Three control tests
A CFC is a non-resident company that satisfies one of three control tests. Whether a company is a resident of a foreign country is determined according to the Australian tax law as modified by double taxation agreements with other countries.
The three control tests are the:
- strict control test
- assumed controller test
- de facto control test.
Strict control test
A foreign company will be treated as a CFC under the strict control test if a group of five or fewer Australian '1 per cent entities', together with their associates, own or are entitled to acquire a control interest of at least 50% in the foreign company.
An Australian 1 per cent entity is an Australian entity that, together with its associates, holds an interest of at least 1% in the foreign company.
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. A Part X Australian resident is a resident of Australia who is not treated solely as a resident of another country under a double taxation agreement between Australia and that country.
The associate-inclusive control interest of an entity is the sum of interests held by the entity and its associates in the foreign company. Interests that the entity and its associates are entitled to acquire are also taken into account.
Example 1: Strict control test
This test will be satisfied if three Australian residents each hold interests of 30%, 10% and 10% respectively in a foreign company.End of example
Assumed controller test
A foreign company will normally be treated as a CFC under the assumed controller test if a single Australian entity owns, or is entitled to acquire, an associate-inclusive control interest of at least 40% in the foreign company. An entity's associate-inclusive control interest in a foreign company is the sum of the interests held in the company by the entity and the associates of the entity. A foreign company will not be treated as a CFC under the assumed controller test, however, if the company is controlled by a party or parties unrelated to the single resident or its associates.
Example 2: Assumed controller test
If an Australian entity holds 45% of the interests in a foreign company and the remaining 55% is held by several non-residents, it would be assumed under this test that the Australian controls the foreign company.End of example
De facto control test
A foreign company will be treated as a CFC under the de facto control test if a group of five or fewer Australian entities, either alone or with associates, effectively control the foreign company.
Example 3: De facto control test
If an Australian entity can control the appointment of the directors of a foreign company, the Australian entity will generally be taken to have de facto control of that foreign company.End of example
When is control measured?
A statutory accounting period of a CFC is a period of 12 months ending 30 June, unless the CFC makes an election to use another period. The control test is applied at the end of a CFC's statutory accounting period to check whether income of the CFC is to be attributed.
It may also be necessary to measure control at the time a CFC pays a dividend to another CFC or to a controlled foreign trust or at the time a CFC changes residence.
Election to change a CFC's statutory accounting period
A CFC can make an election to change its statutory accounting period only if the accounting period is:
- regularly used by the CFC for complying with the tax law of a foreign country or
- regularly used by the CFC for reporting to its shareholders.
A CFC may also elect in writing to adopt a statutory accounting period ending on a date other than 30 June if the period is regularly used for complying with the tax laws of the CFC's country of residence or is regularly used for reporting to the CFC's shareholders. You may make this election on behalf of a wholly owned CFC.
A CFC may subsequently elect another statutory account period ending on any date, including 30 June, provided the above conditions are satisfied.
Where a CFC chooses another statutory accounting period, it must complete the current statutory accounting period. The intervening statutory accounting period - from the last day of the current period to the beginning of the new period - will be less than 12 months. The new and subsequent statutory accounting periods will be 12 months.
Example 4: Statutory accounting periods
If a company with a statutory accounting period ending 30 June 2002 elected on 30 August 2001 to change to a statutory account period ending 30 September, it would have statutory accounting periods of:
- 1 July 2001 to 30 June 2002
- 1 July 2002 to 30 September 2002
- 1 October 2002 to 30 September 2003,and
- subsequent 12-month statutory accounting periods ending 30 September.
It is not necessary for a CFC to complete the current statutory accounting period before beginning a new period if the election is made when the CFC first comes into existence or where a company first becomes a CFC.End of example
What interests in a foreign company are taken into account in the control tests?
In most cases, an interest in a foreign company will be held in the form of shares. This interest can be held either directly or indirectly through other entities. At a particular time, your interests in a foreign company include the interests you hold in the company as well as the interests you are entitled to acquire.
The interests of your associates in a foreign company are also relevant for determining whether you have an interest in the company.
Direct control interest in a foreign company
Your direct control interest in a foreign company is the greatest of the percentages that you hold, or are entitled to acquire, of the following:
- total paid-up share capital in the foreign company
- total rights to vote, or to participate in any decision making, in relation to:
- the distributions of capital or profits
- the changing of constituent documents
- the varying of share capital of the company
- total rights to distributions of capital or profits of the company on winding-up
- total rights to distributions of capital or profits of the company other than on winding-up.
