Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 3 - Dual resident companies
Overview
3.1 Schedule 3 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to change the tax treatment in respect to certain dual resident companies (and non-individual entities treated as companies) to deny specified benefits that are available in respect to resident companies and ensure the application of specified anti avoidance measures that are targeted at non-resident companies.
3.2 The purpose of the amendments is to change the tax treatment in respect to companies that are residents of both Australia and another country for income tax purposes, but are either in effect treated as a non-residents of Australia for the purposes of a double taxation agreement (DTA), or that while qualifying as residents of Australia solely under the central management and control test in subsection 6(1) of the Act, also have central management and control outside Australia.
3.3 The amendments will deny these dual resident companies access to the intercorporate dividend rebate, CGT roll-over relief for certain assets, and the group transfer of income and capital losses, which are available only in respect to resident companies. The amendments will also subject these dual resident companies to thin capitalisation rules, debt creation rules, and restrictions on access to deductions for accrued liabilities on securities held by offshore associates, which are anti avoidance measures applying in respect to non-resident companies.
3.4 Similar arrangements will apply to corporate limited partnerships, corporate unit trusts and public trading trusts.
3.5 The amendments will take effect on or after 1 July 1997 (see also 'Application' below).
Background to the legislation
3.6 Subsection 6(1) of the ITAA provides that a company is a resident of Australia if it is incorporated in Australia, or carries on business in Australia and either has its central management and control in Australia, or its voting power controlled by shareholders who are resident of Australia. Under the ITAA a resident company is generally subject to tax on its world wide income and a non-resident company is subject to tax only on its Australian sourced income.
3.7 A company that is a resident under subsection 6(1) may be treated as a resident solely of another country for the purposes of a DTA while remaining a resident for domestic law purposes. As a resident of the other country under the DTA, Australia's taxing rights would be limited to the Australian source income of the company, whereas Australian residents are normally taxable on their worldwide income. However, since the company continues to qualify as a resident under domestic law, it would still be able to claim tax concessions available under that law to resident companies and would not be subject to anti-avoidance measures targeted at non-residents.
3.8 Companies that are essentially non-resident companies may also qualify as residents within the meaning of the central management and control test in our domestic law while continuing to have substantial central management and control, as interpreted by the Courts, and residence outside Australia. For example, under the present central management and control test a non-resident company may gain Australian residence merely by shifting some of its high level decision makers or decision making functions to Australia while retaining substantial central management and control offshore.
3.9 The amendments will ensure that both these types of dual resident companies, which are in substance non-resident companies, are effectively treated as non-residents for the purposes of specified benefits and anti avoidance measures.
Explanation of the amendments
What companies do the amendments apply to?
Companies covered under certain double taxation agreements
3.10 The amendments will apply to two distinct types of companies (to be called 'prescribed dual residents') that qualify as residents of Australia under subsection 6(1) of the ITAA. The first type of companies are those that have their Australian residence status effectively revoked for the purposes of the application of a bilateral DTA applying to Australia and another country [Item 1; definition of a 'prescribed dual resident', paragraph (a)] .
3.11 A DTA generally allocates taxing rights for the purpose of avoiding juridical double taxation, whereby the same taxpayer may be liable for taxation on the same income in more than one jurisdiction. One method of avoiding double taxation where a company is resident in both countries for their respective domestic law purposes is the use of a tie breaker provision, which has the effect of treating the company as a resident of only one of the countries for the purposes of the DTA. The residence is usually allocated under such a tie breaker provision according to the place of effective management of the company, but can also be based on the place of incorporation, or variations or combinations of these two elements.
Multiple central management and control companies
3.12 The second type of resident companies covered by the amendments are those whose central management and control forms the only basis for their Australian residence, but which also have central management and control and residence outside Australia. In other words, they are residents of Australia because they satisfy the carrying on of a business and central management and control test of subsection 6(1) of the ITAA, and no other test in that definition, while also having central management and control in another country. They would also be resident in a foreign country, although not necessarily the same foreign country in which the foreign central management and control exists. [Item 1; amendment to subsection 6(1), definition of a 'prescribed dual resident', paragraph (b)]
3.13 Central management and control is a common law concept that is determined by the particular facts of each case. The term has generally been interpreted to cover high level (as opposed to day-to-day) management and control. The Courts have held that multiple places of central management and control may arise where there is more than one place where substantial controlling power and authority are exercised.
3.14 The dual resident tie breaker test of place of effective management in DTAs is generally considered to be similar to the central management and control test in the domestic definition of residence and this would certainly be the case in most practical situations.
3.15 The measures relating to multiple places of central management and control may also apply where a double tax agreement operates. For example, the double tax agreement may not apply to dual residents, may not have a tie breaker provision for companies, or because 'central management and control' is generally synonymous with the tie breaker test of 'place of effective management', it may not operate to treat the company as a resident solely of one of the contracting states in cases of multiple central management and control.
3.16 The amendments will also apply in respect to other non-individual entities that are treated as companies under the ITAA. These are corporate limited partnerships, corporate unit trusts and public trading trusts. The provisions dealing with these entities ensure that they will be automatically caught by the amendments without requiring further amendment of the ITAA (section 94J, subsection 102L(2) and subsection 102T(2) respectively). While an entity must be treated as a company under Australian law to qualify as a 'prescribed dual resident', the entity does not also have to be teated as a company under the law of the foreign country or another country for the purposes of subparagraphs (a)(iii), (a)(iv), (b)(ii) and (b)(iii).
