Section 4: Is the tainted income ratio less than 5%?
This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.
End of attention
The tainted income ratio for a CFC is worked out as follows:
Gross tainted turnover ÷ gross turnover
Broadly, the gross turnover of a CFC is the sum of the company's net gains and gross revenue. Work out the gross turnover using the following five steps:
- identify the total gross revenue derived by the CFC
- exclude certain comparably taxed amounts
- exclude the proceeds of certain asset disposals
- add back net gains arising from certain asset disposals
- add the CFC's share of the gross turnover of each partnership in which it was a partner.
The figures used are mainly drawn from the accounts of the CFC. If the accounts are prepared in a foreign currency, there is no need to convert the amounts to Australian dollars.
Step 1 - Identify total gross revenue
The total gross revenue is the sum of amounts shown in the accounts of a CFC as gross revenue - that is, deductions are not taken into account. Do not include amounts that have not been brought to account in the period. For example, an amount may not be recognised in the accounts because its receipt is extremely doubtful. This amount would not be included in gross revenue. The exclusion of the amount must, however, be in accordance with commercially accepted accounting principles and give a true and fair view of the CFC's financial position.
Step 2 - Exclude comparably taxed amounts
Certain comparably taxed amounts are excluded from the active income test. They are:
- a franked dividend
- an amount included in the CFC's assessable income in any year of income, unless the amount is only subject to dividend or interest withholding tax or is not fully taxed - for example, certain shipping or insurance premiums
- an amount arising from the disposal of an asset that is taxable Australian property
- an amount that is an attribution account payment to the extent that the profits from which the payment was made have been previously been attributed to you
- an amount derived through a branch in a listed country if the amount is taxed in that country, and
- a non-portfolio dividend from a foreign company.
Because trust amounts arising to a CFC are attributed regardless of whether the CFC passes the active income test, they are also excluded from the tainted income ratio calculation.
Step 3 - Exclude proceeds from certain asset disposals
Amounts that arise from asset disposals are excluded from the gross revenue. However, this exclusion does not extend to disposals of trading stock. Amounts included in gross revenue from currency exchange rate fluctuations and commodity investments are also excluded.
Step 4 - Add back net gains
The amounts that were excluded under step 3 are brought back into gross turnover as net amounts. There are three separate net amounts:
- the net gain from the disposal of commodity investments
- the net gain from currency exchange rate fluctuations
- the net gain from the disposal of other assets that are not trading stock or commodity investments.
In each case, to determine the net gain, the sum of the individual gains is reduced by the sum of the losses. If there is a net loss, the amount is ignored - it does not reduce the gross turnover. It is important to note that there is a separate calculation of net gain for each of the categories. Do not take comparably taxed amounts into account.
Consideration paid or received for asset disposals must be included at market value. Where an amount has been written down in the accounts, the write-down is to be ignored.
Step 5 - Include partnership turnover
A CFC's share of the gross turnover of a partnership must be added to the CFC's gross turnover. This is done for each partnership in which the CFC is a partner. This means that you must go through the same process - steps 1 to 4 - for each partnership.
In working out the total, treat the partnership as if it were a CFC. The partnership is assumed to be a resident of the same country as the CFC.
Result of steps 1 to 5
Add the amounts at steps 2 and 3. Take this total away from the total revenue at step 1. The balance is the gross revenue after exclusions.
Add the totals of steps 4 and 5. This is the CFC's gross turnover.
Gross tainted turnover
Gross tainted turnover is the part of the gross turnover that is either passive income, tainted sales income or tainted services income.
Broadly, passive income includes:
- tainted interest income
- annuity income
- tainted rental income
- tainted royalty income
- amounts derived as consideration for the assignment in whole or part of any copyright, patent, design, trade mark or other like property or right
- net gains on the disposal of a tainted asset
- income derived in carrying on a business of trading in tainted assets
- net tainted commodity gains
- net tainted currency exchange gains.
Tainted sales income and tainted services income are, broadly, income from certain transactions with, or originating from, associates or Australian residents.
The gross tainted turnover is worked out using the following five steps:
Identify the part of gross revenue that is passive income.
Add the part of gross revenue that is tainted services income.
Add the part of gross revenue that is tainted sales income.
Add the part of the gross turnover that is net tainted gains.
Add the CFC's share of the gross tainted turnover of each partnership in which it was a partner.
Identify the tainted part of gross revenue (steps 1, 2 and 3)
Identify which parts of the gross revenue are passive income, tainted sales income or tainted services income - that is, determine the tainted part of the result after step 3 of the calculation of gross turnover.
Identify tainted net gains (step 4)
Identify the parts of the net gains that are tainted - that is:
- the part of the net gain from the disposal of commodity investments that is tainted
- the part of the net gain from currency exchange rate fluctuations that is tainted, and
- the part of the net gain from the disposal of assets - other than trading stock or commodity investments - that is tainted.
Each of the net tainted gains is calculated separately and cannot exceed the amount of the net gain to which it relates. To do this you will need, in each case, to calculate the net gain and the net tainted gain. If the net tainted gain is greater than the net gain, use the net gain instead of the net tainted gain.
Identify the CFC's share of a partnership's gross tainted turnover (step 5)
Go through steps 1 to 4 for each partnership in which a CFC was a partner. The CFC's share of the gross tainted turnover of each partnership is then added to the CFC's tainted income that was derived directly.
Working out the tainted income ratio
The tainted income ratio is worked out by dividing the gross tainted turnover of a CFC by the gross turnover of the CFC.
The following is a simple example of how to work out the tainted income ratio.
Example 15: Working out the tainted income ratio
(shown in accounts)
Interest - passive
Royalty - passive
Business income - from goods manufactured in Hong Kong
Tainted income ratio = gross tainted turnover ÷ gross turnover
3 million ÷ 63 million = 4.8% of gross turnover
Therefore, the CFC passes the test.
End of example
Is the tainted income ratio less than 5%?
Last modified: 18 May 2020QC 19443
The CFC has passed the active income test. Read on.
The CFC has failed the active income test. Go to part 3.