Chapter 6
TAX AVOIDANCE AND MINIMISATION
6.1 The change of approach to tax avoidance recommended by the Ralph Report and
accepted by the Government reflects the view that the most effective way to address tax
avoidance and promote fairness in the tax system is through a comprehensive and soundly
based tax structure. Emphasis is placed on the need for transparency, a clear articulation
of principles and a conceptually sound framework with clear objectives formulated through
meaningful discussion between policy developers, legislative drafters and administrators.
6.2 This is supported by moves to correct flaws in the current system and introduce a
new principles-based culture. The ad hoc and complex nature of the current system is
blamed for the build up of widespread frustration among taxpayers in the business
community, within the bureaucracy and the Parliament.
6.3 The Ralph Report suggested that measures to improve the integrity of the tax system
involved, firstly, clearly articulating the principle that business transactions of a like
nature should be treated similarly and consistently, and secondly, suggesting specific
reforms to significantly reduce existing disparities and flaws in the tax law. It
recommended that, contrary to GST practice, the 'principal effect' test should be excluded
from the employment of the general anti-avoidance rule (GAAR) to business activities on
the basis that its potentially wide scope may disturb business practices with a genuine
commercial purpose.
Tax avoidance, tax evasion or sensible tax planning?
6.4 Tax avoidance is the legal minimisation of tax. In the words of the Ralph Report:
Tax avoidance represents a serious threat to the integrity of the tax system and to the
revenue. It is also a form of subsidy from those paying their fair share of tax according
to the intention of the law to those shirking their similar obligations.
and
A tax system which tolerates significant levels of avoidance cannot be equitable and
can be expected to fall into disrepute as the community witnesses the unfair outcomes. [1]
6.5 The Ralph Report separates tax avoidance from tax evasion and sensible tax planning
by explaining that tax avoidance 'could be characterised as a misuse of the law rather
than a disregard for it'. [2] The Brotherhood of St Laurence
articulates a consistent view, describing tax avoidance as wealthy people sometimes
pursuing tax strategies that are contrary to the intent of the tax laws and, as a
consequence of this approach they pay less tax than society, through its tax laws, expects
them to pay. [3]
in the context of tax avoidance, we do have, I think, a fairly wide spectrum of opinion
as to at what point in time, or what point in the spectrum, legal tax avoidance becomes
offensive. I think one of the great pities which has transpired - and it is not just over
the last few years, it existed probably a decade ago as well - is that there is a great
degree of emotion, both from a tax office point of view and the private sector. [4]
Tax evasion is the intentional disregard by the taxpayer of the Income Tax
Assessment Act 1936 or the Income Tax Assessment Act 1997 or the regulations
under those Acts. Legitimate tax planning is the use of tax concessions in accordance with
Parliament's intention. However, very often the line between tax planning and avoidance
becomes blurred.
6.6 From time to time governments introduce certain tax arrangements to achieve an
economic objective. If the sole or dominant purpose of entering an arrangement is to avoid
paying tax, the measure may be tainted. Access to tax planning is often restricted to
relatively few financially advantaged taxpayers.
The Government's proposals
6.7 A number of the Government's proposed business tax reform anti-avoidance measures
was announced in the Treasurer's press release of 11 November 1999. The Treasurer
indicated that the measures were estimated to raise additional revenue (almost $4 billion
over five years). [5] If achieved, there may be sufficient tax
to offset the tax reductions announced in stage 1 reforms, if those revenue estimates
prove accurate. But in cases such as the mass-marketed schemes such as those currently
under Australian Taxation Office attack, or in issues such as the alienation of personal
services income, many thousands can be involved.
6.8 Due to the lateness of the announcements and the lack of critical detail, the
committee is not in a position to assess whether or not the revenue estimates are
reasonable. While some witnesses presented estimates of the loss of revenue from various
avoidance measures, hard data are lacking in this area.
6.9 The major proposals, as outlined in chapter 2, centre on the following issues. They
are, in order of estimated financial impact:
- restricting the alienation of personal services income (estimated to provide revenue of
$2400 million over five years);
- restricting losses from non-commercial activities ($980 million over five years);
- measures affecting tax shelters ($440 million over five years);
- preventing inter-entity loss multiplication ($105 million over five years);
- improving the general anti-avoidance rule (Part IVA of the ITAA); and
- denying losses on certain interposed companies; and
- changing dividend streaming and franking credit trading rules.
Alienation of personal services income
6.10 The proposal is to treat, from 1 July 2000, the income of an entity that is earned
through the provision of personal services as income of the individual for tax purposes.
It targets individuals, mainly contractors, who use companies, trusts or partnerships to
deliver personal services and who, if they pay tax at all, pay tax at the corporate tax
rate of, currently, 36 per cent rather than the top marginal tax rate of 48.5 cents in the
dollar.
