House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 7 - Foreign dividend accounts and other international rules

Outline of chapter

7.1 This chapter explains technical amendments that:

•

provide for the transfer of an FDA balance from a company that becomes a member of a consolidated group to the head company of the group;

•

phase out the transfer of an FDA surplus between members of a wholly-owned group by the payment of unfranked dividends consisting of an FDA declaration amount;

•

extend the benefits of the OBU concessions contained in Division 9A of Part III to a consolidated or MEC group;

•

deal with elections made under Parts X and XI where entities become subsidiary members of a consolidated or MEC group and where entities leave a group;

•

ensure the calculation of FIF income in Subdivisions 717-D and 717-E of the ITAA 1997 is correctly determined for a consolidated or MEC group and for a leaving company;

•

ensure that the payment of an amount of foreign tax is not counted twice in calculating foreign tax credits; and

•

deal with the grouping of an Australian bank branch of a foreign bank (foreign bank branch) and a head company/single resident company for thin capitalisation purposes.

7.2 In this chapter, a reference to a consolidated group should be read as including a reference to a MEC group and references to provisions discussed in paragraphs are references to provisions contained in the ITAA 1936, unless otherwise stated.

Context of reform

7.3 With the introduction of the new consolidation regime, a number of technical amendments in the areas mentioned in paragraph 7.1 have to be made to ensure that those international provisions apply appropriately to consolidated groups. Amendments are also needed to remove a grouping rule contained in the FDA provisions.

Summary of new law

Foreign dividend accounts

7.4 The new law will enable a head company of a consolidated group to operate a single FDA by pooling the FDA balances transferred to it at the joining time. The head company can then utilise the FDA surplus of the group to pay non-resident shareholders of the group unfranked dividends free from DWT. In this chapter, the term FDA dividend is used to refer to an unfranked dividend that consists of a FDA declaration amount, unless otherwise stated.

7.5 The new law will also phase out the ability of members in a wholly-owned group to transfer a proportion of a FDA surplus by paying another member of the group a FDA dividend.

7.6 A company that ceases to be a subsidiary member of a consolidated group cannot take a FDA balance with it on exit.

7.7 The amendments also make clear that in the case of a MEC group it is the provisional head company of the group at any time that operates the FDA and makes FDA declarations for dividends. There is also a provision to transfer the FDA balance when there is a change in the provisional head company.

Offshore banking units

7.8 The law will deem the head company of a consolidated group to be an OBU where a subsidiary member of the group is a gazetted OBU. The head company will only be deemed to be an OBU, however, for the period in which there is at least one subsidiary member that is a gazetted OBU.

Technical amendments affecting Parts X and XI and FTCs

7.9 New rules ensure that the entry history rule in Part 3-90 of the ITAA 1997 does not adversely affect the head company's ability to make elections in relation to its interests in CFCs, FIFs and FLPs. Similarly, they ensure the exit history rule in Part 3-90 does not adversely affect the leaving entity's ability to make elections in relation to interests in CFCs, FIFs and FLPs that the leaving entity takes with it on exit.

7.10 The new rules ensure the interaction between the entry history rule and the calculation of FIF income under Part 3-90 of the ITAA 1997 does not result in double taxation of an amount of FIF income. There are similar rules to prevent the double taxation of an amount of FIF income because of the interaction between the exit history rule and the calculation of FIF income when a company leaves a consolidated group.

7.11 There will be no double counting of an amount of foreign tax paid when a group company transfers excess foreign tax credits to another member of the group when a period of an income year is treated as though it were an income year.

Thin capitalisation

7.12 Amendments to Subdivision 820-FB of the ITAA 1997 will:

•

subject to certain conditions, allow a single company that is a potential member of a MEC group to join with a foreign bank branch for thin capitalisation purposes; and

•

clarify the rules by which the same choice is available to a head company.

Detailed explanation of new law

FDA measures

7.13 The current FDA measure in Subdivision B of Division 11A of Part III was introduced to enable certain foreign source dividends paid to a resident company to be paid to non-resident shareholders free from DWT. The exemption from DWT is provided where a resident company pays an unfranked dividend that consists of an FDA declaration amount. The FDA declaration amount is calculated by taking into account the FDA surplus available at the beginning of the day. The FDA surplus is essentially the balance in the FDA of a company after the debits in that account are offset against the credits.

7.14 The new rules for consolidation will modify the operation of the FDA measure so as to allow a head company of a consolidated group to credit and debit its FDA where those credits and debits would have otherwise arisen for a subsidiary member of the group. The head company will also be able to make FDA declarations in relation to the dividends paid by any member of the group if the FDA is in surplus. [Schedule 9, item 1, Subdivision 717-J]

Transfer of the FDA balance

A company joining a consolidated group

7.15 A company that becomes a member of a consolidated group will have to determine the FDA balance to be transferred to the head company at the joining time. The FDA balance that will be transferred is either the FDA surplus or deficit (which is the excess of FDA debits over FDA credits) immediately before the joining time. [Schedule 9, item 1, section 717-510]

7.16 The joining company will be required to determine the balance in its FDA just before the joining time (referred to as the balance time) so that all the necessary adjustments, including an adjustment for an FDA debit that arises at the end of the income year, are made to that account before that company transfers the balance to the head company. The transfer of the FDA balance will be effective for the head company at the joining time, rather than at the balance time, because the joining company will not be a subsidiary member of the group before the joining time. However, as the joining time immediately follows the balance time there will be no entries made to the joining company's FDA between the balance time and the joining time.

