House of Representatives

Explanatory Memorandum

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

Relief for Foreign Taxes paid by FIFs held through a CFC

Overview

Where a taxpayer has used the calculation method to determine the foreign investment fund income of a FIF, a foreign tax credit may be allowed in certain circumstances for foreign tax paid by the FIF on its income and gains (this treatment is discussed in the Chapter 22). This chapter deals with the credit a company taxpayer may claim in certain circumstances for foreign tax paid by a FIF where a resident company uses the calculation method to determine the foreign investment fund income of a FIF which is included in the notional assessable income of a CFC.

Background

Under the foreign tax credit system (FTCS) a taxpayer may claim a credit for foreign tax paid on foreign income if the taxpayer has paid and is personally liable for that foreign tax or is deemed to have paid and to have been personally liable for that tax. A resident company is taken to have paid and have been personally liable for tax paid by a CFC in relation to an amount included in the taxpayer's assessable income under the CFC measures. Consequently, the taxpayer will be able to claim a credit for foreign tax paid by the CFC in relation to the amount included in the taxpayer's assessable income under the CFC measures if the CFC is related to the taxpayer.

Consistent with the above treatment and the treatment of an interest held in a FIF directly, a resident company will be taken to have paid and to have been personally liable for an amount of foreign tax paid by a FIF which is held by a CFC in which the taxpayer has an interest. This treatment will apply only where the calculation method is used to determine the foreign investment fund income of the FIF which is to be included in the notional assessable income of the CFC.

Explanation

A resident company will be taken to have paid and to have been personally liable for foreign tax paid by a FIF where all of the following conditions are satisfied:

i)

n amount ("the section 529 amount") is included in the notional assessable income of the CFC under section 529 and

ii)

n amount ("the section 456 amount") is included in the assessable income of the taxpayer under section 456 in relation to the CFC; and

iii)

he calculation method was used to determine the amount included in the CFC's notional assessable income under section 529 because the CFC had an interest in the FIF; and

iv)

n amount ("the gross deductible amount") is a notional deduction under the calculation method from the FIF's notional income because the FIF paid an amount in respect of foreign tax; and

v)

f the FIF is a company, the CFC and the FIF were related to the taxpayer at the end of the notional accounting period of the FIF; and

vi)

f the FIF is not a company, the CFC is related to the taxpayer at the end of the notional accounting period of the FIF. [Subsection 160AFCK(2)]

The amount of foreign tax paid by the FIF which the taxpayer will be taken to have paid and to be personally liable for in respect of the section 456 amount is calculated using the formula:

(The gross deductible amount x ( Attribution credit arising for the FIF / calculated profit of the FIF
[Subsection 160AFCK(3)]In the formula:

"The gross deductible amount" means the foreign tax paid by the FIF which gave rise to a notional deduction from the FIF's notional income;

" Attribution credit arising for the FIF " means the attribution credit that arises for the FIF in relation to the taxpayer before reduction (if any) of that credit for an attribution credit which arises for another FIF in which the relevant FIF has an interest.

" calculated profit of the FIF " means the calculated profit of the FIF using the calculation method.

Example

Assume that a resident taxpayer (Ms Rose) has a 100 per cent interest in a CFC ( CFCco) which has a 25 per cent interest in a ( FIF).

During the relevant period, CFCco does not derive any income. However, using the calculation method, the CFC has notional income from FIF1 of $100,000 and claims a notional deduction for foreign tax paid of $20,000. If FIF1 does not have any other notional deductions, it will have a calculated profit of $80,000 (that is, $100,000 - $20,000) and $20,000 (that is, 25% x $80,000) will be included in CFCco's notional assessable income under section 529.

(i) Calculation of the amount to be included in Ms Rose's assessable income because of her interest in CFCco

Ms Rose's assessable income would include an amount of $20,000 (that is, 100% x $20,000) under section 456 because of her interest in CFCco. It would also include $5,000, being the amount of foreign tax that she is deemed to have paid in relation to that income (see item (iii)).

(ii) attribution credits FIF1

The attribution credit which arises for FIF1 in relation to Ms Rose would be calculated using the formula:

(FIF incom x Section 456 amount) / Notional assessable income
= 9$20,000 x $20,000) / $20,000
= $20,000


CFCco

Normally, under the CFC provisions, an attribution credit of $20,000 would arise for CFCco in relation to Ms Rose [paragraph 371(1)(a)]. However, this credit must be reduced by the amount of the credit which arises for FIF1 [subsections 371(2A) and 371(2B) ]. Consequently, the attribution credit which arises for CFCco is nil (that is, $20,000 - $20,000).

(iii) Calculation of the foreign tax paid by FIF1 which Ms Rose is taken to have paid and for which she is taken to have been personally liable

The amount of foreign tax paid by FIF1 which Ms Rose will be taken to have paid and to have been personally liable for in respect of the section 456 amount is calculated using the formula:

The gross deductible amount x ( Attribution credit arising for the FIF / Calculated profit of the FIF)
= $20,000 x 9$20,000 / $80,000)
= $5,000


Clauses involved in the amendments

Clause 15: Inserts section 160AFCK into the Principal Act.

Subclause 3(c): Inserts a reference to section 160AFCK into section 6AB in order that amounts of tax a taxpayer is taken to have paid and been personally liable for under section 160AFCK are treated as foreign tax for the purposes of the Principal Act.

Subclause 4(a): Inserts a reference to section 160AFCK into section 6AC in order that the amount included in a taxpayer's assessable income under section 456 is grossed up by the amount of foreign tax the taxpayer is taken to have paid and been personally liable for under section 160AFCK. The section 456 amount is not grossed up for the purposes of determining the attribution credit which arises for the taxpayer in relation to a CFC.