Family Companies
11.38. The private company when it is controlled by relatives is one of the most fruitful fields for income-splitting. For the purposes of the Act, a private company is defined as a company that is not a public company (see sections 6 (1), 103A), and it is the company that falls into one of the various categories set forth in the statute which for income taxation purposes constitutes a public company. Not every company classified for income taxation purposes as a private company is used as a medium for tax avoidance. The private company of the ‘family company’ kind is the usual vehicle employed to attain that objective. Private companies that are not family companies may attract the provisions of section 109 (see paragraphs 11.35–11.36 above), but most frequently it is the private company controlled by relatives in which income-splitting is practised. A family company, in the present context, is a private company controlled directly or indirectly by relatives either by means of a preponderance of its shares or the voting rights attached to them or to classes of them or by means of any other rights conferred by the Articles of Association, whether the person to exercise those rights be a shareholder or simply the holder of some office in the company, or by agreement or covenant. The number of relatives who possess that control is irrelevant: the relevant fact is the control.
11.39. One type of transaction which may constitute an income-splitting device by means of a family company can be seen in
the acquisition of shares by a relative of the family which (i) entitle the holder to a share in the distribution of the
company's profits disproportionate to the amount of capital subscribed by him, or (ii) enable those in control of the
company to declare dividends in respect of his shares without distributing dividends to other shareholders, or (iii)
enable those in control to declare differential dividends to selected shareholders. By these means it becomes possible to
regulate the income levels of the various relatives associated with the company in addition to those activities struck at
by section 109. It is not necessary, of course, for shareholders in a family company to subscribe substantial sums by way
of capital in order to be capable of exercising the contemplated control or to be in a position to benefit from its
exercise. It is not uncommon for the proprietor of a prosperous unincorporated business to sell his business to a family
company in exchange for shares of a class which, however numerous they may be, will not necessarily return to their owner
a share of the company's profits bearing any realistic relation to the amount of capital represented by them. The bulk of
the profits will be divided amongst relatives whose shareholdings are nominal, so that the moneys required to take up
those shares can be provided by them out of their own funds or by some friend of the family. The variations in the schemes
that have been adopted to secure the income-splitting objective
― 153 ―
are multiple and further description of them
would serve no useful purpose. But they all have one characteristic feature. The transactions carried out between the
relatives themselves and between them and the company, in conjunction with the structure of the company itself, constitute
a ‘settlement’ or an ‘arrangement’ of their affairs which it would be impossible to say that business people acting at
arm's length in the investment of their own funds and contemplating for that purpose a bona fide commercial transaction
would enter upon.
11.40. Apart from definitions of the word for some special statutory purpose, generally speaking a ‘settlement’ may be said to be created by or consist of any transaction operating or contributing to effect a disposition of property, whether real or personal, by means of one or a number of instruments with the intention that the property, whatever its form, may be enjoyed by others. Where other persons join in the transaction at some point in order to benefit or to be capable of benefiting from the property, either in pursuance of some legally enforceable agreement or of some informal understanding with others (including a family company) engaged in the transaction the scheme regarded as a whole may be termed an ‘arrangement’ whereby the income to be derived from the property can be parcelled out amongst those designed to be its putative beneficiaries.
11.41. In the Committee's view, income-splitting by means of settlements or arrangements of this nature effected through the medium of family companies should be prevented. Where the Commissioner is of the opinion that any such settlement or arrangement was effected by means and created rights or obligations that business people acting at arm's length in a bona fide commercial transaction of that nature would not be likely to adopt, he should be enabled at his discretion to tax the dividend income paid or credited to any shareholder at a deterrent rate: for example, at a rate that would have been payable had such shareholder been paid or credited with all the profits distributed by way of dividend in the relevant year of income. Gift duty could also be involved in these cases. The amount determined as subject to the deterrent income tax rate would be the base for the levy of gift duty (see paragraphs 24.A70–24.A90).