Treatment of Companies
23.40. The Committee recommends that in general the treatment of capital gains realised by companies should be the same as for individual taxpayers: a proportion of the gain should be included in income. The Committee notes that the Budget proposals envisage the taxation of capital gains made by companies at a flat rate of 33½ per cent. The effect is the same as the inclusion in income of, approximately, three-quarters of the gain. The logic of this approach is difficult to discern and the reasons for treating companies in a significantly different fashion to individual taxpayers is not clear. If a proportion of a capital gain is to be regarded as income there is no reason why, in effect, different proportions should be deemed to be income depending upon whether the recipient of the gain is an individual or a corporate entity. The Committee thus disagrees with the Budget proposal. Further problems do, however, arise in considering the appropriate tax treatment of capital gains made by companies. These gains will ultimately be distributed to shareholders and the liability of the shareholders to tax on such distributions must be considered.
23.41. Several different approaches are possible, but the Committee favours, at least at the outset, the simple one of regarding half the gain as income of the company and the other half as a non-income receipt. The half regarded as income will be treated as such for all purposes, and thus it will enter the calculation of a sufficient distribution for purposes of undistributed profits tax when the company is a private one. If the amount treated as a non-income receipt in the hands of the company is the subject of a dividend it will, to this extent, be included in the income of the shareholder. There will, in the result, be some failure to carry through to the shareholder the quality of capital gain which the gain had in the hands of the company. However, if the system of imputation credit on the Canadian model as proposed by the Committee in Chapter 16 is adopted, the shareholder will be entitled to credit in respect of the whole of the dividend, both that part of it representing the amount of the gain taxed to the company and that part representing the amount not taxed. There will, in the result, be some correction of the over-taxation of the gain. If, however, Australia comes to adopt the method of advance corporation tax used in the United Kingdom, which restricts the imputation credit by reference to the amount of tax paid by the company, special provisions will be necessary to give some recognition to the quality of capital gain in the receipt by the shareholder. Thus, one-half of a capital gain derived by the company and treated as not being income might be held in a separate account, and a distribution from that account given favourable treatment in the hands of the shareholder. Canada, in relation to such distributions by private companies, gives an exemption from tax.
23.42. The introduction of a capital gains tax will require a reconsideration of section 47 of the Act. That section
deems distributions on the liquidation of a company to be dividends to the extent that they represent income derived
by the company. While
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the section remains, there will be two elements that have to be distinguished in
distributions on liquidation. To the extent that they represent income derived by the company, they will be dividends
taxable as such to the shareholders with whatever imputation credit is allowed. For the rest, they will be proceeds of
realisation of shares.
23.43. In the United States and the United Kingdom receipts by a shareholder in the liquidation of a company are in general treated as the proceeds of realisation of his shares, which may give rise to a capital gain or a capital loss depending on whether the proceeds exceed or are less than the cost to the shareholder of his shares. This approach has the advantage on the score of simplicity. Section 47 gives rise to some perplexing problems of interpretation and application. If a significant amount of imputation credit comes to be given, the section might be repealed. The present advantage of section 47 to the Revenue in terms of the amount of tax collected would be diminished by the availability of an imputation credit. If a substantial imputation credit is given, and section 47 remains, the advantage to the Revenue will disappear.
23.44. Income may be derived by a company in the course of liquidation, for example from the disposal of trading stock. If section 47 is repealed, there should be provision whereby the liquidator may pay a dividend out of such income or out of income accumulated in periods prior to liquidation which will qualify for imputation credit. In a parallel fashion it could be provided that capital profits generated in the course of a liquidation by the disposal of fixed assets might also be the subject of a dividend. However, if such disposal is simply not recognised for capital gains tax purposes it will be possible to avoid two impositions of tax: there will be no tax to the liquidator. The United States law does not recognise the realisation of a capital asset in liquidation for purposes of taxing company capital gains, though assets distributed in specie are deemed to have been received by shareholders at their market values for purposes of determining the capital gains tax liabilities of shareholders on the deemed realisations of their shares. However, the United States law has not been proof against tax avoidance: if that example is followed, protective provisions will be necessary.