Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Miscellaneous
Overview
This chapter deals with a number of miscellaneous matters including:
- i)
- xempt life business;
- ii)
- mendment to the dividend exemption under section 23AJ;
- iii)
- efinition of passive income:
- iv)
- xemption for certain interests of underwriting members of Lloyd's;
- v)
- mendments to the loss quarantining provisions;
- vi)
- mounts to be included in a taxpayer's assessable foreign income where the taxpayer is deemed to have paid and to have been personally liable for an amount of foreign tax under section 160AFCJ; and
- vii)
- he treatment of exempt distributions under section 23AK for the purposes of calculating the cost base of a beneficiary's interest in a trust estate.
(i) Exempt life business
The Foreign Source Income measures have special provisions for calculating the income of Australian life companies which conduct insurance business offshore through a permanent establishment of the resident life company or a permanent establishment of a CFC.
Income from the investment of assets that cover life policies issued to unrelated non-resident policy holders by an offshore branch of an Australian resident life assurance company or a permanent establishment of a trust or CFC is generally not taxed in Australia.
Legislation that currently provides this relief will also apply to a FIF held by a foreign permanent establishment of a resident life assurance company, or a foreign permanent establishment of a CFC where the FIF represents an investment by the foreign branch of non-resident policy holder funds.
(ii) Amendment to the dividend exemption under section 23AJ
Section 23AJ of the Principal Act provides an exemption for a non-portfolio dividend paid by a company resident in a listed country to a company resident in Australia.
Section 23AJ may also provide an exemption for a part of a non-portfolio dividend paid by a company resident in an unlisted country to a company resident in Australia. The exemption applies where the companies are related companies within the meaning of section 160AFB. The section operates on the basis of identifying the amount of the dividend that is an 'exempting receipt' (defined in Division 6 of Part X). The concept of an exempting receipt is different depending on whether the foreign company is resident in a listed country (paragraph 380(a)) or an unlisted country (paragraph 380(a) and the associated provisions of sections 377 to 379).
An Australian company can get a credit for foreign taxes paid on exempt income only if the dividend is exempt under section 23AI. To ensure that an amount is exempt under section 23AI and not 23AJ, the concept of an exempting receipt excludes attribution account payments that require an attribution debit (subparagraphs 380(a)(i) and 377(1)(d)(i)).
Similarly, taxpayers will get a credit for foreign taxes paid in respect of a dividend that is exempt under section 23AK. In order that the dividend is exempt under section 23AK and not section 23AJ, FIF attribution account payments which carry FIF attribution credits will be excluded from the definition of an exempting receipt.
(iii) Definition of passive income
Section 160AEA of the Principal Act contains the definitions of 'passive income' and 'modified passive income'. The concept of passive income is relevant to the computation of the foreign tax credit, allowable under section 160AF, on a class of income basis.
Under the existing law, the foreign tax credit allowable to a taxpayer is computed separately for each of three classes of income - passive income, offshore banking income and other income.
The concept of 'modified passive income' is relevant to the operation of the foreign loss quarantining provisions of section 79D and to the computation of a foreign loss under section 160AFD.
In general, FIF income will belong to the passive income or modified passive income class for foreign tax credit and foreign loss quarantining provisions of the Principal Act.
Passive income is generally quarantined separately from business income. However, certain assets may be held as an essential part of the taxpayer's insurance business. Quarantining in such cases would produce inequitable results.
Therefore, in cases of this type, the FIF income from these assets will be treated as part of the overall business profits derived from the insurance business carried on by the taxpayer. The effect of this will be to provide relief to taxpayers by including that FIF income as part of the business profits for the purposes of the calculation of foreign tax credits and the quarantining of losses against foreign income.
This exception will only apply in relation to an insurance business actively carried on by a taxpayer.
(iv) Exemption for certain interests of underwriting members of Lloyd's
A taxpayer who is an underwriting member of Lloyd's and who has an interest in assets that form part of a Lloyd's Premiums Trust Fund will be exempt from taxation in respect of foreign investment fund income from that interest. Funds which qualify as Premiums Trust Funds are referred to in section 83 of the Insurance Companies Act 1982 of the United Kingdom. [Section 527]
(v) Loss quarantining provisions
The amendments proposed to the loss quarantining provisions are of a technical nature only.
They will ensure that in calculating a loss for the purposes of section 79E or section 80, the income that is exempt by virtue of section 23AK (income previously attributed under the FIF measures) will not affect the calculation of a loss incurred in a year of income or the amounts of a loss incurred in a previous year of income that may be carried forward to be deducted from a taxpayer's assessable income.
(vi) Amount to be included in assessable income
Under the foreign tax credit system, an amount equal to the credit a taxpayer can claim for foreign tax paid by another entity is included in the taxpayer's assessable foreign income (that is, the taxpayer's assessable foreign income is "grossed up" by the amount of the foreign tax credit that the taxpayer can claim [section 6AC] ). This treatment is required to ensure that the foreign tax credit relief a taxpayer can claim is calculated with regard to pre-tax (that is, 'gross') amounts of foreign income.
Section 23AK, introduced by the Bill, will exempt distributions paid out of profits which gave rise to an amount being included in a taxpayer's assessable income under the FIF measures.
If the taxpayer's assessable income is not increased to include an amount of foreign underlying tax paid by the entity making the distribution or by another entity for which the taxpayer will be able to claim a foreign tax credit, the taxpayer would receive too much relief from double taxation. To achieve the correct result, an amount equal to the amount of the credit the taxpayer can claim for the foreign tax paid by the other entity will be included in the taxpayer's assessable income.
