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Wednesday, 12 September 1984
Page: 943

Senator COLSTON(6.58) —It is coincidental that my comments this evening, which are on taxation, follow shortly after a major announcement on taxation by the Treasurer (Mr Keating). I had planned to raise the matter of a particular tax avoidance proposal before I knew that the Treasurer's announcement was imminent. I have no objection to citizens arranging their financial affairs so that, within the law, they minimise the tax which they are obliged to pay. When the tax law is complex, however, there will inevitably be those who will arrange their affairs in such a way that the intent of the law is undermined. In this case, the Parliament should strengthen the law to close off any unintentional loophole which may have appeared in the legislation it has previously passed.

This evening I wish to speak about an arrangement which can be described only as a tax avoidance measure and which, if allowed to flourish, could undermine a greater part of our tax law. I consider that the Government will have to consider fresh legislation to close what I believe is a tax loophole.

Since becoming aware of the intentions of one particular company to allow its shareholders to avoid tax, I have been informed that the scheme is not a new one and had, in fact, been used by companies prior to this date. If this is so, the Commonwealth has already suffered a loss of revenue from this scheme. What that means, of course, is that either other taxpayers have to make up the shortfall or the Government is unable to provide the level of services which it believes is necessary for the Australian people.

This evening, I shall be referring to a plan by a Queensland based company, Defiance Mills Limited, to alter its articles of association to allow the company to facilitate tax avoidance by its shareholders. The company will have an extraordinary meeting in Toowoomba tomorrow to decide whether its articles should be amended.

I am using Defiance Mills as an example of what could be occurring in other companies and what may be an ever-increasing practice if the Commonwealth holds that the scheme should be allowed to continue. As I shall be referring principally to Defiance, I declare that I have a small financial interest in the company. Together with my spouse, I jointly own a small parcel of ordinary shares in the company and a slightly larger number but still relatively small number, of the company's convertible notes. The company is a sound one and well respected. Its respect may, however, be tarnished if it goes ahead with its plans to alter its articles of association and use the revised articles in the way which it has intended.

Basically, the plan is to allow shareholders to have the option of taking shares in the company in lieu of a cash dividend. On the face of it, such a proposal would seem to be harmless enough. However, it is only a thinly disguised tax avoidance measure, because the Chairman of the Board of Directors has stated that under normal circumstances the issue of shares will not attract Australian income tax, but a cash dividend would.

Let us consider an investor who receives $1,000 a year in dividends from Defiance and whose other income is such that the marginal rate of tax payable by the investor is 60c in the dollar. That person's net return on the investment in the company would be $400, or $390 if the Medicare levy is taken into account. However, if that investor decided to take shares in lieu of the cash dividend, the net return would be about $1,000. There seems to be no reason why an investor could not sell an entitlement so obtained and, even if there were some legal bar, there is no reason why shares with a market price of $1,000 should not be disposed of from an existing holding. The investor is then $600 better off and the Commonwealth has lost revenue to the same extent. It would be interesting to know how many shareholders would opt for the cash dividends, even if their marginal rate of tax is less than 60c in the dollar.

The legal niceties of this proposal are more complex than the summary which I have just outlined, but they do not alter the way in which the scheme will operate. A letter from the Chairman of the Board of Directors gives further detail of the proposed scheme and I seek leave to incorporate the text of that letter in Hansard.

Leave granted.

The letter read as follows-

10 August 1984

Dear Shareholder,

I am attaching Notice of an Extraordinary General Meeting of the Company for the purpose of amending the Articles of Association of the Company. If the resolution is passed by the Company, it will mean that the Directors may decide in respect of any dividend or any portion of any dividend to be declared and paid by the Company that shareholders have the option to receive a normal cash dividend or to elect to forego the cash dividend and to receive instead an issue of ordinary shares credited as fully paid up. The issue price of the shares shall be 95% of market price as defined in proposed Article 135A.(b).

