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Section 3: Modifications to the treatment of capital gains and losses

Last updated 17 May 2020

The operation of the capital gains tax provisions of the Tax Acts is modified for working out the attributable income for a controlled foreign company (CFC).

Assets included in the calculation

Capital gains and losses taken into account in working out attributable income for a CFC are those arising on the disposal of assets, other than CGT assets which are taxable Australian property.

(A capital gain or loss on the disposal of a CGT asset which is taxable Australian property is taken into account in working out the actual assessable income of the CFC as a non-resident taxpayer and is therefore excluded from the calculation of the CFC's attributable income.

Note: This exclusion applies even if the relevant asset is not subject to capital gains tax (CGT) because it was acquired before 20 September 1985.

What is a CGT asset which is taxable Australian property?

In determining whether an asset is a CGT asset that is taxable Australian property, the assumption that the CFC is a resident of Australia is ignored. In almost all cases, however, the residency assumption will make no difference.

There are five categories of CGT assets that are taxable Australian property. These five categories are:

  1. Taxable Australian real property which is directly held.

This includes:

  • Real property situated in Australia; and
  • Mining, quarrying or prospecting rights where minerals, petroleum or quarry materials are situated in Australia.
  • Where such assets are depreciating assets, then capital gains and losses are disregarded for CGT purposes.
  1. Indirect Australian real property interest (other than interests in category 5)

A membership interest held by an entity in another entity where the following two tests are met:

  • Non-portfolio interest test (broadly where the interest in an entity, whether foreign or Australian, must be at least 10%); and
  • Principal asset test (where the market value of the entity's assets is principally attributable to Australian real property).

Note: Where an indirect Australian real property interest held on 10 May 2005 was not previously subject to CGT, its cost base is reset to its market value on that day. For the reset to occur, on 10 May 2005 the following must be satisfied:

  • The interest was held by a foreign resident (or trustee of a non-resident trust);
  • The interest was a post-CGT asset; and
  • The interest held by you and your associates in a public company or unit trust did not exceed 10%.
  • As a result, unrealised capital gains/losses on 10 May 2005 are not subject to CGT.
  1. Business assets used in an Australian permanent establishment of a foreign resident (other than assets in category 1, 2 or 5)
  2. Options or rights over category 1, 2 or 3 assets; and
  3. Assets where a CGT gain or loss is deferred when an entity ceases to be an Australian resident.

Note: The specific list of CGT assets which are taxable Australian property are set out in section 855-15 of the ITAA 1997.

Assets used to produce notional exempt income

In working out taxable income, the capital gains tax provisions do not normally apply to the disposal of assets used solely for the production of exempt income. However, in working out attributable income, capital gains or losses on the disposal of assets used to derive notional exempt income can be taken into account.

Removal of exemption of pre-20 September 1985 assets

When applying the capital gains tax provisions in working out attributable income, all CGT assets other than taxable Australian property that a CFC owns are deemed to have been acquired on 30 June 1990 or a later date being the last day of the most recent period during which there was not an attributable taxpayer with a positive attribution percentage. As such, the exemption for pre-20 September 1985 assets does not apply in working out attributable income.

Cost base of assets

The cost base of assets owned by a CFC is the market value at the later of:

  • the last day of the most recent period during which there was not an attributable taxpayer with a positive attribution percentage in relation to the CFC; and
  • 30 June 1990.

This day is called the 'commencing day'

Start of example

Example 24: Cost base of asset

A company is a CFC from 31 December 1990. However, there is not an attributable taxpayer with a positive attribution interest until 1 March 1993 at 5.00pm. The CFC acquired an asset on 1 May 1992 and disposes of the asset on 1 October 2006.

Consequences

The asset will be deemed to have been acquired for market value on 1 March 1993. This is the commencing day as it is the last day of the most recent period during which an attributable taxpayer did not have an attribution percentage. The capital gain or capital loss is therefore worked out using the change in the asset's value between 1 March 1993 and 1 October 2006.

End of example

Working out a gain or loss on disposal

You work out the amount to include in a CFC's notional assessable income in broadly the same way as for the usual operation of the capital gains tax provisions. That is, you must determine the excess of a CFC's capital gains over the CFC's capital losses and include that excess - the net capital gain - in the CFC's notional assessable income. A net loss can only be carried forward to be offset against future capital gains. However, there are certain modifications to the capital gains tax provisions that apply when working out attributable income.

