Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello MP)Chapter 6 - Regulation impact statement
Policy objective
6.1 This Bill is a further instalment of reforms announced by the Government following the review of international taxation arrangements. The overall purpose of the reforms is to build on Australia's position as an attractive place for business and investment.
The objectives of the measures in this Bill
6.2 Two of the reforms in this Bill aim to align the taxation treatment of branches in Australia of foreign entities more closely with that of foreign-owned subsidiaries. Doing so is intended to provide for a more neutral tax treatment of alternative corporate structures, reduce compliance costs overall, and improve competition in the financial services sector in particular.
6.3 Reforms to the controlled foreign companies rules have a number of objectives. They aim to provide an improved legislative basis for listing further countries as benefiting from a reduced application of the rules, thereby reducing compliance costs. Compliance costs associated with acquisitions of foreign companies and the restructuring of overseas operations are intended to be reduced. A technical deficiency in the rules is also corrected.
6.4 Reforms are also to be made to the treatment of the employee shares or rights of individuals who change their country of residence or work in more than one country. The changes aim to align Australia's taxation rules more closely with the developing international norms, and help prevent double or nil taxation of such cross-border employee shares or rights. By doing so, the changes will improve Australia's ability to attract highly skilled individuals and businesses that employ them.
6.5 The measures addressed in this regulation impact statement arise directly from recommendations made by the Board of Taxation as part of the review of international taxation arrangements. 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).
6.6 Table 6.1 shows where the measures, and principles underlying them, are discussed in the Board's Report and the Consultation Paper.
| Measure | The Board's Report | Consultation Paper |
|---|---|---|
| Extend to Australian branches of foreign financial entities the treatment given to Australian branches of foreign banks under various income tax law provisions. | Recommendation 4.11(1), pages 131 to 134 | Option 4.11, page 70 |
| Tax dividends received by Australian branches of foreign entities under the assessment system instead of the withholding tax system. | Recommendation 4.11(2), pages 131 to 134 | Option 4.11, page 70 |
| Remove inappropriate consequences that follow from the listing of a country and make amendments to the definition of 'commencing day'. | Recommendations 3.4(c) and (d), pages 87 to 89 and Attachments 1 and 2; Recommendation 3.3, page 87 | |
| Amendments to the taxation of cross-border employee shares or rights. | Recommendation 5.2, pages 138 to 141 | Option 5.2, pages 78 and 79 |
6.7 The second last item in Table 6.1 relates to a register of controlled foreign companies rules policy and technical issues. The register is at Attachment 2 to the Board's Report. Following consultative processes established to implement the outcomes of the review of international taxation arrangements, it was considered that the following issues should be dealt with as a priority.
6.8 The definition of commencing day in section 406 of the Income Tax Assessment Act 1936 (ITAA 1936) relates to issue 1.1.14 of Attachment 2 to the Board's Report.
6.9 The Government also agreed to Recommendation 3.3 of the Board's Report to consider further countries for 'listing' (which is done by amendments to the relevant regulations). However, section 457 (and related provisions in sections 384 and 385) of the ITAA 1936 could mean that listing has inappropriate and negative consequences for taxpayers. These problems need to be addressed before any additional countries are listed.
| Measure | Implementation options |
|---|---|
| Tax dividends received by Australian branches of foreign entities under the assessment system instead of the withholding tax system. | In this Bill, the exemption from withholding tax is limited to dividends paid to Australian branches of non-resident companies and individuals. The Board's Report did not specify a limitation to any particular type of entity carrying on business in Australia at or through a branch. This limitation ensures that non-resident partnerships and trusts continue to receive consistent treatment with Australian partnerships and trusts.
Franked distributions received by Australian branches of foreign entities will also be taxed under the assessment system. In order to ensure consistent treatment with Australian subsidiaries, non-resident companies (and individuals) will be entitled to the benefit of a franking tax offset on receipt of a franked distribution, to the extent to which it is attributable to an Australian branch of the non-resident. |
| Changes to the taxation of cross-border employee shares or rights. | The Board's recommendation only referred to the taxation of employee share options. However, shares acquired under employee share schemes are treated in the same way as options under Australian taxation law. This measure extends to all employee shares and rights to ensure consistent treatment. |
6.10 Note, this Bill also contains a technical correction to the application rule in sub-item 140(2) in Schedule 2 to the New International Tax Arrangements (Participation Exemption and Other Measures) Act 2004. The technical correction ensures all the amendments made by Parts 2 and 3 in Schedule 2 operate as intended. Due to its minor nature, no regulation impact statement is required for this amendment.
