House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

Attribution accounts - CFC

Overview

This chapter deals with the prevention of potential Australian double taxation that could arise where foreign investment fund income is included in the notional assessable income of a CFC under the CFC measures. As with the CFC measures, double taxation is to be prevented where a taxpayer later:

eceives a distribution of income and/or gains out of the attributed amount; or

isposes of the interest in the CFC.

This will be done by using the existing exemption for amounts previously attributed under the CFC measures, and the associated CFC attribution accounts.

Background

Dividends paid to a taxpayer out of income derived by a CFC that has been attributed to that taxpayer are exempt from tax (existing section 23AI). Further, the consideration on disposal of an interest in a CFC is reduced to take account of previous attribution (existing section 461).

To claim an exemption under section 23AI, or the reduction under section 461, the taxpayer is required to maintain an 'attribution account' in relation to the CFC which shows:

he amount of the income attributed to the taxpayer (recorded as an ' attribution credit'); and

mounts distributed to the taxpayer, for example, a dividend paid to the taxpayer by the CFC (recorded as an ' attribution debit').

Broadly, attribution credits arise in relation to a CFC if an amount is included in the assessable income of an Australian attributable taxpayer because:

n amount of the CFC's income is attributed to the taxpayer (existing section 456); or

he CFC has changed residence from an unlisted country to a listed country or Australia (existing section 457); or

n unlisted country CFC paid a non-portfolio dividend to a listed country CFC (existing section 458).

The amount of the exemption or reduction of consideration cannot exceed the ' attribution surplus' in the account. The attribution surplus is the amount by which attribution credits exceed attribution debits.

These accounts are similar to the FIF attribution accounts described in Chapter 21.

Attribution credit for FIF income attributed to a CFC

An attribution credit arises for a CFC in relation to a taxpayer if a share of the attributable income of the CFC is included in the taxpayer's assessable income (existing section 456).

An amount of FIF income that is included in the calculation of the CFC's notional assessable income will enter into the calculation of the amount included in the taxpayer's assessable income under section 456. However, without amendment of the current provisions, the attribution credit would wholly arise to the CFC.

Credit to arise to FIF

The current provisions will be modified so that the attribution credit that relates to the foreign investment fund income of a FIF in which a CFC has an interest will arise for the FIF rather than for the CFC. [Paragraph 371(1)(aa)]

Amount of credit arising to FIF

Where the CFC has an interest in a FIF, the taxpayer will need to keep an attribution account for that CFC as well as for the underlying FIF. This will allocate the attribution credit relating to the attributable income of the CFC that is included in the taxpayer's assessable income as follows:

n attribution credit will arise for the underlying FIF to the extent that the attribution under section 456 reflects the amount of FIF income included in the attributable income of the CFC; and

n attribution credit will arise for the CFC, for the remainder of the amount attributed under section 456.

Method of allocation of the credits

A formula will be used to determine the part of the amount attributed under section 456 that related to the application of the FIF measures in the calculation of the attributable income of a CFC. The formula allocates the attribution credit on a gross income basis. That is, it compares the amount that a particular FIF contributed to the notional assessable income of the CFC to the total notional assessable income of the CFC. The formula is as follows:

(FIF income x section 456 amount) / notional assessable income


The ' FIF income' is the amount that was included in that CFC's notional assessable income because of the CFC's interest in a particular FIF. The 'section 456 amount' is the amount that is attributed from that CFC to the taxpayer under section 456. The 'notional assessable income' is the total notional assessable income of the CFC.

This formula is applied to each FIF in which the CFC held an interest that gave rise to an amount of FIF income being included in the CFC's notional assessable income. [Subsection 371(2A)]

The remainder of the section 456 amount that has not been allocated to the underlying FIFs creates an attribution credit for the taxpayer in respect of the CFC.[Subsection 371(2C)]

Example

Assume that a resident taxpayer (Mr Jones) has a 100 per cent interest in a CFC ( CFCco) which, in turn, has an interest in three FIFs. Mr Jones is not entitled to an exemption from the CFC measures, nor from the FIF measures in their application in the calculation of the notional assessable income for CFCco's statutory accounting period. CFCco derived untaxed royalty income (tainted) of $1,000,000 during its statutory accounting period and had allowable deductions of $2,000,000. The market value method is used to calculate the amount to be included in the attributable income of CFCco in relation to the FIFs and the market value increase for each of the underlying FIFs was as follows:

FIF One	$500,000
FIF Two	$700,000
FIF Three	$300,000

This is illustrated on the next page.

