Part 2 deals with the normal operation of the active income test. Special rules for banks, other financial institutions and insurance companies are not included.
Explanation of the terms used in this part. |
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What is the purpose of the active income test? |
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Conditions to be met to satisfy the active income test. |
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Is the tainted income ratio less than 5%? |
Section 1: Explanation of terms used in this part
Meaning of passive income
Dividends
Passive income includes dividends (within the meaning of section 6) and:
- unit trust dividends received from a corporate unit trust or a public trading trust
- a distribution made by a liquidator which is deemed to be a dividend.
Interest income
Passive income includes tainted interest income, which is all interest income except for interest derived through an offshore banking unit. It also specifically includes:
- amounts in the nature of interest - for example, discounts
- income earned from hire purchase and other property financing transactions
- accrued interest on discounted and other deferred interest securities issued after 16 December 1984
- interest deemed to be derived where a CFC assumes the rights of a lender through the purchase of securities through a secondary market
- factoring income.
Tainted rental income
There are three categories of tainted rental income.
- Rent from associates
- Income from any leases between a CFC and an associate and any income that arises where rent is paid to the CFC by an associate.
- Lease of land
- Income from related party lease transactions will be tainted rental income.
- Income from leases of land, including fixtures, in respect of land situated in a country other than the CFC's country of residence will be tainted rental income.
- Income from leases of land, including fixtures, in respect of land situated in the CFC's country of residence will be tainted rental income unless a substantial part of the income is attributable to the provision of labour-intensive 'property management services' by directors or employees of the CFC in connection with the land.
- Ships and aircraft
- Income from the lease of ships or aircraft, cargo containers for use on ships or aircraft or plant or equipment for use on board ships, unless the income relates to the provision of operating crew in relation to ships and aircraft or maintenance or management services by the CFC's directors or employees.
Excluded rental income
An amount of rental income will not be treated as tainted if the following three requirements are satisfied:
- the amount is derived from an associated CFC resident in the same country
- the amount is subject to the normal company rate of tax in that country, and
- the payment of the amount did not wholly or partly give rise to a notional allowable deduction for the associated CFC.
The second requirement is based on whether an amount has been subject to the normal company rate of tax in a country. For an amount to be treated as taxed at a country's normal company rate, the amount must be taxed at the same rate applicable to the company's other income or at a higher rate. In addition, there can be no entitlement to a credit, offset or tax concession in the taxation of the amount.
For the third requirement, it is assumed that the associated CFC failed the active income test. The requirement will not be satisfied if a payment would have resulted in a notional allowable deduction for an associated CFC if the CFC had been required to work out its attributable income.
Tainted royalty income
Tainted royalty income includes income derived from assigning any copyright, patent, trademark or other like property or right.
Specifically excluded from tainted royalty income are royalties received from unrelated persons in the course of carrying on a business where the CFC substantially develops or improves the property or right for which the royalty is paid. For example, if a CFC develops software and licenses it to an unrelated party, the royalty income is not tainted.
Net gains on the disposal of tainted assets
The net gain - that is, the sum of gains less losses - from the disposal of tainted assets is included in passive income.
What is a tainted asset?
Tainted assets include:
- all shares, interests in trusts and interests in partnerships
- most financial instruments - such as loans, forward and futures contracts, swaps, other securities and life assurance policies
- rights or options over any of the above.
An asset will also be tainted if it is held by a CFC to derive tainted rental income. In order to determine whether an asset is used to produce tainted rental income, you must look at the use of the asset over the whole time of ownership. If the purpose changed during that period, the asset will be treated as being used to produce tainted rental income if this was the purpose for the majority of the period of ownership.
An asset will be treated as a tainted asset if it is not trading stock and is not used solely in carrying on business.
Exclusion of commodity investments
Commodity investments are not tainted assets. They are treated separately when working out net tainted commodity gains.
Proceeds from trading in tainted assets
Income derived in carrying on a business of trading in tainted assets is included in passive income.
Net tainted commodity gains and losses
The net gain on the disposal of tainted commodity investments is included in passive income.
What is a tainted commodity gain or loss?
A tainted commodity gain or loss arises from the disposal of a tainted commodity investment.
What is a tainted commodity investment?
Commodity investments that are tainted include futures or forward contracts for a commodity - or a right or option on such a contract - unless the company carries on a business of producing or processing the commodity or uses the commodity as a raw material. To be excluded, the contract right or option must relate to the carrying on of that business and the resultant physical sale of the commodity must not be tainted sales income.
Net tainted currency exchange gains and losses
A net tainted currency gain is the sum of the tainted currency exchange gains less the sum of the tainted currency exchange losses. If this is positive there is a net gain. If not, the amount is ignored.
What is a tainted currency exchange gain or loss?
