Part 3: Working out attributable income and the amount to include in your assessable income

This part explains how to work out the attributable income of a CFC. Your share of the attributable income is included in your assessable income.

Even if the CFC passes the active income test, you will still need to read on; passing the test will eliminate many, but not all, types of attributed income and gains.

Summary of part 3

Section 1	General assumptions for working out the attributable income of a CFC
Section 2	General modifications to the law
Section 3	Modifications to the treatment of capital gains and capital losses
Section 4	Quarantining of losses
Section 5	Working out the net income of a partnership
Section 6	Trust amounts
Section 7	Reduction of attributable income because of interim dividends
Section 8	Relief from double accruals taxation
Section 9	How much is included in assessable income

Section 1: General assumptions for working out the attributable income of a CFC

Attributable income is included directly in your assessable income. It is not necessary to aggregate amounts of attributable income as you trace through a chain of CFCs.

You include an amount in your assessable income as follows:

Like this

Do include $300,000 from the first company and $200,000 from the second in your income.

Not like this

Do not include $200,000 from the second company in the income of the first company, and $500,000 income from the first company in your own income.

Attributable income is taxable income

Attributable income is a hypothetical amount. It is the amount that would be the taxable income of a CFC, based on certain assumptions. These are explained below.

Assume the CFC is a resident taxpayer

To work out attributable income, it must first be assumed that the CFC is both a resident of Australia and a taxpayer for the whole of a statutory accounting period. You can then work out the attributable income in the same way you work out the taxable income of a resident company. Amounts derived by a CFC from all sources will be taken into account because residents are taxable on their worldwide income and gains.

To distinguish the calculation of attributable income from a 'real' calculation of taxable income, the amounts used to work out attributable income are called notional amounts. Attributable income is the amount by which the notional assessable income is greater than notional allowable deductions. Income that is not notional assessable income is notional exempt income.

The assumption that a CFC is a resident of Australia does not change the nature of the activities of the CFC; that is, events that occur in a foreign country will not be taken to have occurred in Australia.

Modifications in working out the attributable income of a CFC

In applying the Act to work out a CFC's hypothetical taxable income, you will need to read the Act as if certain modifications (dealt with later in this chapter) have been made to it.

In some cases, provisions are ignored because the application is not appropriate. In other cases, provisions have been replaced with similar provisions that are tailored to the way the attributable income is worked out.

In addition, provisions have been included that are not comparable to other provisions of the Act. These modifications are explained later in this part.

Some provisions of the Act clearly cannot apply when working out attributable income; for example, Part IV, which deals with the making of returns or assessments. Although these provisions of the Act are not specifically excluded from the calculation, for practical purposes they have no effect and can be ignored.

Accounting period is the year of income

Taxable income is worked out for a period called an income year. To apply the Act, the statutory accounting period of a CFC is assumed to be an income year. The particular income year referred to in working out attributable income will be the income year of the attributable taxpayer in which the statutory accounting period ends.

Work out attributable income separately

You must work out your attributable income for a CFC separately to other attributable taxpayers. Different taxpayers may work out different amounts of attributable income for a CFC; that is, the amount included in assessable income may be different for each attributable taxpayer, even if they have the same attribution percentage in the CFC.

There are differences in working out attributable income, depending on whether a CFC is a resident of a listed country or unlisted country.

Modifications for an unlisted country

The notional assessable income of a CFC includes only amounts that fall into specified categories. All other amounts are treated as notional exempt income.

The excluded amounts depend on whether the CFC passed or failed the active income test.

What if a CFC fails the active income test?

If a CFC fails the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• adjusted tainted income derived by the CFC directly
• adjusted tainted income derived by the CFC indirectly as a partner in a partnership
• trust amounts arising to the CFC directly
• trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership
• transferor trust amounts arising to the CFC directly or indirectly as a partner in a partnership.

What if a CFC passes the active income test?

If a CFC passes the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• trust amounts arising to the CFC directly
• trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership
• transferor trust amounts arising to the CFC directly or indirectly as a partner in a partnership.

These amounts are explained in section 5 and section 6. Any other income is notional exempt income.

Diagram 1: Amounts taken into account – unlisted country CFC

Trust (including transferor trust) income derived directly or indirectly via a partnership are always included; tainted income derived directly or indirectly via a partnership is only included if the CFC fails the active income test; other income is not included.

What is adjusted tainted income?

Adjusted tainted income is based on the definition of tainted income used for the active income test. Broadly, it comprises amounts that are either passive income, tainted sales income or tainted services income.

The main difference in the definition of tainted income for the active income test and the definition for working out attributable income is that net gains are included in determining the active income test, whereas the entire consideration on disposal of an asset is included when working out attributable income.

Amounts not included

Some amounts that would normally be assessable if derived by a resident company are treated as notional exempt income in working out the attributable income of a CFC. Certain exemptions are also disregarded when working out attributable income. These exemptions have been replaced with similar provisions that are tailored for working out attributable income.

Amounts taxed in Australia

Amounts that have been taxed in full in Australia are not included in notional assessable income. Amounts will be treated as taxed in full if they have been included in a CFC's assessable income; for example, income sourced in Australia from a CFC's branch in Australia would normally be included in the CFC's assessable income in Australia. Amounts that will not be considered fully taxed, although subject to Australian taxation, are:

• amounts subject to interest or dividend withholding tax, and
• certain shipping income, film and video tape royalties, and insurance premiums.

