Explanatory MemorandumCirculated By the Authority of the Treasurer, the Hon Wayne Swan MP
Chapter 1 - Repeal of the foreign investment fund and deemed present entitlement rules
Outline of chapter
1.1 Schedule 1 to this Bill repeals the foreign investment fund (FIF) and the deemed present entitlement rules in the Income Tax Assessment Act 1936 ( ITAA 1936).
1.2 This Schedule also makes consequential amendments to the ITAA 1936, the Income Tax Assessment Act 1997 ( ITAA 1997) and to the Superannuation Industry (Supervision) Act 1993 as a result of the repeal of the FIF and deemed present entitlement rules.
1.3 This chapter explains:
- the effect of the repeal on certain areas of the taxation law; and
- the consequential amendments.
1.4 All legislative references are to the ITAA 1936 unless otherwise stated.
Context of amendments
1.5 Following a comprehensive review by the Board of Taxation, the Government announced in the 2009-10 Budget its intention to repeal the FIF and deemed present entitlement rules (see the then Assistant Treasurer and Minister for Competition Policy and Consumer Affairs' Media Release No. 049 of 12 May 2009).
1.6 The repeal of the FIF and deemed present entitlement rules is the first instalment in a package of reforms designed to improve the operation of the foreign source income anti-tax-deferral (attribution) rules. The remaining reforms, which were also announced by the Government in the 2009-10 Budget, will modernise the controlled foreign company (CFC) rules and improve the effectiveness of the transferor trust rules. It is anticipated that these measures will be introduced into Parliament as soon as practicable together with a specific anti-roll-up fund rule that was also announced by the Government as part of these reforms.
1.7 For taxpayers that have exposure to the FIF and deemed present entitlement rules, their repeal will considerably simplify compliance with the law. Repealing the FIF rules also contributes to achieving the Government's objective to promote Australia as a financial hub in our region and supports Australian jobs by reducing complexity and compliance costs associated with the making of foreign investments.
1.8 The managed fund sector, in particular, has contended that the FIF regime imposes significant costs and an uncompetitive tax burden on Australian fund managers. These changes will make the handling of their foreign investments much simpler.
1.9 In the absence of the FIF and deemed present entitlement rules, resident beneficiaries holding interests in foreign trusts will need to turn to the ordinary trust rules contained in Division 6 and the transferor trust provisions in Division 6AAA in order to determine their tax obligations. The ordinary trust rules will also continue to apply in precedence to the transferor trust rules. This outcome is largely consistent with the arrangements that applied prior to the introduction of the FIF and deemed present entitlement regimes in 1992.
Summary of new law
1.10 Part 1 of this Schedule:
- repeals section 96A, Part XI (the FIF rules) and sections 96B and 96C (the deemed present entitlement rules) of the ITAA 1936;
- makes consequential amendments to the ITAA 1936 and the ITAA 1997 as a result of the repeal of these rules; and
- preserves the effect of certain elections that are currently linked to the operation of the FIF rules.
1.11 Part 2 of this Schedule ensures the provisions dealing with the disposal of interests in foreign entities where amounts have been previously attributed will continue to operate as intended.
Detailed explanation of new law
Amendments to the Income Tax Assessment Act 1936
Rules being repealed
FIF and deemed present entitlement rules
1.12 The FIF rules currently apply to Australian residents with non-controlling shareholdings in foreign companies or with interests in foreign trusts. These rules apply to approximate a resident taxpayer's share of the undistributed profits of a FIF and to assess the taxpayer on those profits. The FIF rules also apply to Australian residents with an interest in a foreign life assurance policy.
1.13 The deemed present entitlement rules currently apply to interests in closely held foreign trusts and other interests in foreign trusts that are exempt from the FIF rules. These rules deem beneficiaries to be presently entitled to a share of profits accumulated in a foreign trust based on their rights to receive distributions from the trust in the future.
1.14 This Schedule repeals the FIF rules and the deemed present entitlement rules in relation to the 2010-11 and later income years . [Schedule 1, items 9 and 37, Part XI and sections 96B and 96C]
1.15 Section 96A is designed to alleviate possible double Australian tax in relation to taxation under the FIF regime, and to reduce the compliance burden on small investors in resident public unit trusts.
