Explanatory Memorandum
(Circulated by the authority of the Treasurer,the Hon Ralph Willis, M.P.)Chapter 9 The Taxation of Foreign Source Income
Clauses: 57,58,59,60,61,62,63 and 74
Overview
Reduces the income of a controlled foreign company that is attributed to resident taxpayers by dividends paid by the company to unrelated parties on certain widely distributed finance shares.
The Taxation of Foreign Source Income
Summary of the proposed amendments
9.1 The proposed amendment relates to the foreign source income measures in Part X of the Income Tax Assessment Act 1936. The amendment will modify the attribution rules under which income is attributed to certain Australian "attributable taxpayers". This will have the effect that the attributable income will be calculated after deducting dividends paid by the company to arm's-length holders of widely distributed finance shares.
Background to the legislation
9.2 The existing foreign source income measures require taxpayers to include in their assessable income a share of the attributable income of a controlled foreign company (CFC). The attributable income is generally calculated without regard to dividends that may be paid by the CFC. One of the exceptions provided is for dividends paid on "eligible finance shares" issued to a subsidiary of an Australian Financial Intermediary. Dividends paid on these shares are a substitute for interest on loans made in the ordinary course of (generally banking) business. The proposed amendments will provide a similar exception for widely distributed finance shares.
9.3 Unless dividends paid by the CFC on widely distributed finance shares are excluded in the calculation of its attributable income, the attributable taxpayers (usually those of the ordinary shareholders who are Australian residents) would be attributed a share of all of the income of the CFC. This attributed income would include the income required to be paid out as dividends (usually preference dividends) to the shareholders of widely distributed finance shares.
9.4 These holders of widely distributed finance shares, who have provided finance on arm's length terms, generally have no interest in the company apart from ensuring repayment of the funds and regular payment of dividends in a form which is, in effect, a substitute for interest on a loan.
9.5 Exclusion of the dividends paid on widely distributed finance shares will ensure that the attributable taxpayers are not attributed income that they will never receive. These shares are to be excluded from the calculation of a direct attribution interest in a CFC or a controlled foreign trust (CFT) (section 356 of the Principal Act) and a direct attribution account interest in a company (section 366 of the Principal Act). In addition, in calculating the attributable income of a company, under sections 384 or 385 of the Principal Act, a deduction is to be allowed under section 394 for dividends paid out on widely distributed finance shares.
Explanation of the proposed amendments
What are widely distributed finance shares ?
9.6 The conditions required for a share to qualify as a widely distributed finance share are set out in new section 327A. They include requirements about the company that issues the shares, and in some cases, its parent company, the shares that are issued and requirements about the shareholder who receives the shares. [Clause 58]
9.7 There are a number of tests for the company that issues the shares. These are similar to the tests in section 103A of the Principal Act which are used for determining whether a company is treated for taxation purposes as a public company, or as a subsidiary of a public company.
9.8 The tests are applied to the company's shares, other than shares entitled to a fixed rate of dividend, usually the ordinary shares.
9.9 The first requirement in section 327A will be that the company's shares are listed on an official list of a stock exchange either in Australia or elsewhere. A second board listing would not satisfy the listing requirement of this section.
9.10 Alternatively, where the company being tested is not itself the listed company then the listed company will be required to have a direct or indirect interest of 90% or more in the test company. If each subsidiary is not 100% owned, an apportionment is to be made in tracing through subsidiaries of the listed company to measure the listed company's percentage interest in the test company.
9.11 There are further tests to determine whether any of the rights attached to the listed company's shares are concentrated in the hands of a small number of its shareholders. If a company fails any of the tests in relation to the shares then none of its shares will qualify as widely distributed finance shares.
9.12 These tests are designed to ensure that 75% or more of the shares (other than shares entitled to a fixed rate of dividend) are not closely held by a single entity or by a group of less than 21 entities. In testing for close holdings regard is to be had to voting, dividend and capital rights, or the entitlement to acquire such rights, at any time in the company's statutory accounting period.