Dividends that are franked under the imputation provisions are treated as notional exempt income.

Branch in a listed country

An amount of income or profits derived by a CFC in an unlisted country from carrying on a business through a permanent establishment (for example, a branch) in a listed country is excluded, provided the amount is not eligible designated concession income (EDCI) in relation to any listed country.

Exclusion of dividends

Most dividends paid to a CFC by a foreign company are not included in the notional assessable income of the CFC. The only dividends you may need to include for a CFC that is resident in an unlisted country are dividends that are portfolio dividends paid to the CFC (see chapter 3).

Modifications for a listed country

Working out attributable income for a CFC resident in a listed country is similar to working out attributable income for a CFC resident in an unlisted country. However, more exemptions are provided for CFCs in listed countries.

What if a CFC fails the active income test?

If a CFC fails the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• EDCI that is adjusted tainted income arising to the CFC directly or indirectly as a partner in a partnership
• low-taxed third-country income arising to the CFC directly or indirectly as a partner in a partnership (only where it is of a kind specified in the Income Tax Regulations 1936)
• trust amounts arising to the CFC directly that are not subject to tax in a listed country or are subject to tax and are designated concession income
• trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership, if the amounts are not subject to tax in a listed country or are subject to tax and are designated concession income
• transferor trust amounts arising to the CFC directly or indirectly as a partner in a partnership.

Any other amounts are notional exempt income.

What if a CFC passes the active income test?

If a CFC passes the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• low-taxed third-country income arising to the CFC directly or indirectly as a partner in a partnership (only where it is of a kind specified in the Income Tax Regulations 1936)
• trust amounts arising to the CFC directly that are not subject to tax in a listed country or are subject to tax and are designated concession income
• trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership, if the amounts are not subject to tax in a listed country or are subject to tax and are designated concession income
• transferor trust amounts arising to the CFC directly or indirectly as a partner in a partnership.

Any other income is notional exempt income.

Diagram 2: Amounts taken into account – listed country CFC

Other income is not included; tainted EDCI derived directly or indirectly via a partnership is only included if CFC fails the active income and de minimis tests; low-taxed third-country income (of a kind specified in the Income Tax Regulations 1936) is always included unless the de minimis test is satisfied; trust (including transferor trust) income derived directly or indirectly via a partnership is always included.

See Exemption for small amounts for more information concerning the de minimis tests.

 

Adjusted tainted income

Adjusted tainted income is based on the definition of tainted income used for the active income test. Broadly, it comprises amounts that are either passive income, tainted sales income or tainted services income.

The difference in the definition of tainted income for the active income test and the definition for working out attributable income is that net gains are included in determining the active income test, whereas the entire consideration on disposal of an asset is included when working out attributable income.

Low-taxed third-country income

The notional assessable income of a CFC in a listed country includes amounts derived from sources outside the CFC's country of residence if the amounts are of a kind specified in the Regulations. This rule does not apply to amounts of eligible designated concession income (these amounts may be included if the CFC fails the active income test).

Amounts taxed in Australia

Amounts that have been taxed in full in Australia are not included in notional assessable income. Amounts will be treated as taxed in full if they have been included in a CFC's assessable income. Amounts that will not be considered fully taxed, although subject to Australian taxation, are:

• amounts subject to Australian interest or dividend withholding tax, and
• certain shipping income, film and videotape royalties and insurance premiums.

Dividends that have been franked under the imputation provisions are treated as notional exempt income.

Dividends not included

Most dividends paid to a CFC by a foreign company are not included. The only dividends you must include are dividends (other than non-portfolio dividends) paid to the CFC by a company that was a resident of an unlisted country (other than a section 404 country) when the dividends were paid.

These amounts will not be included in notional assessable income if the profits from which the dividends were paid have previously been attributed to you.

Exemption for small amounts

For CFCs in listed countries, if the total of:

• eligible designated concession income (if the active income test was not passed), and
• low-taxed third-country income (of a kind specified in the Regulations)

earned directly by the CFC does not exceed the lesser of $50,000 or 5% of the CFC's gross turnover, then that amount is excluded from the CFC's attributable income .

There is no similar exemption for a CFC that is a resident of an unlisted country.

The general anti-avoidance provisions of the Act may apply where attempts are made to split income among a number of CFCs to take advantage of the exemption.

Section 2: General modifications to the law

This section explains a number of general modifications to the taxation law which apply when working out the attributable income of a CFC. There are also modifications to:

• the treatment of gains and losses made by a CFC on the disposal of a capital asset
• the treatment of losses incurred by a CFC, including the quarantining of deductions
• the treatment of amounts derived through a partnership.

These modifications are dealt with in section 3, section 4 and section 5 of part 3.

Elections to be made by the taxpayer

You can make most elections on behalf of a CFC in working out its attributable income: you must make the elections when you lodge your tax return. We may extend the time for making the elections.

Lodgment of elections

In the case of companies and superannuation funds, no notice of the election is to be sent to us: only give notice if we request you to do so.

Exceptions to the rule

An election for rollover relief under the capital gains tax provisions must normally be made by a CFC, although you can make the election for a wholly owned CFC. The rules for making these elections are explained in section 3 of part 3.

