Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Calculation of the Attributable Income of a CFC
Overview
It is possible that a Controlled Foreign Company ( CFC) will have an interest in another company or trust which is a FIF. This Chapter deals with the amendments to the calculation of the attributable income of the CFC to take account of the CFC's interest in the FIF.
Background to the CFC system
Where a foreign company is a CFC at the end of its statutory accounting period, its attributable income will be calculated separately for each attributable taxpayer. Broadly, the attributable income of a CFC is calculated using the rules that exist under the Principal Act for the calculation of taxable income on the assumption that the CFC was a taxpayer that was a resident of Australia. In making this hypothetical calculation of the taxable income, it must be assumed that a variety of modifications have been made to the Principal Act.
Although these assumptions are common for all CFCs, the amounts of income to be included in the calculation of attributable income for a particular period will differ depending on the residence of the CFC at the end of that period, and on whether or not the CFC passes the active income test in respect of that attributable taxpayer in respect of that period.
The active income test determines whether a CFC is to be treated as predominantly engaged in active business operations.
A CFC fails that test if, in broad terms, 5 per cent or more of the gross turnover of the CFC consists of tainted income. Tainted income includes passive income and income from certain related party transactions.
Attributable income of an unlisted country CFC
Where, for a particular attributable taxpayer, a CFC that is a resident of an unlisted country fails the active income test, the attributable income of the CFC is calculated by taking into account the tainted income of the CFC. Also taken into account is any income derived from a trust, or attributable to the CFC because the CFC is a transferor to a non-resident trust. Where the CFC passes the active income test, the attributable income is calculated by taking into account only the trust amounts.
Attributable income of a listed country CFC
Where a CFC that is a resident of a listed country fails the active income test in respect of an attributable taxpayer, the attributable income of the CFC is calculated by taking into account the following amounts:
- esignated concession income which is also passive income or amounts arising from certain related party transactions provided that, broadly, the amounts are not comparably taxed in a listed country or in Australia;
- ncome derived from a trust provided that the income is not comparably taxed in a listed country or in Australia;
- mounts attributable to the CFC as transferor to a non-resident trust; and
- mounts derived from a source outside the listed country that are not comparably taxed in the listed country, in another listed country or in Australia.
In the case where a CFC is a resident of a listed country and passes the active income test, an exemption from attribution will be given for those amounts that are eligible designated concession income.
FIF measures in the calculation of a CFC's attributable income
The FIF measures will apply in the calculation of the attributable income of a CFC. As discussed, the major assumption under which the calculation of the attributable income of a CFC operates is that the attributable income of the CFC is the amount that would be the taxable income if the CFC were a resident of Australia for the whole of the statutory accounting period of the CFC (existing sections 382 and 383 of the Principal Act). This residency assumption has the effect that the FIF measures automatically apply in the calculation of the attributable income of a CFC.
Normally, a taxpayer may elect to use the calculation method of taxation both for the taxpayer's interest in a FIF (the first tier FIF) and for any interest of the first tier FIF in a second tier FIF. However, the FIF measures will be modified for the purpose of calculating the notional assessable income of a CFC. This modification will prevent a taxpayer from electing under subsection 535(3) to use the calculation method for a second tier FIF where the interest in the first tier FIF is held by a CFC [subsection 577(2)]. Instead, the market value or deemed rate of return method will be used for the second tier FIF.
The amount attributed from a FIF to the CFC will be included irrespective of whether the CFC is resident in a listed or unlisted country, and regardless of whether or not the CFC passes the active income test in respect of a particular attributable taxpayer. [Paragraph 384(2)(ca) and paragraph 385(2)(ca) ]
A de minimis exemption applies where the CFC is a resident of a listed country. There is no corresponding exemption for a CFC that is a resident of an unlisted country. The existing exemption will be modified to add to the categories eligible for the exemption amounts included in the CFC's income under the FIF measures from a direct interest in a FIF. In effect, this will mean that where a CFC has gross turnover of $1 million or more, the exemption will only apply if the sum of the
- ligible designated concession income;
- ncome or profits from sources outside the listed country that are not subject to tax in the listed country or in another listed country; and
- FIF income arising to the CFC,
is $50,000 or less.