Section 26D will include in a taxpayer's assessable income, an amount equal to the credit the taxpayer can claim on an exempt distribution under section 23AK for foreign tax paid by another entity. This amount is determined by components (AEP x UT) - AT of the formula in proposed subsection 160AFCJ(3). Broadly, these components have the following meanings.
'AEP' [Adjusted exempt percentage] means the percentage of the relevant distribution which is exempt under section 23AK. For the purposes of this calculation, the relevant FIF attribution account payment is to be reduced to the extent that it is exempt under section 23AJ.
'UT' [Underlying Tax] means the credit for underlying tax that the taxpayer would be able to claim in relation to the relevant distribution which is exempt under 23AK. For the purposes of this calculation, the relevant distribution is to be treated as assessable income.
'AT' [Attributed Tax] means the amount of any FIF attributed tax account debit arising for the relevant FIF attribution account entity in relation to the taxpayer on the making of the FIF attribution account. The amount of the FIF attribution account debit cannot exceed the amount of the formula component AEP x UT . Formula component AT is basically a measurement of the credit the taxpayer received for foreign tax paid when an amount (relating to the profits from which the distribution was paid) was included in the taxpayer's assessable income under the FIF measures.
Consistent with the treatment of amounts included under section 529, amounts included in a taxpayer's assessable income under section 26D are to be treated as amounts of foreign income. [Subsection 6AB(1)]
In addition, amounts included in a taxpayer's assessable income under section 26D will be treated as passive income for the purposes of the foreign tax credit and foreign loss provisions of the Principal Act. [Paragraph 160AEA(1)(n)]
Example
Assume that a resident company (Ausco) has an interest in a foreign company ( FIF1) which is a resident of an unlisted country.
Year 1: Using the market value method, it was determined that FIF1 had FIF income of $5,000 in relation to Ausco. Consequently, an amount of $5,000 was included in Ausco's assessable income under section 529 and a FIF attribution credit of $5,000 arose for FIF1 in relation to Ausco.
Year 2: FIF1 makes a distribution of $20,000 to Ausco. This distribution gives rise to a $5,000 FIF attribution debit for FIF1 in relation to Ausco. Accordingly, $5,000 of the $20,000 distribution to Ausco is exempt under section 23AK.
Assume that if no part of the $20,000 distribution had been exempt under section 23AK, Ausco would have been taken to have paid $10,000 foreign underlying tax under section 160AFC in relation to the distribution.Calculation of the amount to be included in the taxpayer's foreign assessable income under section 26D
The amount which would be included in Ausco's foreign assessable income (passive class of income) under proposed section 26D would be calculated as follows:(AEP x UT) - AT = (25% x $10,000 - nil = $2,500
(AEP x UT) - AT
where:
- 'AEP' = 25%(that is, $5,000/$20,000 x 100)
- 'UT' = $10,000
- 'AT' = nil
Consequently, $2,500 would be included in Ausco's assessable income under section 26D. Note that Ausco would also be taken to have paid, and to be personally liable for, foreign tax of $2,500 under section 160AFCJ in relation to the amount of the distribution received by Ausco that was exempt under section 23AJ (refer to Chapter 22 for an explanation of the operation of section 160AFCJ).
(vii) Return of capital on an investment in a trust estate
Section 160ZM provides that, for the purposes of Part IIIA (the capital gains tax provisions), where the trustee of a trust estate pays an amount to a taxpayer in respect of an interest, or units, in the trust estate that is not assessable income of the taxpayer, that payment will be treated as a return of capital and the cost base of the interest or units in the trust estate are to be reduced by the amount of the payment. The reduction of the cost base of the interest or units in the trust estate may, on the disposal of the interest or units, have the effect of increasing the taxpayer's capital gains tax liability or reducing the extent of a capital loss.
A reference to section 23AK will be inserted in subsection 160ZM(1A) so that distributions from a trust estate which are exempt under section 23AK will not reduce the cost base of the beneficiary's interest or units in the trust estate.
Clauses making the amendments
Subclause 3(a): Will insert a reference to section 26D into subsection 6AB(1) so that amounts included in a taxpayer's assessable income under section 26D will be treated as amounts of foreign income.
Clause 6: Will insert section 26D into the Principal Act which will operate to include an amount equal to the foreign underlying tax which a taxpayer is taken to have paid and to have been personally liable for under section 160AFCJ in the taxpayer's assessable foreign income.
Clauses 8 and 9: Amend sections 79E and 80 of the Principal Act respectively to ensure that income previously subject to attribution under the FIF measures does not reduce the amount of a loss that may be allowed as a deduction when calculating the taxpayer's assessable income.
Subclause 14(a): Will insert a reference to section 26D into paragraph 160AEA(1)(n) so that amounts included in a taxpayer's assessable income under section 26D will be treated as amounts of passive income.
Subclause 14(c): Amends section 160AEA of the Principal Act to treat passive income arising from assets treated as an essential part of a taxpayer's insurance business as business profits.
Clause 16: Will include a reference to section 23AK in subsection 160ZM(1A) so that distributions from a trust which are exempt under section 23AK will not reduce the cost base of the beneficiary's interest in the trust for the purposes of Part IIIA of the Principal Act (that is, the capital gains tax provisions).
Clause 19: Amends section 380 of the Principal Act to ensure that a dividend is first exempt to the extent possible under proposed section 23AK and then under section 23AJ.