House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer,the Hon. J. Kerin, M.P.)

Chapter 17 Overview of Existing Law : Accruals Tax System

[Includes Definition of Key Terms]

Overview

Brief outline of basic concepts in the Taxation of Foreign Source Income.

Introduction

17.1. Chapters 17 to 22 deal with amendments that are proposed to be made to the provisions relating to the taxation of foreign source income.

17.2. They relate mainly to the provisions of the Act that deal with the accruals tax system introduced with general effect from the 1990-91 income year.

Some Basic Concepts in the Taxation of Foreign Source Income

The accruals tax system - controlled foreign companies

17.3. If Australian residents have specified interests in a non-resident company, then the accruals tax system may include certain income and gains derived by that company in the residents' assessable income. A non-resident company that is subject to these measures is called a controlled foreign company (CFC).

Attributable income

17.4. The income and gains of a CFC that may be included in the assessable income of resident taxpayers is called attributable income. That income is calculated, subject to some modifications, as if the CFC were a resident of Australia.

The active income test

17.5. The CFC's income will generally not be included in the assessable income of resident taxpayers if the CFC is predominantly engaged in active business operations. An active income test determines whether a CFC is to be treated as predominantly engaged in active business operations.

17.6. A CFC fails that test if, in broad terms, 5 per cent or more of the gross turnover of the CFC consists of tainted income. Tainted income includes passive income and income from certain related party transactions.

Listed and unlisted country CFCs

17.7. A listed country is a country that is treated as having a tax system that is generally comparable to Australia's. A list of these countries is contained in the Income Tax Regulations. An unlisted country is a country that is not listed in the Regulations.

Attributable income of a listed country CFC

17.8. The attributable income of a CFC that is a resident of a listed country will include :

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certain tainted income that is taxed at concessional rates in the listed country. This type of income, called designated concession income, will be included in attributable income only if the CFC fails the active income test. A list of the income that is treated as taxed at concessional rates is contained in the Income Tax Regulation;

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income from an unlisted country that is not taxed in the listed country; and

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certain low taxed income that is derived, or treated as derived, from trusts.

Attributable income of an unlisted country CFC

17.9. The attributable income of a CFC that is a resident of an unlisted country includes :

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certain tainted income, if the CFC fails the active income test; and

•

certain income that is derived, or treated as derived, from trusts.

Dividends paid by a CFC

17.10. The accruals tax measures will also include in the assessable income of resident taxpayers amounts of dividends paid by an unlisted country CFC to a:

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listed country CFC; or

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controlled foreign trust (CFT).

17.11. The amount that is included in the assessable income of a resident taxpayer is the proportion that relates to the taxpayer's interest in the CFC or CFT that receives the dividend.

Change of residence of a CFC

17.12. Where a CFC changes residence from an unlisted country to a listed country or Australia, a resident attributable taxpayer must include in his attributable income a certain amount of the distributable profits of the CFC (section 457).

17.13. Where a CFC changes residence to a listed country, its distributable profits are deemed to include the profits that would have been made if the assets of the CFC were sold for their market value.

17.14. Section 457 is an anti-avoidance provision to prevent an unlisted country CFC distributing its profits in a tax free form by simply changing its residence.

Tax exemption for distribution from attributed income

17.15. Dividends received by a resident taxpayer from a non-resident company are exempt from tax up to a certain limit. This limit is equivalent to the amount of the dividends that are paid out of profits of that company that have been previously attributed to the taxpayer. Put another way, if a dividend is paid by a company to an Australian taxpayer and, if on the payment of the dividend, and attribution debit arises, the dividend is exempt from tax under section 23AI to the extent of the debit (see definition of 'Attribution debit' below).

Definitions of Key Terms in the Taxation of Foreign Source Income

17.16. Certain terms that are used in Chapters 17 to 22 are explained below.

'Attribution account'

17.17. An attribution account establishes a link between:

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income that has been attributed to the taxpayer from an attribution account entity; and

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income actually distributed to that taxpayer by the entity.

'Attribution account entity'

17.18. An attribution account entity is an entity for which a resident taxpayer is to maintain an attribution account (in order to trace distributions of attributed income). An entity includes:

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a company that is not a Part X Australian resident;

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a partnership; and

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a trust.

'Attribution credit'

17.19. When an amount is attributed to a taxpayer from an entity, the attribution account is credited (attribution credit) with the amount of the attributable income. For instance, an attribution credit will arise where an amount of the attributable income of a CFC is attributed to a taxpayer under section 456.

'Attribution debit'

17.20. When an entity subsequently distributes income that has been attributed to a taxpayer, the amount of the distribution is debited (attribution debit) to the attribution account. The amount of the debit cannot exceed the balance of the account, referred to as the attribution surplus.

'Attribution surplus'

17.21. An attribution surplus exists if the total of the attribution credits for an entity exceeds its attribution debits.

'Australian trust'

17.22. The term Australian trust is defined in section 338 of the Act. It includes, in broad terms, a trust that has a resident trustee. It also includes a trust that has its central management and control in Australia. Certain specified categories of trusts, such as a corporate unit trust and a public trading trust, are also treated as Australian trusts.

'Controlled foreign company' (CFC)

17.23. In broad terms, a controlled foreign company is a non-resident company in which resident individuals, partnerships, companies or trusts hold specified interests. The meaning of the term controlled foreign company is set out in section 340 of the Act.

'Controlled foreign trust' (CFT)

17.24. A controlled foreign trust is a non-resident trust in which resident individuals, partnerships, companies or trusts hold specified interests. The term includes a non-resident trust to which a resident person has transferred property or services in certain circumstances. The meaning of the term controlled foreign trust is set out in section 342 of the Act.

'Distributable profits'

17.25. The distributable profit is the amount of profits of the company that would be available for distribution by way of dividends.

'Exempting profits'

17.26. Exempting profits are the distributable profits of a company that result from the exempting receipts of a company. Exempting profits are calculated using the formula :

Exempting profits = exempting receipts less expenses and taxes attributable to those receipts


'Exempting receipts'

17.27. Exempting receipts of an unlisted country company are amounts received by that company that have either:

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been included in assessable income for Australian tax purposes; or

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been taxed at comparable rates in a listed country.

'Foreign tax credits'

17.28. A resident taxpayer whose assessable income includes foreign income could, subject to certain limits, claim a credit for the foreign tax paid on the foreign income against the Australian tax payable on that income. A resident company that receives a non-portfolio dividend from a foreign company is entitled to a credit for the foreign tax paid on the dividend as well as for the foreign underlying tax paid by the company on profits out of which the dividend is paid.

'Non-portfolio dividends'

17.29. 'Non-portfolio dividends' are dividends paid to a company with at least a 10% voting interest in the company paying the dividend.

'Part X Australian resident'

17.30. A Part X Australian resident is a resident of Australia other than one who is treated solely as a resident of treaty partner country under a double taxation agreement between Australia and that country.

'Passive income'

17.31. In broad terms, passive income includes items of income such as:

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interest;

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annuities;

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royalties;

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receipts from the assignment of intellectual property; and

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capital gains on the disposal of certain assets.

17.32. The term passive income is defined in section 446 of the Act.

'Statutory accounting period'

17.33. A statutory accounting period of a CFC is a period of 12 months, ending on 30 June unless the CFC has elected a 12 month period ending on another day (section 319).