Assessment of impacts
6.11 The measures in this Bill specifically impact on those taxpayers identified in Table 6.3.
| Measure | Taxpayers affected |
|---|---|
| Extend to Australian branches of foreign financial entities the treatment given to Australian branches of foreign banks under various income tax law provisions. | Foreign financial entities with branches in Australia, and related Australian subsidiaries. |
| Tax dividends received by Australian branches of foreign entities under the assessment system instead of the withholding tax system. | Non-resident companies and individuals with branches in Australia that are in receipt of dividends from Australian companies, and Australian companies that are paying dividends to the Australian branches of non-residents. |
| Remove inappropriate consequences that follow from the listing of a country. | Attributable taxpayers of controlled foreign companies where the country of residence of the companies becomes a 'listed country'. |
| Changes to the definition of commencing day. | Attributable taxpayers of controlled foreign companies that have assets acquired when there was no attributable taxpayer with a positive attribution percentage. |
| Changes to the taxation of employee shares or rights | Employees with employee shares or rights who change their country of residence or work in more than one country, and their employers. |
6.12 It has not been possible to provide a fully detailed analysis of the impacts on compliance costs because of the lack of available information on affected taxpayers. However, some general observations are outlined.
Extend to Australian branches of foreign financial entities the treatment given to Australian branches of foreign banks under various income tax law provisions
6.13 There may be additional compliance costs for taxpayers with the introduction of this measure. Under separate entity treatment, certain transactions between foreign financial entities and their Australian branches, previously ignored for taxation purposes, will be recognised. Consequently, foreign financial entities will be required to keep accounting records in respect of their branches in Australia. These accounting records provide a means by which the foreign entities can separately account for money used in the activities of their branches in Australia. Many of these records may already be kept for internal reporting purposes. The conditions imposed on foreign financial entities for the purposes of this measure are no more onerous than those imposed on foreign banks.
6.14 Taxpayers may also incur some additional compliance costs if they require advice from the Australian Taxation Office (ATO) and taxation professionals in respect of this measure.
Tax dividends received by Australian branches of foreign entities under the assessment system instead of the withholding tax system
6.15 This measure will result in compliance cost savings for Australian companies paying unfranked dividends to the Australian branches of non-residents as they will no longer be required to withhold tax when paying unfranked dividends to the Australian branches of non-residents.
6.16 Non-residents operating in Australia through branches will also benefit from this measure. Currently, the law provides different treatment for the branches of residents of Australia's treaty partner countries to that of the branches of residents of non-treaty partner countries.
6.17 Australia's tax treaties require that dividends received by a non-resident with an Australian branch be taxed by Australia on a net profit basis. However, the only mechanism in Australia's domestic taxation law for taxing dividends paid to the Australian branch of a non-resident is withholding tax, which applies to gross amounts. This may result in a mismatch between the amount of tax withheld by the payer of the dividend and the amount of tax that is due and payable on the net dividend under the relevant tax treaty.
6.18 To resolve the mismatch, the ATO currently makes a refund available for any excess of dividend withholding tax over the amount of tax that is calculated under a business profits article. With the implementation of this measure, the ATO will no longer need to administer the law in this manner, leading to significant compliance cost savings, both for taxpayers and the ATO.
6.19 There will likely be few non-recurrent costs, such as taxpayer familiarisation and training, because this measure will make use of the existing assessment taxation system.
Remove inappropriate consequences that follow from the listing of a country
6.20 This exclusion will result in minor compliance cost savings associated with calculating 'adjusted distributable profits' when an 'unlisted country' controlled foreign company becomes a listed country controlled foreign company due to its country of residence becoming listed. Minor compliance cost savings associated with calculating tainted income will also occur when tainted assets are subsequently disposed of. Non-recurrent compliance costs in the form of familiarisation and training, if any, would be minimal because the measure is a simple removal of income from attribution.
Changes to the definition of commencing day
6.21 This change will reduce compliance costs associated with acquisitions of overseas groups and restructuring of overseas operations. This is because the calculation of income is no longer necessary for periods of time where there was no attributable taxpayer with a positive attribution percentage in relation to a foreign company. This measure will present small familiarisation and training costs as it is a minor additional requirement needed to satisfy commencing day.
Changes to the taxation of cross-border employee shares or rights
6.22 This measure will generally benefit taxpayers by clarifying taxation rules and obligations. Currently, the employee share scheme provisions generally require choices about timing of taxation to be made at the time of acquisition of an employee share or right. There is no guidance for taxpayers who commence work in Australia at a later time.
6.23 These amendments will clarify residence and source country taxing arrangements and improve the interaction of the employee share scheme and capital gains tax provisions. It will give greater assurance that no double taxation will result from the crystallisation of a benefit under an employee share or right. Compliance costs associated with taxpayers becoming familiar with the changes will be ongoing because the main affected group is inbound expatriates on short-term assignments to Australia. However, as taxation obligations will be clearer, the amendments will achieve greater certainty for taxpayers.
Extend to Australian branches of foreign financial entities the treatment given to Australian branches of foreign banks under various income tax law provisions
6.24 The administration cost impact of this measure should be minimal. On the basis that foreign financial entities with branches in Australia will now be treated the same as foreign bank branches in Australia, the ATO has systems in place that could also be used to administer this measure.