7.17 Where the joining company's FDA is in surplus immediately before the joining time, a debit equal to the FDA surplus will arise in the FDA of the joining company at the balance time [Schedule 9, item 1, paragraph 717-510(2)(a)] . A corresponding credit equal to the FDA surplus of the joining company at the balance time will arise in the FDA of the head company at the joining time [Schedule 9, item 1, paragraph 717-510(2)(b)] .

7.18 Where the joining company's FDA is in deficit immediately before the joining time, the FDA debit balance is transferred to the head company at the joining time. The transfer of the deficit balance is effected by crediting the joining company's FDA for that amount at the balance time and entering a corresponding debit in the head company's FDA at the joining time. [Schedule 9, item 1, subsection 717-510(3)]

7.19 Once the joining company has transferred the FDA balance to the head company, the head company will operate a single FDA by pooling all the FDA balances of the subsidiary members with any it had itself.

FDA debit for an Australian taxable dividend amount

7.20 Under the current law, an FDA debit for an Australian taxable dividend amount can arise when a resident company receives non-portfolio dividends in respect of which it is entitled to a foreign tax credit (paragraph 128TB(1)(d)). The debit is because of any Australian tax paid on the dividend and to avoid a double benefit arising for the same income from the FDA system and imputation. The amount of the FDA debit is determined according to the formula in subsection 128TB(2) and will give rise to an FDA debit in that company's FDA at the end of its income year.

7.21 Where a company joins a consolidated group part-way through its income year and an FDA debit under paragraph 128TB(1)(d) would have arisen for that company at the end of its income year, the joining company is to make an FDA debit just before the balance time. The joining company can treat the period from the start of its income year in which it joins the group until immediately before the balance time as though that period were an income year. [Schedule 9, item 1, subsection 717-510(4)]

7.22 Where a company ceased to be a subsidiary member of a consolidated group but subsequently rejoined the group or joined another consolidated group, any such FDA debit is calculated only for the last non-membership period ending immediately before the balance time. [Schedule 9, item 1, subparagraph 717-510(4)(a)(ii)]

7.23 Any FDA debits that arise for the period treated as an income year are taken into account by the joining company in determining the FDA balance that is transferred to the head company at the joining time. The FDA debit that will be made immediately before the balance time will ensure that the FDA balance of the joining company is accurate when it is transferred to the head company.

Example 7.1

Assume:

•

A Co, B Co and C Co formed a consolidated group on 1 July 2002. A Co is the head company of the group.

•

D Co joins the group on 1 December 2003 and has an income year that starts on 1 July and ends on 30 June.

•

D Co has an FDA surplus of $300 on 31 August 2003.

•

On 1 September 2003 D Co is paid a non-portfolio dividend of $100 in respect of which $10 of foreign tax was paid.

-

This dividend is not exempt under section 23AJ but is to be included in D Co's assessable income.

-

D Co does not incur any expenses in relation to the non-portfolio dividend.

-

An FDA debit for an Australian taxable dividend amount (under paragraph 128TB(1)(d)) will arise on 30 June 2004 for $67.

•

There are no further FDA credits or FDA debits made to D Co's account. The applicable company tax rate is 30%.

The net non-portfolio dividend received by D Co is $90 (i.e. $100 - $10). On 1 September 2003 an FDA credit of $90 arises in D Co's FDA. As the non-portfolio dividend received by D Co is not exempt under section 23AJ, D Co will be liable for Australian tax on it. The payment of Australian tax will also give rise to an imputation credit for D Co.

D Co's FDA balance before the joining time will be $390. However, this balance does not reflect the FDA debit for an Australian taxable dividend amount that would arise for D Co at the end of its income year. New subsection 717-510(4) of the ITAA 1997 will apply to ensure D Co debits the FDA for $67 [(0.3 ($100 - $0)) - $10) / 0.3] immediately before the balance time.

Once an FDA debit of $67 is made immediately before the balance time, the balance in the FDA is a surplus of $323. D Co's FDA surplus of $323 is transferred to A Co by debiting D Co's FDA for $323 at the balance time and crediting A Co's FDA for $323 at the joining time.

Treatment of a subsidiary member's FDA during consolidation

7.24 The FDA of a subsidiary member will be inoperative during the time that company is a member of a consolidated group. That is, no credit or debit entries are made to the FDA of the subsidiary member from the time it joins the group until the time it leaves the group. Instead, the credit and debit entries will be made to the head company's FDA.