Functional currency elections are also an exception to the general rule that allows you to make most elections when working out the attributable income of a CFC: see ‘Choice to use functional currency’ below.

Foreign currency conversion rules

When calculating attributable income, you must convert all amounts into Australian currency. This conversion is done using the conversion rules under the usual operation of the Act: see Foreign exchange (forex): the general translation rule.

Choice to use functional currency

You can choose to calculate attributable income in the sole or predominant currency in which the CFC keeps its accounts (ledgers, journals, statements of financial performance). This sole or predominant currency is called the applicable functional currency.

When calculating attributable income in a functional currency, all amounts that are not in the applicable functional currency (including Australian currency amounts) must be converted into the applicable functional currency. This conversion is done using the conversion rules under the usual operation of the Act. However, when applying these rules, the applicable functional currency is taken not to be foreign currency and all other amounts (including Australian currency) are taken to be foreign currency.

Once you have calculated your attributable income, you then convert that amount into Australian currency in accordance with the relevant conversion rules.

The choice of applicable functional currency must be in writing, but you are not required to notify the Commissioner of Taxation (Commissioner). You must keep written evidence of the choice for as long as you are required to keep your tax records.

Generally, the choice will apply to the CFC’s statutory accounting period immediately following the one in which you make the choice. However, it will apply to the statutory accounting period in which you make the choice, where you make the choice within 90 days of the beginning of that statutory accounting period.

The choice to use the applicable functional currency applies until you withdraw it. You can only withdraw a choice where the functional currency has ceased to be the sole or predominant currency in which the CFC keeps its accounts. The withdrawal has effect from immediately after the end of the CFC’s statutory accounting period in which the choice is withdrawn. The withdrawal must be in writing and retained with your tax records. You may make a new choice applicable to subsequent statutory accounting periods.

Treatment of foreign and Australian taxes

Deduction for taxes

A notional allowable deduction is available for foreign or Australian tax paid on amounts included in the attributable income of a CFC. An Australian tax is defined to be a withholding or income tax. It does not include additional amounts, such as late payment penalties. If the tax is paid in a subsequent year, the earlier year's assessment can be amended to allow a deduction for the tax, subject to the time limits for amendments.

Trading stock provisions

Valuation is cost only

In working out attributable income, you must value trading stock at cost. The normal rules for determining the cost of trading stock apply.

What happens to obsolete stock?

In working out taxable income, a special valuation is allowed for obsolete stock. This valuation is not allowed when working out attributable income.

Depreciation provisions

Basis for depreciation

Generally, the normal depreciation rules apply for working out the attributable income of a CFC. This means you can choose to depreciate assets by the diminishing value method or the prime cost method. In addition, the rates of depreciation that apply for working out taxable income will also apply in working out attributable income.

Apportionment for exempt usage

A notional allowable deduction for depreciation must be reduced if an asset is only partially used for the production of notional assessable income. The normal rules apply in working out the reduction.

Asset used in a non-attributable period

Special rules apply for an asset held by a CFC during a period for which it was either:

• not necessary to work out the attributable income of the CFC, or
• not necessary to take depreciation on the asset into account in working out the attributable income of the CFC.

In such cases, the depreciation rules apply as if the asset were held solely for the production of notional assessable income during the period.

Sale of a depreciable asset

Under the normal operation of the Act, a deduction for the difference may be allowed where an asset is sold for less than the notional depreciated value of the asset. This deduction is also allowable in working out the attributable income of a CFC.

An amount may also be included in notional assessable income as a result of the sale of the asset.

For more information, phone 13 28 66.

What about other capital deductions?

There are other provisions of the Act that allow for a deduction of the capital amounts and these may apply when working out attributable income. Where the assets were used in a non-attributable income period, the amount of the deduction allowed or the recoupment included in notional assessable income needs to be determined. However, it is not expected that this will often occur.

For more information, phone 13 28 66.

Transfer pricing rules

Division 13 of Part III

The Act contains measures to counter arrangements designed to move profits from one entity to another: these arrangements are commonly called transfer pricing or profit shifting. Broadly, the transfer pricing rules allow us to increase a taxpayer’s assessable income or decrease allowable deductions to negate the effect of the arrangement.

Tax treaty

Subdivision 815-A of the ITAA 1997 confirms Australia's ability to assess tax based on the associated enterprises and business profits articles in Australia's tax treaties. The rules apply only where there is a relevant tax treaty. For the purpose of applying the definitions in such a tax treaty, the CFC is treated as a resident of a foreign country. The result is that the associated enterprises article may apply to arrangements involving the CFC.

Application of the transfer pricing rules to non-arm’s-length arrangements involving CFCs resident in the same listed country

The transfer pricing rules do not apply to arrangements involving CFCs resident in the same listed country at any time when a tax treaty is in force.

Impact on active income test

We can make adjustments reflecting arm’s-length values to amounts used in determining whether a CFC has passed the active income test. An adjustment can be made if, in working out the attributable income of a CFC, we would make a transfer pricing adjustment in relation to the acquisition or supply of property by the CFC.

Requests for rulings

You can request a ruling from us on whether Division 13, as modified, applies to an arrangement.

