The Commissioner of Taxation has forwarded the following memorandum for advice:

I should be glad if you will give consideration to the following matter: Companies whose head offices are in England, and others who have borrowed money on debentures the interest on which is payable in England, have, 1 am informed, been advised that section 24 of the Income Tax Act is ultra vires. I am also informed that there is a similar claim to invalidity in connection with section 14 (b), where dividends, or interest credited or paid to members, shareholders or debenture holders of companies whose head offices are not in Australia, are deemed to be part of taxable income.

The advice upon which this information has been conveyed to me was, I understand, given by Counsel in England, but I am also informed that leading Counsel in Australia, including Mr Mitchell, have similarly advised. I have not seen any copy of the advice.

I bring the matter under notice as it may be advisable, if there is a weakness in the Act, to provide for some alternate method of securing the end desired, viz. the taxation of income which has its source in Australia, but is received by some person beyond Australian jurisdiction.

Should the point taken be considered valid, I would suggest for consideration the following method of dealing with company interests. The suggestion is based on the presumption that the Government will adhere to its policy of declining to tax companies on a uniform flat rate in respect of the income distributed to absentee shareholders. This will be the simplest method from an administrative point of view, but admittedly at variance with the policy of distributing the taxation burden in proportions corresponding to the incomes of individuals, whether associated in companies or otherwise.

1. As regards the undistributed income of companies, the present method to be followed.
2. As regards the income distributed to Australian shareholders the present method to be followed.

As the Department can secure a check on shareholders who are resident in Australia and can enforce the inclusion of dividends in private returns it is possible to continue the work under the present scheme.

3. As regards the dividends distributed to absentees, to regard this as taxable in the hands of the company but not as agent for the absentee shareholders.

The amount of tax in this case to be arrived at by the company on the basis of the amount of dividend actually distributed to the individual shareholder.

The company to calculate the amount of tax payable by reference to the Department's Ready Reckoner and to provide the Department with the total amount of tax thus assessable.

The company to be authorised to collect from the shareholder so much as is necessary to recoup it for its payment.

Should this latter suggestion be ultra vires, the Commonwealth Government need not concern itself as to the source from which the tax is paid, or whether the company is recouped or not. The company may be trusted to make such arrangements that the balance of shareholders will not suffer.

4. The law to provide that the interest payable by the company to debenture holders should be similarly dealt with.

The work of calculating the amount of tax would be a comparatively small task for the individual company, but if the Department had to do it, it would be immense in the aggregate and would necessitate the employment of many men to carry out the duty. It is thought that the companies would have no serious objection to undertaking this responsibility, as it would relieve them of a number of difficulties that are seriously exercising the minds of the managers under the system at present embodied in the law. One illustration of this system will show the difficulties by which it is attended:

Take the case of the Sunlight Soap Manufacturing Company. It has 40,000 shareholders, almost all of whom are absentees from Australia. Any one of these shareholders may challenge the right of the company to make payment on his behalf, and if the directors assumed the responsibility which we seek to place upon the company under the law, they might be held to be personally liable. If the Department has to make an assessment on the lines indicated in the present law, it must require the company to provide it with the full list of 40,000 shareholders, together with the amount of dividend paid to each. There is then the possibility that any one of these shareholders may have interests in some other Australian company, in which case the Department would have to aggregate the interests in order to determine the rate of tax. This would involve an enormous amount of clerical labour.

Under the scheme proposed it would be necessary to assume that no shareholder in this particular company possessed any interest in any other company. This will be the case in the great majority of absentee shareholders.

In the case of the Sunlight Company a large number of the shares are held by employees of the company who are not interested in any other Australian concern. For the Sunlight Company to provide the Department with the amount of tax corresponding to the amount of dividend paid to the absentee shareholders would be no doubt a considerable task, but if the Department had to do this for every company that operates in Australia the whole system of administration would be likely to break down.

I have spoken to representatives of large companies who have expressed themselves satisfied with this proposal. They state that a company as a rule has a sufficient staff employed to undertake annually a work of this kind without serious interference with the ordinary business of the company, and they would welcome a scheme which would put the legal position beyond doubt.

Absentee debenture holders

Regarding the question as to the competence of the Commonwealth Parliament to levy an income tax on absentee debenture holders, it is now well established that where a power to legislate is given by the Imperial Parliament to a Dominion Parliament, the Dominion Parliament has all the powers necessary for the effectual carrying out of the legislation and may exercise those powers outside the territorial limits of the Dominion if necessary for the effectual carrying out of the legislation (see Attorney-General for Canada v. Cain and Gilhula [1906] A.C.412).