1.16 Subsection 96A(1) excludes from the assessable income of a presently entitled resident beneficiary of a non-resident trust, the beneficiary's share of the net income of the trust estate which is attributable under the FIF regime (or, but for Division 8 or 11A of Part XI, would have been attributed under the FIF regime).
1.17 The effect of subsection 96A(1) is two-fold:
- to ensure amounts attributable under the FIF regime are not subject to tax under Division 6 of Part III of the ITAA 1936; and
- to ensure that section 97 does not apply where a beneficiary of a trust is specifically exempted from attribution under the FIF regime (where Division 8 or 11A of Part XI apply).
1.18 Subsection 96A(1A) also prevents double taxation of a trust's income. The broad effect of this subsection is that an amount (other than an amount relating to an interest in a FIF to which Division 8 of Part XI applies) which is not assessable to a beneficiary under section 97 by subsection 96A(1), is also not assessable under sections 99 and 99A (for the trustee), and section 102AAU (for a transferor). The reference to Division 8 limits the circumstances where subsection 96A(1A) reduces the assessable income (Australian source income) of a trustee.
1.19 Subsection 96A(2) provides that the impact of the FIF measures will not apply in the calculation of a taxpayer's share of net income of a resident public unit trust where the taxpayer is a natural person with not more than $50,000 invested in foreign companies, trusts, life policies and resident public unit trusts
1.20 Subsections 96A(3A) and 96A(3B) ensure that taxation does not arise under both the CFC and FIF measures where a beneficiary in a non-resident trust estate has an interest in a CFC which is held through that trust. In this regard, double taxation may only arise in relation to non-resident trust estates where they are also controlled foreign trusts for the purposes of the CFC measures. Taxation under the CFC measures is given priority and the net income of the trust does not include any FIF amount.
1.21 As a consequence of repealing the FIF rules, this Schedule repeals section 96A as there is no longer a need to deal with the possibility of double taxation that this section deals with.
1.22 The practical effect of the repeal of section 96A is that certain amounts that are excluded from taxation under Division 6 of Part III of the ITAA 1936 (specifically, income explicitly exempt from the FIF rules under Divisions 8 and 11A of Part XI of the ITAA 1936) may now be taxed under that Division . [Schedule 1, item 9, section 96A]
1.23 The repeal of section 96A applies in relation to the 2010-11 year of income for a taxpayer and later income years . [Schedule 1, item 9 and subitem 93(1), section 96A]
Amounts paid out of attributed FIF income is not assessable
1.24 Section 23AK prevents double taxation in relation to amounts paid out of attributed FIF income. A FIF attribution account payment received by a taxpayer from a trust, partnership, foreign life assurance policy or non-resident company is exempt from tax to the extent of the attribution surplus in the relevant FIF attribution account.
1.25 This Schedule substitutes a new section 23AK so that amounts previously taxed under the FIF rules will continue to be exempt from further tax upon their subsequent distribution . [Schedule 1, item 7, section 23AK]
Reduction of disposal consideration if FIF attributed income is not distributed
1.26 Existing section 613 within Part XI ensures there is no double taxation in relation to a disposal of an interest in a FIF where the income of the FIF has been attributed but not distributed before the disposal. The section operates to reduce the proceeds from a capital gain where the taxpayer has an attribution surplus in relation to that FIF.
1.27 This Schedule inserts new section 23B to preserve the effect of section 613 . [Schedule 1, item 7, section 23B]
1.28 This Schedule also corrects a technical deficiency that inappropriately prevented the consideration from being reduced where the asset is held on revenue account (as opposed to capital account). This amendment applies from the 2006-07 and later income years, the moment when the defect first arose (being the application of the amendments made by the Tax Laws Amendment (Repeal of Inoperative Provisions) Act 2006). [Schedule 1, items 92 and 94, section 613]
Reduction of disposal consideration if CFC attributed income is not distributed
1.29 Amendments similar to those made to section 613 have been made to sections 401 and 461, for interests in CFCs. The future of those sections will depend on the rewrite of the CFC provisions . [Schedule 1, items 88 to 91, subsections 401(1) and (3), subsections 461(1) and (3)]
Amendments to the Income Tax Assessment Act 1997
Interaction with Division 230
1.30 In broad terms, Division 230 of the ITAA 1997 applies to gains and losses arising from a financial arrangement unless a specific exception applies. One of these exceptions includes interests in FIFs (which, importantly, includes CFC interests) and foreign life assurance policies (subsection 230-460(12)). This has the effect that the FIF and CFC rules apply in precedence to Division 230.
