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Reservation to Chapter 11: Income-Splitting

My reservations relate, in the first place, to the chapter's explanation of the principle that measures directed against transfers of income should serve. The descriptions given in the chapter of unacceptable ‘income-splitting’ transactions fail to identify any such principle except a notion that a course of action is ‘tax avoidance’, and therefore unacceptable, if it is undertaken solely or primarily for the purpose of reducing income tax liability. In my view such a notion is not a satisfactory explanation nor, where it is adopted as such, is it a workable test of the operation of measures intended to deal with transfers of income.

It is true that this notion is at the basis of the interpretation of section 260 of the Act. But, in that context, it has led to the development of a question-begging distinction between cases where a taxpayer is said to have a ‘choice’ to pursue a course of action which will reduce his tax and cases where he has not. And the drawing of an inference of purpose to reduce tax is unpredictable. A gift of property by a husband to his wife is as much open to the construction that he has moved by love for her as it is open to the construction that it was done to reduce tax on the income produced by the property given.

A principle requiring the defeat of a transfer of income to a person, most likely a spouse, who may be expected to share the enjoyment of the income with the transferor may have some merit as the basis of measures directed against transfers of income, though the appropriate measures would, of course, have a significantly narrower operation than those proposed by the Committee. This principle might be seen as some expression of the philosophy of family unit taxation discussed in Chapter 10. It would be said that the transferor's ability to pay tax should be determined not only by reference to income he himself has derived, but also by reference to income derived by others who may be expected to share that income with him. The income transferred should be taxed to him or taxed at a rate determined by reference to his income.

Clearly the expression given to the family unit philosophy by the principle would be very limited. That philosophy assumes that the ability of an individual to pay tax should reflect not only the benefits he may expect from the expenditure of income by others, but also the benefits he confers on others by sharing his income with them. It requires an aggregation of the incomes of those who share expenditures, and the taxing of that aggregated income at a rate which reflects the fact that the aggregated income supports more than one individual. And the principle would apply only when the shared income had been the subject of transfer. The principle cannot give effect to the philosophy where the shared income enjoyed by one spouse is income derived from property which the other has inherited from a third party.

Moreover, there are very significant practical limitations on how far measures giving effect to the principle can go. Any attempt, otherwise than by the most arbitrary rules, to identify as income transferred income which flows from the investment of money transferred or from property transferred is clearly an impossible undertaking. There may have been movements of money and other property, sometimes in both directions, between husband and wife over a period of years and dealings with that money or other property.

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The imperfections and inadequacies of measures against transfers of income as an expression of family unit philosophy suggest that what is really called for is the explicit application of family unit taxation. The Committee has rejected compulsory family unit taxation. I appreciate that it is unlikely to be politically acceptable, though those who would reject it on the ground that it denigrates the status of women curiously assert, at the same time, that a widow should be treated as having been an equal partner in the acquisition of assets which her husband owned at his death. An elective system of family unit taxation could not, however, be said to denigrate the status of women, and it ought to be politically feasible. It should not be too costly to Revenue, nor would it be unfair to unmarried individuals, if the rate structure were carefully framed to offer a limited advantage, over a lifetime, to most married couples, compared with the lifetime operation of individual unit taxation.

An elective system of family unit taxation would not make measures against transfers of income between husband and wife wholly inappropriate, but it would then be possible to give a satisfactory explanation of the limited measures which practical considerations would allow. Husband and wife who did not elect would be taken to have asserted that family unit philosophy had no application to them because the financial affairs of each were wholly separate from the other's. Transfers of current income made without consideration between husband and wife contradict the assertion of separateness and those who have not elected family unit taxation should not be allowed by such transfers to gain a tax advantage over those who have. The possible tax advantage that they could gain would, in any event, be significantly less than they could gain under an exclusively individual unit system. Put in another way, elective family unit taxation gives some of the advantages to be gained by transfers of income but gives it to all those who elect, whether or not there are techniques of transfer of income open to them.

