Appropriate transport telex and telephone links and mail services are needed to allow persons concerned in tax schemes to maintain regular contact with each other so that the person for whose benefit the scheme is implemented retains effective control over it and thus over the assets involved Although Norfolk Island did not have a telephone link with Australia until 15 July 1972 its proximity to Australia the availability of regular air services to both Australia and New Zealand and a reliable cable service with Australia provided sufficiently good communications to sustain tax haven operations Set out hereunder are details of the growth of communications traffic between Norfolk Island and Sydney over the period 1965 to 1974.
Communications traffic between Norfolk Island and Sydney
1965-66 to 1973-74
Year Telegrams Telephone (Minutes
(Inward and Outward) of outgoing calls)
1965 - 66 29,082 -
1966 - 67 35,797 -
1967 - 68 42,607 -
1968 - 69 44,010 -
1969 - 70 53,809 -
1970 - 71 62,754 -
1971 - 72 66,442 -
1972 - 73 58,139 31 989
1973 – 74 65 479 40 702
Notes: (a) For years 1965-66 to 1968-69 the only link was by Morse code radio circuit with Sydney.
(b) For years 1969-70 to 1971-72 this link was replaced by a radio teleprinter circuit.
(c) On 15 July 1972 the OTC radio telephone link came into operation.
Freedom of currency movements
The ability to shift money freely into and out of a count is another requirement valued by those wishing to resort to tax avoidance or evasion schemes Norfolk Island is within the Australian currency area and there was no restriction at all the movement of funds between Australia and the Island prior t 1974. However, persons who sought to take advantage of the 1s tax—free status in relation to dealings beyond both Australia Norfolk Island had first to obtain exchange control approval f the Reserve Bank of Australia Although the position has now changed to some extent as a consequence of the tax screening certain exchange control applications implemented by legislation enacted in 1974 the exchange control mechanism did not operate as a bar to implementation through Norfolk Island of tax—saving schemes having an international element
Availability of professional and financial services
To be viable, a tax haven needs to be able to provide expert legal and accounting services to prospective clients, and to provide a safe, efficient banking system. Also the relevant system of commercial law must provide an adequate framework within which to operate.
As to legal and financial advice, in addition to a small number of lawyers and accountants who soon after 1966 opened practices and lived in the Island, the Island’s proximity to Australia made it possible for mainland advisers to travel there to set up Island—based avoidance schemes. There were people living in the Island prepared to act as company shareholders and directors and trustees on behalf of the people for whom the schemes were devised. The system of law in Norfolk Island was, for practical purposes, the same as that in Australia, and while the company law dated back for many years and did not contain the secrecy rules commonly found in the company law of highly sophisticated tax havens sponsored by governmental policy, it was adequate for the setting up of a variety of company structures.
As mentioned earlier, the Commonwealth Trading Bank opened a branch in the Island in 1964 and the Bank of New South Wales did likewise in 1969.
Political and administrative stability
Taxpayers have no wish to implement possibly expensive tax haven schemes only to lose their money or the tax benefits they had planned to obtain. They would hesitate long before they would use as a haven a politically unstable country where the danger of confiscation of one’s assets is high, or where fraud would be condoned. There was never any possibility of the above elements being present in Norfolk Island. To those considering resort to the Island as a tax haven, action to thwart their plans by the Australian Government or the Island Administration would have had to be reckoned as a possibility, but as the Island’s tax—free status had dated back to 1932, people viewing the scene in 1964 (the significance of which date will become apparent later) concluded that major difficulties lay in the way of changing the tax status of the Island At all events it seems likely that many taxpayers and their advisers in effect gambled that either nothing would be done or that action would be delayed long en( for schemes to at least yield some worthwhile benefit - if only temporary in character.