A company leaving the group not to take any FDA balance

7.25 A company that leaves a consolidated group is not able to take a proportion of the FDA balance on exit. The principle that the FDA balance remains with the group when a company ceases to be a subsidiary member is consistent with the consolidation treatment of most other tax attributes on exit (e.g. franking credits and foreign tax credits).

7.26 The leaving company can operate its own FDA from the leaving time onwards according to Subdivision B of Division 11A of Part III.

Treatment of a head company's FDA during consolidation

7.27 The FDA balances transferred to the head company will be pooled by the head company into a single FDA. The head company will be able to maintain a single account during consolidation by treating the companies that become subsidiary members of the group as being part of the head company, rather than separate entities, for this purpose. The single entity treatment will apply for the purposes of section 128TA (which deals with FDA credits) and section 128TB (which deals with FDA debits). [Schedule 9, item 1, section 717-515]

7.28 The single entity rule for FDA credits and debits will permit the head company to credit the FDA when a member of the group is paid a non-portfolio dividend and to debit the FDA when, for example, an expense is incurred in relation to the non-portfolio dividend received by that member. Any FDA credits and debits that are taken to arise for a head company will not arise for a subsidiary member of the group during consolidation. [Schedule 9, item 1, section 717-515]

7.29 New section 717-515 of the ITAA 1997 also enables a head company to aggregate the foreign investments of all its members to determine whether a dividend paid during consolidation qualifies as a non-portfolio dividend. The aggregation of the group's interests in foreign companies allows the head company to operate the FDA on the basis of the total dividends received and the total foreign tax paid. [Schedule 9, item 1, note 1(b) to section 717-515]

Foreign tax taken to be paid by head company

7.30 Under the current law, a company can credit its FDA for a non-portfolio dividend if that company is taken to have paid and to have been personally liable for foreign tax on the dividend. In consolidation, if a dividend is paid to a subsidiary member and that company paid and was personally liable for foreign tax in relation to that dividend, the head company will be able to credit its FDA for the dividend amount. The head company can do so because section 717-10 of the ITAA 1997 would deem the head company to have paid and to have been personally liable for the foreign tax (including any underlying foreign tax under section 160AFC) paid by a subsidiary member, where the foreign income is included in the assessable income of the head company.

7.31 Therefore, as the head company will be taken to have paid and to have been personally liable for foreign tax, then the head company will be able to credit the FDA for the dividend amount. Equally, where the total foreign tax paid needs to be calculated for an FDA debit for an Australian taxable dividend amount, then the head company will be able to do so because it will be taken to have paid and to have been personally liable for the tax. [Schedule 9, item 1, note 2 to section 717-515]

FDA declaration for dividends paid by subsidiary members

7.32 The head company of a consolidated group is able to make FDA declarations in relation to dividends paid to its non-resident shareholders under the operation of the current FDA provisions. During consolidation, the head company will also be able to make FDA declarations in respect of dividends paid by the subsidiary members of the group. The head company can make the FDA declarations because it will be held for FDA purposes to have paid dividends that are paid to non-resident shareholders of the subsidiary members. [Schedule 9, item 1, subsection 717-520(2)]

7.33 To enable the head company to make FDA declarations for dividends paid by its subsidiary members, subsection 128TC(2) will have a modified application. Under that modified operation, the head company will determine the FDA declaration percentages and the FDA declaration amounts for the dividends paid [Schedule 9, item 1, subsection 717-520(2)] . The head company will do that calculation for all dividends paid to the shareholders in the subsidiary member on a particular day [Schedule 9, item 1, subsection 717-520(4)] . Essentially, this means that the head company will be required to apply the formula in subsection 128TC(2) separately for each subsidiary member paying a dividend on a given day .

7.34 Once the FDA declaration is made, the head company will be required to make an FDA debit equal to the sum of the FDA declaration amounts for all of the dividends to which the declaration relates.

Multiple FDA declarations made on a particular day

7.35 Where the head company makes multiple FDA declarations on a particular day in relation to dividends paid by itself and/or one or more of its subsidiary members, the total FDA declarations made by the group on that day will need to be determined to ensure the FDA surplus at the beginning of the day is not exceeded by the total FDA declaration amounts. [Schedule 9, item 1, subsection 717-525(2)]

7.36 If the sum of the FDA declaration amounts worked out under subsection 128TC(2) does not exceed the FDA surplus at the beginning of the day then the head company will debit its FDA for that sum immediately after the FDA dividends are paid. The FDA debit for the declarations made by the head company will arise under section 128TB for the sum of the declaration amounts for all of the dividends (to which the declarations relate) paid by all group members.

7.37 If the sum of the declaration amounts exceeds the FDA surplus at the beginning of the day, each FDA declaration will nevertheless, be treated as valid. The FDA dividends paid are not adjusted and new declarations are not required by the head company. However, all the declaration amounts will be proportionally reduced so as not to exceed the FDA surplus in total [Schedule 9, item 1, subsection 717-525(3)] . This has the effect that only the adjusted FDA declaration percentages will be relevant for FDA purposes. The operation of this rule is consistent with the principles embodied in the equivalent provision in the existing law.

