Meaning of passive income
Dividends
Passive income includes all dividends. The term dividend includes:
- unit trust dividends received from a corporate unit trust or a public trading trust
- a distribution made by a liquidator which is deemed to be a dividend.
Interest income
Passive income includes tainted interest income, which is all interest income except for interest derived through an offshore banking unit. It also specifically includes:
- amounts in the nature of interest - for example, discounts
- income earned from hire purchase and other property financing transactions
- accrued interest on discounted and other deferred interest securities issued after 16 December 1984
- interest deemed to be derived where a CFC assumes the rights of a lender through the purchase of securities through a secondary market
- factoring income.
Tainted rental income
There are three categories of tainted rental income.
- Rent from associates
- Income from any leases between a CFC and an associate and any income that arises where rent is paid to the CFC by an associate.
- Lease of land
- Income from related party lease transactions and income from leases of land - including all fixtures - except where the land is located in the same country as the CFC is resident. The income from the lease of the land will not be tainted if the CFC provides labour-intensive property management by directors or employees of the CFC.
- Ships and aircraft
- Income from the lease of ships or aircraft, cargo containers for use on ships or aircraft or plant or equipment for use on board ships, unless the income relates to the provision of operating crew in relation to ships and aircraft or maintenance or management services by the CFC's directors or employees.
Excluded rental income
An amount of rental income will not be treated as tainted if the following three requirements are satisfied:
- the amount is derived from an associated CFC resident in the same country
- the amount is subject to the normal company rate of tax in that country
- the payment of the amount did not wholly or partly give rise to a notional allowable deduction for the associated CFC.
The second requirement is based on whether an amount has been subject to the normal company rate of tax in a country. For an amount to be treated as taxed at a country's normal company rate, the amount must be taxed at the same rate applicable to the company's other income or at a higher rate. In addition, there can be no entitlement to a credit, offset or tax concession in the taxation of the amount.
For the third requirement, it is assumed that the associated CFC failed the active income test. The requirement will not be satisfied if a payment would have resulted in a notional allowable deduction for an associated CFC if the CFC had been required to work out its attributable income.
This exclusion applies only for statutory accounting periods of CFCs commencing on or after 1 July 1997.
Tainted royalty income
Tainted royalty income includes income derived from assigning any copyright, patent, trademark or other like property or right.
Specifically excluded from tainted royalty income are royalties received from unrelated persons in the course of carrying on a business where the CFC substantially develops or improves the property or right for which the royalty is paid. For example, if a CFC develops software and licenses it to an unrelated party, the royalty income is not tainted.
Net gains on the disposal of tainted assets
The net gain - that is, the sum of gains less losses - from the disposal of tainted assets is included in passive income.
What is a tainted asset?
Tainted assets include:
- all shares, interests in trusts and interests in partnerships
- most financial instruments - such as loans, forward and futures contracts, swaps, other securities and life assurance policies
- rights or options over any of the above.
An asset will also be tainted if it is held by a CFC to derive tainted rental income. In order to determine whether an asset is used to produce tainted rental income, you must look at the use of the asset over the whole time of ownership. If the purpose changed during that period, the asset will be treated as being used to produce tainted rental income if this was the purpose for the majority of the period of ownership.
An asset will be treated as a tainted asset if it is not trading stock and is not used solely in carrying on business.
Exclusion of commodity investments
Commodity investments are not tainted assets. They are treated separately when working out net tainted commodity gains.
Proceeds from trading in tainted assets
Income derived in carrying on a business of trading in tainted assets is included in passive income.
Net tainted commodity gains
The net gain on the disposal of tainted commodity investments is included in passive income.
What is a tainted commodity gain?
A tainted commodity gain or loss arises from the disposal of a tainted commodity investment.
What is a tainted commodity investment?
Commodity investments that are tainted include futures or forward contracts for a commodity - or a right or option on such a contract - unless the company carries on a business of producing or processing the commodity or uses the commodity as a raw material. To be excluded, the contract right or option must relate to the carrying on of that business and the resultant physical sale of the commodity must not be tainted sales income.
Net tainted currency exchange gains
A net tainted currency gain is the sum of the tainted currency exchange gains less the sum of the tainted currency exchange losses. If this is positive there is a net gain. If not, the amount is ignored.
What is tainted currency exchange gain or loss?