The proliferation and diminution of tax avoidance
Until about 1964 the tax—free status of Norfolk Island ha not been exploited there were for example only ten companies incorporated in the Island by the end of 1963 In 1964 follow the report of the Ligertwood Committee on Taxation of June 196 an extensive range of measures was taken against income tax avoidance occurring within Australia and many taxpayers wishing to escape Australian tax found it profitable to move their base to the Island In other words the tax haven attributes that Norfolk Island possessed lay unexplored until a tightening of the Australian income tax law induced taxpayers to take advantage them Conversely once it was seen in later years (m e after the Income Tax Assessment Act (No 4) of 1973 became law) that Norfolk Island’s days as a tax haven appeared to be numbered, avoidance schemes were moved — to a limited extent to Papua New Guinea and to other havens beyond Australian jurisdiction
3.The uses made of Norfolk Island as a tax haven
Means employed in tax avoidance schemes
Basis of arrangements
Arrangements for avoidance by Australian residents of tax on Australian income were based on the legal position already outlined that a resident of the Island was not subject to Australian tax on income that had an Island source The broad object of the arrangements was to establish a technical ‘source’ in Norfolk Island for income in circumstances in which it would be derived by a company that had its technical taxation ‘residents in the Island, by a trust established in the Island or sometimes, by an individual resident there.
Steps to secure ‘residency’ of companies
Because technical residence in the Island of the companies involved was an essential element in avoidance schemes, elaborate steps were generally taken to ensure that companies were ‘resident’ in the Island. The following is an illustration of steps taken by taxation consultants to achieve Norfolk Island residency for a company:
A company was incorporated in Norfolk Island with its registered office there;
The shares in that company were held by individuals or companies or trustees resident in the Island;
Shareholders’ meetings were always held in the Island;
All Directors’ meetings were held regularly in the Island, and the directors, or at least a majority of them, resided in the Island;
Meetings of directors dealt with matters of substance and not mere formalities;
The Memorandum and Articles of Association of the company made it clear that it was the board of directors who were required to manage the affairs of the company;
If it was required that an Australian should be party to decisions of the board of directors, he attended meetings in Norfolk Island and did not forward instructions or ‘advice’ or ‘guidance’ from Australia;
All decisions as to the application of profits, appointment of directors and matters of policy or finance were taken in the Island;
The following were all kept in Norfolk Island:
Minute books of both shareholders and directors
Register of members share transfer forms
Other statutory registers
The main bank account was located in Norfolk Island;
The accounts of the company were prepared in the Island and if an audit was required it was carried out there.
The creation of a legal fiction
Such steps were taken in the overwhelming majority of cases for the purpose of creating a legal fiction T artificiality in substance if not in law of the technical residence of these companies emerged when m was established in most cases upon investigation by t Taxation Office that in fact the real control over company affairs remained in the hands of mainland principals or their advisers The great majority of Island residents who acted as company directors had little idea of the details of the transactions in what they were engaged, although of course they were probably aware of the broad purpose, viz, tax avoidance.
The means of control used included signed blank share transfers declarations of trust in favour of mainland persons options over shares in the company granted to mainland persons and proxies in respect of voting shares either in blank or in favour of such persons.
Examples of practices adopted
As mentioned earlier achievement of a Norfolk Island source for income was also a most important objective While, on general principles, the territorial source income has been held judicially to be a ‘practical, h matter of fact’ the application of that principle seen often to be heavily influenced by matters of form. The place where contracts are concluded, accounts kept, registered and payments of money made (all of which can readily be effected in one place rather than another) are of great importance in establishing the source of income. Accordingly, it was not difficult for arrangements to be made so that income had a technical legal source in Norfolk Island. Some examples of practices designed to achieve this object are set out below:
The purpose of a common type of scheme based on the payment of interest was to enable an Australian company group to get part of its income tax—free in the guise of a tax-deductible expense by way of a tax—free interest payment. Shareholders in an Australian company (A) withdrew an amount they had on interest—free loan to it and made an interest— free loan of the same amount to a Norfolk Island company (Nl) set up for the exercise. Nl on—lent the same amount at interest to a second Island company (N2), also set up for the same exercise, and N2 in turn lent back the same amount to A at the same rate of interest.
The desired results were:
First that A received a tax deduction in respect of the interest it paid N2.
Second N2 paid no Australian tax because it was entitled to a deduction of an amount equal to that paid by way of interest to Nl on the loan N2 had received.