The calculation of the attributable income of CFCco would be as follows:

The amount included in Mr Jones' assessable income would be $500,000, being 100 per cent of the attributable income of CFCco. This means that the total of the credits to Mr Jones' attribution accounts must equal $500,000.

The attribution accounts for the FIFs will be credited in the proportion of the FIF income arising from each FIF compared to the gross notional assessable income arising to the CFC, as follows:

The CFC's attribution account will be credited with the remainder, as follows:

FIFs held by a CFC through an interposed FIF

Separate attribution accounts are required to be maintained by a taxpayer for each FIF held by a CFC through an interposed FIF if the calculation method is used to determine the attributable income of the interposed FIF.

An attribution credit will arise for a FIF (referred to in section 371 as the "eligible entity") held by a CFC through an interposed FIF if all of the following conditions are satisfied:

i)

n amount was included in a taxpayer's assessable income under section 456 in relation to a CFC (referred to in paragraph 371(1)(ab) as "the other entity"); [Subparagraph 371(1)(ab)(i)]

ii)

hat amount is referable to an amount which was included in the notional assessable income of the CFC under Part XI because the CFC had an interest in a FIF (this FIF is referred to in paragraph 371(1)(ab) as "the interposed entity"); [Subparagraph 371(1)(ab)(ii)]

iii)

he notional income (using the calculation method) of the interposed entity will include an amount referable to an interest that the interposed entity has in the eligible entity (that is, the FIF for which the attribution credit will arise under paragraph 371(1)(ab)). [Subparagraph 371(1)(ab)(iii)]

The diagram on the next page illustrates how the terms used in paragraph 371(1)(ab) relate to a structure of entities.

Amount of credit arising for the eligible entity

The following formula is to be used to determine the amount of the attribution credit which will arise for the FIF under paragraph 371(1)(ab): [Section 371(2B)]

(FIF income x Section 456 amount) / Notional assessable income
In the formula:

" FIF income" means the amount worked out using the formula:

( FIF income of the eligible entity x Section 529 amount) / Notional income of the interposed entity
where:

" FIF income of the eligible entity" means the amount included in the notional income of the interposed FIF entity under section 576 because it had an interest in the 'eligible entity' that is a FIF (that is, the entity for which the attribution credit will arise);

"Section 529 amount" means the amount included in the notional assessable income of the CFC under section 529 because of the interest it holds in the interposed FIF entity;

"Notional income of the interposed entity" means the notional income of the interposed FIF entity;

" Section 456 amount" means the amount included in the taxpayer's assessable income under section 456 because the taxpayer has an interest in the CFC;

"Notional assessable income" means the notional assessable income of the CFC in relation to the taxpayer.

This formula will apply to each FIF in which the interposed entity has an interest. [Subsection 371(2B)]

The remainder of the section 456 amount that has not been allocated to an underlying FIF under paragraph 371(1)(ab) creates an attribution credit for the taxpayer in respect of the interposed entity or of the CFC. The amount of the credit that arises for the interposed entity under paragraph 371(1)(aa) is calculated under subsection 371(2A) and reduced by the attribution credits which arise for entities held through the interposed entity under paragraph 371(1)(ab) [subsection 371(2D)]. The attribution credit which would normally arise for the CFC under paragraph 371(1)(a) is reduced by the amount of the attribution credit which would arise for the interposed entity if not for the reduction of that FIF attribution credit for the attribution credits which arise for entities held through the interposed entity. [Section 371(2C)]

Example

Assume that a resident taxpayer (Ms Brown) has a 50 per cent interest in a CFC ( CFCco) which has a 25 per cent interest in a FIF ("the interposed entity") which in turn has an interest in two FIFs ("FIF1" and "FIF2"). Refer to the diagram below.

