― 223 ―

20. Chapter 16 Company Income Tax

16.1. Taxation of company income is an important element of the Australian tax system. As indicated in Chapter 2, it accounts today for nearly one-fifth of total taxes raised in Australia—a larger fraction than in most countries.

16.2. There is a tendency when considering companies and the taxes they pay to think principally of those companies employing large numbers of the work force or those in which investments are held. However, the term ‘companies’ embraces a wide variety of incorporated and unincorporated bodies. Table 16.A shows, for selected years, the number of resident companies lodging taxation returns, the taxes they paid, and the number disclosing taxable incomes of less than $20,000.

16.3. The table reveals a significant growth in the number of private companies—an increase of 349 per cent between 1955–56 and 1971–72 as against 127 per cent for public companies. There is reason to believe that a high proportion of the additional private companies may have been formed with the intention of spreading income, particularly investment income, between members of a family and of reducing death duties and not for normal business purposes.

16.4. The system of taxing company income must accommodate widely differing shareholding structures and business circumstances. Active businesses are the major contributors to tax revenue. Hence, the Committee believes it should formulate its views with active business operations primarily in mind. Special provisions that may be necessary to deal with companies not engaged in active business operations require separate consideration.


Income year   Total number of companies   Number of dormant and loss companies   Total excluding dormant and loss companies   Net company tax paid   Companies with less than $20,000 taxable income  
$m.  No.  per cent (b) 
Private companies (a) 
1955–56 …  38 143  10 817  27 326  96  23 027  84.3 
1960–61 …  71 260  23 734  47 526  120  41 948  88.3 
1965–66 …  102 130  36 241  65 889  205  57 514  87.3 
1970–71 …  157 079  61 454  95 625  403  82 244  86.0 
1971–72 …  171 109  70 529  100 580  430  86 244  85.7 
Public companies (a) 
1955–56 …  7 298  1 605  5 693  281  2 718  47.7 
1960–61 …  12 156  2 938  9 218  396  4 891  53.1 
1965–66 …  13 970  3 799  10 171  534  5 362  52.7 
1970–71 …  16 758  5 328  11 430  969  5 621  49.2 
1971–72 …  16 581  5 587  10 994  1 024  5 448  49.6 
note note  

  ― 224 ―

16.5. An initial question of a very fundamental kind is how companies should be regarded for tax purposes. One approach is to consider the company as a taxable entity in its own right, with an ability to pay quite distinct from that of the shareholders. Then, company tax problems would have to be seen largely in terms of securing equity between companies: the concept of fairness in the tax structure would have to be extended to define fair treatment of companies as well as of individuals.

16.6. Many people would argue, however, that it is in principle necessary to go behind the veil of separate legal personality which the company enjoys and translate the tax formally imposed on company income into a set of individual tax ‘burdens’—on shareholders, or on purchasers of the company's product. The fairness of the tax is then related to the capacities to pay of the various individuals whose private disposable incomes are reduced by the tax.

16.7. This latter approach is basically the one adopted by the Committee. Hence some judgment has to be made about which set of individuals undergoes a reduction in private income. Is it the shareholders, or consumers of the company's product, or both in some proportions? These questions are much debated by economists, with inconclusive results; but if anything, the balance of informed opinion has tended towards the view that the tax is unshifted.

16.8. In many cases, particularly for small family-owned companies, there is very little difference between a tax liability imposed under company income tax and one imposed under personal income tax on company profits as it accrues to the owners of the company. In such cases it seems difficult to justify making any assumptions about the incidence of company income tax that are not made in respect of personal income tax also. Although there is a very real possibility of personal income tax being shifted forward, as was mentioned in Chapters 4 and 6, it is not customary to predicate tax policy on the assumption that the personal income tax is so shifted, and no such assumption has been made in this report. Consistency suggests a similar line with company income tax.

16.9. In terms of abstract analysis it is certainly possible to distinguish the kinds of current economic situations in which firms can or cannot treat all or some tax as a cost, and to work out the factors determining how long shifting could be sustained and what distortion to economic efficiency might ensue. But it seems clear that in the complex and changing circumstances of reality the actual extent and location of such forward-shifting must defy measurement and forbid any attempt to allow for it in the design of a company income tax. At least it permits a more logical planning of this tax to make the general assumption, somewhat simplistic as it may be, that shifting is not significant and that the tax is substantially paid by shareholders.

16.10. The case for taxing individual shareholders through company tax must then rest on the judgment that, in the absence of company tax, shareholders would be taxed inadequately: that elements of the shareholder's capacity to pay would either not be brought to tax at all, or would be taxed too lightly, by the existing personal income tax. There are three distinct reasons why such a view might be taken:

  • (a) that those who own or operate business conducted under limited liability should pay extra tax for that privilege;
  • (b) that, unless capital gains were taxed on an accruals basis (whatever allowance is made for inflation), company retentions would not be sufficiently taxed, and scope for tax avoidance would be provided for those accumulating savings behind the corporate veil;

  •   ― 225 ―
    (c) that taxation of company income provides one of the few available means—from the revenue point of view certainly the most significant means—of levying tax on foreign residents deriving income from operations in Australia.

16.11. In the Committee's view, the first of these reasons is far from convincing. The second and third reasons for company tax are, by contrast, judged to be extremely important, and the ensuing discussion reflects this judgment.

I. Present System of Company Income Taxation

16.12. Company tax systems vary greatly from country to country and are being modified year by year. The present Australian system, which broadly resembles the system in the United States and the one the United Kingdom had between 1965 and 1972, has the prime characteristic of imposing a tax on the company that is quite separate from the further personal income tax shareholders pay on dividends. It is therefore generally known as the ‘separate’ system, though in much of the vast literature on corporate taxation it is termed the ‘classical’ system.

16.13. In Australia companies are classified for income tax purposes as either ‘public’ or ‘private’. The definitions are complex, but generally those companies whose shares are listed on a stock exchange and are consequently available for purchase by the general public (together with their subsidiaries and also Australian subsidiaries of overseas listed companies) are classed as ‘public’ and all other companies as ‘private’. Commencing with the 1973–74 income year, both public and private companies are subject to company tax at 45 per cent; previously, for many years, private companies had been taxed at a lower rate than public companies.

16.14. Dividends received by Australian resident companies normally attract a tax rebate which effectively prevents any further levy of company tax on the profits from which the dividends have been paid. Dividends received by Australian resident individuals are taxed as income without regard to any company tax paid on the profits from which the dividends derive. Dividends paid by Australian resident companies to non-residents are, in general, subject to Australian taxation in the form of a withholding tax at 30 per cent, or at 15 per cent if the non-resident receiving the dividend resides in a country with which Australia has a double taxation agreement.

16.15. The opportunity for high-income shareholders to defer and sometimes avoid personal tax by accumulating income in a private company in which they have a controlling interest is largely precluded by the imposition of a penal undistributed profits tax. This additional tax is levied at a rate of 50 per cent on the amount by which actual distribution of profits by a private company is less than a specified minimum distribution. In not requiring minimum distributions for public companies the system assumes that the larger spread of shareholdings of public companies will ensure that there is no unreasonable retention of their profits.

Criticisms of the present system

16.16. Separate systems are sometimes criticised for involving ‘double taxation’, since shareholders are required to pay personal income tax on company profits that have already borne company tax. But what is basically important is the total amount of levy a particular kind of income bears, not the number of taxes by which that amount is collected.

  ― 226 ―

16.17. Whether the separate system taxes company profits fairly depends upon whether or not it leads to the shareholder paying tax on his share of the profits at the marginal rate of personal income tax appropriate to his income if it included the whole of his share of the profits. The amount of tax paid, by the company and shareholder, in respect of the shareholder's interest in company profits depends upon the proportion of company profits distributed, the rate of company tax, and the shareholder's marginal rate of personal income tax. The manner in which these influences operate is shown in Table 16.B. In this table, assuming a company tax rate of 47½ per cent, the rate of tax paid by a shareholder on company profits can be compared with his marginal tax rate, for various levels of shareholder's income and various levels of retention by the company. In this calculation, all retained profits are presumed to bear tax at 47½ per cent: in the long term these may contribute to a capital gain in the value of the company's shares, and to the extent that they do any such gain will not have incurred personal income tax. Only the distributed portion of profits will bear the personal income tax as well. Thus if a company retains half its profits after payment of company tax, a shareholder on a personal marginal rate of 66.7 per cent will in effect pay only 65 per cent on his proportion of the company's before-tax earnings. But had his marginal rate on personal income been 15.4 per cent, his full share of profits would have been taxed at 51.5 per cent.


Shareholder's notional income (a)  Shareholder's marginal rate of personal income tax (b)  Combined company / personal tax expressed as a percentage of company profits, assuming proportion of profits retained is: (c) 
per cent  0 per cent  25 per cent  50 per cent  75 per cent  100 per cent 
2,000  15.4  55.6  53.6  51.5  49.5  47.5 
5,000  33.3  65.0  60.6  56.3  51.9  47.5 
12,000  48.2  72.8  66.5  60.2  53.9  47.5 
50,000  66.7  82.5  73.8  65.0  56.3  47.5 

(a) Including an attribution of company profits before tax according to his shareholding. (b) On final increments of income as shown in previous column; 1973–74 rate scale. (c) The company tax rate is taken as 47½ per cent, the 1972–73 public company rate. The personal tax rate is as shown in the second column, implying that the amount of company profits attributable is modest enough to be wholly taxable at the one marginal rate.