Third Nl paid no tax to Australia being not subject to Australian tax because:
It was a resident of Norfolk Island; and
The interest, being paid to it on a loan made in Norfolk Island, had a source in the Island.
The overall result was a deduction for interest paid on intra—group loans without anyone in the group being taxed on receipt of the interest a result which could not be achieved if the recipient of the interest were a resident in Australia
Probably the most common form of this arrangement also involved the interest received by the from Norfolk Island company being returned through second Norfolk company as additional loans to Australian company This gave a snowballing effect to the arrangement and meant that the interest well as the principal completed a full circle actual cash resources of the parties remaining unaffected by the chain of transactions In non—disturbance of the cash resources of the pa was very often an absolute necessity where some them had no real cash funds to implement the arrangements. They relied on exchanges of cheque with each party being dependent for its credit backing on the deposit of another
Avoidance schemes relating to dividends
The broad purpose here was to store up family company profits either from investments or from trading operations, in such a way that the comp avoided undistributed profits tax (at the rate c 50%) and because dividends were not paid the shareholders were not liable to personal income tax at progressive rates at least for the time being. Indeed, if the ‘right’ arrangements, e.g a dividend stripping operation, could in the long run be made, the shareholders would not be taxed at all and the relevant income would have been subject to a tax rate as low as 32.5%.
These schemes were put into effect by large and wealthy family groups. Instead of allowing dividend distributions to follow the paths within Australia they would ordinarily take, the dividends were paid to a specially created Island company which in turn passed them on to another company established in the Island to receive them. As explained earlier, Norfolk Island companies were entitled to the same rebate of tax on dividends received as were Australian companies, so that the companies employing these schemes envisaged that the first Norfolk Island company would receive the dividends free of Australian tax and the second company, being a Norfolk Island company receiving dividends from a technical ‘source’ in Norfolk Island, would not only be free from Australian company tax but also, because of the way the undistributed profits tax law is framed, be able to retain them tax—free for as long as it liked.
At one time some groups, anticipating that the Commissioner might successfully employ a discretionary power in s.46 of the Act to deny one-half of the rebate on dividends, organised things so that dividends derived from Australia by the Norfolk Island company were wholly offset by interest (with a technical source in the Island) paid to another Island company. There then being no taxable income, unless the Commissioner could deny a deduction for the interest payments, the possibility of only a half-rebate on dividends received became of no consequence.
The significance of the Esquire Nominees CaseEsquire Nominees Ltd (Trustee of Manolas Trust) v. Federal Commissioner of Taxation (1973) 129 C.L..R 177
Concerned dividends that originated in income earned in a pharmacy located in Australia. With a view to avoidance of the undistributed profits tax imposed on private companies (or personal tax if distributed to individual shareholders) the dividends were passed through a chain of companies some resident in the Island, to the trustee of an accumulative trust set up in the Island for the Australian family who ‘owned’ the pharmacy The dividends paid to the trustee were paid out of profits represented by dividends received on shares (in an Island company) located in an Island register Gibbs J of the High Court of Australia upheld the Commissioner’s assessment of the dividends received by the trustee While he accepted that the trustee was resident in Norfolk Island he held that precedent authorities did not require a decision that the geographical source of the profits was the place where those shares were located Rather he followed the rule that ‘source’ is a ‘practical hard matter of fact’ and decided on a review of the ‘realities of the situation’, and notwithstanding ‘the devices adopted to give the facts a specious appearance’ that the only ‘source’ of the dividends was Australia However the Full High Court of Australia on 24 September 1973 reversed His Honour’s decision and held that the source of the trustee’s income was Norfolk Island on the basis that the fund and the business from which the dividends came were located there,
The case served to highlight the difficulties involved and emphasised the need for amending legislation which was, by that date, before the Commonwealth Parliament,
Examples of avoidance schemes other than interest and dividend schemes
Rents - The principals of an Australian company (A) lent money interest—free to a Norfolk Island company (Nl) which then lent the funds at interest to a second Island company (N2), N2 used the funds to purchase an Australian property which it then rented to A which used the property in its business in Australia. The rents derived by N2 from Australia were largely offset by the interest payments made by it to Nl, so that N2 had only a small taxable income on which Australian tax could be levied. A obtained a deduction for the rent it paid, while Nl claimed to be exempt from Australian tax on income it derived. All companies involved were beneficially owned by the same Australian principals.