During the relevant period, CFCco does not derive any income, whereas the interposed entity derives $10,000 income. In addition, under the market value method, the interposed entity is taken to have derived $20,000 FIF income from FIF1 and $40,000 FIF income from FIF2. Also, assume that the interposed entity has a past calculated loss of $30,000 and that the CFC has carried forward losses of $2,000 for the passive class of income.

(i) Calculation of the amount to be included in Ms Brown's assessable income because of her interest in < CFCco

The interposed entity has notional income of $70,000 (that is, $10,000 + $20,000 + $40,000). Its calculated profit would be $40,000 (that is, $70,000 less its past calculated loss of $30,000).

CFCco's notional assessable income will include $10,000 FIF income under section 529, being its share of the interposed entity's calculated profit. The attributable income of CFCco would be $8,000 (that is, $10,000 less its carried forward loss of $2,000).

Ms Brown's assessable income would include an amount of $4,000 (that is, 50% x $8,000) because of her interest in CFCco.

(ii) Attribution credits FIF 1

FIF1's " FIF income" would be calculated using the following formula":

(FIF income of the eligible entity x Section 529 amount) / Notional income of the interposed entity
FIF1's "FIF income" = ($20,000 x $10,000) / $70,000
= $2,857.14


The attribution credit which arises for FIF1 in relation to Ms Brown would be calculated using the following formula:

FIF income x Section 456 amount / Notional assessable income
FIF1's attribution credit = ($2,857.14 x $4,000) / $10,000
= $1,142.86


FIF 2

FIF2's " FIF income" would be calculated using the following formula"

( FIF income of the eligible entity x Section 529 amount) / Notional income of the interposed entity
FIF2's "FIF income" = ($40,000 x $10,000) / $70,000
= $5,714.29


The attribution credit which arises for FIF2 in relation to Ms Brown would be calculated using the following formula:

(FIF income x Section 456 amount) / Notional assessable income
FIF2's attribution credit = ($5,714.29 x $4,000) / $10,000
= $2,285.72


The interposed entity

The unmodified attribution credit which arises for the interposed entity in relation to Ms Brown would be calculated using the formula:

(FIF income x Section 456 amount) / Notional assessable income
The interposed entity's unmodified attribution credit = ($10,000 x $4,000) / $10,000
= $4,000


This amount must be reduced by the amount of the attribution credits which arise for FIF1 and FIF2. Consequently, an attribution credit of $571.42 ( that is, $4,000 - ($1,142.86 + $2,285.72) arises for the interposed entity in relation to Ms Brown.

CFCco

Normally an attribution credit of $4,000 would arise for CFCco in relation to Ms Brown [paragraph 371(1)(a)]. However, this credit must be reduced by the amount of the unmodified credit which arises for the interposed entity [ Subsection 371(2D) / Subsection 371(2B) ]. Consequently, the attribution credit which arises for CFCco is nil (that is, $4,000 - $4,000).

Attributed tax account credits

Overview

Attributed tax accounts ensure that a credit arising for foreign tax when an amount is included in a taxpayer's assessable income under the CFC measures cannot be claimed again when the taxpayer receives a distribution of profits from the CFC.

An attributed tax account credit will arise in relation to a taxpayer for a FIF held by a CFC if:

i)

n amount is included in the assessable income of the taxpayer under section 456 in respect of a statutory accounting period of a CFC; and

ii)

he taxpayer was taken under section 160AFCK to have paid and to be personally liable for an amount of foreign tax paid by the FIF in relation to the section 456 amount. [Paragraph 375(1)(da)]

[Refer to the Chapter 28 for a description of the operation of new section 160AFCK.]

The amount of the attributed tax account credit which arises for the FIF in relation to the taxpayer is equal to the amount of foreign tax the taxpayer is taken to have paid and to be personally liable for under section 160AFCK as a result of the taxpayer's interest in the FIF which is held through the relevant CFC. [Subsection 375(2)]

Clauses making the amendments

Clause 17: Amends section 371 of the Principal Act to ensure that attribution credits arising because a CFC has an interest in a FIF are allocated to the FIF.

Clause 18: Amends section 375 of the Principal Act to ensure that an attributed tax account credit arises for a FIF in relation to a taxpayer to the extent that the taxpayer can claim a credit for foreign tax paid by the FIF in relation to an amount included in the taxpayer's assessable income under section 456.