16.18. Table 16.B indicates more generally the way in which over-taxation of a shareholder on company profits is related to the shareholder's total income and the retention policy of the company. At all income levels, the effective tax rate is lower the greater the proportion of profits retained, although the tax saving from retention (both relatively and absolutely) is greater the higher the individual's income. At the same time, the amount of over-taxation, for a given retentions policy, is greater (both relatively and absolutely) the lower the individual's income: indeed, for high-income individuals, high retention results in under-taxation.

16.19. Thus the combined conpany / personal income tax borne by shareholders paying marginal rates of personal income tax of less than 47.5 per cent will in all cases exceed those marginal rates, but whether this is true of higher-income shareholders will depend upon what distributions are made. The system is clearly inequitable. In low income ranges, it discriminates against those who invest relatively more of their savings in equity shares; in very high income ranges, it probably discriminates the other way. It discriminates between individuals on the same incomes with identical

  ― 227 ―
savings according to the different distribution policies of the companies whose shares they hold. It substantially defeats the general progressivity of the income tax.

16.20. It fails also, in several distinct ways, when the test of efficiency is applied:

  • (a) The over-taxation of the profit entitlements of some shareholders creates a bias against their doing business in corporate form, although the under-taxation of other shareholders creates the opposite bias. Admittedly, the former bias may inhibit the use of company organisation for income splitting purposes; but even if the discouragement of income splitting is proper, the over-taxing of company profits is not an appropriate way of going about it. The Committee believes that tax law should, as far as possible, be neutral in its effect on the choice of a form of business organisation.
  • (b) The separate system favours retention of profits, as retained profits bear income tax only at the company level. The addition of a capital gains tax, as proposed by the Committee, will not fully correct this distortion, since capital gains tax applies only on realisation and thus may be indefinitely deferred. Whether the distortion is a ground for criticism depends on the view that is taken of company self-financing through retention of profits, compared with financing by resort to the market. In terms of general economic policy and ignoring the financial strain that high rates of inflation can impose on active businesses, a case can be made for companies distributing all their profits over a period and relying upon the market for acquiring more capital, though innumerable reasons can be suggested why it might be thoroughly imprudent for them to distribute fully each year. This would imply that it would be desirable to reconstruct the tax in such a way as to replace its present bias against full distribution with one in its favour. But in view of the great diversity of kinds of business conducted in the company form, the variations in the annual fortunes of companies, the variations in pressure to retain or distribute to which managements are subject and possible large discrepancies between accounting, economic and business definitions of profit, any attempt to do this may create serious problems in practice. On the whole, therefore, the Committee concludes that neutrality is the best practical test.
  • (c) The separate system is clearly not neutral as between equity and debt financing. Company income going in payment of interest on debt is not taxed at the company level, but only under the personal income tax in the hands of the lender. As indicated in Table 16.B, this produces a bias in favour of investment in debentures and other fixed-interest securities for all low-income shareholders and a bias in favour of equity investment in high-retention companies for high-income shareholders. It creates pressure to increase the gearing of debt finance to equity and fixed-interest capital raising may become more difficult for less well established ventures with few assets that can be offered as security. It tends to divert the savings particularly of low-income individuals away from equity investment, and to create a gap in the flow of Australian funds to developmental enterprises requiring equity capital. The gap may then be filled to a greater extent by overseas investors than is felt desirable on general grounds.

  ― 228 ―

II. Unacceptable Alternatives to the Present System

16.21. It is thus clear that the existing system is in need of reform. Four alternative schemes, all of which have been seriously proposed in various contexts and all involving the outright abolition of one or other of the two taxes now imposed on income arising in companies, have been examined by the Committee. None of them can however be recommended.

Tax the Allocation of Profits

16.22. One system—perhaps the theoretical ideal—would require the company to allocate its annual profits to shareholders in accordance with their interests in those profits, and require shareholders to include the allocations in their incomes. There would be a like allocation of losses.

16.23. ‘Double taxation’ would be avoided, there being no separate company liability for tax. Equity would be served. The tax system would be neutral in all those respects referred to in paragraph 16.20 in which neutrality is at present lacking. In theory, liquidity problems for shareholders could be overcome by the company making cash distributions sufficient to cover personal tax at the maximum marginal rate on the allocation.

16.24. There is scope for such a system where corporate structures are simple enough for the interests of individuals in the company profits to be readily identified. In effect the company is taxed as a partnership. (Proposals enabling shareholders to elect to be taxed as a partnership when defined conditions are met are made later in this chapter.) But an arrangement of this kind could never be universally applied. Even when all shareholders in a company are individuals, it may be impossible to determine a correct allocation because different classes of shareholders may have differential rights to profits and those rights are not definitively expressed. The task of allocation will be that much greater when allocation must be made through a series of company shareholders. There may be additional practical problems.

16.25. There is a method of allocation available under the existing law involving bonus issues of shares from revenue profits. This method can, however, have only limited operation and could not be the general method of allocation. It involves a change in the company's capital structure by converting reserves into share capital. And it is hard to see how the method could be used when allocations have to be made through a number of companies.

16.26. The taxation of non-resident shareholders under this system would probably raise insuperable difficulties. The present system of taxing dividends received by non-residents involves a withholding tax which, with the underlying company tax, imposes what is thought to be an adequate flat rate of tax. The amount of withholding tax which can be imposed is limited to 15 per cent by a number of international agreements to which Australia is a party. Presumably those agreements would be construed so as to allow withholding tax on allocations; however, non-residents would not be taxed sufficiently unless the permitted amount of withholding tax were multiplied several times over. Double taxation agreements can be renegotiated, but a change of the kind envisaged might not easily be secured.

Tax Actual Distributions and Accruals in Value of Shares

16.27. Another system would tax shareholders only, on actual distributions and increases in share values, those increases reflecting, among other things, the profits

  ― 229 ―
not distributed. If decreases have occurred in the value of shares, these would need to be taken into account in determining the amount subject to tax. The system would reach undistributed profits only in so far as such profits are reflected in the value of shares. At the same time, it would reach other gains by the company, realised and unrealised, reflected in the value of its shares as well as increases in value due to changes in interest rates and other market factors.

16.28. The system would have many of the advantages of the allocation arrangement. But it is not feasible to tax capital gains from all varieties of assets on an accruals basis; hence this scheme would involve non-neutrality between shares and other assets. Also, while it might be practicable and was once proposed for Canada to tax capital gains on listed shares in this manner, the problems of an annual valuation of all shares would be intolerable. Finally, the implications for taxing non-residents would be akin to those of the allocation system.

Require Distribution of all Profits and Tax These Distributions

16.29. The method of requiring distributions would be the imposition of an undistributed profits tax not intended to raise revenue but to penalise a failure to distribute. Equity would be achieved. Neutrality would be restored in all respects except between retention and distribution of profits. This want of neutrality could be mitigated if the system allowed a bonus issue of shares to count as a cash distribution. The difficulties involved in regard to such bonus issues are adverted to in paragraph 16.25. A scheme of this kind, including the mitigation, was proposed in the economists’ study referred to in paragraph 1.5.

16.30. This system would have implications for the taxation of non-residents akin to those of the two systems just dismissed.

Tax the Company and Exempt Dividends from Personal Income Tax

16.31. Taxing the company while exempting dividends from personal income tax is clearly unacceptable on equity grounds. If the company was not to be used as a tax shelter by high-income shareholders, the rate of company tax would have to be the maximum marginal rate of personal tax, in which case it would be absurdly high for the lower-income shareholder. Unless the present maximum marginal rate is substantially reduced, the rate of tax would be out of line with rates of company tax abroad. Foreign portfolio investors would be deterred from making investments in Australian companies and direct investors would seek by various devices or excess reliance on loan capital to ensure that a controlled Australian company had little or no profits.

III. Split-Rate and Imputation Systems

16.32. It is thus clear that income tax must continue to be imposed both on companies and on shareholders, above all for international reasons and to prevent the company from being a tax shelter for high-income shareholders. But the unfair incidence upon the individual shareholder of the existing system needs remedying. To this end consideration must be given to a system that makes some allowance at either the company level or the shareholder level for company tax on distributed profits.

16.33. Where an allowance is made at company level, the system is generally referred to as split-rate. For example, if dividends paid are allowed as a deduction in computing profits subject to company tax, there are in effect two rates of tax: a positive rate on undistributed profits and a zero one on distributed profits. Initially, this was the way the Commonwealth company tax operated. Split-rate systems more often,

  ― 230 ―
however, impose a positive rate of company tax on distributed profits, though a rate lower than that on undistributed profits.

16.34. Alternatively, the shareholder may be permitted a credit against personal income tax on dividends received to allow for all or some of the tax paid by the company on the profits distributed. This is generally referred to as the imputation system. The system involves adding to the cash dividend received by the shareholder an amount representing tax paid by the company. The shareholder is taxed on the dividend so ‘grossed up’ and is allowed credit of the amount representing the company tax against his personal income tax liability. The mechanism of imputation is illustrated later in Tables 16.D and 16.E.

16.35. The differences between split-rate and imputation systems are not significant at the domestic level: if a withholding tax on dividends paid to residents is added to a split-rate system, it will be virtually indistinguishable in its consequences from a corresponding imputation system. But the differences are by no means insignificant in the international field. Thus a split-rate system imposing a zero rate of tax on distributed profits would tax non-resident shareholders only to the amount of withholding tax on such profits—in other words, to a maximum levy of only 15 per cent where the shareholder is resident in a country with which Australia has a double taxation agreement. This difficulty is shared by the split-rate system with all the one-tax systems at the shareholder level.

16.36. It is therefore assumed in what follows that some form of imputation is needed and that this should allow, with as much precision as is administratively possible, for all or some of the company tax on distributed profits.

