House of Representatives

Taxation Laws Amendment (Foreign Income Measures) Bill 1997

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 3 - Creation of a new list for accruals taxation purposes

Summary of the amendments

Purpose of the amendments

3.1 This Chapter will discuss amendments necessary to create a list of broad-exemption countries. The list, comprising seven countries, will be used to determine whether amounts of tainted income have been comparably taxed and should therefore be exempt from accruals taxation under the CFC and transferor trust measures. A list of limited-exemption countries will be used together with the list of broad-exemption countries for the purposes of exemptions under the FTCS. Countries on these lists taken together will be referred to as listed countries.

Date of effect

3.2 The creation of two lists is to apply in calculating attributable income for statutory accounting periods of CFCs and years of income of transferor trusts commencing on or after 1 July 1997. For other purposes (eg, the taxation of dividends and branch profits) the changes are to apply from 1July 1997. The commencement arrangements are discussed in more detail later in the Chapter.

Background

3.3 Problems have been encountered under the CFC measures because the current list of countries (Schedule 10 of the Income Tax Regulations (Appendix C)) has been used for two distinct purposes that would have been best served by separate lists. The same list has been used:

·
for the purposes of determining when income should be exempt from accruals taxation under the CFC measures; and
·
to determine when dividends and branch profits derived by resident companies should be exempt under the FTCS (sections23AJ and 23AH respectively).

3.4 The countries on the current list have tax regimes sufficiently comparable for the purposes of exemptions under the FTCS. However, a higher degree of comparability is required for the purposes of exemptions from accruals taxation under the CFC measures. It is important that only closely comparable tax countries are listed for the purposes of the CFC measures because the CFC measures deal primarily with the taxation of tainted income. Tainted income arises from investments and arrangements that are most likely to be influenced by taxation considerations and thus the location of those investments are likely to be significantly influenced by more favourable taxation treatment offshore. Accruals taxation of non comparably taxed tainted income is therefore crucial to ensure investments offshore are not favoured over similar investments in Australia for purely taxation reasons.

3.5 A shorter list will also make the task of designating tax concessions more manageable. Broadly, an amount will not be exempt from accruals taxation under the CFC measures (or under the FTCS where derived by a branch) if the amount is EDCI. Efforts to designate tax deferral opportunities in listed countries have had only limited success and are made more difficult by the large number of countries that must be monitored. The risks to the revenue associated with not designating a tax deferral opportunity are significant because tainted income by its nature can easily be diverted to take advantage of the opportunity.

3.6 The list of broad-exemption countries will comprise:

Canada
France
Germany
Japan
New Zealand
United Kingdom of Great Britain and Northern Ireland
United States of America

3.7 These countries will be designated in the Income Tax Regulations as broad-exemption listed countries.

3.8 The list will also apply for the purposes of exemptions from accruals taxation under the transferor trust measures (Division 6AAA of Part III). The following diagram provides a general outline of the treatment of CFCs for accruals taxation purposes under the two list approach.

Summary of accruals taxation under a two list approach

Accruals taxed if the active income test is failed

3.9 Countries on the current list have tax regimes sufficiently comparable for the purposes of exemptions under the FTCS because the exemptions apply to amounts derived from investments and arrangements that are less sensitive to taxation considerations. A list of limited-exemption countries, comprising countries on the current list (with minor updating) and excluding broad-exemption listed countries, will be designated in the Income Tax Regulations (AppendixD).

3.10 The list of limited-exemption countries will be used together with the list of broad-exemption listed countries for the purposes of exemptions under the FTCS. The exemptions will therefore generally continue to be available for dividends and branch profits derived from either broad-exemption listed countries or limited-exemption listed countries (ie, from listed countries). The following diagram provides a general outline of the taxation of dividends under the two list approach.

Summary of dividend taxation under a two list approach

Dividends paid from profits that have been taxed on an accruals basis under the CFC measures are exempt under section 23AI.

Explanation of the amendments

Terminology

3.11 The new terms for referring to countries will be defined in section320 which currently defines "listed" and "unlisted" countries. References to the new terms will also be included in section 317. The new terms are summarised below.