Compensating adjustments

To avoid double taxation, we may make adjustments in the assessment of another taxpayer to compensate for a transfer pricing adjustment. For example, a compensating adjustment may be made where a transfer pricing adjustment decreases the amount of a royalty payment made to a related company. In this case, a compensatory adjustment could be made to reduce the amount included in the assessable income of the related company as a result of the royalty payment.

As with the usual operation of the transfer pricing rules, where one CFC’s notional assessable income or notional allowable deductions are adjusted, we may make a compensating adjustment to:

• a taxpayer’s allowable deductions or assessable income
• another CFC’s notional assessable income or notional allowable deductions, or
• the attributable income of a transferor trust estate.

Similarly, compensating adjustments may be made to the attributable income of a CFC when the transfer pricing rules have been applied to:

• a taxpayer’s allowable deductions or assessable income, or
• the attributable income of a transferor trust estate.

Deduction for eligible finance shares

A deduction is not normally available for the payment of a dividend. However, a notional allowable deduction is available for an eligible finance share dividend paid by a CFC. Broadly, this is a dividend paid on a share issued under a preference share financing arrangement with an Australian financial intermediary (for example, a bank) and its subsidiaries. In effect, the issue of eligible finance shares is treated as a type of loan.

Dividends on eligible finance shares are treated as an interest expense. A notional allowable deduction is available for the dividends, to the extent a notional allowable deduction would have been available if the dividends had been an interest outgoing.

Deduction for widely distributed finance shares

A deduction, similar to that provided for eligible finance shares, is available for dividends paid by a CFC on widely distributed finance shares. Widely distributed finance shares include shares issued by a CFC as a public issue under a preference share financing arrangement to persons who are not associates of the CFC and who have provided finance on arm’s-length terms. To qualify, the shareholders should have no interest in the CFC apart from ensuring repayment of the funds and regular payment of the dividends in a form which is, in effect, a substitution for interest on a loan.

Diagram 3: Operation of widely distributed finance share measures

members of the public

->

funds raised by public issue of widely distributed finance shares

->

CFC A

->

funds may be lent

->

CFC B

A deduction is available from the attributable income of CFC A for dividends paid on its widely distributed finance shares. In addition, CFC B is allowed a deduction for interest paid to CFC A on the loan from that company.

Section 3: Modifications to the treatment of capital gains and losses

The operation of the capital gains tax provisions of the tax acts is modified for working out the attributable income for a controlled foreign company (CFC).

Assets included in the calculation

Capital gains and losses taken into account in working out attributable income for a CFC are those arising on the disposal of assets, other than capital gains tax (CGT) assets which are taxable Australian property.

A capital gain or loss on the disposal of a CGT asset which is taxable Australian property is taken into account in working out the actual assessable income of the CFC as a non-resident taxpayer; as a result, it is excluded from the calculation of the CFC's attributable income.

This exclusion applies even if the relevant asset is not subject to CGT because it was acquired before 20 September 1985.

What is a CGT asset which is taxable Australian property?

In determining whether an asset is a CGT asset that is taxable Australian property, the assumption that the CFC is a resident of Australia is ignored. However, in most cases, the residency assumption will make no difference.

There are five categories of CGT assets that are taxable Australian property. They are:

1. Taxable Australian real property which is directly held.

This includes:

• real property situated in Australia, and
• mining, quarrying or prospecting rights, where minerals, petroleum or quarry materials are situated in Australia.

Where such assets are depreciating assets, then capital gains and losses are disregarded for CGT purposes.

2. Indirect Australian real property interest (other than interests in category 5).

A membership interest held by an entity in another entity where the following two tests are met:

• non-portfolio interest test (broadly where the interest in an entity, whether foreign or Australian, must be at least 10%), and
• principal asset test (where the market value of the entity’s assets is principally attributable to Australian real property).

Where an indirect Australian real property interest held on 10 May 2005 was not previously subject to CGT, its cost base is reset to its market value on that day. For the reset to occur, on 10 May 2005 the following must be satisfied:

• the interest was held by a foreign resident (or trustee of a non-resident trust)
• the interest was a post-CGT asset, and
• the membership interest did not have the necessary connection with Australia (within the meaning of the law on 10 May 2005) disregarding the operation of items 5(b) and 6(b) of the table in section 136-25.

As a result, unrealised capital gains and capital losses on 10 May 2005 are not subject to CGT.

3. Business assets used in an Australian permanent establishment of a foreign resident (other than assets in category 1, 2 or 5).

4. Options or rights over category 1, 2 or 3 assets.

5. Assets where a CGT gain or loss is deferred when an entity ceases to be an Australian resident.

The specific list of CGT assets which are taxable Australian property are set out in section 855-15 of the ITAA 1997.

Assets used to produce notional exempt income

In working out taxable income, the capital gains tax provisions do not normally apply to the disposal of assets used solely for the production of exempt income. However, in working out attributable income, capital gains or losses on the disposal of assets used to derive notional exempt income can be taken into account.

Removal of exemption of pre-20 September 1985 assets

When applying the capital gains tax provisions in working out attributable income, all CGT assets other than taxable Australian property that a CFC owns are deemed to have been acquired on 30 June 1990 or a later date (being the last day of the most recent period during which there was not an attributable taxpayer with a positive attribution percentage). As such, the exemption for pre-20 September 1985 assets does not apply in working out attributable income.

