Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 4 - Regulation impact statement
Policy objective
Review of international taxation arrangements
4.1 This bill is a further instalment of the legislative program implementing the reforms the Government announced last year following the review of international taxation arrangements.
4.2 The reforms in this bill will improve the international competitiveness of Australian companies with offshore operations, and will reduce their compliance costs. The reforms will make Australia a more attractive location as a base for regional headquarters for overseas companies, as well as a continuing base for Australian multinational companies.
The objectives of the measures in this bill
4.3 Providing capital gains tax (CGT) relief for the disposal of non-portfolio interests in a foreign company with an active business will provide Australian companies (and their controlled foreign companies) greater flexibility in corporate restructuring decisions. Similar tax consequences will result from the sale of a non-portfolio interest in a foreign company as currently result where the foreign company sells its active foreign business assets and distributes those profits as a dividend.
4.4 The extension of the exemption for non-portfolio dividends and certain foreign branch profits will allow Australian multinationals (and their controlled foreign companies) to compete more effectively in overseas markets by removing the Australian tax liability on active business profits. This will improve flexibility for companies to use capital profits. The measure is also part of a systematic solution to the treatment of conduit income of Australian companies.
4.5 The modifications to the tainted services income rules are designed to improve the competitiveness of Australian companies with offshore operations, by allowing for greater flexibility in dealing with offshore associates, including using service centres to provide services to other offshore group companies. The modifications will also reduce taxpayer compliance costs.
Implementation options
4.6 The measures addressed in this regulation impact statement arise directly from the review of international taxation arrangements. Those recommendations were the subject of extensive consultation. The implementation options for these measures can be found in the Board of Taxation's report, International Taxation - A Report to the Treasurer (the Board's Report) and the Treasury's consultation paper, Review of International Taxation Arrangements (Consultation Paper). Table 4.1 shows where the measures, and principles underlying them, are discussed in these publications.
| Measure | The Board's Report | Consultation Paper |
|---|---|---|
| CGT relief for disposal of a non-portfolio interest in a foreign company with an active business. | Recommendation 3.10(2), pages 97 to 104 | Option 3.10, pages 43 to 50 |
| Extend exemption for non-portfolio dividends and certain foreign branch profits to all countries. | Recommendation 3.9, pages 97 to 102 | Option 3.9, pages 42 and 43 |
| Modified application of the tainted services income rules (note modifications in Table 4.2). | Recommendation 3.2, pages 85 and 86 | Option 3.2, page 35 |
4.7 Where the Board's Report and the Consultation Paper do not address details in this bill, the implementation options are set out in Table 4.2. The table also sets out options endorsed by the Board of Taxation (the Board) that were not adopted by the Government in this bill.
| Measure | Implementation options |
|---|---|
| CGT relief for disposal of a non-portfolio interest in a foreign company with an active business. | Defining an active business
In this bill, 'active business' is defined by reference to the proportion of assets held by the foreign company that are 'active'. An alternative approach, supported by the Board, was to define active business by reference to the active income test in the controlled foreign companies rules. Following industry consultation, the former approach was adopted because it was considered more suitable to a wider range of industries. Applying the active asset formula to tiers of companies and wholly-owned groups
|
| Modified application of the tainted services income rules. | The Board recommended that the tainted sales and tainted services income rules be abandoned (except in relation to income or gains derived in designated tax havens), and that services raising particular integrity issues be dealt with separately.
The Government decided on an alternative approach to deal with the concerns underlying the Board's recommendation. Under this alternative, services provided by a company to non-resident associates are generally excluded from the rules. In consultation with the business community, a different way (to that initially proposed by the Government) has been developed to deal with integrity issues arising from this change. This approach has many of the benefits of the Board's option in terms of improved competitiveness for Australian companies. However, it better protects against the transfer overseas of businesses providing services to Australian-based customers, or profit shifting, where these are undertaken for tax reasons. The tainted sales income rules are retained as they are not a significant impediment to business competitiveness. |
Assessment of impacts
4.8 The Government, the Board and the business sector have carefully considered the potential compliance, administrative and economic impacts of the measures in this bill.