9.13 If a shareholder is associated with the company, then the shares to which that relationship applies cannot be widely distributed finance shares.
9.14 Only shares that are issued to the public may qualify as widely distributed finance shares. In deciding whether it is reasonable to consider that the shares have been issued with a view to public subscription, purchase or other wide distribution, regard will be had to the manner in which the shares were offered for public subscription, the way that applications for subscription were handled and whether the practices employed by brokers, agents and other persons associated with the issue of the shares were in accordance with ordinary business practices of brokers, agents, underwriters etc. Consideration is also to be given to any arrangements between persons associated either with the company or with each other in relation to any of the shares to be offered for public subscription or purchase or arrangements, direct or indirect, in relation to the monies raised by the subscription.
Direct attribution interest in a CFC or CFT
9.15 Section 356 of the Principal Act contains the rules for determining an entity's direct attribution interest in a CFC or a CFT. The amendment made by [clause 59] will include in section 356 a reference to widely distributed finance shares to ensure that such shares are ignored for the calculation of a direct attribution interest.
Direct attribution account interest in a company
9.16 Section 366 of the Principal Act defines a direct attribution account interest in a company. This is relevant for determining attribution debits and credits to eliminate double taxation when a company pays a dividend out of previously attributed income. The amendment made by [clause 60] will include in section 366 a reference to widely distributed finance shares to ensure that such shares are not included in a direct attribution account interest. Relief from taxation in relation to dividends on widely distributed finance shares is to be provided by way of a notional allowable deduction in section 394 of the Principal Act.
Notional allowable deduction for eligible finance share dividends and widely distributed finance share dividends
9.17 Section 394 of the Principal Act allows a notional allowable deduction from the notional assessable income for eligible finance share dividends paid by a CFC during a specified time. This notional deduction ensures that the attributable taxpayers in relation to the CFC are not subject to attribution on income that they do not receive because it is paid out by the CFC as a dividend on the eligible finance shares.
9.18 The amendment made by [clause 61] will allow a similar notional allowable deduction for dividends paid on widely distributed finance shares.
9.19 Definitions of "widely distributed finance share" and "widely distributed finance share dividend" are to be inserted in existing section 317 by [clause 57].
Additional notional exempt income - unlisted or listed country CFC.
9.20 Section 402 of the Principal Act treats certain amounts as notional exempt income, including specified non-portfolio dividends. To ensure that a widely distributed finance share dividend is not exempt, an amendment to section 402 is to be made. A widely distributed finance share dividend will be excluded from the classes of non-portfolio dividends referred to in section 402. [Clause 62]
Commencement date
9.21 The amendments in relation to widely distributed finance shares will generally take effect from the date on which the foreign source income measures took effect, generally the 1990/91 income year.
9.22 With one exception, the foreign source income measures in Part X of the Principal Act will, therefore, always be read in their amended form. However, in determining whether a person has committed an offence against the record keeping requirements in Division 11 of Part X before the date of Royal Assent in relation to the amendments made by [clauses 59, 60 and 61] those amendments are to be disregarded. This will avoid any possibility of a retrospective offence. [Clause 74]
Clauses involved in the proposed amendments
Clause 57: amends section 317 of the Principal Act - the general definition section of Part X - to insert new definitions of 'widely distributed finance share' and ' widely distributed finance share dividend'.
Clause 58: inserts new section 327A after section 327 of the Principal Act. It sets out the requirements for a share to qualify as a widely distributed finance share.
Clause 59: includes reference to widely distributed finance shares in section 356 of the Principal Act - direct attribution interest in a CFC or CFT.
Clause 60: includes reference to widely distributed finance shares in section 366 of the Principal Act - direct attribution account interest in a company.
Clause 61: includes reference to widely distributed finance shares in section 394 of the Principal Act - notional allowable deduction for eligible finance share dividends and widely distributed finance share dividends.
Clause 62: will amend section 402 of the Principal Act so that a widely distributed finance share dividend will not be treated as notional exempt income.