This section explains a number of general modifications to the taxation law which apply when working out the attributable income of a CFC. There are also modifications to:
- the treatment of gains and losses made by a CFC on the disposal of a capital asset
- the treatment of losses incurred by a CFC, including the quarantining of deductions, and
- the treatment of amounts derived through a partnership.
These modifications are dealt with in section 3, section 4 and section 5 of part 3.
Elections to be made by the taxpayer
You can make most elections on behalf of a CFC in working out its attributable income. You must make the elections when you lodge your tax return. The Tax Office may extend the time for making the elections.
Lodgment of elections
In the case of companies and superannuation funds, no notice of the election is to be sent to the Tax Office. Only give notice if the Tax Office requests you to do so.
Exceptions to the rule
An election for rollover relief under the capital gains tax provisions must normally be made by a CFC, although you can make the election for a wholly owned CFC. The rules for making these elections are explained in section 3 of part 3.
Functional currency elections are also an exception to the general rule that allows you to make most elections when working out the attributable income of a CFC - see Choice to use functional currency below.
Foreign currency conversion rules
When calculating attributable income you must convert all amounts into Australian currency. This conversion is done using the conversion rules under the usual operation of the Act. For more information see Translation (conversion) rules.
Choice to use functional currency
You can choose to calculate attributable income in the sole or predominant currency in which the CFC keeps its accounts (ledgers, journals, statements of financial performance etc) provided you are not an authorised deposit-taking institution (ADI) or a non-ADI financial institution. This sole or predominant currency is called the applicable functional currency.
When calculating attributable income in a functional currency, all amounts that are not in the applicable functional currency (including Australian currency amounts) must be converted into the applicable functional currency. This conversion is done using the conversion rules under the usual operation of the Act. However, when applying these rules, the applicable functional currency is taken not to be foreign currency and all other amounts (including Australian currency) are taken to be foreign currency.
Once you have calculated your attributable income, you then convert that amount into Australian currency in accordance with the relevant conversion rules.
The choice of applicable functional currency must be in writing but you are not required to notify the Commissioner. You must keep written evidence of the choice for as long as you are required to keep your tax records.
Generally, the choice will apply to the CFC's statutory accounting period immediately following the one in which you make the choice. However, it will apply to the statutory accounting period in which you make the choice where you make the choice within 90 days of the beginning of that statutory accounting period, or by 16 January 2004 (whichever is the later).
The choice to use the applicable functional currency applies until you withdraw it. You can only withdraw a choice where the functional currency has ceased to be the sole or predominant currency in which the CFC keeps its accounts. The withdrawal has effect from immediately after the end of the CFC's statutory accounting period in which the choice is withdrawn. The withdrawal must be in writing and retained with your tax records. You may make a new choice applicable to subsequent statutory accounting periods.
Treatment of foreign and Australian taxes
Deduction for taxes
A notional allowable deduction is available for foreign or Australian tax paid on amounts included in the attributable income of a CFC. An Australian tax is defined to be a withholding or income tax. It does not include additional taxes such as late payment penalties. If the tax is paid in a subsequent year, the earlier year's assessment can be amended subject to the time limits for amendments to allow a deduction for the tax.
Trading stock provisions
Valuation is cost only
In working out attributable income you must value trading stock at cost. The normal rules for determining the cost of trading stock are to apply.
What happens to obsolete stock?
In working out taxable income, a special valuation is allowed for obsolete stock. This valuation is not allowed when working out attributable income.
Depreciation provisions
Basis for depreciation
Generally, the normal depreciation rules apply for working out the attributable income of a CFC. This means you can choose to depreciate assets by the diminishing value method or the prime cost method. In addition, the rates of depreciation that apply for working out taxable income will also apply in working out attributable income.
Example 18: Deduction for depreciation
A CFC purchased a depreciable asset on 1 July 2005 and uses it solely for the production of notional assessable income. For the statutory accounting period ended 30 June 2006, depreciation would be worked out as follows using the diminishing value method.
Base value at 1 July 2005 |
$20,000 |
Effective life of asset |
7.5 years |
Adjustable value at 30 June 2006 |
$16,000 |
Notional depreciation for 2005-2006 |
$4,000 |
The formula for the diminishing value method is:
Decline in value = base value × (days held ÷ 365) × (150% ÷ asset's effective life)
End of exampleApportionment for exempt usage
A notional allowable deduction for depreciation must be reduced if an asset is only partially used for the production of notional assessable income. The normal rules apply in working out the reduction.