Example 5: Direct control interest in a foreign company
A foreign company is established issuing 100 ordinary shares. An Australian taxpayer purchases 50 of these shares which entitle the taxpayer to 50% of the income, voting and capital rights of the company. The direct control interest of the Australian taxpayer in the foreign company is 50%.End of example
Example 6: Direct control interest in a foreign company where shares confer different rights
An Australian company has a 50% voting interest and a 75% income interest in a foreign company. The direct control interest of the Australian company in the foreign company is 75%.End of example
How is a direct control interest measured if the test time occurs before the end of an accounting period?
A taxpayer's direct control interest in a company has to be measured at a point in time - referred to as the test time.
However, in some cases it may not be possible to measure the percentage a taxpayer holds of the total rights to the profits of a company, or to a distribution of capital on winding up of the company, before the end of the accounting period of the company.
This would be the case, for example, if some shareholders are entitled to a fixed return of capital or profits.
In these cases, the taxpayer's rights to capital or profits are measured at the end of the accounting period of the company. It is assumed for this purpose that the rights held by the taxpayer at the test time are held at the end of the accounting period of the company.
Exclusion of eligible finance shares
Eligible finance shares are not taken into account in working out an entity's direct control interest in a company. Broadly, these are shares issued under preference share financing arrangements with Australian financial intermediaries - for example, banks - and their subsidiaries. In effect, the shares are issued in place of loans.
Exclusion of real estate investment trust shares
Real estate investment trust shares are not taken into account - except for section 459 of the Income Tax Assessment Act 1936 - in working out an entity's direct control interest in a United States real estate investment trust that derives income or holds assets principally in the United States. Control interests held through a United States real estate investment trust will still be taken into account in determining whether a subsidiary of the trust qualifies as a controlled foreign company (CFC). This will attribute income from a real estate investment trust subsidiary where a taxpayer has a direct interest in the subsidiary.
This exemption applies to statutory accounting periods of CFCs ending on or after 2 July 1998.
Indirect control interest in a company
A taxpayer may hold a direct control interest in an entity - entity A - which holds a direct control interest in another entity - entity B. In this case, the taxpayer has an indirect control interest in entity B.
A taxpayer's indirect control interest in entity B is obtained by multiplying the direct control interest of the taxpayer in entity A by the entity's direct control interest in entity B.
This process of multiplication is continued where there are further entities in the chain.
Indirect control interest may only be traced through a controlled foreign entity
An indirect control interest in a foreign entity can be traced only through controlled foreign entities (CFEs). These are CFCs, controlled foreign partnerships (CFPs) and controlled foreign trusts (CFTs).
A CFP is a partnership which does not have a resident partner and has at least one CFC or a CFT as a partner. A CFT is a trust, other than a resident trust:
- that has an eligible transferor - see appendix 2 or
- where five or fewer residents and their associates hold, or are entitled to acquire, 50% or more of the income or capital of the trust.
Deeming rules for tracing an indirect control interest
For determining the indirect control interest in an entity - but not for working out the amount of the income to be attributed to a taxpayer - a resident or an interposed CFC is deemed, in the following specified circumstances, to own a 100% interest in a lower tier entity.
The control tracing interest of an entity will be treated as 100% if, together with associates, the entity:
- has an interest of at least 50% in a foreign company
- satisfies the assumed controller test in relation to a foreign company
- actually controls the foreign company - is a partner in a partnership that is not an Australian partnership
- is an eligible transferor in relation to a trust, or
- has an interest of at least 50% in a trust that is not an Australian trust.
Example 7: Indirect control interest
A resident company holds a 60% interest in a foreign company, FC1, which holds a 35% interest in another foreign company, FC2. FC2 holds a 60% interest in foreign company FC3. Another resident holds a 20% interest in FC2.
The indirect control interest of the resident company in FC3 is:
Direct control interest
Control tracing interest
The indirect control interest of the resident company in FC3 is worked out as follows:
100% × 35% × 100% = 35%
It is possible to trace interests through FC2 because it is a CFC. FC3 is also a CFC because the resident company has an indirect control interest of 35% in FC3 and another resident has an indirect control interest of 20% in FC3 - that is, 20% in FC2 × 100% interest for tracing control of FC2 in FC3.End of example
Associate inclusive control interest
Your associate-inclusive control interest in a foreign company is the sum of:
- your direct control interests in the foreign company
- your indirect control interests in the foreign company
- the direct and indirect control interests of your associates in the foreign company.
To avoid double counting, an indirect control interest is not taken into account when determining a direct control interest or another indirect control interest.