controller' is defined in proposed sub-section 160ZZRN(1). Paragraph (a) of that subsection deals with the case where a shareholder controls 50% or more of the rights to vote at a general meeting of a company. This is the classic test of control applied by the courts.

  However, the definition goes further and provides, in paragraph (c), for the case where the taxpayer `controls the company'. This deals with de facto control of the company. The specific inclusion of paragraph (c) indicates that the concept of control of a company is wider than that of the control of the voting rights.

  The Explanatory Memorandum provides an example of circumstances in which this de facto control is generally taken to occur, i.e. when the taxpayer can control the appointment of directors of the company.

Response to Senator Harradine's question on Taxation Laws Amendment Bill (No. 2) 1994

  4. Cannot the Bill's provisions on accruals assessability of securities be used to avoid interest withholding tax, since a deduction is given to an Australian issuer for a notional amount, without any provision to deem that to be in the nature of interest? Would any deeming provision declaring the notional amounts to be interest be invalid as being contrary to Australia's double tax treaties?

  The Bill's amendments to Division 16E do not bring securities within the scope of the Division that are not currently within its scope. Similarly, they do not seek to accrue amounts that re not currently being accrued under the Division. Essentially, what the amendments do is change the method of accrual in relation to some securities already within the scope of the Division.

  The basic points are:

  Where a qualifying (ie, Division 16E) security is held by a non-resident, the Division 16E accruals rules do not apply to that non-resident. The rationale for this is that it is not possible to withhold tax in respect of an amount accrued where there is no corresponding payment by the issuer to the holder in the accrual period.

  Any proposal to impose interest withholding tax on qualifying securities on an accruals basis would raise broader policy issues, including consideration of whether it was consistent with Australia's rights and obligations under double tax treaties.

  There are several existing anti-avoidance rules relating to Division 16E and non-residents:

  1. Where a qualifying security issued after 22 May 1986 is a negotiable instrument issued payable to bearer, a deduction is not allowed under Division 16E.

  2. Where a qualifying security issued after 22 May 1986 is issued outside Australia, a deduction is not allowed under Division 16E.

  3. Where a qualifying security issued after 23 April 1987 is issued to (or for the benefit) of a non-resident associate, no deduction is allowed under Division 16E.

  4. Where a qualifying security issued after 23 April 1987 is issued to an associate on the understanding that it is to be transferred to a non-resident associate, no deduction is allowed under Division 16E.

  5. Where a qualifying security is held by a non-resident and sold prior to maturity, the difference between the transfer price and issue price is deemed to be interest, and interest withholding tax is applied.

5.  Cannot the value shifting provisions be used to avoid tax by having a non-resident shareholder shift value into shares held by Australians to increase their cost base?

Answer

If a non-resident shifts value into shares held by Australians there will be an increase in their market value. The cost base of those shares may also be increased, but the increase in the cost base cannot exceed the amount of the increase in market value. Therefore the value shifting provisions would not give rise to tax avoidance by the Australian shareholders.

The value shifting provisions can apply to impose a CGT liability on non-residents. However, the provisions will have regard to Australia's treaty obligations.

If a non-resident shareholder has only worthless shares, it would of course not be possible to collect taxes from that shareholder if he or she has no other Australian assets. However, as stated earlier, resident shareholders into whose shares value is shifted will not be able to avoid tax.


Senator HARRADINE —I want to make a couple of observations and ask a couple of rhetorical questions. In respect of the first question, I am concerned—I think everybody is concerned—about the thickness of the volume of the Income Tax Assessment Act; it runs into something like 5,000 pages. I do not know the precise number. The number of pages of the Fringe Benefits Tax Assessment Act has doubled since 1985. I am concerned at the complexity of this area.

  The first question I asked was whether any analysis had been undertaken of the impact of the capital gains tax on the attractiveness of Australia as a regional headquarters for international companies—say American or European companies—investing in the Asia-Pacific region. The Tax Office has given a response, and I am thankful for that. The Tax Office is confident that that would not be the case. I wonder whether private sector tax advisers who advise overseas companies share the view of the Tax Office and the government as it relates to this legislation which includes measures such as the value shifting provisions.

  The government and the Tax Office obviously consider that those provisions are not a deterrent for incorporation of Australian regional headquarters by overseas companies. I wonder whether we might get a response from the Business Council. Is that view shared by the Business Council or the corporate tax association? It will be interesting to see whether those organisations share that view. No doubt they will tell us all at some time.

  In the second question, I asked about income tax. I will give the Senate an example. People are being taxed on a deemed capital gain when they have not sold any shares and the shares concerned have depreciated in value rather than being disposed of at a profit. How can they be so regarded? To my simple mind it seems to me that that would not be the subject, surely, of taxation upon income.


Senator Bell —It is not income.


Senator HARRADINE —That is true. The responses are detailed and they refer to the case of Harding v The Commissioner of Taxation. In that case the Tax Office said that this notional, hypothetical, unrealised accruing benefit was held not to represent a separate subject of taxation. I am advised that the Harding case dealt with an in-kind benefit formerly included as income under the UK income tax law of 1799. Apart from the answer to the question, I have not been advised that there is any authority for the proposition that something which is a loss of value, or neither a gain nor a loss, forms part of the subject of taxation comprehended by the term `income tax'. That is my comment on that matter.

  The other matter goes to the question that I asked about the definition of `controller' in clause 26 of proposed paragraph 160ZZRN (1)(c). I want to make this comment: if company law and the articles of association place control of a company in the hands of its directors, how can the phrase `controls the company' be applied to a person other than directors or de facto directors? The department is saying that the definition includes the case where a taxpayer controls the company. That taxpayer is neither a director of the company nor a de facto director of the company.

  Now it appears that this term is going to extend to persons who have some sort of outside say over the directors of the company. It seems to me that it is questionable as to how that could occur. The department says that there are examples—and it is true that there are examples—in the explanatory memorandum, and they are there for honourable senators to look at. Explanatory memoranda are aids to the interpretation of the law if the courts so decide to use them as aids, but they are not to be substituted for the actual phrases and clauses in the legislation.

  Apropos of that, Hepple's case in the High Court refused to allow an explanatory memorandum to make up for drafting deficiencies in the act. Mr Justice Deane suggested that taxpayers were entitled to clarity in legislation imposing tax. I am sure that all honourable senators would agree with those sentiments. As a lay person who nevertheless is a legislator, and as a taxpayer, I find it rather difficult to match the actual terms of clause 26 of proposed paragraph 160ZZRN(1)(c) with the example that is included in the explanatory memorandum. Time will tell, no doubt, but I do conclude by thanking the minister and the officers for the courtesy and efficiency with which they responded to the questions that I asked.