16.37. The effect on shareholders with various incomes of full imputation is shown in Table 16.C. Clearly, the full imputation system is not wholly neutral between retention and distribution: low-income shareholders will prefer distribution, while high-income shareholders will prefer retention. But this is to be contrasted with the existing ‘separate’ system in which all shareholders, if they consider only tax consequences, have reason to favour retention. However, the full imputation system, coupled with the 1973–74 personal income tax rate schedule, would leave the shareholder on $12,000 a year more or less indifferent between distribution and retention, and in so far as this is the income position of the ‘average’ shareholder neutrality will be very nearly achieved.


Shareholder's notional income (a)  Shareholder's marginal rate of personal income tax (b)  Combined company / personal tax expressed as a percentage of company profits, assuming proportion of profits retained is: (c) 
per cent  0 per cent  25 per cent  50 per cent  75 per cent  100 per cent 
2,000 A   15.4  15.4  23.4  31.4  39.5  47.5 
B   55.6  53.6  51.5  49.5  47.5 
5,000 A   33.3  33.3  36.8  40.4  43.9  47.5 
B   65.0  60.6  56.3  51.9  47.5 
12,000 A   48.2  48.2  48.0  47.8  47.6  47.5 
B   72.8  66.5  60.2  53.9  47.5 
50,000 A   66.7  66.7  61.9  57.1  52.3  47.5 
B   82.5  73.8  65.0  56.3  47.5 

  ― 231 ―

16.38. One conspicuous feature of Table 16.C is that for shareholders on incomes up to $12,000 a year the over-taxation of income derived through the company is substantially reduced vis-a-vis the separate system. On the other hand, shareholders with incomes over $12,000 will continue to be under-taxed to the extent that profits are retained, ignoring for the moment any tax levied on capital gains to which those retained profits give rise. In fact, this latter group of shareholders will be more under-taxed than under the separate system.

16.39. It seems clear that under full imputation (Table 16.C) equity will be better served the higher the proportion of profits distributed. A requirement, were it feasible, of full distribution of profits would thus achieve equity for all domestic shareholders. But such a requirement would offend notions of neutrality. Where the company tax is levied at a rate lower than the maximum marginal rate of personal income tax, it may nevertheless be desirable in the full imputation case to impose, in the interests of equity, a minimum distribution requirement, thereby limiting the extent to which the company can be used as a tax shelter by high-income shareholders.

Choice of an Imputation System

16.40. There are three main kinds of imputation system to choose between:

  • A. One that taxes the company at the maximum rate of personal tax and allows full imputation.
  • B. One that taxes the company at a rate less than the maximum marginal rate of personal tax and allows full imputation.
  • C. One that taxes the company at a rate less than the maximum marginal rate of personal tax and allows partial imputation.

16.41. While the maximum marginal rate of personal tax continues at the present level, system A involves a company tax rate out of line with rates of company tax in other countries. One might, however, envisage in the long term a lowering of the maximum marginal rate of personal tax to a level which, adopted as the company rate, would not be out of line internationally.

16.42. The system would have the advantage that it would no longer be necessary to require minimum distributions by private companies.

16.43. The prospect of capital gains tax on the realisation of shares, together with a rate of tax on retained profits equal to the maximum marginal rate on personal income, would give an incentive for companies to make maximum feasible distributions. This is so because undistributed profits, in so far as they give rise to capital gains, would bear total company and capital gains tax at a higher rate than would apply to distributed profits. The resultant pressure towards maximum distributions would operate in the interests of equity as Table 16.C indicates, but would be far from neutral between retention and distribution.

16.44. To overcome this problem the Canadian Royal Commission, which favoured system A, proposed that there should be means of allocating profits by companies. The profits allocated would be taxed to individual shareholders with credit, and added to the shareholder's cost of his shares for capital gains tax purposes. The Committee has already dismissed universal allocation as impracticable.

  ― 232 ―

16.45. Without such allocations provisions, the lack of neutrality in the treatment of company retentions would be too severe. The Committee accordingly rejects system A.

16.46. System B, whereby the company is taxed at a rate less than the maximum marginal rate of personal tax and the shareholder is allowed full imputation, need not involve a company rate out of line with other countries and could ensure adequate taxation of non-residents. It would also reduce the extent of non-neutrality in the choice of form of organisation and in the choice between equity and loan capital. It could be neutral, in the sense explained in paragraph 16.37, between retention and distribution.

16.47. If existing levels of company distributions continue, system B will mitigate inequity towards the bottom of the scale. However, it is likely to create a tax shelter for high-income controlling shareholders, a shelter that could not be completely corrected by any minimum-distribution requirement. With anything less than full distribution, the high-income shareholder has the advantage of a tax deferral which would continue until full distribution or realisation of the shares. If full distribution were required, the system would be open to the non-neutrality and impracticality objections already raised to such systems.

16.48. A minimum-distribution requirement would, nevertheless, reduce the tax shelter possibilities of the system, particularly if the gap between the company rate and the maximum marginal rate for individuals were reduced so that it was not more than, say, 10 per cent. Closing the gap between the company rate and the maximum marginal rate for individuals, given a continuance of existing levels of distribution, will mean that the mitigation of inequity towards the bottom end of the scale will be less but there will be a gain in equity at all levels of income compared with the present system. Full imputation and a narrowing of the gap between company tax and the maximum marginal rate of personal tax are likely, as already explained, to cause an increase in distributions. The effect of any increase must be to improve the equity of the company tax system at all levels of income.

16.49. System B might then be regarded as the appropriate long-term target. Admittedly, there would be difficulties stemming from the need to limit the gap between the maximum marginal rate of personal tax and the company tax rate; but in the long term it may be possible to envisage a lowering of the maximum marginal rate of personal tax that will make this feasible. The system would be costly to revenue and would need to be associated with changes in the tax structure generally.

16.50. The changes required, were system B to be implemented, would be considerable. And, as a matter of principle, such a system of company tax would need to be introduced slowly: if it were not, there would be a distinct danger that much of the benefit of imputation would be capitalised immediately into the value of shares, with haphazard distributional consequences unrelated to the aims of allowing imputation. For these reasons, any such approach to system B should be gradual, for example via a partial imputation system like system C. This system provides a company rate that need not be out of line internationally, yet would ensure adequate taxation of non-residents. It would mitigate the inequity and the non-neutralities of the present system. The extent of mitigation would depend on the rate of company tax adopted, the measure of imputation allowed and the rate of tax on capital gains.

16.51. In the Committee's view, a company tax at less than the maximum marginal rate of personal income tax coupled with a partial imputation of company tax at the

  ― 233 ―
shareholder level (system C) is the appropriate immediate step. It therefore recommends a system of this kind.

IV. Proposed Imputation System

16.52. In recommending a partial imputation system the Committee is proposing a system that is in force in several overseas countries and is gaining support in others. It was in use in the United Kingdom up to 1965, and a carefully reconstructed system was reintroduced there in 1972. It is the system introduced in Canada in 1971. It has also been recommended for adoption in Ireland.

16.53. The extent of the effective imputation of company tax fluctuates under most systems as the company tax rises and falls. The method adopted involves allowing a tax credit of a portion of the actual dividend received by a shareholder, the shareholder being required to include in his income subject to tax the amount of the actual dividend and the amount of the tax credit. Thus, in Canada an individual shareholder is entitled to a tax credit of one-third of a dividend received. If one assumes that the company tax rate is 50 per cent, this will involve an imputation of one-third of the company tax. However, some Canadian companies pay a lesser rate of company tax. The one-third dividend-received credit will in the case of these companies involve an imputation of a greater proportion of the company tax.

16.54. The United Kingdom system is intended to ensure that the tax imputed is no more than a specified amount of the United Kingdom tax that has actually been paid by the company. It was felt important to ensure that the United Kingdom revenue did not, by way of credit or refund, remit to shareholders taxes that it had never received. Company distributions in many cases are made from profits which have been taxed in another country and relieved from United Kingdom corporation tax by the operation of a tax credit and also from profits which, because of accelerated depreciation provisions under the United Kingdom law, have not been taxed to the company. Canada does not attempt to ensure that imputation is limited to the Canadian company tax actually paid. In the United Kingdom the shareholder is entitled to the tax credit and a refund should the credit exceed his total tax liability. In Canada the credit may be applied against the total tax liability of the shareholder but it may not result in a refund to him.

16.55. The Canadian system has the advantage of simplicity. A number of special procedures are incorporated in the United Kingdom law. Moreover, under the United Kingdom system a distribution must be identified as it passes through interposed companies.

16.56. The virtue of the simplicity in the Canadian system may be purchased at a price in terms of credit for, and refunds of, tax not in fact paid by the company. Whether this price would be excessive in Australia depends on the amount of imputation allowed, the extent of the foreign operations of Australian companies, and the significance of incentive and other provisions which may reduce company taxable income below a company's profits. The Committee proposes for the short term the adoption of the Canadian system of imputation; it also proposes, in the interests of the low-income shareholder, additional provisions by which a refund of tax may be made. It is conscious, however, that as one moves towards the long-term objective the price may become excessive and the need for a system of the United Kingdom type compelling.

  ― 234 ―

16.57. The revenue consequence of the Committee's recommendations will depend on the rate of company tax adopted, the measure of imputation and the level of distribution made by companies. If the present rates of company tax remain and distributions do not increase, any imputation will clearly result in a loss of revenue. Some loss is unavoidable, however, if the inequities of the present system are to be corrected and there will be some offset arising from the introduction of the capital gains tax proposed by the Committee.

