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Schemes to avoid income tax

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EMBARGO Not to be published or broadcast before 11.59 p.m., 12 June 1979



The Government has decided to amend the income tax

law to counter schemes that misuse the depreciation provisions

of the law in order to create deductions for paper losses.

One type of scheme relies upon the fact that depreciation provisions limiting the depreciation that is

allowable to a purchaser of plant apply only where depreciation has previously been allowed or allowable in respect of the plant.

• A scheme exploiting this weakness in the law operates

essentially along the following lines. A scheme promoter has an item of plant that has not previously attracted depreciation

allowances and is worth, say, $5,000. The promoter lends a taxpayer an amount several times greater than the worth of the

plant, with the terms and conditions of the loan being so

arranged that its present value is nominal, (e.g., it is for

50 years, interest free). The taxpayer then uses the loaned

moneys to buy the plant, at an excessive price, from the

promoter, and produces assessable income from use of the plant

by hiring it back to the promoter for a short period. This is

designed to give the taxpayer an entitlement to a depreciation deduction based on the inflated cost price. In practice, the

plant may never leave the possession of the promoter. The

.taxpayer then sells the plant at its true value of $5,000 (perhaps back to the promoter), thereby generating a depreciation

deduction, mainly by way of a balancing adjustment, of the .

difference between the inflated cost price and $5,000. The

promoter assigns his rights under the loan to an associate of

the taxpayer for its nominal present value, with the result that

for a payment of that amount the taxpayer effectively does not

have to repay the loan.

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To overcome this scheme the Government proposes to

amend the income tax law so that for the purposes of the

depreciation provisions, in situations where the existing

limiting provision does not apply, the cost of. a unit of plant

cannot exceed the true value of the plant. In line with this, a

part of the existing law that permits the Commissioner of Taxation

to allow depreciation based on a greater amount than the limiting

provision would allow, will, be amended so that a purchaser who pays

more for secondhand plant than its true value will, where appropriate, be able to be allowed depreciation based on that

true value.

A second type of depreciation scheme is more complex and exploits a feature of a special provision that deems a disposal of plant to occur where plant is transferred on the

formation or dissolution of a partnership or on a change in partners or in partners' interests in a partnership. In these

circumstances, the law permits the parties to specify a· disposal

value in the agreement giving rise to the change and, if this is

done, that value must be accepted by the Commissioner of Taxation.

- Relying upon this provision, a partnership might

purchase plant for $600,000 of which $5,000 is provided from

partnership capital and $595,000 by a loan from the promoter.

As with the first scheme, the plant is hired out by the partner­ ship (usually back to the vendor) for a short period to qualify

the partnership for depreciation. The partnership is then reconstituted to admit as a partner a company controlled by the

promoter. The new partnership agreement specifies $6,000 as the take-over value of the plant, ostensibly reflecting the fact that the plant is subject to a charge as security for the loan

from the promoter, and because this value must be accepted by the Commissioner, the old partnership claims a depreciation

deduction by way of a balancing adjustment of $594,000 to be shared by the partners. The new partnership then transfers the

plant for a nominal amount to the introduced partner (the

promoter's company) which in turn sells the plant back to the

original owner for the original price of $600,000, and uses the

proceeds to repay the loan of $595,000. The promoter's company

does not use the plant for business purposes prior to the sale

back to the original owner and that person, on the basis of a

view that the limiting provisions referred to earlier do not

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apply, seeks on re-acquisition to claim depreciation on the

cost of $600,000.

In some cases, the same plant is, in reliance on this

view, used in successive.schemes to create similar deductions

for other taxpayers, .despite the fact, that the plant may never

leave the possession of the original owner. In other cases,

as an alternative to the final sale back to the original owner,

the plant may be sold for actual and continuing use to a

purchaser who has been a member of the.partnership. In this case, the purchaser would claim to be entitled to normal

depreciation in respect of plant for which he of she had already

shared a balancing adjustment deduction for almost the full cost.

. To deal with this second type of scheme, the special

provision that enables partners to specify a transfer value of

plant will be amended so that, should the parties specify a

value that is less than both the true value and the depreciated

value of the plant, the lower of the true and depreciated

values will be adopted in calculating the balancing adjustments applicable to the transferors.

By varying the second type of scheme another area of

the depreciation provisions can be exploited. For example, instead of the old partnership being re-constituted, it might

simply sell the plant to the promoter's company for $5,000.

In that event, the partnership could, as the law is now framed, claim a balancing adjustment deduction based on the actual (but nominal) sale price.

To counter this, the law will be amended so that if

depreciable plant is sold, in a situation in which the parties are not dealing in an arm's length way, at a price that is lower

than both its true value and its depreciated value, the vendors

will be treated as having sold the plant at the lower of those

two values.

I mention also that the special mining provisions of

the income tax law contain provisions in the same terms as the

transfer provision that applies for general depreciation purposes

The Government proposes that a corresponding amendment be made

to these provision's. ' ' .

The amendments now outlined will apply in all cases

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to plant acquired, to transfers of interests in plant, and to

sales of plant, after today, and will be given effect in

legislation to be introduced in the Budget sittings of the


The Government.has, in addition, decided to propose

that where, today or earlier, a deduction has been created under a depreciation scheme of avoidance there will be no

carry-forward from one year to another of a resulting loss.

As I. announced on 24 May 1979, losses generated in the 1977-78 income year and earlier years under schemes

against which action was taken or foreshadowed in 1978 are not to be carried forward for deduction against income of the

1978-79 income year or subsequent years. Losses generated under such schemes in the 1978-79 income year are not to be

carried forward to the 1979-80 income year or subsequent

years. A corresponding rule is to apply to carry-forward of

losses created in depreciation schemes. Thus depreciation losses

created in 1977-78 will not be allowed as carry-forward

deductions in 1978-79.



12 June 1979