Valuation date for assets owned at the end of the commencing day

An unrealised gain that accumulated on or before the commencing day will not be taxed. Correspondingly, any unrealised loss accumulated up to that date will not be allowed. This is done by valuing the assets on the commencing day and, in general, using that value as the consideration paid.

However, where an asset had decreased in value on or before the commencing day, the gain using the market value as the consideration paid could be bigger than the actual gain. Similarly, where the asset had appreciated in value on or before the commencing day, the loss using the market value as the consideration paid could be greater than the actual loss. In either of these cases, only the actual gain or loss is taken into account. To achieve this result, you must use as the consideration paid for such assets either the market value of the asset at the commencing day or the actual cost base of the asset, whichever produces the smaller gain or loss. That is:

  • in working out a gain, use the greater of the unindexed cost base and the market value on the commencing day
  • in working out a loss, use the lower of the unindexed cost base and market value on the commencing day.

Indexation of the cost base

The cost base of an asset acquired by a company on or before 21 September 1999 may be indexed for inflation. However, the cost base of the asset may only be indexed for inflation up until 21 September 1999 if that asset was held for at least 12 months.

Indexation factor

The indexation factor used is the same as that normally used under the capital gains tax provisions - the consumer price index. This index is published in the Guide to capital gains tax 2006–07 (NAT 4151). You can get the consumer price index from the Australian Bureau of Statistics in your capital city or from any Tax Office.

Adjustment to the cost base

In some cases, the cost base of an asset will need to be adjusted. This would occur where, for example, there was a return of capital on shares or a tax free distribution from a unit trust.

Phone the Business Infoline on 13 28 66 for more information.

Provisions for profit-making ventures

The provisions of the Act that include in assessable income a capital gain from the disposal of an asset purchased for profit-making by sale or from carrying out a profit-making undertaking or that allow a deduction for a loss - that is, sections 25A and 52 - do not apply in working out the attributable income of a CFC.

Treatment of a net capital loss under the capital gains tax provisions

In working out taxable income, capital losses are offset against capital gains to determine the net capital gain to include in assessable income. Where there is a net capital loss, you cannot use the loss to reduce assessable income. The same rules apply in working out attributable income.

A CFC cannot use a net capital loss under the CGT provisions to reduce its notional assessable income. It can only carry the loss forward for offset against capital gains in subsequent years.

You cannot transfer a loss - for example, you cannot use the loss of one CFC to reduce the notional assessable income of another CFC or your own assessable income.

In working out attributable income you cannot take into account a capital loss incurred on the disposal of an asset where the disposal occurred before 1 July 1990.

Where a company becomes a CFC after 30 June 1995, asset disposals made before it became a CFC are not taken into account when working out attributable income.

This ensures that a capital loss is not available where it is incurred before a company becoming a CFC.

Rollover of assets under the capital gains tax provisions

Forced disposals

The capital gains tax provisions allow you to defer working out a capital gain or capital loss where the disposal was:

  • as a result of a breakdown of marriage
  • caused by the loss or destruction of the asset
  • from certain resumptions of property
  • from the disposal of certain mining leases.

These rollover provisions will apply in working out the attributable income because of the assumption that the CFC is a resident.

Most of these provisions require that the person disposing of the asset must make an election. You can make the election on behalf of a wholly owned CFC. For more details, read Procedures for electing that the rollover provisions apply, below.

Group transfers

The CGT rollover provisions allow companies that have 100% common ownership to defer, in certain circumstances, capital gains or capital losses on assets transferred between companies in the group. In the case of asset transfers between CFCs with 100% common ownership the circumstances under which the rollover provisions apply are modified. These are set out in the table below:

Residence of CFC

Recipient company residence

Asset requirement

Resident of a listed country

Either a resident of that listed country or an Australian resident

Any asset

Resident of a listed country

A resident of a particular unlisted country

The asset must have been used in connection with a permanent establishment of the CFC in an unlisted country

Resident of an unlisted country

Either a resident of an unlisted country at that time or an Australian resident

Any asset

The assumption that a CFC is a resident of Australia is ignored in determining its residence for the group transfer provisions.

Procedures for electing that the rollover provisions apply

How to elect for rollover relief

If an election for rollover relief is required, a CFC - or in the case of group rollovers, both the transferor and transferee - must elect in writing that the particular rollover provision applies.

The CFC must normally make the election. An attributable taxpayer may, however, make an election on behalf of a wholly owned CFC.

