Foreign income return form guide 2007

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About this guide

Foreign income return form guide 2006-07

The Foreign income return form guide contains an explanation of measures relating to the taxation of foreign income derived by, or attributed to, Australian residents. The chapters in this guide are:

Chapter 1	Attribution of the current year profits of a controlled foreign company
Chapter 2	Transferor trust and related measures
Chapter 3	Taxation of foreign dividends and branch profits, and explaining the foreign tax credit system
Chapter 4	Proving your assessment
Chapter 5	Consolidation (consolidated income tax treatment for groups of entities)

Summary sheets at the end of this guide provide a quick reference to assist you in determining if and to what extent the measures apply to you. Where necessary, worksheets have also been provided to help you work out your tax liability.

Although the guide is quite detailed, it may not cover all the qualifications and conditions contained in the law that relate to your circumstances. For instance, it does not discuss the special rules that apply in working out attributable income for companies conducting banking or insurance activities. If you are not sure about the application of the law, phone the Business Infoline on 13 28 66.

The Tax Office regularly receives information from foreign tax authorities under our tax treaties regarding foreign source income paid to (and the tax withheld from) Australian resident taxpayers. We are making increasing use of information-matching technology to verify the correctness of tax returns. Ensure that all information is fully and correctly declared in the relevant tax return.

Unless otherwise stated, references in this guide to provisions of the law are to provisions of the Income Tax Assessment Act 1936 (ITAA 1936).

Abbreviations and glossary

Abbreviations

Some abbreviations used in this publication without accompanying explanation are:

ADI	authorised deposit-taking institution
ANFI	adjusted net foreign income
CFC	controlled foreign company
CFE	controlled foreign entity
CFP	controlled foreign partnership
CFT	controlled foreign trust
Commissioner	Commissioner of Taxation
DTA	double taxation agreement
EDCI	eligible designated concession income
FIF	foreign investment fund
FLP	Foreign life assurance policy
FTC	foreign tax credit
FTCS	foreign tax credit system
ITAA 1936	Income Tax Assessment Act 1936
ITAA 1997	Income Tax Assessment Act 1997
MEC group	Multiple entry consolidated group
NFI	net foreign income
P/Y loss	previous years losses
Regulations	Income Tax Regulations 1936

Glossary

Accruals taxation

Accruals taxation is the taxation of Australian residents on profits derived through a foreign company or trust as they are earned by the company or trust. Normally, the profits would not be taxed in Australia until they are distributed to the taxpayer as a dividend or trust distribution.

Act

In this guide, the term 'the Act' means the Income Tax Assessment Act 1936, as amended. Unless specified otherwise, all references to legislation are to the ITAA 1936

Active income test

The active income test ensures that small amounts of tainted income derived by a controlled foreign company (CFC) are exempt from accruals taxation. An exemption is provided from accruals taxation for most amounts derived by a CFC if the test is satisfied.

Adjusted net foreign income

In relation to foreign tax credits, adjusted net foreign income (ANFI) is net foreign income adjusted for apportionable deductions.

Adjusted tainted income

Adjusted tainted income comprises passive, tainted sales and tainted services income.

Apportionable deductions

In relation to foreign tax credits, apportionable deductions are those deductions of a concessional nature which do not relate directly to income-producing activities - for example, gifts.

Arm's length amount

This expression means, in relation to an actual transfer of property or services to a non-resident trust estate, the amount that the trustee of the non-resident trust might reasonably be expected to pay to the transferor for the property or services if the property or services had been transferred under an arrangement between independent parties dealing at arm's length with each other.

Associates

There are four parts to determining who are the associates of an entity. They deal with:

1. associates of an individual
2. associates of a company
3. associates of a trustee
4. associates of a partnership.

Part 1 - Associates of an individual

The associates of an individual - other than an individual acting in the capacity of a trustee - are:

• relatives of the individual - that is, the parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of his or her spouse; and the spouse of the individual or of any other person mentioned above
  
   
• a partner of the individual or a partnership of which the individual is a partner
  
   
• the spouse, including de facto spouse, or child of a partner, where the partner is also an individual - other than an individual acting in the capacity of a trustee
  
   
• the trustee of a trust, where the individual or another entity that is an associate by virtue of this part benefits under the trust
  
   
• a company where that company is sufficiently influenced by
  • the individual
  • another entity that is an associate of the individual because of the rules in this part or
  • another company which is sufficiently influenced by the individual, or
  • two or more of the above entities, or 
    
     
• a company where the capacity to cast or control greater than 50% of the maximum votes at a general meeting of the company is held by
  • the individual
  • associates of the individual under the rules in this part
  • the individual and the associates.

Part 2 - Associates of a company

Part 2 deals with the associates of a company - called company A. The associates of company A include:

• a partner of company A
  
   
• a partnership of which company A is a partner
  
   
• where a partner of company A is an individual otherwise than in the capacity of a trustee, the spouse or child of the partner
  
   
• the trustee of a trust where company A, or an entity that is an associate of company A, benefits under the trust
  
   
• an entity (entity B) that exerts sufficient influence over company A or holds a majority voting interest in company A. The influence may be exerted by entity B alone or together with other entities. The majority interest may be held by entity B alone or together with entities that would be associates of entity B if it were treated as company A
  
   
• a company (company C) that is sufficiently influenced by company A or in which company A holds a majority voting interest. The influence may be exerted by company A alone or together with other entities that are sufficiently influenced by company A or in which company A holds majority voting interests. The majority voting interests may be held by company A alone or together with entities that are associates of company A, and 
  
   
• any other entity (entity D) that would be an associate of a third entity (entity E) which would be an associate of company A if the associates of entity E were determined by treating it as company A.

Majority voting interest

An entity holds a majority voting interest in a company if the following shareholdings amount to 50% or more of the maximum number of votes that can be cast at a general meeting of the company:

• the entity's direct shareholding in the company, and
• the entity's indirect shareholding in the company - for example, through a subsidiary.

An example is where a company has a wholly owned subsidiary that has a 75% voting interest in another company. Both the parent and subsidiary would be associates of the third company because the subsidiary has a majority voting interest in the third company and the parent has a majority voting interest in the subsidiary.

Sufficient influence

An entity is sufficiently influenced by a second entity or other entities if the entity is accustomed, under an obligation or might reasonably be expected to act in accordance with directions, instructions or wishes of the second entity or other entities.

Part 3 - Associates of a trustee

The associates of a trustee are:

• any entity that benefits under the trust
• any entity that is an associate of an individual who benefits under the trust, or
• an entity that is an associate of a company, where the company is an associate of the trustee under either of the two above dot points.

Rules relating to public unit trusts

In applying the tests for associates, the trustee of a public unit trust is treated as if it were a company. Special rules apply to determine whether a public unit trust is sufficiently influenced by another entity or whether an entity has a majority voting interest in the public unit trust.

Generally, a public unit trust will be sufficiently influenced by another entity or entities where the trust is accustomed to act or is under an obligation to act or might reasonably be expected to act in accordance with the directions, instructions or wishes of the entity or entities.

The concept of a majority voting interest in relation to a public unit trust is determined by reference to the capital or income of the trust. If an entity is entitled to, or is entitled to acquire, 50% or more of the income or capital of the trust, the entity is considered to hold a majority voting interest in the public unit trust. Corresponding rules apply to test whether a group of entities have a majority voting interest in the trust.

Part 4 - Associates of a partnership

The associates of a partnership are:

• a partner in the partnership
• any entity that would be an associate of an individual, where the partner is an individual, or
• any entity that would be an associate of a company, where the partner is a company.

Attributable income

Amounts taxed on an accruals basis under the CFC, transferor trust or foreign investment fund (FIF) measures.

Attributable taxpayer

An attributable taxpayer is an Australian entity that is liable to pay tax on attributable income.

Attribution

The process by which income is taxed on an accruals basis under the CFC, transferor trust or FIF measures.

Attribution percentage

The attribution percentage is the pro rata share of a CFC's attributable income that will be attributed to a particular taxpayer's assessable income.

Australian 1% entity

An Australian 1% entity, in relation to a company or trust, is an Australian entity whose associate inclusive control interest in the company or trust is at least 1%.

Australian entity

An Australian entity is an Australian partnership, an Australian trust, or an entity - other than a partnership or trust - that is a Part X Australian resident.

Australian partnership

An Australian partnership is a partnership of which at least one of the partners is an Australian entity.

Australian resident trust

An Australian resident trust is:

• a trust estate which, at any time during an income year, has a trustee who is a resident of Australia or has its central management and control in Australia
  
   
• a corporate unit trust or public trading trust which is taxed in the same way as a company, or
  
   
• a superannuation fund, approved deposit fund or pooled superannuation trust within the meaning of Part IX of the Act.

Australian tax payable

In relation to foreign tax credits, Australian tax payable is the product of the average rate of Australian tax and adjusted net foreign income less any rebates which are applicable to that income.

Australian trust

An Australian trust is a trust which at a particular time - or at a time in the 12 months before that time - has a trustee who is a Part X Australian resident or has its central control and management in Australia. It includes a corporate unit trust and a public trading trust as defined in the Act.

Average rate of Australian tax

In relation to foreign tax credits, average rate of Australian tax is gross tax on taxable income - less certain rebates - divided by taxable income.

Branch - see Permanent establishment

CFC measures

The CFC measures deal with the accruals taxation of Australian residents that have a controlling interest in a foreign company.

Controlled foreign company

Broadly, a controlled foreign company (CFC) is a company that is not a resident of Australia and is controlled by five or fewer residents.

Creditable taxes

Creditable taxes are, broadly, foreign taxes which are equivalent in nature to Australian income tax - for example, a tax on net income or capital gains - including tax imposed on attributed income.

Designated concession income

Designated concession income is income or profits of a kind specified in the Income Tax Regulations. Broadly, it refers to income or profits that are subject to a tax concession in a listed country. Details of the specified types of income and profits are set out in appendix 1 of this guide.

Discretionary trust estate

A discretionary trust estate is a trust estate for which:

• Both of the following conditions are satisfied:
  • a person - including the trustee - has a power of appointment or other discretion, and
  • the exercise of, or the failure to exercise, the power or discretion has the effect of determining, to any extent, either or both of the following:
    • the persons who may benefit under the trust
    • how the beneficiaries are to benefit under the trust

Or

• One or more of the beneficiaries under the trust have a contingent or defeasible interest in some or all of the capital or income of the trust estate

Or

• The trustee of another trust estate that satisfies both conditions in the first dot point above benefits or is capable of benefiting under the first-mentioned trust estate.

Double taxation agreement

A double taxation agreement (DTA) is an agreement made between the Australian Government and another Government under the International Tax Agreements Act 1953.

Eligible designated concession income

Eligible designated concession income (EDCI) is designated concession income, in relation to a particular listed country, derived by an entity in an income year:

• that is not subject to tax in another listed country in a tax accounting period that ends before the end of, or commences during, that income year, or
• is subject to tax in another listed country but is also designated concession income in relation to that other listed country.

Eligible transferor

For the purposes of accruals taxation under the CFC measures, an eligible transferor is an Australian entity or a controlled foreign entity that has transferred property or services in certain specified circumstances to a non-resident trust.

If the transfer was to a trust which is a discretionary trust before the IP time, the transferor will be an eligible transferor if he or she was able to control the trust at any time after the IP time and before the transfer. The IP time is 7.30pm, by standard time in the Australian Capital Territory, on 12 April 1989.

An exception is made where the transfer was an ordinary business transaction for full value. If the transfer was made after the IP time, the transferor will be an eligible transferor unless the transfer was for full value and the transferor did not have control of the trust after the transfer.

If the transfer was made after the IP time to a trust that is a non-discretionary trust or a public unit trust at the test time, the transferor will be an eligible transferor if the transfer was made for no consideration or for inadequate consideration.

Financial intermediary business

A banking business or a business whose income is principally derived from the lending of money.

Foreign investment fund

A foreign investment fund (FIF) is any foreign company or foreign trust - other than a deceased estate.

Foreign investment fund measures

The FIF measures deal with the accruals taxation of Australian residents that have a non-controlling interest in a foreign company or foreign trust.

Foreign tax credit system

Under the foreign tax credit system (FTCS) foreign source income derived by Australian residents - apart from certain salary and wage income - is generally subject to Australian tax. A credit for foreign tax paid is allowed against the Australian tax payable, up to the amount of the Australian income tax referable to the foreign income.

Income year

An income year - or year of income - is a 12-month period ending on 30 June, or a 12-month period ending on another date where the Commissioner has approved that other date under section 18 of the Act.

Listed country

A foreign country that is declared by the Regulations to be a listed country for the purposes of the CFC rules (see attachment A of appendix 1).

Net income

In relation to a non-resident trust estate, net income essentially means the total assessable income of the trust estate, worked out as though the trustee were an Australian resident and a taxpayer in respect of that income, less all allowable deductions, as provided by section 95 of the Act.

Net foreign income

In relation to foreign tax credits, net foreign income (NFI) is gross assessable foreign income less:

• allowable deductions relating exclusively to foreign income
• any domestic loss carried forward that you have elected to use against foreign income, and
• deductions allowed by the Commissioner as being appropriately related to foreign income.

Non-discretionary trust estate

A non-resident trust estate is a non-discretionary trust estate if it is not a discretionary trust estate.

Non-portfolio dividends

Broadly, non-portfolio dividends are dividends paid to a company where that company has a 10% or greater voting interest in the company paying the dividend.

Non-resident trust estate

A non-resident trust estate is a trust other than an Australian resident trust.

Notional accounting period

A notional accounting period is the period used to determine the attributable income of a FIF or a foreign life assurance policy (FLP).

Notional assessable income

The assessable income of a CFC for the purposes of determining the CFC's attributable income.

Offshore banking income

In relation to foreign tax credits, offshore banking income includes interest, fees, commissions or similar income derived from offshore banking transfers and dividends paid by a company out of profits derived from offshore banking transfers.

Other income

In relation to foreign tax credits, other income is income other than passive income, offshore banking income or certain lump sum payments from a foreign non-complying superannuation fund which are assessable under section 27CAA. It includes income from normal commercial activities, salary and wages and most pensions.

Part X Australian resident

A Part X Australian resident is a resident of Australia who is not treated solely as a resident of a treaty partner country under a double taxation agreement between Australia and that country.

Passive income

Passive income includes certain types of dividend, interest, royalty, annuity and rental income (section 446). It also includes gains on the disposal of assets that produce passive income or that are not used solely in carrying on a business.

Permanent establishment

A permanent establishment is widely defined in subsection 6(1). Generally, it can be described as a place through or at which an entity in Australia conducts its business in another country. A permanent establishment is also referred to as a 'branch' in this publication.

Property

This term includes money, a chose in action, any trust estate and interest, right or power, whether at law or in equity, in or over property.

Related foreign companies

Generally, an Australian company is related to a foreign company for the purposes of the FTCS when:

• the companies are both group companies, and
• the Australian company has, either directly or indirectly, a voting interest of at least 5% in the foreign company (section 160AFB).

For these purposes, a company is a group company when the Australian parent has a voting interest of at least 10% in the foreign company. If the foreign company has an equivalent interest in a second foreign company, then that second foreign company will also be a group company. This result will continue to apply through any number of tiers of companies.

Section 404 country

A foreign country that is declared by the Regulations to be a section 404 country for the purposes of the CFC rules (see attachment A of appendix 1).

Services

This term includes any benefit, right, privilege or facility. Services include a right in relation to real or personal property as well as an interest in real or personal property. Services also include a right, benefit, privilege, service or facility that is provided or is to be provided:

• under an arrangement for, or in relation to:
  • the performance of work, whether or not property was also provided as part of the work performed
  • the provision of entertainment, recreation or instruction or the use of facilities for entertainment, recreation or instruction, or
  • the conferring of benefits, rights or privileges for which remuneration is payable in the form of a royalty, tribute, levy or similar payment
• under a contract of insurance, including life assurance, or
• under an arrangement for, or in relation to, the lending of money.

Statutory accounting period

A statutory accounting period is the period used to determine the attributable income of a CFC.

Tainted income

Tainted income includes passive income, tainted sales income and tainted services income.

Tainted rental income

Tainted rental income includes rental income of a CFC where:

• land is leased to an associate or the rent is paid by an associate or
• land is leased by a company not resident in the same country.

It can also include rental income from particular leases on ships, aircraft or cargo containers.

Tainted sales income

Tainted sales income is income of a CFC from the sale of goods purchased from or sold to:

• an associate who is an Australian resident, or
• an associate who is not an Australian resident but carries on business in Australia through a permanent establishment.

Tainted services income

Tainted services income is, in very broad terms, income derived from the provision of services by a CFC:

• to an Australian resident, or
• in connection with a permanent establishment in Australia.

Tax sparing

Tax sparing deems tax forgone by a foreign country in providing a specified concession to an Australian resident to be foreign tax paid for the purposes of Australia's foreign tax credit rules. The Australian resident may therefore be entitled to claim a credit for the tax forgone by the foreign country.

Transfer

Transfer is defined in broad terms. In relation to the transfer of property, it includes a disposal of property by assignment, creation of a trust or any other manner or the provision of property. For the transfer of services, it includes such concepts as allow, confer, give, grant, perform or provide.

Transfer pricing rules

Transfer pricing rules are contained in Division 13 of Part III of the Act. This Division seeks to impose 'arms-length' consideration on agreements for the sale of property between Australians and non-residents when the agreement effectively shifts profits from Australia.

Transferor trust

A non-resident trust to which a resident has made, or is deemed to have made, a transfer of property or services (Division 6AAA of Part III).

Transferor trust measures

The transferor trust measures deal with the accruals taxation of Australian residents who have directly or indirectly transferred value to a non-resident trust. Broadly, the rules operate to accruals tax the undistributed income of the trust.

Underlying tax

Underlying tax means the amount by which the section 23AI part of a non-portfolio dividend would have been greater if no foreign tax had been paid by the company paying the dividend on the profits out of which that dividend is paid.

Unlisted country

An unlisted country means a foreign country which is not a listed country.

Note: Unless specified otherwise, all references to legislation are to the Income Tax Assessment Act 1936

Chapter 1: Attribution of the current year profits of a controlled foreign company (CFC)

This chapter explains the accruals tax system for residents with interests in foreign companies.

The accruals tax system applies to Australian residents who have a substantial interest in a foreign company controlled by Australians - referred to as a controlled foreign company (CFC). The system operates to include a taxpayer's share of specified income and gains of a CFC in the taxpayer's assessable income. This is called attribution. Subject to some modifications, the income and gains of CFCs are worked out using the same tax rules that apply for residents.

Part 1	Are you subject to the CFC measures?
Part 2	Is the CFC largely exempt because it is primarily engaged in a genuine active business?
Part 3	Working out attributable income and the amount to include in your assessable income

Part 1: Are you subject to the CFC measures?

The accruals tax system may apply to you if you are an Australian resident who has a substantial interest in a CFC. This part explains:

• when a foreign company is a CFC
• the types of interests in a foreign company that are taken into account in testing whether that company is a CFC
• the size of an interest in a CFC you need before you must include an amount in your assessable income
• how to determine the size of your interest in a CFC
• whether income of a CFC is to be included in your assessable income for the current income year.

Summary of part 1

Section 1	Is there a CFC?
Section 2	Are you an attributable taxpayer?
Section 3	Is the CFC's income generally exempt from accruals taxation?
Section 4	What types of attribution can apply?
Section 5	Do you have to work out the attributable income of a CFC?

Section 1: Is there a CFC?

Three control tests

A CFC is a non-resident company that satisfies one of three control tests. Whether a company is a resident of a foreign country is determined according to Australian tax law as modified by double taxation agreements with other countries.

The three control tests are the:

• strict control test
• assumed controller test, and
• de facto control test.

Strict control test

A foreign company will be treated as a CFC under the strict control test if a group of five or fewer Australian '1% entities', together with their associates, owns or is entitled to acquire a control interest of at least 50% in the foreign company.

An Australian 1% entity is an Australian entity that, together with its associates, holds an interest of at least 1% in the foreign company.

An Australian entity is an Australian partnership, an Australian trust, or an entity - other than a partnership or trust - that is a Part X Australian resident. A Part X Australian resident is a resident of Australia who is not treated solely as a resident of another country under a double taxation agreement between Australia and that country.

The associate-inclusive control interest of an entity is the sum of interests held by the entity and its associates in the foreign company. Interests that the entity and its associates are entitled to acquire are also taken into account.

Example 1

Strict control test

This test will be satisfied if three Australian residents each hold interests of 30%, 10% and 10% respectively in a foreign company.

Assumed controller test

A foreign company will normally be treated as a CFC under the assumed controller test if a single Australian entity owns, or is entitled to acquire, an associate-inclusive control interest of at least 40% in the foreign company. An entity's associate-inclusive control interest in a foreign company is the sum of the interests held in the company by the entity and the associates of the entity. A foreign company will not be treated as a CFC under the assumed controller test, however, if the company is controlled by a party or parties unrelated to the single resident or its associates.

Example 2

Assumed controller test

If an Australian entity holds 45% of the interests in a foreign company and the remaining 55% is held by several non-residents, it would be assumed under this test that the Australian entity controls the foreign company.

De facto control test

A foreign company will be treated as a CFC under the de facto control test if a group of five or fewer Australian entities, either alone or with associates, effectively controls the foreign company.

Example 3

De facto control test

If an Australian entity can control the appointment of the directors of a foreign company, the Australian entity will generally be taken to have de facto control of that foreign company.

When is control measured?

A statutory accounting period of a CFC is a period of 12 months ending 30 June, unless the CFC makes an election to use another period. The control test is applied at the end of a CFC's statutory accounting period to check whether income of the CFC is to be attributed.

It may also be necessary to measure control at the time a CFC pays a dividend to another CFC or to a controlled foreign trust or at the time a CFC changes residence.

Election to change a CFC's statutory accounting period

A CFC can make an election to change its statutory accounting period only if the accounting period is:

• regularly used by the CFC for complying with the tax law of a foreign country, or
• regularly used by the CFC for reporting to its shareholders.

A CFC may also elect in writing to adopt a statutory accounting period ending on a date other than 30 June if the period is regularly used for complying with the tax laws of the CFC's country of residence or is regularly used for reporting to the CFC's shareholders. You may make this election on behalf of a wholly owned CFC.

A CFC may subsequently elect another statutory accounting period ending on any date, including 30 June, provided the above conditions are satisfied.

Where a CFC chooses another statutory accounting period, it must complete the current statutory accounting period. The intervening statutory accounting period - from the last day of the current period to the beginning of the new period - will be less than 12 months. The new and subsequent statutory accounting periods will be 12 months.

Example 4

Statutory accounting periods

If a company with a statutory accounting period ending 30 June 2002 elected on 30 August 2001 to change to a statutory account period ending 30 September, it would have statutory accounting periods of:

• 1 July 2001 to 30 June 2002
• 1 July 2002 to 30 September 2002
• 1 October 2002 to 30 September 2003, and
• subsequent 12-month statutory accounting periods ending 30 September.

It is not necessary for a CFC to complete the current statutory accounting period before beginning a new period if the election is made when the CFC first comes into existence or when a company first becomes a CFC.

What interests in a foreign company are taken into account in the control tests?

In most cases, an interest in a foreign company will be held in the form of shares. This interest can be held either directly or indirectly through other entities. At a particular time, your interests in a foreign company include the interests you hold in the company as well as the interests you are entitled to acquire.

The interests of your associates in a foreign company are also relevant for determining whether you have an interest in the company.

Direct control interest in a foreign company

Your direct control interest in a foreign company is the greatest of the percentages that you hold, or are entitled to acquire, of the following:

• total paid-up share capital in the foreign company
• total rights to vote, or to participate in any decision making, in relation to
  • the distributions of capital or profits
  • the changing of constituent documents
  • the varying of share capital of the company
• total rights to distributions of capital or profits of the company on winding up
• total rights to distributions of capital or profits of the company other than on winding up.

Example 5

Direct control interest in a foreign company

A foreign company is established issuing 100 ordinary shares. An Australian taxpayer purchases 50 of these shares which entitle the taxpayer to 50% of the income, voting and capital rights of the company. The direct control interest of the Australian taxpayer in the foreign company is 50%.

Example 6

Direct control interest in a foreign company where shares confer different rights

An Australian company has a 50% voting interest and a 75% income interest in a foreign company. The direct control interest of the Australian company in the foreign company is 75%.

How is a direct control interest measured if the test time occurs before the end of an accounting period?

A taxpayer's direct control interest in a company has to be measured at a point in time - referred to as the test time.

However, in some cases it may not be possible to measure the percentage a taxpayer holds of the total rights to the profits of a company, or to a distribution of capital on winding up of the company, before the end of the accounting period of the company.

This would be the case, for example, if some shareholders are entitled to a fixed return of capital or profits.

In these cases, the taxpayer's rights to capital or profits are measured at the end of the accounting period of the company. It is assumed for this purpose that the rights held by the taxpayer at the test time are held at the end of the accounting period of the company.

Exclusion of eligible finance shares

Eligible finance shares are not taken into account in working out an entity's direct control interest in a company. Broadly, these are shares issued under preference share financing arrangements with Australian financial intermediaries - for example, banks - and their subsidiaries. In effect, the shares are issued in place of loans.

Exclusion of real estate investment trust shares

Real estate investment trust shares are not taken into account in working out an entity's direct control interest in a United States (US) real estate investment trust that derives income or holds assets principally in the US. Control interests held through a US real estate investment trust will still be taken into account in determining whether a subsidiary of the trust qualifies as a controlled foreign company (CFC). This will attribute income from a real estate investment trust subsidiary where a taxpayer has a direct interest in the subsidiary.

This exemption applies to statutory accounting periods of CFCs ending on or after 2 July 1998.

Indirect control interest in a company

A taxpayer may hold a direct control interest in an entity - entity A - which holds a direct control interest in another entity - entity B. In this case, the taxpayer has an indirect control interest in entity B.

A taxpayer's indirect control interest in entity B is obtained by multiplying the direct control interest of the taxpayer in entity A by the entity's direct control interest in entity B.

This process of multiplication is continued where there are further entities in the chain.

Indirect control interest may only be traced through a controlled foreign entity

An indirect control interest in a foreign entity can be traced only through controlled foreign entities (CFEs). These are CFCs, controlled foreign partnerships (CFPs) and controlled foreign trusts (CFTs).

A CFP is a partnership which does not have a resident partner and has at least one CFC or a CFT as a partner. A CFT is a trust, other than a resident trust:

• that has an eligible transferor - see the glossary, or
• where five or fewer residents and their associates hold, or are entitled to acquire, 50% or more of the income or capital of the trust.

Deeming rules for tracing an indirect control interest

For determining the indirect control interest in an entity - but not for working out the amount of the income to be attributed to a taxpayer - a resident or an interposed CFC is deemed, in the following specified circumstances, to own a 100% interest in a lower tier entity.

The control tracing interest of an entity will be treated as 100% if, together with associates, the entity:

• has an interest of at least 50% in a foreign company
• satisfies the assumed controller test in relation to a foreign company
• actually controls the foreign company - is a partner in a partnership that is not an Australian partnership
• is an eligible transferor in relation to a trust, or
• has an interest of at least 50% in a trust that is not an Australian trust.

Example 7

Indirect control interest

A resident company holds a 60% interest in a foreign company, FC1, which holds a 35% interest in another foreign company, FC2. FC2 holds a 60% interest in foreign company FC3. Another resident holds a 20% interest in FC2.