4.9 The measures in this bill specifically impact on those taxpayers identified in Table 4.3.
| Measure | Taxpayers affected |
|---|---|
| CGT relief for disposal of a non-portfolio interest in a foreign company with an active business. | This measure will affect Australian companies (and controlled foreign companies) that hold non-portfolio interests in foreign companies, including foreign companies that are not controlled foreign companies (similar to the group affected by the second measure). |
| Extend exemption for non-portfolio dividends and certain foreign branch profits to all countries. | The current exemptions for non-portfolio dividends and certain foreign branch profits affect approximately 230 companies.
The extension of the exemption to all countries will expand the range of options available, potentially impacting on all companies considering substantial investments offshore. It is not known how many companies would be affected. |
| Modified application of the tainted services income rules. | The measure will primarily benefit Australian resident taxpayers with controlled foreign companies or overseas branches that provide services to non-resident associates.
Around 2,000 taxpayers, predominantly companies, have reported interests in controlled foreign companies. The number of reported controlled foreign companies (and controlled foreign trusts) is around 10,000. A reliable estimate of the number of overseas permanent establishments of Australian companies is not available given current data holdings. |
Note: No other data relating to taxpayers affected by measures in this bill are available.
CGT relief for disposal of a non-portfolio interest in a foreign company with an active business
4.10 For taxpayers seeking the benefits of the CGT exemption, the requirement to calculate the 'active foreign business asset percentage' will impose some new compliance costs on Australian companies (and their controlled foreign companies) that dispose of non-portfolio interests in foreign companies. However, this bill seeks to minimise these costs by allowing taxpayers the choice of using either market value or book value. The way the taxpayer prepares its income tax return for the year of income in which the relevant CGT event happens under this measure is sufficient evidence of the choice.
4.11 Taxpayers may also incur some additional compliance costs if they require advice from the Australian Taxation Office (ATO) and tax professionals in respect of the measure. Taxpayers have the option of forgoing any reduction in a capital gain or ignoring a capital loss so as to avoid these compliance costs.
Extend exemption for non-portfolio dividends and certain foreign branch profits to all countries
4.12 The measure will result in substantial compliance cost savings for companies, with a reduction of over 20 pages of legislation and improvements to the readability of the legislation.
4.13 Australia exempts from company tax non-portfolio dividends (and certain branch profits) received from 63 listed countries. Non-portfolio dividends from companies in listed countries currently comprise around 95% of all foreign non-portfolio dividends received. However, Australian companies with non-portfolio holdings receiving foreign dividends, or with a permanent establishment offshore, must examine income to determine whether an exemption applies. The extended exemption will significantly reduce costs associated with monitoring these amounts.
4.14 The changes will also reduce compliance costs for taxpayers with controlled foreign company interests because it will become unnecessary to track the payment of non-portfolio dividends through offshore companies.
Modified application of the tainted services income rules
4.15 The measure will generally reduce compliance costs for Australian companies, and their offshore subsidiaries, joint-ventures and branches, where those offshore entities provide services to non-resident associates. Compliance costs will be reduced as income from providing such services will no longer need to be attributed to, or (for branches) be included in the assessable income of, the Australian company.
4.16 The removal of services provided to non-resident associates from tainted services income may mean more offshore entities pass the active income test. This may completely remove a small number of offshore entities from the controlled foreign company regime, or (for branches) mean that their income is not assessable income.
CGT relief for disposal of a non-portfolio interest in a foreign company with an active business
4.17 As a result of this measure, the ATO may incur some initial costs in making changes to its material and educating its staff about the measure. It may also incur costs in providing advice to taxpayers, including by public and private rulings. However, none of these costs is likely to be significant.
Extend exemption for non-portfolio dividends and certain foreign branch profits to all countries
4.18 The expanded exemption for dividends received from all countries and for certain foreign branch profits will require changes in ATO administration systems. An education campaign for taxpayers will also be necessary.
4.19 There may also be a slight increase in administration costs to monitor potential avoidance under the new rules. On the other hand, the simplified law will also have administrative benefits.