7.38 The proportional reduction of the FDA declaration percentages will ensure that the FDA debit made for the FDA declaration amounts (under paragraph 128TB(1)(a)) does not exceed the FDA surplus at the beginning of that day.

Example 7.2

Assume:

•

F Co, a non-resident company, has 2 wholly-owned Australian subsidiaries: A Co and D Co. A Co has 2 wholly-owned Australian subsidiaries: B Co and C Co.

•

A Co, B Co, C Co and D Co form a MEC group on 1 July 2002. A Co is the provisional head company of the group.

•

On 1 September 2002, A Co and D Co both pay an unfranked dividend of $5,000 each to F Co.

•

A Co sets the FDA declaration percentage at 60% for both dividends.

•

A Co has an FDA surplus of $7,000 at the beginning of the day on which the FDA declarations are made.

The FDA declaration percentage of 60% will permit A Co and D Co to pay their dividends exempt from DWT to the extent of the FDA declaration amounts. The FDA declaration amount is $3,000 (i.e. 60% $5,000) for each dividend. That amount of each dividend is exempt from DWT.

The total FDA declaration for A Co and D Co is $6,000 ($3,000 $3,000) which does not exceed the available FDA surplus of $7,000 and a debit of $6,000 would be made to the FDA of A Co.

Example 7.3

Assume:

•

The MEC group from Example 7.2 had an FDA surplus of $7,500 at the beginning of 1 September 2003.

•

On that day, A Co and D Co pay dividends to F Co. A Co pays an unfranked dividend of $5,000 and D Co pays one of $4,000.

•

A Co makes an FDA declaration in relation to both dividends. The FDA declaration percentage is set at 90% for both dividends.

The FDA declaration percentage of 90% permits the dividends paid to be exempt from DWT to the extent of the declaration amounts. The FDA declaration amounts are $4,500 (i.e. 90% $5,000) for the dividend paid by A Co and $3,600 (i.e. 90% $4,000) for the dividend paid by D Co.

The sum of the declaration amounts is $8,100 ($4,500 + $3,600), which exceeds the FDA surplus of $7,500. As such, the declaration amount is reduced by applying the formula in the new subsection 717-525(3) of the ITAA 1997. The result is an FDA declaration percentage of 83% that is taken to have effect for FDA purposes [i.e. 90% ($7,500 / $8,100)].

The reduced FDA declaration percentage will in turn reduce the total declaration amount to $7,500. However, that amount does not reduce the declaration amounts already set by A Co in the dividend statements issued to F Co. Therefore, the failure by A Co and D Co to deduct sufficient withholding tax on dividends paid will result in A Co being liable for additional tax.

An FDA debit of $7,500 is made to A Co's FDA to reflect the corrected total declarations made by the group on that day.

Head company liable for penalty tax

7.39 An FDA declaration made by a head company that results in the FDA surplus being exceeded by the declaration amount will trigger the operation of the penalty provision in the existing law. Similarly, if a head company issues an incorrect dividend statement to a non-resident shareholder of a subsidiary member then the head company will be liable for additional tax [Schedule 9, item 1, subsection 717-520(6)] . Section 128TE applies in relation to the declaration made by the head company even though the shareholders and dividends mentioned in that section may relate to a subsidiary member.

7.40 Therefore, a consequence of the head company issuing a dividend statement is that the head company will be held liable for any incorrect amounts set out in the statement, as provided by section 128TE. [Schedule 9, item 1, subsection 717-520(6)]

7.41 Similarly, where a head company makes multiple FDA declarations that exceed the available FDA surplus at the beginning of the day then the head company will be liable for additional tax by way of a penalty for an amount equal to the withholding tax shortfall on the dividends. The head company will be liable for the additional tax if the incorrect statement relates to the dividend paid to its shareholders or those paid to a shareholder of a subsidiary member. [Schedule 9, item 1, subsections 717-520(6) and 717-525(5) and (6)]

Extended application of certain provisions

7.42 Section 128AAA applies Division 11A of Part III to a non-share equity interest and an equity holder in the same way as it applies to a dividend and a shareholder. That provision has an application in relation to new sections 717-520 and 717-525 of the ITAA 1997 in the same way it applies to the provisions in Division 11A. [Schedule 9, item 1, section 717-530]

FDA balances and change in head company

7.43 The rule in section 703-75 of the ITAA 1997 deals with a situation where a company is an interposed head company. That rule provides that everything that happened to the original company (the old head company) before the completion time is taken instead to happen to the interposed company (the new head company) in relation to the head company and entity core purposes and for the franking account balance. The FDA measure does not fall within the head company or entity core purposes. Therefore, subsection 703-75(3) will be amended by this bill to allow the FDA balance to be transferred from the old head company to the new head company.