16.58. Loss of revenue can be averted, in whole or in part, by an increase in the company tax rates. But the effect on equity would have to be considered. Retained profits attributable to low-income shareholders will have been taxed at rates exceeding still further the marginal rates of those shareholders. A higher rate of company tax indicates the need for greater distribution, if the low-income shareholder's position is to be restored.

16.59. The proposed system, whatever company rate and imputation rate are adopted, will not remove the differential tax treatment under the present system between high- and low-income shareholders. Though the difference may be reduced, the system will continue to favour the former.

Amount of Imputation

16.60. The Committee proposes that initially a dividend tax credit in the range from one-quarter to one-third of the dividend received might be contemplated in association with an increase in the company tax rate over the 1972–73 rate, say to 50 per cent. The cost to revenue of an imputation system involving a dividend tax credit of one-quarter on this basis would, on the assumption that it is not allowed to non-residents, life insurance companies and exempt bodies, be minimal. Whether it should be allowed to any of these is not here considered. Clearly, the cost of a one-third credit would be somewhat higher. Tables 16.D and 16.E illustrate the operation of imputation in the taxing of dividends received by shareholders on different marginal rates of personal tax when the dividend tax credits are one-quarter and one-third respectively.

16.61. The introduction of this limited imputation system is unlikely in itself to affect share prices significantly. Any tendency for share prices to rise may well be offset, perhaps more than offset, by the effects of introducing the Committee's proposals for taxing capital gains.

Minimum Distributions by Companies

16.62. The fact that the rate of company tax will be less than the maximum marginal rate of personal tax will leave the prospect of the use of a company as a tax shelter by a high-income shareholder. The present undistributed profits tax on private companies will continue to be necessary to ensure that minimum distributions are made, and its possible extension to all companies is considered later in this chapter.

16.63. The amount of a minimum distribution required of a private company will need to be re-examined. The likely preference of company management for self-finance has to be recognised, but the fixing of a minimum distribution should reflect the level of distribution necessary to ensure that the company is not used as a tax shelter by high-income shareholders. Under an imputation system, the level of a minimum distribution should, prima facie, be higher than under the present system. But this would not take account of any increase in the rate of company tax or the Committee's proposals for the introduction of a capital gains tax.

  ― 235 ―


Shareholder's marginal rate  
20 per cent   30 per cent   40 per cent   50 per cent   60 per cent   66 2/3 per cent  
1. Company profit before tax  200.00  200.00  200.00  200.00  200.00  200.00 
2. Company tax (50 per cent)  100.00  100.00  100.00  100.00  100.00  100.00 
3. Company profit after tax (1–2)  100.00  100.00  100.00  100.00  100.00  100.00 
4. Retained by company (50 per cent)  50.00  50.00  50.00  50.00  50.00  50.00 
5. Dividend to shareholder (3–4)  50.00  50.00  50.00  50.00  50.00  50.00 
6. Gross up on dividend (shown in 5) by ¼  12.50  12.50  12.50  12.50  12.50  12.50 
7. Amount shown in shareholder's tax return (5 + 6)  62.50  62.50  62.50  62.50  62.50  62.50 
8. Tax (on 7) at marginal rate  12.50  18.75  25.00  31.25  37.50  41.66 
9. Tax credit (= 6)  12.50  12.50  12.50  12.50  12.50  12.50 
10. Tax payable by shareholder  nil  6.25  12.50  18.75  25.00  29.16 
11. Total tax paid by company and shareholder (2 + 10)  100.00  106.25  112.50  118.75  125.00  129.16 
12. Under a separate system with 50 per cent tax rate and 50 per cent distribution, the total tax paid by company and shareholder would be:  110.00  115.00  120.00  125.00  130.00  133.33 
13. The net of tax gain to shareholder of one-quarter imputation on this basis would be:  10.00  8.75  7.50  6.25  5.00  4.17 
14. Under the 1972–73 public company rate of 47½ per cent with a 50 per cent distribution, the profit after tax would be $105 and the retention and dividend each $52.50. Were the assumption made that the absolute sum of retention would remain constant at $52.50 after the tax rate is increased to 50 per cent and one-quarter imputation operated, the dividend would decrease to $47.50. The net of tax gain to shareholder, using these assumptions and despite the reduction in dividend from $52.50 to $47.50, from the adoption of one-quarter imputation coupled with a company tax rate of 50 per cent, would be:  5.50  4.81  4.12  3.44  2.75  2.29 
15. If the original profit of $200 were earned directly by an individual, the tax payable would be:  40.00  60.00  80.00  100.00  120.00  133.33 

International Implications of the Proposed Imputation System

16.64. The discussion of the proposed imputation system has so far assumed that imputation will be available only to Australian resident shareholders and that, in principle, it should be available only in respect of dividends from profits that have borne Australian tax. But an imputation system also has international implications that cannot be ignored: they concern both investment by non-residents in Australia and investment by Australian residents in other countries.

  ― 236 ―


Shareholder's marginal rate  
20 per cent   30 per cent   40 per cent   50 per cent   60 per cent   66 2/3 per cent  
1. Company profit before tax  200.00  200.00  200.00  200.00  200.00  200.00 
2. Company tax (50 per cent)  100.00  100.00  100.00  100.00  100.00  100.00 
3. Company profit after tax (1–2)  100.00  100.00  100.00  100.00  100.00  100.00 
4. Retained by company (50 per cent)  50.00  50.00  50.00  50.00  50.00  50.00 
5. Dividend to shareholder (3–4)  50.00  50.00  50.00  50.00  50.00  50.00 
6. Gross up on dividend (shown in 5) by 1/3  16.67  16.67  16.67  16.67  16.67  16.67 
7. Amount shown in shareholder's tax return (5 + 6)  66.67  66.67  66.67  66.67  66.67  66.67 
8. Tax (on 7) at marginal rate  13.33  20.00  26.67  33.33  40.00  44.44 
9. Tax credit (= 6)  16.67  16.67  16.67  16.67  16.67  16.67 
10. Tax payable by shareholder  (3.34)  3.33  10.00  16.66  23.33  27.77 
11. Total tax paid by company and shareholder (2 + 10)  96.66  103.33  110.00  116.66  123.33  127.77 
12. Under a separate system with 50 per cent tax rate and 50 per cent distribution, the total tax paid by the company and shareholder would be:  110.00  115.00  120.00  125.00  130.00  133.33 
13. The net gain to shareholder of one-third imputation on this basis would be:  13.34  11.67  10.00  8.34  6.67  5.56 
14. Under the 1972–73 public company rate of 47½ per cent with a 50 per cent distribution, the profit after tax would be $105 and the retention and dividend each $52.50. Were the assumption made that the absolute sum of retention would remain constant at $52.50 after the tax rate is increased to 50 per cent and one-third imputation operated, the dividend would decrease to $47.50. The net of tax gain to shareholder, using these assumptions and despite the reduction in dividend from $52.50 to $47.50, from the adoption of one-third imputation coupled with a company tax rate of 50 per cent, would be:  8.67  7.58  6.50  5.42  4.33  3.61 
15. If the original profit were earned directly by an individual, the tax payable would be:  40.00  60.00  80.00  100.00  120.00  133.33 

16.65. Investment by non-residents. Australia may expect pressure from other countries, especially those involved in double taxation agreements, to extend to non-residents at least some part of the imputation given to residents. The pressure will of course be greatest from countries already having a system that allows imputation to non-residents.

16.66. There does not appear to be any legal obligation, under existing agreements to which Australia is a party, to extend imputation to non-residents. There is, for example, no clause in these agreements corresponding to the non-discrimination clause in the 1963 OECD draft convention. In any case, the discrimination with which that clause deals is discrimination against another country's nationals, and this has

  ― 237 ―
never been contemplated: if imputation is denied to some shareholders, it would be on the basis of their residence whatever their nationality.

16.67. Agreements to which Australia is a party include provisions imposing, on a reciprocal basis, a ceiling on the tax Australia may levy on dividends paid by an Australian resident company to a resident of the other country. It might be argued that tax on a dividend should be interpreted to include that part of the tax paid by the company which is subject to imputation in the hands of an Australian resident shareholder. The argument would be difficult to sustain in relation to an imputation system of the Canadian type, which does not attempt to correlate the imputation credit available to the shareholder with an amount of tax paid by the company. On the other hand, the argument might be thought to have some force where there is such a correlation, as under the United Kingdom system. Yet in asserting that one should look beyond the tax expressly levied on a dividend to the tax paid by the company in order to find the amount of tax on the dividend, the argument opens up the whole question of the incidence of company tax. It is difficult to see why it should be any more appropriate to treat the imputed tax as a tax on the dividend than to treat the whole of the company tax on the profits from which the dividend is paid as a tax on the dividend.

16.68. Apart from any legal obligation resting on Australia, it might be said that there is an obligation of comity between nations requiring reciprocity in levels of tax that one country imposes on residents of another. This obligation might, for example, require that Australian tax on a resident of the United States should not exceed the tax which, in similar circumstances, the United States imposes on a resident of Australia. Even if company tax is assumed to be paid by the shareholders of the company, the consequence of the suggested obligation would only be that the burden of Australian company tax and tax on dividends paid to a United States resident should be in line with the taxes the United States imposes in relation to dividends paid to an Australian resident. Perhaps there is in the suggested obligation some requirement, if a country's rate of company tax is greater than that imposed in another, to make an adjustment to its rate of tax on dividends flowing to that other country.

16.69. All these requirements, whether in terms of legal obligation or comity between nations, proceed on a notion of fairness to the shareholder that may be thought unreal. Fairness to a non-resident shareholder in relation to a dividend received depends not only on how Australia taxes the dividend but also on how it is taxed, more particularly what credit is allowed, in the country of residence.