Cost base of assets

The cost base of assets owned by a CFC is the market value at the later of:

• the last day of the most recent period during which there was not an attributable taxpayer with a positive attribution percentage in relation to the CFC, and
• 30 June 1990.

This day is called the ‘commencing day’.

Working out a gain or loss on disposal

You work out the amount to include in a CFC’s notional assessable income in broadly the same way as for the usual operation of the capital gains tax provisions: that is, you must determine the excess of a CFC’s capital gains over the CFC’s capital losses and include that excess (the net capital gain) in the CFC’s notional assessable income. A net loss can only be carried forward to be offset against future capital gains. However, there are certain modifications to the CGT provisions that apply when working out attributable income.

Valuation date for assets owned at the end of the commencing day

An unrealised gain that accumulated on or before the commencing day will not be taxed. Correspondingly, any unrealised loss accumulated up to that date will not be allowed. This is done by valuing the assets on the commencing day and, in general, using that value as the consideration paid.

However, where an asset had decreased in value on or before the commencing day, the gain using the market value as the consideration paid could be bigger than the actual gain. Similarly, where the asset had appreciated in value on or before the commencing day, the loss using the market value as the consideration paid could be greater than the actual loss. In either of these cases, only the actual gain or loss is taken into account. To achieve this result, you must use as the consideration paid for such assets either the market value of the asset at the commencing day or the actual cost base of the asset, whichever produces the smaller gain or loss. That is:

• in working out a gain, use the greater of the unindexed cost base and the market value on the commencing day
• in working out a loss, use the lower of the unindexed cost base and market value on the commencing day.

Indexation of the cost base

The cost base of an asset acquired by a company on or before 21 September 1999 may be indexed for inflation. However, the cost base of the asset may only be indexed for inflation up until 21 September 1999 if that asset was held for at least 12 months.

 

Indexation factor

The indexation factor used is the same as that normally used under the capital gains tax provisions; that is, the consumer price index (CPI).

Adjustment to the cost base

In some cases, the cost base of an asset will need to be adjusted; for example, this would occur where there was a return of capital on shares or a tax-free distribution from a unit trust.

For more information, phone 13 28 66.

Provisions for profit-making ventures

The provisions of the Act that include in assessable income a capital gain from the disposal of an asset purchased for profit-making by sale or from carrying out a profit-making undertaking or that allow a deduction for a loss (that is, sections 25A and 52 of the ITAA 1936 and sections 1515 and 2540 of the ITAA 1997) do not apply in respect of the disposal of a non-taxable Australian asset of a CFC.

Treatment of a net capital loss under the capital gains tax provisions

In working out taxable income, capital losses are offset against capital gains to determine the net capital gain to include in assessable income. Where there is a net capital loss, you cannot use the loss to reduce assessable income. The same rules apply in working out attributable income.

A CFC cannot use a net capital loss under the CGT provisions to reduce its notional assessable income. It can only carry the loss forward for offset against capital gains in subsequent years.

You cannot transfer a loss: for example, you cannot use the loss of one CFC to reduce the notional assessable income of another CFC or your own assessable income.

In working out attributable income, you cannot take into account a capital loss incurred on the disposal of an asset where the disposal occurred before 1 July 1990.

Where a company becomes a CFC after 30 June 1995, asset disposals made before it became a CFC are not taken into account when working out attributable income.

This ensures that a capital loss is not available where it is incurred before a company becomes a CFC.

Rollover of assets under the capital gains tax provisions

Forced disposals

The capital gains tax provisions allow you to defer working out a capital gain or capital loss where the disposal was:

• as a result of a breakdown of marriage
• caused by the loss or destruction of the asset
• from certain resumptions of property
• from the disposal of certain mining leases.

These rollover provisions will apply in working out the attributable income because of the assumption that the CFC is a resident.

Most of these provisions require that the person disposing of the asset must make an election. You can make the election on behalf of a wholly owned CFC: for more information, see Procedures for electing that the rollover provisions apply.

Group transfers

The CGT rollover provisions allow companies that have 100% common ownership to defer, in certain circumstances, capital gains or capital losses on assets transferred between companies in the group. In the case of asset transfers between CFCs with 100% common ownership, the circumstances under which the rollover provisions apply are modified. These are set out in the table below:

Residence of CFC	Recipient company residence	Asset requirement
Resident of a listed country	Either a resident of that listed country or an Australian resident	Any asset
Resident of a listed country	A resident of a particular unlisted country	The asset must have been used in connection with a permanent establishment of the CFC in an unlisted country
Resident of an unlisted country	Either a resident of an unlisted country at that time or an Australian resident	Any asset

The assumption that a CFC is a resident of Australia is ignored in determining its residence for the group transfer provisions.

Procedures for electing that the rollover provisions apply

How to elect for rollover relief

If an election for rollover relief is required, a CFC (or in the case of group rollovers, both the transferor and transferee) must elect in writing that the particular rollover provision applies.

The CFC must normally make the election. However, an attributable taxpayer may make an election on behalf of a wholly owned CFC.

Timing of elections

An election must be lodged with us on or before the lodgment of a return by an attributable taxpayer that is affected by the election. If more than one attributable taxpayer is affected, the election will be valid if made on or before the lodgment of the affected tax returns.