The indirect control interest of the resident company in FC3 is:

Resident company	Direct control interest %	Control tracing interest %
FC1	60	100
FC2	35	35
FC3	60	100

The indirect control interest of the resident company in FC3 is worked out as follows:

100% X 35% X 100% = 35%

It is possible to trace interests through FC2 because it is a CFC. FC3 is also a CFC because the resident company has an indirect control interest of 35% in FC3 and another resident has an indirect control interest of 20% in FC3 - that is, 20% in FC2 x 100% interest for tracing control of FC2 in FC3.

Associate-inclusive control interest

Your associate-inclusive control interest in a foreign company is the sum of:

• your direct control interests in the foreign company
• your indirect control interests in the foreign company
• the direct and indirect control interests of your associates in the foreign company.

To avoid double counting, an indirect control interest is not taken into account when determining a direct control interest or another indirect control interest.

Section 2: Are you an attributable taxpayer?

If you have an interest in a CFC you must determine if you are an attributable taxpayer. You are only required to include an amount of attributable income from a CFC in your assessable income if you are an attributable taxpayer in relation to the CFC.

You will be an attributable taxpayer if:

• you have an associate-inclusive control interest of 10% or more in a CFC, or
• all of the following rules apply:
  • the CFC is a CFC because of the application of the de facto control test
  • you are an Australian 1% entity
  • you are part of a group of five or fewer Australian entities who, alone or with associates - regardless of whether the associates are Australian entities - controls the CFC.

What share of the attributable income of a CFC must you include in your assessable income?

If you are an attributable taxpayer, you may be attributed a share of a CFC's attributable income. Your share is called an attribution percentage and is based on your rights to profits from the CFC.

Working out your attribution percentage

Your attribution percentage in a CFC is the sum of your:

• direct attribution interest in the CFC, and
• indirect attribution interests in the CFC.

The interests of your associates are not included.

Direct attribution interest in a CFC

Your direct attribution interest in a CFC is the greatest of the percentages that you hold, or are entitled to acquire, of the following:

• total paid-up share capital in the CFC
• total rights to vote, or to participate in any decision making, in relation to
  • the distributions of capital or profits
  • changing of constituent documents
  • varying of share capital of the CFC
• total rights to distributions of capital or profits of the CFC on winding up
• total rights to distributions of capital or profits of the CFC other than on winding up.

Test time

Your direct attribution interest in a CFC is measured at a point in time called a test time. The test time may occur during the accounting period of a CFC.

In some cases, it may not be possible to measure the percentage you hold of the total rights to the profits of a company or to a distribution of capital on winding up of the company before the end of the company's accounting period.

In these cases, your rights to capital or profits are measured at the end of the accounting period of the company. It is assumed for this purpose that the rights you held at the test time are held at the end of the company's accounting period.

Exclusion of eligible finance shares

In working out your direct attribution interest in a CFC, eligible finance shares in the CFC are not taken into account.

Indirect attribution interest in a CFC

You may hold an attribution tracing interest in an entity - entity A - which holds an attribution tracing interest in another entity - entity B.

Your indirect attribution interest in entity B is obtained by multiplying your attribution tracing interest in entity A by that entity's attribution tracing interest in entity B.

This process of multiplication is continued where there are further CFEs in the chain of entities.

Attribution tracing interests in a CFC

Your attribution tracing interest in a CFC is equal to your direct attribution interest in the CFC - the deemed 100% rule for tracing control does not apply when tracing your attribution percentage.

Attribution tracing interest in a CFP

The attribution tracing interest of a partner in a partnership is the percentage the partner holds, or is entitled to acquire, of the profits of the partnership or of the partnership property. Where the two percentages differ, the attribution tracing interest will be the greater of those percentages.

Attribution tracing interest in a CFT

The attribution tracing interest that a beneficiary of a trust holds in the trust is the percentage of the income or property of the trust to which the beneficiary is presently entitled. The beneficiary's attribution tracing interest also includes a percentage of the income or property of the trust which the beneficiary is entitled to acquire. If the percentage of the income and the percentage of the property differ, the higher percentage is treated as the attribution tracing interest.

An eligible transferor has an attribution tracing interest in the CFT equal to 100%. See part 1 of chapter 2 to determine whether you are an eligible transferor.

Reduction of the attribution percentage where the total percentage is more than 100%

In some cases, the total of the attribution percentage of all attributable taxpayers may be more than 100%. In these cases, the aggregate is reduced to 100% by reducing proportionately the interest of each attributable taxpayer.

Example 8

Reduction where attribution percentage is more than 100%

A foreign company has two classes of shares on issue. Class A carries the right to vote but no income rights. Class B carries the right to income and is non-voting. An Australian resident - Res1 - owns 25% of the Class A shares and 75% of the Class B shares. Another resident - Res2 - owns the remaining shares in each class. The foreign company is a CFC and both residents are attributable taxpayers.

Res1's attribution percentage (greater of 25% and 75% )	75%
Res2's attribution percentage (greater of 75% and 25% )	75%
Total interest of residents	150%

Each attributable taxpayer's attribution percentage is reduced in proportion, so that the aggregate interests of all attributable taxpayers is 100%.

Res1's reduced attribution percentage	=	attribution percentage   total interest of attributable taxpayers
	=	75/150 = 50%
Res2's reduced attribution percentage	=	attribution percentage   total interest of attributable taxpayers
	=	75/150 = 50%

Section 3: Is the CFC's income generally exempt from accruals taxation?

A number of exemptions from accruals taxation are provided for amounts taxed in a comparable tax country listed in the Income Tax Regulations 1936 (the Regulations).

Countries listed for accruals taxation purposes are called listed countries. These countries are listed in attachment A of appendix 1. Countries not listed for accruals taxation purposes are called unlisted countries (a subset of unlisted countries is 'section 404 countries').

Summary of the terms used to refer to countries

Listed countries

Listed countries are those listed in Schedule 10 of the Regulations. Amounts taxed at full rates by listed countries are generally exempt from accruals taxation.

Unlisted countries

Unlisted countries are those that are not listed countries. This includes section 404 countries for all purposes of the CFC rules except the application of section 404.

Section 404 countries

Section 404 countries are those listed as 'section 404 countries' in Schedule 10 of the Regulations. The list of section 404 countries is in attachment A of appendix 1.

Section 404 excludes from attributable income dividends paid from a company resident in a listed country or section 404 country to a CFC that is also resident in a listed or section 404 country.

When is a CFC a resident of a listed country?

A CFC is treated as a resident of a listed country if:

• the CFC is not a Part X Australian resident, and
• the CFC is treated as a resident of a listed country under the tax laws of that country.

When is a CFC a resident of a section 404 country?

A CFC is a resident of a section 404 country if:

• the CFC is not a Part X Australian resident
• the CFC is treated as a resident of a section 404 country under the tax laws of that country, and
• the CFC is not treated as a resident of a listed country at that time for the purposes of the tax law of the listed country.

When is a company a resident of an unlisted country?

A company is treated as a resident of an unlisted country if the company is neither a Part X Australian resident nor a resident of a listed country.

Rules that determine the particular country of residence

In some cases, it is necessary to determine whether a company is treated as a resident of a particular unlisted country - for example, for determining the active income test.

A company is treated as a resident of a particular unlisted country if:

• the company is treated as resident under a tax law of the unlisted country, and
• the company is not treated as a resident of any other unlisted country under the tax law of that country.

If a company is treated as a resident of more than one unlisted country under the tax laws of those countries and is incorporated in one of those countries, it is treated as resident in the country of incorporation.

If a company is not treated as a resident under the tax law of any unlisted country, it will be a resident of the unlisted country in which its management and control is solely or principally located.

If a company is not treated as a resident under the tax law of any unlisted country and does not have its central management and control solely or principally in an unlisted country, it will be a resident of the unlisted country in which it is incorporated.

Section 4: What types of attribution can apply?

Sections 1 and 2 asked the following questions:

• is there a CFC?
• are you an attributable taxpayer?

If the answer to both of these questions is yes, the next step is to determine whether you must include an amount in your assessable income.

Attribution on change of residence

If you were an attributable taxpayer of a CFC resident in an unlisted country and the CFC changed its residence to a listed country or to Australia while you were an attributable taxpayer, you may be subject to attribution on your share of the accumulated profits of the CFC.

Attribution of current year profits

If you are an attributable taxpayer of a CFC at the end of the CFC's statutory accounting period, you may need to include the whole or a part of the profits of that period in your assessable income.

The attribution of current year profits of a CFC may be reduced if you have been subject to dividend attribution or attribution on change of residence by the CFC. Read chapter 3 and appendix 2 to see whether either of these apply to you.

Section 5: Do you have to work out the attributable income of a CFC?

This section will tell you whether you need to work out the attributable income of the CFC. A brief description of the calculation follows.

Overview of the calculation

If you are an attributable taxpayer, your assessable income may include a share of the profit, if any, from certain types of income and gains of the CFC. The profit of the CFC is called attributable income and is worked out before taking into account your share of the profit - called your attribution percentage.

You work out attributable income based on the existing rules for working out the taxable income of a resident company. However, not all of the profits of a CFC are taken into account in working out the attributable income of the CFC.

The general rule

The general rule is that only amounts that arise from certain transactions (called tainted income) which are classified as prone to tax minimisation are taken into account. These will only be taken into account if a CFC is not mainly engaged in genuine business activities - that is, where the CFC fails the active income test.

Exception for a listed country

An exception to the general rule is made for a CFC that is resident in a listed country and derives certain untaxed income or gains (of a kind specified in the Regulations) from sources outside listed countries. These amounts are taken into account whether or not the CFC passes the active income test.

Exception for trust amounts

Another exception to the general rule is for certain trust amounts derived by a CFC. These will be taken into account whether or not the CFC passes the active income test.

Exception for foreign investment fund income

Income arising under the FIF measures will also be taken into account even if the CFC passes the active income test.

Exception for comparably taxed amounts

Amounts are generally only taken into account if they are not taxed in full in Australia or comparably taxed in a listed country. Amounts arising in a listed country are assumed to be comparably taxed if they do not qualify as eligible designated concession income as described in Schedule 9 of the Regulations and in appendix 1.

Relevant period

An amount will normally only be included in your assessable income if the CFC's statutory accounting period ends in your income year.

Example 9

Taxpayer with a standard year of income

A taxpayer whose income year ends on 30 June has a CFC with a statutory accounting period which also ends on 30 June. For the taxpayer's income year ending 30 June 2003, the taxpayer must include a share of the attributable income of the CFC for the statutory accounting period ending 30 June 2003.

Example 10

Taxpayer who balances early

A taxpayer whose income year ends on 31 March has a CFC with a statutory accounting period ending 30 June. For the taxpayer's income year ending 31 March 2003, the taxpayer must include a share of the attributable income of the CFC for the statutory accounting period ending 30 June 2002. The CFC's attributable income for the period 1 July 2002 to 30 June 2003 would not be included in the taxpayer's assessable income until the income year ending 31 March 2004.

Special rule for companies that cease to exist

If a company that was a CFC at the beginning of its statutory accounting period ceases to exist before the end of that period, the end of the company's statutory accounting period is deemed to be immediately before it ceased to exist.

Example 11

Shortened statutory accounting period when a company ceases to exist

A CFC elects a statutory accounting period that aligns with its usual accounting period of 1 January to 31 December. The company members pass a resolution to wind up the company on 1 August 2003 and it is finally de-registered on 2 November 2003 in accordance with the corporation law in the company's country of residence. As the company ceased to exist during what was its statutory accounting period, the company's statutory accounting period is taken to be from 1 January 2003 to 2 November 2003.

Conditions to be met before you work out attributable income

You only need to work out attributable income if a foreign company is a CFC at the end of the foreign company's statutory accounting period. In addition, you will only need to work it out if you are an attributable taxpayer at the end of the period.

If you have an interest in a CFC at the end of the CFC's statutory accounting period, you must work out the attributable income of the CFC for the entire period, not just for the time you held the interest.

Example 12

Disposal of a CFC before the end of a statutory accounting period

A resident individual with an income year ending 30 June has a CFC with a statutory accounting period that coincides with the individual's income year. On 31 December 2002 the individual disposes of the CFC to an unassociated resident company.

In this case, the resident individual will not be an attributable taxpayer for the CFC's statutory accounting period ending 30 June 2003. Consequently, the resident individual will not include in their assessable income any of the attributable income of the CFC for the period.

Example 13

Acquisition of a CFC part way through a statutory accounting period

Changing the facts from the previous example so that the CFC was acquired (not disposed of) on 31 December 2002 the resident company would be an attributable taxpayer for the CFC's statutory accounting period ending 30 June 2003. The company would therefore be taxed on the attributable income of the CFC for the entire period even though the company owned the foreign company for only the second half of that period.

Note

An arrangement that is designed to avoid the CFC measures by selling an interest before the end of a CFC's statutory accounting period and acquiring the interest after the end of the period will be treated as if the interest were not sold.

Were you an attributable taxpayer at the end of the CFC's statutory accounting period?

No	You do not need to work out attributable income. You do not need to continue reading this guide.
Yes	Read on.

Part 2: Is the CFC largely exempt because it is primarily engaged in a genuine active business?

Part 2 deals with the normal operation of the active income test. Special rules for banks, other financial institutions and insurance companies are not included.

Section 1	Explanation of the terms used in this part.
Section 2	What is the purpose of the active income test?
Section 3	Conditions to be met to satisfy the active income test.
Section 4	Is the tainted income ratio less than 5%?

Section 1: Explanation of terms used in this part.

Meaning of passive income

Dividends

Passive income includes dividends (within the meaning of section 6) and:

• unit trust dividends received from a corporate unit trust or a public trading trust
• a distribution made by a liquidator which is deemed to be a dividend.

Interest income

Passive income includes tainted interest income, which is all interest income except for interest derived through an offshore banking unit. It also specifically includes:

• amounts in the nature of interest - for example, discounts
• income earned from hire purchase and other property financing transactions
• accrued interest on discounted and other deferred interest securities issued after 16 December 1984
• interest deemed to be derived where a CFC assumes the rights of a lender through the purchase of securities through a secondary market
• factoring income.

Tainted rental income

There are three categories of tainted rental income.

• Rent from associates
  • Income from any leases between a CFC and an associate and any income that arises where rent is paid to the CFC by an associate.
• Lease of land
• Income from related party lease transactions will be tainted rental income.
• Income from leases of land, including fixtures, in respect of land situated in a country other than the CFC's country of residence will be tainted rental income.
• Income from leases of land, including fixtures, in respect of land situated in the CFC's country of residence will be tainted rental income unless a substantial part of the income is attributable to the provision of labour-intensive 'property management services' by directors or employees of the CFC in connection with the land.
• Ships and aircraft
  • Income from the lease of ships or aircraft, cargo containers for use on ships or aircraft or plant or equipment for use on board ships, unless the income relates to the provision of operating crew in relation to ships and aircraft or maintenance or management services by the CFC's directors or employees.

Excluded rental income

An amount of rental income will not be treated as tainted if the following three requirements are satisfied:

• the amount is derived from an associated CFC resident in the same country
• the amount is subject to the normal company rate of tax in that country, and
• the payment of the amount did not wholly or partly give rise to a notional allowable deduction for the associated CFC.

The second requirement is based on whether an amount has been subject to the normal company rate of tax in a country. For an amount to be treated as taxed at a country's normal company rate, the amount must be taxed at the same rate applicable to the company's other income or at a higher rate. In addition, there can be no entitlement to a credit, offset or tax concession in the taxation of the amount.

For the third requirement, it is assumed that the associated CFC failed the active income test. The requirement will not be satisfied if a payment would have resulted in a notional allowable deduction for an associated CFC if the CFC had been required to work out its attributable income.

Tainted royalty income

Tainted royalty income includes income derived from assigning any copyright, patent, trademark or other like property or right.

Specifically excluded from tainted royalty income are royalties received from unrelated persons in the course of carrying on a business where the CFC substantially develops or improves the property or right for which the royalty is paid. For example, if a CFC develops software and licenses it to an unrelated party, the royalty income is not tainted.

Net gains on the disposal of tainted assets

The net gain - that is, the sum of gains less losses - from the disposal of tainted assets is included in passive income.

What is a tainted asset?

Tainted assets include:

• all shares, interests in trusts and interests in partnerships
• most financial instruments - such as loans, forward and futures contracts, swaps, other securities and life assurance policies
• rights or options over any of the above.

An asset will also be tainted if it is held by a CFC to derive tainted rental income. In order to determine whether an asset is used to produce tainted rental income, you must look at the use of the asset over the whole time of ownership. If the purpose changed during that period, the asset will be treated as being used to produce tainted rental income if this was the purpose for the majority of the period of ownership.

An asset will be treated as a tainted asset if it is not trading stock and is not used solely in carrying on business.

Exclusion of commodity investments

Commodity investments are not tainted assets. They are treated separately when working out net tainted commodity gains.

Proceeds from trading in tainted assets

Income derived in carrying on a business of trading in tainted assets is included in passive income.

Net tainted commodity gains and losses

The net gain on the disposal of tainted commodity investments is included in passive income.

What is a tainted commodity gain or loss?

A tainted commodity gain or loss arises from the disposal of a tainted commodity investment.

What is a tainted commodity investment?

Commodity investments that are tainted include futures or forward contracts for a commodity - or a right or option on such a contract - unless the company carries on a business of producing or processing the commodity or uses the commodity as a raw material. To be excluded, the contract right or option must relate to the carrying on of that business and the resultant physical sale of the commodity must not be tainted sales income.

Net tainted currency exchange gains and losses

A net tainted currency gain is the sum of the tainted currency exchange gains less the sum of the tainted currency exchange losses. If this is positive there is a net gain. If not, the amount is ignored.

What is a tainted currency exchange gain or loss?

A gain or loss from a currency exchange fluctuation will be tainted unless it falls within one of the following categories:

• the underlying transaction was for the purchase of goods from an unassociated person
• the underlying transaction was for the purchase or sale of depreciable plant or equipment that was used mainly to produce income that is not passive, tainted sales or tainted services
• the underlying transaction was a hedge for one of the preceding transactions
• the CFC was carrying on business as a currency trader and no other party to the transaction was an associate or an Australian resident.

Meaning of tainted sales income

The tainted sales income of a CFC includes that part of gross turnover that represents sales income where the goods sold were purchased from or sold to:

• an associate who is a Part X Australian resident, or
• an associate who is not a Part X Australian resident but carried on business in Australia through a permanent establishment.

Sales which result in tainted sales income

	Purchased from	Tainted sales?
Sold to anyone	Associated Australian	Yes
	Associated non-resident (via Australian branch)	Yes
	Unassociated Australian	No
	Associated non-resident (not via Australian branch)	No
	Unassociated non-resident	No

Purchases which result in tainted sales income on sale

	Sold to	Tainted sales?
Purchased from anyone	Associated Australian	Yes
	Associated non-resident (via Australian branch)	Yes
	Unassociated Australian	No
	Associated non-resident (not via Australian branch)	No
	Unassociated non-resident	No

Exclusions from tainted sales income

Manufacturing exclusion

The main exclusion from tainted sales income is sales where the CFC manufactures, extracts, produces or substantially alters the goods sold. This would include, for example, sales from mining and quarrying operations.

This exclusion will apply only where the goods sold were manufactured, produced or substantially altered by the directors or employees of the CFC. The packaging and labelling of goods is not considered to be a substantial alteration of those goods.

The exclusion will not be available where the CFC subcontracts the manufacture, production or substantial alteration to agents or subcontractors. However, the fact that a CFC subcontracts some operations will not disqualify it from the manufacturing exclusion if directors or employees of the CFC carry out a substantial part of the manufacture, production or substantial alteration.

Hospitality exclusion

Also excluded from tainted sales income are sales that, broadly, arise from the tourism and hospitality industry. These are sales provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.

Passive income exclusion

Amounts of passive income are excluded from tainted sales income. This prevents double counting.

Meaning of tainted services income

Tainted services income, in broad terms, means income derived from the provision of services by a company to:

• a resident (except in connection with a foreign permanent establishment of the Australian resident), or
• a non-resident in connection with the non-resident's Australian permanent establishment.

Tainted services income also includes income derived from services provided indirectly to Australian residents, subject to certain requirements.

Services includes any benefit, right or privilege provided under an arrangement for the performance of work or the provision of facilities - for example, performance of technical, managerial or transport work.

Tainted services income

Provided to	Tainted services?
Associated Australian	Yes
Associated non-resident (via Australian branch)	Yes
Unassociated Australian	Yes
Associated non-resident (not via Australian branch)	No, subject to indirect services rule
Unassociated non-resident (via Australian branch)	Yes
Unassociated non-resident (not via Australian branch)	No

Exclusions from tainted services income

General exclusions

Tainted services income does not include:

• royalties
• any income in respect of a lease of land
• any income from trading in assets, or
• gains from currency exchange rate fluctuations, commodity investments and assets.

Manufacturing exclusion

There is an exclusion from tainted services income where the service relates to goods manufactured by a CFC - for example, payments for after sales service or income derived under a service contract for equipment manufactured by a CFC.

Hospitality exclusion

Also not included in tainted services income are services that, broadly, arise from the tourism and hospitality industry. These amounts are services provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.

Passive and tainted services income exclusion

Tainted services income does not include passive income or tainted sales income. This prevents double counting.

Indirect services rule

Income from services provided to an Australian resident or Australian permanent establishment of a non-resident is tainted services income. To prevent avoidance of attribution, income from services provided indirectly to certain Australian residents or Australian permanent establishments will also be tainted services where the following conditions are met:

• services provided by the company to an associated entity are received by another entity that is an Australian resident
• the services are provided under a scheme (as defined in section 995-1 of the ITAA 1997), and
• the income from the services would have been tainted income if they had been provided directly by the company to the ultimate recipient.

The services originally provided by the company have to be the same services that are provided to the ultimate recipient.

Example 14

Architect Co and Plans Co are both members of the same corporate group, and both are CFCs of AustCo, an Australian resident company. Architect Co provides architectural services (house designs) to Australian customers. Plans Co also develops building and house plans.

Plans Co provides Architect Co (an entity that is an associate) with a suite of highly specific house designs. Architect Co markets these into the Australian market, assisting customers in choosing the most appropriate design, but otherwise making no changes. In this case, Plans Co has indirectly provided services to Australian customers, with the house designs received by those customers the same as those originally provided by Plans Co to Architect Co.

Therefore, the application of the indirect services rule means that AustCo may have to include an amount in its assessable income that is tainted services income in relation to the services provided by Plan Co to Architect Co.

Section 2: What is the purpose of the active income test?

The active income test is used to determine whether a CFC is predominantly engaged in carrying on an active business. An exemption from accruals taxation is available for certain amounts if the test is satisfied.

To determine whether the CFC is mainly engaged in carrying on an active business, the first step is to determine amounts that are likely to be earned in a low-tax jurisdiction to defer Australian tax. These amounts are compared to the CFC's total income to determine the proportion of potential tax deferral activities. Only if this proportion is less than 5% will the CFC be taken to be mainly engaged in genuine business activities.

The meaning of special terms used in the following commentary are contained in section 1 of this part.

Section 3: Conditions to be met to satisfy the active income test.

A CFC has to satisfy the following five conditions to pass the active income test:

0. it a resident of a foreign country?
0. it have a permanent establishment in its country of residence?
0. it keep proper records?
0. it substantiate your claim that it has met the active income test?
0. its tainted income ratio less than 5%?

Condition 1 - Is the CFC a resident of a foreign country?

The CFC must be a resident of a particular country throughout the statutory accounting period. A change of residence of the CFC does not mean that the CFC will fail the active income test. However, it must have been a resident of a particular country both before and after the change.

New companies

If a CFC was in existence for only part of a statutory accounting period, it must be a resident of a particular country throughout the period in which it existed - that is, in the period from incorporation to the end of the statutory accounting period.

Treatment of dormant companies

The term 'in existence' does not include a company that is dormant within the meaning of Part VI of the Companies Act 1981. A CFC that is dormant for the whole of the statutory accounting period will fail the active income test. However, because the CFC is dormant, it will have no income or gains and will have no attributable income.

Is the CFC resident in a particular country?

Yes	Read on.
No	The CFC has failed the active income test. Go straight to part 3.

Condition 2 - Does the CFC have a permanent establishment in its country of residence?

The CFC must carry on business through a permanent establishment in its country of residence for the whole of a statutory accounting period in which it is in existence.

What is a permanent establishment?

The definition of permanent establishment is contained in section 6 of the Act. Broadly, the term includes a place at or through which normal business activities are carried on. However, it specifically excludes a place where a person:

• is engaged in business dealings through a commission agent or broker who is acting in the ordinary course of business and receiving customary rates of remuneration
  
   
• is carrying on business through an agent who does not have or does not usually exercise a general authority to negotiate or conclude contracts or to fill orders from stock situated in the country
  
   
• maintains the place solely for the purpose of purchasing goods or merchandise.

Partnership with a permanent establishment

Even if the CFC did not carry on business at or through a permanent establishment, the CFC will satisfy this condition if any partnership in which it is a member carried on business at or through a permanent establishment in the country of residence of the CFC.

Did the CFC directly or indirectly through a partnership carry on business through a permanent establishment in its country of residence?

Yes	Read on.
No	The CFC has failed the active income test. Go straight to part 3.

Condition 3 - Does the CFC keep proper records?

The figures used in the active income test are mainly drawn from accounting records and, in general, are not adjusted to comply with tax law concepts. Therefore, the accounts of the company must be properly prepared.

The accounts must be prepared in accordance with commercially accepted accounting principles. Where there are commercially accepted accounting principles in the country of residence of the CFC, it is acceptable if the accounts of the CFC comply with those principles. In other cases, it is acceptable if the accounts of the CFC comply with Australian commercially accepted accounting principles.

The documents you must take into consideration are:

• the profit and loss statement and balance sheet
• any ledgers or journals, and
• any notes, statements or reports that are attached to, or meant to be read with, these accounts.

The accounts of a CFC for a statutory accounting period must give a true and fair view of the financial position of the CFC. If the accounts are prepared in accordance with commercially accepted accounting principles but do not give a true and fair view, the CFC will fail the active income test.

Treatment of partnerships

Where a CFC is a partner in a partnership, the CFC's share of the partnership income must be taken into account. This means that the partnership must also keep proper accounts. If the partnership does not keep proper accounts, the CFC will fail the active income test.

Has the CFC and every partnership in which it was a partner kept proper accounts that give a true and fair view?

Yes	Read on.
No	The CFC has failed the active income test. Go straight to part 3.

Condition 4 - Can the CFC substantiate your claim that it has met the active income test?

A CFC must have, and be able to produce, accounts to substantiate your claim that the CFC has passed the active income test. If the CFC is a partner in a partnership, that partnership must also keep accounts to substantiate amounts derived by the partnership. If the CFC or partnership does not have the accounts, or does not produce them, the CFC is taken to have failed the active income test. See chapter 4 for details of the substantiation requirements and the procedures.

Is the CFC and any partnership in which it is a partner able to substantiate your claim?

Yes	Read on.
No	The CFC has failed the active income test. Go straight to part 3.

Condition 5 - Is the CFC's tainted income ratio less than 5%

To pass the active income test, the tainted income ratio of a CFC for a statutory accounting period must be less than 0.05 - that is, less than 5%. If both the bottom line and the top line of the relevant formula is nil, the CFC is taken to have passed the active income test.

Section 4: Is the tainted income ratio less than 5%?