16.70. So far as the arguments are made in terms of fairness between the public revenues of countries, it must be borne in mind that Australia is a net capital-importing country. Relatively, a forbearance to tax a non-resident is more expensive for Australia in terms of revenue forgone than is the same forbearance by a net capital-exporting country.

16.71. The Committee is content to express the view that Australia is not under any present obligation to extend imputation to non-residents. Whether or not imputation is extended to residents of any foreign country will depend on the economic policies Australia may wish to pursue as well as on revenue considerations.

16.72. Investment by Australian residents in foreign countries. The adoption of an imputation system will have a bearing on the choice for Australian capital between investing in Australia and investing in other countries. The discouragement to investing abroad will be evident enough if Australia follows an imputation system of the

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United Kingdom type, which would confine imputation to dividends paid by Australian resident companies and would set a limit to the amount of tax subject to imputation so that it cannot exceed Australian tax actually paid by the company. If the Canadian model is followed, an Australian resident company will not be discouraged from investing abroad. The Canadian system allows imputation in respect of dividends paid by a resident company, whether or not the profits from which the dividend has been paid have borne Canadian tax.

16.73. Imputation would not be available to an Australian resident individual against Australian tax on the dividends he receives from a foreign resident company. Therefore whether Australia follows the United Kingdom or the Canadian model, there will be reason for an Australian resident individual to prefer investing in an Australian resident company to investing in a foreign resident company.

16.74. A compromise between the United Kingdom and Canadian systems, which would overcome the discouragement to foreign investment by an Australian company involved in the former system, would in effect allow imputation credit of tax paid abroad but confine the credit so that it was available only against Australian tax on the dividend in the hands of the shareholder. The Committee would not favour such a compromise in its application to dividends paid from profits that had borne Australian tax. In relation to such dividends, the credit should be available against other tax liability of the shareholder or, if necessary, give rise to a refund. The compromise would need to be confined to dividends paid from foreign-source profits that had not borne Australian tax. There would be considerable administrative complications; but one might visualise companies being required to distinguish in their accounts between profits that have borne Australian tax and those that have not, with the compromise credit treatment applying to dividends from the latter.

V. Imputation and Forward-Shifting

16.75. In recommending a full imputation system as the appropriate long-term target, with a partial imputation as an intermediate step, the Committee carries to its logical conclusion its assumption that company tax is best treated as a levy on the income of shareholders, despite the probability that in cases where competition is weak it may be shifted forward. Others may believe that the frequency of such shifting is, and would be even under an imputation system, so great that company tax should be designed on an assumption of partial shifting (which, since company tax rules must apply universally, would have to be uniform). The Committee, to repeat, rejects this approach, but its logical implications may be briefly noted.

16.76. On this view company tax is partly an indirect tax on consumers and only partly a tax on shareholders. The former part, it would have to be conceded, is non-neutral and probably inequitable; but as long as the company tax itself exists, it seems quite impracticable to remedy this.

16.77. As regards its impact upon shareholders, the crucial consideration would be that the effective company tax rate is below the nominal, and presumably intended, rate. The simple remedy would be to increase the nominal rate above the level that would otherwise be felt appropriate.

16.78. The assumption of shifting would not destroy the general case for imputation. On the assumption that imputation credits are forward-shifted in the same way

  ― 239 ―
as the company tax itself—if, in other words, the imputation credit involves a reduction in the amount of gross company tax shifted—the credit should be raised to match the increased nominal company tax rate.

VI. Proposal to Allow an Election to be Taxed as a Partnership

16.79. An alternative to the present system—the allocation by the company of all its profits to its shareholders, the allocation reflecting their interests in those profits, and the taxing of those profits to the shareholders—was dismissed in paragraph 16.24, principally because of the impracticability of applying it to all companies.

16.80. The Committee does, however, consider it appropriate that the law, whether or not an imputation system is adopted, should specify the conditions of a corporate regime within which an arrangement of this kind is practicable, and should allow the shareholders of a company meeting those conditions to elect to be taxed on allocations in the manner in which partners are taxed.

16.81. The United States has had a system of election for a number of years and is currently considering its reform. A similar system was proposed for Canada, both by the Carter Commission in 1966 and in the subsequent government White Paper of 1969. The proposal has not been implemented, possibly because a similar result to a system allowing an election is achieved in Canada by the provisions described later in paragraph 16.97. Those provisions ensure that smaller companies are taxed in a way which involves payment ultimately of no more tax than would have been paid had the business been carried on in partnership form, and may involve a deferral of tax in the meanwhile. In the United Kingdom the Report of the Committee of Inquiry on Small Firms (Bolton Committee, 1971) recommended that close companies—the equivalent of Australian private companies—should be allowed to elect to be taxed as partnerships. The fact that this recommendation has not been acted on may be because the United Kingdom has now adopted provisions, described in paragraph 16.98, allowing a lower rate of tax on smaller companies.

16.82. As explained in paragraphs 16.100–16.101, the Committee does not favour provisions along Canadian or United Kingdom lines. Its proposal to allow an election to be taxed in the manner of a partnership has therefore a more important function in its overall recommendations for the taxing of company profits.

16.83. It is not proposed to spell out in detail the system Australia might adopt. There are, however, certain issues of principle bearing on the scope of the system to which reference should be made. Some indication will be given, in a general description of a proposed system, of the inevitable complexities involved.

Eligibility to Elect

16.84. A number of issues relating to eligibility to elect call for examination. These concern the possibility of confining the election to companies whose profits are below a specified limit and whose income is not investment income; the possibility of confining the election to companies whose income is derived from Australian sources; the restrictions that should be imposed in terms of numbers of shareholders, the kinds of shareholders, and the capital structure of the company.

16.85. Amount and nature of company profits. In the United States the election is available whatever the amount of company profits, and in this respect there is no

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attempt to confine the election to smaller companies. In Canada the Carter Commission would have confined the election to companies with incomes below $200,000. In the Committee's view the election to be taxed in the manner of a partnership is not primarily directed to assisting small companies, but is a means of ensuring that company profits are taxed fairly. It follows that there should be no restriction on the election by reference to the amount of company profits.

16.86. The United States law denies the election to a company deriving 20 per cent or more of its income from investments, though it has been proposed that this restriction be eliminated. The Committee does not think it appropriate to impose such a restriction. The availability of the election to an investment company is consistent with the treatment proposed in paragraphs 16.116–16.117 of investment income of companies that have not elected.

16.87. The United States does not allow an election when more than 80 per cent of a company's income is derived from foreign sources. The only reason for such a restriction would seem to be the administrative complications involved in allowing tax credits to shareholders; but in the Committee's view these are not sufficient to justify discriminating between companies with domestic-source and companies with foreign-source income.

16.88. Number and nature of shareholders. The compliance and administrative costs of an election system will be minimised if the election is confined to companies with small numbers of shareholders all of whom are individuals and beneficially entitled. In the United States the number of shareholders may not exceed ten, though it has been proposed that this be raised to fifteen to allow greater flexibility, making it possible, for example, to issue shares to key employees. The Committee favours the maximum number of shareholders being set at ten, at least until the administrative problems involved in an election system have been carefully assessed.

16.89. All shareholders should be individuals who are beneficially entitled. An exception might be made of the administrator of a deceased estate; but the system could not be conveniently applied where a shareholder is another company. All shareholders and the company itself should be resident in Australia.

16.90. Capital structure of the company. If the allocation of profits to shareholders is to be made as easy as possible, all shares in the company should carry the same rights to income and capital. In the United States all shares must be of the same class, though consideration is currently being given to allowing also a class of shareholders without voting rights who have rights to fixed annual distributions and to a fixed amount upon redemption. The Committee would take the view that, at the outset at least, only one class of shares should be allowed.

Manner and Timing of Election and Manner of Termination of Election

16.91. The working out of detailed provisions as to the manner and timing of an election and the manner of termination of an election will be assisted by drawing on United States experience. If, as suggested in paragraph 16.93, both profits and losses are allocated to shareholders by reference to their daily holdings of shares throughout the year, it will be necessary to set the time for making an election early in the year of income and to deem a shareholder who signs an election to have been a shareholder from the beginning of the year. A person who acquires shares thereafter should be deemed to have consented to the election unless he gives the Commissioner notice of revocation. Subject to this, the unanimous consent of all shareholders should be

  ― 241 ―
required. All shareholders who have consented would need to join in any revocation. A new shareholder who has not consented might, however, bring about a revocation by giving notice to the Commissioner.

16.92. Unanimity of consent, in the view of the Committee, is necessary to prevent prejudice to a minority shareholder who might otherwise be forced to accept liability to tax on profits he has no immediate prospect of receiving.

Consequences of Election and of Termination of Election

16.93. When an election applies, the taxable income or allowable loss of the company should be allocated to shareholders in accordance with their daily holdings of shares during the year of income. This will accord with the law as proposed in the United States where, for the present, allocation on daily holdings applies only to losses. Allocations of taxable income to shareholders will bear the same character as the income had in the hands of the company. There will need to be rules by which income of any class, for example dividends carrying an imputation credit, are treated as being spread over the allocations. Capital gains and losses will be allocated.

16.94. Special rules will be necessary to deal with pre-election accumulated income or pre-election losses of the company.

16.95. Allocations taxed to a shareholder will increase the cost of his shares for purposes of tax on any gain made on realisation of the shares. An actual distribution to a shareholder from allocated profits will not be taxed to the shareholder but will reduce the cost of his shares.