Modified application of the tainted services income rules
4.20 The administration cost impact of this measure should be minimal. Administration of a new rule dealing with services provided indirectly to Australian residents may require interpretation products such as rulings. Potential behavioural response to the modified rules could require the ATO to develop new audit products and practices.
4.21 The financial impact of these measures will be a loss to the revenue over financial years as outlined in Table 4.4.
| 2003-2004 | 2004-2005 | 2005-2006 | 2006-2007 | |
|---|---|---|---|---|
| CGT relief for disposal of a non-portfolio interest in a foreign company with an active business. | * | * | * | * |
| Extend exemption for non-portfolio dividends and certain branch profits to all countries. | Nil | Nil | -$30 million | -$55 million |
| Modified application of the tainted services income rules. | Nil | Nil | -$10 million | -$10 million |
| Key: * a reliable estimate cannot be provided for the measure | ||||
CGT relief for disposal of a non-portfolio interest in a foreign company with an active business
4.22 This measure will align more closely the tax treatment of selling an interest in a foreign company (that has an active business) with the tax outcome that would result if the foreign company disposed of its active foreign business assets and distributed those profits to its shareholders. In other words, there will be no liability to Australian tax if an Australian company (or its controlled foreign company) sells a non-portfolio interest in a foreign company or if the Australian company (or its controlled foreign company) procures the foreign company to sell its active assets and distribute those profits as a dividend.
4.23 This will increase flexibility in corporate restructuring decisions, and will provide an exemption to Australian companies similar to what is currently available in many European countries. This will ensure that Australian companies are not at a competitive disadvantage when they seek to invest offshore, and will encourage foreign groups to establish a regional headquarters in Australia.
Extension of the exemption for non-portfolio dividends and certain foreign branch profits to all countries
4.24 The measure will assist Australian companies investing in foreign countries to be more competitive with foreign counterparts, as they will not be required to pay additional Australian tax on foreign active business income. It will also remove income tax impediments for companies who distribute profits from countries not currently eligible for an exemption, but who will benefit from the extended exemption.
4.25 The substantial compliance cost savings for companies will also provide economic benefits.
Modified application of the tainted services income rules
4.26 The measure will allow Australian multinationals to better compete internationally, with negligible risk to the tax base. It will also provide a more neutral treatment of services provided to group companies by offshore group service centres. Achieving these outcomes will increase Australia's ability to retain and attract multinationals and regional headquarter operations.
Consultation
4.27 Business, legal and accounting representatives and the ATO have been consulted extensively and have actively assisted in developing these initiatives. This involved the establishment of an advisory group constituted by members of industry and professional peak bodies to help in the design of legislation. The more technical issues and the details of the measures, or those that affect a specific interest group, were referred to particular sub-groups. In addition, direct discussions with taxpayers affected by these measures were undertaken as necessary.
4.28 Suggestions on the legislative details of the measures made by working group members were adopted where they were consistent with the intended policy objectives and the integrity of the measures. The consultative groups have been supportive of the consultation process and of the final form of the measures.
Conclusion
4.29 The measures in this bill are a further instalment of reforms to implement the Government's response to the review of international tax arrangements. The measures are consistent with the Government's policy objectives of improving the international competitiveness of Australian companies (and their controlled foreign companies) while maintaining the integrity of Australia's international tax rules.
4.30 The provision of CGT relief for the disposal of non-portfolio interests in a foreign company with an active business will give Australian multinationals greater flexibility in the use of their capital. While this necessarily involves some compliance costs to be incurred by taxpayers in order to receive the consequent benefits, these costs have been minimised to the extent possible within integrity concerns. The extension of the exemption for non-portfolio dividends and certain foreign branch profits will substantially reduce compliance costs for taxpayers while improving their international competitiveness. Reducing the scope of tainted services income will improve the competitiveness of Australian companies with offshore operations, and reduce their compliance costs. Apart from the addition of new law for the CGT measure, these measures have enabled some substantial improvements to the law in this area. It will be more easily understood.