7.44 The amended subsection 703-75(3) of the ITAA 1997 will enable the new head company to operate the FDA rather than the old one by taking everything to have happened to the new head company instead. [Schedule 9, item 13, paragraph 703-75(3)(d)]

FDA balances and MEC groups

7.45 The rules in the new Subdivision 717-J of the ITAA 1997 will operate for a provisional head company of a MEC group in the same way as they do for a head company of a consolidated group. [Schedule 9, item 2, section 719-900]

7.46 The application of the new Subdivision 717-J to MEC groups will allow the provisional head company of a MEC group to operate a single FDA by debiting and crediting the account at various points in time according to the rules in the existing law. The provisional head company of a MEC group can also make the FDA declarations in relation to dividends paid to non-resident shareholders by a subsidiary member of the group.

7.47 A provisional head company of the group at a particular point in time will not be a subsidiary member of the group for FDA purposes. Similarly, a company that is a subsidiary member at a particular point in time will not be a provisional head company of a group for FDA purposes at that time. [Schedule 9, item 2, subsection 719-900(3)]

Transfer of the FDA balance to a new provisional head company

7.48 Section 719-90 of the ITAA 1997 provides that a new head company is treated as substituting the old head company for all times before the transition time. Subsection 719-90(3) restricts the scope of that provision to head company and entity core purposes. Due to the fact that the FDA measure does not fall within the head company or entity core purposes, the FDA balance cannot be transferred from the old head company to the new head company by applying section 719-90.

7.49 The new law transfers the FDA balance held by the former provisional head company to the new provisional head company where one company ceases to be a provisional head company and another company becomes the provisional head company. The transfer from one provisional head company to another is carried out in the same way as when a company joins a consolidated group. [Schedule 9, item 2, section 719-905]

Repeal of the FDA grouping provisions

7.50 Under the current law, one resident company can pay an FDA dividend to another resident member of the same wholly-owned group. When the FDA dividend is paid to a resident company, an FDA debit arises for the paying company and an FDA credit arises for the receiving company. The transferred FDA surplus is then used by the receiving resident company to pay its non-resident shareholders unfranked dividends free from DWT.

7.51 The rule that allows an FDA dividend to be paid from one member of a wholly-owned group to another, and thereby to transfer FDA credits within the group, will be repealed. Repealing this rule is consistent with the removal of other grouping provisions. This means that members of a wholly-owned group operating outside the consolidation regime will be denied the opportunity to transfer an FDA surplus to another member with the payment of an FDA dividend. [Schedule 9, items 3 to 11]

The OBU regime

7.52 Under the current law certain entities can be gazetted by the Treasurer as OBUs. These entities are then entitled to reduce their income and expenses arising from OB activities so that such activities are effectively taxed at 10%.

7.53 With the introduction of the consolidation regime one or more members of a consolidated group may be an OBU. However, where the head company of the consolidated group is not itself an OBU but one or more subsidiary members are, it is necessary that Division 9A of Part III operates to extend the concession to the head company.

Definition of an OBU

7.54 OBU is defined in section 128AE to be a person that the Treasurer may, by notice published in the Gazette, declare to be an OBU. Broadly, subsection 128AE(2) provides that the following can be OBUs:

•

a company that is an authorised deposit-taking institution;

•

a public authority constituted under the law of an Australian State that carries on banking;

•

a company wholly owned beneficially by an OBU (other than a dealer in foreign exchange);

•

authorised foreign exchange dealers;

•

life insurance companies;

•

funds managers subject to certain eligibility criteria; and

•

a company the Treasurer determines in writing to be an OBU.

7.55 Provided the membership criteria for inclusion in a consolidated group or MEC group are satisfied (see Division 703 and Division 719 of Part 3-90 of the ITAA 1997) any of these entities can join a consolidated group or a MEC group.

Head company an OBU

7.56 Where the head company of a consolidated group is an OBU, the single entity principle contained in section 701-1 of the ITAA 1997 will operate to treat subsidiary members of the consolidated group as parts of the head company. In these circumstances OB activities undertaken by subsidiary members will for the purposes of Division 9A be subject to the concessional OBU treatment provided for by that Division if the other requirements imposed by that Division are satisfied.

7.57 It is important to note that the single entity principle only applies for core purposes, that is, the calculation of the head company's income tax liability for a year of income (subsection 701-1(2) of the ITAA 1997). Division 11A of Part III provides for certain withholding tax exemptions on interest paid to non-residents by an OBU and excludes such interest from the assessable income of the non-resident. As Division 11A deals with the liability of the non-resident lender to withholding tax this is not a core purpose. Accordingly, the requirement for the exemption that the interest be paid by an OBU will not be met where the loan contract is between a subsidiary member of the consolidated group and the non-resident lender.