What tax measures do the amendments apply to?
Intercorporate dividend rebate
3.17 The amendments will apply in relation to section 46, which requires both the dividend paying company and the recipient company shareholder to be Australian residents for the intercorporate dividend rebate to operate. A similar arrangement applies in respect of subsection 46A for dividends paid as part of a dividend stripping operation.
3.18 Companies that are prescribed dual residents and that qualify for the rebate as shareholders will still be entitled to the rebate in respect to the franked component of the dividends, but will be denied the rebate (and therefore subject to company tax) in respect to the unfranked component of the dividends. This is similar to the treatment of private companies that are not part of a wholly owned company group (section 46F(2)) and will ensure that economic double taxation does not arise in respect to the portion of the dividends that has been taxed in the hands of the transferor company. [Item 2 - new subsection 46F(2A)]
3.19 Where the dividend paying company is a prescribed dual resident, Australian resident shareholder companies that would otherwise qualify for the full rebate, will also be denied the rebate in respect to the unfranked component of the dividends. [Item 2 - new subsection 46F(2B]
3.20 The amendments will also apply in relation to the loss grouping provisions, which require the loss making company to be a resident in respect to a year of income in which the loss is incurred and the loss acquiring company to be a resident in respect to a year of income which has taxable income (subsection 80G(6)).
3.21 The amendments will exclude a prescribed dual resident from the operation of the loss grouping provisions either as a loss making company (the 'loss company') or a loss acquiring company (the 'income company'). [Items 3, 4, 15, 16 and 17]
Discounted or deferred interest securities
3.22 The amendments will also apply to section 159GT, which provides deductibility on an accruals basis in respect of certain qualifying discounted or deferred interest securities issued by the taxpayer for amounts that would have been assessable income of the taxpayer if the securities had been issued to the taxpayer rather than by the taxpayer. Subsection 159GT(6) operates as an anti-avoidance mechanism to deny the accrued deductibility where the qualifying security is issued directly or indirectly to a non-resident associate of the taxpayer.
3.23 The amendments provide that the anti avoidance mechanism of subsection 159G(6) will also apply where the associate of the taxpayer is a prescribed dual resident. [Item 5]
3.24 The amendments will apply to section 159GZE, which requires a company to be a non-resident for the purposes of determining whether it is a foreign controller for purposes of the thin capitalisation purposes.
3.25 The amendments will provide that a prescribed dual resident will also be considered when determining whether a company is a foreign controller under section 159GZE. In practice, it is likely that this amendment would impact mainly on prescribed dual residents that are not part of a non-resident group. Prescribed dual residents that are part of a non-resident group would generally already be caught under the 'associates' provisions of the thin capitalisation rules (section 159GZC) and the amendments, while altering the entities in the foreign group to which the thin capitalisation rules will apply, will generally not alter the overall result in relation to that group. [Items 6 and 7]
3.26 Similar to the thin capitalisation provisions, the amendments will apply to section 159GZZA, which requires a company to be a non-resident for the purposes of determining whether it is a foreign controller for purposes of the debt creation provisions.
3.27 The amendments will provide that a prescribed dual resident will also be considered when determining whether a company is a foreign controller under section 159GZE. [Item 8]
3.28 The amendments will also apply to the CGT loss grouping provisions, which require the loss making company to be a resident in respect to a year of income in which the loss is incurred and the loss acquiring company to be a resident in respect to a year of income in which a gain is made (subsection 160ZP(7)).
3.29 The amendments will exclude a prescribed dual resident from the operation of the CGT loss grouping provisions either as a capital loss making company (the 'loss company') or a capital loss acquiring company (the 'gain company'). [Items 9 and 10]
Capital gains tax roll-over relief
3.30 The amendments will also apply to the capital gains tax provisions contained in section 160ZZO. Subparagraph 160ZZO(1)(a)(i) requires both the transferor and the transferee of an asset to be residents for capital gains tax roll over relief to apply in respect to related companies. Subparagraph 160ZZO(1)(a)(ii) requires the transferee to be a resident for the purposes of roll-over relief for transfers of a taxable Australian asset from a non-resident company.
3.31 The amendments will exclude a prescribed dual resident that is a either a transferor or a transferee from the operation of subparagraph 160ZZO(1)(a)(i). The amendments will also exclude a prescribed dual resident that is a transferee from the operation of subparagraph 160ZZO(1)(a)(ii). This will ensure that CGT roll-over relief will not be available for transfers involving a prescribed dual resident in respect to assets that are not, or do not continue to be, taxable Australian assets. [Items 11, 12 and 13]
3.32 The amendments will apply to:
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- the intercorporate dividend rebate provisions in respect to dividends received or paid by a prescribed dual resident on or after 1 July 1997.
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- the thin capitalisation and debt creation provisions, and subsection 159GT(6) in respect to interest expense incurred or accrued on or after 1 July 1997. This will apply on a pro rata basis for companies with substituted accounting periods in relation to their first affected year of income.
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- the loss grouping provisions in relation to a year of income where a company is a 'prescribed dual resident' at any time during that year of income and is a 'prescribed dual resident' on or after 1 July 1997. The company will not qualify as a 'loss company' or an 'income company' for the whole of that particular year of income, including the year of income of a company with a substituted accounting period.
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- the CGT roll over relief provisions in respect to asset transfers undertaken on or after 1 July 1997 involving a prescribed dual resident. [Items 14 and 18]