6.25 The ATO may be required to provide additional advice to taxpayers and taxation professionals in relation to this measure, including by public and private rulings. The information provided through the ATO's website and publications may also need to be updated for this measure.
Tax dividends received by Australian branches of foreign entities under the assessment system instead of the withholding tax system
6.26 This measure will provide immediate relief to the ATO in relation to its administration costs. In particular, dividends paid to treaty partner residents operating in Australia through a branch will be treated as taxable on a net assessment basis, both in the domestic taxation law and under Australia's tax treaties.
6.27 Further, the systems required to administer this measure are already in place, thereby minimising its administration cost impact. However, the ATO may need to make some minor changes to published information as a result of this measure to ensure that affected taxpayers are aware of the changes.
Remove inappropriate consequences that follow from the listing of a country and changes to the definition of commencing day
6.28 The administration cost impact of these measures should be minimal. The systems required to administer these measures should already be in place. However, the ATO may be required to provide additional advice to taxpayers and taxation professionals in relation to these measures. As a result of these measures, minor changes to information provided through the ATO's website and publications will be necessary.
Changes to the taxation of cross-border employee shares or rights
6.29 The administration costs of this measure are expected to be minimal. The affected taxpayers are likely to be employees of multinational corporations in Australia temporarily who receive professional taxation advice from their taxation advisor, their employer or their employer's taxation advisor. Consequently, it is anticipated that the ATO will receive relatively few requests for advice on the measure.
6.30 No systems changes will be required for implementation. The ATO will incur some costs in training staff and developing information products.
6.31 The revenue impact of the new definition of commencing day is unquantifiable. The revenue cost of the changes to remove inappropriate consequences that follow from the listing of a country is insignificant and has been rounded down to nil.
6.32 A reliable revenue estimate of the other measures cannot be provided. However, none of these measures is expected to have a discernible effect on revenue.
Extend to Australian branches of foreign financial entities the treatment given to Australian branches of foreign banks under various income tax law provisions
6.33 Providing similar tax outcomes for the Australian branches of foreign financial entities as for foreign banks will foster competitive neutrality between these two types of financial service providers. The measure also provides a more neutral treatment of the corporate structuring decisions of foreign financial entities.
Tax dividends received by Australian branches of foreign entities under the assessment system instead of the withholding tax system
6.34 As with the measure above, this measure will improve tax neutrality between Australian branches of non-residents and Australian subsidiaries of non-residents. It will also improve the cash flow position of non-resident individuals and companies in receipt of Australian dividends through an Australian branch. At present, withholding tax is required to be paid at the time of a dividend payment. On an assessment basis, tax is not required to be paid until a later time (usually at the time of lodgement of the income tax return).
Remove inappropriate consequences that follow from the listing of a country
6.35 These of themselves are unlikely to have a significant economic impact as they have no effect before a new country is listed (which has not yet occurred), or they correct a technical deficiency.
Changes to the definition of commencing day
6.36 This change will have a limited economic effect, in that it will reduce the 'lock-in effect' for gains relating to a time when an asset should not have been in the capital gains tax net. The lock-in effect is the incentive a taxpayer faces to not dispose of an asset because of the tax cost that disposal would crystallise, even though disposal will allow a more efficient utilisation of capital.
Changes to the taxation of cross-border employee shares or rights
6.37 By reducing the risk of double or nil taxation, providing more certainty to taxpayers, and aligning the taxation treatment of cross-border employee shares and rights more closely with international norms, the changes will assist in attracting highly skilled workers to Australia as well as the industries that employ them.
Consultation
6.38 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.
6.39 Bodies consulted with as part of the processes outlined above included the Business Council of Australia; Investment and Financial Services Association; International Banks and Securities Association of Australia; Australian Bankers' Association; Taxation Institute of Australia; Corporate Tax Association; Law Council of Australia; Institute of Chartered Accountants in Australia; and Certified Practicing Accountants Australia.
6.40 Suggestions on the legislative details of the measures made by those consulted with group members were adopted where they were consistent with the intended policy objectives and the integrity of the measures. For example, that the measure changing the treatment of cross-border employee rights be extended to employee shares. The consultative groups have been supportive of the consultation process and have no remaining concerns with the final form of the measures.
Conclusion
6.41 The measures in this Bill are a further instalment of reforms to implement the Government's response to the review of international taxation arrangements. The measures are consistent with the Government's policy objectives of increasing the attractiveness of Australia as a location for business and investment.
6.42 Most of the measures will also reduce compliance costs and increase certainty for taxpayers. The improved treatment of financial entity branches may impose some additional compliance costs, but the costs are not significant when compared with the expected benefits of the measure, which include more neutral taxation treatment of Australian branches of foreign financial entities and Australian subsidiaries and improved competition in the financial services sector.
6.43 The Treasury and ATO will monitor these taxation measures, as part of the whole taxation system, on an ongoing basis.