Subsidiary member is an OBU

7.58 Where an entity that is an OBU is a subsidiary member of a consolidated group or joins such a group the head company will, if it is not itself an OBU, be treated as if it were an OBU. This treatment will persist for the period of time that at least one subsidiary member of the group is an OBU. [Schedule 10, item 2, section 717-710]

7.59 As is the case outlined at paragraph 7.57, the head company will only be treated as if it were an OBU for the purposes of Division 9A, that is, the calculation of the amount to be included in the taxable income of the head company and taxed to give an effective tax rate on that amount of 10% [Schedule 10, item 2, subsection 717-710(1)] . The deeming of the head company to be an OBU will not apply for the purposes of determining whether a non-resident lender to the group is entitled to a withholding tax exemption on interest paid on the loan under Division 11A.

7.60 Subsidiary members of a consolidated group continue to be persons as defined in section 6 and there is no requirement in section 128AE that the person be a taxpayer. In these circumstances the Treasurer will continue to be able to declare subsidiary members of a consolidated group to be OBUs if they satisfy the criteria set out in subsection 128AE(2). If this occurs and the head company is not an OBU the head company will be treated as if it were an OBU for Division 9A purposes. [Schedule 10, item 2, subsection 717-710(1)]

Consequences of consolidation

7.61 A consequence of the head company either being an OBU or being treated as one is that OB activities undertaken outside the declared OBU member or members may be entitled to the OBU concession conferred by Division 9A. The concession will apply provided the requirements set out in that Division and the record keeping requirements specified in section 262A are met.

7.62 Where the OB activity as defined in section 121D can only be undertaken if the person meets certain criteria under legislation other than tax legislation the proposed law will not affect that external requirement or penalties to be imposed for breach of that requirement. An example would be the license required to be held by foreign exchange dealers.

7.63 It is worth noting that section 121EH which is aimed at preventing the excessive use of non-OB money to fund OB activities will apply to the consolidated group as a whole rather than only to actual OBUs within the group. The provisions of Division 9A that deal with OB resident-owner money will not apply to the equity interest in subsidiary members of the group.

7.64 Similarly, section 121EK deeming interest to be paid on OBU resident-owner money will not operate in respect of the internal shareholding arrangements within the consolidated group.

Elections in relation to CFCs, FIFs and FLPs

7.65 Within Part X and Part XI, a taxpayer can make decisions about how to calculate attributable income in relation to CFCs, and FIF income in relation to FIFs and FLPs. Some of these choices or elections are irrevocable and some decisions mean that other options cannot be taken.

7.66 With the ordinary application of the entry history rule (section 701-5 of the ITAA 1997), the decisions made by entities that become subsidiary members of a consolidated group may affect the ability of the head company to make different decisions when calculating its income tax liability. Similarly, with the application of the exit history rule (section 701-40 of the ITAA 1997), the decisions made by the head company may affect the ability of an entity that leaves the group to make different decisions when calculating its income tax liability.

Irrevocable elections

7.67 The irrevocable elections made under Part X or Part XI by entities that join a consolidated group will not become the elections of the head company under the entry history rule (section 701-5 of the ITAA 1997). Instead, the head company may decide whether or not to make the irrevocable elections according to its preferences rather than be bound by decisions made by other taxpayers over which it may have had no control at the time those decisions were made. [Schedule 8, item 9, section 717-285]

7.68 Irrevocable elections that a head company has made will continue to apply to the head company and will affect the interests in CFCs, FIFs and FLPs that the head company may hold under the single entity rule (section 701-1 of the ITAA 1997) when entities become subsidiary members of a consolidated group.

7.69 Similarly, where entities leave a consolidated group any irrevocable elections made by the head company will not become the elections of the entity that left the group under the exit history rule (contained in section 701-40 of the ITAA 1997). Instead, the leaving entity will be able to choose for itself whether or not to make an irrevocable election under Part X or XI. [Schedule 8, item 9, section 717-310]

Calculating FIF income using the calculation method (entry/exit)

7.70 A taxpayer may use any one of 3 methods to calculate the attributable income from an interest in a FIF (section 534). The 3 methods for FIF interests are:

•

the market value method;

•

the deemed rate of return method; and

•

the calculation method.

7.71 A taxpayer can only elect to calculate FIF income under the calculation method once (section 535). If the taxpayer changes to another method in a subsequent year, the taxpayer is not able to go back to the calculation method to calculate the FIF income of that particular FIF at any time in the future. This means the election to use the calculation method is not an irrevocable election. However, the taxpayer can only use the calculation method if it makes an irrevocable election under subsection 486(3) to change the notional accounting period of a FIF. Paragraph 7.67 discusses the consequence of such an irrevocable election if the taxpayer becomes a subsidiary member of a consolidated group.