Self-assessment – extension of time to make an election

The self-assessment guidelines do not apply to an election by a CFC for rollover relief and Taxation Ruling IT 2624– Income tax: company self-assessment; elections and other notifications; additional (penalty) tax; false or misleading statement does not authorise an extension of time in which to make the election. If an extension of time is required, the CFC or its agent should approach us. For convenience, the request should go to our office where the tax return of the largest attributable taxpayer is lodged. If this is not readily apparent, the request can be lodged at any of our offices.

Which officer makes the election?

The person who acts for the CFC should make the election. In Australia, that person would normally be the public officer of the company; however, foreign laws may require a different officer to act for the company. Whoever is authorised (whether under the foreign law or, if no law governs this, under the constituent document of the CFC) may make the election.

Election by an agent in Australia

The requirement that a CFC make an election will also be satisfied where an agent makes the election for or on behalf of the CFC, provided that the person is authorised by the CFC to do so: for example, the Australian parent of the CFC or the CFC’s tax agent in Australia, if authorised, could make the election.

Reduction of disposal consideration where attributable income is not distributed

An adjustment will be made to the consideration received by a CFC in respect of the disposal of an interest in an attribution account entity if the income or profits of that entity have been attributed to you, but have not been distributed. The adjustment only applies where the consideration is included in working out notional assessable income, whether under the capital gains tax provisions or any other provision.

The adjustment is mandatory and does not depend on any finding that the share price reflects the retained earnings. If you think that it applies to the CFC, you can contact our office where you lodge your return for more information.

CGT concession for active foreign companies

For certain CGT events happening on or after 1 April 2004, a CFC may be able to reduce its capital gains or capital losses arising in relation to its interest in a foreign company, including a CFC. This can be done when:

• the CFC holds shares in a company that is a foreign resident (excluding eligible finance shares and widely distributed finance shares)
• a CGT event occurs in respect of the CGT asset that is the share in the foreign company, and
• the CFC has held a direct voting percentage of at least 10% in that foreign company for a continuous period of 12 months in the 24 months before the time of the CGT event.

The gain or loss resulting from the CGT event is reduced by a percentage, calculated at the time of the CGT event, called the active foreign business asset percentage. The method for calculating the active foreign business asset percentage is explained below.

Active foreign business asset

An asset will be an active foreign business asset if, at the time of the CGT event, it is:

• an asset included in the total assets of the foreign company, and
• is used or held ready for use by the foreign company in the course of carrying on a business,

and is not

• a CGT asset that is taxable Australian property
• a membership interest in an Australian resident company
• a membership interest in a resident trust for CGT purposes, or
• an option or right to acquire a membership interest of the type referred to in the previous two bullet points in this list.

Goodwill of the foreign company is included as an active business asset, but financial instruments (other than shares and trade debts) and certain other assets are not included (section 768-540 of the ITAA 97).

To be included in the total assets of the foreign company, the asset must be a CGT asset that is owned by the foreign company at the time of the CGT event.

Active foreign business asset percentage

You can work out the active foreign business asset percentage of a foreign resident company in relation to the CFC using either the market value method or the book value method. If you do not choose either method, the effect of the default method is that you will not gain any benefit under the concession.

Market value method

The active foreign business asset percentage is worked out under the market value method using the following formula:

market value of all active foreign business assets market value of the total assets

Book value method

The active foreign business asset percentage is worked out under the book value method using the following formula:

average value of active foreign business assets average value of total assets

The average value of the active foreign business assets is worked out using the following formula:

value of the active foreign business assets at the end of the most recent period + the value of the assets of the previous period 2

The average value of the total assets of the foreign company are worked out in a similar way.

After applying the formula under either method, the active foreign business asset percentage is determined as follows:

Result of calculation	Active foreign business asset percentage
Less than 10%	0%
10% to less than 90%	The result of the calculation
90% or more	100%

Foreign wholly owned groups

In certain circumstances where the determination of the active foreign business asset percentage involves a tier of foreign companies, the calculation may be done on a consolidated basis for wholly owned companies comprising or within that tier of companies. This removes the need to determine the active foreign business asset percentage for each individual company in the tier, where those companies are considered part of the wholly owned group. Rather, one calculation is performed for the top foreign company in the wholly owned group that also covers all its wholly owned foreign subsidiary companies.

Section 4: Quarantining of losses

Quarantining

If a CFC’s notional allowable deductions are more than the notional assessable income for an accounting period, the excess cannot be claimed against notional assessable income of another CFC. However, the CFC will be able to offset a revenue loss against a net capital gain because of the repeal of subsection 424(2) of the ITAA 1936.

The excess loss incurred by a CFC is carried forward and can be claimed as a notional allowable deduction against the notional assessable income of that CFC in a later year.

Different quarantining rules apply to prior years of income ending on or before 30 June 2008. For more information, see the Foreign income return form guide for that year.

Application of transitional foreign loss rules to CFCs

A CFC with unutilised losses quarantined into the four classes of notional assessable income for an earlier statutory accounting period must convert those losses at the commencement of the statutory accounting period starting on or after 1 July 2008.

What is a convertible CFC loss?

A CFC must convert to one loss bundle any loss in relation to notional assessable income of a particular class that has not yet been taken into account. A CFC will have a loss, for an earlier statutory accounting period, if:

• it has an undeducted loss in relation to notional assessable income of a particular class
• the loss was made in any of the most recent 10 statutory accounting periods ending before the commencement period, and
• a loss remains after disregarding certain amounts.