The tainted income ratio for a CFC is worked out as follows:

gross tainted turnover gross turnover

Gross turnover

Broadly, the gross turnover of a CFC is the sum of the company's net gains and gross revenue. Work out the gross turnover using the following five steps:

1. identify the total gross revenue derived by the CFC

2. exclude certain comparably taxed amounts

3. exclude the proceeds of certain asset disposals

4. add back net gains arising from certain asset disposals

5. add the CFC's share of the gross turnover of each partnership in which it was a partner.

The figures used are mainly drawn from the accounts of the CFC. If the accounts are prepared in a foreign currency, there is no need to convert the amounts to Australian dollars.

Step 1 - Identify total gross revenue

The total gross revenue is the sum of amounts shown in the accounts of a CFC as gross revenue - that is, deductions are not taken into account. Do not include amounts that have not been brought to account in the period. For example, an amount may not be recognised in the accounts because its receipt is extremely doubtful. This amount would not be included in gross revenue. The exclusion of the amount must, however, be in accordance with commercially accepted accounting principles and give a true and fair view of the CFC's financial position.

Step 2 - Exclude comparably taxed amounts

Certain comparably taxed amounts are excluded from the active income test. They are:

• a franked dividend 
• an amount included in the CFC's assessable income in any year of income, unless the amount is only subject to dividend or interest withholding tax or is not fully taxed - for example, certain shipping or insurance premiums 
• an amount arising from the disposal of an asset that is taxable Australian property 
• an amount that is an attribution account payment to the extent that the profits from which the payment was made have been previously been attributed to you 
• an amount derived through a branch in a listed country if the amount is taxed in that country, and 
• a non-portfolio dividend from a foreign company.

Because trust amounts arising to a CFC are attributed regardless of whether the CFC passes the active income test, they are also excluded from the tainted income ratio calculation.

Step 3 - Exclude proceeds from certain asset disposals

Amounts that arise from asset disposals are excluded from the gross revenue. However, this exclusion does not extend to disposals of trading stock. Amounts included in gross revenue from currency exchange rate fluctuations and commodity investments are also excluded.

Step 4 - Add back net gains

The amounts that were excluded under step 3 are brought back into gross turnover as net amounts. There are three separate net amounts:

• the net gain from the disposal of commodity investments
• the net gain from currency exchange rate fluctuations
• the net gain from the disposal of other assets that are not trading stock or commodity investments.

In each case, to determine the net gain, the sum of the individual gains is reduced by the sum of the losses. If there is a net loss, the amount is ignored - it does not reduce the gross turnover. It is important to note that there is a separate calculation of net gain for each of the categories. Do not take comparably taxed amounts into account.

Consideration paid or received for asset disposals must be included at market value. Where an amount has been written down in the accounts, the write-down is to be ignored.

Step 5 - Include partnership turnover

A CFC's share of the gross turnover of a partnership must be added to the CFC's gross turnover. This is done for each partnership in which the CFC is a partner. This means that you must go through the same process - steps 1 to 4 - for each partnership.

In working out the total, treat the partnership as if it were a CFC. The partnership is assumed to be a resident of the same country as the CFC.

Result of steps 1 to 5

Add the amounts at steps 2 and 3. Take this total away from the total revenue at step 1. The balance is the gross revenue after exclusions.

Add the totals of steps 4 and 5. This is the CFC's gross turnover.

Gross tainted turnover

Gross tainted turnover is the part of the gross turnover that is either passive income, tainted sales income or tainted services income.

Broadly, passive income includes:

• dividends
• tainted interest income
• annuity income
• tainted rental income
• tainted royalty income
• amounts derived as consideration for the assignment in whole or part of any copyright, patent, design, trade mark or other like property or right
• net gains on the disposal of a tainted asset
• income derived in carrying on a business of trading in tainted assets
• net tainted commodity gains
• net tainted currency exchange gains.

Tainted sales income and tainted services income are, broadly, income from certain transactions with, or originating from, associates or Australian residents.

The gross tainted turnover is worked out using the following five steps:

Step 1

Identify the part of gross revenue that is passive income.

Step 2

Add the part of gross revenue that is tainted services income.

Step 3

Add the part of gross revenue that is tainted sales income.

Step 4

Add the part of the gross turnover that is net tainted gains.

Step 5

Add the CFC's share of the gross tainted turnover of each partnership in which it was a partner.

Identify the tainted part of gross revenue (steps 1, 2 and 3)

Identify which parts of the gross revenue are passive income, tainted sales income or tainted services income - that is, determine the tainted part of the result after step 3 of the calculation of gross turnover.

Identify tainted net gains (step 4)

Identify the parts of the net gains that are tainted - that is:

• the part of the net gain from the disposal of commodity investments that is tainted
• the part of the net gain from currency exchange rate fluctuations that is tainted, and
• the part of the net gain from the disposal of assets - other than trading stock or commodity investments - that is tainted.

Each of the net tainted gains is calculated separately and cannot exceed the amount of the net gain to which it relates. To do this you will need, in each case, to calculate the net gain and the net tainted gain. If the net tainted gain is greater than the net gain, use the net gain instead of the net tainted gain.

Identify the CFC's share of a partnership's gross tainted turnover (step 5)

Go through steps 1 to 4 for each partnership in which a CFC was a partner. The CFC's share of the gross tainted turnover of each partnership is then added to the CFC's tainted income that was derived directly.

Working out the tainted income ratio

The tainted income ratio is worked out by dividing the gross tainted turnover of a CFC by the gross turnover of the CFC.

The following is a simple example of how to work out the tainted income ratio.

Example 15

Working out the tainted income ratio

		HK$ (shown in accounts)
Interest - passive		2m
Royalty - passive		1m
Business income - from goods manufactured in Hong Kong		60m
Manufacturing expenses		40m
Tainted income ratio	= gross tainted turnover          gross turnover = 3m/63m  = 4.8% of gross turnover

Therefore, the CFC passes the test.

Is the tainted income ratio less than 5%?

Yes	The CFC has passed the active income test. Read on.
No	The CFC has failed the active income test. Go to part 3.

Part 3: Working out attributable income and the amount to include in your assessable income

This part explains how to work out the attributable income of a CFC. Your share of the attributable income is included in your assessable income.

Even if the CFC passes the active income test, you will still need to read on. Passing the test will eliminate many, but not all, types of attributed income and gains.

Summary of part 3

Section 1	General assumptions for working out the attributable income of a CFC
Section 2	General modifications to the law
Section 3	Modifications to the treatment of capital gains and capital losses
Section 4	Quarantining of losses
Section 5	Working out the net income of a partnership
Section 6	Trust amounts
Section 7	Reduction of attributable income because of interim dividends
Section 8	Relief from double accruals taxation
Section 9	How much is included in assessable income

Section 1: General assumptions for working out the attributable income of a CFC

Attributable income is included directly in your assessable income. It is not necessary to aggregate amounts of attributable income as you trace through a chain of CFCs.

Example 16

Attribution directly to taxpayer

Assume you wholly own a foreign company which, in turn, wholly owns another foreign company. Also assume that the first company has $300,000 attributable income and the second company has $200,000 attributable income.

You include an amount in your assessable income as follows:

Like this	Not like this
Do include $300,000 from the first company and $200,000 from the second in your income	Do not include $200,000 from the second company in the income of the first company, and $500,000 income from the first company in your own income

Attributable income is taxable income

Attributable income is a hypothetical amount. It is the amount that would be the taxable income of a CFC, based on certain assumptions. These are explained below.

Assume the CFC is a resident taxpayer

To work out attributable income it must first be assumed that the CFC is both a resident of Australia and a taxpayer for the whole of a statutory accounting period. You can then work out the attributable income in the same way you work out the taxable income of a resident company. Amounts derived by a CFC from all sources will be taken into account because residents are taxable on their worldwide income and gains.

To distinguish the calculation of attributable income from a 'real' calculation of taxable income, the amounts used to work out attributable income are called notional amounts. Thus, attributable income is the amount by which the notional assessable income is greater than notional allowable deductions. Income that is not notional assessable income is notional exempt income.

The assumption that a CFC is a resident of Australia does not change the nature of the activities of the CFC - that is, events that occur in a foreign country will not be taken to have occurred in Australia.

Modifications in working out the attributable income of a CFC

In applying the Act to work out a CFC's hypothetical taxable income, you will need to read the Act as if certain modifications (dealt with later in this chapter) have been made to it.

In some cases, provisions are ignored because the application is not appropriate. In other cases, provisions have been replaced with similar provisions that are tailored to the way the attributable income is worked out.

In addition, provisions have been included that are not comparable to other provisions of the Act. These modifications are explained later in this part.

Some provisions of the Act clearly cannot apply when working out attributable income - for example, Part IV, which deals with the making of returns or assessments. Although these provisions of the Act are not specifically excluded from the calculation, for practical purposes they have no effect and can be ignored.

Accounting period is the year of income

Taxable income is worked out for a period called an income year. To apply the Act, the statutory accounting period of a CFC is assumed to be an income year. The particular income year referred to in working out attributable income will be the income year of the attributable taxpayer in which the statutory accounting period ends.

Example 17

Assume you are working out the amount to be included in assessable income for the year ending 30 June 2003 and the statutory accounting period of the CFC ended on 30 September 2002. The attributable income of the CFC for that statutory accounting period is to be worked out in accordance with the provisions of the Act that applied for the year ended 30 June 2003.

Work out attributable income separately

You must work out your attributable income for a CFC separately to other attributable taxpayers. Different taxpayers may work out different amounts of attributable income for a CFC - that is, the amount included in assessable income may be different for each attributable taxpayer even if they have the same attribution percentage in the CFC.

There are differences in working out attributable income depending on whether a CFC is a resident of a listed country or unlisted country.

Modifications for an unlisted country

The notional assessable income of a CFC includes only amounts that fall into specified categories. All other amounts are treated as notional exempt income.

The excluded amounts depend on whether the CFC passed or failed the active income test.

What if a CFC fails the active income test?

If a CFC fails the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• adjusted tainted income derived by the CFC directly
• adjusted tainted income derived by the CFC indirectly as a partner in a partnership
• trust amounts arising directly
• trust amounts arising indirectly because the CFC is a partner in a partnership, or
• FIF income derived by the CFC directly or indirectly as a partner in a partnership.

What if a CFC passes the active income test?

If a CFC passes the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• FIF income derived by the CFC directly or indirectly as a partner in a partnership
• trust amounts arising to the CFC directly, or
• trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership.

These amounts are explained in section 5 and section 6. Any other income is notional exempt income.

Diagram 1: Amounts taken into account

What is adjusted tainted income?

Adjusted tainted income is based on the definition of tainted income used for the active income test. Broadly, it comprises amounts that are either passive income, tainted sales income or tainted services income.

The main difference in the definition of tainted income for the active income test and the definition for working out attributable income is that net gains are included in determining the active income test whereas the entire consideration on disposal of an asset is included when working out attributable income.

FIF income

The FIF rules apply in working out the attributable income of a CFC because of the assumption that the company is a resident of Australia. However, rules apply to prevent double taxation where a company FIF is also a CFC. These rules provide an exemption from the FIF measures for an interest held by a CFC in a company FIF if a share of the attributable income of the company FIF is included in your assessable income under the CFC measures for:

• a statutory accounting period coinciding with the notional accounting period of the company FIF for FIF taxation purposes, or
• statutory accounting periods ending and commencing during the notional accounting period of the company FIF.

For the purposes of the above tests, the Tax Office will accept that a share of the attributable income of a company FIF has been included in your assessable income if no amount was included solely because the company FIF had no attributable income. See Taxation Determination TD 93/167 - Income tax: foreign income - when is Foreign Investment Fund (FIF) income not included in: (a) assessable income of an attributable taxpayer of a Controlled Foreign Company (CFC); or (b) the notional assessable income of a CFC? for further assistance.

Amounts not included

Some amounts that would normally be assessable if derived by a resident company are treated as notional exempt income in working out the attributable income of a CFC. Certain exemptions are also disregarded when working out attributable income. These exemptions have been replaced with similar provisions that are tailored for working out attributable income.

Amounts taxed in Australia

Amounts that have been taxed in full in Australia are not included in notional assessable income. Amounts will be treated as taxed in full if they have been included in a CFC's assessable income - for example, income sourced in Australia from a CFC's branch in Australia would normally be included in the CFC's assessable income in Australia. Amounts that will not be considered fully taxed, although subject to Australian taxation, are:

• amounts subject to interest or dividend withholding tax
• certain shipping income, film and video tape royalties and insurance premiums.

Dividends that are franked under the imputation provisions are treated as notional exempt income.

Branch in a listed country

An amount of income or profits derived by a CFC in an unlisted country from carrying on a business through a permanent establishment (for example, a branch) in a listed country is excluded provided the amount is not eligible designated concession income (EDCI) in relation to any listed country.

Exclusion of dividends

Most dividends paid to a CFC by a foreign company are not included in the notional assessable income of the CFC. The only dividends you may need to include for a CFC that is resident in an unlisted country are dividends that are portfolio dividends paid to the CFC (see chapter 3).

Modifications for a listed country

Working out attributable income for a CFC resident in a listed country is similar to working out attributable income for a CFC resident in an unlisted country. However, more exemptions are provided for CFCs in listed countries.

What if a CFC fails the active income test?

If a CFC fails the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• EDCI that is adjusted tainted income
• low-taxed third country income (only where it is of a kind specified in the Regulations)
• trust amounts arising to the CFC directly that are not subject to tax in a listed country
• trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership, if the amounts are not subject to tax in a listed country, or
• FIF income derived directly by the CFC or indirectly as a partner in a partnership.

Any other amounts are notional exempt income.

What if a CFC passes the active income test?

If a CFC passes the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

• low-taxed third country income (only where it is of a kind specified in the Regulations)
• trust amounts arising to the CFC directly that are not subject to tax in a listed country
• trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership, provided that the amounts are not subject to tax in a listed country, or
• FIF income derived by the CFC directly or indirectly as a partner in a partnership.

Any other income is notional exempt income.

Diagram 2: Amounts taken into account

See Exemption for small amounts for more information concerning the de minimis tests.

Adjusted tainted income

Adjusted tainted income is based on the definition of tainted income used for the active income test. Broadly, it comprises amounts that are either passive income, tainted sales income or tainted services income.

The difference in the definition of tainted income for the active income test and the definition for working out attributable income is that net gains are included in determining the active income test whereas the entire consideration on disposal of an asset is included when working out attributable income.

Low-taxed third country income

The notional assessable income of a CFC in a listed country includes amounts derived from sources outside the CFC's country of residence if the amounts are of a kind specified in the Regulations. This rule does not apply to amounts of eligible designated concession income - these amounts may be included if the CFC fails the active income test.

FIF income

The foreign investment fund (FIF) rules apply when working out the attributable income of a CFC because of the assumption that the company is a resident of Australia. However, rules apply to prevent double taxation in instances where a company FIF is also a CFC. These rules provide an exemption from the FIF measures for an interest held by a CFC in a company FIF if a share of the attributable income of the company FIF is included in your assessable income under the CFC measures for:

• a statutory accounting period coinciding with the notional accounting period of the company FIF for FIF taxation purposes, or
• statutory accounting periods ending and commencing during the notional accounting period of the company FIF.

For the purposes of the above tests, the Tax Office will accept that a share of the attributable income of a company FIF has been included in the assessable income of an attributable taxpayer if no amount was included solely because the company FIF had no attributable income. See Taxation Determination TD 93/167 for further assistance.

Amounts taxed in Australia

Amounts that have been taxed in full in Australia are not included in notional assessable income. Amounts will be treated as taxed in full if they have been included in a CFC's assessable income. Amounts that will not be considered fully taxed, although subject to Australian taxation, are:

• amounts subject to Australian interest or dividend withholding tax, and
• certain shipping income, film and videotape royalties and insurance premiums.

Dividends that have been franked under the imputation provisions are treated as notional exempt income.

Dividends not included

Most dividends paid to a CFC by a foreign company are not included. The only dividends you must include are dividends - other than non-portfolio dividends - paid to the CFC by a company that was a resident of an unlisted country (other than a section 404 country) when the dividends were paid.

These amounts will not be included in notional assessable income if the profits from which the dividends were paid have previously been attributed to you.

Exemption for small amounts

An exemption applies for CFCs in listed countries if the total of:

• eligible designated concession income
• low-taxed third country income (of a kind specified in the Regulations), and
• FIF income is not greater than a threshold amount.

There is no similar exemption for a CFC that is a resident of an unlisted country.

Threshold amount

If the CFC has a gross turnover of $1 million or more, the threshold amount is $50,000 - that is, the exemption will only apply if the total of the amounts is $50,000 or less.

If a CFC has a gross turnover of less than $1 million, the threshold amount is 5% of the CFC's gross turnover - that is, the exemption will only apply if the sum of the amounts is less than or equal to 5%.

How does the exemption operate?

If the threshold is not exceeded, a CFC's eligible designated concession income, low-taxed foreign source income and FIF income are not included in the notional assessable income of the CFC. The general anti-avoidance provisions of the Act may apply where attempts are made to split income among a number of CFCs to take advantage of the exemption.

Section 2: General modifications to the law

This section explains a number of general modifications to the taxation law which apply when working out the attributable income of a CFC. There are also modifications to:

• the treatment of gains and losses made by a CFC on the disposal of a capital asset
• the treatment of losses incurred by a CFC, including the quarantining of deductions, and
• the treatment of amounts derived through a partnership.

These modifications are dealt with in section 3, section 4 and section 5 of part 3.

Elections to be made by the taxpayer

You can make most elections on behalf of a CFC in working out its attributable income. You must make the elections when you lodge your tax return. The Tax Office may extend the time for making the elections.

Lodgment of elections

In the case of companies and superannuation funds, no notice of the election is to be sent to the Tax Office. Only give notice if the Tax Office requests you to do so.

Exceptions to the rule

An election for rollover relief under the capital gains tax provisions must normally be made by a CFC, although you can make the election for a wholly owned CFC. The rules for making these elections are explained in section 3 of part 3.

Functional currency elections are also an exception to the general rule that allows you to make most elections when working out the attributable income of a CFC - see Choice to use functional currency below.

Foreign currency conversion rules

When calculating attributable income you must convert all amounts into Australian currency. This conversion is done using the conversion rules under the usual operation of the Act. For more information see the fact sheet Foreign exchange (forex): the general translation rule (NAT 9339), available on our website.

Choice to use functional currency

You can choose to calculate attributable income in the sole or predominant currency in which the CFC keeps its accounts (ledgers, journals, statements of financial performance etc) provided you are not an authorised deposit-taking institution (ADI) or a non-ADI financial institution. This sole or predominant currency is called the applicable functional currency.

When calculating attributable income in a functional currency, all amounts that are not in the applicable functional currency (including Australian currency amounts) must be converted into the applicable functional currency. This conversion is done using the conversion rules under the usual operation of the Act. However, when applying these rules, the applicable functional currency is taken not to be foreign currency and all other amounts (including Australian currency) are taken to be foreign currency.

Once you have calculated your attributable income, you then convert that amount into Australian currency in accordance with the relevant conversion rules.

The choice of applicable functional currency must be in writing but you are not required to notify the Commissioner. You must keep written evidence of the choice for as long as you are required to keep your tax records.

Generally, the choice will apply to the CFC's statutory accounting period immediately following the one in which you make the choice. However, it will apply to the statutory accounting period in which you make the choice where you make the choice within 90 days of the beginning of that statutory accounting period, or by 16 January 2004 (whichever is the later).

The choice to use the applicable functional currency applies until you withdraw it. You can only withdraw a choice where the functional currency has ceased to be the sole or predominant currency in which the CFC keeps its accounts. The withdrawal has effect from immediately after the end of the CFC's statutory accounting period in which the choice is withdrawn. The withdrawal must be in writing and retained with your tax records. You may make a new choice applicable to subsequent statutory accounting periods.

Treatment of foreign and Australian taxes

Deduction for taxes

A notional allowable deduction is available for foreign or Australian tax paid on amounts included in the attributable income of a CFC. An Australian tax is defined to be a withholding or income tax. It does not include additional taxes such as late payment penalties. If the tax is paid in a subsequent year, the earlier year's assessment can be amended subject to the time limits for amendments to allow a deduction for the tax.

Trading stock provisions

Valuation is cost only

In working out attributable income you must value trading stock at cost. The normal rules for determining the cost of trading stock are to apply.

What happens to obsolete stock?

In working out taxable income, a special valuation is allowed for obsolete stock. This valuation is not allowed when working out attributable income.

Depreciation provisions

Basis for depreciation

Generally, the normal depreciation rules apply for working out the attributable income of a CFC. This means you can choose to depreciate assets by the diminishing value method or the prime cost method. In addition, the rates of depreciation that apply for working out taxable income will also apply in working out attributable income.

Example 18

Deduction for depreciation

A CFC purchased a depreciable asset on 1 July 2005 and uses it solely for the production of notional assessable income. For the statutory accounting period ended 30 June 2006, depreciation would be worked out as follows using the diminishing value method.

Base value at 1 July 2005	$20,000
Effective life of asset	7.5 years
Adjustable value at 30 June 2006	$16,000
Notional depreciation for 2005-2006	$4,000

The formula for the diminishing value method is:

decline in value

=

Base value

x

days held 365

x

150%         asset's effective life

Apportionment for exempt usage

A notional allowable deduction for depreciation must be reduced if an asset is only partially used for the production of notional assessable income. The normal rules apply in working out the reduction.

Example 19

Apportionment of deduction for depreciation

A CFC purchased a depreciable asset on 1 July 2006 and used it for the production of income. For the statutory accounting period ended 30 June 2007, only 50% of the usage was for the production of notional assessable income. Notional depreciation, using the diminishing value method, would be worked out as follows.

Base value at 1 July 2006	$20,000
Depreciation to 30 June 2007	$4,000
Adjustable value at 30 June 2007	$16,000
Notional depreciation in 2006-07 (50% of $4,000)	$2,000

Asset used in a non-attributable period

Special rules apply for an asset held by a CFC during a period for which it was either:

• not necessary to work out the attributable income of the CFC, or
• not necessary to take depreciation on the asset into account in working out the attributable income of the CFC.

In such cases, the depreciation rules apply as if the asset were held solely for the production of notional assessable income during the period.

Example 20

Deduction for depreciation in non-attributable period

A CFC purchased a depreciable asset on 1 July 2004 and used it for the production of income. It was not necessary to work out the attributable income of the CFC for the statutory accounting period ending 30 June 2005. For the statutory accounting period ended 30 June 2006, only 50% of the usage was for the production of notional assessable income. In working out the notional depreciation for the 2005-06 statutory accounting period using the diminishing value method, the first step is to notionally depreciate the asset to the beginning of the income year.

Base value at 1 July 2004	$20,000
Depreciation to 30 June 2005	$4,000
Notional adjustable value at 30 June 2005	$16,000

The next step is to determine the depreciation for the 2005-06 income year.

	$
Notional opening adjustable value at 1 July 2005	$16,000
Depreciation to 30 June 2006	$3,200
Notional adjustable value at 30 June 2006	$12,800

The last step is to apportion the depreciation because the asset is not used wholly for the production of notional assessable income.

Notional depreciation in 2005-06 (50% of $3,200)

$1,600

Sale of a depreciable asset

Under the normal operation of the Act, a deduction for the difference may be allowed where an asset is sold for less than the notional depreciated value of the asset. This deduction is also allowable in working out the attributable income of a CFC.

Example 21

Deduction on disposal

In the next statutory accounting period the depreciable asset in example 20 was again used for 50% of the time to derive notional assessable income. At the end of the year it was sold for $9,000. The depreciation calculation would be as follows.

Notional opening adjustable value at 1 July 2006	$12,800
Depreciation to 30 June 2007	$2,560
Notional adjustable value at 30 June 2007	$10,240
Proceeds of sale	$9,000
Notional loss	$1,240
Notional depreciation in 2006-07 (50% of $2,560)	$1,280
Notional deduction for loss (50% of $1,240)	$620

An amount may also be included in notional assessable income as a result of the sale of the asset.

Example 22

Notional assessable income on disposal

Assume that the asset was sold for $18,000. In this case an amount would be included in notional assessable income as follows.

	$
Base value at 1 July 2004	20,000
Depreciation allowed	2,800
Adjustable value at 30 June 2007	17,120
Proceeds of sale	18,000
Less adjustable value	17,120
Notional assessable income on disposal	880

Phone the Business Infoline on 13 28 66 for more information.

What about other capital deductions?

There are other provisions of the Act that allow for a deduction of the capital amounts and these may apply when working out attributable income. Where the assets were used in a non-attributable income period, the Tax Office must determine the amount of the deduction allowed or the recoupment included in notional assessable income. However, it is not expected that this will often occur.

Phone the Business Infoline on 13 28 66 for more information.

Transfer pricing rules

The Act contains measures to counter arrangements designed to move profits from one entity to another. These arrangements are commonly called transfer pricing or profit shifting. Broadly, the transfer pricing rules allow the Tax Office to increase a taxpayer's assessable income or decrease allowable deductions to negate the effect of the arrangement - see Division 13 of Part III.

International agreement

The rules apply only where there is an international agreement. For the purpose of applying the definition of an international agreement, the CFC is treated as a resident of a foreign country. The result is that the transfer pricing rules apply to most non-arm's length arrangements involving the CFC.

Example 23

CFC in an unlisted country

Unlist Co1, which you wholly own, is a CFC resident of an unlisted country. In turn, Unlist Co1 wholly owns another CFC in an unlisted country - Unlist Co2. Unlist Co1 lends Unlist Co2 $1 million and there is no interest payable on the loan. The market interest rate is 10%.

Unlist Co1 will be taken to have received $100,000 on the loan. This amount will be tainted interest income and will be included in the tainted income of the company. If the company fails the active income test, the notional assessable income of Unlist Co1 will include $100,000.

Application of the transfer pricing rules to non-arm's length arrangements involving CFCs resident in the same listed country

The transfer pricing rules do not apply to arrangements involving CFCs resident in the same listed country at any time when an international agreement is in force.

Impact on the active income test

The Tax Office can make adjustments reflecting arm's length values to amounts used in determining whether a CFC has passed the active income test. An adjustment can be made if, in working out the attributable income of a CFC, the Tax Office would make a transfer pricing adjustment in relation to the acquisition or supply of property by the CFC.

Requests for rulings

You can request a ruling from the Tax Office on whether Division 13, as modified, applies to an arrangement.

Compensating adjustments

To avoid double taxation, the Tax Office may make adjustments in the assessment of another taxpayer to compensate for a transfer pricing adjustment. A compensatory adjustment may be required, for instance, where a transfer pricing adjustment is made to decrease the amount of a royalty payment made to a related company. In this case, a compensatory adjustment could be made to reduce the amount included in the assessable income of the related company as a result of the royalty payment.

As with the usual operation of the transfer pricing rules, where one CFC's notional assessable income or notional allowable deductions are adjusted, the Tax Office may make a compensating adjustment to:

• a taxpayer's allowable deductions or assessable income
• another CFC's notional assessable income or notional allowable deductions, or
• the attributable income of a transferor trust estate.

Similarly, compensating adjustments may be made to the attributable income of a CFC when the transfer pricing rules have been applied to:

• a taxpayer's allowable deductions or assessable income, or
• the attributable income of a transferor trust estate.

Deduction for eligible finance shares

A deduction is not normally available for the payment of a dividend. A notional allowable deduction is available, however, for an eligible finance share dividend paid by a CFC. Broadly, this is a dividend paid on a share issued under a preference share financing arrangement with an Australian financial intermediary - for example, a bank - and its subsidiaries. In effect, the issue of eligible finance shares is treated as a type of loan.