Commission — An Australian manufacturer that sold its products overseas arranged for a Norfolk Island company (Nl) to act as its selling agent in respect of all overseas sales and agreed to pay it a commission on those sales. N1 then appointed N2 (another Island company) as its selling agent and agreed to pay it a similar commission. The results sought by this arrangement were:
A reduction in the assessable income of the Australian company equal to the amount of commission paid to Ni;
N1 to have little or no income which would be subject to tax; and
N2 to accumulate tax—free the commissions paid to it.
Again, the ultimate ownership of all the companies rested with the same group of Australians.
Share trading profits - Australian principals, instead of purchasing speculative mining shares directly, arranged for an Island company (N1) to purchase the shares. N1 then granted an option to purchase the shares to N2, a second Island company. The option fee paid by N2 was only a small fraction of the value of the shares. Subsequently, N1 sold the shares to an arm’s length purchaser for a profit in excess of $460 000. However, as a preliminary to the sale of the shares N1 paid to N2 an cancellation fee of approximately $440,000, thus reducing its taxable profit to about $20 000 tax involved amounted to over $180 000.
Franchise fees — A franchise for the sale of a certain product in Australia, previously grants direct from a foreign company to an Australian company (A) was replaced by arrangements under the foreign company granted a franchise to a Norfolk Island company (Nl) N1 granted to N2 another Island company, the right to exploit the franchise and it in turn granted rights to A Amounts paid by A to N2 were claimed as deduction in Australia but the receipts by N2 were nearly offset by payments to N1, leaving N2 with a mm taxable income. N1 was not taxable on the amount it received and these found their way, by a cir route, to the principals of A.
Other examples included the shifting to Norfolk Island in similar ways of profits derived from the sale of Australian land and the sub—underwriting new share issues
Use of trusts
Whatever was the nature of the income diverted from Australia it was sometimes the case that it was ultimately directed to a trust established in the Island for the benefit of the Australian family group concerned Income derived from a Norfolk Island source by a trust created and formally managed in the Island by a trustee resident there was not in the trustee’s hands subject to Australian tax The great flexibility offered by trust law for the operation of trusts was in Norfolk Island as in other tax havens of great advantage in tax avoidance schemes There was of course no public record of their existence or of their terms, and facts about them were, and are, hard for the Australian taxation authorities to ascertain.
Avoidance by Australians of Australian tax on foreign income
The fact that Australian companies have virtual freedom from company tax on dividends from abroad (due to the s.46 rebate), and are exempt in respect of most other income from overseas if it is taxed in the country of source (s.23q), meant that the scope for exploitation of Norfolk Island’s tax status to avoid Australian tax on foreign income was somewhat limited. Nevertheless, there were avenues open for avoidance. Undistributed profits tax could be avoided on dividends from abroad that would otherwise be received in Australia by a private company and, if non—dividend income was derived in a foreign country that did not levy tax on the income, tax savings were possible by having the income sent to an Island company or trust, rather than to the Australian resident concerned.
In one case, it appears that an Australian private company with a profitable wholly owned subsidiary in the United Kingdom arranged to receive part of the profits of the subsidiary as loans rather than as dividends. If the moneys were received as dividends the Australian company would have either had to redistribute them as dividends, on which tax would be paid by the shareholders in the parent company, or retain the funds and pay undistributed profits tax. Instead, the United Kingdom company issued a preference share to a Norfolk Island company (Nl). This share changed hands and came into the possession of a Singapore company (S1) which received a large dividend on that share. The dividend received by S1 passed to a related Norfolk Island company (N2) in the form of a loan. N2 then lent the funds at a higher rate of interest to another Norfolk Island company (N3) which on-lent the funds, at the same rate of interest to the Australian company group Accordingly not only was the Australian company to be enabled to avoid tax on the dividend from its United Kingdom subsidiary which it now received in the form of a loan but it also was to be enabled to reduce it primary tax to the extent of the deduction obtained mm respect of the interest paid on the loan.