The amount of the loss is the sum of each loss in relation to notional assessable income of a particular class for the earlier period, after disregarding certain amounts.

How does a CFC reduce a loss of a particular class of notional assessable income?

Before summing together each loss of a particular class of notional assessable income, the CFC is required to reduce each loss according to the conversion rules, using a step-by-step approach.

The first step applies only to a CFC that has an existing loss in respect of the 'all other amounts' class of notional assessable income. The CFC must reduce the loss, except to the extent it is attributable to income that would be its notional assessable income or sometimes-exempt income.

The second step requires a CFC with a loss older than seven years, but not more than 10 years (from the first statutory accounting period starting on or after the 1 July following commencement) to halve the loss that remains after step 1 (where applicable).

The result is the amount of the convertible CFC loss for the earlier statutory accounting period. This removes the classes of notional assessable income, leaving the CFC with a single convertible CFC loss for some or all of the most recent 10 statutory accounting periods ending before 1 July 2008.

What happens to a convertible CFC loss?

A convertible CFC loss will be treated as a loss only for the purpose of applying Part X to statutory accounting periods beginning on or after 1 July 2008. This ensures that the CFC cannot deduct the convertible CFC loss from notional assessable income in accounting periods prior to commencement.

Deductions for sometimes exempt income loss

You may claim a notional allowable deduction for a ‘sometimes exempt income loss’. A sometimes exempt income loss can arise for a CFC in an accounting period if:

• the CFC passed the active income test for the period, or
• the CFC gained the benefit of the de minimis exemption for the period, and
• the CFC has any expenses that are not notional allowable deductions, but would have been if the CFC had not passed the active income test or gained the benefit of the de minimis exemption.

How is the sometimes exempt income loss worked out?

The sometimes exempt income loss is worked out by:

• assuming that the CFC had passed the active income test and did not have the benefit of the de minimis exemption
• working out the amounts that would be included in the notional assessable income, called the sometimes exempt income
• working out notional allowable deductions that would be available if the sometimes exempt income were assessable, called ‘sometimes exempt deductions’.

If sometimes exempt deductions are more than the sometimes exempt income, the difference is a sometimes exempt income loss.

How is a sometimes exempt income gain worked out?

In contrast, a sometimes exempt income gain will arise where the amount of sometimes exempt income is more than the sometimes exempt deductions. The sometimes exempt income gain reduces a CFC’s loss. Losses in the current period are reduced before losses carried forward from a previous period.

Conditions before a loss is allowed

You are allowed a notional deduction for a previous year’s loss only if the CFC was a CFC when the loss was incurred and at the end of each period until the loss is claimed.

In working out the CFC’s previous years’ losses, you must assume that you were always an attributable taxpayer who was required to work out attributable income. It is possible to carry forward a loss from a period when you were not an attributable taxpayer.

You cannot take into account any loss incurred in a statutory accounting period that commenced before 1 July 1983.

Residency requirement for losses

A loss that was incurred in a previous statutory accounting period is only allowable if the CFC was a CFC at the end of that statutory accounting period in which the loss arose and at the end of each of the following statutory accounting periods before the eligible period.

In addition, certain residency requirements must be met before the loss may be applied against the notional assessable income in the eligible period. If these are not satisfied the loss will not be taken into account.

Modifications to the general rule deal with cases where a company:

• remains a resident of the same country, but
• is treated as changing residence from a listed country to an unlisted country, or vice versa, as a result of changes to the lists of countries or political developments: for example, as a result of the dissolution of a country.

In these cases, the losses incurred by a CFC in an earlier period are not denied solely because the listing status of a CFC’s country of residence changes.

The following table summarises the availability of losses incurred in previous statutory accounting periods:

CFC’s country of residence at end of eligible period	CFC’s country of residence at end of the substituted accounting period in which loss arose	Consequence
Listed	Listed	Allowable
Listed	Unlisted	Generally not allowable unless the unlisted country: arose from the dissolution of the listed country, or is the same country as the listed country.
Unlisted	Unlisted	Allowable
Unlisted	Listed	Generally not allowable unless the listed country is the same as the unlisted country.

Losses are not allowable if they were denied in an earlier statutory accounting period.

 

Section 5: Working out the net income of a partnership

The notional assessable income of a CFC includes the CFC’s share of the net income of a partnership. You work out the net income of the partnership in accordance with the partnership provisions of the Act. However, it is assumed that:

• the partnership derived only certain income and gains
• the operation of the Act is modified.

Assumption about income and gains

The assumptions made for amounts derived by a partnership mirror the assumptions made for working out the income and gains of a CFC, except where the assumption applies only to companies. The amounts taken into account in working out the net income of the partnership depends on whether the CFC passes the active income test. The amounts also depend on whether the CFC is a resident of a listed country or an unlisted country.

If a CFC is resident in an unlisted country and it:

• passes the active income test, then the only amounts taken into account in determining the net income of the partnership are trust amounts (including transferor trust) arising for the partnership
• fails the active income test, then only the following amounts are taken into account in determining the net income of the partnership:
  • adjusted tainted income
  • trust amounts (including transferor trust) arising for the partnership.
   

