Tax havens and tax administration

The law in Australia

Broadly, under Australian tax law a resident is subject to Australian tax on their income from all sources inside or outside Australia. A non-resident is subject to Australian tax only on income from sources in Australia, as well as certain other amounts such as capital gains on some assets.

Residency for tax purposes and income source are central concepts in our tax laws. For example, a company that is not incorporated in Australia may nevertheless be regarded as resident and taxable in Australia if it carries on business in Australia and has its central management and control here (for more information refer to Taxation Ruling TR 2004/15).

As Australian residents are taxed on their worldwide income, they must report all relevant foreign income in their Australian income tax return. However some foreign-source income of Australian residents may be exempt from Australian tax. For example:

• some employment income derived by an Australian resident working overseas
• some dividends and branch profits derived by Australian resident companies
• some capital gains arising from the disposal of shares in a foreign company which are held either by Australian companies or controlled foreign companies (CFCs), to the extent that the foreign company has an underlying active business.

Certain foreign-source income and capital gains of 'temporary residents' may also be exempt. If there is a tax treaty between their country and Australia, non-residents' Australian-sourced business profits are generally non-taxable unless they have a permanent establishment in Australia.

Australia's tax law has specific provisions for international dealings, including dealings with tax havens. For example:

• under our foreign tax credit system, an Australian resident can receive a credit against Australian tax for foreign tax paid on certain income derived overseas
• Australian-sourced income (such as dividends, interest and royalties) paid to a non-resident is generally subject to a final withholding tax (although exemptions to this tax apply in some circumstances).

There are specific anti-tax-deferral provisions for Australian residents engaging in international dealings. These provisions set out the rules for taxing Australian resident taxpayers on the income of non-resident entities in which they have an interest. The income is taxed on an accruals basis, not when or if it is remitted back to Australia. The following information is an introduction to the anti-tax-deferral provisions.

• Controlled foreign companies (CFCs): Australian shareholders who have a controlling interest in certain foreign companies are taxed on their share of the foreign company's 'attributable income'. This includes passive income, such as income from investments (for example, rent, some interest, dividends and royalties) and certain sales and services income from related party transactions. This measure will generally not apply where the CFC's income is comparably taxed in certain countries or the income is derived almost exclusively from active business activities. Special anti-avoidance provisions may apply to specific benefits provided (directly or indirectly) by CFCs resident in certain countries, to their associated entities. That is, the benefit may be deemed to be a dividend paid to the recipient taxpayer and assessed accordingly.
   
• Transferor trusts: Where a taxpayer transfers property or services to a non-resident trust for inadequate or no consideration, some of the non-resident trust's income may be included in the taxpayer's assessable income. In certain circumstances, the transferor trust rules may apply to offshore trusts that a taxpayer may have established before migrating to Australia.
   
• Foreign investment funds: Where the CFC and transferor trust rules do not apply, Australian resident taxpayers may be taxed on income sheltered in offshore companies and trusts in which they do not have a controlling interest. This also applies to Australian residents who hold a foreign life insurance policy. Note that there are a number of exemptions to this measure.

There are other specific anti-avoidance provisions, such as measures for transfer pricing, thin capitalisation and value shifting that deal with arrangements to shift profits or value out of Australia. Further, the general anti-avoidance provisions of Australian tax law may also apply to international arrangements when its conditions are met.

Developments in Australian law

The Board of Taxation is currently (in 2007) reviewing the foreign-source income anti-tax-deferral regimes covering controlled foreign companies, foreign investment funds, transferor trusts and deemed present entitlements.

The review aims to reduce the complexity and compliance costs associated with the anti-tax-deferral regimes, with the possibility of collapsing them into a single regime. It will also examine whether the anti-tax-deferral regimes strike an appropriate balance between effectively countering tax deferral and unnecessarily inhibiting Australians from competing in the global economy. As at 30 June 2007 the Board had not presented its report to government.

Separate from the Board's review, on 24 September 2007, the Tax Laws Amendment (2007 Measures No. 4) Act 2007 received royal assent. The Act introduces new foreign income tax offset rules that remove the quarantining of foreign losses and foreign tax credits.

Sections within Tax havens in context

• What is a tax haven?
• Extent of tax haven use
• The law in Australia
• Lawful use of tax havens
• Arrangements we are concerned about
• What we are seeing and doing