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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.

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