I accept that, so long as family unit taxation is not applied, or is not available on an elective basis, what can be done should be done to prevent an individual gaining a tax advantage by transferring income in whose enjoyment he continues to share. The opportunities to transfer income which property law and the tests of derivation in tax law afford are unevenly distributed between taxpayers. They are readily available to taxpayers in business and to taxpayers who have substantial property incomes but not to wage and salary earners. Nonetheless, my acceptance of measures to defeat transfers is tempered by the fact that the divisions of income between husband and wife which occur as a result of the good fortune of inheritance or gifts from third parties continue to give tax advantages. It is tempered too by the fact that defeat of the principal technique of transfer of income—outright gift of capital—is beyond the limits of effective legal action.

Having regard to my understanding of their function and what I consider to be administratively feasible, the measures against transfers of income which I think appropriate will have a narrower operation than those proposed by the Committee. The measures would be limited to transfers of income between husband and wife. There are other cases, it is true, where a person who transfers income may be expected to share in the expenditure of the income transferred: a son may transfer income to his aged parent who lives with him. But these other cases are not a serious threat to the equity of the tax system. The measures would not attempt to deal with the income flowing from the investment of money or from other property which has been the subject of an outright transfer. The problems involved are quite unmanageable even if the attempt is confined to income flowing from capital transfers. And there is no

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reason in logic why the attempt should not extend to income flowing from the investment of income currently transferred, for example, through a partnership.

The measures should be limited to transfers of income made without full consideration. Where full consideration is given for a transfer there will be an offsetting transfer of income which cannot fairly be ignored, though, in the interests of administrative feasibility, an offsetting transfer involved in a less than full consideration will have to be ignored. Division 6A of Part III, referred to in paragraph 11.37, in its present terms, applies to transfers of income whether or not consideration has been given. I think that its operation should be qualified so that it applies only when there is a transfer for less than full consideration. I would, in any case, limit its operation to transfers of income between husband and wife. The principle expressed in Division 6A is not easily discovered. It applies notwithstanding that there has been a transfer for full consideration, whether or not the transfer was between persons who share the enjoyment of income and whatever might be thought to have been the purpose of the transfer.

I have a number of reservations in regard to the detail of the measures proposed by the Committee. The proposals are not fully integrated, as I think they should be, with the proposals in Appendix A to Chapter 24 as to the operation of gift duty in relation to gifts of income. The references to taxing income transferred at ‘a deterrent rate’, for example in paragraph 11.30, seem to me to be inappropriate. The income transferred should either be taxed to the transferor as if it were his income, or, preferably, be taxed to the transferee at a rate determined by reference to a notional addition to the income of the transferor.

The assumption in paragraphs 11.34–11.36 that sections 65 and 109 are designed to prevent ‘income-splitting’ seems to me to be open to question. While they will in some circumstances defeat transfers of income, their basic purpose is to deny deductions in respect of payments which are not in fact made in the deriving of income. Without such measures tax might be imposed on an amount less than the true net income of a business and, to this extent, income might escape tax altogether. I agree that there is need for such measures and that they should have a wider operation than they have at present.

The proposals made in paragraphs 11.42–11.44 in regard to section 260 do not have my support. I do not agree that they will overcome the uncertainty and dissatisfaction associated with the operation of the section. The proposed express exclusions of ordinary business transactions and bona fide arrangements of a family's affairs have already been written into the section by judicial interpretation. And the Commissioner's proposed powers to tax any person deriving income consequent upon the arrangement at ‘a deterrent rate’, are too wide. In any case it is my view that section 260 has no place in the Act. Any general provision directed against courses of action described only as ‘tax avoidance’ involves an abdication of Parliament's responsibility to formulate and inform the taxpayer of the principles intended to be expressed in the tax law.

I concur in the proposal to tax the unearned income of a minor child at a rate determined by reference to his parent's incomes. I think it should be made explicit that this is an adoption of the philosophy of family unit taxation. The child's ability to pay tax on his income reflects the fact that he shares in the expenditure of the income of those on whom he is dependent for support. However, as an expression of that philosophy, the proposal in paragraph 11.9, in my opinion, goes too far. It is not appropriate to tax the income of a minor child at a rate which takes account not only of

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the incomes of his parents but also the incomes of other minor children of the same parents.

R. W. Parsons