16.96. The revocation of an election in any year should be treated as relating to the whole of that year. To minimise scope for tax planning that might be practised by moving into and out of the election system, and to minimise administrative complications, the right to make a fresh election after a revocation should be restricted. In the United States a fresh election may not be made until five years after the revocation, except with the leave of the Revenue.

VII. Appropriateness of Special Provisions for Small Enterprises

16.97. In Canada, a ‘Canadian-controlled private corporation’—very generally, an unlisted company controlled by Canadian resident individuals—is taxed on its ‘active’ business income at a special rate of 25 per cent on the first $100,000 of such income, provided its accumulated income does not exceed $500,000 and the income accumulated is invested in the business in the form of business assets, cash or shortterm securities. The effect of this special treatment, and of the one-third dividend tax credit available to individual shareholders in that country, is that none of the corporation's business income distributed to shareholders need bear any more tax than would have been paid had it been derived directly by the shareholders. It should be noted, moreover, that having regard to the difference between the 25 per cent rate, which may be all the tax payable by the company on business income, and marginal rates higher than this payable by shareholders, the Canadian-controlled private corporation involves substantial tax deferral.

16.98. In the United Kingdom, a ‘small company’ is charged to corporation tax at a lower rate than other companies: while the general rate is 52 per cent, the concessional rate is only 42 per cent. A small company is defined as one with profits in the

  ― 242 ―
year in question of up to £25,000; there are tapering provisions for companies with profits between £25,000 and £40,000. Exploitation of the small company provisions by fragmenting an enterprise over several companies is controlled.

16.99. In relation both to public and to private companies, Australia until quite recently imposed a lower rate of company tax on the first $10,000 of company income and a higher rate on subsequent dollars. This may be seen as a very crude way of providing some relief from the burden of over-taxation to shareholders in small enterprises. The lower rate on the first $10,000 was available to all companies however large their income. In the case of private companies, there was a sliding scale of retention allowance which also might be seen as providing some relief for small enterprises. Both the lower initial rate of tax and the sliding scale of retention allowance encouraged fragmentation.

16.100. If special provisions are to be made for small enterprises, the Committee would prefer the Canadian or United Kingdom model rather than a return to what used to be the Australian law. However, the Committee takes the view that one should not lightly introduce a new element of non-neutrality into the company tax system. There can be no question that the Canadian provisions afford very substantial tax deferral; and although this element of non-neutrality is much less conspicuous in the United Kingdom model, it is nonetheless significant.

16.101. It is noteworthy that neither Canada nor the United Kingdom allows an election by shareholders to be taxed as a partnership. In the Committee's view, this election is sufficient to afford protection to shareholders in a small enterprise from any element of over-taxation. If the furthering of economic growth is thought to justify tax concessions or other financial incentives to small enterprises, they should be offered whatever the form of business organisation adopted. This is also the view of the Bolton Committee which argued that, since so many small enterprises in the United Kingdom are unincorporated, assisting such enterprises through corporate income tax would be highly discriminatory and of only limited effectiveness.

VIII. Aspects of Present Company Taxation

Minimum Distribution Requirements

16.102. Reference has already been made to the distinction drawn in the Act between public and private companies and to the undistributed profits tax intended to compel minimum distributions by private companies.

16.103. At the inception of Commonwealth income taxation in 1915, it was provided that if a company did not make a reasonable distribution a deemed distribution could be made and the distribution assessed as income in the hands of the shareholders; however, the concept of ‘reasonable distribution’ was left undefined. The amending Act of 1922 fixed two-thirds of the taxable income as a reasonable distribution and provided that tax on deemed distributions would be imposed on the company, the tax so imposed being the tax that would have been paid by the shareholders on the amount unreasonably retained had it been distributed to them. The practice of the Commissioner at this time was to limit the application of the provisions to closely controlled companies, i.e. companies controlled by a few individuals.

16.104. The Ferguson Commission recommended in its first report, in 1932, that the deemed distribution provisions be limited in a way that would give legislative approval to the Commissioner's practice. It was said that:

  ― 243 ―

‘The dividend policy of a public company in which the public are substantially interested, and whose shares are dealt in on the Stock Exchange, is not likely to be affected by consideration of the amount of tax which will be paid by individual shareholders. The influence of shareholders will be exerted to induce the directors to distribute as much and not as little as possible, and its published accounts will show what profit has been earned, and how it has been appropriated.’

The 1934 Amending Bill gave effect to the recommendation. The amended law defined a private company and confined the deemed distribution provisions to such companies.

16.105. The definition of a private company was complex; but it did not cover all closely-controlled companies, and company structures were adopted to escape the definition. In the early 1950s the Spooner Committee recommended a new definition of a private company, intended to prevent such escape; and it also recommended that in place of the tax calculated by reference to deemed distributions, there should be a tax on company profits designed to force distributions. The tax proposed was to be a penalty levy applicable to so much of the profits of the company after payment of company tax and after deduction of a retention allowance as had not been distributed within a defined period. The recommendation of the Committee was adopted by amendment to the Act in 1952.

16.106. The new definition did not succeed in preventing the practice of employing company structures that fell outside the definition though in fact the companies were closely-controlled. Moreover, companies coming within the definition were able formally to satisfy the requirement to make a sufficient distribution by distributing to a series of related companies (known as chains) or around circles of related companies (known as snakes). The profits thus remained in a pipeline of companies forever moving between companies but never being taxed to individual shareholders.

16.107. In 1964, following recommendations of the Ligertwood Committee in 1961, yet another attempt was made to define a private company, this time by defining a public company and providing that all other companies would be private. The provisions allowing a tax rebate on dividends passing between companies were amended at the same time. The practice of storing profits in a pipeline of companies is now prevented by a partial denial of the rebate when dividends are received by a private company from another private company. However, the Commissioner is given a discretion to allow a full rebate. That discretion will ordinarily be exercised if the Commissioner is satisfied that the dividends will reach the hands of persons, who are not private companies, within 22 months of the end of the year of income in which the dividends were received by the company claiming the full rebate.

16.108. But the new definition of private company, like its predecessors, failed to embrace all closely-controlled companies. Again company structures were adopted by which closely-controlled companies escaped the definition, this time exploiting the provisions making a subsidiary of a public company a public company. Amendments to the definition were made in 1973 with the object of preventing this avenue of escape.

16.109 The history surveyed in the previous paragraphs reflects two assumptions. The first, recognised by the Ferguson Commission, is that because of pressure exerted by their shareholders listed companies in which the public are substantially interested may be expected to distribute sufficient profits, ultimately to individuals, to prevent

  ― 244 ―
the company affording a tax shelter. The second is that it is possible to draw a distinction between such companies and others that need to be put under a legal discipline to make adequate distributions.

16.110 Experience over the years tends to belie the latter assumption. But whether or not an effective distinction can be drawn, the question remains whether the first assumption—that listed companies in which the public are substantially interested do not afford tax shelters—is correct.

16.111. Empirical evidence casts some doubt on the correctness of the assumption. Distribution policies of listed companies in which the public are substantially interested may reflect a variety of purposes that management is seeking to further. But if in fact the distribution policy of a company involves substantial retention of profits, it will give tax advantages to high-income shareholders whether or not management has this in mind, though it is true that the retained profits in terms of their value to the shareholders in the market place may be less than the amount retained.

16.112 The Committee has given some consideration to the technical aspects of an extension of minimum distribution requirements to all companies. Apart from the aspect about to be mentioned, the general structure of the present undistributed profits tax presents no problems. In this it contrasts with the earliest provisions requiring minimum distribution: those provisions, though formally applicable to all companies, could only be effectively administered in relation to closely-controlled companies. However, as a measure to prevent the storing of profits in a pipeline of companies, the present undistributed profits tax could not be applied to all companies, since a company whose shares are widely held cannot know the ultimate destination of distributions it makes to other companies. An alternative to undistributed profits tax would have to be considered.

16.113 Two methods of ensuring that no tax advantage attends the holding of profits in a pipeline of companies deserve some consideration. The first is the method used in the United States and involves denying exemption to a fraction of a dividend received by a company from another company at each point of movement of profits in the pipeline. This method was in fact proposed by the Ligertwood Committee which suggested that the fraction of a dividend denied exemption should be set at 15 per cent—the fraction actually employed in the United States. However, unless dividends moving within a group of companies are accorded special treatment, as in fact they are in the United States, the method involves an arbitrary and wide-ranging cascade tax on company profits. Even if such special treatment is given, there remains an element of cascade taxation where dividends move through companies that are not members of a group.

16.114 The second method involves an adaptation of a Canadian scheme which at present applies in that country only to dividend income received by closely-controlled investment companies. A company receiving a dividend would hold that dividend in a separate account. The dividend would be subject, in the hands of the company, to a refundable tax at a rate reflecting the tax that an individual shareholder on the maximum marginal rate would pay, after making allowance for any tax credit available to him under the prevailing imputation system. When a dividend is paid by the company from the amount in this account, the tax would be refunded to the company. If such distributions are made in a year of income so as to absorb all dividends received by the company in that year of income, there will of course be no net refundable tax payable. The method involves some complications where the company receiving the dividend has suffered a loss in an earlier year or in the year of income; the company might

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not, in these circumstances, have any immediate prospect of paying a dividend which would generate the refund of tax. In such circumstances the company might be allowed to apply the loss against the dividend received and so avoid payment of the refundable tax; in the result, however, it will have applied the loss to relieve tax at the refundable tax rate, which will be less than the company tax rate.