Dividends on eligible finance shares are treated as an interest expense. A notional allowable deduction is available for the dividends to the extent a notional allowable deduction would have been payable if the dividends had been an interest outgoing.

Deduction for widely distributed and transitional finance shares

A deduction, similar to that provided for eligible finance shares, is available for dividends paid by a CFC on widely distributed finance shares. Widely distributed finance shares include shares issued by a CFC as a public issue under a preference share financing arrangement to persons who are not associates of the CFC and who have provided finance on arm's length terms. To qualify, the shareholders should have no interest in the CFC apart from ensuring repayment of the funds and regular payment of the dividends in a form which is, in effect, a substitution for interest on a loan.

A deduction is also available for dividends paid by a CFC on transitional finance shares. Transitional finance shares are shares issued by a CFC to a related CFC and paid for by the related CFC out of funds raised by the issue of widely distributed finance shares. The transitional finance shares must be issued under similar terms to the widely distributed finance shares.

Sunset clause

The deduction for dividends paid on transitional finance shares is only available where the shares were issued before 12 April 1989. A sunset clause is provided so that a deduction for dividends paid on transitional finance shares is only available for dividends paid by the CFC before 1 July 1998.

Diagram 3: Operation of widely distributed finance share measures

members of the public

->

funds raised by public issue of widely distributed finance shares

->

CFC A

->

funds may be lent

->

CFC B

Diagram 4: Operation of transitional finance share measures

members of the public

->

funds raised by public issue of widely distributed finance shares

->

CFC A

->

funds provided through share issue

->

CFC B

In each of the diagrams, a deduction is available from the attributable income of CFC A for dividends paid on its widely distributed finance shares.

In diagram 3, CFC B is allowed a deduction for interest paid to CFC A on the loan from that company.

In diagram 4, a deduction is available from the attributable income of CFC B for dividends paid on shares that it issued to CFC A on substantially the same terms as widely distributed finance shares issued by CFC A.

Section 3: Modifications to the treatment of capital gains and losses

The operation of the capital gains tax provisions of the Tax Acts is modified for working out the attributable income for a controlled foreign company (CFC).

Assets included in the calculation

Capital gains and losses taken into account in working out attributable income for a CFC are those arising on the disposal of assets, other than CGT assets which are taxable Australian property.

(A capital gain or loss on the disposal of a CGT asset which is taxable Australian property is taken into account in working out the actual assessable income of the CFC as a non-resident taxpayer and is therefore excluded from the calculation of the CFC's attributable income.

Note: This exclusion applies even if the relevant asset is not subject to capital gains tax (CGT) because it was acquired before 20 September 1985.

What is a CGT asset which is taxable Australian property?

In determining whether an asset is a CGT asset that is taxable Australian property, the assumption that the CFC is a resident of Australia is ignored. In almost all cases, however, the residency assumption will make no difference.

There are five categories of CGT assets that are taxable Australian property. These five categories are:

1. Taxable Australian real property which is directly held.

This includes:

• Real property situated in Australia; and
• Mining, quarrying or prospecting rights where minerals, petroleum or quarry materials are situated in Australia.
• Where such assets are depreciating assets, then capital gains and losses are disregarded for CGT purposes.

2. Indirect Australian real property interest (other than interests in category 5)

A membership interest held by an entity in another entity where the following two tests are met:

• Non-portfolio interest test (broadly where the interest in an entity, whether foreign or Australian, must be at least 10%); and
• Principal asset test (where the market value of the entity's assets is principally attributable to Australian real property).

Note: Where an indirect Australian real property interest held on 10 May 2005 was not previously subject to CGT, its cost base is reset to its market value on that day. For the reset to occur, on 10 May 2005 the following must be satisfied:

• The interest was held by a foreign resident (or trustee of a non-resident trust);
• The interest was a post-CGT asset; and
• The interest held by you and your associates in a public company or unit trust did not exceed 10%.
• As a result, unrealised capital gains/losses on 10 May 2005 are not subject to CGT.

3. Business assets used in an Australian permanent establishment of a foreign resident (other than assets in category 1, 2 or 5)

4. Options or rights over category 1, 2 or 3 assets; and

5. Assets where a CGT gain or loss is deferred when an entity ceases to be an Australian resident.

Note: The specific list of CGT assets which are taxable Australian property are set out in section 855-15 of the ITAA 1997.

Assets used to produce notional exempt income

In working out taxable income, the capital gains tax provisions do not normally apply to the disposal of assets used solely for the production of exempt income. However, in working out attributable income, capital gains or losses on the disposal of assets used to derive notional exempt income can be taken into account.

Removal of exemption of pre-20 September 1985 assets

When applying the capital gains tax provisions in working out attributable income, all CGT assets other than taxable Australian property that a CFC owns are deemed to have been acquired on 30 June 1990 or a later date being the last day of the most recent period during which there was not an attributable taxpayer with a positive attribution percentage. As such, the exemption for pre-20 September 1985 assets does not apply in working out attributable income.

Cost base of assets

The cost base of assets owned by a CFC is the market value at the later of:

a) the last day of the most recent period during which there was not an attributable taxpayer with a positive attribution percentage in relation to the CFC; and

b) 30 June 1990.

This day is called the 'commencing day'

Example 24

Cost base of asset

A company is a CFC from 31 December 1990. However, there is not an attributable taxpayer with a positive attribution interest until 1 March 1993 at 5.00pm. The CFC acquired an asset on 1 May 1992 and disposes of the asset on 1 October 2006.

Consequences

The asset will be deemed to have been acquired for market value on 1 March 1993. This is the commencing day as it is the last day of the most recent period during which an attributable taxpayer did not have an attribution percentage. The capital gain or capital loss is therefore worked out using the change in the asset's value between 1 March 1993 and 1 October 2006.

Working out a gain or loss on disposal

You work out the amount to include in a CFC's notional assessable income in broadly the same way as for the usual operation of the capital gains tax provisions. That is, you must determine the excess of a CFC's capital gains over the CFC's capital losses and include that excess - the net capital gain - in the CFC's notional assessable income. A net loss can only be carried forward to be offset against future capital gains. However, there are certain modifications to the capital gains tax provisions that apply when working out attributable income.

Valuation date for assets owned at the end of the commencing day

An unrealised gain that accumulated on or before the commencing day will not be taxed. Correspondingly, any unrealised loss accumulated up to that date will not be allowed. This is done by valuing the assets on the commencing day and, in general, using that value as the consideration paid.

However, where an asset had decreased in value on or before the commencing day, the gain using the market value as the consideration paid could be bigger than the actual gain. Similarly, where the asset had appreciated in value on or before the commencing day, the loss using the market value as the consideration paid could be greater than the actual loss. In either of these cases, only the actual gain or loss is taken into account. To achieve this result, you must use as the consideration paid for such assets either the market value of the asset at the commencing day or the actual cost base of the asset, whichever produces the smaller gain or loss. That is:

• in working out a gain, use the greater of the unindexed cost base and the market value on the commencing day
• in working out a loss, use the lower of the unindexed cost base and market value on the commencing day.

Indexation of the cost base

The cost base of an asset acquired by a company on or before 21 September 1999 may be indexed for inflation. However, the cost base of the asset may only be indexed for inflation up until 21 September 1999 if that asset was held for at least 12 months.

Indexation factor

The indexation factor used is the same as that normally used under the capital gains tax provisions - the consumer price index. This index is published in the Guide to capital gains tax (NAT 4151). You can get the consumer price index from the Australian Bureau of Statistics in your capital city or from any tax office.

Adjustment to the cost base

In some cases, the cost base of an asset will need to be adjusted. This would occur where, for example, there was a return of capital on shares or a tax free distribution from a unit trust.

Phone the Business Infoline on 13 28 66 for more information.

Provisions for profit-making ventures

The provisions of the Act that include in assessable income a capital gain from the disposal of an asset purchased for profit-making by sale or from carrying out a profit-making undertaking or that allow a deduction for a loss - that is, sections 25A and 52 - do not apply in working out the attributable income of a CFC.

Treatment of a net capital loss under the capital gains tax provisions

In working out taxable income, capital losses are offset against capital gains to determine the net capital gain to include in assessable income. Where there is a net capital loss, you cannot use the loss to reduce assessable income. The same rules apply in working out attributable income.

A CFC cannot use a net capital loss under the CGT provisions to reduce its notional assessable income. It can only carry the loss forward for offset against capital gains in subsequent years.

You cannot transfer a loss - for example, you cannot use the loss of one CFC to reduce the notional assessable income of another CFC or your own assessable income.

In working out attributable income you cannot take into account a capital loss incurred on the disposal of an asset where the disposal occurred before 1 July 1990.

Where a company becomes a CFC after 30 June 1995, asset disposals made before it became a CFC are not taken into account when working out attributable income.

This ensures that a capital loss is not available where it is incurred before a company becoming a CFC.

Rollover of assets under the capital gains tax provisions

Forced disposals

The capital gains tax provisions allow you to defer working out a capital gain or capital loss where the disposal was:

• as a result of a breakdown of marriage
• caused by the loss or destruction of the asset
• from certain resumptions of property
• from the disposal of certain mining leases.

These rollover provisions will apply in working out the attributable income because of the assumption that the CFC is a resident.

Most of these provisions require that the person disposing of the asset must make an election. You can make the election on behalf of a wholly owned CFC. For more details, read Procedures for electing that the rollover provisions apply, below.

Group transfers

The CGT rollover provisions allow companies that have 100% common ownership to defer, in certain circumstances, capital gains or capital losses on assets transferred between companies in the group. In the case of asset transfers between CFCs with 100% common ownership the circumstances under which the rollover provisions apply are modified. These are set out in the table below:

Residence of CFC	Recipient company residence	Asset requirement
Resident of a listed country	Either a resident of that listed country or an Australian resident	Any asset
Resident of a listed country	A resident of a particular unlisted country	The asset must have been used in connection with a permanent establishment of the CFC in an unlisted country
Resident of an unlisted country	Either a resident of an unlisted country at that time or an Australian resident	Any asset

The assumption that a CFC is a resident of Australia is ignored in determining its residence for the group transfer provisions.

Procedures for electing that the rollover provisions apply

How to elect for rollover relief

If an election for rollover relief is required, a CFC - or in the case of group rollovers, both the transferor and transferee - must elect in writing that the particular rollover provision applies.

The CFC must normally make the election. An attributable taxpayer may, however, make an election on behalf of a wholly owned CFC.

Timing of elections

An election must be lodged with the Tax Office on or before the lodgment of a return by an attributable taxpayer that is affected by the election. If more than one attributable taxpayer is affected, the election will be valid if made on or before the lodgment of the affected tax returns.

Self-assessment - extension of time to make an election

The self-assessment guidelines do not apply to an election by a CFC for rollover relief and Taxation Ruling IT 2624 - Income tax: company self assessment; elections and other notifications; additional (penalty) tax; false or misleading statement does not authorise an extension of time in which to make the election. If an extension of time is required, the CFC or its agent should approach the Tax Office. For convenience, the request should go to the tax office where the tax return of the largest attributable taxpayer is lodged. If this is not readily apparent, the request can be lodged at any tax office.

Which officer makes the election?

The person who acts for the CFC should make the election. In Australia, that person would normally be the public officer of the company. However, foreign laws may require a different officer to act for the company. Whoever is authorised - whether under the foreign law or, if no law governs this, under the constituent document of the CFC - may make the election.

Election by an agent in Australia

The requirement that a CFC make an election will also be satisfied where an agent makes the election for or on behalf of the CFC, provided that the person is authorised by the CFC to do so. For example, the Australian parent of the CFC or the CFC's tax agent in Australia, if authorised, could make the election.

Reduction of disposal consideration where attributable income is not distributed

An adjustment will be made to the consideration received by a CFC in respect of the disposal of an interest in an attribution account entity if the income or profits of that entity have been attributed to you but have not been distributed. The adjustment only applies where the consideration is included in working out notional assessable income - whether under the capital gains tax provisions or any other provision.

The adjustment is mandatory and does not depend on any finding that the share price reflects the retained earnings. If you think that it applies to the CFC, you can contact the tax office where you lodge your return for more information.

CGT concession for active foreign companies

For certain CGT events happening on or after 1 April 2004, a CFC may be able to reduce its capital gains or capital losses arising in relation to its interest in a foreign company, including a CFC. This can be done when:

• the CFC holds shares in a company that is a foreign resident (excluding eligible finance shares and widely distributed finance shares)
• a CGT event occurs in respect of the CGT asset that is the share in the foreign company, and
• the CFC has held a direct voting percentage of at least 10% in that foreign company for a continuous period of 12 months in the 24 months before the time of the CGT event.

The gain or loss resulting from the CGT event is reduced by a percentage, calculated at the time of the CGT event, called the active foreign business asset percentage. The method for calculating the active foreign business asset percentage is explained below.

Active foreign business asset

An asset will be an active foreign business asset if, at the time of the CGT event, it is:

• an asset included in the total assets of the foreign company
• used or held ready for use by the foreign company in the course of carrying on a business, and
• not a CGT asset that is Australian taxable property.

Goodwill of the foreign company is included as an active business asset but financial instruments (other than shares and trade debts) are not included.

To be included in the total assets of the foreign company, the asset must be a CGT asset that is owned by the foreign company at the time of the CGT event.

Active foreign business asset percentage

You can work out the active foreign business asset percentage of a foreign resident company in relation to the CFC using either the market value method or the book value method. If you do not choose either method, the effect of the default method is that you will not gain any benefit under the concession.

Market value method

The active foreign business asset percentage is worked out under the market value method using the following formula:

market value of all active foreign business assets market value of the total assets

Book value method

The active foreign business asset percentage is worked out under the book value method using the following formula:

average value of active foreign business assets average value of total assets

The average value of the active foreign business assets is worked out using the following formula:

value of the active foreign business asset at the end of the most recent period + the value of the asset of the previous period 2

The average value of the total assets of the foreign company are worked out in the same way.

After applying the formula under either method, the active foreign business asset percentage is determined as follows:

Result of calculation	Active foreign business asset percentage
< 10%	0%
10% - 89%	The result of the calculation
> 90%	100%

Foreign wholly owned groups

In certain circumstances where the determination of the active foreign business asset percentage involves a tier of foreign companies the calculation may be done on a consolidated basis for wholly owned companies comprising or within that tier of companies. This removes the need to determine the active foreign business asset percentage for each individual company in the tier where those companies are considered part of the wholly owned group. Rather, one calculation is performed for the top foreign company in the wholly owned group that also covers all its wholly owned foreign subsidiary companies.

Section 4: Quarantining of losses

Quarantining

If a CFC's notional allowable deductions relating to a particular class are more than the notional assessable income of that class for an accounting period, the excess cannot be claimed against notional assessable income of another class or used to reduce a net capital gain under the capital gains tax provisions.

The excess loss of a class of income is carried forward and can be claimed as a notional allowable deduction against income of the same class.

Note: The government announced in the May 2005 Budget that the foreign loss quarantining restrictions are to be removed, with effect for losses incurred in income years first commencing on or after the relevant legislation receives Royal Assent. This will mean that foreign losses may be offset against domestic income. However, foreign losses that arise before then continue to be treated under the current rules.

What are the classes of income?

Notional assessable income is divided into four classes:

• interest
• offshore banking
• modified passive
• other income.

The classes may include both income and gains of a capital nature. However, capital gains under the capital gains tax provisions are not included in any of the classes. In effect, these capital gains are treated as a separate class of income.

Interest

Most interest income, including payments in the nature of interest, falls into the interest class.

Excluded are:

• interest that falls into the offshore banking income class
• interest that is received in the active conduct of a trade or business - for example, interest on receivables
• interest derived from money lending - for example, a banking business.

Offshore banking income

Offshore banking income is income derived through an offshore banking unit. It is unlikely that a CFC will have this type of income.

Modified passive income

Modified passive income is passive income other than amounts that fall within the interest class or the offshore banking income class. As mentioned previously, capital gains under the capital gains tax provisions are not included. Passive income includes rent, royalties, dividends, annuities, capital gains and amounts derived from the assignment of copyrights, for example.

Other income

The 'other income' class comprises amounts that do not fall within the other three classes.

Deductions for sometimes exempt income loss

You may claim a notional allowable deduction for a 'sometimes exempt income loss'. A sometimes exempt income loss can arise for a CFC in an accounting period if:

• the CFC passed the active income test for the period, or
• the CFC gained the benefit of the de minimis exemption for the period
• and the CFC has any expenses that are not notional allowable deductions but would have been if the CFC had not passed the active income test or gained the benefit of the de minimis exemption.

How is the sometimes exempt income loss worked out?

The sometimes exempt income loss is worked out by:

• assuming that the CFC had passed the active income test and did not have the benefit of the de minimis exemption
• working out the amounts that would be included in the notional assessable income - called the sometimes exempt income
• working out notional allowable deductions that would be available if the sometimes exempt income were assessable - called sometimes exempt deductions.

If sometimes exempt deductions of a class of income are more than the sometimes exempt income of that class, the difference is a sometimes exempt income loss.

Deductions for previous year losses

You may claim a notional allowable deduction for a CFC's previous years' losses. Do this separately for each class of income. In determining the loss for a particular class of notional assessable income, only the notional allowable deductions that relate to that particular class and were derived in that period are taken into account. If the notional allowable deductions are more than the notional assessable income, the difference is set off against the sometimes exempt income gain of that class for the period. The amount that remains is the CFC's loss for that class for the period.

How is a sometimes exempt income gain worked out?

The sometimes exempt income gain for each class of income is the amount of sometimes exempt income that is more than the sometimes exempt deductions. The sometimes exempt income gain reduces a CFC's loss in a class of income. Losses in the current period are reduced before losses carried forward from a previous period.

Conditions before a loss is allowed

You are allowed a notional deduction for a previous year's loss only if the CFC was a CFC when the loss was incurred and at the end of each period until the loss is claimed.

In working out the CFC's previous years' losses you must assume that you were always an attributable taxpayer who was required to work out attributable income. Therefore, it is possible to carry forward a loss from a period when you were not an attributable taxpayer.

You cannot take into account any loss incurred in a statutory accounting period that commenced before 1 July 1983.

Residency requirement for losses

A loss that was incurred in a previous statutory accounting period is only allowable if the CFC was a CFC at the end of that statutory accounting period in which the loss arose and at the end of each of the following statutory accounting periods before the eligible period.

In addition, certain residency requirements must be met before the loss may be applied against the notional assessable income of that class in the eligible period. If these are not satisfied the loss will not be taken into account.

Modifications to the general rule deal with cases where a company:

• remains a resident of the same country, but
• is treated as changing residence from a listed country to an unlisted country or vice versa as a result of changes to the list(s) of countries or political developments - for example, as a result of the dissolution of a country.

In these cases, the losses incurred by a CFC in an earlier period are not denied solely because the listing status of a CFC's country of residence changes.

The following table summarises the availability of losses incurred in previous statutory accounting periods.

CFC's country of residence at end of eligible period	CFC's country of residence at end of the substituted accounting period in which loss arose	Consequence
Listed	Listed	Allowable
Listed	Unlisted	Generally not allowable unless the unlisted country arose from the dissolution of the listed country or unless the unlisted country is the same country as the listed country.
Unlisted	Unlisted	Allowable
Unlisted	Listed	Generally not allowable unless the listed country is the same as the unlisted country.

Note: Losses are not allowable if they were denied in an earlier statutory accounting period

Losses confined to the CFC

Where a CFC has incurred a loss of a class of income, you cannot transfer the loss to reduce the notional assessable income of another CFC or your own assessable income. The loss is locked into the CFC.

Ordering

If there is more than one previous year's loss, you must claim the losses in the order in which they were incurred.

Section 5: Working out the net income of a partnership

The notional assessable income of a CFC includes the CFC's share of the net income of a partnership. You work out the net income of the partnership in accordance with the partnership provisions of the Act. However, it is assumed that:

• the partnership derived only certain income and gains
• the operation of the Act is modified.

Assumption about income and gains

The assumptions made for amounts derived by a partnership mirror the assumptions made for working out the income and gains of a CFC. The amounts taken into account in working out the net income of the partnership depends on whether the CFC passes the active income test. The amounts also depend on whether the CFC is a resident of a listed country or an unlisted country.

If a CFC is resident in an unlisted country:

• passes the active income test - the only amounts taken into account in determining the net income of the partnership are trust amounts arising for the partnership and amounts of FIF income.
• fails the active income test - only the following amounts are taken into account in determining the net income of the partnership:
  • adjusted tainted income
  • trust amounts arising for the partnership, and
  • FIF income.

If a CFC is resident in a listed country:

• passes the active income test - only the following amounts are taken into account in determining the net income of the partnership:
  • low-taxed third-country income of a kind specified in the Regulations
  • FIF income, and
  • trust amounts arising for the partnership that are not subject to comparable tax in a listed country
• fails the active income test - only the following amounts are taken into account in determining the net income of the partnership:
  • eligible designated concession income that is adjusted tainted income
  • low-taxed third-country income of a kind specified in the Regulations
  • FIF income, and
  • trust amounts arising for the partnership that are not subject to comparable tax in a listed country.

Assumption about modifications to the Act

The modifications that apply in working out the net income of a partnership are similar to those that apply for working out notional assessable income and notional allowable deductions of a CFC - see section 3, section 4 and section 5.

Additional modifications to the Act

Three additional modifications are made in working out the net income of a partnership.

• First, the partnership is treated as a resident of the same country as the CFC. 
• Second, a dividend will not be notional exempt income of a partnership unless the dividend is paid out of previously attributed income. 
• Third, the capital gains tax provisions apply to assets acquired by a partnership after 19 September 1985 - the deemed acquisition of assets on 30 June 1990 for CFCs does not apply to assets held by partnerships.

Section 6: Trust amounts

The notional assessable income of a CFC may include certain trust amounts arising for the CFC in the statutory accounting period. There are three types of trust amounts:

• amounts derived as a beneficiary of a trust estate where the CFC is presently entitled to a share of the net income of the trust estate
• other amounts paid to, or applied for the benefit of, the CFC by the trustee of a trust estate, and
• amounts attributed to the CFC under the transferor trust measures.

CFC a beneficiary of a trust - present entitlement

Where the CFC is presently entitled to a share of the net income of a trust estate, the CFC must include the share of the net income in notional assessable income. The calculation of the net income of the trust estate is made under the existing trust provisions of the Act. The modifications that apply in working out the net income of a trust are similar to those that apply for working out notional assessable income and notional allowable deductions of the CFC - see section 3, section 4 and section 5.

Additional modifications that apply when working out the net income of a trust are outlined below.

Trust is a resident of the same country as the CFC

A trust estate is treated as a resident of the same country as the CFC.

Dividends

A dividend will not be notional exempt income of a trust unless the dividend is paid out of previously attributed income.

Trust is treated as a resident trust estate

A trust is treated as an Australian resident trust estate or a resident unit trust for the purposes of the capital gains tax provisions.

Modifications to capital gains tax provisions

The modifications to the capital gains tax provisions - see section 4 - that provide for the removal of the exemption for assets acquired before 20 September 1985 do not apply in working out the net income of a trust. Consequently, the capital gains tax provisions apply to assets acquired by a trust after 19 September 1985.

Transferor trust measures

The transferor trust measures apply in working out the attributable income of a CFC. See chapter 2 to determine whether the CFC will have an amount attributed to it.

Section 7: Reduction of attributable income because of interim dividends

The attributable income of a CFC is reduced if you are taxed on a dividend paid by the CFC out of current year profits and you would be assessable on those profits under the CFC rules at the end of the statutory accounting period of the CFC.

An interim dividend is only regarded as having been paid out of the attributable income of the current statutory accounting period if there are no earlier profits available out of which the dividend could have been paid. To the extent that there are such earlier profits, the dividend will firstly be regarded as having been paid out of those profits. Any balance is treated as having been paid out of the attributable income of the current statutory accounting period. Taxation Determination TD 2003/27 - Income tax: how is double taxation avoided in the following situations where a Controlled Foreign Company (CFC) pays a dividend to an attributable taxpayer... provides further guidance on how the attributable income of a CFC is reduced in these circumstances.

Working out the reduction

Dividend paid to an attributable taxpayer

If the dividend is paid to you, the amount of the reduction in attributable income is worked out as follows:

amount of the dividend assessed        your attribution percentage in the CFC

Example 25

Dividend paid wholly out of attributed income

A taxpayer has a 50% attribution percentage in a CFC resident of an unlisted country. The CFC has no profits from previous years and $1 million current year profits are distributed as a dividend. The dividend was paid wholly from profits referable to the attributable income of the CFC. The $500,000 received by the taxpayer is included in the taxpayer's assessable income.

The amount by which the attributable income would be reduced is worked out as follows:

$500,000 50%

=

$1 million

Example 26

Dividend paid partly out of attributed income

A taxpayer has a 50% attribution percentage in a CFC resident of an unlisted country. The CFC has an accumulated profit of $2 million. The CFC pays a dividend of $2.2 million. The dividend would be taken to have been paid out of the accumulated profits first. The whole of the $200,000 component of the dividend paid from current year profits is referable to the attributable income of the CFC.

The reduction would be:

$100,000 50%

=

$200,000

Example 27

Dividend is exempt

A resident company has a 50% interest in a CFC resident of a listed country. The CFC has no profits from previous years and distributes all of the current year profits as an exempt dividend.

There is no reduction of attributable income in this case because the dividend was not assessable income.

Section 8: Relief from double accruals taxation

If an amount of income or gain is to be included in your assessable income as a result of tracing control through a foreign entity and that foreign entity has also been taxed on that amount under the accruals tax laws of another country, you may reduce your assessable income by an amount calculated as follows:

Indirect attribution interests through a controlled foreign entity (CFE)

x

Foreign accruals-taxed attributable income

Your indirect attribution interest through a CFE is your attribution interest in a CFC traced through the CFE.

The foreign accruals-taxed attributable income is that part of an amount of income or gain derived by a CFC on which an interposed CFE has been taxed under an accruals tax law of a listed country. The income or gain must be taxed at that country's normal company rate of tax and during a tax accounting period which commences or ends either in your year of income or the statutory accounting period of the CFC.

Only countries listed in the Income Tax Regulations as having accruals tax laws are recognised for the purpose of granting this relief. They are:

• Canada
• France
• Germany
• Japan
• New Zealand
• United Kingdom of Great Britain and Northern Ireland
• United States of America

Example 28

Reduction of an otherwise assessable section 456 amount

Scenario

Ausco owns 50% of the share capital of US Co - a company resident in the United States - which in turn owns 50% of the share capital of a company that is a resident of an unlisted country. Ausco also holds a direct interest of 25% of the unlisted country company.

Because of the interests Ausco holds in US Co and the unlisted country company, both foreign companies are CFCs.

For the 2004-05 period, the unlisted country CFC's only item of income was interest income. The amount of this interest income was determined to be $8,000 under Australia's income tax laws.

The United States taxed US Co on an accruals basis on the item of interest income derived by the unlisted country CFC. US Co's interest in the unlisted country company was 50%. Therefore, only half of the item of interest income was attributed to US Co by the United States.

Australia applied the transfer pricing provisions to an interest-free loan which the unlisted country company provided to a related CFC. Consequently, another $2,000 interest income was included in the unlisted country CFC's attributable income under Australia's accruals tax laws. This amount was not included in the unlisted country CFC's attributable income under the accruals tax laws of the United States.