6.11 As currently defined, the measures will apply if 80 per cent or more of the income
comes from a single source, or in cases where 80 per cent of income is received from one
service requirer but the services are not provided in the manner of a personal services
business. The provisions will not apply to personal service businesses, which provides its
services to the public at large. Work-related tax deductions will be limited to those
available had the service provider been employed by the service requirer. The 80 per cent
rule will be self-assessed.
6.12 The rationale for the proposed change is that the increasing use of interposed
entities poses a growing threat to the tax base. Income received by an entity (such as a
company, trust or partnership) can be split with other members of the entity, allowing
less tax to be paid; more deductions may also be claimed. The use of interposed entities
to avoid or defer income tax raises issues of equity between those who can take advantage
of such arrangements and wage and salary earners.
6.13 Both the Australian Council of Trade Unions (ACTU) and former Treasurer Ralph
Willis were strong supporters of the need to stem the alienation of personal services
income. Mr Willis submitted:
the [Ralph] recommendations on alienation of personal services income must be adopted.
Not to do so would represent further tolerance of a burgeoning tax loophole that
undermines the integrity and equity of the tax system. It would also mean the Government's
Tax Package would be patently underfunded and so not achieve the requirement for revenue
neutrality in relation to taxation of income from investment and capital gains. [6]
6.14 Those most affected by the proposed changes were less enthusiastic. In its
submission, the Housing Industry Association drew attention to the government's
responsibility 'to ensure that legitimate industry players are not disadvantaged'. [7] The association challenged the proposal to introduce
state-based payroll tax system definitions of employee, recommending instead that ordinary
common law tests be applied to determine dependence and independence.
6.15 The Master Builders Association (MBA) pointed out that the use of specialist
contractors was a feature of the building and construction industry and rejected
suggestions made by the CFMEU that there was evidence of widespread tax avoidance because
of it. The MBA supported legislative amendments only to the extent that they clarified the
distinction between work performed as an employee or as a separate business enterprise,
without undermining the inherent benefits of the independent contract system. [8]
6.16 Another aspect of the proposed legislation was not supported by the MBA. The
proposed 80 per cent rule relating to the source of income would, in the MBA's view,
present difficulties for contractors who performed a series of separate contracts for the
same organisation. [9]
Restricting losses from non-commercial activities
6.17 The government proposes to tighten provisions applying to individuals' offsetting
of losses from non-commercial activities against other income. Deductions will be
allowable if the activity from which the loss arises satisfies certain criteria: it
relates to the rental of real property and to share investments by individuals; it relates
to an activity with assessable income greater than $20,000; total assets of the activity
exceed $500,000 in real property or $100,000 of other assets (excluding motor vehicles);
the activity results in a taxable income in three out of the last five years; and the loss
arises from an activity with a significant commercial purpose or from, for example, a
natural disaster outside of the control of the taxpayer.
6.18 It is open currently to taxpayers to claim expenses associated with one activity
against income earned from a totally unrelated activity, such as a hobby farm. Subject to
straightforward testing to protect genuinely unprofitable small business activities,
losses from non-commercial activities will not be allowable against other income.
6.19 According to the Treasurer, there is significant revenue leakage from unprofitable
activities carried out by individual taxpayers who claim deductions for activities which
are more like hobbies or lifestyle choices, unlikely to make a profit and without
particular commercial purpose. [10]
Measures affecting tax shelters
6.20 The Government proposes to tighten the provision allowing immediate deductibility
for advance expenditure incurred in respect of services to be completed within 13 months,
where such expenditure relates to a tax shelter arrangement. The measure is directed at
arrangements where deductions exceed income from the arrangement in the same year. All
revenue prepayments relating to participation in a tax shelter will be deducted over the
period to which they relate. This will apply to all expenditure incurred after 1pm AEST 11
November 1999 but will exclude those prepayments to which the taxpayer is irrevocably
committed at that time.
6.21 This provision will affect many agricultural schemes, such as timber plantations,
macadamia nut plantations and vineyards, which typically provide large tax deductions for
investors before the end of the financial year. Under the new proposal, such investors
will get a one-month deduction in June and the rest over the following year.
Improving the general anti-avoidance rule (Part IVA of the ITAA)
6.22 The principal changes proposed by the government to strengthen the general
anti-avoidance rule (GAAR) are to provide an improved 'reasonable hypothesis' test, an
expanded concept of 'tax benefit' and powers to allow the Commissioner to issue a single
determination in respect of a scheme. The new measures are designed to apply to schemes
entered into after 1pm AEST, 11 November 1999. At present, the Commissioner of Taxation
can cancel a tax benefit obtained through a scheme designed to obtain such a benefit. A
tax benefit is identified and quantified by forming a reasonable hypothesis as to what
would have occurred in the absence of the scheme. The Commissioner must make a separate
determination in respect of each taxpayer who has obtained a tax benefit, even in the case
of identical schemes. The proposed changes will, if enacted, provide legislative guidance
to taxpayers, and a consistent penalty regime will apply to all forms of tax avoidance
including artificially created losses currently not subject to penalties.