A gain or loss from a currency exchange fluctuation will be tainted unless it falls within one of the following categories:
- the underlying transaction was for the purchase of goods from an unassociated person
- the underlying transaction was for the purchase or sale of depreciable plant or equipment that was used mainly to produce income that is not passive, tainted sales or tainted services
- the underlying transaction was a hedge for one of the preceding transactions
- the CFC was carrying on business as a currency trader and no other party to the transaction was an associate or an Australian resident.
Meaning of tainted sales income
The tainted sales income of a CFC includes that part of gross turnover that represents sales income where the goods sold were purchased from or sold to:
- an associate who is a Part X Australian resident, or
- an associate who is not a Part X Australian resident but carried on business in Australia through a permanent establishment.
Purchased from |
Tainted sales? |
|---|---|
Associated Australian |
Yes |
Associated non-resident |
Yes |
Unassociated Australian |
No |
Associated non-resident |
No |
Unassociated non-resident |
No |
Sold to |
Tainted sales? |
|---|---|
Associated Australian |
Yes |
Associated non-resident |
Yes |
Unassociated Australian |
No |
Associated non-resident |
No |
Unassociated non-resident |
No |
Exclusions from tainted sales income
Manufacturing exclusion
The main exclusion from tainted sales income is sales where the CFC manufactures, extracts, produces or substantially alters the goods sold. This would include, for example, sales from mining and quarrying operations.
This exclusion will apply only where the goods sold were manufactured, produced or substantially altered by the directors or employees of the CFC. The packaging and labelling of goods is not considered to be a substantial alteration of those goods.
The exclusion will not be available where the CFC subcontracts the manufacture, production or substantial alteration to agents or subcontractors. However, the fact that a CFC subcontracts some operations will not disqualify it from the manufacturing exclusion if directors or employees of the CFC carry out a substantial part of the manufacture, production or substantial alteration.
Hospitality exclusion
Also excluded from tainted sales income are sales that, broadly, arise from the tourism and hospitality industry. These are sales provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.
Passive income exclusion
Amounts of passive income are excluded from tainted sales income. This prevents double counting.
Meaning of tainted services income
Tainted services income, in broad terms, means income derived from the provision of services to either:
- an associate of the CFC
- a resident of Australia, or
- in connection with a permanent establishment in Australia.
Services includes any benefit, right or privilege provided under an arrangement for the performance of work or the provision of facilities for example, performance of technical, managerial or transport work.
Provided to |
Tainted services? |
|---|---|
Associated Australian |
Yes |
Associated non-resident |
Yes |
Unassociated Australian |
Yes |
Associated non-resident |
Yes |
Unassociated non-resident |
Yes |
Unassociated non-resident |
No |
Exclusions from tainted services income
General exclusions
Tainted services income does not include:
- royalties
- any income in respect of a lease of land
- any income from trading in tainted assets
- gains from currency exchange rate fluctuations, commodity investments and assets.
Manufacturing exclusion
There is an exclusion from tainted services income where the service relates to goods manufactured by a CFC. For example, payments for after sales service or income derived under a service contract for equipment manufactured by a CFC.
Hospitality exclusion
Also not included in tainted services income are services that, broadly, arise from the tourism and hospitality industry. These amounts are services provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.
Passive and tainted services income exclusion
Tainted services income does not include passive income or tainted sales income. This prevents double counting.
Exclusion for services income derived from a CFC resident in the same country
Amounts of services income will not be treated as tainted if the following three requirements are satisfied:
- the amounts are derived from an associated CFC resident in the same country
- the amounts are subject to the normal company rate of tax in that country and
- the payment of the amounts did not wholly or partly give rise to a notional allowable deduction for the associated CFC.
For more information on these requirements, refer to the exclusion for rental income discussed earlier in this section.
This exclusion is available only for statutory accounting periods of CFCs commencing on or after 1 July 1997.
Section 5 - Tainted income ratio for listed country CFCs for statutory accounting periods commencing before 1 July 1997
The following tainted income ratio is used to determine the active income test for a CFC in a country on the original list for statutory accounting periods commencing before 1 July 1997:
Tainted eligible designated concession income ÷ eligible designated concession income
Countries on the original list are shown at attachment A in appendix 1.
Eligible designated concession income (EDCI) is the part of gross turnover that is both:
- designated as a concession by the Income Tax Regulations - see appendix 1
- is not taxed in any listed country other than under a designated concession.
Tainted EDCI is EDCI that is also passive income, tainted sales income or tainted services income.