1.31 In the absence of the FIF rules it follows that an amendment is required to Division 230. The effect of this amendment will be that direct participation interests of an attributable taxpayer in a CFC will be excepted from the operation of Division 230. Other interests in foreign companies (whether FIFs or CFCs), foreign trusts and foreign life assurance policies will not to be explicitly exempted from the coverage of Division 230 . [Schedule 1, item 49, subsection 230-460(12)]
Foreign companies that are a FIF and use the CFC calculation method
1.32 Under the existing FIF rules, a taxpayer can elect to have the FIF income calculated by using the CFC provisions, with the FIF afforded treatment as an Australian financial institution subsidiary. Where that election has been made, section 768-533 of the ITAA 1997 currently provides similar recognition of the special nature of bank subsidiaries when the taxpayer disposes of its interest in the FIF.
1.33 An amendment to subsection 768-533(1) will ensure that, with the repeal of the FIF rules, taxpayers will continue to be able to take advantage of electing to use the CFC provisions (and thereby treat the FIF as an Australian financial institution subsidiary) when it comes to determining any reduction in a capital gain or capital loss arising from a CGT event that happens in relation to a share in a foreign company . [Schedule 1, item 62, subsection 768-533(1)]
Foreign hybrid limited partnerships and foreign hybrid companies
1.34 Amendments to sections 830-10 and 830-15 of the ITAA 1997 (which treat certain entities as foreign hybrids and therefore taxed like partnerships) are made to ensure that:
- following the repeal of section 485AA, taxpayers can continue to rely on an election made under that section (before its repeal), and can make an election under subsections 830-10(2) or 830-15(5) (subsequent to the repeal of section 485AA); and
- the interaction of subsections 830-10(1) and 830-15(1) (automatic treatment of an entity as a foreign hybrid) with the new election for foreign hybrid treatment continue to operate as intended.
Election for foreign hybrid treatment
1.35 This Schedule amends subsections 830-10(2) and 830-15(5) to maintain an election made under subsection 485AA(1) prior to its repeal.
1.36 Further, this Schedule inserts a new election mechanism so that, going forward, taxpayers will be able to elect for hybrid treatment (that is, treatment as a partnership) despite the repeal of section 485AA. The conditions required for making this election are the same as those required under the former section 485AA . [Schedule 1, items 76, 78 and 96, subsections 830-10(2) and 830-15(5)]
Interaction of an election for foreign hybrid treatment and automatic foreign hybrid treatment
1.37 Subsection 830-10(1) of the ITAA 1997 provides that a limited partnership is a foreign hybrid limited partnership in relation to an income year only if it satisfies five conditions:
- the limited partnership must be formed in a foreign country;
- foreign income tax is imposed under the law of the foreign country on the partners, not the limited partnership in respect of the income or profits of the partnership;
- at no time, during the year of income is the limited partnership, for the purposes of the tax law of any foreign country, treated as a resident of that country;
- the limited partnership must not be an Australian resident at any time during the income year; and
- the limited partnership is a CFC with at least one attributable taxpayer having an attribution percentage greater than nil.
1.38 Similarly, subsection 830-15(1) provides that certain companies are foreign hybrid companies where the conditions in that subsection are met.
1.39 However, if a particular partner in a limited partnership (or a shareholder in a foreign company) is not an attributable taxpayer in relation to that foreign entity (either because the entity is not a CFC, or because they do not hold a sufficient interest in an entity that is a CFC to be an attributable taxpayer), then the partner (shareholder) can choose whether or not that interest held is treated as an interest in a foreign hybrid limited partnership (or company).
1.40 Amendments to section 830-10 and 830-15 ensure that, with the inclusion of the election for foreign hybrid treatment in subsections 830-10(2) and 830-15(5), those sections operate as intended.
