Explanatory Memorandum
(Circulated by the authority of the Treasurer,the Hon. J. Kerin, M.P.)Chapter 22 No access to underlying foreign tax credits when a CFC changes its residence from a listed to an unlisted country
Overview
Prevents taxpayers from gaining an unintended advantage by changing the residence of a company from a listed country to an unlisted country and claiming foreign tax credits on dividends paid out of pre 1990-91 profits. The amendment will deny foreign tax credits in those circumstances.
Summary of proposed amendments
22.1. The proposed amendment applies to a CFC that changes its residence from a listed to an unlisted country. It will deny a resident company access to foreign tax credits on non-portfolio dividends paid out of the CFC's accumulated profits of accounting periods ending before 1 July 1990.
22.2. Access to the foreign tax credits will be denied by increasing the amount of the dividends that are treated as paid from exempting profits.
22.3. As non-portfolio dividends received by an Australian company, which are paid out of exempting profits, are exempt from tax, there is no credit for foreign tax paid in relation to those dividends.
Background to the legislation
Non-portfolio dividends paid by a listed country CFC to a resident company
22.4. Beginning from the 1990-91 income year, a non-portfolio dividend paid by a CFC that is a resident of a listed country to an Australian resident company is exempt from Australian tax (section 23AJ).
22.5. This is because:
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- foreign underlying taxes on the profits from which a non-portfolio dividend is paid; and
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- foreign direct (withholding) taxes on the dividend,
have been paid to the relevant foreign country at a rate generally comparable to the Australian rate of tax.
22.6. Foreign tax credits (FTCs) are not available on non-portfolio dividends paid by listed country companies to a resident company where those dividends are exempt from tax under section 23AJ.
22.7. A non-portfolio dividend paid from income previously attributed to a resident company under the accruals tax measures is exempt from tax (section 23AI).
22.8. Upon payment of the dividend FTCs are available for any additional foreign tax paid on the dividend such as withholding tax (s160AFCD).
Non-portfolio dividends paid by an unlisted country CFC to a resident company
22.9. A non-portfolio dividend that is treated as paid by an unlisted country CFC out of exempting profits to a resident company is exempt from Australian tax (section 23AJ).
22.10. Income categorised as exempting receipts must be derived by the CFC in an accounting period of the company ending on or after 1 July 1990.
22.11. No foreign tax credit is available on dividends exempt from tax under section 23AJ.
22.12. The rules which apply to a listed country CFC also apply to unlisted country CFCs.
22.13. A non-portfolio dividend paid from other income of the unlisted country company (ie, income other than exempting profits or income previously attributed to the taxpayer) is liable to tax (section 44). A credit is available for any foreign withholding and underlying taxes in relation to the dividend (section 160AFC).
Possibility for an undue tax advantage under the existing law
22.14. In certain situations, a resident taxpayer can reduce Australian tax liability by taking undue advantage of the access to foreign tax credits. In effect, this is achieved by converting a non-portfolio dividend from a listed country company that would have been exempt from tax (section 23AJ), to a dividend paid from 'other income' of an unlisted country CFC.
22.15. This may occur where a listed country CFC has:
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- profits accumulated prior to the accounting period ending on or after 1 July 1990,
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- paid listed country taxes out of those profits at a level sufficient to generate excess tax credits in Australia; and
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- changed its residence from a listed to an unlisted country.
22.16. Clause 82 of the bill will deny FTCs in the above situation. This will be achieved by treating those profits as exempting receipts.
Explanation of the proposed amendments
Removing the possibility of an undue tax advantage
22.17. The proposed amendment is necessary to prevent a resident company from obtaining an unintended tax advantage.
22.18. Under the current law the advantage occurs through access to excess FTCs for non-portfolio dividends. The FTCs are available because the CFC changes its residence from a listed to an unlisted country before the dividend is paid.
22.19. The proposed amendment will only affect resident companies to which non-portfolio dividends are paid by unlisted country CFCs which have changed their residence from a listed country. These dividends may be paid directly or through other foreign companies.
22.20. Currently, subsection 378(1) applies to all CFCs resident in an unlisted country.
22.21. After the amendment, subsection 378(1) will apply to CFCs resident in an unlisted country who have not changed their residence from a listed country.
22.22. Proposed subsection 378(3) will apply to CFCs that have changed their residence from a listed to an unlisted country.
Exempting profits where no change of residence
22.23. The exempting profits of an unlisted country CFC which has not changed its residence from a listed country are determined by proposed subsection 378(1) [Clause 82] . In this case, exempting profits arise only for the accounting period of the CFC that ends on or after 1 July 1990, and for subsequent accounting periods.
Exempting profits where change of residence occurs
22.24. Exempting profits of a CFC that has changed its residence from a listed to an unlisted country are determined by proposed subsection 378(3). [Clause 82]
22.25. The exempting profits of an unlisted country CFC that has changed its residence will be determined in a similar manner to a CFC that has not changed its residence [proposed paragraph 378(3)(a)] . However, the distributable profits at the time of the change of residence will also be treated as exempting profits of the CFC. [Proposed paragraph 378(3)(b)]
22.26. When the distributable profits represent attributed income they will not be treated as exempting profits. [Proposed subparagraph 378(3)(b)(iii)]
Exempting receipts to be counted only once as exempting profits
22.27. Exempting receipts that are treated as exempting profits under proposed subparagraph 378(3)(a) will not be included under proposed subparagraph 378(3)(b)(ii). This means you do not count any exempting receipts as exempting profits twice. [Clause 82, proposed subparagraph 378(3)(b)(ii)]
Commencement date
22.28. Proposed subsection 378(3) applies where the change of residence occurred on or after 1 July 1989 and the dividend was paid after 28 June 1991. [Clause 82]
Clauses involved in the proposed amendments
Clause 82 : amends section 378 of the Act by inserting proposed subsection 378(3).
Subclause 85(19) : provides the proposed amendment will apply where a change of residence occurs on or after 1 July 1989 and the dividend is paid after 28 June 1991.