Working out the amount to be attributed to Ausco

Step 1 - Determine Ausco's otherwise assessable amount

Ausco's attributed percentage of the attributable income of the unlisted country CFC is:

direct attribution interest	25%
indirect attribution interest	25%
attribution percentage	50%

Ausco's otherwise assessable amount is $5,000 (50% attribution percentage) x ($8,000 interest income + $2,000 interest income), arising from the application of the transfer pricing provisions.

Step 2 - Determine Ausco's indirect attribution interests through US Co

Ausco's indirect attribution interest in the unlisted country CFC through US Co is 25% - that is, Ausco's 50% direct interest in US Co multiplied by US Co's 50% interest in the unlisted country CFC.

Step 3 - Determine the unlisted country CFC's foreign accruals-taxed attributable income

The unlisted country CFC's foreign accruals-taxed attributable income worked out under Australian accruals tax rules equals $8,000. This amount is referable to the item of interest income included in the attributable income of the unlisted country CFC under the United States' accruals tax laws. It is important to note that the amount is not necessarily the same as the amount worked out under the United States' accruals tax laws.

Step 4 - Determine the amount by which Ausco's otherwise assessable amount is to be reduced

Reduce the otherwise assessable amount by $2,000 - that is, step 2 multiplied by step 3.

Step 5 - Determine Ausco's assessability in respect of the unlisted country CFC's attributable income

Ausco's assessability for the unlisted country CFC's attributable income is $3,000 - that is, step 1 minus step 4.

Section 9: How much is included in assessable income

You need to work out how much of the attributable income of the CFC to include in your assessable income. Multiply your attribution percentage in the CFC at the end of the statutory accounting period by the attributable income of the CFC. Include the result in your assessable income.

Chapter 2: Transferor trust and related measures

This chapter:

• helps Australian residents who have transferred, or are deemed to have transferred, property or services to a non-resident trust estate to:
  • determine whether, under the transferor trust measures, any income or capital gains derived by the trust estate should be attributed to them for inclusion in their assessable income
  • work out the amount to be attributed
    
     
• helps Australian beneficiaries who have received a distribution from a non-resident trust estate to determine whether an interest charge applies to the distribution.

Introduction

The transferor trust measures operate to accruals tax residents of Australia who have transferred property or services to a non-resident trust estate on certain profits derived by the trust.

Related measures also operate to impose an interest charge on certain trust distributions from non-resident trusts that are included in the assessable income of a resident beneficiary. Broadly, the interest charge applies if the profits of the trust from which the distribution was made were not subject to tax:

• in a listed country, or
• because of attribution under the transferor trust provisions.

See the glossary at the start of this guide to find the meaning of certain words and expressions used in this chapter.

Summary of chapter 2

Part 1	Are you subject to the transferor trust measures?
Part 2	Interest charge for beneficiaries of non-resident trust estates

Part 1: Are you subject to the transferor trust measures?

This part helps you determine whether you are subject to the transferor trust measures. It also shows how to work out the amount to include in your assessable income if the measures do apply.

Summary of part 1

Section 1	Are you a transferor in relation to a non-resident trust estate?
Section 2	Are you subject to the transferor trust measures?
Section 3	What amount do you have to include in your assessable income? Subsection 1: Working out your assessable income where information is available from the trust. Subsection 2: Working out your assessable income where you do not have sufficient information to work out attributable income. Subsection 3: What happens if there is more than one transferor?

Section 1: Are you a transferor in relation to a non-resident trust estate?

Transfers of property or services

If you have transferred property or services to a non-resident trust estate, the profits of the trust may be attributed to you - that is, the profits may be included in your assessable income even though you have not received a distribution from the trust.

You will be regarded as a transferor if you:

• have at any time transferred property or services to a non-resident discretionary trust estate, or
• transferred property or services after 7.30pm on 12 April 1989 to a non-resident trust estate that is non-discretionary for either no consideration or for consideration less than an arm's length amount.

Deemed transfers

Certain transfers of property or services made to another entity may be deemed to have been made to a trust estate if the transfer is connected with a transfer to the trust estate.

Example 1

Deemed transfer to a trust estate

Entity A transfers property to Entity B on condition that Entity B transfers the property to a trust estate. In this case, Entity A would be deemed to have transferred to the trust estate the property transferred by Entity B.

Example 2

Marketing of units in a unit trust

The trustee of a unit trust issues units to Entity A, which acts as manager, underwriter or dealer for the placement of the units. Entity A then disposes of the units to Entity B, which transfers property or services to Entity A as consideration for the acquisition of the units.

In this case, Entity B is deemed to have transferred the property or services that Entity A originally transferred to the unit trust. In the circumstances, Entity A will not be taken to have transferred property or services to the trust estate.

Where a partnership has transferred property or services to a non-resident trust estate, each partner is deemed to have transferred property or services in proportion to their interest in the partnership.

Where a trust estate has transferred property or services to a non-resident trust estate, each person who has transferred property or services to the first-mentioned trust estate is deemed to have transferred property or services to the second-mentioned trust estate.

If the partnership or trust estate is in existence at the end of the non-resident trust estate's year of income, any attributable income of the non-resident trust estate is attributed to the partnership or trust estate. If the partnership or trust estate is not in existence at the end of the non-resident trust estate's year of income, any attributable income of the non-resident trust estate is attributed to the partners of the partnership or the original transferors to the trust estate.

The Tax Office may also treat you as having transferred property or services to a trust if you benefited from a transfer by a company, partnership or trust that ceases to exist.

If you need further information on deemed transfers, contact the Tax Office.

Section 2: Are you subject to the transferor trust measures?

The amount to be included in the assessable income of a resident transferor for profits derived by a non-resident trust estate is called 'attributable income' and the resident transferor to whom it is attributed is called an 'attributable taxpayer'.

Exemptions from the transferor trust measures

A number of exemptions are provided from the transferor trust measures. These exemptions depend on the type of trust estate to which you have transferred property or services.

Public unit trusts

The transferor trust measures do not apply to a transfer of property or services to a non-resident trust estate if:

• the trust estate is a public unit trust at all times during the transferor's year of income
• the transfer was made for arm's length consideration
• the sole purpose of the transfer was the arm's length acquisition of units in the unit trust.

A unit trust will be a public unit trust if, at any time during the income year, any of the units were listed on a stock exchange in Australia or elsewhere or were offered to the public. A unit trust will also be a public unit trust if, at all times during the income year, the units in the unit trust were held by 50 or more individuals.

The transferor trust measures will apply to you if you make a transfer of property or services to a non-resident public unit trust on or after 12 April 1989 for less than an arm's length consideration.

Deceased estates

The transferor trust measures generally do not apply to a trustee of a deceased estate who transfers property or services to a non-resident trust estate according to directions contained in the deceased person's will or codicil, or according to a court order which varies the will or codicil. The measures will apply, however, if:

• the transfer is made through the exercise of the power of appointment or of a discretion by the trustee or any other person - for example, where the trustee of a deceased estate has a discretion to invest money of the trust estate and decides to transfer the money to a discretionary trust estate, or
  
   
• the trustee transfers property or services to a non-resident trust estate but the transfer was caused by another entity - other than a deceased person - in which case, the entity that caused the transfer is treated as a transferor.

Non-resident family trusts

The transferor trust measures do not apply to an individual who has transferred property or services to a non-resident family trust. However, the trust must be a non-resident family trust at all times when it is in existence after the beginning of the transferor's 1990-91 income year until the end of the current income year - that is, the income year for which the transferor is working out assessable income.

An exemption from the transferor trust measures is also available to an individual who:

• first becomes an Australian resident after 12 April 1989
• makes a transfer to a non-resident family trust before taking up residency in Australia.

To qualify, the trust estate must be a non-resident family trust at all times after the transferor becomes a resident of Australia.

The exception does not apply to an individual who, as trustee, transferred any property or services to the non-resident family trust from any other trust estate.

Two types of non-resident family trusts are covered by this exception - post-marital family trusts and family relief trusts.

Post-marital family trusts

Post-marital family trusts come into existence after a decree or order of dissolution or annulment of a marriage or a decree or order of judicial separation or similar instrument. Trusts resulting from the breakdown of a de facto marriage also qualify. The beneficiaries of the trust estate must be non-resident individuals and:

• the spouse or former spouse of the individual, or
• a child of the individual or the individual's spouse, or
• a child of the individual's former spouse during the marriage.

Family relief trusts

Family relief trusts are established and operated to help non-resident family members. Trusts with Australian or non-family beneficiaries do not qualify as family trusts. The only beneficiaries permitted are non-residents who are related to the transferor. The following persons are treated as related to the transferor for this purpose:

• a spouse or former spouse
• a parent of the transferor or of the transferor's spouse or former spouse
• a child of the transferor or of the transferor's spouse or former spouse
• a grandparent of the transferor
• a grandchild of the transferor
• a brother or sister of the transferor or of the transferor's spouse or former spouse
• a child of the transferor's brother or sister
• a child of a brother or sister of the transferor's spouse or former spouse.

A trust estate will generally not qualify as a family trust if the assets of the trust are excessive given the requirements of the beneficiaries. There is an exception to this rule, however, if there have been no transfers of property or services to the trust after 12 April 1989. In this case the trust can have excessive assets and still qualify as a family trust.

Contingent beneficiaries

A trust estate can still be a family trust estate if, in the event of the death of a family member, one or more individuals benefit or are capable of benefiting under the trust. These persons must, however, be:

• non-residents
• children of the deceased family member.

If all beneficiaries die, the trust estate can still be a family trust estate if there are one or more funds, authorities or institutions covered by section 78 - the gift provisions - of the Act that would benefit or be capable of benefiting under the trust.

Migrant transferors

An individual who first became an Australian resident after 12 April 1989 will not be subject to the transferor trust measures if they transferred property or services to a non-resident trust estate before becoming a resident.

Discretionary trust estates

The transferor trust measures do not apply to a transferor who has transferred property or services to a discretionary trust estate if both of the following conditions are satisfied:

• the transfer was made in the course of carrying on a business, and
• the transfer was made in terms identical or similar to those that relate to transactions undertaken by the transferor, at or about the time of the transfer, in the ordinary course of business with ordinary clients or customers - that is, on an arm's length basis and subject to similar terms and conditions.

If the transfer was not made on an arm's length basis in the course of carrying on a business, the transferor trust measures will normally apply if at any time after the transfer the transferor or the transferor's associates were in a position to control the trust estate. However, if the transfer was made before 12 April 1989, the transferor trust measures will only apply if the transferor or the transferor's associates were in a position to control the trust after 12 April 1989.

If a transferor subsequently gains control of the discretionary trust estate, all years before the commencement of the transferor trust measures become subject to the measures.

A transferor is taken to be in a position to control a non-resident trust estate if the transferor or any associates:

• have power, by whatever means, to obtain the beneficial enjoyment of the corpus or income of the trust estate
• were able to control, directly or indirectly, the application of the income or corpus of the trust estate
• were capable, under a scheme, of gaining the enjoyment or control referred to in the above two points
• could expect the trustee to follow their directions, instructions or wishes, or
• have the ability to remove or appoint any trustees of the trust estate.

All factors must be taken into account in determining whether the trustee of a trust estate was accustomed, or might reasonably be expected, to follow directions, instructions or wishes of a transferor or an associate of the transferor.

For example, a requirement in a trust deed for the trustee to ignore directions, instructions or wishes would not pre-empt the examination of the actual circumstances to determine whether the transferor or an associate controls the trustee. The way in which the trustee has acted in the past, the relationship between the transferor or transferor's associate and the trustee and the amount of property or services transferred to the trust estate, are some of the other matters that need to be considered.

Non-discretionary trust estates

The transferor trust measures will not apply to a transferor who transferred property or services to a non-discretionary trust estate before 12 April 1989. Moreover, the measures will not apply to a transfer of property or services after 12 April 1989 if:

• the trust estate was a non-discretionary trust estate at all times during the transferor's current year of income
• the transfer was made for an arm's length consideration.

If:

• one transferor - the original transferor - makes transfers of property or services to a non-resident non-discretionary trust estate which were all made for consideration at an arm's length amount, and
• another transferor - the second transferor - makes a transfer of property or services to the same non-resident trust estate on or after 12 April 1989 which is made for no consideration or consideration at less than an arm's length amount

the second transferor - but not the original transferor - would become an attributable taxpayer in relation to the trust estate. Therefore, all the attributable income of the trust estate would be attributed to the second transferor.

Section 3: What amount do you have to include in your assessable income?

This section is relevant only if you are an attributable taxpayer in relation to a non-resident trust estate.

You must follow the steps in subsection 1 to work out your attributable income if you can obtain the necessary information.

If you cannot reasonably be expected to have access to the necessary information, work out the amount to be included in your assessable income following the steps in subsection 2.

Once you have worked out the amount to include in your assessable income, you may be able to apply for a reduction of this amount. Subsection 3 explains how to do this.

Subsection 1: Working out your assessable income where information is available

Working out the attributable income of a non-resident trust estate

To determine the attributable income of a non-resident trust estate you must first work out its net income. The net income of a trust estate is worked out as though the trust estate were an Australian resident and taxpayer. The foreign loss quarantining rules will, for instance, apply when working out the net income of the trust estate.

Note: The government announced in the May 2005 Budget that the foreign loss quarantining restrictions are to be removed, with effect for losses incurred in income years first commencing on or after the relevant legislation receives royal assent. This will mean that foreign losses may be offset against domestic income. However, foreign losses that arise before then continue to be treated under the current rules.

In working out the net income of a non-resident trust estate, you need to identify whether it is a listed country trust estate.

If it is a listed country trust estate, only the trust's eligible designated concession income is taken into account when working out the net income. The balance of the income of the trust estate is treated as exempt income.

If it is an unlisted country trust estate, all its income or gains are included in working out its net income.

A non-resident trust estate is treated as a listed country trust estate if all the income of the trust estate - other than eligible designated concession income - is either subject to tax in a listed country or is assessable in Australia in the hands of the trustee or a beneficiary.

Amounts that may be excluded from attributable income

In determining the attributable amount, the net income of a non-resident trust estate is reduced by the following amounts to the extent they relate to amounts included in the net income of the trust estate:

• amounts that have been included in the assessable income of a beneficiary under section 97 of the Act - that is, amounts to which a beneficiary is presently entitled 
• amounts where the trustee of the non-resident trust estate has been assessed and is liable to pay tax under section 98 of the Act - for example, on behalf of a resident beneficiary under a legal disability 
• amounts where the trustee of the non-resident trust estate has been assessed and is liable to pay tax under section 99 or 99A - for example, where the trust has undistributed Australian source income 
• amounts paid to beneficiaries who are residents of a listed country if those amounts are paid during the non-resident trust estate's income year or within one month after the end of the income year. These amounts must be subject to tax in a listed country in a tax accounting period ending before the income year or commencing during the income year
• franked dividends - that is, dividends paid by Australian companies or similar amounts paid by corporate unit trusts and public trading trusts, out of profits that have been subject to Australian tax 
• amounts included in the assessable income of the trustee of a trust estate where a dividend is grossed up for dividend imputation purposes 
• amounts received by a trustee from another trust estate to the extent that the amount has already been attributed to a transferor 
• amounts received by the trustee that are referable to the income or profits of a CFC that have been included in the assessable income of any resident taxpayer under the CFC measures 
• income or profits of the trust estate - other than eligible designated concession income - that are subject to tax in any listed country in a tax accounting period ending before the end of, or commencing during, the non-resident trust estate's income year
• foreign investment fund (FIF) income attributed to the trust estate for a notional accounting period of a company FIF if a share of the attributable income of the company FIF is included in your assessable income under the CFC measures for
  • a statutory accounting period coinciding with the notional accounting period of the company FIF, or
  • statutory accounting periods ending and commencing during the notional accounting period of the company FIF 
• amounts of foreign tax or Australian tax paid by the trustee or a beneficiary on amounts included in the attributable income of the trust estate.

For a listed country trust estate, exclude only the amounts that relate to the part of the net income that consists of eligible designated concession income.

Modifications made to Australian tax law

Rules that do not apply in working out the attributable income of a trust estate

The following rules do not apply in working out the attributable income of a trust estate:

• the general currency conversion rules
• the exemption for distributions from profits that have been taxed under the CFC measures
• the rules in sections 38 to 43 dealing with the taxation of a business only partly carried on in Australia
• the exemption for amounts that have been subject to withholding tax in Australia, and
• the CFC measures.

Conversion of income and expenses to Australian dollars

When calculating attributable income you must convert all amounts into Australian currency. This conversion is done using the conversion rules under the usual operation of the Act. For more information see the fact sheet Foreign exchange (forex): The general translation rule (NAT 9339).

Choice to use functional currency

The transferor trust may choose to have its attributable income calculated in the sole or predominant currency in which it keeps its accounts (ledgers, journals, statements of financial performance etc). This sole or predominant currency is called the 'applicable functional currency'.

When calculating attributable income in functional currency, all amounts that are not in the applicable functional currency (including Australian currency amounts) must be converted into the applicable functional currency. This conversion is done using the conversion rules under the usual operation of the Act. However, when applying these rules, the applicable functional currency is taken not to be foreign currency and all other amounts (including Australian currency amounts) are taken to be foreign currency.

Once the attributable income is calculated, it is converted into Australian currency in accordance with the relevant conversion rules.

The choice of applicable functional currency must be in writing but the transferor trust is not required to notify the Commissioner. The transferor trust must keep written evidence of the choice for as long as it is required to keep its tax records.

Generally, the choice will apply to the income year immediately following the one in which the choice is made. However, it will apply to the income year in which the choice is made where the choice is made within 90 days of the beginning of that income year, or by 16 January 2004 (if this is later).

The choice to use the applicable functional currency applies until you withdraw it. You can only withdraw a choice where the functional currency has ceased to be the sole or predominant currency in which the trust keeps its accounts. The withdrawal has effect from immediately after the end of the income year in which the choice is withdrawn. The withdrawal must be in writing and retained with your tax records. You may make a new choice applicable to subsequent income years.

Modified application of trading stock provisions

All items of trading stock are to be valued at cost when brought to account by a non-resident trust estate.

Modified application of depreciation provisions

A non-resident trust estate is allowed depreciation on the same basis as a resident taxpayer. However, assets are treated as having been held for the production of assessable income in income years where there was no calculation of attributable income.

Where the trustee has used a property during an income year partly for producing exempt income and partly for producing assessable income, the Tax Office can determine the amount that is an allowable deduction.

Modified application of the transfer pricing rules

The Tax Office can make adjustments reflecting arm's length values to amounts used in working out the attributable income of a trust estate. To avoid double taxation, the Tax Office can make a corresponding adjustment to an amount in determining the taxable income of another taxpayer.

Modifications relating to capital gains tax

The capital gains tax provisions of the Act - that is, Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 - apply as if the non-resident trust estate were a resident trust for CGT purposes. This ensures that a capital gain on the disposal of a CGT asset which is not taxable Australian property is taken into account under the transferor trust measures. It also ensures that the pre 20 September 1985 status of assets is retained.

Special rules apply to prevent double taxation of capital gains where a trust estate was formerly a resident of Australia. In this case, the cost base of assets that were taxed under the capital gains tax provisions at the residence change time is taken to be the market value of the assets at that time.

Modification of loss provisions

Losses are not available for income years before the year starting 1 July 1990.

De minimis exemption

The de minimis exemption ensures that the transferor trust measures do not apply to small amounts derived by a trust estate in a listed country.

The de minimis exemption is worked out having regard to the total of the attributable incomes of all trust estates for which a taxpayer is an attributable taxpayer. The de minimis exemption will be satisfied if the total of the attributable incomes of all the trust estates is equal to or less than the lesser of:

• $20,000, or
• 10% of the total of the net incomes of those trust estates.

If these tests are satisfied, the attributable income of listed country trust estates will not be included in the assessable income of the attributable taxpayer. The attributable income from unlisted country trust estates would still be included.

Working out the amount of attributable income to include in your assessable income

If you are an attributable taxpayer in relation to a non-resident trust estate, all the attributable income of the non-resident trust estate for an income year coinciding with your income year is included in your assessable income.

If there is more than one attributable taxpayer, the Tax Office may allow a reduction of the amount of attributable income to be included in the assessable income of each attributable taxpayer. To obtain the reduction, the taxpayer must apply to the Tax Office - see subsection 3 for more information.

Resident for part of a year

If you are a resident for only part of the income year, the attributable income included in your assessable income is reduced. The amount included is worked out as follows:

Notional attributable income

x

the number of days during the period that you were a resident total number of days in the period

Example 3

Part-year residency

George is a resident of Australia for 200 days out of the 365 days in the income year 1 July 2004 to 30 June 2005. He is an attributable taxpayer in relation to YZ trust that was a non-resident trust with the same income year. The attributable income of the trust estate was $40,000.

The amount George is required to include in assessable income for 2004-05 is:

$40,000 x (200/365) = $21,917

Overlapping years of income

If you are an attributable taxpayer and your income year is different from that of a non-resident trust estate, the trust estate's attributable income for the two income years which overlap your income year is apportioned using the number of days that fall within your current income year.

Example 4

Overlapping years of residency

Helen's current income year is 1 July 2004 to 30 June 2005. She is an attributable taxpayer in relation to XY trust estate. The trust estate's income years are 1 January 2004 to 31 December 2004 and 1 January 2005 to 31 December 2005. The attributable income of the trust estate is $30,000 for the 2004 income year and $40,000 for the 2005 income year.

The amount worked out for the trust estate's 2004 income year is:

$30,000 x (184/365) = $15,123

For the trust estate's 2005 income year, the amount is:

$40,000 x (181/365) = $19,835

Helen adds the amounts to give a total attributable income of $34,958 for her 2004-05 income year.

Partnerships and trusts

The attributable income from a trust estate is included in working out the net income of a partnership or a trust estate and is treated as having a foreign source.

Where a partner of a partnership or a beneficiary of a trust estate is an Australian resident for the whole income year, they are to include in their assessable income their share of the net income - including attributable income - of the partnership or trust estate.

Where a partner or beneficiary is a non-resident of Australia at all times during an income year, they would not include any attributable income of the partnership or trust estate in their assessable income.

Subsection 2: Working out your assessable income where you do not have sufficient information to work out attributable income

If you are unable to obtain the information necessary to work out the attributable income of a trust estate, you must include an amount worked out using the following formula in your assessable income.

The formula is to be used for each transfer of property or services you made to the trust estate that is subject to the transferor trust measures.

The amount to include in your assessable income is worked out by applying a deemed rate of return to the market value of the property or services you transferred to the trust estate. The market value is adjusted for this calculation to reflect deemed returns for previous periods. The deemed rate of return applicable to assessments for the income year commencing 1 July 2006 is 5% above the rate of interest that applies for that period under section 8AAD(2) of the Taxation Administration Act 1953. If there are two or more rates of interest for the income year, you use the weighted average of these rates for the income year.

Use the following formulas to determine the amount to include in your assessable income for transfers of property or services after 12 April 1989.

Transfers made after 12 April 1989

Amount to be included in assessable income

=

Adjusted value of the transfer

x

Weighted statutory interest rate plus 5%

The adjusted value for transfers made during the current income year is worked out as follows.

Adjusted value of the transfer

=

Market value, immediately before the transfer of property or services

x

Days after the transfer to the end of the income year days in income year

Example 5

Transfer during current income year

An attributable taxpayer transferred property worth $30,000 to a non-resident trust estate on 31 May 2007. There are 30 days between the transfer on 31 May and the end of the year - 30 June 2007.

The adjusted value is worked out as follows:

$30,000 x (30/365) = $2,465

If the transfer occurred before the taxpayer's current income year, the adjusted value of the transfer is the total of:

• the market value, immediately before the transfer, of the property or services transferred, and
• the total of the amounts that would have been included in the transferor's assessable income for that transfer in the income years preceding the taxpayer's current income year, if this method had been used in those years.

Where more than one transfer was made after 12 April 1989, the formula is applied separately to each transfer and then the relevant amounts are added together.

Transfers made before 12 April 1989

Use the following formula to determine the amount to include in your assessable income for transfers of property or services before 12 April 1989.

Amount to be included in assessable income

=

Adjusted net worth of the trust estate

x

Weighted statutory interest rate plus 5%

The adjusted net worth of a trust estate is its net worth adjusted for the deemed return on the property or services transferred before 12 April 1989.

The net worth of the trust estate is determined on 1 July 1990. Its net worth on that date is the market value of its assets at 1 July 1990, reduced by its liabilities on 1 July 1990.

To determine the adjusted net worth, the net worth is increased by the total of amounts that would be worked out in each previous income year commencing on or after 1 July 1990 using the above formula.

When using the formula method to work out the amount to include in your assessable income, if two or more taxpayers have transferred property or services to the trust estate, the Tax Office is empowered to provide relief along lines similar to those referred to in subsection 3.

Subsection 3: What happens if there is more than one transferor?

The assessable income of a transferor in relation to a non-resident trust estate will include the part of the attributable income of the trust estate relating to the period that the transferor was a resident of Australia. This can have the effect of subjecting more than one person to tax for the same income.

The Tax Office can reduce the amount included in your assessable income if there is more than one transferor. When determining the amount of the reduction, the Tax Office takes into account the amount of attributable income of the trust estate that relates to the property or services transferred to the trust estate and to any other matters that are considered relevant. You will need to apply to the Tax Office for the reduction.

Part 2: Interest charge for beneficiaries of non-resident trust estates

This part explains how distributions received by Australian residents from non-resident trusts are taxed under section 99B of the Act. It also explains when an interest charge will be payable on these distributions.

Summary of part 2

Section 1	Have you received an assessable distribution from a non-resident trust estate?
Section 2	Do you have to pay an interest charge?

S ection 1: Have you received an assessable distribution from a non-resident trust estate?

This section explains the tax treatment under section 99B of distributions made by a non-resident trust estate - whether or not the distribution was made out of income or gains which have previously been attributed to an attributable taxpayer.

Is the distribution assessable?

Under section 99B, distributions made by a non-resident trust estate to Australian resident beneficiaries are assessable in the hands of the beneficiaries, except in the following five cases:

1.	the distribution is capital of the trust estate - an amount derived by the trust estate which would have been subject to tax if it had been derived by a resident taxpayer will not be taken to represent capital
2.	the distribution is an amount that has been taxed or is liable to tax in the hands of the beneficiary under section 97 or in the hands of the trustee under sections 98, 99 or 99A
3.	the distribution paid to or applied for the benefit of a resident taxpayer - other than a company - represents an amount of attributable income of a non-resident trust estate that has previously been included in the assessable income of any taxpayer
4.	the distribution paid or applied for the benefit of a company represents an amount of attributable income of a non-resident trust estate that has previously been included in the assessable income of that same company. This exemption applies where the company is acting as a beneficiary, not as a trustee
5.	the distribution is from any amount that would not have been assessable income in the hands of a resident taxpayer - for example, exempt income or non-assessable non-exempt income. This would include an amount that, if it had been derived by a resident taxpayer, would have been not assessable under section 23AH.

Section 2: Do you have to pay an interest charge?

If you are an Australian resident beneficiary of a non-resident trust estate and section 99B includes a distribution of accumulated income from the non-resident trust estate in your assessable income, you may be liable to pay additional tax in the nature of an interest charge on the distribution.

The interest charge does not apply if the amount included in your assessable income was paid from profits that have previously been taxed on an accruals basis under the transferor trust measures.

The charge is also not applicable for distributions from a public unit trust unless it is a controlled foreign trust.