16.115 These observations suggest that it might be technically feasible to extend minimum distribution requirements to all companies. The possible gain in equity must, however, be weighed against the costs involved. These costs include not only those of administration and compliance but also the loss of neutrality between retention and distribution of profits. In the Committee's view, the costs are likely to outweigh the gain in equity, and therefore the extension of minimum distribution requirements to all companies is not recommended.

Income of Private Investment Companies

16.116 The present undistributed profits tax applied to private companies in effect imposes a penalty on the company if it does not distribute what remains of profits after company tax and after a retention allowance. Originally the retention allowance was seen as enabling the company to hold back funds for the maintenance and expansion of its business operations. Even when the retention allowance had ceased to depend on any exercise of discretion by the Commissioner as to the amount of a reasonable retention, this purpose of the allowance continued to be reflected in the diminishing fractions applied to successive slices of profits in computing the amount of the allowance. The present law applies one fraction—50 per cent—to all after-tax profits whatever their amount. There is in the result very little suggestion of the original purpose: the present retention allowance is basically no more than a method of fixing how much of the company's profits should be taxed at shareholders’ individual rates. In one respect, however, the original purpose does find a continuing expression. The retention allowance on income from property—income not accompanied by the same degree of commitment to hold back funds for the continuance of business operations—is fixed at the much lower figure of 10 per cent, or, in the case of private company dividends, at zero.

16.117 As long as the separate system of company taxation remains, and even under a limited imputation system, there is a general bias against the use of the corporate form. The result of the less generous retention allowance on income from property is that such bias is correspondingly greater where the corporate form is used as a vehicle of investment in property other than shares. In the Committee's view this additional bias is unjustified, and it therefore recommends that the retention allowance in respect of income from property other than shares be brought into line with that applying to other income.

16.118 In contrast with the special bias against the use of the corporate form as a vehicle for deriving income from other kinds of property, the present law gives rise to a significant incentive to use the corporate form as a vehicle for deriving income from shares. An individual with a portfolio of share investments can secure significant tax saving by vesting the portfolio in a private investment company which will derive the dividends on those shares. Because of the tax rebate on dividends allowed to a company, the dividends will not be taxed in the hands of the investment company. The effect of the retention allowance of 10 per cent of the amount of the dividends (available unless the dividends are from private companies) is that tax on this fraction of the dividends can be indefinitely deferred. The prospect of undistributed profits tax

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will force a distribution of the remainder; but tax on the individual who vests his portfolio in a company can be delayed for at least one year, and as long as three years, after the derivation of the dividends by the company. (The longer delay is achieved by the interposition of other private companies between the individual and the company holding the portfolio of shares.)

16.119 Where a business is carried on through a private company, a deferral of tax on dividends paid by the company can be obtained by vesting the shares in that company in an interposed private holding company. There will be no retention allowance in this case, but again tax can be deferred for at least a year, and longer if further companies are interposed.

16.120 The Committee recommends that measures be introduced to prevent this deferral of tax. The measures should be applied to a private investment company as defined for this purpose: the definition would be based on income from property being the predominant element in the company's income. The measure would employ the technique of a refundable tax to which reference was made in paragraph 16.114. The company holding the portfolio of shares would be subject to tax at a rate equivalent to the tax an individual on the maximum marginal rate would pay, after making allowance for any tax credit available to him under the prevailing imputation system. There would be corresponding refunds on distribution. The same regime would apply to any interposed company.

16.121. If the Committee's recommendation is adopted, there will need to be either a phasing-in period or adequate notice of its introduction, in order to accommodate liquidity problems that will inevitably arise in some instances.

Assessment of Company Groups

16.122. A number of submissions have drawn attention to the absence of any provisions whereby a loss suffered by one company of a group of companies may be offset against the net income of another company in the same group.

16.123. It is argued in these submissions that the fact that two companies are legally distinct entities should not prevent their being treated as one entity for income tax purposes when the same persons are beneficially interested in the equity of both companies. Parent and subsidiary companies it is said should be regarded as one taxable entity, and the subsidiary companies as branches or divisions of the parent. This would be in line with the requirements of the Australian Companies Act in relation to the preparation of consolidated accounts for groups of companies in which the results of the operations of the group, as a whole, are reported.

16.124. The point has also been raised that where the companies involved are private companies there are special difficulties. A profitable parent company, engaged in trading, may be required to pay a dividend to avoid undistributed profits tax even though its profits are offset by a loss incurred by its subsidiary company.

16.125. The treatment of company groups in other countries. Overseas the practices adopted are varied. In the United States a group of companies having a certain common ownership is permitted to make a consolidated return of income. The principle thus expressed is that the true income of a single enterprise should be taxed even though the enterprise is carried on through more than one company. The regulations provide extensive and detailed rules covering the preparation of consolidated returns, the basis for computing taxable income of the group and the liability for the tax assessed. The privilege of lodging consolidated returns is denied foreign companies,

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life insurance companies, exempt companies and a number of others specifically defined. Some conception of the complexity of the rules thought necesary to prevent the provisions being abused may be gained from the fact that the rules and associated comments in one of the standard tax services relating to consolidated returns in the United States cover nearly 400 pages.

16.126. In New Zealand there are provisions requiring the income of related companies to be aggregated, but here the requirement is largely a consequence of the fact that the income of a company is taxed at graduated rates ranging from 20 per cent up to the general rate of company tax of 45 per cent. Requiring aggregation precludes any tax advantages which might otherwise be gained by multiple incorporation. There is provision for the transfer of losses without restriction between companies in a group where they are wholly owned by the same interests. Where minority interests are involved there is provision whereby one company in the group may make up the current loss of another through a payment to it, referred to as a subvention payment. The payment is deductible by the company making it and is income of the receiving company.

16.127. There is no provision in the Canadian law for the lodging of consolidated income tax returns by company groups. However, there are some provisions in regard to multiple incorporation, which are mainly aimed at ensuring that undue advantage is not taken of the lower rates of tax available on some company income.

16.128. The United Kingdom has no provisions for consolidated returns but the law contains what are termed ‘group relief’ provisions which, like the New Zealand loss transfer provisions, have the effect, in certain respects, of treating a company group as a single taxpayer. Under the United Kingdom provisions a company may, under certain conditions, surrender to any company in the same group which is profitable its own entitlement to relief for trade losses and for certain other amounts eligible for relief from corporation tax—for example, capital allowances and management expenses. The effect is to cancel one company's losses and reduce the profits of others in the group. It is not necessary that there be an actual payment for the surrender but if a payment is made it will not give rise to tax consequences for either party.

16.129. The choice of method of relief. There is little doubt that consolidated return procedures involve some major compliance and administrative difficulties. Moreover, procedures which would have the effect of permitting the extensive offsetting of losses within all company groups could have significant revenue implications.

16.130. Some of the major difficulties which arise in regard to returns concern defining companies which are part of a group, the question of the time at which any relevant ownership tests decided upon should be applied, the treatment of companies with common ownership but differing balance dates, the extent to which overseas income of foreign members should be aggregated with Australian income, assessing difficulties resulting from the necessity for all member companies to lodge their income tax returns at the same tax office, inordinate delays in assessing because one company's return is late in lodgment and the possible need to amend assessments of all group member companies where an adjustment or error arises in respect of one of them. In addition, there would be special problems arising in relation to sufficient distributions and undistributed profits tax in the case of private companies.

16.131. While the Committee accepts in principle that a company and, at least, its wholly-owned subsidiaries should be treated as one entity for income tax assessment

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purposes, it does not favour the adoption of group assessment procedures. It recommends that group relief procedures modelled on those currently in force in the United Kingdom should be available in Australia, though subject to conditions which would be more restrictive than under the United Kingdom law.

16.132. Holding and subsidiary companies. Relief should only be available when:

  • (a) the companies concerned are resident in Australia;
  • (b) one company is a wholly-owned subsidiary of the other or both are wholly-owned subsidiaries of a third company for the whole of the year of income;
  • (c) both companies have the same year of income;
  • (d) the loss surrendered by one company was incurred in the same year of income as that in which it is claimed by the other company;
  • (e) the surrender of the loss is evidenced by a written agreement, nominating the amount surrendered, made and notified to the Commissioner within three months of the end of the year of income in which it was incurred.

The adoption of this restriction basis would avoid a number of difficulties and possible abuses and should minimise the effect on revenue.

16.133. The Committee does not think it necessary for the tax law to require that the surrendering company should be paid any amount by the claimant company for the loss transferred. It is apparent, however, that there will be circumstances where commercial reasons, and perhaps company law reasons, require that a payment be made. Under the Committee's proposals there will not be any minority interests in a company which could be prejudiced by the surrender of the loss, but a creditor of the surrendering company might be prejudiced if no payment is received by that company for the loss surrendered. There should be provisions whereby a payment which is in fact made will not be treated as income of the surrendering company or as a deductible outgoing by the claimant company.

16.134. Trading and consortium companies. The United Kingdom extends its group relief provisions so that they are available where the surrendering company carries on business and is owned by a consortium of companies and is not a 75 per cent subsidiary of any company, and the claimant company is a member of that consortium; or where the surrendering company is a 90 per cent subsidiary of a holding company which is in turn owned by a consortium of companies and the claimant company is a member of that consortium; or where the surrendering company is the holding company owned by the consortium of companies and the claimant company is a member of that consortium. A company is owned by a consortium of companies if it is owned by five or fewer companies. These latter companies are the members of the consortium. Relief is only available in favour of the member of the consortium in respect of the loss of the company carrying on the business, or of the holding company. A member of the consortium cannot surrender a loss to another member of the consortium nor can a member surrender a loss to the holding company or to the company carrying on the business.