As a relatively minor example of tax avoidance but deserving of mention nonetheless to illustrate the spread of such activities it is recorded that a case was observed where payments from overseas for the right to use Australian produced films and other associated payments have been received by a group of Norfolk Island resident companies
Avoidance of Australian tax by Foreigners
Australia has two withholding taxes payable by non— residents on income from Australia — one on gross dividends (30% reduced to 15% for countries with which Australia has comprehensive double taxation agreements) and one c gross interest (10%). Both are final taxes on income derived by foreign residents from Australia. The amour of tax is deducted (withheld) by the Australian payer of the dividend or interest before remitting the balance to the foreign resident and the tax is then forwarded to the Commissioner of Taxation. As already explained, withholding tax was not payable on income remitted from Australia to Norfolk Island or on income remitted over-seas from the Island
This situation led some companies in Australia to set up Island schemes for the purpose of avoiding Australian withholding tax. An overseas loan of $50m was involved in one case Funds borrowed from an overseas lender were borrowed in the first instance by a Norfolk Island company (N1) which on-lent them at interest to a second Island company (N2) which then on—lent, at the same rate of interest, to the Australian borrower. Australian tax was avoided because N2, being a ‘cost company’, derived no taxable income. Also, the interest earned by Ni was exempt in its hands on the grounds that the interest was derived by a Norfolk Island resident from a source in the Island. It was able to remit the interest, free of withholding tax, to the overseas lender.
Dividend withholding tax could also be avoided, A foreign company - particularly a public company - had only to set up a subsidiary in Norfolk Island to hold its Australian portfolio in order to avoid dividend withholding tax, no other Australian tax being payable by the Island subsidiary. There were avenues for dividends paid by the Island subsidiary to reach the foreign company free of all Australian tax. One case of this kind is known to have occurred and interest in the state of affairs had been evinced by foreign enterprises.
Australian tax on royalties payable to foreign residents could also be avoided by the same ‘cost’ company device as was used to avoid interest withholding tax.
Avoidance of foreign tax by foreigners
The investigations conducted by the Australian Taxation Office into Norfolk Island schemes were directed to discovering avoidance or evasion of Australian tax, and evidence of resort to Norfolk Island for the purpose of avoidance by foreigners of foreign tax was not of immediate importance.
The Island did, however, receive wide prominence in books and articles as a tax haven and its complete freedom from tax was a noted feature, which sooner or later would have attracted foreigners to resort the to avoid tax of their home country Avenues existence for income from Australia or from other countries that matter to be accumulated tax—free in companies trusts set up in the Island The tax—free status of Norfolk Island was the subject of concern to the other countries involved in double tax agreement negotiation with Australia that took place during the period prior to 1973 Agreements drafted in that period were so framed that they would not in relation to Norfolk Island contain loopholes capable of being used for tax avoidance.
The extent of past avoidance and evasion
Effective virtual commencement date
This is highlighted by the fact that from 1926 when Island’s Companies Ordinance was first promulgated until the end of 1962 a period of thirty—seven years only seven companies were registered. In the next ten years however i.e to the end of 1972 as many as 1920 companies were registered in the Island The following table shows the year-by-year figures
Norfolk Island Company Statistics
Deregistered (in liquidation or struck off)
Balance at 31 December
During the period 1.1.63 to 31.12.71 there were 1754 new companies registered and only 190 companies deregistered
From 1.1.72 to 1.12.75 only 425 new companies were registered while 998 were deregistered.
Some of these companies undoubtedly engaged in genuine business activity in the Island. It is not possible to state precisely the number of such companies without a very detailed investigation, but from information available to the Taxation Office it is believed that it would not approach three figures. It is obvious that the overwhelming majority of the companies established in the Island since 1962 had tax avoidance or evasion as the sole or major reason for their existence. No other explanation was advanced for the existence of so many companies to serve a population of some 1600 people.
The indicator provided by banking activity
The very establishment of the bank branches in the Island and the rise in the volume of money passing through their company accounts provides perhaps the most dramatic illustration of the extent of the activities by tax avoidance or evasion companies. Set out below are figures which give some indication of the number of accounts and the volume of transactions handled by the two bank branches in the Island on behalf of tax-avoiding or evasion companies over the years specified.
