Committee's Proposals
17.42. In the Committee's view, the comparison in the previous paragraphs establishes a case for extending the exercise of jurisdiction to tax on the basis of residence so that all foreign-source income is subject to Australian tax and credit, so far as administratively feasible, is given for foreign tax on that income. Equity and efficiency considerations point strongly to this conclusion and outweigh the loss in simplicity likely to result.
17.43. The Committee would, however, wish to leave open the possibility of making specific exceptions to the general regime to retain some of the simplicity of the exemption system. Where an Australian resident company receives dividends from a foreign resident company in which it has a substantial shareholding and that company is resident in a country which imposes a rate of company tax comparable with the Australian rate, it may not be inappropriate to continue the exemption given by section 46. In these circumstances the credit system and the present exemption system will bring about much the same result. But it would be necessary to confine section 46 treatment to dividends from profits having a source in the foreign country: a wider exemption would open up the prospect of defeat of the purpose of the general regime where the foreign country applies an exemption system to income from sources outside that country.
17.44. It might also be thought appropriate to continue exempting profits derived by an Australian resident company from sources in a foreign country if the foreign country imposes a rate of company tax comparable to the Australian rate. It would be necessary to confine the exemption to profits bearing the foreign company tax. Where royalties and interest with a source in the foreign country bear tax at a lesser rate, for example by way of a withholding tax, the exemption should be denied. The denial of the exemption would follow the precedent set by section 12 of the Income Tax (International Agreements) Act in relation to royalties and interest which, because of a provision in an international agreement, are taxed in the country of source at a low rate.
17.45. With regard to salary and wages, equity considerations would clearly favour the application of a credit system to foreign-source income. There may, however, be reason to exempt such income where it relates to a substantial period of service abroad.
17.46. The adoption of a credit system will take away some of the tax advantages to be gained from establishing tax-haven companies in foreign countries. When income which may have borne no foreign tax is repatriated as dividends to an Australian resident company, it will be no longer be freed from Australian company tax by section 46, but will be taxed in full. However, the advantages of indefinite deferral of tax on income accumulated by the tax-haven company will remain.
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17.47. Similar advantages can at present be obtained by the use of what might be called a ‘tax-haven’ trust: that is, a trust created or controlled by Australian residents but which has foreign trustees and is administered in a tax-haven country. If a trust has foreign-source income that is accumulating, no Australian tax is payable even though the persons who it may be expected will ultimately receive the income are Australian residents.
17.48. The tax advantages to be obtained from establishing tax-haven companies could be removed by provisions of the kind adopted by the United States in Subpart F of its 1954 Code. The accumulating income of a tax-haven company would be taxed currently to its Australian resident shareholders by reference to some apportionment to them of that income. The tax advantages of tax-haven trusts could be removed by similar provisions, though in this case it would be necessary to seek to tax the trust estate on a proportion of its income in some way related to the extent of the contingent interests held by Australian residents. It would not be appropriate to attempt to tax those Australian beneficiaries without vested interests.
17.49. The complexities and problems of administration which such provisions would involve should not be underestimated. In the case of a company there is a question of defining the persons whose interests would make them subject to current taxation on the company's profits. Rules of constructive ownership would be necessary.
17.50. It would be necessary to define the income to which the provisions apply. It may not be thought appropriate to include income from active business operations in the tax-haven country itself. And it may not be thought appropriate to include income that has its origin in third countries. To include such income would be to put Australian companies using tax-haven subsidiaries for their foreign operations at a competitive disadvantage. On the other hand, it would be of the first importance to ensure that any income that has an Australian origin is included, where present Australian law does not tax that income on the basis of such origin. Income from operations involving ‘invoicing-on’ of goods that move from or to Australia but are at no time physically present in the tax-haven country is the most likely illustration.
17.51. United States experience has not been encouraging. Its provisions are extremely complex and pose great difficulties in enforcing compliance. Canada has adopted similar provisions but there has been some delay in bringing them into operation.
17.52. Apart from the complexities and administrative difficulties involved, the observations made in paragraph 17.50 in relation to the income to which the provisions would be applied may suggest some doubt about their policy. Deferral of tax on foreign-origin income of a foreign subsidiary of an Australian resident company or of foreign-origin income of a foreign resident trust will in the normal case, under the Committee's proposals, be allowed until the income is remitted to Australia as dividends or distributed to Australian resident beneficiaries. It may fairly be asked whether it should make any difference that the foreign-origin income has, because of the tax-haven residence of the company or trust, been subject to foreign tax only at low rates. If it is thought that the policy should be simply to ensure that Australian-origin income be adequately taxed, it is possible to achieve this by other means.
17.53. At present Australian-origin income may be inadequately taxed for a number of reasons. A tax-haven company or
trust will commonly enter into transactions with Australian residents which give rise to income with an Australian
origin that is not subject to Australian tax because it does not come within the scope of the jurisdiction
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Australia exercises in taxing Australian-origin income. The meaning of source in relation to Australia's
jurisdiction to tax on the basis of origin needs to be clarified and extended in certain respects. When the scope of
the jurisdiction Australia exercises does extend, the amount of income brought to tax may be thought too little
because of expenses claimed by the tax-haven company or trust; the amount of tax may be thought too little because a
withholding tax is the only tax applicable. Broader reconstruction provisions might be made available which will
enable the Commissioner to deny the deductibility of expenses in appropriate cases. Special rates of withholding tax
might be applied to income going to a tax-haven company or trust.
17.54. Australian-origin income may be inadequately taxed because it has been diverted by an Australian resident to a tax-haven company or trust in whose hands it is exempt because it does not have an Australian source or is subject only to Australian interest withholding tax. Broader reconstruction provisions would enable the Commissioner to prevent this diversion of income and tax the Australian resident.
17.55. The Committee is not persuaded that it is an appropriate policy to seek to tax foreign-origin income of tax-haven companies and trusts and is very conscious of the complexities and administrative and compliance costs of attempting to do so. It prefers to ensure that the general provisions of the Australian law as to source of income in Australia are effective; that there are adequate provisions in regard to the reconstruction of Australian-origin income of non-residents; and that there are also adequate provisions to prevent the diversion of income by Australian residents to non-residents. There may, in addition, be room for special provisions whereby some income of a tax-haven company or trust that has an origin in Australia is made subject to a special rate of tax, and whereby procedures are established to ensure collection of Australian tax payable by tax-haven companies and trusts. These matters are taken up in Section II.