If a CFC is resident in a listed country and it:

• passes the active income test, then only the following amounts are taken into account in determining the net income of the partnership:
  • low-taxed third-country income of a kind specified in the Regulations
  • trust amounts arising for the partnership that are not subject to tax in a listed country or are subject to tax and are designated concession income, and
  • transferor trust amounts arising for the CFC as a partner in a partnership
   
• fails the active income test, then only the following amounts are taken into account in determining the net income of the partnership:
  • eligible designated concession income that is adjusted tainted income,
  • low-taxed third-country income of a kind specified in the Regulations
  • trust amounts arising for the partnership that are not subject to tax in a listed country or are subject to tax and are designated concession income, and
  • transferor trust amounts arising for the CFC as a partner in a partnership.
   

Assumption about modifications to the Act

The modifications that apply in working out the net income of a partnership are similar to those that apply for working out notional assessable income and notional allowable deductions of a CFC: see section 3, section 4 and section 5.

Additional modifications to the Act

Three additional modifications are made in working out the net income of a partnership:

1. The partnership is treated as a resident of the same country as the CFC.
2. A dividend will not be notional exempt income of a partnership unless the dividend is paid out of previously attributed income.
3. The capital gains tax provisions apply to assets acquired by a partnership after 19 September 1985 (the deemed acquisition of assets on 30 June 1990 for CFCs does not apply to assets held by partnerships).

Section 6: Trust amounts

The notional assessable income of a CFC may include certain trust amounts arising for the CFC in the statutory accounting period. There are three types of trust amounts:

• amounts derived as a beneficiary of a trust estate where the CFC is presently entitled to a share of the net income of the trust estate
• other amounts paid to, or applied for the benefit of, the CFC by the trustee of a trust estate
• amounts attributed to the CFC under the transferor trust measures.

CFC a beneficiary of a trust – present entitlement

Where the CFC is presently entitled to a share of the net income of a trust estate, the CFC must include the share of the net income in notional assessable income. The calculation of the net income of the trust estate is made under the existing trust provisions of the Act. The modifications that apply in working out the net income of a trust are similar to those that apply for working out notional assessable income and notional allowable deductions of the CFC: see section 3, section 4 and section 5.

Additional modifications that apply when working out the net income of a trust are outlined below.

Trust is a resident of the same country as the CFC

A trust estate is treated as a resident of the same country as the CFC.

Dividends

A dividend will not be notional exempt income of a trust unless the dividend is paid out of previously attributed income.

Trust is treated as a resident trust estate

A trust is treated as a resident trust estate or a resident unit trust for the purposes of the capital gains tax provisions.

Modifications to capital gains tax provisions

The modifications to the capital gains tax provisions (see section 4) that provide for the removal of the exemption for assets acquired before 20 September 1985 do not apply in working out the net income of a trust. As a result, the capital gains tax provisions apply to assets acquired by a trust after 19 September 1985.

Transferor trust measures

The transferor trust measures apply in working out the attributable income of a CFC: see Chapter 2: Transferor trust and related measures to determine whether the CFC will have an amount attributed to it.

Section 7: Reduction of attributable income because of interim dividends

The attributable income of a CFC is reduced if you are taxed on a dividend paid by the CFC out of current year profits and you would be assessable on those profits under the CFC rules at the end of the statutory accounting period of the CFC.

An interim dividend is considered to have been paid out of the attributable income of the current statutory accounting period only if there are no earlier profits available out of which the dividend could have been paid. When there are such earlier profits, the dividend is considered to have been paid out of those profits. Any balance of interim dividend is considered to have been paid out of the attributable income of the current statutory accounting period.

Taxation Determination TD 2003/27 – Income tax: how is double taxation avoided in the following situations where a Controlled Foreign Company (CFC) pays a dividend to an attributable taxpayer provides further guidance on how the attributable income of a CFC is reduced in these circumstances.

Working out the reduction

Dividend paid to an attributable taxpayer

If the dividend is paid to you, the amount of the reduction in attributable income is worked out as follows:

amount of the dividend assessed      your attribution percentage in the CFC

 

 

 

 

Section 8: Relief from double accruals taxation

If an amount of income or gain is to be included in your assessable income as a result of tracing control through a foreign entity, and that foreign entity has also been taxed on that amount under the accruals tax laws of another country, you may reduce your assessable income by an amount calculated as follows:

Indirect attribution interests through a controlled foreign entity

x

Foreign accruals-taxed attributable income

Your indirect attribution interest through a controlled foreign entity is your attribution interest in a CFC traced through the controlled foreign entity.

The foreign accruals-taxed attributable income is that part of an amount of income or gain derived by a CFC on which an interposed controlled foreign entity has been taxed under an accruals tax law of a listed country. The income or gain must be taxed at that country’s normal company rate of tax and during a tax accounting period which commences or ends either in your year of income or the statutory accounting period of the CFC.

Only countries listed in the Income Tax Regulations 1936 as having accruals tax laws are recognised for the purpose of granting this relief. They are:

• Canada
• France
• Germany
• Japan
• New Zealand
• United Kingdom of Great Britain and Northern Ireland
• United States of America.

 

Section 9: How much is included in assessable income

You need to work out how much of the attributable income of the CFC to include in your assessable income. Multiply your attribution percentage in the CFC at the end of the statutory accounting period by the attributable income of the CFC; include the result in your assessable income.