Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Exemption for Attributable Taxpayer
Overview
In order to avoid double taxation, a taxpayer with an interest in a Foreign Investment Fund ( FIF) will not be subject to the FIF measures if that interest is subject to the existing CFC or transferor trust measures. Further, an attributable taxpayer in a controlled foreign trust (CFT) will be subject to the existing trust provisions instead of the FIF measures. This Chapter will explain the exclusion of amounts taxed under the existing CFC and transferor trust measures from a taxpayer's attributable income under the FIF measures.
Background to the CFC measures
The FIF measures are designed as an adjunct to the accruals tax measures for the taxation of offshore entities. If Australian residents have substantial interests in a non-resident company, the accruals tax system may include certain income and gains derived by that company in the residents' assessable income. A non-resident company that is subject to these accruals measures is called a controlled foreign company ( CFC).
Where a taxpayer is subject to attribution in respect of an interest in a CFC or a controlled foreign trust, the FIF measures will not apply to that interest. In particular, the FIF measures will not override the exemptions from accruals taxation provided under the CFC measures, for instance, where the CFC passes the active income test.
Explanation
Exemption of attributable taxpayer referred to in section 456
The income and gains of a CFC that may be included under section 456 in the assessable income of resident taxpayers is called attributable income. That income is calculated, subject to some modifications, as if the CFC were a resident of Australia.
There are two tests for determining whether a taxpayer's interest in a CFC is to be excluded from the calculation of the taxpayer's attributable FIF income because section 456 also applies to that interest. [Section 494]
The first test is used where the statutory accounting period of the CFC coincides with the notional accounting period of the FIF. In this case, no amount will be included in respect of the taxpayer's interest in the CFC under the FIF measures if section 456 applies to the interest at the end of that period [subsection 494(1)] . This exemption will not apply where, at the end of the company's statutory accounting period, the company ceases to be a CFC or if the taxpayer ceases to be an attributable taxpayer of the CFC. The exemption would, however, apply where a company became a CFC during its notional accounting period for the purposes of the FIF measures.
The second test is used where the statutory accounting period of the CFC does not coincide with the notional accounting period of the FIF. In this case, no amount will be included in respect of the taxpayer's interest in the CFC under the FIF measures if section 456 applies to that interest in both of the CFC's statutory accounting periods which overlap the FIF's notional accounting period (i.e., the statutory accounting period of the CFC which ends and the period which commences during the notional accounting period of the FIF). [Subsection 494(2)]
Both of the above tests require that section 456 applies to the taxpayer's interest in the CFC. Section 456 is taken to apply to a taxpayer's interest in a CFC even if no amount was included in the taxpayer's attributable income for a statutory accounting period. For example, a CFC which passes the active income test might not have any attributable income. Therefore, no amount would be included in the attributable income of a taxpayer under section 456. In this case, section 456 will still be taken to apply to the attributable taxpayer's interest in the CFC.
Reduction of attributable income where section 457 applies
Where a CFC changes residence from an unlisted country to a listed country or Australia, a resident attributable taxpayer must include a certain amount of the distributable profits of the CFC in attributable income (section 457).
Section 457 is an anti-avoidance provision to prevent an unlisted country CFC distributing its profits in a tax free form by simply changing its residence.
An amount which is included in a taxpayer's assessable income under section 457 that relates to an interest in a FIF is treated as a FIF attribution payment by the FIF to the taxpayer for the purposes of subsection 530(2). This means that the attributable income of the taxpayer referable to that FIF interest will be reduced to the extent that an amount was included in the taxpayer's assessable income under section 457. The attribution payment arises at the residence change time of the CFC and is therefore relevant for the purposes of calculating the FIF's attributable income for the notional accounting period of the FIF during which the change in residence of the CFC occurred. [Section 530]
The amount which is included in a taxpayer's assessable income under section 457 that relates to an interest in a FIF is only treated as a FIF attribution payment for the purposes of subsection 530(1). It does not give rise to a FIF attribution payment for the purposes of Division 19 of Part XI which provides for the operation of FIF attribution accounts (refer to Chapter 21 for an explanation of the operation of FIF attribution accounts). Consequently, the amount which is included in the taxpayer's assessable income under section 457 does not have any affect on the FIF attribution accounts of the company although a credit would arise in the attribution accounts of the company as a CFC.
It should be noted that the above treatment will only apply in a few instances. Normally, a taxpayer's interest in a CFC will be excluded from the calculation of a taxpayer's attributable FIF income when that interest is included in the taxpayer's assessable income under section 456. The above treatment would be relevant, however, where a CFC changes residence and:
- hen ceases to be a CFC (for instance, due to an Australian resident selling shares to a non-resident); or
- he taxpayer ceases to be an attributable taxpayer of the CFC under the CFC measures but still maintains an interest in the CFC (this may happen where a taxpayer only disposes of part of his interest in the CFC).
Under the existing foreign source income measures there is a distinction between foreign trusts that are controlled by residents of Australia and other foreign trusts. There are two types of controlled foreign trust (CFT):
- trust estate to which an Australian has transferred certain property or services to which Division 6AAA applies; or
- controlled foreign trust as defined in Part X. These are, broadly, trust estates where five or fewer Australian residents have 50 per cent or more of the interests in either the income or the corpus of the trust.
If a taxpayer is an attributable taxpayer in respect of either type of controlled foreign trust during the notional accounting period of the trust for FIF purposes, the taxpayer will be excluded from the FIF measures in respect of any interest in that trust estate [section 493]. Instead, they will be required to calculate the net income of the trust for the purposes of Division 6 (using a modified attribution percentage calculation), or the attributable income of the controlled foreign trust for the purposes of Division 6AAA of Part III of the Principal Act.
Even though an attributable taxpayer in a controlled foreign trust to which Part X applies will not be subject to the FIF measures in respect of the interest in the controlled foreign trust, it is possible that trust estate will have an interest in another entity which is a FIF. Where the taxpayer, through the controlled foreign trust, is not an attributable taxpayer in respect of the lower tier FIF (be it a company or a trust estate), the FIF measures apply in the calculation of the net income or attributable income of the controlled foreign trust (refer to Chapter 25).