The interest charge may apply to a distribution of profits from a non-resident trust estate to the extent the distribution was made from profits that:

• are referable to eligible designated concession income derived in an income year when the trust was a resident of a listed country, or 
• were not subject to tax in a listed country and were derived in an income year when the trust was a resident of an unlisted country.

Working out the amount of the interest charge

The amount on which interest is payable is worked out using the following formula:

Amount on which interest is payable = (Distributed amount x Applicable rate of tax) - Foreign tax

Distributed amount

The distributed amount is the amount of the distribution that is included in your assessable income under section 99B. This amount is grossed up for any foreign tax you can claim on that share.

Applicable rate of tax

The applicable rate of tax for a company is the general rate of Australian tax imposed on companies for the income year in which the company receives a trust distribution. The general rate will apply irrespective of the actual rate of tax applicable to the company.

For a taxpayer other than a company, the applicable rate of tax is the maximum marginal rate that applies for the income year of the taxpayer in which the trust distribution is received. The maximum rate would apply irrespective of the actual marginal rate of tax applicable to the taxpayer.

Foreign tax credit

The foreign tax credit is the credit you can claim on the amount included in your assessable income for the distribution made by the non-resident trust.

Example 6

Unlisted country trust estate

During the 2004-05 income year, a resident individual received a distribution of $10,000 from an unlisted country trust estate. The entire amount was included in the taxpayer's assessable income under section 99B. The distribution was paid from $20,000 foreign income derived by the trust in the 1998-99 income year. The income was not subject to tax in a listed country and the trust paid foreign tax of $5,000.

Interest is payable on the distributed amount of $10,000 grossed up by the amount of foreign tax relating to the distributed amount - $3,333 - multiplied by the applicable rate of tax - 47% - less the amount of foreign tax credit.

($13,333 x 47%) - $3,333 = $2,934

Note: The foreign tax credit is worked out by allocating, on a pro rata basis, the foreign tax paid by the trust estate on its foreign income. The profits and income of the trust estate that were available for distribution were:

$20,000 - $5,000		$15,000
Amount of the distribution		$10,000
Foreign tax attributable to the distribution =
	$10,000 x $5,000 15,000	$3,333

Period over which the interest charge accrues

The interest charge accrues as follows:

• where the trust distribution is paid out of trust income or profits accumulated before 1990-91, the charge will accrue from the start of the beneficiary's 1990-91 income year
• where the trust distribution is paid out of trust income accumulated by the non-resident trust estate in the 1990-91 or a subsequent income year, the charge will accrue from the start of the beneficiary's next income year - that is, the income year first following the income year of the trust estate for which the income would have been included in the assessable income of the trust if the trust had been a resident trust estate.

The interest charge will cease to accrue on the last day of the income year in which the distributed amount is included in the assessable income of the beneficiary.

What interest rate applies?

The rate of interest that applies before 1 July 1994 is the rate applicable under section 10 of the Taxation (Interest on overpayments) Act 1983. The rate from 1 July 1994 until 30 June 1999 is the rate applying under section 214A of the ITAA 1936 less 4 percentage points. The rate from 1 July 1999 until 14 September 2006 is the rate applying under section 214A of the ITAA 1936. The rate from 14 September 2006 is the rate applying under section 8AAD of the Taxation Administration Act 1953.

Chapter 3: Taxation of foreign dividends and branch profits, and explaining the foreign tax credit system

This chapter explains the taxation treatment of foreign dividends and of branch profits derived by Australian companies. It also explains the rules for claiming a foreign tax credit.

Summary of chapter 3

Part 1	Taxation of foreign dividends
Part 2	Taxation of branch profits
Part 3	What credit can you claim for foreign tax?

Part 1: Taxation of foreign dividends

This part explains how dividends paid by a foreign company are taxed in Australia. This can occur in two ways:

• when a resident taxpayer is taxed on a dividend received from a non-resident company, or
• when an attributable taxpayer in relation to a controlled foreign company (CFC) or a controlled foreign trust (CFT) is liable to tax on the taxpayer's share of a dividend paid by an unlisted country CFC directly or indirectly to another CFC or CFT.

Summary of part 1

Section 1	How do you treat a dividend received from a non-resident company?
Section 2	What if a CFC receives a dividend from another CFC?
Section 3	When is a CFC deemed to have paid a dividend?

S ection 1: How do you treat a dividend received from a non-resident company?

This section sets out the basis for taxing dividends received by a resident from a non-resident company.

Non-portfolio dividends

Definition of non-portfolio dividends

The concept of a non-portfolio dividend is central to the scheme of taxation of foreign dividends. A dividend is a non-portfolio dividend if six conditions are met. These are:

• the dividend is paid to a company 
• the company receiving the dividend has a 10% or greater voting interest in the voting power of the company that paid the dividend 
• the voting power in a company is the maximum number of votes that can be cast on a poll at a general meeting of the company at which all matters that can be referred to such a meeting are decided 
• the shareholder is the beneficial owner of the shares that carry the required voting interest 
• the voting interest is held at the time the dividend is paid, and 
• there is no arrangement in force at that time by which any person is in a position - or may become in a position - to affect the voting right.

Non-portfolio dividends received from a foreign company

Non-portfolio dividends received by a resident company from a company that is a resident of a listed or unlisted country are non-assessable non-exempt income, because:

• they are paid out of profits of a CFC that have been previously attributed to the resident company under the accruals tax measures (section 23AI), and/or 
• they are received from a foreign company (section 23AJ).

Example 1

Non-portfolio dividend paid partly from profits taxed on an accruals basis

Resco, a resident company, wholly owns a CFC in a listed country. Attributable income of $10,000 from the CFC was included in Resco's assessable income for the 2004-05 income year.

The CFC then paid a non-portfolio dividend of $25,000 to Resco on 1 August 2005.

Resco can treat part of the non-portfolio dividend - $10,000 - as non-assessable non-exempt income under section 23AI, as it is a distribution out of previously attributed income.

The $15,000 balance of the non-portfolio dividend can be treated as non-assessable non-exempt income under section 23AJ.

Non-portfolio dividends received by a resident individual from a company that is a resident of a listed or unlisted country may also be treated as non-assessable non-exempt income if they are paid out of profits of a CFC that have been previously attributed to the resident individual under the accruals tax measures (section 23AI).

Distributions of attributed income - maintaining records to support a claim that an amount is not assessable

Attribution accounts

To be able to work out what distributions out of a CFC's attributed income are non-assessable non-exempt income, you will need to keep certain records called attribution accounts.

You must maintain an attribution account for:

• each CFC from which income is attributed to you. This account will contain a record of
  • income attributed to you from the CFC
  • income distributed to you by the CFC which is treated as distributed from attributed income
• each entity through which the income of that CFC is distributed to you. These entities may be
  • partnerships
  • trusts
  • companies that are not Part X Australian residents
• each foreign investment fund (FIF) where an amount of FIF income is included in the notional assessable income of the CFC
• each CFC that has changed residence from an unlisted country to Australia. Dividends paid by a company out of profits which were attributed to you before the company becoming a resident of Australia are non-assessable non-exempt income.

These accounts are used to keep track of profits that have been taxed on an accruals basis so that you determine what amounts are non-assessable non-exempt income when you receive a distribution from those profits.

Example 2

Attribution accounts

A resident company - Resco - owns all the share capital of a CFC that is a resident of an unlisted country. The CFC commenced business on 1 July 2004. For the 2004-05 income year, its only income was attributable income of $2,500. It paid no tax. On 1 August 2005, it paid a dividend of $2,500 to Resco.

Attribution credit:

Resco will open an attribution account for the CFC and credit it with $2,500 on 30 June 2005 because this amount was included at that time in Resco's assessable income under the CFC measures. The CFC is called an attribution account entity.

Attribution debit:

Resco will debit $2,500 to the attribution account for the CFC on 1 August 2005 because of the dividend paid by the CFC. The debit is referred to as an 'attribution debit'. The amount of the debit cannot be more than the credit balance in the account - called the 'attribution surplus' - at the time the debit is made. In this case, the debit could not be more than $2,500.

The dividend received by Resco is non-assessable non-exempt income to the extent the dividend gave rise to an attribution debit. In this case, Resco can claim the whole amount of the dividend as non-assessable non-exempt income in the 2005-06 income year. The effect is that Resco only pays tax on the CFC's income when it is attributed, and not again when it is distributed.

An attribution account maintained by you for a CFC is specific to you. This means that when you sell shares in a CFC, you cannot transfer the attribution account to the purchaser of the shares.

Tracing the path of distributions of attributed income

There are a number of ways you can receive amounts that were paid from profits that have previously been attributed to you. In general, these amounts will be distributed to you as a dividend. The dividend may be distributed to you directly, or indirectly through a chain of companies, partnerships, or trusts.

When are attribution account payments made?

To work out your exemption, you will need to know the date on which attribution account payments are taken to have been made.

The following table sets out:

• the types of attribution account payments that can occur
• the entities that are treated as making and receiving an attribution account payment
• the date on which the payment is taken to be made.

Type of attribution payment	Entity making payment	Entity receiving payment	Date payment made
Dividend	paying company	shareholder	on date dividend is paid
Partner's share in the net income of a partnership	partnership	partner	at the end of the income year of the partnership
Share of the net income of a trust estate equal to the beneficiary's present entitlement	trust	beneficiary	at the end of the income year of the trust
Whole or part of the net income of a trust estate is assessable to the trustees. sections 99 or 99A	trust	trustee	at the end of the income year of the trust
Other distribution of accumulated trust income	trust	beneficiary	income year in which the distribution was made

What accounting entries should you make?

As mentioned earlier, attribution accounts link distributions a CFC has made to you - either directly or through other entities - to the income of the CFC that has already been attributed to you. The link is made when you:

• debit the attribution account of the entity that makes the payment, and
• credit the account of the entity that receives the payment.

Continue this process down a chain of entities until you receive a distribution made by the CFC.

Example 3

Distribution of attributed income

A resident company - Resco - owns all of the shares of CFC1, which owns all of the shares of CFC2. The CFCs are residents of unlisted countries.

CFC2 commenced business on 1 July 1997 and for the 2004 income year CFC2 derived $100 which was attributed under the CFC measures. The company paid no tax on the attributed amount. On 1 August 2004 the company paid its first dividend of $100 to CFC1, which paid the dividend to Resco on the same day.

All the entities close accounts to 30 June 2005.

Attribution accounts CFC2
Debit		Credit
1 August 2004 dividend to CFC1	$100	30 June 2004 amount attributed to Resco	$100
CFC1
Debit		Credit
1 August 2004 dividend to Resco	$100	30 June 2004 amount attributed to CFC2	$100

As the $100 attributed from CFC2 to Resco on 30 June 2004 was included in Resco's 2004 assessable income, and as the distribution Resco received on 1 August 2004 is no more than the income already attributed, Resco will treat the dividend as non-assessable non-exempt income.

Proportionate interests in the CFC and in interposed entities

A resident taxpayer might hold only a proportion - that is, less than 100% - of the interests in a CFC. That interest may be held directly or indirectly through interests in other foreign entities.

If you hold an interest of less than 100% in a CFC, only a proportion of the attributable income of the CFC is included in your assessable income. The proportion you use depends on the interest - called the attribution percentage - you have in the CFC - see chapter 1.

When tracing a distribution made by a CFC through a chain of interposed entities to yourself, note any proportionate interests you have in any of these entities.

Your interest in the CFC - and in each interposed entity - is called your attribution account percentage. This interest may differ from your attribution percentage in an entity. The foreign entities in the chain along which the attributed income of the CFC is later distributed to you need not necessarily be controlled foreign entities.

If you have both direct and indirect attribution account interests in an entity, then your attribution account percentage in that entity is the sum of the interests as follows:

Attribution account percentage

=

direct attribution account interest

+

indirect account attribution interest

How do you work out your direct attribution account interest in an entity?

Your direct attribution account interest in an entity will depend on the type of entity it is.

If the entity is a foreign company, your direct attribution account interest in the company is the same as your direct attribution interest in that company.

If the entity is a partnership of which you are a partner, your direct attribution account interest is the percentage that you hold - and any percentage you are entitled to acquire - of either the partnership's profits or the partnership's property. If the two percentages differ, use the higher percentage as your direct attribution account interest.

Your interest in a partnership is measured at the end of the accounting period in which the dividend is distributed through the partnership to you. The date of the dividend payment is called the test time. You should assume that you held the same interest in the profits and property of the partnership throughout the accounting period that you held at the test time. When working out your interest in the profits, use the amount of profit for the whole of the period.

Example 4

Attribution account interest in a partnership

It is necessary to measure the direct attribution account interest of CFC 1 in the partnership in order to measure the attribution account percentage of the resident individual in the partnership when the dividend is paid.

If the entity is a trust of which you are a beneficiary, your interest in the trust is the percentage of either the income or property of the trust to which you are presently entitled - and any percentage you are entitled to acquire. If the two percentages differ, use the higher percentage as your attribution account interest.

As in the case of an interest in a partnership, your interest in a trust is measured at the end of the accounting period of the trust in which the dividend is distributed through the trust to you. The date of this payment is called the test time. You should assume that you held the same interest in the income or property of the trust throughout the accounting period as you held at the test time. When working out your interest in the income, use the amount of income earned for the whole period.

How do you work out your indirect attribution account interest in an entity?

Your attribution account percentage in an entity is the sum of your direct and indirect interests in that entity. To work out your indirect interest in an entity - entity B - which is held through another entity - entity A - multiply your direct interest in entity A by entity A's direct interest in entity B.

If there are more than two entities in a chain, continue the process of multiplication along the chain until you reach the entity in which you are measuring your indirect interest.

Example 5

Attribution account interest

In this case, the resident taxpayer's attribution account percentage in CFC2 is 61% - that is, the taxpayer has a direct attribution account interest of 25% plus an indirect attribution account interest of 36%.

Example 6

Direct and indirect attribution account percentage

The following example shows how to work out direct and indirect interests and the attribution account percentage in an entity.

A resident company owns 50% of the share capital of CFC1 and CFC1 owns 50% of the share capital of CFC2. The CFCs are residents of unlisted countries. CFC2 commenced business on 1 July 2004. For the 2004-05 financial year the only income of CFC2 was attributable income of $100. On 1 August 2005, CFC2 paid a dividend of $50 to CFC1.

The resident company's attribution percentage in CFC2 is 25% - that is, 50% of 50%. The resident company's share of the attributable income of the CFC is therefore $25 - that is, 25% of $100.

The dividend of $50 paid to CFC1 is an attribution account payment. When the dividend is paid to CFC1 it is necessary to measure how much of the dividend can be treated as a distribution of CFC2's previously attributed income. The amount is worked out by applying the attribution account percentage of the resident company in CFC1 to the dividend paid to CFC1.

The direct attribution account interests will be as follows:

Direct attribution account interest of the resident company in CFC1	= 50%
Direct attribution account interest of CFC1 in CFC2	= 50%

The indirect attribution account interest is obtained by multiplying the direct attribution interests along the chain. The indirect attribution account interest of the resident in CFC2 will be 25% (50% x 50%). Up to $25 of the dividend can therefore be treated as paid from previously attributed income.

Example 7

Attribution debit

A resident individual has a direct attribution account interest of 80% in CFC1. CFC1 has a direct attribution interest of 90% in CFC2. The CFCs are resident in unlisted countries.

CFC2 commenced business on 1 July 2004. For the 2005 income year, its only income was attributable income of $100. It paid no tax. On 1 August 2005 it distributed its 2005 income. On the same day, CFC1 distributed the full amount of the dividend it received from CFC2.

Attribution accounts CFC2
Debit		Credit
1 August 2005 dividend to CFC1 (note 2)	$72	30 June 2005 attributed income (note 1)	$72
CFC2
Debit		Credit
1 August 2005 dividend to Resco (note 4)	$72	30 June 2005 dividend from CFC2 (note 3)	$72

Note 1:

This represents CFC2's attributable income of $100 multiplied by the resident's attribution percentage in CFC2 - that is, 80% (interest of the resident in CFC1) x 90% (interest of CFC1 in CFC2) x $100 = $72.

Note 2:

This represents the resident's attribution account percentage in the dividend received by CFC1 - that is, 80% of the $90 dividend.

Note 3:

The resident's attribution account percentage in the dividend received by CFC1 - worked out as in note 2.

Note 4:

The dividend paid by CFC1 to the resident.

The dividend of $72 received by the resident is non-assessable non-exempt income to the extent of the attribution debit that arose when the dividend was paid. As this debit was also $72, the entire dividend is non-assessable non-exempt income.

When should you make a credit in an attribution account?

You must make a credit in an attribution account if you include an amount in your assessable income because:

• An amount of the CFC's income has been attributed to you - section 456. The credit amount will be the amount of the attributed income included in your assessable income under section 456 without any addition for foreign or Australian tax paid by the CFC on that income. You must enter the credit at the end of the CFC's statutory accounting period. Where a company is a CFC at the beginning of its statutory accounting period but ceases to exist during that period, the statutory accounting period is deemed to end immediately before the company ceases to exist. However, in this circumstance the credit arises at the beginning of the statutory account period
  
   
• An amount of FIF income is included in the attributable income of a CFC. In this case a credit arises in relation to the FIF equal to the amount included in your assessable income under section 456 that is referable to the FIF income. The credit that would otherwise arise for the CFC is reduced by the amount that arises for the FIF. If a FIF has an interest in another FIF and the calculation method applies to determine the FIF income of the first FIF, a credit will arise for the second FIF. The FIF income is based on the FIF income of the first FIF referable to the FIF income of the second FIF. In this case, the attribution credit for the first FIF is reduced by the credit that arises for the second FIF
  
   
• The CFC has both:
  • ceased to be a resident of an unlisted country
  • become a resident of a listed country or of Australia.

The amount of the credit will be the amount you included in your assessable income under section 457 without any addition for foreign or Australian tax the CFC paid on that amount. You must normally enter the credit at the time the CFC changed residence. You have the option to defer the credit, however, to the extent it relates to an amount included in attributable income under section 457 for an unrealised gain on a tainted asset.

The credit may be deferred until the CFC pays a dividend out of profits arising from the subsequent disposal of the asset.

You must also make a credit in an entity's attribution account if:

• that entity receives an attribution account payment from another entity, and
• the payment gives rise to an attribution debit for the paying entity.

The credit amount will be the same as the attribution debit. You must enter the credit on the date of the attribution account payment.

How are credits made when the taxpayer is an Australian partnership or Australian trust?

Only the taxpayer who is actually liable to tax on the attributed income of the CFC can obtain an exemption from tax for distributions of that income.

This means that if the income of a CFC is attributed to an Australian partnership or Australian trust, the credit you make in the CFC's account is for the partner of the partnership or for the trust beneficiary who is presently entitled to the trust income. If there is no such beneficiary, the credit arises for the trustee.

The credit does not normally arise for the partnership or trust itself. There is an exception where the trust is a corporate unit trust, a public trading trust, an approved deposit fund, an eligible superannuation fund or a pooled superannuation trust.

When should you make debits in attribution accounts?

You must make an attribution debit in an entity's attribution account if that entity makes an attribution account payment to either:

• an attributable taxpayer, or
• another attribution account entity.

There are, however, two rules you must observe. These are:

• you can only make a debit if there is an attribution surplus in the attribution account at the time the attribution account payment is made - that is, the account balance must be more than nil
• the debit cannot be more than the amount of the surplus in the account at the time.

What is the amount of the attribution debit?

There are, again, two rules to observe:

• if an entity makes an attribution account payment to a resident taxpayer, the debit is the same as the amount of the payment
• if the entity makes an attribution account payment to another entity, the debit will equal the resident taxpayer's attribution account percentage of the payment received by the second entity.

Dividends other than non-portfolio dividends

Portfolio dividends are generally taxable unless they are paid from profits taxed previously on an accruals basis. Portfolio dividends are dividends that do not qualify as non-portfolio dividends.

You must maintain an attribution account for each CFC from which income is attributed to you. An explanation of how these accounts are maintained was provided earlier in this part.

S ection 2: What if a CFC receives a dividend from another CFC?

Non-portfolio dividends paid by a foreign company to a CFC are non-assessable non-exempt income of the CFC. Therefore, such dividends cannot form part of the attributable income of the CFC in relation to which an attributable taxpayer may be assessable under section 456.

Section 3: When is a CFC deemed to have paid a dividend?

It is possible that a resident taxpayer with an interest in an unlisted country CFC may try to minimise Australian tax by arranging for the CFC to distribute benefits in a form other than dividends to its shareholders or their associates.

There are rules to prevent this form of tax avoidance in section 47A. These rules deem certain transfers and payments made by an unlisted country CFC to be dividends. These dividends are then taxed in the normal way.

For section 47A to apply, a CFC must provide a benefit to:

• a resident who is a shareholder or an associate of a shareholder of the CFC, or
• another CFC or CFT, directly or through other entities, where the first entity that received the dividend is a shareholder or an associate of a shareholder of the CFC.

When should you deem a dividend to have been paid by a CFC?

Types of benefits that are covered under section 47A

The following seven types of benefits provided by a CFC could be treated as dividends:

1.	the waiver by the CFC of a debt owed by another entity
2.	the grant by the CFC of a non-arm's length loan to another entity
3.	the grant by the CFC of a loan - whether at arm's length or not - to another entity to facilitate, directly or indirectly, the payment by that entity of a dividend that would be non-assessable non-exempt income
4.	the transfer by the CFC to another entity of property or services for no consideration, or for inadequate consideration
5.	a payment made by the CFC for allotment of shares in a company rights or options to acquire shares units in a unit trust, or rights or options to acquire units
6.	a payment made by the CFC in respect of calls on shares in another company
7.	the grant by the CFC of a loan - whether at arm's length or not - to another entity to facilitate a transaction of the type referred to in any of the above points.

Treat the fifth and sixth types of payments as dividends only if:

• a shareholder of the CFC - or shareholder's associate - holds any direct interest, or later acquires any direct interest, in any of the shares of the company in which the CFC acquired shares or in the unit trust in which the units were acquired, or
• the company - or unit trust - uses the proceeds of the issue to facilitate a transaction providing any of the above types of benefits.

Entities providing and receiving the benefit

For a benefit to be treated as a deemed dividend, the benefit must be provided by the CFC to a shareholder or an associate of a shareholder.

The benefit must be provided by either:

• an unlisted country CFC, or
• another entity under an arrangement with the CFC, where the CFC has transferred property or services in consideration for the benefit to
  • the other entity, or
  • any other entity.

These transfers of property or services are referred to as arrangement transfers.

The time the benefits are deemed to have been provided

The following table sets out some of the types of benefits provided by a CFC that are subject to section 47A, the time at which they are taken to be provided and the amount of the benefit.

Type of benefit	Time	Amount
Waiver of a debt	time the debt was waived	amount of the debt
Non-arm's length loan	time the loan was made	amount of the loan
Transfer of property for no consideration	time the property was transferred	market value at time of transfer
Transfer of property or services for a consideration less than market value	time the property or services were transferred	difference between the market value of the property or services and the consideration paid
Payment or transfer of property for the allotment of shares or units	time the payment or transfer was made	amount paid or market value of the property transferred
Benefit provided by another entity under an arrangement with the CFC - if there is one 'arrangement transfer'	time the CFC made the arrangement transfer	amount of the arrangement transfer or market value of arrangement transfer
Benefit provided by another entity under an arrangement with the CFC - if there are several arrangement transfers	time the agreement to make the arrangement transfers was entered into	total amount of the arrangement transfers or the total market value of the arrangement transfers

Working out the amount of the deemed dividend

The amount of a benefit that can be treated as a dividend paid by a CFC cannot be more than the CFC's profits at the time the benefit was provided.

In this context, profits does not mean distributable profits. 'Profits' in this situation means 'commercial profits' of either an income or capital nature that the company has at the time the benefit is provided. Work out these profits at the time the company provided the benefit.

If the CFC provided a benefit by transferring property or services at less than their market value, work out the CFC's profits at the time the benefit was provided as if the property or services were transferred for their full market value.

Effect of deeming a benefit to be a dividend

A deemed dividend paid to a resident taxpayer is generally treated the same as other dividend payments. For example, a deemed dividend that is a non-portfolio dividend paid by an unlisted country CFC to an Australian company is treated as non-assessable non-exempt income.

Disclosure of deemed dividends

You will be denied access to certain credits and concessions in relation to a section 47A deemed dividend if you:

• do not disclose the deemed dividend in your tax return, and 
• do not notify the Tax Office of the deemed dividend within one year of the end of the income year in which the dividend is deemed to have been paid.

The credits and concessions you lose are:

• any credit for foreign taxes you have paid on the dividend, and 
• any possibility that a part of the deemed dividend may qualify as non-assessable non-exempt income under section 23AI.

The deemed dividend will also not give rise to an attribution credit.

Other deemed dividends - section 108

Under section 108 of the Act, the Tax Office may treat as a dividend:

• an amount paid by a private company to a shareholder - or a shareholder's associate - by way of an advance or loan, or
• an amount paid or credited on behalf of, or for the individual benefit of, a shareholder or a shareholder's associate.

To deem these payments to be dividends, the Tax Office must be of the opinion that the payments and credits represent a distribution of profits.

Section 108 will not apply to an amount paid or credited after 2 June 1990 by an unlisted country CFC if that amount is deemed, under section 47A, to be a dividend.

Part 2: Taxation of branch profits

Foreign branch income of a resident company that is not assessable

Which resident companies qualify?

Two broad groups qualify to have certain branch profits treated as non-assessable non-exempt income. These are resident companies that either:

• carry on business through a permanent establishment - for example, a branch, or 
• are partners of a partnership or are presently entitled beneficiaries of a trust - and that partnership or trust carries on business through a permanent establishment.

Non-assessable non-exempt income treatment does not apply to resident taxpayers, other than companies, with foreign permanent establishments.

What is a permanent establishment?

A permanent establishment of an Australian resident company is a place through which the business of the company is carried on. The term 'permanent establishment' is defined in section 6 of the Act.

If the listed country is one with which Australia has a double taxation agreement, the meaning of the term permanent establishment is determined by the agreement.

Permanent establishments are referred to as branches in this part.

What income is non-assessable non-exempt?

Whether branch profits are treated as non-assessable non-exempt income depends on whether the branch is in a listed or unlisted country.

Non-assessable non-exempt income treatment

Branches in listed countries

In general, non-assessable non-exempt income treatment is available for income derived by a resident company through a branch in a listed country if:

• the income is from carrying on a business in the listed country, and 
• the branch satisfies an active income test.

Non-assessable non-exempt income treatment is not available for income derived through a branch in a listed country if:

• the branch does not satisfy the active income test, and 
• the income is both adjusted tainted income and eligible designated concession income.

You must test each item of income individually against these criteria to see if it is non-assessable non-exempt income.

Branches in unlisted countries

Non-assessable non-exempt income treatment is generally available for income derived by a resident company through a branch in an unlisted country if:

• the income is from carrying on a business in the unlisted country, and 
• the branch satisfies an active income test.

Non-assessable non-exempt income treatment is not available for income derived through a branch in an unlisted country if:

• the branch does not satisfy the active income test, and 
• the income is adjusted tainted income.

The same concept of adjusted tainted income is used for this purpose as that used in determining the attributable income of a CFC. The following modifications apply, however, in determining the adjusted tainted income of a branch:

• the passive income of a branch conducting life assurance activities is not reduced under subsection 446(2) 
• a branch and its Australian head office are treated as separate legal entities for the purpose of determining whether the branch has derived tainted sales income, and 
• branches of Australian financial institutions (AFIs) are provided with an exemption for banking income broadly consistent with the exclusion from accruals taxation available under the CFC measures for AFI subsidiaries.

