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Reconstruction of Income of Australian Residents from Transactions with Non-residents

17.84. Income may be diverted by an Australian resident to a non-resident in whose hands it either escapes Australian tax altogether, because it does not have an Australian source, or is subject to tax at a rate less than it would have borne in the hands of the Australian resident.

17.85. Thus an Australian resident company may buy goods at an inflated price from an associated non-resident company or pay an inflated commission to that company in a transaction which will ensure that the non-resident company's profit does not have an Australian source. Furthermore, the profits of the resident company, subject to company tax, may be the less because of an interest payment to the non-resident subject only to withholding tax at 10 per cent. The non-resident company may be a tax-haven company.

17.86. The diversion of income may take the form of a sale of goods by a resident company to an associated non-resident company at a price which ensures that the resident company makes no profit. The non-resident company may be a tax-haven company that simply ‘invoices-on’ to a foreign buyer. The resident company may pay a commission to an associated non-resident company for making a sale abroad. Again the non-resident company may be a tax-haven company.

17.87. Sections 51, 42 and 36 are no more helpful in enabling reconstruction in these situations than they are in enabling reconstruction of the incomes of non-residents in the situations considered in paragraphs 17.78–17.83. And here, too, section 136, which can apply to income derived by a resident, is inadequate. The resident company will be carrying on business in Australia, but in the deflated receipts situation described in paragraph 17.86 the Commissioner's power to substitute notional receipts in a non-arm's length transaction is doubtful. Both in this situation and in the inflated cost one described in paragraph 17.85, the Commissioner may have no power to reconstruct because the resident company does not come within any of the clauses of section 136 identifying the persons to whom the section may apply. Clause (b) can be avoided if a majority of the shares is vested in residents, even though those shares carry only a small fraction of rights to dividends or distribution of capital and have no voting rights. Since a company holding shares in another company does not hold those shares on behalf of its shareholders, clauses (b) and (c) can be avoided by interposing a second company incorporated in Australia to hold the shares in the resident company and, in the case of clause (b), in the non-resident company. The control contemplated by clause (a), in the case of a company, probably refers to director control. It may be inferred from judicial authorities on the meaning of central management and control in the definition of residence in relation to a company that it will be enough to prevent the operation of clause (a) if a majority of the directors are Australian residents. In any event, where tax-haven operations are involved, the persons who have the real interests in and control of the resident company are likely to be Australian resident individuals: thus, unless the tax-haven company is its subsidiary, section 136 will not be applicable.

17.88. In the Committee's view section 136 should be replaced by a new section empowering the Commissioner to reconstruct the profits of non-residents derived from sources in Australia and the profits of residents dealing with associated non-residents. The models of reconstruction provisions in double taxation agreements, such as articles 5 and 7 of the United Kingdom agreement, may be helpful.

17.89. The effectiveness of a redrafted section 136 will depend on the Commissioner coming to know facts which persons liable to pay tax may have sought, sometimes with the co-operation of governments in other countries, to keep from him. And it will

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depend on there being assets in Australia that may be taken in payment of tax. These limitations on effectiveness are inevitable, but they do not justify denying power to do what can be done.

17.90. Special measures may be necessary to assist the enforcement of provisions intended to ensure adequate taxation of Australian-origin income when tax-haven operations are involved. The existing provisions of the Act, in particular sections 254–257, may not be adequate. The Committee has noted the recent amendments to the Banking Act and the Taxation Administration Act relating to the tax screening of proposed transactions with persons in tax-haven countries, and the notice issued by the Treasurer specifying the acts or things to which section 39B of the Banking Act applies. Experience with these new provisions will doubtless indicate whether further measures will be needed to ensure adequate taxation of Australian-origin income.