1.41 That is, where the taxpayer is not an attributable taxpayer in relation to a foreign limited partnership (or company), the taxpayer will have the right to choose whether partnership treatment is to apply to its interest in the limited partnership (or company). Where such election is not made, the normal tax treatment will continue to apply (for example, they may be treated as holding a share in a company). This will be the case despite the fact that there may be another taxpayer that is an attributable taxpayer in relation to the foreign limited partnership (or company) that is a CFC . [Schedule 1, items 75 to 78, subsections 830-10(1) and (2), and subsections 830-15(1) and (5)]
Example 1.1 On 1 July 2011 Jess, an Australian resident taxpayer, acquires a 2 per cent interest in US LLC. At 30 June 2012 Andy (an Australian resident taxpayer) holds a 10 per cent interest in US LLC (which is a CFC with Andy an attributable taxpayer in relation to US LLC).For the 2011-12 income year US LLC meets all of the requirements of subsection 830-15(1) and is therefore a foreign hybrid company in relation to the 2011-12 income year. Andy's interest in the CFC is therefore treated as an interest in a partnership.Jess does not make an election under subsection 830-15(5) for her interest to be treated as an interest in a foreign hybrid company. Although the US LLC is treated as a foreign hybrid company because of Andy's interest, the fact that Jess has not made an election under subsection 830-15(5) means that Jess's interest is not treated as an interest in a foreign hybrid company.
Example 1.2 Assume the same facts as in Example 1.1, but Andy does not hold any interest in US LLC. Also, no other Australian resident taxpayer is an attributable taxpayer in relation to US LLC. US LLC does not meet all of the requirements of subsection 830-15(1) and therefore is not a foreign hybrid company in relation to the 2011-12 income year.In relation to the 2011-12 income year, all of the requirements in subsection 830-15(7) are satisfied. On or before the day on which Jess lodges her income tax return for the 2011-12 year, Jess makes an election under subsection 830-15(5) for her interest in US LLC to be treated as an interest in a foreign hybrid company. Jess's interest in US LLC is treated as an interest in a partnership.This election is in force during the 2011-12 income year and all later income years and is irrevocable.
Application and saving provisions
Application of Part 1 amendments
1.42 The amendments made by items 2 to 7, 9, 37, 39, 47 to 49, 51, 54 to 56, 59 to 80 and 82 to 87 apply in relation to the 2010-11 and later income years for taxpayers . [Schedule 1, subitem 93(1)]
1.43 The amendments made by items 10 to 13 apply in relation to the 2010-11 and later income years for trust estates . [Schedule 1, subitem 93(2)]
1.44 The amendments made by items 14 to 36 apply in relation to statutory accounting periods ending in the 2010-11 and later income years . [Schedule 1, subitem 93(3)]
Application of Part 2 amendments
1.45 The amendments made by Part 2 apply to assessments for the 2006-07 income year and later income years. These are backdated because the amendments reverse the effect of the Tax Laws Amendment (Repeal of Inoperative Provisions) Act 2006 and are consistent with the application date of that Act . [Schedule 1, item 94]
Saving of regulations relating to stock exchanges
1.46 The first of the savings provisions prevents the definition of 'approved stock exchange' being affected by the repeal of Part XI (item 37) and provides that regulations made for the purposes of that definition that were in force immediately before this item commences continue in force on and after that commencement as if those regulations had been made for the purposes of the new definition of 'approved stock exchange' in the ITAA 1997 as inserted by item 81 of this Schedule . [Schedule 1, item 95]
Saving of elections relating to foreign hybrids