7.72 Where an entity with an interest in a FIF becomes a subsidiary member of a consolidated group, the head company will be able to choose whether or not it wishes to apply the calculation method to calculate the FIF income. The head company can use the calculation method whether or not the joining entity would have been prevented from using that method. However, the head company could not make the election if it was precluded from using the calculation method because of past decisions made by the head company in relation to that FIF. [Schedule 8, item 9, section 717-290]

7.73 Similarly, where an entity leaves a consolidated group with an interest in a FIF, the leaving company will be able to choose whether or not it wishes to use the calculation method to calculate the FIF income. The leaving entity can decide to use the calculation method whether or not the head company would have been precluded from using that method. [Schedule 8, item 9, section 717-315]

Deferred attribution credits (entry/exit)

7.74 Part X has rules for maintaining an attribution account, including when credits and debits are made to this account. Briefly, a company maintains an attribution account to exempt dividends paid by a CFC out of income on which the taxpayer has already been taxed. At any time, an attribution account surplus arises when the credits exceed the debits.

7.75 Generally, an attribution credit arises when attributable income is included in the taxpayer's assessable income. Where a CFC ceases to be a resident of an unlisted country and becomes a resident of a listed country, the CFC's attributable income includes the unrealised capital gains on the deemed disposal of the CFC's assets. Under subsection 371(8) an attributable taxpayer may elect to defer the timing of the attribution credit until the time of the CFC's payment of a dividend out of gains derived by it from the actual disposal of any of the assets.

Entry rules

7.76 If a company joining a consolidated group has an interest in a CFC, then the joining company's attribution account for the CFC will not reflect credits deferred as a result of elections made under subsection 371(8). However, under section 717-210 of the ITAA 1997, the company joining the consolidated group transfers the surplus (if any) of the attribution account to the head company at the joining time.

7.77 The joining company's deferred attribution credits (because of elections it made under subsection 371(8)) will be available to the head company of a consolidated group when they would have been available to the joining company had it not joined the group. [Schedule 8, item 2, section 717-227]

Exit rules

7.78 Where a company leaves a consolidated group with an interest in an attribution account entity, the attribution account held by the head company in respect of that entity will not reflect credits deferred as a result of elections under subsection 371(8). However, under section 717-245 of the ITAA 1997, the head company will transfer to the leaving company a proportion of the surplus (if any) of the attribution account at the leaving time. The proportion of the surplus that may be transferred is determined by applying the formula contained in section 717-245.

7.79 The leaving company will also be able to use the appropriate proportion of the deferred attribution credits the head company would have been entitled to as a result of elections under subsection 371(8). The credit will arise for the leaving company at the time it would have arisen for the head company if the leaving company had not left the group. [Schedule 8, item 7, section 717-262]

7.80 The appropriate proportion of the deferred attribution credit that will be available to the leaving company will be determined by reference to the percentage of the group's interest in the attribution account entity that the leaving company takes with it at the leaving time. [Schedule 8, item 7, subsection 717-262(3)]

7.81 The amount of the deferred attribution credit that the leaving company can use in the future reduces any entitlement that the head company may have had. [Schedule 8, item 7, subsection 717-262(4)]

Ensuring FIF income is not taxed twice (entry/exit)

7.82 Where a company joins a consolidated group with an interest in a FIF, section 717-230 of the ITAA 1997 operates when the joining time is part-way through the notional accounting period of the FIF. The section allocates an amount of FIF income to the joining company for the period from the beginning of the notional accounting period of the FIF until the time the company joins the consolidated group.

7.83 To ensure the head company includes the appropriate amount of FIF income in its assessable income, the head company will be deemed to have acquired the interest in the FIF at the time the joining company joined the consolidated group. Deeming the head company to have acquired the FIF interest at the joining time will mean that the entry history rule will not apply for the purposes of calculating the FIF income. The ordinary operation of Part XI ensures the head company includes in its assessable income an amount of FIF income for so much of the notional accounting period of the FIF from the joining time until the usual end of the notional accounting period. [Schedule 8, item 3, subsection 717-230(4)]

7.84 Similarly, section 717-265 of the ITAA 1997 operates when a company leaves a consolidated group with an interest in a FIF part-way through the notional accounting period of the FIF. The section allocates an amount of FIF income to the head company for the period from the beginning of the notional accounting period of the FIF until the time the leaving company left the consolidated group.

7.85 To ensure the leaving company includes the appropriate amount of FIF income in its assessable income the leaving company will be deemed to have acquired the interest in the FIF at the time the company leaves the consolidated group. Deeming the leaving company to have acquired the FIF interest at the leaving time will mean that the exit history rule will not apply for the purposes of calculating the FIF income for the leaving company. The ordinary operation of Part XI ensures the leaving company includes in its assessable income an amount of FIF income for so much of the notional accounting period from the leaving time until the normal end of the notional accounting period. [Schedule 8, item 8, subsection 717-265(5)]

7.86 The value of the interest in the FIF that the head company will be deemed to have acquired at the joining time or that the leaving company will be deemed to have acquired at the leaving time is determined under paragraph 538(2)(a). [Schedule 8, item 3, subsection 717-230(5) and item 8, subsection 717-265(6)]

No double counting of foreign tax

7.87 New item 11 in the June Consolidation Act will apply to a taxpayer during the transitional period where the taxpayer chooses to apply the old section 160AFE to transfer excess foreign tax credits that relate to part of an income year to another group company [Schedule 18, item 1] . This may occur when a consolidated group is formed part-way through the prospective head company's income year or simply where the old section 160AFE ceases to operate (on 1 July 2003) part-way though the transferring company's income year.