6.23 When asked by Senator Cook whether the strengthening of the anti-avoidance rule
would impact on the ability to convert income to capital so as to avoid tax, Mr
Fitzpatrick of the Australian Taxation Office explained:
the changes announced yesterday are more to the effective operation of the
anti-avoidance provision, but certainly it extends to the concept of tax benefit. To what
extent that would have an effect on the arrangements to convert income to capital is
unclear . As Dr Preston said, it certainly would not do any harm, and it would help the
operation of the anti-avoidance provision. The anti-avoidance provision presently, as it
is interpreted by the courts and certainly since the High Court looked at it in Spotless,
is ... a fairly effective measure to counter arguments which seek to exploit the law in
its intended operation. [11]
Denying losses on certain interposed companies
6.24 The proposal is to deny, for tax purposes, losses on interests held by entities
interposed between a loss company and its ultimate individual owners when there is a
change in the majority ownership of the company. This will reduce the scope for multiple
recognition of losses.
Changing dividend streaming and franking credit trading rules
6.25 Current rules require resident taxpayers to hold shares, at risk, for at least 45
days to be eligible to receive franking benefits from dividends paid on shares and
specifies a minimum level of ownership risk (30 per cent). It is claimed that the 45-day
rule may deter what would otherwise be legitimate commercial transactions because of
prohibitive holding costs. No specific holding period has yet been decided. The small
transactions exemption is proposed to be lifted from $2000 to $5000.
Ongoing scrutiny
6.26 The Treasurer's press release of 21 September 1999 advised that the Board of
Taxation proposed by the Review of Business Taxation is to be established as a
non-statutory advisory body. It is intended to provide private sector expertise on a
regular basis on business taxation matters. It is expected that the Board will advise on
anti-avoidance measures.
The fiscal impact of the proposed integrity measures
| Integrity measures |
1999-00 $m |
2000-01 $m |
2001-02 $m |
2002-03 $m |
2003-04 $m |
2004-05 $m |
| Stage 1 |
|
|
|
|
|
|
| Addressing lease assignments |
0 |
15 |
45 |
55 |
70 |
70 |
| Value shifting through debt forgiveness |
0 |
25 |
22 |
0 |
0 |
0 |
| Loss duplication in groups |
0 |
35 |
20 |
0 |
0 |
0 |
| Repeal excess deductions rules for mining operations |
0 |
30 |
40 |
35 |
35 |
35 |
| Prevent duplication of unrealised losses |
0 |
65 |
90 |
85 |
95 |
100 |
| Remove defects in the continuity of ownership test |
0 |
35 |
35 |
35 |
40 |
40 |
| Disposal of loss assets within majority owned groups |
0 |
60 |
50 |
15 |
10 |
5 |
| Value shifting measures outside groups |
0 |
0 |
0 |
140 |
150 |
160 |
| Tighten 13 month prepayment rule |
15 |
220 |
325 |
260 |
275 |
255 |
| Total |
15 |
485 |
627 |
625 |
675 |
665 |
| Stage 2 |
|
|
|
|
|
|
| Prevent inter-entity loss multiplication |
0 |
15 |
20 |
25 |
20 |
25 |
| Measures affecting tax shelters |
0 |
70 |
100 |
90 |
90 |
90 |
| Restricting losses from non-commercial activities |
0 |
50 |
310 |
240 |
200 |
180 |
| Restricting alienation of personal services income |
0 |
380 |
480 |
495 |
515 |
530 |
| Total |
0 |
515 |
910 |
850 |
825 |
825 |
| Grand total for integrity measures |
15 |
1000 |
1537 |
1475 |
1500 |
1490 |
Note: Combined measures from the Government's Stage 1 and Stage 2 responses.
Footnotes
[1] Review of Business Taxation, A Tax System Redesigned, July
1999, p. 15.
[2] Review of Business Taxation, A Tax System Redesigned, July
1999, p. 46.
[3] Brotherhood of St Laurence, Tax Reform: the missing
dimension,: Social tracts for our times No.2.
[4] Mr Wachtel, in Senate Economics References Committee, Operations
of the Australian Taxation Office, September 1999, p. 83.
[5] The almost $4 billion is derived from totalling both sets
of integrity measures in the Treasurer's press release, no. 74, Attachment O.
[6] Submissions and Documents, p. 151.
[7] ibid., p. 140.
[8] ibid., 158.
[9] ibid., p. 159.
[10] Treasurer, The New Business Tax System: Stage 2
Response, Press Release no. 74, 11 November 1999, Att.A.
[11] Evidence, 12 November 1999, p. 230.
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