1.47 The second of the savings provisions ensures that, despite the repeal of section 485AA, elections made under subsection 485AA(1) continue to have effect as if the repeal had not happened. This is consistent with the new paragraphs 830-10(2)(a) and 830-15(5)(a) . [Schedule 1, items 76, 78 and 96, subsections 830-10(2) and 830-15(5)]
1.48 As a result of the repeal of Part XI, many consequential amendments arise, particularly where sections contain references to 'Part XI', or to terms in that Part . [Schedule 1, items 1 and 2, 6, 8, 10, 12 and 13, 17 to 19, 35, 38, 48, 50 and 51, 63, 66 to 68, 74, 81 and 82 and 87, subsection 6(1) (definition of 'approved stock exchange'), subsection 6(1)(paragraph (l) (definition of 'passive income'), subsection 6AB(1), subsection 82 KZL(1) (definition of 'approved stock exchange'), paragraphs 102AAU(1)(b), subparagraphs 102AAU(1)(c)(ix), subsections 102AAU(7) to (9), subsection 317(1)(definition of 'grossed-up amount'), subparagraphs 356(4B)(b)(ii) and 356(4C)(b)(ii), subsection 402(4), subsection 272-140(1) in Schedule 2F (definition of 'approved stock exchange'), subsections 116-10(7) (note 1) of the ITAA 1997, subsections 703-75(4) (note) and 715-660(1) ( items 1 and 2 in the table) of the ITAA 1997, sections 768-900, 770-135 (heading), subsections 770-135(1), (2) and (6) to (8), subsection 995-1(1) (definition of 'approved stock exchange'), subsection 995-1(1) (definition of 'attribution percentage') of the ITAA 1997 and subsection 66(5) (paragraph (b) of the definition of 'listed security') of the Superannuation Industry (Supervision) Act 1993]
1.49 Other consequential amendments repeal various definitions which are no longer required as a result of the repeal of Part XI . [Schedule 1, items 14 to 16 and 83 to 86, definition of 'FIF attribution account entity', 'FIF attribution account payment', 'FIF attribution debit' in subsection 317(1) of the ITAA 1936, definition of 'FIF', 'foreign life assurance policy', 'foreign investment fund' and 'notional accounting period' in subsection 995-1(1)]
1.50 Further consequential amendments repeal provisions that are no longer required as a consequence of the repeal of Part XI and the deemed present entitlement rules . [Schedule 1, items 20, 22 to 24, 26, 28, 31, 34, 36, 39, 47, 64 and 65, 70, 72 and 73 and 80, paragraphs 371(1)(aa) and 371(1)(ab), subsections 371(2A) to (2D), paragraphs 371(5)(aa), 371(5)(ab) and 384(2)(ca), subparagraph 384(2)(d)(iv), paragraph 385(2)(ca), subparagraph 385(2)(d)(v), subsections 402(2A) to (2C), Subdivision E of Division 7 of Part X, Schedules 3 to 5 to the ITAA 1936, sections 70-70, 768-965 and 768-975 of the ITAA 1997, paragraphs 770-135(3)(c), 770-135(5)(c), 770-135(5) (note) and 960-50(10)(d) of the ITAA 1997]
1.51 Definitions have also been inserted into subsection 6(1) for 'post FIF abolition credit', 'post FIF abolition debit', and 'post FIF abolition surplus' as a consequence of the repeal of Part XI . [Schedule 1, items 3 to 5, subsection 6(1)]
1.52 Various provisions and headings in Subdivisions 717-D and E are amended to allow the head company or the leaving member to continue to take advantage of the section 23AK exemption or the section 613 reduction of capital proceeds on disposal of an interest in the FIF . [Schedule 1, items 52 to 61, Subdivision 717-D of Part 3-90 (heading), section 717-200, paragraph 717-205(c), sections 717-220 and 717-230, Subdivision 717-E of Part 3-90 (heading), section 717-235, paragraph 717-240(c), sections 717-255 and 717-265 of the ITAA 1997]
1.53 There are also a number of further consequential amendments to reflect changes resulting from the repeal of Part XI . [Schedule 1, items 11, 21, 25, 27, 29 and 30, 32 and 33, 69 to 71 and 79, sub-subparagraphs 102AAU(1)(c)(viii)(B), subsection 371(2), subparagraph 384(2)(d)(iii), paragraphs 385(2)(a), (b) and (d), sub-subparagraph 385(2)(d)(iv)(B), subsection 385(4), paragraph 389(a), paragraphs 770-135(3)(b) and (c), 770-135(5)(b) and 960-50(10)(c) of the ITAA 1997]
1.54 Several items update the checklists in sections 10-5, 11-55 and 12-5 of the ITAA 1997 . [Schedule 1, items 40 to 46, sections 10-5, 11-55 and 12-5 of the ITAA 1997]