16.135. A company owned by a consortium, in the language of the United Kingdom provisions, is sometimes described in Australia as a ‘joint venture company’. In the Committee's view there should be provisions allowing the surrender of losses by a joint venture company to its owners modelled on the United Kingdom provisions. Where there is a surrender of part of a loss in favour of one member of the consortium

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but no surrendering in favour of another—the latter may have no net income to absorb it—a payment by the member of the consortium receiving the surrender will be commercially appropriate. A payment in these circumstances, like the payments referred to in paragraph 16.133 should not attract any tax consequences.

Restrictions on Carry-forward of Company Losses

16.136. The general provisions of the law in regard to the carry-forward of losses has been explained in Chapter 8.

16.137. Until 1944 no restrictions were imposed on the carry-forward of losses by companies. In that year provisions were inserted in the Act denying the carry-forward of losses by a private company unless shares having not less than 25 per cent of the voting power in the company were beneficially held by the same persons in both the year of loss and the year in which it was sought to apply the loss.

16.138. The reason for adopting these provisions was explained by the Ligertwood Committee in the terms of the Treasurer's speech when introducing the Bill. The Treasurer referred to a practice by persons who had been refused Capital Issues Board permission to form companies ‘of buying up shares in practically defunct companies and then operating those companies for purposes other than those for which they were originally registered’.

16.139. After the war-time capital issues controls had ceased to function, the provisions continued to be part of the law as a means of limiting the carry-forward by private companies of losses of previous years. In this they were designed to control the practice of buying the shares in a company that has suffered losses in order to be able to take advantage of those losses by applying them against future profits of the company. But they proved quite ineffective. Schemes were devised by which they were easily avoided and they became no more than traps for the unwary.

16.140. The Ligertwood Committee considered the policy of limiting the allowance of company losses of previous years by reference to the need for continuity of shareholding in the company and questioned whether the principle of limiting, for taxation purposes, ‘the allowance of losses of previous years incurred by companies which have substantially changed their shareholders, is soundly based’. In recommending the repeal of the provisions inserted in 1944, the Ligertwood Committee referred to its view that a company, in fact as well as in law, is a legal entity separate from its shareholders and concluded that a company's losses should be treated for fiscal purposes without regard to the identity of its shareholders.

16.141. The Ligertwood Committee's conclusion was not adopted. In 1964 new provisions were inserted in the Act limiting the carry-forward of losses by companies, whether private or public. A continuity of ownership of shares carrying 40 per cent of voting and dividend rights and rights to capital was now required. In 1965 these provisions were qualified to some extent by further provisions under which a failure of the required continuity could be disregarded if the company continued the same business. The qualification was so strictly drafted that it did not significantly modify such effect as there was in the continuity of ownership provisions.

16.142. However, the continuity of ownership provisions enacted in 1964, like the 1944 provisions, proved ineffective in preventing the practice of acquiring the shares in companies that had suffered losses in order to exploit the potential tax savings to be gained by the application of the losses when carried forward. Arrangements were adopted whereby the continuity of ownership required by the law was satisfied even

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though, in substance, there was no continuity. Further provisions were inserted in the Act in 1973 to defeat such arrangements, as a result of which a more than 50 per cent continuity of ownership is now required.

16.143. The Committee agrees with the policy of these provisions limiting the carry-forward of company losses and is not persuaded by the reasoning of the Ligertwood Committee. In the taxation of companies it is necessary to go behind the veil of separate legal personality. An individual carrying on business as a sole proprietor or partner who suffers losses has no means open to him of obtaining their equivalent in tax relief except by subsequently making profits against which those losses will be deductible. Moreover, he is limited in thus taking advantage of the losses by the span of his life: losses suffered by an individual cannot be applied against profits made by his personal representative after his death. If there were no restrictions, by reference to continuity of ownership, on the carry-forward of losses by companies, an individual who conducts business through a company would have an unfair advantage: by selling his shares he would obtain immediately the tax equivalent of the losses suffered by the company; and the value of the losses could be turned to advantage after his death.

16.144. The objective that the seller of shares in a loss company seeks to further is to obtain the tax equivalent of those losses immediately. Other ways of doing this which do not involve any unfair advantage will be available if recommendations of the Committee in regard to carry-back of losses and transfer of losses are adopted. The Committee has recommended in Chapter 8 that carry-back of losses be allowed. It has also recommended in this chapter that the law allow a loss to be moved from one company in a group to another in the same group. In addition, it has suggested that losses of companies electing to be taxed as partnerships be allocated to shareholders.

Loan Capital and Share Capital

16.145. In the discussion of the present separate system of taxing company profits, attention was drawn to the fact that the system is not neutral as between equity finance and debt finance. This want of neutrality will be less if the partial imputation system proposed by the Committee is adopted; it will virtually disappear under full imputation.

16.146. However, even under partial imputation it would be possible to achieve neutrality if the treatment of loan capital were brought into line with the treatment of share capital. Interest on loan capital would be denied deduction, and imputation would be allowed of part of the resulting increase in company tax. The debenture-holder would be given a credit for the tax imputed against the tax on the interest he receives, in the same manner as credit is given to a shareholder against tax on dividends he receives. It would obviously not be appropriate to extend the treatment to all interest. A company engaged in, for example, banking could hardly be denied a deduction for interest paid on deposits, nor could a company which was a customer of the bank be denied a deduction for interest paid to the bank on its overdraft. There would be a question of how one should treat payments under hire-purchase agreements or under leasing arrangements, which at least in part have the same character as interest. It might be possible to draw a distinction between short-term and long-term loan capital and to deny a deduction of interest on the latter, but the line of ratio would necessarily be arbitrary. The Committee considers that in general the present method of taxing loan capital should be retained. However, there are two situations—one relating to convertible notes, the other to the high gearing of loan to share capital—where it may not be inappropriate, for tax purposes, to treat loan capital like share capital.

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16.147. Convertible notes. The present tax treats certain loan capital, generally referred to as convertible notes, in the same manner as share capital. In 1960 interest on notes carrying an option of conversion into shares was made non-deductible in determining the taxable income of the company. In 1970 deductibility of interest on some convertible notes was restored. Deduction is allowed only if the convertible notes meet strictly defined statutory tests intended to ensure that they serve the commercial purposes for which they are ostensibly issued. Thus the option to convert must rest with the note-holder so that, pending conversion, he has the income yield and security of investment that the note provides.

16.148. If deduction were allowed of interest paid on all convertible notes, the operation of the system of taxing company profits would be undermined. That system, where no undistributed profits tax applies, depends for its operation on pressure by those who have an interest in accumulated profits for some measure of current distribution. In the case of a high-income shareholder, the under-taxation of undistributed profits is compensated for by the over-taxation, at company and shareholder levels, of distributed profits. In the case of a holder of convertible notes, whose security gives him a potential claim on a portion of undistributed profits, the pressure for current distribution is satisfied by the interest he receives. This interest will not, however, have borne tax at the company level if the convertible notes are treated as loan capital. The Committee therefore considers that the general denial of deduction of interest on convertible notes should remain.

16.149. Where, however, there are safeguards against defeat of the general operation of the system of taxing company profits, the deduction may be appropriate. The Committee thus does not question the statutory code under which interest on convertible notes is deductible in defined circumstances. Those circumstances are defined so as to ensure that the commercial purposes of the convertible note issue predominate over any tax advantages which may flow.

16.150. High gearing. Where interest is paid by a resident company to a resident, the Committee does not consider that a high gearing of loan to share capital should affect deductibility. The fact that the gearing of loan to share capital may be too high, as a matter of commercial judgment, is a concern of the tax law only so far as it points to the need to overcome the want of neutrality in the treatment of share and loan capital which may have encouraged the high gearing. It does not justify, in the case of a particular company, the denial of deduction of interest on some part of the loan capital.

16.151. However, the Committee would take a rather different view in regard to some loan capital held by a non-resident in an Australian resident company. The taxation of non-residents is considered in Chapter 17. For present purposes it is enough to refer to the fact that Australian tax on profits distributed as dividends to non-residents amounts to company tax, currently 45 per cent, plus a 30 per cent dividend withholding tax (15 per cent if a double taxation agreement limits the rate of tax); on the other hand, Australian tax on profits going in payment of interest to a non-resident is confined to a withholding tax of 10 per cent of the amount of interest so paid. Thus the tax on $100 of profits distributed as dividends (assuming a 30 per cent withholding tax rate) is $63.33; the tax on $100 of profits distributed as interest is only $10. While the Committee does not wish to pronounce generally on the appropriateness of the rate of withholding tax on interest, it is apparent that the low rate may lead a foreign resident investor who controls an Australian resident company to provide an undue proportion of the capital of the company in the form of loan finance. The

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inducement to do so will depend on the level of tax in the country of the investor's residence and the credit for foreign tax that country may allow. The inducement will be at its greatest when the foreign investor is resident in a low-tax, sometimes called a tax-haven, country. Canada has recently adopted provisions which may deny a deduction of a portion of interest payable to a non-resident by a resident company where, either alone or in combination with others, the non-resident owns more than 25 per cent of the shares of the company. The denial depends on the ratio of the loan capital held by the non-resident to the share capital of the company. In the Committee's view, provisions along the lines of the Canadian model should be adopted in Australia. It is realised, of course, that such provisions will operate subject to any double taxation agreement to which Australia is, or may become, a party.

16.152. Alternatively to contributing an undue proportion of capital by way of loan finance, subject to the provisions of the exchange control law a non-resident may lend a smaller amount at a high rate of interest, calculated to have the same effect. Provisions intended to enable what would amount to treating the loan capital on which the interest is paid as share capital are proposed in the next chapter.