An active income test concession is provided to allow branches in both listed and unlisted countries to derive up to 5% of gross turnover as tainted income and still obtain non-assessable non-exempt income treatment under section 23AH for income amounts.

Broadly, this active income test is the same as that for CFCs. The following modifications are made to the test for branches:

• the only amounts taken into account are those derived through the branch 
• the income year of the company with the branch is used for the purposes of the test 
• those conditions of the active income test relating to the existence and residency of a CFC do not apply because they are not relevant to branches, and 
• the modifications to the adjusted tainted income of a branch referred to above also apply in determining the adjusted tainted income of the branch for the purposes of the active income test.

What branch capital gains are non-assessable non-exempt income?

Permanent establishment in a listed country

A resident company includes in the calculation of its net capital gains any capital gain or capital loss as a result of a CGT event happening in relation to a tainted asset that is used in carrying on a business through a permanent establishment in a listed country if:

• the gain is also eligible designated concession income, or 
• there is a loss but there would have been eligible designated concession income if the loss had instead been a gain.

Permanent establishment in an unlisted country

A resident company includes in the calculation of its net capital gains any capital gain or capital loss arising as a result of a CGT event happening in relation to a tainted asset that is used in carrying on a business through a permanent establishment in an unlisted country.

Effect of non-assessable non-exempt income treatment on a resident company's deductions, losses and foreign tax credits

A deduction is not allowable for:

• outgoings or expenses connected to branch income and gains that are non-assessable non-exempt income 
• capital losses on the disposal of a branch asset if, had there been a profit on the disposal, the profit would have been non-assessable non-exempt income.

Current year losses or carried forward losses of a resident company are not reduced by branch income or gains that are non-assessable non-exempt income.

Foreign tax credits are not allowed for foreign taxes paid on branch income that is non-assessable non-exempt income.

Part 3: What credit can you claim for foreign tax?

This part explains the general foreign tax credit rules for Australian residents and the rules that apply specifically to Australian companies.

Summary of part 3

Section 1	Foreign tax credits available to all Australian residents
Section 2	Credits available only to Australian resident companies

The general rule is that:

• if you are an Australian resident for taxation purposes, you may be entitled to a credit for the foreign tax you have paid, and 
• if you are an Australian company, you may also be entitled to a credit for foreign underlying tax paid by a CFC on your share of assessable, attributable income.

Section 1: Foreign tax credits available to all Australian residents

Partnerships

Partners can claim a credit for their share of foreign tax paid on foreign income derived through a partnership. The amount of foreign income and the credit for foreign tax paid should be included in each partner's return.

Trusts

Where an amount of trust income is included in the return of a beneficiary, that beneficiary may claim a credit for the foreign tax paid by the trust.

The trust's income must be divided into the appropriate classes of income. The beneficiary's share of the trust income must also be divided into the appropriate classes of income.

The trustee has to show in the trust tax return the amount of foreign income and attributed foreign income.

The trustee is also required to show in the trust tax return the sum of the foreign tax paid and deemed paid in respect of the part of the net income to which beneficiaries are presently entitled (and assessable) and the foreign tax credit allowable in respect of the part of the net income on which the trustee is assessable.

On the distribution statement, the trustee has to show the portion of foreign tax that relates to the share of foreign income to which each beneficiary is presently entitled (and assessable).

The trustee also has to show the amount of foreign income included in net income on which the trustee is assessable and the foreign tax credit allowable in respect of that income.

A credit is not available for foreign tax paid in respect of income that is attributed to a transferor as a result of the transferor trust measures. For details on the transferor trust measures, see chapter 2.

Unit trusts

The foreign income of a unit trust is treated in the same manner as foreign income of any other trust.

For which types of foreign tax is a credit allowable?

Creditable foreign taxes include:

• foreign tax equivalent in nature to Australian income tax - for example, a tax on net income or capital gains
• foreign withholding tax similar to Australian withholding tax on interest and dividends
• foreign taxes listed in Australia's double taxation agreements.

Taxation Ruling IT 2507 - Income tax: foreign tax credit system - foreign taxes eligible for credit against Australian income tax provides a list of creditable taxes. The list in the ruling is not exhaustive. If you wish to seek credit for foreign taxes not identified in the list you should ask for a ruling from the Tax Office, using the format set out in Taxation Ruling IT 2507.

You are not allowed a credit for penalties, fines, interest, and unitary or credit absorption taxes.

Credit for notional tax forgone by developing countries

Certain double taxation agreements with developing countries provide for 'tax sparing'. Tax sparing preserves taxation incentives which are provided by a treaty partner to promote economic development. If tax sparing applies to a tax incentive, you can claim a credit for tax forgone by a treaty partner under the incentive. The double taxation agreements list the taxes for which tax sparing is provided.

Foreign tax credit allowable for a dividend paid from income which has previously been attributed

Dividends derived by all Australian residents for tax purposes (including individuals) from profits that have been taxed on an accruals basis are non-assessable non-exempt income. A credit is available for foreign tax paid by the Australian resident on these dividends even though they are not assessable.

Credit for foreign taxes paid after your assessment

You are allowed a credit only for foreign tax which you have actually paid or which you are deemed to have paid. You will need to request that a determination of your foreign tax credit entitlement be made or amended if you wish to claim a credit for foreign tax paid after your original assessment. Your assessment may also need to be amended to gross up your foreign income for any additional foreign tax credit you claim.

For further information please see Taxation Ruling IT 2529 - Income tax: foreign tax credit system - foreign tax credit determinations. Note that the three-year period for claiming a credit referred to in the ruling has since been extended to four years.

Refunds of foreign tax

You cannot claim a credit for foreign tax refunded to you or to another person. Nor can you claim a credit where any other benefit is provided as a result of the payment of the foreign tax.

Two types of benefits will not result in the denial of a tax credit:

• a general benefit which arises as a result of the payment of foreign tax - a general benefit is a benefit not directly linked with the payment of foreign tax 
• a benefit which is a reduction of a tax liability.

A credit will therefore not be denied solely because a country provides an imputation credit, a rebate of tax or a foreign tax credit for the foreign tax.

Evidence of foreign tax paid

The following documents will be acceptable as evidence of payment of foreign tax:

• a notice of assessment and receipt for the tax paid 
• a statement from a foreign tax authority setting out particulars normally recorded on a notice of assessment and receipt for payment 
• a certificate for deduction of withholding tax issued by the person who pays the interest, dividends or any other income that is subject to a deduction of foreign tax.

In all cases, retain the original documents because the Tax Office may need to see them at a later date.

If the documentary evidence is in a foreign language, you will need a translation of the documents.

For further information see Taxation Ruling IT 2527 - Income tax: foreign tax credit system -.procedures in relation to claims for foreign tax paid.

Working out your foreign tax credits

You must work out your foreign tax credit entitlement separately for each class of foreign income. This is called quarantining. Your foreign tax credit for each class cannot be more than the Australian tax applicable to that class of your taxable foreign income.

Note: The government announced in the May 2005 Budget that the requirement to quarantine foreign tax credits will be removed, with effect for credits arising in income years first commencing on or after the relevant legislation receives Royal Assent.

What are the classes of foreign income?

Foreign income is divided into four classes for the purpose of allowing a foreign tax credit:

• passive income
• offshore banking income
• certain lump sum payments from foreign non-complying superannuation funds
• other income.

What is passive income?

Passive income includes dividends, interest, annuities, rental income, royalties, amounts received for the assignment of a patent, copyright, capital gains, passive commodity gains and amounts included in assessable income under the CFC, FIF or transferor trust measures.

Capital gains

An assessable gain or profit of a capital nature is deemed to be foreign income for working out a foreign tax credit if it is derived from a source in a foreign country. Capital gains are included in the 'passive' class of foreign income.

For further details on credits for foreign tax paid on capital gains, please see Taxation Ruling IT 2562 - Income tax: foreign tax credit system - interaction of foreign tax credit provisions with capital gains and capital losses provisions of part IIIA.

What is offshore banking income?

Offshore banking income includes:

• interest, fees, commissions or similar income derived from offshore banking transfers 
• dividends paid by a company out of profits derived from offshore banking transfers.

What are lump sum payments from foreign non-complying superannuation funds?

These lump sum payments included in assessable income under section 27CAA are treated as a separate class of income.

What is other income?

Other income is income that does not belong to any of the other classes of income. For instance, it would include income from commercial activities, salary or wages and most pensions.

Working out the amount of assessable foreign income for creditable foreign taxes

Your assessable foreign income for each class is 'grossed up' by the amount of foreign tax credit you can claim for that class of income. A company must also include an amount equal to any credit allowable for foreign underlying tax.

Example 8

Creditable foreign taxes

A company resident in New Zealand pays a dividend of $100 to an Australian resident individual. As New Zealand deducts $15 withholding tax, the taxpayer actually received $85. The taxpayer's assessable foreign income for that dividend will be $100 - that is, the amount of the dividend before the payment of withholding tax.

What deductions are allowable?

You may claim the following deductions for each class of assessable foreign income:

• expenses directly related to that class of foreign income
• other deductions relating to that class of foreign income
• a share of the apportionable deductions - that is, deductions that cannot be related to a particular type of income - for example, gifts
• unused quarantined foreign losses from prior years
• prior year domestic losses, if you make an election to offset those losses against a class of foreign income
• if your allowable deductions for the current year are more than your domestic source income, the amount by which those deductions are more than your domestic source income.

See appendix 2 of this guide and Taxation Ruling IT 2446 - Income tax: foreign tax credit system: allowable deductions referable to foreign income for more information on allowable deductions.

Conversion of foreign amounts

All foreign income, deductions and foreign tax paid must be expressed in Australian dollars, (unless a functional currency election is in effect). The following table shows how to convert certain amounts.

Type of foreign income	Convert foreign income to Australian dollars at*:
Foreign employment income, pensions and annuities	the exchange rate that applied at the time you were paid or had the income applied or dealt with on your behalf or as you directed (such as into a bank account), even if no amount was remitted to Australia.
Foreign business income, dividends, interest and other income	the exchange rate that applied at the earlier of when you received or derived the income (or, for statutory income, the earlier of when you received the income or were first required to include it in your assessable income)
Foreign capital gains	the exchange rate that applied at the time of the transaction or event for each transaction or event involving an amount of foreign currency (or the market value of property expressed in a foreign currency). For example, if an amount included in the cost base of an asset is expressed in foreign currency, convert that amount into Australian currency on the date that the expenditure was incurred. Convert capital proceeds on the date of the CGT event.
Foreign tax paid	the exchange rate that applied at the time the foreign tax was paid.
Foreign deductions (other than capital allowances)	the exchange rate applicable at the earlier of when the amount was paid or when it became deductible.
Depreciating assets	the cost of a depreciating asset is to be converted at the exchange rate that applied at the earlier of when you begin to hold the asset or satisfied your obligations for it (that is, when you paid for it). This converted cost is then used to calculate the capital allowance deductible.

At the time of publication, the tax law did not permit the use of average rates. However, there is a regulation-making power under which methods of conversion other than those set out above may be specified. For more information on converting foreign amounts to Australian dollars see the Tax Office fact sheet (Foreign exchange (forex): The general translation rule) available on our website.

Working out your Australian tax payable

The foreign tax credit you are allowed for each class of foreign income is limited to the Australian tax payable on that class of income. Therefore, you must first work out the Australian tax payable.

To do this, multiply your average rate of Australian tax by your adjusted net foreign income. Deduct any rebates which apply to that income - apart from a rebate under an Act fixing the rates of income tax or under an Act imposing income tax. Expressed as a formula, the calculation is as follows:

ATP = AR X ANFI

ATP	= Australian tax payable
AR	= average rate of Australian tax
ANFI	= adjusted net foreign income

How is the average rate of Australian tax worked out?

The average rate of Australian tax (AR) is worked out by dividing the gross tax on your taxable income less certain rebates by your taxable income. Expressed as a formula, the calculation is as follows:

AR

=

gross tax + Medicare levy +Medicare levy surcharge - qualifying tax offsets taxable income

For this calculation, deduct concessional, zone or overseas service rebates.

What is adjusted net foreign income?

Adjusted net foreign income (ANFI) is your net foreign income adjusted for apportionable deductions. Apportionable deductions are deductions of a concessional nature that do not relate directly to income producing activities - for example, gifts.

Net foreign income is your gross assessable foreign income less:

• allowable deductions relating exclusively to your foreign income 
• any domestic loss carried forward that you have elected to use against your foreign income 
• deductions allowed as being appropriately related to your foreign income.

How is adjusted net foreign income determined?

Your adjusted net foreign income is determined as follows:

• If your net foreign income exceeds the sum of your taxable income plus apportionable deductions, your adjusted net foreign income will equal your taxable income 
• If your net foreign income consists of two or more classes of income - that is, quarantining applies - and your combined net foreign income from all classes is more than the sum of your taxable income plus apportionable deductions, your ANFI for each class will equal your taxable income. ANFI is divided proportionately, as shown in example 9, into:
  • passive income
  • offshore banking income
  • lump sum payments assessable under section 27CAA, and
  • other income 
• In any other case, your adjusted net foreign income is your net foreign income multiplied by your taxable income divided by the total of your taxable income and apportionable deductions. Expressed as a formula, the calculation is as follows:

ANFI =

NFI x

TI      TI + AD

ANFI	= adjusted net foreign income
NFI	= net foreign income of a class
TI	= taxable income
AD	= apportionable deductions

Example 9

Working out adjusted net foreign income

An individual has:	$
Domestic source income	7,000
Allowable deductions from domestic source income	10,000
net passive foreign income	2,000
net other foreign income	5,000
apportionable deductions	100
Taxable income ($7,000 - $10,000 + $2,000 + $5,000 - $100)	3,900
Taxable income plus apportionable deductions ($3,900 + $100)	4,000
Net foreign income ($2,000 + $5,000)	7,000

The net foreign income is greater than the taxable income plus apportionable deductions. Therefore, the adjusted net foreign income is taken to equal taxable income. As there are two classes of foreign income, it is necessary to apportion the adjusted net foreign income into the relevant classes - that is, passive income and other income.

The taxpayer's passive income is 2/7 and other income 5/7 of the combined net foreign income. The adjusted net foreign income for each class is as follows:

$
ANFI - passive income (2/7 of the taxable income of $3,900)	1,114
ANFI - other income (5/7 of the taxable income of $3,900)	2,786

Example 10

Working out adjusted net foreign income

An individual has:	$
Domestic income	7,000
passive foreign income	2,000
other foreign income	5,000
apportionable deductions	100

First work out ANFI for passive income:

The taxpayer's taxable income ($7,000 + $2,000 + $5,000 - $100)			13,900
ANFI - passive income
2,000 x	13,900      (13,900+100)		1,986

then work out ANFI for other income:

ANFI - other income
5,000 x	13,900      (13,900+100)		4,964

Working out the credit

Your foreign tax credit entitlement for a class of foreign income is the lesser of:

• the creditable foreign tax which you have paid on that class of income, and 
• the Australian tax payable on that class of income, worked out using the above procedure.

The following example shows the steps to use to work out your foreign tax credit.

Example 11

Working out the foreign tax credit

An individual has:	$
Domestic income	7,000
passive income - net of foreign tax	2,000
foreign tax paid - passive income	200
other income - net of foreign tax	5,000
foreign tax paid - other income	1,000
apportionable deductions	100

Step 1

Work out taxable income.

Gross up foreign income by the amount of creditable foreign tax paid:

	$
Assessable passive income (2,000 + 200)	2,200
Assessable other income (5,000 + 1,000)	6,000
Taxable income (7,000 + 2200 + 6,000 - 100)	15,100

Step 2

Work out the average rate (AR) of Australian tax

AR	=	gross tax + Medicare levy + Medicare levy surcharge - qualifying tax offsets taxable income
Gross tax on 15,100			1,365.00
Medicare levy			0
Medicare levy surcharge			0
Qualifying tax offsets			0
AR	=	1,365 + 0 + 0 - 0 15,100	0.09

Step 3

Work out adjusted net foreign income.

For the passive class of income:

ANFI (passive income)   =	NFI x TI TI + AD
NFI - net foreign passive income		2,200
TI - taxable income		15,100
AD - apportionable deductions		100
ANFI (passive income) =	2,200 x 15,100  15,100 + 100	2,185.53

For the other class of income:

NFI - net foreign passive income		6,000
TI - taxable income		15,100
AD - apportionable deductions		100
ANFI (other income)    =	6,000 x 15,100  15,100 + 100	5,960.53

Step 4

Work out the Australian tax payable (ATP) on each class of income.

For foreign passive income:

ATP = AR x ANFI (passive income)

ATP = 0.09 x 2,185.53 = 197.57

For foreign other income:

ATP = AR x ANFI (other income)

ATP = 0.09 x 5,960.53 = 536.45

Step 5

Determine allowable foreign tax credit for each class of foreign income.

$
Foreign tax paid on passive income	200
Australian tax payable	197.57
As the Australian tax payable is less than the foreign tax, the foreign tax credit is	197.57
Foreign tax paid on other income	1,000
Australian tax payable	536.45

As the foreign tax paid is more than the Australian tax payable, the foreign tax credit is limited to the extent of the Australian tax payable on the foreign income - that is, $536.45.

The excess foreign tax credit can be carried forward for offset in later years against Australian tax payable on the same class of foreign income.

Carry forward of excess foreign tax credits

You will have an excess foreign tax credit for an income year if the amount of foreign tax you have paid is more than the Australian tax payable on that class of foreign income.

You may carry forward an excess foreign tax credit that arises in an income year for a class of foreign income for five years immediately following that income year. Your excess credit for a class of income may only be used where there is a credit shortfall for the same class of income in a later year. A credit shortfall will arise where the credit allowed for a class of foreign income for an income year is less than the Australian tax payable on that class of foreign income.

If you have incurred a loss for a class of foreign income, you cannot claim a tax credit in that year because the Australian tax payable on that class of income is nil. You may, however, carry forward the foreign tax credit relating to that class of income to subsequent years.

Section 2: Credits available only to Australian resident companies

Australian resident companies are entitled to a foreign tax credit as worked out in section 1. In addition, in some circumstances a company - other than a company in the capacity of trustee - may be:

• entitled to a credit for tax paid by a CFC on amounts attributed to the Australian company 
• not assessable on foreign non-portfolio dividends- see part 1 of this chapter, or 
• not assessable on foreign income derived through a foreign branch - see part 2 of this chapter.

Credits available to resident companies for direct and underlying tax

• An Australian resident company which receives a dividend from a related company may be entitled to a credit for the direct foreign tax - for example, withholding tax - on the dividend received.

This credit will generally be available only if the dividend is included in assessable income. The only exception is where a dividend is received from a related foreign company and is treated as paid out of income previously attributed to the resident company under the accruals tax system. A tax credit can be claimed for both the direct foreign tax and underlying tax on these non-assessable non-exempt dividends.

• An Australian resident company that is related to a CFC may also be entitled to a foreign tax credit in relation to the assessable, attributable income.

Related foreign companies

Under section 160AFB, an Australian company is treated as related to any number of linked foreign companies provided that:

• each company in the chain - starting with the Australian company - has at least a 10% voting interest in the company in the tier below it, and
• the Australian company has a direct or indirect interest of at least 5% in the voting shares of each foreign company that is a member of the chain.

A chain of related companies cannot include a trust or partnership - that is, the chain will be broken by the interposition of a trust or partnership.

Example 12

Related foreign companies

Australian company A has a 50% voting interest in foreign company B, which in turn has a 10% voting interest in foreign company C. Both B and C will be treated as related to A.

Step 1

Are the companies members of the same group?

Yes - each company in the chain, starting with the Australian company, has at least a 10% voting interest in the company in the tier below it.

Step 2

Does company A have a 5% or more direct or indirect voting interest?

Yes - company A has a voting interest of 50% (50% x 100%) in company B and a voting interest of 5% (50% x 10%) in company C.

Step 3

Are the companies related?

Yes - both tests are satisfied for both companies B and C. Therefore, they are both related to company A.

Credits available to resident companies for attributed income

Working out the foreign tax credit when income is attributed

If a company is related to a CFC at the end of the CFC's statutory accounting period and the assessable income of the company includes a share of the attributable income of the CFC - see chapter 1 - the company is allowed a credit for an amount of tax equal to its attribution percentage of the CFC's notional allowable deductions for taxes paid.

A CFC can claim a notional deduction for foreign or Australian tax paid by the CFC on amounts included in the CFC's notional assessable income.

Example 13

Foreign tax credit for attributed income

An Australian resident company AustCo has a 60% interest in a CFC, ForCo, a resident of an unlisted country

ForCo

Profits from a foreign branch (not attributable income)	$2,000
Tax paid in the foreign country on the foreign branch income	$600
Income derived in an unlisted country (attributable income)	$10,000
Tax paid in the unlisted country on all income (including foreign branch income)	$1,200

AustCo is deemed to have paid the following amount of tax on the attributed income:

Attribution percentage 60%
Tax paid on attributed income (10,000/12,000) x 1,200	$1,000
Tax deemed paid by AustCo (1,000/60) x 100	$600

AustCo must gross up its assessable foreign income by this amount. AustCo can claim a foreign tax credit for $600.

Credits where dividends are deemed to have been paid to an Australian resident taxpayer

If a benefit provided by a CFC to a resident taxpayer is deemed to be a dividend paid to that taxpayer under section 47A, credit for foreign tax paid will be allowed only if:

• the amount of the deemed dividend is included in the taxpayer's assessable income in their return lodged in the year of the distribution, or would be so included apart from section 23AI, or 
• the taxpayer notifies the Tax Office, in writing, within 12 months after the end of the income year in which the benefit was provided.

Credits where income is attributed due to a change in residence of a CFC

A resident company is allowed a credit for foreign tax paid by a CFC if an amount of income is attributed to it because the CFC changed its residence from an unlisted country to a listed country or to Australia. However, the credit is available only if the resident company is related to the CFC at the time of the change of residence - see section 160AFCB. The company is allowed a credit for the foreign tax and the Australian tax paid by the CFC on the attributed amount.

Working out a foreign tax credit when a dividend is paid from income that was previously attributed to an Australian resident company

A dividend paid out of income previously attributed to an Australian resident is non-assessable non-exempt income - see part 1 of this chapter. In addition, an Australian resident company is allowed a credit for foreign tax - including foreign underlying tax - paid on a non-portfolio dividend from attributed income. The credit for the underlying tax is limited to the amount by which the section 23AI part of the dividend would have been greater if no foreign tax had been paid.

The formula to work out the foreign tax for which a credit is due when a dividend is received from previously attributed income is:

	FTP = (EP x DT) + (AEP x UT) - AT
FTP	foreign tax paid on previously attributed income for which a credit is now allowable
EP	percentage of the payment which is non-assessable non-exempt because the income has been previously attributed
DT	amount of foreign tax which the taxpayer is taken to have paid, and to have been personally liable for, in relation to the attribution account payment
AEP	percentage that would be EP if the attribution account payment were reduced by any part of the payment that is non-assessable non-exempt income under section 23AJ
UT	where the taxpayer is a company and the attribution account payment is a non-portfolio dividend, UT equals the amount by which the section 23AI non-assessable non-exempt part would have been greater if an attribution account entity had not paid foreign tax on its profits
AT	amount of the attributed tax account debit arising from the payment of the dividend that is equal to or less than AEP x UT

Example 14

Credit for foreign taxes on a dividend paid from profits attributed to an Australian company

Austco has a wholly owned subsidiary, Subco, in an unlisted country. Subco had distributable profits of $10,000 on which it paid foreign tax of $1,000. These profits have previously been attributed to Austco.

On 1 August 2004, Subco paid a dividend of $10,000 to Austco. The unlisted country levied dividend withholding tax at a rate of 10%.

The dividend received by Austco is non-assessable non-exempt income because it was paid from previously attributed income. At the attribution stage, Austco would have received a credit of $1,000 for foreign tax paid.

Even though the dividend is not included in Austco's assessable income, a foreign tax credit is available for withholding tax and underlying tax relating to the dividend. This is because the profits out of which the dividend was paid were attributed to Austco and taxed in Australia.

The method by which this credit is granted is as follows:

Work out the foreign tax credit for dividend withholding tax and for underlying tax on the dividend as though the dividend was paid from income that had not been attributed to Austco.

The formula for working out the foreign tax credit Austco can claim is as follows:

FTP = (EP x DT) + (AEP x UT) - AT

This formula can be broken down as follows:

EP x DT	= percentage of the dividend paid from previously attributed income x tax paid on the dividend
	= 100% x $1,000 (dividend withholding tax)
	= $1,000
AEP x UT	= adjusted exempt percentage of the dividend x underlying tax paid on the dividend (excluding tax paid under a foreign accruals regime)
	= 100% x $1,000
	= $1,000
AT	= tax for which a credit was allowed when the income of the unlisted country CFC was attributed to Austco
	= $1,000
FTP	= foreign tax paid on previously attributed income for which a credit is now allowable
	= $1,000 + $1,000 - $1,000
	= $1,000

In this example, when the income of $10,000 was attributed to Austco and a credit was given for $1,000, Austco would have opened accounts as follows:

Attribution account for Subco		Attributed tax account for Subco
Attributed income	$10,000	Tax credited	$1,000

When the dividend is received, Austco will debit the attribution account $10,000 and treat the dividend as non-assessable non-exempt income. It will also debit $1,000 to the attributed tax account.

This debit is the amount referred to as AT. Attributed tax accounts are dealt with below.

Evidence of underlying tax paid

Your company should retain full particulars of the material on which its underlying tax credit has been worked out. Obtain a statement from the company which paid the dividend, certifying the amount of tax paid on the distributable profits out of which the dividend was paid. When underlying tax paid is traced down a chain of related foreign companies, such details will be required for each company in the chain.

Attribution accounts relevant to foreign tax credits for companies

Attributed tax accounts

What is the purpose of attributed tax accounts?

A resident company can claim a foreign tax credit for dividend withholding tax and certain underlying taxes on a non-assessable non-exempt dividend paid from previously attributed profits.

The credit is initially worked out on the basis that no foreign tax credit was allowed at the time the profits were attributable. The foreign tax credit worked out in this way is then reduced by the credit allowed at the time the attributable income of the CFC was included in the assessable income of the resident company. The attributed tax accounts trace the foreign tax credit allowed at the attribution stage so that this reduction can be made.

Who should maintain attributed tax accounts?

Attributed tax accounts are to be maintained by a resident company to which the attributable income of a related foreign company has been attributed under the CFC measures. Other taxpayers need not maintain these accounts.

Attributed tax account credits

An attributed tax account credit can arise in relation to a CFC where an amount is attributed under any of the following sections:

• section 160AFCA where the attribution of income of the CFC arises under section 456, or
• section 160AFCB where the attribution of income of the CFC on a change of residence arises under section 457.

Each time a credit is made to an attribution account - as explained in part 1 of this chapter - a corresponding credit must be made to an attributed tax account for the entity for which the attribution account is operated.

Attributed tax account debits

An attributed tax account debit must be made each time the attribution account entity pays a dividend. The attributed tax account debit is worked out using the following formula.

Attributed tax account debit

=

attribution debit   attribution surplus

x

attributed tax account surplus

In order to claim a credit for foreign tax paid on income that was previously attributed, the amount of attributed tax account debit must be verifiable. The attributed tax accounts for each of the relevant entities in respect of the taxpayer claiming the credit must be available or a credit will not be allowed.