Example 19: Apportionment of deduction for depreciation
A CFC purchased a depreciable asset on 1 July 2006 and used it for the production of income. For the statutory accounting period ended 30 June 2007, only 50% of the usage was for the production of notional assessable income. Notional depreciation, using the diminishing value method, would be worked out as follows.
Base value at 1 July 2006 |
$20,000 |
Depreciation to 30 June 2007 |
$4,000 |
Adjustable value at 30 June 2007 |
$16,000 |
Notional depreciation in 2006-07 (50% of $4,000) |
$2,000 |
End of example
Asset used in a non-attributable period
Special rules apply for an asset held by a CFC during a period for which it was either:
- not necessary to work out the attributable income of the CFC, or
- not necessary to take depreciation on the asset into account in working out the attributable income of the CFC.
In such cases, the depreciation rules apply as if the asset were held solely for the production of notional assessable income during the period.
Example 20: Deduction for depreciation in non-attributable period
A CFC purchased a depreciable asset on 1 July 2004 and used it for the production of income. It was not necessary to work out the attributable income of the CFC for the statutory accounting period ending 30 June 2005. For the statutory accounting period ended 30 June 2006, only 50% of the usage was for the production of notional assessable income. In working out the notional depreciation for the 2005-06 statutory accounting period using the diminishing value method, the first step is to notionally depreciate the asset to the beginning of the income year.
Base value at 1 July 2004 |
$20,000 |
Depreciation to 30 June 2005 |
$4,000 |
Notional adjustable value at 30 June 2005 |
$16,000 |
The next step is to determine the depreciation for the 2005-06 income year.
Notional opening adjustable value at 1 July 2005 |
$16,000 |
Depreciation to 30 June 2006 |
$3,200 |
Notional adjustable value at 30 June 2006 |
$12,800 |
The last step is to apportion the depreciation because the asset is not used wholly for the production of notional assessable income.
Notional depreciation in 2005-06 (50% of $3,200) |
$1,600 |
End of example
Sale of a depreciable asset
Under the normal operation of the Act, a deduction for the difference may be allowed where an asset is sold for less than the notional depreciated value of the asset. This deduction is also allowable in working out the attributable income of a CFC.
Example 21: Deduction on disposal
In the next statutory accounting period the depreciable asset in example 20 was again used for 50% of the time to derive notional assessable income. At the end of the year it was sold for $9,000. The depreciation calculation would be as follows.
Notional opening adjustable value at 1 July 2006 |
$12,800 |
Depreciation to 30 June 2007 |
$2,560 |
Notional adjustable value at 30 June 2007 |
$10,240 |
Proceeds of sale |
$9,000 |
Notional loss |
$1,240 |
Notional depreciation in 2006-07 (50% of $2,560) |
$1,280 |
Notional deduction for loss (50% of $1,240) |
$620 |
An amount may also be included in notional assessable income as a result of the sale of the asset.
End of example
Example 22: Notional assessable income on disposal
Assume that the asset was sold for $18,000. In this case an amount would be included in notional assessable income as follows.
Base value at 1 July 2004 |
$20,000 |
Depreciation allowed |
$2,800 |
Adjustable value at 30 June 2007 |
$17,120 |
Proceeds of sale |
$18,000 |
Less adjustable value |
$17,120 |
Notional assessable income on disposal |
$880 |
End of example
Phone the Business Infoline on 13 28 66 for more information.
What about other capital deductions?
There are other provisions of the Act that allow for a deduction of the capital amounts and these may apply when working out attributable income. Where the assets were used in a non-attributable income period, the Tax Office must determine the amount of the deduction allowed or the recoupment included in notional assessable income. However, it is not expected that this will often occur.
Phone the Business Infoline on 13 28 66 for more information.
Transfer pricing rules
The Act contains measures to counter arrangements designed to move profits from one entity to another. These arrangements are commonly called transfer pricing or profit shifting. Broadly, the transfer pricing rules allow the Tax Office to increase a taxpayer's assessable income or decrease allowable deductions to negate the effect of the arrangement - see Division 13 of Part III.
International agreement
The rules apply only where there is an international agreement. For the purpose of applying the definition of an international agreement, the CFC is treated as a resident of a foreign country. The result is that the transfer pricing rules apply to most non-arm's length arrangements involving the CFC.