Such ordinary shares will be funded by the capitalisation of reserves of the company which are tax free under present law and which include Share Premium Reserve, Asset Revaluation Reserve and Capital Profits Reserve to the extent such profits were derived from the sale of assets not acquired for the purpose of resale. Accordingly, you may expect, in normal circumstances, no liability for Australian Income Tax in respect of the issue of shares made pursuant to your Election. Of course, cash dividends which you receive will continue to form part of your Australian assessable income.

If the resolution as attached is passed, your Directors will forward to you a Notice of Election prior to the payment of the next dividend and you may complete that Notice in respect of the whole of your shareholding or any portion thereof. If the Election is not completed and returned to the Company by the date nominated or if the election is not in respect of your total shareholding, you will receive a cash dividend in the normal way in respect of shares not covered by the Election.

You will note that once having given the Notice of Election to the Company, it will continue to apply to those shares nominated by you unless you revoke the Election by written notice addressed to and received by the Company.

The ordinary shares allotted pursuant to the Election will be issued immediately after the due date for payment of the dividend and will rank pari passu with the existing fully paid ordinary shares and will rank for all dividends on ordinary shares declared after the date of such allotment.

Your Board recommends that the resolution be passed.

Your faithfully,

Defiance Mills Limited

P. W. O'Brien

Chairman of the Board of Directors

Senator COLSTON —I consider that the proposed amendment to the articles of association is too lengthy to incorporate in Hansard. For any person who is interested in perusing it, the amendment is as readily available as the articles of association of any public company. I cannot agree with such a form of tax avoidance as proposed by this company and indeed by any other company in Australia. If a dividend is declared, it should be duly paid in cash and those who receive that cash dividend should pay their way by fulfilling their tax obligations. If a company for some reason wants more share capital, there are ways by which that capital may be obtained and shareholders can benefit from bonus issues or issues at par or premium values. The two should not be combined to allow shareholders to avoid tax that within the intent of the law should be paid.

Some time ago, I referred Defiance's proposal to the Treasurer (Mr Keating) to determine whether it breaches the current tax laws. As far as I can ascertain from the Treasurer's letter, it is a legal scheme. I seek leave to incorporate a reply from the Treasurer in Hansard.

Leave granted.

The letter read as follows-

Dear Senator Colston,

I have now received advice from the Commissioner of Taxation in relation to the proposal by Defiance Mills Limited to amend its Articles of Association to provide shareholders with the opportunity to take up an issue of ordinary shares credited as fully paid in lieu of a normal cash dividend. Documents relating to the proposal were enclosed with your letter of 15 August 1984.

The Commissioner of Taxation has informed me that there is no liability to income tax on dividends paid to shareholders wholly and exclusively out of profits arising from the sale or revaluation of assets not acquired for the purpose of resale at a profit where the dividends are satisfied by the issue of shares. Nor is there any income tax liability on distributions from a share premium account. There are, however, safeguarding provisions in the income tax law to prevent manipulation of share premium accounts.

To the extent, therefore, that the company makes distributions to its shareholders out of the funds referred to in the preceding paragraph the shareholders would not be liable to tax. The Commissioner stated that it is always necessary to be satisfied that, where a dividend is paid to shareholders out of profits arising from the sale or revaluation of assets not acquired for resale at a profit, it is paid wholly and exclusively out of those profits. Where companies pay dividends out of more than one fund, it is generally the practice to declare separate dividends out of each particular fund. In this way, the requirements of the income tax law are observed.

If the declaration of the dividend were part of some wider arrangement which could be seen as having tax avoidance implications, it would be necessary to have regard to the safeguarding provisions and to the general anti-avoidance provisions of the income tax law.

The Commissioner went on to say that the proposal has already been considered in his Office and he is satisfied, in the light of the explanations given by the company, that it is not a situation to which the safeguarding provisions or the general anti-avoidance provisions apply.

Yours sincerely


Senator COLSTON —I was not surprised that the proposal falls within the existing Commonwealth legislation, as I am sure that a company of Defiance's standing would have received appropriate legal advice before proceeding. Whilst the scheme may be legal, I consider that it breaches the intent of our tax laws. That being the case, the law should be changed to close this loophole and nip in the bud what would become an established tax avoidance scheme in Australia.