Example 15

Credit for foreign tax reduced by credits previously allowed

Forco1 is a resident of an unlisted country and is a wholly owned subsidiary of Ausco. Forco1 derived income of $16,500 from sources in its country of residence, all of which is attributed to Ausco, and pays foreign tax of $1,500.

Forco1 has distributable profits of $15,000 ($16,500 - $1,500).

It pays a dividend of $10,000 to Ausco in the following year, from which withholding tax of $1,500 was deducted - the net dividend is therefore $8,500.

The dividend Ausco received is non-assessable non-exempt income. Ausco is also entitled to a credit for foreign tax paid on the income which was previously attributed. The credit is reduced, however, to the extent a credit for foreign tax was allowed when the income was attributed to Ausco. The non-assessable non-exempt income is not included in working out the Australian tax payable on the foreign income and thus does not increase Ausco's foreign tax credit limit.

The credit is worked out as follows:

	FTP = (EP x DT) + (AEP x UT) - AT
FTP	foreign tax paid on previously attributed income for which a credit is now allowable
EP	percentage of the payment which is non-assessable non-exempt income because the income has been previously attributed. In this example EP is 100% as the dividend is paid from previously attributed income.
DT	amount of foreign tax which the taxpayer is taken to have paid, and to have been personally liable for, in relation to the attribution account payment - in this example, $1,500 withholding tax.
AEP	percentage that would be EP if the attribution account payment were reduced by any amount of that payment which is non-assessable non-exempt income under section 23AJ.
UT	foreign underlying tax credit allowable for the attribution account payment, other than CFC-type foreign tax - that is, foreign tax arising from laws that generally correspond with Australia's accruals measures
	(Dividend/Distributable Profits) x tax on distributable profits
	($10,000/$15,000) x $1,500				$1,000
AT	amount of the attributed tax account debit for the tax credit previously allowed on the attributed income that is equal to or less than AEP x UT. The attributed tax account debit is equal to
	Attribution debit  attribution surplus	X	attributed tax account surplus
	($10,000/$15,000) x $1,500			$1,000

Note: When $15,000 income was attributed to Ausco, Ausco would have credited an attribution account for Forco1 with $15,000. It would also have credited $1,500 tax to the attributed tax account for Forco1 - that is, tax for which a credit was allowed at the attributed stage. When the dividend was paid by Forco, this would have remained as an attribution surplus. The dividend of $10,000 is an attribution account payment.

FTP

$1,500 + $1,000 - $1,000

$1,500

Transfer of excess foreign tax credits

A resident company that is a member of a company group may transfer an excess credit to another member of the group if:

• there is 100% common ownership within the group
• there is a shortfall of foreign tax credits in a class of income for the company receiving the transfer
• the shortfall is for income of the same class as that for which there is an excess foreign tax credit in the company transferring the credit
• both companies retain a record of the transfer showing the credit transferred.

The transfer of an excess credit may include credit carried forward from five previous years as well as the current year. The transfer operates only for the following two classes of income:

• passive income 
• other income - excluding offshore banking income.

A company can transfer only an amount equal to the credit shortfall for that class of income - that is, the transferee cannot carry forward the transferred amount.

Note: The grouping provisions for wholly owned groups were removed as part of the introduction of the consolidations tax regime. From July 1 2003 unconsolidated wholly owned groups are generally no longer able to transfer excess foreign tax credits between entities in the group.

Carry forward of foreign losses by companies

An overall foreign loss for a class of assessable foreign income may be carried forward indefinitely and used to reduce a future year's assessable foreign income for that class.

Losses incurred by a company before the 1990 income year can be carried forward only for seven years and are therefore no longer available.

Chapter 4: Proving your assessment

Overview

You will need to keep receipts, invoices, ledgers and other accounting records of a company or trust that relate to the calculation of its notional assessable income.

In addition, you will need to keep details of your interest in the company, the interests of your associates and how you worked out the amount you included in your assessable income.

This chapter also explains the substantiation requirements of the active income test, the use of offshore information notices and the keeping of records of elections.

Summary of chapter 4

Subject
Part 1	Part 2	Part 3	Part 4
Record keeping for attributable taxpayers	Passing the active income test	Can the Tax Office ask you to get information from overseas?	What records of elections must you keep?
Applies to
Attributable taxpayer	Attributable taxpayer	Taxpayer	CFC or taxpayer
Action
Keep records of attributable amount	Supply accounts and accounting information to Tax Office	Produce documents	Make election
If not done
Prosecution $3,000	No offence if not supplied - but CFC fails active income test	Evidentiary sanction - no documents can be used in evidence without Commissioner's consent	Treated as if no election made

Part 1: Record keeping for attributable taxpayers

Who needs to keep records?

You must keep records (as set out below) if you are an attributable taxpayer of:

• a controlled foreign company (CFC), or
• a non-resident trust estate.

An attributable taxpayer is a person who:

• alone, or together with associates, has an interest in a CFC or a controlled foreign trust of at least 10%, or
• is a transferor of a non-resident trust, or
• is one of the actual controllers of the CFC with an interest of at least 1%.

Record keeping for a controlled foreign company

You will need to keep records of your interest in a CFC and of its financial transactions if you meet both of the following conditions:

• you are an attributable taxpayer of a controlled CFC at the end of the company's statutory accounting period, and
• the company has attributable income.

You must keep records of:

• the circumstances that resulted in your becoming an attributable taxpayer for the statutory accounting period of the CFC
• how you worked out your direct and indirect attribution interest and your attribution percentage for the CFC's statutory accounting period, and
• how you worked out the amount you included in your assessable income.

You must keep records of your calculations even if they show that no amount is to be included in your assessable income.

Specific record keeping requirements called attribution accounts apply where an amount is included in an attributable taxpayer's assessable income because a CFC paid a dividend to another controlled entity.

Record keeping for non-resident trusts

You are required to keep records for a non-resident trust estate if you are an attributable taxpayer in relation to the trust estate.

You must keep records of:

• how you became an attributable taxpayer for the non-resident trust
• how you worked out the trust's attributable income for each of the trust's income years which falls wholly or partly within your year of income and
• how you worked out the amount included in your assessable income.

If you cannot get the information necessary to work out the trust's attributable income, the amount to be included in your assessable income is worked out using a formula - see chapter 2.

You must keep these records even if no amount is to be included in your assessable income.

Record keeping for partnerships

A partnership needs to keep records if it is an attributable taxpayer.

A partnership may be an attributable taxpayer if it:

• has transferred property or services to a non-resident trust, or
• is an attributable taxpayer in relation to a controlled foreign company.

It is important to note that each individual partner could be liable if the partnership breaches the record keeping requirements.

What happens if the records are not kept?

You may be prosecuted and fined up to $3,300 by a court if you fail to keep adequate records.

You will not be convicted if you can show that any of the following statutory defences apply to you:

• you did not know that you had an obligation to keep the records and you had no reason to suspect the obligation existed - if you suspected that the record keeping requirements applied to you, you won't be able to claim the benefit of this exemption, or 
• you did not know that you had an obligation to keep the records even after you had made all reasonable efforts to find out whether there was an obligation to keep the records, or 
• if you have made all reasonable efforts to obtain the information required but simply can't get it - if you had actual or effective control of the company or another entity which has the information, you would not be considered to have made a reasonable effort unless you used your position of influence in a genuine attempt to get the information required.

If you wish to take advantage of any of these exemptions, you will have to prove that reasonable grounds existed or that you made reasonable efforts. To do this, you will need to keep a record of the efforts you have made to get the information.

How should the records be kept and for how long?

If you are required to keep records you must:

• Keep written records in English. If records are not in a written form - for example, if kept on magnetic tape or computer disc - you must be able to get access to them readily to convert them into written English.
• Keep records in a way that allows your tax liability to be readily determined.
• Keep the records either for five years after they were prepared or obtained, or for five years after the completion of the transactions to which those records relate, whichever is the later.

The records need not necessarily be kept in Australia but they must be kept by the attributable taxpayer. This means that you, as the attributable taxpayer, are responsible for the custody and control of the records. If an Australian company allows its CFC to physically keep records outside Australia, the Australian company must maintain custody and control of those records.

Are you required to keep attribution accounts?

There is no legal requirement for an attributable taxpayer of a CFC to keep attribution accounts. However, taxpayers are required to keep records that explain all transactions and other acts relevant to, among other statutes, the Income Tax Assessment Act 1936 and Income Tax Assessment Act 1997. A taxpayer must, therefore, maintain adequate records to substantiate their tax treatment of dividends paid by a CFC (for example, as non-assessable non-exempt income, as conduit foreign income etc).

Part 2: Passing the active income test

Who has to prove they have passed the test?

A person who is an attributable taxpayer for a CFC and who claims that the CFC has passed the active income test may be asked to prove that the CFC has passed the test.

How do you prove that you meet the requirements?

If you wish to claim a tax exemption on the basis that a CFC has passed the active income test - see chapter 1 - you must:

• ensure that the company has kept accounts for the statutory accounting period. These accounts must
  • be prepared in accordance with commercially accepted accounting principles
  • give a true and fair view of the financial position of the company 
• ensure that the CFC will assist by providing accounting and other information which the Tax Office may ask you to supply.

Commissioner's notice to an attributable taxpayer

If you prepared a tax return claiming the active income test exemption, the Tax Office may give you a Commissioner's notice asking you to prove that the test has been passed. In this notice, the Commissioner will ask you to get copies of accounts and other documents from the CFC.

If the documents are not in English, you will have to translate them and give the documents and translations to the Tax Office within the allotted time.

The Tax Office will allow you a minimum of 90 days to produce these documents. If you want extra time you must apply in writing to the Tax Office before the time runs out. The Tax Office may agree to extend the time allowed.

Extra time will be granted if the Tax Office has not answered your request before the time allowed runs out.

Taxpayer's notice to a CFC

To get the documents from the CFC, you may send the CFC a written request - a Taxpayer's notice.

General accounting records

So that you can get the documents that the Tax Office may ask for, the Tax Office requires the company to keep general accounting records. These may be kept either in Australia or elsewhere.

These records include:

• invoices
• receipts
• orders for the payment of money
• bills of exchange
• cheques
• promissory notes
• vouchers, and
• other documents of prime entry.

The records would also include any working papers and other documents necessary to explain how the accounts are made up.

General accounting records should also correctly record and explain the matters, transactions, acts and operations that are relevant to the preparation of the CFC's recognised accounts for the statutory accounting period. These records must be available if the Tax Office needs to check the matters and figures in the accounts.

Recognised accounts

Recognised accounts are accounts kept for the statutory accounting period that are:

• prepared in accordance with commercially accepted accounting principles, and
• give a true and fair view of the financial position of the company.

These accounts include:

• journals
• ledgers
• profit and loss accounts
• balance sheets
• other financial statements, and
• reports and notes attached to, or intended to be read with, the accounts.

The company must keep both the recognised accounts and the general accounting records for five years starting from the end of the company's statutory accounting period.

If you ask the CFC for copies of documents included in or drawn from the recognised accounts and general accounting records, the CFC must give them to you - but you must allow the CFC at least 60 days to comply.

In your taxpayer's notice to the CFC, you may ask the CFC for any or all of the following:

• copies of the recognised accounts of the company for the statutory accounting period
• copies of the general accounting records of the company for the statutory accounting period
• copies of a document showing how the tainted income ratio of the company was worked out for the statutory accounting period. This document will summarise information drawn from the recognised accounts and general accounts to work out the tainted income ratio.

CFC's notice to its partnership

If the CFC is a partner, the CFC may ask the partnership for information it needs to answer the taxpayer's notice. The CFC's notice must allow the partnership at least 30 days to comply.

Minimum time for notice to produce documents

Tax Office	- - >	Taxpayer	- - >	CFC	- - >	Partnership
		minimum 90 days notice		minimum 60 days		minimum 30 days

What will happen if you don't fully meet the substantiation requirements of the active income test?

If you refuse or fail to comply with the Commissioner's notice, you have not committed an offence: you will not be prosecuted if the CFC or a partnership involving a CFC does not keep the records listed above.

However, if you fail to meet the substantiation requirements because you have not produced the documents requested, the CFC will be treated as if it has failed the active income test. As a result, the Tax Office may amend your tax assessment to include attributable income. You may also have to pay the shortfall interest charge and a penalty in respect of the tax that would have been paid if you had treated the active income test as applying to you.

Part 3: Can the Tax Office ask you to get information from overseas?

Offshore information notices

If we believe that information relevant to your assessment is held overseas, you may receive a written 'offshore information notice' asking you to get the information for us.

The Tax Office will give you 90 days to supply the information. You may ask for extra time by applying in writing to a tax office before the time runs out. If you are allowed extra time, you will be advised of this in writing. The extra time will be given if the Tax Office has not answered your request before the time allowed runs out.

The Tax Office may change the notice in writing to:

• reduce its scope, or
• correct a clerical error or obvious mistake.

The Tax Office may also issue you with another notice or vary or withdraw a notice.

If you fail or refuse to comply with an offshore information notice, you have not committed an offence.

However, if you don't give the Tax Office all of the information asked for, you could be stopped from using it as evidence in proceedings in which you dispute the assessment.

The Tax Office may consent to information being admissible in proceedings where the Commissioner considers that its use would not be misleading.

Part 4: What records of elections must you keep?

If you have been required to do any of the following, you are required to keep a record of having done so:

• make an election
• make a declaration
• make a selection, or
• give certain notices to the Tax Office when working out your attributable income.

You are also required to keep a record of a CFC's election if you are claiming the benefit made either:

• under capital gains tax rollover provisions, or
• due to a change in its statutory accounting period.

Note that the CFC may make an election to vary its statutory accounting period from the standard period ending 30 June.

Chapter 5: Consolidation (consolidated income tax treatment for groups of entities)

Overview

For income tax purposes, consolidation is optional. However, if the head company of a wholly owned resident group decides to consolidate, all its wholly owned Australian resident group entities must become members of that consolidated group.

Once a group has consolidated the choice becomes irrevocable and the consolidated group it is treated as a single entity for income tax purposes.

Where a foreign company, either directly or through its wholly owned foreign group, has multiple entry points of investment into Australia through Australian resident companies, special multiple entry consolidated (MEC) group rules will apply to the wholly owned resident companies and their wholly owned resident subsidiary entities.

The following losses and tax attributes can generally be brought into a consolidated group and used by the group's head company:

• losses (including foreign losses)
• franking credits
• excess foreign tax credits
• attribution account surpluses, and
• attribution tax account surpluses.

Note: This chapter simply provides a summary of the provisions that relate to the application of income attributed from controlled foreign companies (CFCs) and included in the assessable income of a head company of a consolidated group. Detailed information on the operation of consolidation is contained in the Consolidation reference manual (NAT 6835) - see also More information below.

Excess foreign tax credits

The consolidation regime through the single entity rule ensures that only the head company of a consolidated group includes the foreign income of the consolidated group (or MEC group) in its assessable income.

Once consolidated, the head company can use foreign tax credits to reduce its Australian tax liabilities to avoid double taxation. The head company can claim foreign tax credit against Australian tax payable on this income - using its own foreign tax credits, foreign tax credits of subsidiaries and excess foreign tax credits transferred into the group from joining entities.

Generally, the head company can only use the transferred excess credits at the end of the income year after the year the entity joined the group, unless the member joins the group at the start of the head company's income year.

However, transitional rules apply to groups that consolidated within the transitional period of 1 July 2002 to 30 June 2004, to allow such groups ('transitional groups') to use a joining entity's excess foreign tax credits in the joining year, provided certain conditions are met.

Where an entity pays foreign tax on foreign income while it is a member of a consolidated group, the head company will be assessed on the foreign income and will be taken to have paid and been personally liable for the foreign tax paid by the subsidiary member.

Where an entity leaves a consolidated group (or MEC group) it cannot take any excess foreign tax credits with it and it is only required to include foreign income in its assessable income for the period it is not a member of any consolidated group.

The provisions relating to consolidation and excess foreign tax credits became effective on 1 July 2002.

Attribution account surpluses and attributed tax account surpluses

Under consolidation, only the head company can operate attribution accounts and attributed tax accounts for the purposes of the CFC measures.

Subsidiary members transfer the pre-consolidation balances of their attribution accounts and attributed tax accounts to the head company, on formation or when the entity joins the consolidated group (or MEC group), to facilitate its use of any pre-consolidation surpluses during consolidation.

Once the account balances have been transferred to the head company of a consolidated group, the attribution and attributed tax accounts of subsidiary members become inoperative during the period the entity is a member of the consolidated group (or MEC group). However, the attribution and attributed tax account surpluses are transferred to the head company so that, to the extent that income had previously been attributed to the member entity, subsequent distributions of income from an attribution entity - for example, a CFC, that had previously been attributed to the member entity - are not assessed to the head company.

When a entity with an interest in a CFC leaves a group, a proportion of the attribution and attributed tax account surpluses that the head company has in relation to the interests in the CFC that leave the group with the leaving company will be transferred to the leaving entity.

Elections

Where entities become subsidiary members of a consolidated group and where members leave a group subdivisions 715-J and 715-K of the ITAA 1997 deal with elections made in relation to Part X (the CFC measures) of the ITAA 1936.

Subdivision 715-J ensures that the entry history rule does not adversely affect the head company's ability to make elections in relation to its interests in CFCs. Similarly, subdivision 715-K ensures the exit history rule does not adversely affect the leaving entity's ability to make elections in relation to its interests in CFCs that it takes with it on exit.

More information

The Consolidation reference manual provides detailed information on the operation of consolidation, including its practical impacts for business. It is available on the Tax Office website.

If you have any queries, phone the Business Infoline on 13 28 66.

You can email any enquiries to consolidation@ato.gov.au

Appendixes

Appendix 1 - Foreign income regulations

Introduction

Part 8A of the Income Tax Regulations 1936, and associated schedules, deal with the taxation of foreign source income. The provisions:

• declare those countries that are to be treated as listed, unlisted and section 404 countries
• provide that Swiss cantonal taxes are treated as if they were federal taxes
• contain rules for determining whether an amount is designated concession income
• specify when the capital gains are taken to have been subject to tax for the purpose of the CFC measures, the transferor trust measures, and the non-assessable non-exempt treatment of foreign branches of Australian companies, and
• set out the accruals taxation laws of other countries that are recognised for the purpose of providing relief from double accruals taxation.

Listed countries

The Regulations specify those countries that are listed countries and section 404 countries. These lists are reproduced in attachment A.

Designated concession income

Normally, amounts derived in a listed country are exempt from accruals taxation. This exemption does not apply to amounts of 'eligible designated concession income'. Broadly, an amount may be designated concession income if it is concessionally taxed in a listed country.

What kinds of income or profits are specified as designated concession income?

Income or profits are designated concession income only if:

• they are of a kind specified in the Regulations in relation to a particular listed country, and
• they are derived by an entity that is of a type specified in the Regulations.

The full list of designated concession income has been reproduced in attachment B.

Capital gains deemed subject to tax

Capital gains are defined (except for the purposes of regulation 152D) in the Regulations as gains or profits of a capital nature that arise from the sale or disposal of all or part of a CGT asset, other than gains or profits that would not be capital gains but for a provision of Australian tax law.

Regulation 152D provides that a capital gain (defined as gains or profits or other amounts of a capital nature) will be taken to be subject to tax in a listed country where the gain would have been subject to tax except for the operation of a rollover relief provision of a kind specified in the Regulations contained in the tax law of that country. Broadly, the types of rollover relief relate to the types of rollover relief provisions available for capital gains tax purposes under Australian tax law.

Attachment A

Listed countries

Canada

France

Germany

Japan

New Zealand

United Kingdom of Great Britain and Northern Ireland

United States of America

Section 404 countries

Argentina	Myanmar
Austria	Netherlands
Bangladesh	New Caledonia
Belgium	Norway
Brazil	Pakistan
Brunei	Papua New Guinea
Bulgaria	Philippines
China (except the Hong Kong Special Administrative Region)	Poland
Czech Republic	Portugal
Denmark	Romania
Fiji	Russian Federation
Finland	Saudi Arabia
French Polynesia	Singapore
Greece	Slovak Republic
Hungary	Solomon Islands
Iceland	South Africa
India	Spain
Indonesia	Sri Lanka
Iran	Sweden
Ireland	Switzerland
Israel	Taiwan
Italy	Thailand
Kenya	Tokelau
Kiribati	Tonga
Korea, Republic of	Turkey
Luxembourg	Tuvalu
Malaysia	Vietnam
Malta	Western Samoa
Mexico	Zimbabwe

Attachment B

Items of designated concession income

Country	Entity	Kind of income or profit	Feature of income or profit under tax law of the country
Canada	An entity that operates in Canada as an international banking centre under Canadian law	All passive income and tainted services income	Not subject to tax in Canada in a tax accounting period
Canada	A company that operates in Canada as an investment corporation or as a mutual fund corporation under Canadian tax law	All passive income	Not taxed in Canada at the normal company tax rate
France	A company that operates in France as a société d'investissement à capital variable (SICAV) under French law	All passive income	Not subject to tax in France in a tax accounting period
France	A company that is treated as a resident of France for the purposes of the tax law of France, and that has elected to be taxed on a tonnage basis rather than on income or profits	All income or profits	Not used as the basis for establishing the amount of taxable income, taxable profits, tax base or tax liability of the entity under the tax law of France
Germany	A company that is treated as a resident of Germany for the purposes of the tax law of Germany	All passive income in carrying on business outside Germany at or through a permanent establishment	Not subject to tax in Germany in a tax accounting period
Germany	Either: (a) a company that is treated as a resident of Germany for the purposes of the tax law of Germany, or (b) any company in carrying on business in Germany at or through a permanent establishment of the company in Germany	Capital gains in respect of shares in companies	Not taxed in Germany at the normal company tax rate
Germany	A company that is treated as a resident of Germany for the purposes of the tax law of Germany, and that has elected to be taxed on a tonnage basis rather than on income or profits	All income or profits	Not used as the basis for establishing the amount of taxable income, taxable profits, tax base or tax liability of the entity under the tax law of Germany
Japan	An entity in carrying on business in Japan at or through a permanent establishment of the entity in that country	All income or profits derived from Japanese governmental bonds	Not subject to tax in Japan in a tax accounting period
New Zealand	Either: (a) a company that is treated as a resident of New Zealand for the purposes of the tax law of New Zealand, or (b) any entity in carrying on business in New Zealand at or through a permanent establishment of the entity in New Zealand	Capital gains in respect of tainted assets	Not subject to tax in New Zealand in a tax accounting period
United Kingdom	A company that is treated as a resident of the United Kingdom for the purposes of the tax law of the United Kingdom	Capital gains in respect of shares in companies where: (a) the CGT assets of the companies; or (b) the underlying CGT assets of the companies held through one of more non-resident entities that are associates include CGT assets having the necessary connection with Australia	Not subject to tax in the United Kingdom in a tax accounting period as a consequence of the substantial shareholding exemption available under the tax law of the United Kingdom
United Kingdom	A company that is treated as a resident of the United Kingdom for the purposes of the tax law of the United Kingdom, and that has elected to be taxed on a tonnage basis rather than on income or profits	All income or profits	Not used as the basis for establishing the amount of taxable income, taxable profits, tax base or tax liability of the entity under the tax law of the United Kingdom
United Kingdom	An entity that operates in the United Kingdom as a open-ended investment company under the law of the United Kingdom	All passive income	Not taxed in the United Kingdom at the normal company tax rate
United States	Either: (a) a company that is treated as a resident of the United States for the purposes of the tax law of the United States, or (b) any entity in carrying on business in the United States at or through a permanent establishment of the entity in that country	All income or profits derived from tax-exempt governmental bonds	Not subject to tax in the United States in a tax accounting period
United States	An entity that operates in the United States as a regulated investment company under the tax law of the United States	All passive income	Not taxed in the United States at the normal company tax rate

Appendix 2 - Accruals taxation on the change of residence of a CFC from an unlisted country to a listed country or to Australia

The attributable taxpayers in relation to a CFC are taxed under section 457 on the amount that relates to the period until the change of residence. Non-portfolio dividends received by the CFC during the period are not included.

Change of residence of a CFC from an unlisted country to Australia

If a CFC changes residence from an unlisted country to Australia, a resident taxpayer who is an attributable taxpayer of the CFC is taxable on the taxpayer's attribution percentage of the adjusted distributable profits of the CFC. The amount of the distributable profits that is taxable to a resident taxpayer includes the adjusted tainted income of the CFC (excluding non-portfolio dividends) less any expenses relating to that adjusted tainted income.

Example 1

AustCo owns 75% of CFC1, a CFC that is resident in an unlisted country CFC1 becomes a resident of Australia on 30 September 2006. CFC1 has a statutory accounting period of 1 July-30 June. For the period 1 July - 30 September CFC1 earned the following amounts of income:

Portfolio dividends	$10,000
Non-portfolio dividends	$15,000
Tainted interest income	$12,000
Tainted services income	$23,000
	$60,000

CFC1's adjusted tainted income is $45,000. It incurs expenses of $5,000 in earning the adjusted tainted income.

CFC1's adjusted distributable profits are $40,000.

Therefore the amount attributable to AustCo under section 457 is 75% x $40,000 = $30,000.

Change of residence of a CFC from an unlisted country to a listed country

If a CFC changes residence from an unlisted country to a listed country, a resident attributable taxpayer has to include in assessable income a share of the adjusted distributable profits of the CFC.

The amount to be included is worked out in the same way as the amount that arises where an unlisted country CFC becomes a resident of Australia. However, a further adjustment is made to the CFC's distributable profits. The CFC is treated as having disposed of all of its tainted assets for their market value at the time it changed residence. Accordingly, the distributable profits also include a net profit arising on the deemed disposal of those assets.

Example 2

AustCo owns 75% of CFC2, a CFC that is resident in an unlisted country. CFC2 becomes a resident of a listed country on 30 September 2006. CFC2 has a statutory accounting period of 1 July-30 June. For the period 1 July - 30 September CFC2 earned the following amounts of income:

Portfolio dividends	$10,000
Non-portfolio dividends	$15,000
Tainted interest income	$12,000
Tainted services income	$23,000
	$60,000

CFC2's adjusted tainted income is $45,000. It incurs expenses of $5,000 in earning the adjusted tainted income. The net profit (deemed) arising on CFC2's tainted assets at 30 September is $100,000.

CFC2's adjusted distributable profits are $140,000.

Therefore the amount attributable to AustCo under section 457 is 75% x $140,000 = $105,000.

Treatment of residence changes arising from changes to the lists of countries

If an unlisted country CFC is treated as having changed residence to a listed country as a result of the unlisted country becoming listed, section 457 will not apply to this type of change in residence.

Appendix 3 - Summaries and worksheets

Overview

Section 1 of this appendix contains the following summary sheets that may be useful when preparing your tax return:

Summary sheet 1	attributed income
Summary sheet 2	working out your share of the attributable income of a CFC
Summary sheet 3	active income test.

Section 1 also contains the following worksheets:

• worksheet 1 - working out your control and attribution percentages
• worksheet 2 - working out the tainted income ratio for a CFC
• worksheet 3 - working out amounts from partnerships to be included in the tainted income ratio
• worksheet 4 - working out the attributable income of a CFC.

Section 2 contains a summary sheet for the transferor trust measures. Section 3 contains a summary sheet for working out the amount of foreign dividend income to include in your assessable income.

The summaries and worksheets are intended as guides only and may not cover all the qualifications and conditions contained in the law that may apply to a particular case.

Last Modified: Monday, 2 July 2007

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ATO references:
NO NAT 1840