Example 23: CFC in an unlisted country
Unlist Co1, which you wholly own, is a CFC resident of an unlisted country. In turn, Unlist Co1 wholly owns another CFC in an unlisted country - Unlist Co2. Unlist Co1 lends Unlist Co2 $1 million and there is no interest payable on the loan. The market interest rate is 10%.
Unlist Co1 will be taken to have received $100,000 on the loan. This amount will be tainted interest income and will be included in the tainted income of the company. If the company fails the active income test, the notional assessable income of Unlist Co1 will include $100,000.
End of exampleApplication of the transfer pricing rules to non-arm's length arrangements involving CFCs resident in the same listed country
The transfer pricing rules do not apply to arrangements involving CFCs resident in the same listed country at any time when an international agreement is in force.
Impact on the active income test
The Tax Office can make adjustments reflecting arm's length values to amounts used in determining whether a CFC has passed the active income test. An adjustment can be made if, in working out the attributable income of a CFC, the Tax Office would make a transfer pricing adjustment in relation to the acquisition or supply of property by the CFC.
Requests for rulings
You can request a ruling from the Tax Office on whether Division 13, as modified, applies to an arrangement.
Compensating adjustments
To avoid double taxation, the Tax Office may make adjustments in the assessment of another taxpayer to compensate for a transfer pricing adjustment. A compensatory adjustment may be required, for instance, where a transfer pricing adjustment is made to decrease the amount of a royalty payment made to a related company. In this case, a compensatory adjustment could be made to reduce the amount included in the assessable income of the related company as a result of the royalty payment.
As with the usual operation of the transfer pricing rules, where one CFC's notional assessable income or notional allowable deductions are adjusted, the Tax Office may make a compensating adjustment to:
- a taxpayer's allowable deductions or assessable income
- another CFC's notional assessable income or notional allowable deductions, or
- the attributable income of a transferor trust estate.
Similarly, compensating adjustments may be made to the attributable income of a CFC when the transfer pricing rules have been applied to:
- a taxpayer's allowable deductions or assessable income, or
- the attributable income of a transferor trust estate.
Deduction for eligible finance shares
A deduction is not normally available for the payment of a dividend. A notional allowable deduction is available, however, for an eligible finance share dividend paid by a CFC. Broadly, this is a dividend paid on a share issued under a preference share financing arrangement with an Australian financial intermediary - for example, a bank - and its subsidiaries. In effect, the issue of eligible finance shares is treated as a type of loan.
Dividends on eligible finance shares are treated as an interest expense. A notional allowable deduction is available for the dividends to the extent a notional allowable deduction would have been payable if the dividends had been an interest outgoing.
Deduction for widely distributed and transitional finance shares
A deduction, similar to that provided for eligible finance shares, is available for dividends paid by a CFC on widely distributed finance shares. Widely distributed finance shares include shares issued by a CFC as a public issue under a preference share financing arrangement to persons who are not associates of the CFC and who have provided finance on arm's length terms. To qualify, the shareholders should have no interest in the CFC apart from ensuring repayment of the funds and regular payment of the dividends in a form which is, in effect, a substitution for interest on a loan.
A deduction is also available for dividends paid by a CFC on transitional finance shares. Transitional finance shares are shares issued by a CFC to a related CFC and paid for by the related CFC out of funds raised by the issue of widely distributed finance shares. The transitional finance shares must be issued under similar terms to the widely distributed finance shares.
Sunset clause
The deduction for dividends paid on transitional finance shares is only available where the shares were issued before 12 April 1989. A sunset clause is provided so that a deduction for dividends paid on transitional finance shares is only available for dividends paid by the CFC before 1 July 1998.
Diagram 3: Operation of widely distributed finance share measures
members of the public |
-> |
funds raised by public issue of widely distributed finance shares |
-> |
CFC A |
-> |
funds may be lent |
-> |
CFC B |
Diagram 4: Operation of transitional finance share measures
members of the public |
-> |
funds raised by public issue of widely distributed finance shares |
-> |
CFC A |
-> |
funds provided through share issue |
-> |
CFC B |
In each of the diagrams, a deduction is available from the attributable income of CFC A for dividends paid on its widely distributed finance shares.
In diagram 3, CFC B is allowed a deduction for interest paid to CFC A on the loan from that company.
In diagram 4, a deduction is available from the attributable income of CFC B for dividends paid on shares that it issued to CFC A on substantially the same terms as widely distributed finance shares issued by CFC A.