By the Constitution the Commonwealth Parliament has power to legislate for the peace, order and good government of the Commonwealth with respect to taxation.

Primarily a taxation Act would refer to persons or things within the Commonwealth, but in legislating for the purpose of taxation the legislature may provide for the application of the scheme to persons beyond the Commonwealth if it is necessary so to do in order to effectually carry out the taxation in respect of the persons or things within the Commonwealth.

The legislature in levying an income tax for the Commonwealth must levy that tax in relation to some person who is connected in some real way with the Commonwealth, e.g. the income is derived from a source in Australia, or the person is resident in Australia, or the person is the owner of land or property situate in Australia. There must be some real connection between the Commonwealth and the person to be taxed.

An Act passed on those lines would be equally applicable to persons within or without the limits of the Commonwealth who came within its scope.

Non-residence in Australia would be no defence if the reason for levying the tax on the person is on account of the real connection between that person and the Commonwealth.

Applying these principles to the case of absentee debenture holders, I do not think that because the debenture holder is an absentee and the contract has been made outside Australia, it necessarily follows that the Commonwealth has no power to legislate with regard to any income derived by him. Something more is necessary. If the debenture holder is an absentee, and the contract is made outside the Commonwealth, and the holder has no property in the Commonwealth, I do not think that the Commonwealth Parliament has power to levy an income tax on that debenture holder. If, however, the holder has property in Australia, there appears to me to be no constitutional bar to the right of the Commonwealth Parliament to tax that person.

Whether an income tax has been levied on this second class of absentee debenture holder depends on the terms of the Income Tax Assessment Act 1915-1916. Section 10 (1) of that Act provides that income tax shall be levied and paid upon the taxable income derived directly or indirectly by every taxpayer from a source within Australia, and by section 14 (b) of the Act income includes interest credited or paid to a debenture holder of a company which derives income from a source in Australia. From these two sections it is clear that to render a debenture holder liable to taxation, not only must he be a debenture holder in a company deriving income from a source in Australia, but the interest on his debenture must also be derived from a source in Australia. Where the debenture holder is an absentee, and the contract is made outside Australia and the interest and principal are payable outside Australia, I do not think that the interest has been derived from a source in Australia. Where, however, the contract is made here and the interest and principal are payable here, I think that the interest is derived from a source in Australia, and the debenture holder would be liable to taxation notwithstanding that he is an absentee.

As regards section 24, which makes the company agent for the absentee debenture holder, I do not think that section is invalid, but it only applies to the cases where the debenture holder is himself taxable. Unless the principal is taxable, the agent cannot be liable on his behalf.

Absentee shareholders

As regards absentee shareholders, the same constitutional limits apply, as in the case of debenture holders, but the application of these principles has a different effect.

Where a number of persons employ a common fund in a country, I think that they put themselves within the jurisdiction of the government of that country to the extent of the property so employed and the operations engaged in, and it can make no difference that, as part of the machinery for their purpose, they form a company and carry on business in the name of the company.

The Commonwealth Parliament has power to levy taxation on the operations of that company, and I do not think that the Parliament is confined merely to the
company in its area of taxation.

The company is an entity of the law created by virtue of the positive law of a state or a foreign country, but although as a result of the creation of such an entity, the operations may, in law, be regarded as carried on for the company as distinct from the shareholders, I do not think that the Commonwealth legislature is debarred from looking at the actual facts of the case, and levying the taxation upon the persons, for whose benefits the operations are carried on, in proportion with the benefits received (see Morgan v. Deputy Federal Commissioner o f Land Tax 15 C.L.R. 661).

The Income Tax Assessment Act 1915-1916 levies tax on income derived directly or indirectly from a source in Australia, and includes in ‘income’ dividends credited or paid to a shareholder in a company.

It may be contended that dividends paid to a shareholder are derived directly from the share which may not be situated in Australia, but I think that the dividends are, in view of the beneficial interest of the shareholder in the operations of a company, derived indirectly from the operations of the company.

If the company carries on business in Australia, the dividends are, I think, derived indirectly from a source in Australia, within the meaning of section 10 (1) of the Act, and non-residence in Australia is immaterial.

In my opinion, absentee shareholders are under the Income Tax Assessment Act 1915-1916 taxable on the dividends credited or paid to them from companies deriving income from a source in Australia.

[Vol. 15, p. 197]