House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

Exemption for Interest in a Foreign Real Property Company

Overview

Investment in real property companies is not an eligible activity for the purpose of the active business exemption (ABE). A specific exemption is provided for an interest consisting of shares in a publicly listed company whose activities are connected with commercial real property and whose shares are widely held.

Explanation

The exemption in Division 7 will apply to an interest in a FIF consisting of shares in a foreign company that carries certain activities in relation to commercial real property.

Approved stock exchange

The shares held by the taxpayer must be of a class of shares listed on any stock market of a stock exchange approved in Schedule 3. There are 113 approved stock exchanges spread throughout 48 countries. [Section 511]

Taxpayer's shares - quoted on an approved stock exchange

The Australian resident's investment must be in shares in the foreign company of a class that is quoted on the stock market of any approved exchange upon which the foreign company is listed. [Section 511]

Where a taxpayer holds shares in a foreign company that are quoted on the stock market of an approved stock exchange and shares in the same company which are either:

ot quoted on the stock market of any stock exchange, or

uoted on a stock market of a non-approved stock exchange,

then, only that part of the interest in the foreign company comprising the taxpayer's shares that are quoted on the stock market of an approved stock exchange will be exempt from taxation under the FIF measures, provided the other requirements are satisfied. [Paragraph 511(a)]

Trading requirement

The shares of the foreign company must be 'widely held and actively traded on a regular basis' on a stock market of an approved stock exchange during the period in which the exemption applies to the relevant taxpayer. [Subparagraph 511(b)(i)]

The term 'widely held' does not have the same meaning as the term 'widely distributed' used in section 327A of the Principal Act. The term 'widely held' denotes a more widespread holding of shares than 'widely distributed' which only requires that 20 per cent of the share holders must not hold more than 75 per cent of the share capital.

The requirement that the shares in the foreign company are 'widely held' by the public at large will ensure that the exemption does not apply to foreign companies which do not have a substantial public shareholding.

The term 'widely held' must also be read in connection with the requirement that the shares be 'actively traded on a regular basis'. The phrase 'actively traded on a regular basis' must be viewed in the context of the trading pattern and volume of the particular stock market. In times of recession the degree of trade required to satisfy this criteria will be considerably less than in a bullish market.

To satisfy this requirement it will be necessary that for the majority of the time in which the exemption operates in respect of a particular taxpayer there was an active market in the shares of the foreign real property company on any stock market of an approved stock exchange on which the foreign real property company was listed.

Foreign company principally engaged in the active carrying on of real property activities

During the period in which the exemption applies to the relevant taxpayer the foreign company must be 'principally engaged in the active carrying on' of one or more of certain activities connected with real property. [Subparagraph 511(b)(ii)]

The phrase 'principally engaged in the active carrying on' requires that:

he foreign company's main activity is one or several of the specified activities in subparagraph 511(b)(ii);

large majority of the business conducted by the foreign company is one or several of the specified activities in subparagraph 511(b)(ii); and

he foreign company's business associated or connected with real property is not dormant.

Activities connected with real property

The specified activities connected or associated with real property are:

onstruction;

evelopment of real property through capital improvement;

eceipt of rental income from commercial real property owned by the foreign company where the management, maintenance, and security services for the commercial property are principally provided by directors or employees of the foreign company or by a wholly owned subsidiary that is principally engaged in providing those services through its directors and employees;

rovision of management services through directors or employees of the foreign company in relation to real property that it does not own;

cting as agent for the sale or purchase of commercial real property. [Subparagraph 511(b)(ii)]

Test time

An Australian resident investor must look at the end of the notional accounting period of the foreign company that ends during his or her year of income to determine if the exemption applies to the investor's shares in the foreign company.

The definition of a notional accounting period is set out in section 486. Generally, it is the year of income of the taxpayer unless the taxpayer elects for the accounting period of the company.

However, the following requirements must be satisfied throughout the period in which the taxpayer holds shares in the foreign company:

he foreign company must be principally engaged in the active carrying on of the specified activities connected with real property; and

he shares in the foreign company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange.