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Accruals taxation is the taxation of Australian residents on profits derived through a foreign company or trust as they are earned by the company or trust. Normally, the profits would not be taxed in Australia until they are distributed to the taxpayer as a dividend or trust distribution.
In this guide, the term 'the Act' means the Income Tax Assessment Act 1936, as amended. Unless specified otherwise, all references to legislation are to the ITAA 1936
Active income test
The active income test ensures that small amounts of tainted income derived by a controlled foreign company (CFC) are exempt from accruals taxation. An exemption is provided from accruals taxation for most amounts derived by a CFC if the test is satisfied.
Adjusted net foreign income
In relation to foreign tax credits, adjusted net foreign income (ANFI) is net foreign income adjusted for apportionable deductions.
Adjusted tainted income
Adjusted tainted income comprises passive, tainted sales and tainted services income.
In relation to foreign tax credits, apportionable deductions are those deductions of a concessional nature which do not relate directly to income-producing activities - for example, gifts.
Arm's length amount
This expression means, in relation to an actual transfer of property or services to a non-resident trust estate, the amount that the trustee of the non-resident trust might reasonably be expected to pay to the transferor for the property or services if the property or services had been transferred under an arrangement between independent parties dealing at arm's length with each other.
There are four parts to determining who are the associates of an entity. They deal with:
- associates of an individual
- associates of a company
- associates of a trustee
- associates of a partnership.
Part 1 - Associates of an individual
The associates of an individual - other than an individual acting in the capacity of a trustee - are:
- relatives of the individual - that is, the parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of his or her spouse; and the spouse of the individual or of any other person mentioned above
- a partner of the individual or a partnership of which the individual is a partner
- the spouse, including de facto spouse, or child of a partner, where the partner is also an individual - other than an individual acting in the capacity of a trustee
- the trustee of a trust, where the individual or another entity that is an associate by virtue of this part benefits under the trust
- a company where that company is sufficiently influenced by
- the individual
- another entity that is an associate of the individual because of the rules in this part or
- another company which is sufficiently influenced by the individual, or
- two or more of the above entities, or
- a company where the capacity to cast or control greater than 50% of the maximum votes at a general meeting of the company is held by
- the individual
- associates of the individual under the rules in this part
- the individual and the associates.
Part 2 - Associates of a company
Part 2 deals with the associates of a company - called company A. The associates of company A include:
- a partner of company A
- a partnership of which company A is a partner
- where a partner of company A is an individual otherwise than in the capacity of a trustee, the spouse or child of the partner
- the trustee of a trust where company A, or an entity that is an associate of company A, benefits under the trust
- an entity (entity B) that exerts sufficient influence over company A or holds a majority voting interest in company A. The influence may be exerted by entity B alone or together with other entities. The majority interest may be held by entity B alone or together with entities that would be associates of entity B if it were treated as company A
- a company (company C) that is sufficiently influenced by company A or in which company A holds a majority voting interest. The influence may be exerted by company A alone or together with other entities that are sufficiently influenced by company A or in which company A holds majority voting interests. The majority voting interests may be held by company A alone or together with entities that are associates of company A, and
- any other entity (entity D) that would be an associate of a third entity (entity E) which would be an associate of company A if the associates of entity E were determined by treating it as company A.
Majority voting interest
An entity holds a majority voting interest in a company if the following shareholdings amount to 50% or more of the maximum number of votes that can be cast at a general meeting of the company:
- the entity's direct shareholding in the company, and
- the entity's indirect shareholding in the company - for example, through a subsidiary.
An example is where a company has a wholly owned subsidiary that has a 75% voting interest in another company. Both the parent and subsidiary would be associates of the third company because the subsidiary has a majority voting interest in the third company and the parent has a majority voting interest in the subsidiary.
An entity is sufficiently influenced by a second entity or other entities if the entity is accustomed, under an obligation or might reasonably be expected to act in accordance with directions, instructions or wishes of the second entity or other entities.
Part 3 - Associates of a trustee
The associates of a trustee are:
- any entity that benefits under the trust
- any entity that is an associate of an individual who benefits under the trust, or
- an entity that is an associate of a company, where the company is an associate of the trustee under either of the two above dot points.
Rules relating to public unit trusts
In applying the tests for associates, the trustee of a public unit trust is treated as if it were a company. Special rules apply to determine whether a public unit trust is sufficiently influenced by another entity or whether an entity has a majority voting interest in the public unit trust.
Generally, a public unit trust will be sufficiently influenced by another entity or entities where the trust is accustomed to act or is under an obligation to act or might reasonably be expected to act in accordance with the directions, instructions or wishes of the entity or entities.
The concept of a majority voting interest in relation to a public unit trust is determined by reference to the capital or income of the trust. If an entity is entitled to, or is entitled to acquire, 50% or more of the income or capital of the trust, the entity is considered to hold a majority voting interest in the public unit trust. Corresponding rules apply to test whether a group of entities have a majority voting interest in the trust.
Part 4 - Associates of a partnership
The associates of a partnership are:
- a partner in the partnership
- any entity that would be an associate of an individual, where the partner is an individual, or
- any entity that would be an associate of a company, where the partner is a company.
Amounts taxed on an accruals basis under the CFC, transferor trust or foreign investment fund (FIF) measures.
An attributable taxpayer is an Australian entity that is liable to pay tax on attributable income.
The process by which income is taxed on an accruals basis under the CFC, transferor trust or FIF measures.
The attribution percentage is the pro rata share of a CFC's attributable income that will be attributed to a particular taxpayer's assessable income.
Australian 1% entity
An Australian 1% entity, in relation to a company or trust, is an Australian entity whose associate inclusive control interest in the company or trust is at least 1%.
An Australian entity is an Australian partnership, an Australian trust, or an entity - other than a partnership or trust - that is a Part X Australian resident.
An Australian partnership is a partnership of which at least one of the partners is an Australian entity.
Australian resident trust
An Australian resident trust is:
- a trust estate which, at any time during an income year, has a trustee who is a resident of Australia or has its central management and control in Australia
- a corporate unit trust or public trading trust which is taxed in the same way as a company, or
- a superannuation fund, approved deposit fund or pooled superannuation trust within the meaning of Part IX of the Act.
Australian tax payable
In relation to foreign tax credits, Australian tax payable is the product of the average rate of Australian tax and adjusted net foreign income less any rebates which are applicable to that income.
An Australian trust is a trust which at a particular time - or at a time in the 12 months before that time - has a trustee who is a Part X Australian resident or has its central control and management in Australia. It includes a corporate unit trust and a public trading trust as defined in the Act.
Average rate of Australian tax
In relation to foreign tax credits, average rate of Australian tax is gross tax on taxable income - less certain rebates - divided by taxable income.
See Permanent establishment
The CFC measures deal with the accruals taxation of Australian residents that have a controlling interest in a foreign company.
Controlled foreign company
Broadly, a controlled foreign company (CFC) is a company that is not a resident of Australia and is controlled by five or fewer residents.
Creditable taxes are, broadly, foreign taxes which are equivalent in nature to Australian income tax - for example, a tax on net income or capital gains - including tax imposed on attributed income.
Designated concession income
Designated concession income is income or profits of a kind specified in the Income Tax Regulations. Broadly, it refers to income or profits that are subject to a tax concession in a listed country. Details of the specified types of income and profits are set out in appendix 1 of this guide.
Discretionary trust estate
A discretionary trust estate is a trust estate for which:
- Both of the following conditions are satisfied:
- a person - including the trustee - has a power of appointment or other discretion, and
- the exercise of, or the failure to exercise, the power or discretion has the effect of determining, to any extent, either or both of the following:
- the persons who may benefit under the trust
- how the beneficiaries are to benefit under the trust
- One or more of the beneficiaries under the trust have a contingent or defeasible interest in some or all of the capital or income of the trust estate
- The trustee of another trust estate that satisfies both conditions in the first dot point above benefits or is capable of benefiting under the first-mentioned trust estate.
Double taxation agreement
A double taxation agreement (DTA) is an agreement made between the Australian Government and another Government under the International Tax Agreements Act 1953.
Eligible designated concession income
Eligible designated concession income (EDCI) is designated concession income, in relation to a particular listed country, derived by an entity in an income year:
- that is not subject to tax in another listed country in a tax accounting period that ends before the end of, or commences during, that income year, or
- is subject to tax in another listed country but is also designated concession income in relation to that other listed country.
For the purposes of accruals taxation under the CFC measures, an eligible transferor is an Australian entity or a controlled foreign entity that has transferred property or services in certain specified circumstances to a non-resident trust.
If the transfer was to a trust which is a discretionary trust before the IP time, the transferor will be an eligible transferor if he or she was able to control the trust at any time after the IP time and before the transfer. The IP time is 7.30pm, by standard time in the Australian Capital Territory, on 12 April 1989.
An exception is made where the transfer was an ordinary business transaction for full value. If the transfer was made after the IP time, the transferor will be an eligible transferor unless the transfer was for full value and the transferor did not have control of the trust after the transfer.
If the transfer was made after the IP time to a trust that is a non-discretionary trust or a public unit trust at the test time, the transferor will be an eligible transferor if the transfer was made for no consideration or for inadequate consideration.
Financial intermediary business
A banking business or a business whose income is principally derived from the lending of money.
Foreign investment fund
A foreign investment fund (FIF) is any foreign company or foreign trust - other than a deceased estate.
Foreign investment fund measures
The FIF measures deal with the accruals taxation of Australian residents that have a non-controlling interest in a foreign company or foreign trust.
Foreign tax credit system
Under the foreign tax credit system (FTCS) foreign source income derived by Australian residents - apart from certain salary and wage income - is generally subject to Australian tax. A credit for foreign tax paid is allowed against the Australian tax payable, up to the amount of the Australian income tax referable to the foreign income.
An income year - or year of income - is a 12-month period ending on 30 June, or a 12-month period ending on another date where the Commissioner has approved that other date under section 18 of the Act.
A foreign country that is declared by the Regulations to be a listed country for the purposes of the CFC rules (see attachment A of appendix 1).
In relation to a non-resident trust estate, net income essentially means the total assessable income of the trust estate, worked out as though the trustee were an Australian resident and a taxpayer in respect of that income, less all allowable deductions, as provided by section 95 of the Act.
Net foreign income
In relation to foreign tax credits, net foreign income (NFI) is gross assessable foreign income less:
- allowable deductions relating exclusively to foreign income
- any domestic loss carried forward that you have elected to use against foreign income, and
- deductions allowed by the Commissioner as being appropriately related to foreign income.
Non-discretionary trust estate
A non-resident trust estate is a non-discretionary trust estate if it is not a discretionary trust estate.
Broadly, non-portfolio dividends are dividends paid to a company where that company has a 10% or greater voting interest in the company paying the dividend.
Non-resident trust estate
A non-resident trust estate is a trust other than an Australian resident trust.
Notional accounting period
A notional accounting period is the period used to determine the attributable income of a FIF or a foreign life assurance policy (FLP).
Notional assessable income
The assessable income of a CFC for the purposes of determining the CFC's attributable income.
Offshore banking income
In relation to foreign tax credits, offshore banking income includes interest, fees, commissions or similar income derived from offshore banking transfers and dividends paid by a company out of profits derived from offshore banking transfers.
In relation to foreign tax credits, other income is income other than passive income, offshore banking income or certain lump sum payments from a foreign non-complying superannuation fund which are assessable under section 27CAA. It includes income from normal commercial activities, salary and wages and most pensions.
Part X Australian resident
A Part X Australian resident is a resident of Australia who is not treated solely as a resident of a treaty partner country under a double taxation agreement between Australia and that country.
Passive income includes certain types of dividend, interest, royalty, annuity and rental income (section 446). It also includes gains on the disposal of assets that produce passive income or that are not used solely in carrying on a business.
A permanent establishment is widely defined in subsection 6(1). Generally, it can be described as a place through or at which an entity in Australia conducts its business in another country. A permanent establishment is also referred to as a 'branch' in this publication.
This term includes money, a chose in action, any trust estate and interest, right or power, whether at law or in equity, in or over property.
Related foreign companies
Generally, an Australian company is related to a foreign company for the purposes of the FTCS when:
- the companies are both group companies, and
- the Australian company has, either directly or indirectly, a voting interest of at least 5% in the foreign company (section 160AFB).
For these purposes, a company is a group company when the Australian parent has a voting interest of at least 10% in the foreign company. If the foreign company has an equivalent interest in a second foreign company, then that second foreign company will also be a group company. This result will continue to apply through any number of tiers of companies.
Section 404 country
A foreign country that is declared by the Regulations to be a section 404 country for the purposes of the CFC rules (see attachment A of appendix 1).
This term includes any benefit, right, privilege or facility. Services include a right in relation to real or personal property as well as an interest in real or personal property. Services also include a right, benefit, privilege, service or facility that is provided or is to be provided:
- under an arrangement for, or in relation to:
- the performance of work, whether or not property was also provided as part of the work performed
- the provision of entertainment, recreation or instruction or the use of facilities for entertainment, recreation or instruction, or
- the conferring of benefits, rights or privileges for which remuneration is payable in the form of a royalty, tribute, levy or similar payment
- under a contract of insurance, including life assurance, or
- under an arrangement for, or in relation to, the lending of money.
Statutory accounting period
A statutory accounting period is the period used to determine the attributable income of a CFC.
Tainted income includes passive income, tainted sales income and tainted services income.
Tainted rental income
Tainted rental income includes rental income of a CFC where:
- land is leased to an associate or the rent is paid by an associate or
- land is leased by a company not resident in the same country.
It can also include rental income from particular leases on ships, aircraft or cargo containers.
Tainted sales income
Tainted sales income is income of a CFC from the sale of goods purchased from or sold to:
- an associate who is an Australian resident, or
- an associate who is not an Australian resident but carries on business in Australia through a permanent establishment.
Tainted services income
Tainted services income is, in very broad terms, income derived from the provision of services by a CFC:
- to an Australian resident, or
- in connection with a permanent establishment in Australia.
Tax sparing deems tax forgone by a foreign country in providing a specified concession to an Australian resident to be foreign tax paid for the purposes of Australia's foreign tax credit rules. The Australian resident may therefore be entitled to claim a credit for the tax forgone by the foreign country.
Transfer is defined in broad terms. In relation to the transfer of property, it includes a disposal of property by assignment, creation of a trust or any other manner or the provision of property. For the transfer of services, it includes such concepts as allow, confer, give, grant, perform or provide.
Transfer pricing rules
Transfer pricing rules are contained in Division 13 of Part III of the Act. This Division seeks to impose 'arms-length' consideration on agreements for the sale of property between Australians and non-residents when the agreement effectively shifts profits from Australia.
A non-resident trust to which a resident has made, or is deemed to have made, a transfer of property or services (Division 6AAA of Part III).
Transferor trust measures
The transferor trust measures deal with the accruals taxation of Australian residents who have directly or indirectly transferred value to a non-resident trust. Broadly, the rules operate to accruals tax the undistributed income of the trust.
Underlying tax means the amount by which the section 23AI part of a non-portfolio dividend would have been greater if no foreign tax had been paid by the company paying the dividend on the profits out of which that dividend is paid.
An unlisted country means a foreign country which is not a listed country.
Note: Unless specified otherwise, all references to legislation are to the Income Tax Assessment Act 1936
Last modified: 18 May 2020QC 19443