House of Representatives

Explanatory Memorandum

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

Chapter 19 Change of Residence of CFC - Election to defer attribution Credit

[Clause: 79, 81, 85]

Overview

Provides relief from the double taxation of profits that can occur when an Australian-controlled foreign company (CFC) changes its residence from an unlisted country to either a listed country or Australia. Where a CFC changes residence to Australia, a taxpayer will continue to be exempt from tax on distributions made by the CFC up to the amount of the CFC's income that was previously attributed to the taxpayer. Relief in relation to a change of residence to a listed country is provided by enabling a taxpayer to obtain foreign tax credits for foreign tax paid on certain gains arising to the CFC on the sale of the assets of the CFC after the change of residence.

Summary of proposed amendments

19.1. When a CFC changes residence from an unlisted country to a listed country, certain profits of the CFC are attributed to the attributable taxpayers of the CFC. These profits include unrealised gains on the assets of the CFC. (section 457)

19.2. The proposed amendment will allow an attributable taxpayer to elect to defer the timing of so much of an attribution credit that relates to the attribution (under section 457) of an unrealised gain on an asset. Section 457 applies where a CFC changes residence from an unlisted country to a listed country or to Australia.

19.3. By the election, the attributable taxpayer will be able to defer the attribution credit until the CFC pays a dividend out of the gain derived from the disposal of the asset. This will enable the payment of the dividend after the foreign tax payable on the disposal of the asset has been paid. That tax will therefore be taken into account when calculating the tax credit to which the taxpayer is entitled in relation to that dividend.

19.4. The election will be available in respect of a change in residence of a CFC which occurred on or after 1 July 1989.

19.5. In effect, the election will only benefit a resident company which is related to a CFC that has changed residence. This is because only a related company may claim a credit for the underlying tax paid by the CFC on the profits from which the dividend is paid. (sections 160AFB and 160AFC)

Background to the legislation

19.6. An amount relating to the unrealised gain on an asset held by a CFC which is attributed to a taxpayer when a CFC changes residence from an unlisted country to a listed country may, in some circumstances be taxed by both Australia and that listed country without the taxpayer receiving relief from double taxation.

19.7. In some instances, the taxable gain on an asset situated in a listed country is calculated by that country from the time the CFC purchased the asset. Consequently, that part of a gain which accrued prior to the change of residence of the CFC is taxed by both Australia and the listed country. Relief from double taxation is normally provided under section 160AFCD. Broadly, that section allows a corporate taxpayer that receives a dividend from a related company to claim a credit for the tax imposed by the listed country on that part of the company's profits that relate to an attribution surplus.

19.8. However, relief may not be available for the foreign tax that will be paid on the disposal of an asset relating to the unrealised gain which was attributed to the taxpayer under section 457. This is because a foreign tax credit determination may not be amended after the end of 4 years after the original determination date except to correct an error in calculation or a mistake in fact (subsection 160AK(2)). Consequently, a tax credit will not be allowable for foreign tax which is paid more than 4 years after the original credit determination under section 160AFCD.

19.9. The following diagram illustrates the problem.

CFC's residence: (Unlisted Country) (Listed Country)
1.8.90 1.3.91 1.7.91 1.8.98
(A) (B) (C) (D)


(A)

A CFC resident in an unlisted country purchases an asset located in a listed country.

(B)

The CFC changes residence to the listed country. The CFC's Australian parent company is attributed the unrealised gain accrued on the asset since 1.8.90. The attribution of the unrealised gain gives rise to an attribution credit for the parent company.

(C)

The CFC pays a dividend which reduces the attribution surplus to nil. The dividend will be exempt under section 23AI to the extent of the attribution debit which arose on the payment of the dividend (the balance of the dividend will be exempt under section 23AJ). No foreign tax credit is allowable under section 160AFCD because the foreign tax has yet to be paid on the unrealised gain which gave rise to the attribution credit.

(D)

The CFC disposes of the asset and pays capital gains tax in that country on the gain which has accrued since 1.8.90. However, no foreign tax credit will be available when the capital gain is distributed to the parent company (no attribution debit will arise) even though Australia has already taxed the gain which accrued during the period 1.8.90 to 1.3.91. Consequently, the gain which accrued during that period has effectively been taxed twice.

Explanation of the proposed amendments

19.10. Broadly, the proposed amendment will permit an attributable taxpayer to elect to defer the timing of an attribution credit that relates to the attribution (under section 457) of an unrealised gain on an asset held by a CFC. This election will permit the attributable taxpayer to defer the attribution credit until the CFC pays a dividend out of the gain derived from the actual disposal of the asset. Accordingly, a company taxpayer, which is related to the CFC, can claim a tax credit (under section 160AFCD) for the foreign tax paid on that part of the notional gain on assets held by the CFC which was attributed to the taxpayer when the CFC changed residence. This is because the foreign tax payable on the disposal of those assets will have been paid at the time the attribution debit arises.

19.11. An attribution credit relating to an amount included in a taxpayer's assessable income under section 457 arises at the time the CFC changes residence (paragraph 371(5)(b)). The amendment will allow a taxpayer that is able to satisfy certain conditions to elect to defer an attribution credit that is referable to an amount attributed to the taxpayer (under section 457) in respect of a notional gain on the assets of a CFC at the time it changed residence. The election will result in the attribution credit being deferred until immediately before the payment by the CFC of a dividend out of a gain derived from the disposal of those assets. [Clause 81, subsection 371(8)]

19.12. The election should be retained by the taxpayer for a 5 year period for the purpose of examination by the Tax Office if requested (section 262A). A penalty is provided on conviction for failure to comply with that section.

Commencement date

19.13. This amendment has effect in relation to any change of residence of a CFC that occurred on or after 1 July 1989.

Clauses involved in the proposed amendments

Clause 81 : inserts new subsections 371(8) and (9) which will permit an attributable taxpayer to elect to defer the timing of so much of an attribution credit that relates to the attribution (under section 457) of an unrealised gain on an asset.

Subclause 85(18) : provides that the amendment will apply in relation to a CFC changing residence after 1 July 1989.

Clause 79 : amends subsection 262A(4A) to provide that an election made under proposed subsection 371(9) is to be retained for 5 years.