Where the CFC has a turnover of less than $1 million, the exemption will only apply where the sum of the amounts is less than 5 per cent of the gross turnover. [Subsection 385(4)]
Consequential amendments
It is necessary to modify the operation of Part XI as it applies to the calculation of the attributable income of a CFC, and a new Subdivision E in Division 7 of Part X has been inserted to achieve this. [Sections 431A and 431B]
Modifications to the operation of the FIF measures in the calculation of the attributable income of a CFC
Reduction of FIF income because of interim dividend etc
Under subsection 530(1), FIF income is reduced to take account of a distribution made by the FIF to the taxpayer during the notional accounting period of the FIF. Where a CFC has an interest in a FIF such double taxation is also to be prevented. However, where the attribution is under section 456, an attribution credit only arises at the end of the statutory accounting period of the CFC. For the calculation of the FIF income to take into account a dividend paid after the end of the notional accounting period of the FIF, it is necessary to exempt the dividend paid after the calculation of the FIF income. This will be done by modifying the operation of section 530.
Example
A taxpayer owns 100% of a CFC which in turn has a 1% interest in a company (not a CFC) resident in an unlisted country. The accounting periods are as follows:
- he taxpayer's year of income ends on 30 June 1995;
- he CFC's statutory accounting period ends on 31 December 1994; and
- he FIF's notional accounting period ends on 30 June 1993.
The interest in the FIF is not exempt from the FIF measures and the increase in the market value of the FIF interest for the period 1 January 1993 to 30 June 1993 was $20,000. The FIF paid a dividend to the CFC of $10,000 on 1 October 1993.
In calculating the taxpayer's assessable income for the 1994/95 income year, the taxpayer would need to calculate the CFC's notional assessable income for the statutory accounting period of the CFC ending on 31 December 1994. This would include an amount in respect of the FIF income and also the dividend.
Normally, the FIF income would be $20,000. However, because of the modification to section 530, the FIF income is reduced from $20,000 to $10,000.
Miscellaneous
The amendment of section 399 of the Principal Act corrects an anomaly in the method of calculating the net income of a partnership or trust which is to be included in the attributable income of a CFC.
The anomaly results in the following unintended consequences:
- he exempting profits percentage of a non-portfolio dividend (broadly, the comparably taxed part of the dividend) paid by a company in an unlisted country (that is, a country which is not designated as a comparable tax country) to a partnership or trust was excluded from the partnership's or trust's net income instead of being included; and
- mounts which had been taxed in Australia were included in the partnership's or trust's net income instead of being excluded.
The amendment to the calculation of the net income of a partnership or trust will apply as follows.
The inclusion in net income of the exempting profits part of a non-portfolio dividend will apply prospectively to dividends paid after the date of introduction of this Bill.
The deletion of the reference to listed country branch profits, will apply retrospectively for any calculation of the attributable income of a CFC, including the calculation of a loss that arose before the start of the CFC measures. This amendment will be to the taxpayer's advantage.
Clauses making the amendments
Clauses 21 and 22: Inserts paragraphs 384(2)(ca) and 385(2)(ca) to ensure that an amount of FIF income will be attributed whether a CFC is a resident of a listed or unlisted country and regardless of whether the CFC passes the active income test in respect of a particular attributable taxpayer.
Clauses 20, 21(a) and 22(a): Amend Division 7 of Part X to change references to Subdivisions B to D to Subdivisions B to E, to take account of the addition of Subdivision E.
Clause 23: Amends section 389 to exclude the operation of certain provisions of the Principal Act in the calculation of the attributable income of a CFC.
Clause 24: Amends section 399 of the Principal Act to correct an anomaly in the method of calculating the net income of a partnership which is included in the attributable income of a CFC.
Clause 25: Amends subsection 402(3) of the Principal Act to ensure that double taxation does not arise where previously attributed FIF income is distributed to a CFC.
Clause 26: Inserts Subdivision E in Division 7 of Part X of the Principal Act to modify the calculation of CFC attributable income consequential to the introduction of Part XI.