7.88 Where a taxpayer pays foreign tax in relation to foreign income that is included in its assessable income, that foreign tax will not give rise to a foreign tax credit under section 160AF to the extent the taxpayer has transferred to another taxpayer some of that foreign tax under the old section 160AFE. [Schedule 18, item 1, subitem 11(2) of Schedule 10 of the June Consolidation Act]

7.89 This is to avoid both the taxpayer making the transfer and the taxpayer receiving the additional credit claiming a foreign tax credit for the same amount of foreign tax.

Thin capitalisation

Expanding when a foreign bank branch is able to be treated as part of a single company

7.90 The thin capitalisation rules that permit a single company to group with a foreign bank branch are intended to be consistent with the loss transfer rules as amended following the introduction of the consolidation regime. Under the loss transfer rules, a single company that meets certain requirements can group with a foreign bank branch provided it is not a member of a potential or actual consolidated group.

7.91 The thin capitalisation provisions included in the September Consolidation Act, however, contain an additional condition at subparagraph 820-599(2)(c)(iv) of the ITAA 1997 whereby the single company cannot be a member of a potential MEC group. No such restriction applies for loss transfers.

7.92 The repeal of this provision will correct this anomaly and ensure that the circumstances when a single company can group with a foreign bank branch for thin capitalisation purposes are consistent with the general policy underlying the consolidation regime. [Schedule 22, item 1, subparagraph 820-599(2)(c)(iv)]

7.93 This change will mean that grouping is permitted where:

•

a single company (that is an eligible tier-1 company with no Australian resident subsidiaries) has not joined with another tier-1 company to form a MEC group; or

•

the single company and the branch represent the foreign bank's only presence in Australia.

Clarifying the choice available to a head company

7.94 The same thin capitalisation rules also permit, in certain circumstances, a head company to make a choice to group with an Australian bank branch under either the head company option or the single company option. This occurs where a consolidated group consists of only one member, that being the head company.

7.95 The intention of the legislation was, however, to distinguish between a choice made by the head company of a consolidated group or a MEC group (under subsection 820-597(1) of the ITAA 1997) and that made by a single company that is not a head company (under subsection 820-599(1) of the ITAA 1997).

7.96 The inclusion of the criteria that the single company cannot be a member of a consolidated group or MEC group will ensure that a company that is considered to be a head company is confined to making its choice under subsection 820-597(1) of the ITAA 1997. It will also ensure that a single company that is part of an actual MEC group cannot make a choice to group with a foreign bank branch. [Schedule 22, item 1, subparagraphs 820-599(2)(c)(iv) and (v)]

7.97 This amendment will not affect the ability of a head company to group with a foreign bank branch for thin capitalisation purposes.

Application and transitional provisions

7.98 The rules dealing with FDAs for a consolidated group and amendments made to subsection 995-1(1) of the ITAA 1997 will apply from 1 July 2002 to accommodate consolidated groups formed from that date.

7.99 Subitem 12(1) in Schedule 9 provides the general rule that the current grouping provision in Subdivision B of Division 11A of Part III will apply until 30 June 2003 to allow members of a wholly-owned group to pay FDA dividends to another member of the group. [Schedule 9, item 12]

7.100 Subitem 12(2) is an exception to the application of the general rule in subitem 12(1). It ensures that where a wholly-owned group consolidates before 1 July 2003 the amended Subdivision B will apply to dividends paid from the consolidation day. If a company joins the consolidated group after the consolidation day then subitem 12(1) will apply. While technically this means that the current Subdivision B applies to the joining company until 30 June 2003, this has no practical effect because of the operation of the single entity rule once it has joined the group. [Schedule 9, subitems 12(2) and 12(3)]

7.101 However, if a wholly-owned group does not consolidate on or before 1 July 2003, the ability to pay an FDA dividend will be governed by the amended Subdivision B from 1 July 2003 onwards. The one exception to this rule is where the head company has a substituted accounting period and consolidates at the beginning of its first income year commencing after 1 July 2003 and before 1 July 2004. In that case, the amended Subdivision B will apply to dividends paid from the consolidation day. Subdivision B as it currently stands would apply to dividends paid by any group member up until the beginning of the head company's income year. [Schedule 9, subitems 12(2)(b) and 12(3)]

7.102 The other technical amendments discussed in this chapter will apply from 1 July 2002. There are no transitional rules for these measures.

Consequential amendments

7.103 Consequential amendments made to subsection 995-1(1) of the ITAA 1997 will include new Dictionary terms relating to FDAs. [Schedule 9, items 15 to 20]

7.104 Consequential amendments (if any) in relation to the other technical amendments discussed in this chapter will be included in subsequent legislation.