Timing of elections

An election must be lodged with the Tax Office on or before the lodgment of a return by an attributable taxpayer that is affected by the election. If more than one attributable taxpayer is affected, the election will be valid if made on or before the lodgment of the affected tax returns.

Self-assessment - extension of time to make an election

The self-assessment guidelines do not apply to an election by a CFC for rollover relief and Taxation Ruling IT 2624 - Income tax: company self assessment; elections and other notifications; additional (penalty) tax; false or misleading statement does not authorise an extension of time in which to make the election. If an extension of time is required, the CFC or its agent should approach the Tax Office. For convenience, the request should go to the tax office where the tax return of the largest attributable taxpayer is lodged. If this is not readily apparent, the request can be lodged at any tax office.

Which officer makes the election?

The person who acts for the CFC should make the election. In Australia, that person would normally be the public officer of the company. However, foreign laws may require a different officer to act for the company. Whoever is authorised - whether under the foreign law or, if no law governs this, under the constituent document of the CFC - may make the election.

Election by an agent in Australia

The requirement that a CFC make an election will also be satisfied where an agent makes the election for or on behalf of the CFC, provided that the person is authorised by the CFC to do so. For example, the Australian parent of the CFC or the CFC's tax agent in Australia, if authorised, could make the election.

Reduction of disposal consideration where attributable income is not distributed

An adjustment will be made to the consideration received by a CFC in respect of the disposal of an interest in an attribution account entity if the income or profits of that entity have been attributed to you but have not been distributed. The adjustment only applies where the consideration is included in working out notional assessable income - whether under the capital gains tax provisions or any other provision.

The adjustment is mandatory and does not depend on any finding that the share price reflects the retained earnings. If you think that it applies to the CFC, you can contact the tax office where you lodge your return for more information.

CGT concession for active foreign companies

For certain CGT events happening on or after 1 April 2004, a CFC may be able to reduce its capital gains or capital losses arising in relation to its interest in a foreign company, including a CFC. This can be done when:

  • the CFC holds shares in a company that is a foreign resident (excluding eligible finance shares and widely distributed finance shares)
  • a CGT event occurs in respect of the CGT asset that is the share in the foreign company, and
  • the CFC has held a direct voting percentage of at least 10% in that foreign company for a continuous period of 12 months in the 24 months before the time of the CGT event.

The gain or loss resulting from the CGT event is reduced by a percentage, calculated at the time of the CGT event, called the active foreign business asset percentage. The method for calculating the active foreign business asset percentage is explained below.

Active foreign business asset

An asset will be an active foreign business asset if, at the time of the CGT event, it is:

  • an asset included in the total assets of the foreign company
  • used or held ready for use by the foreign company in the course of carrying on a business, and
  • not a CGT asset that is Australian taxable property.

Goodwill of the foreign company is included as an active business asset but financial instruments (other than shares and trade debts) are not included.

To be included in the total assets of the foreign company, the asset must be a CGT asset that is owned by the foreign company at the time of the CGT event.

Active foreign business asset percentage

You can work out the active foreign business asset percentage of a foreign resident company in relation to the CFC using either the market value method or the book value method. If you do not choose either method, the effect of the default method is that you will not gain any benefit under the concession.

Market value method

The active foreign business asset percentage is worked out under the market value method using the following formula:

Market value of all active foreign business assets ÷ market value of the total assets

Book value method

The active foreign business asset percentage is worked out under the book value method using the following formula:

Average value of active foreign business assets ÷ average value of total assets

The average value of the active foreign business assets is worked out using the following formula:

(Value of the active foreign business asset at the end of the most recent period + the value of the asset of the previous period) ÷ 2

The average value of the total assets of the foreign company are worked out in the same way.

After applying the formula under either method, the active foreign business asset percentage is determined as follows:

Result of calculation

Active foreign business asset percentage

< 10%

0%

10% - 89%

The result of the calculation

> 90%

100%

Foreign wholly owned groups

In certain circumstances where the determination of the active foreign business asset percentage involves a tier of foreign companies the calculation may be done on a consolidated basis for wholly owned companies comprising or within that tier of companies. This removes the need to determine the active foreign business asset percentage for each individual company in the tier where those companies are considered part of the wholly owned group. Rather, one calculation is performed for the top foreign company in the wholly owned group that also covers all its wholly owned foreign subsidiary companies.

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