COMPANY ACCOUNTS AND VOLUME OF MONEY TRANSACTIONS FOR NORFOLK ISLAND
Commonwealth Trading Bank
Year ended 30 June
Total No. of accounts 30 June
Total volume of funds in transactions up to $10,000
Total volume of funds in transactions between $10,000 & $ 100,000
Total volume of funds in transactions over $100,000
Total funds involved per year
3 378 300
4 273 900
1 449 300
7 911 200
62 004 900
71 365 400
2 271 300
12 247 500
62 741 300
77 260 100
1 630 300
11 020 300
44 755 200
57 405 800
2 181 000
10 161 300
45 637 300
57 979 600
1 878 000
11 939 600
109 158 100
122 975 700
1 749 700
9 855 000
115 957 900
127 562 600
10 340 900
67 375 000
78 405 400
3 445 500
11 497 700
15 581 400
613 652 300
Bank of New South Wales
Year ended 30 September
Total No. of accounts 30 September
Total volume of funds in transactions up to $10,000
Total volume of funds in transactions between $10,000 & $ 100,000
Total volume of funds in transactions over $100,000
Total funds involved per year
1 413 000
5 988 000
7 523 000
2 172 000
20 795 000
23 096 000
3 369 000
201 295 000
204 865 000
4 434 000
142 012 000
146 751 000
4 967 000
86 687 000
91 929 000
2 280 000
101 595 000
104 049 000
2 433 000
62 934 000
65 559 000
643 772 000
It can be seen that in the case of the Bank of New South Wales branch alone, over 204 million dollars passed through its books in the peak year of 1970-71 and over the seven years of its operations an aggregate of $643,772,000 was involved,
Estimations of tax lost to Australia
There is no doubt according to evidence given on behalf of the Australian Taxation Office that the total amount of Australian income tax lost through the tax haven status of Norfolk Island runs into many millions of dollars. In eleven particular dividend cases, tax avoided amounted to over $l.5m for one year, the amounts in each case ranging from $349,000 to $16,500, and that sample of eleven was not atypical. Amounts involved in individual interest schemes varied considerably. For example in four particular cases, tax avoided over the five-year period 1968 to 1972 amounted to over $165,000, the individual amounts ranging from $57,000 to $16,000. In another twenty-one cases the income that was, over the same period, diverted to Norfolk Island as interest amounted to some $3.lm. The tax avoided on that amount was in excess of $lm. For another family the amount put through the Island in loan/trust arrangements was over $12m.
While it is not possible to be precise in any estimates of tax lost, nonetheless a broad appreciation of the order of magnitude can be given. If for instance it is assumed that there were 900 tax avoidance schemes and that the average tax saving was $1000 per annum, the tax cost each year would be $900 000. If the tax saving averaged $10 000, the tax lost would amount to $9m per annum. At an average of $50 000 avoided in each case, the total becomes $45m. As indicated, the tax avoided in some individual cases was well over $50 000. However, this is a theoretical approach and, as stated earlier, the evidence does not establish a basis for making any precise estimation of the income tax avoided.
Indicator from numbers of service industries
It may be inferred from the number of accountants and solicitors who established practices or resided in the Island when taken into account with other evidence that Norfolk was being used extensively for tax avoidance. At the height of the boom there were several such practices in Norfolk Island an unusually large number to serve a population of some 1600 people and bearing in mind the Island’s type of economy Much of the work was of course done by mainland firms
The element of publicity
The tax haven status of Norfolk Island was given wide publicity both in Australia and abroad. This wide publicity is yet another indication of the use which was being made of the Island for tax avoidance
The potential loss from tax avoidance
It is important that this be noted During Norfolk Island’s existence as a tax haven there have always been clouds over the scene the technical situation regarding source and residence was not entirely clear and action to take away the Island’s tax advantages was always a possibility Had the Island been given an ‘all clear’ as a tax haven it would be no exaggeration to say that tax avoidance would have escalated to mammoth proportions