A gain or loss from a currency exchange fluctuation will be tainted unless it falls within one of the following categories:
- the underlying transaction was for the purchase of goods from an unassociated person
- the underlying transaction was for the purchase or sale of depreciable plant or equipment that was used mainly to produce income that is not passive, tainted sales or tainted services
- the underlying transaction was a hedge for one of the preceding transactions
- the CFC was carrying on business as a currency trader and no other party to the transaction was an associate or an Australian resident.
Meaning of tainted sales income
The tainted sales income of a CFC includes that part of gross turnover that represents sales income where the goods sold were purchased from or sold to:
- an associate who is a Part X Australian resident, or
- an associate who is not a Part X Australian resident but carried on business in Australia through a permanent establishment.
Purchased from |
Tainted sales? |
|---|---|
Associated Australian |
Yes |
Associated non-resident (via Australian branch) |
Yes |
Unassociated Australian |
No |
Associated non-resident (not via Australian branch) |
No |
Unassociated non-resident |
No |
Sold to |
Tainted sales? |
|---|---|
Associated Australian |
Yes |
Associated non-resident (via Australian branch) |
Yes |
Unassociated Australian |
No |
Associated non-resident (not via Australian branch) |
No |
Unassociated non-resident |
No |
Exclusions from tainted sales income
Manufacturing exclusion
The main exclusion from tainted sales income is sales where the CFC manufactures, extracts, produces or substantially alters the goods sold. This would include, for example, sales from mining and quarrying operations.
This exclusion will apply only where the goods sold were manufactured, produced or substantially altered by the directors or employees of the CFC. The packaging and labelling of goods is not considered to be a substantial alteration of those goods.
The exclusion will not be available where the CFC subcontracts the manufacture, production or substantial alteration to agents or subcontractors. However, the fact that a CFC subcontracts some operations will not disqualify it from the manufacturing exclusion if directors or employees of the CFC carry out a substantial part of the manufacture, production or substantial alteration.
Hospitality exclusion
Also excluded from tainted sales income are sales that, broadly, arise from the tourism and hospitality industry. These are sales provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.
Passive income exclusion
Amounts of passive income are excluded from tainted sales income. This prevents double counting.
Meaning of tainted services income
Tainted services income, in broad terms, means income derived from the provision of services by a company to:
- a resident (except in connection with a foreign permanent establishment of the Australian resident), or
- a non-resident in connection with the non-resident's Australian permanent establishment.
Tainted services income also includes income derived from services provided indirectly to Australian residents, subject to certain requirements.
Services includes any benefit, right or privilege provided under an arrangement for the performance of work or the provision of facilities - for example, performance of technical, managerial or transport work.
Provided to |
Tainted services? |
|---|---|
Associated Australian |
Yes |
Associated non-resident (via Australian branch) |
Yes |
Unassociated Australian |
Yes |
Associated non-resident (not via Australian branch) |
No, subject to indirect services rule |
Unassociated non-resident (via Australian branch) |
Yes |
Unassociated non-resident (not via Australian branch) |
No |
Exclusions from tainted services income
General exclusions
Tainted services income does not include:
- royalties
- any income in respect of a lease of land
- any income from trading in assets, or
- gains from currency exchange rate fluctuations, commodity investments and assets.
Manufacturing exclusion
There is an exclusion from tainted services income where the service relates to goods manufactured by a CFC - for example, payments for after sales service or income derived under a service contract for equipment manufactured by a CFC.
Hospitality exclusion
Also not included in tainted services income are services that, broadly, arise from the tourism and hospitality industry. These amounts are services provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.
Passive and tainted services income exclusion
Tainted services income does not include passive income or tainted sales income. This prevents double counting.
Indirect services rule
Income from services provided to an Australian resident or Australian permanent establishment of a non-resident is tainted services income. To prevent avoidance of attribution, income from services provided indirectly to certain Australian residents or Australian permanent establishments will also be tainted services where the following conditions are met:
- services provided by the company to an associated entity are received by another entity that is an Australian resident
- the services are provided under a scheme (as defined in section 995-1 of the ITAA 1997), and
- the income from the services would have been tainted income if they had been provided directly by the company to the ultimate recipient.
The services originally provided by the company have to be the same services that are provided to the ultimate recipient.
Architect Co and Plans Co are both members of the same corporate group, and both are CFCs of AustCo, an Australian resident company. Architect Co provides architectural services (house designs) to Australian customers. Plans Co also develops building and house plans.
Plans Co provides Architect Co (an entity that is an associate) with a suite of highly specific house designs. Architect Co markets these into the Australian market, assisting customers in choosing the most appropriate design, but otherwise making no changes. In this case, Plans Co has indirectly provided services to Australian customers, with the house designs received by those customers the same as those originally provided by Plans Co to Architect Co.
Therefore, the application of the indirect services rule means that AustCo may have to include an amount in its assessable income that is tainted services income in relation to the services provided by Plan Co to Architect Co.
End of example