Broad-exemption listed countries

3.12 There will be seven broad-exemption listed countries. The term "broad-exemption" reflects that amounts taxed at full rates by countries on the short list are generally exempt from both accruals taxation and taxation on repatriation to Australia. [Items 18 & 26]

Limited-exemption listed countries

3.13 Limited-exemption listed countriesare countries on the longer list of countries. The term "limited-exemption" reflects that amounts taxed at full rates by countries on the longer list are generally exempt from tax on repatriation to Australia. An exemption from accruals taxation will, however, no longer be provided for amounts of tainted income that have been taxed in a limited-exemption listed country. [Items19 & 27]

Listed countries

3.14 Listed countries arecountries on the list of broad-exemption listed countries or on the list of limited-exemption listed countries. [Item28]

Unlisted countries

3.15 Unlisted countries are countries that are not on either list.

Non-broad-exemption listed countries

3.16 Non-broad-exemption listed countries are countries that are not on the list of broad-exemption countries. They comprise unlisted countries or countries on the list of limited-exemption countries. [Items20 & 29]

3.17 Section 332, which currently provides rules for determining whether a CFC is a resident of a listed country, will be repealed. New sections332 and 332A will be inserted to provide rules for determining whether a company is a resident of a broad-exemption listed or a limited-exemption listed country. A company that is resident of both a broad-exemption listed country and a limited-exemption listed country will be treated as a resident of broad-exemption listed country. [Items31 & 32]

Treatment of broad-exemption listed countries

3.18 Only broad-exemption listed countries will be treated as listed for the purposes of provisions in the following table. The provisions deal with the accruals taxation of CFCs and transferor trusts. References to "listed countries" and "unlisted countries" in the provisions will be changed to "broad-exemption listed countries" and "non-broad-exemption listed countries" respectively.

Table of provisions for which only broad-exemption listed countries will be treated as listed
Affected provision Outline of the provision's effect Items making the changes
Division 6AAA (Transferor trust measures) The transferor trust measures attribute the income of a non-resident trust to an Australian resident who has, directly or indirectly, transferred value to the trust 7, 8, 9, 10, 11, 12, 13, 14, 15, 58, 59, 60, 61, 62, 63, 64, 65, 66, 67, 68, 69, 70, 71, 72, 73, 74, 75, 76, 77, 106 & 114
Definition of "accruals tax law" The term is used in section 456A which provides a reduction in attributable income for amounts that have been taxed under an accruals tax law of another country 78
Definition of "designated concession income" (Section 317) "Designated concession income" (DCI) comprises low taxed amounts of narrowly defined tainted income as determined in accordance with rules provided in the Income Tax Regulations. DCI is used for the purposes of the definition of "eligible designated concession income". 79
Definition of "eligible designated concession income" (Section 317) "Eligible designated concession income" (EDCI) comprises amounts of DCI that are not subject to full tax in another listed country. Non-EDCI amounts derived in a listed country are generally exempt from Australian tax. 80
Definition of "tainted rental income" (Section 317) "Tainted rental income" is a component of "passive income" 81, 82, 83, 84, 107, 108, 115 & 116
Sections 384 and 385 (not including sub-subparagraph 385(2)(a)(ii)(C)) Assumptions for calculating the attributable income of unlisted and listed country CFCs respectively 34, 85, 86, 87, 88, 89, 90, 91, 92, 93 & 117
Paragraph 403(a) Exemption from accruals taxation for profits derived by an unlisted country CFC through a branch in a listed country 94
Section 418A Gains on non-taxable Australian assets derived by a CFC that was formerly an Australian company are calculated from the time the company became a CFC 95 & 118
Section 419 Group company rollover relief for calculating capital gains derived by a CFC 45, 96 & 119
Subsection 431(4) Prior year losses are not available for a listed country CFC if they were incurred when the CFC was a resident of an unlisted country. Similarly, prior year losses are not available for an unlisted country CFC if they were incurred when the CFC was a resident of a listed country. 49
Paragraphs 432(1)(b) and (e) Requires that a company must be a resident of a particular country throughout a statutory accounting period to satisfy the active income test 97, 98, 109 & 110
Paragraph 436(1)(b) Excludes profits derived through a branch in a listed country from the active income test 99, 100 & 101
Subparagraph 437(1)(c)(iii) Treatment of partnership income for the purposes of the active income test 102 & 111
Subsection 437(2) Allows a company to satisfy the residency requirement in the active income test where the company is a partner of a partnership that carries on business through a branch in a particular country 103 & 112
Section 456A Reduces attributable income for amounts that have been taxed under an accruals tax law of another country 104

Treatment of listed countries

3.19 References to "listed countries" in provisions outlined in the following table will not change. The provisions will therefore apply toboth broad-exemption listed countries and limited-exemption listed countries. The provisions ensure that low taxed profits derived through companies offshore are taxed in a listed country at some point prior to repatriation to Australia. They also provide exemptions under the FTCS for amounts that have been taxed in a listed country.

Table of provisions for which both broad-exemption listed countries and limited-exemption listed countries will be treated as listed
Affected provision Outline of the provisions effect
Section 23AH (other than paragraphs (1)(c), (6)(f) & (7)(f)) Exemption for certain foreign branch profits of Australian companies
Section 23AJ Exemption for non-portfolio dividends received by resident companies
Section 63D Ensures that a deduction is not allowable for writing off debts of a foreign branch where the income of the branch is exempt under section 23AH
Division 18 of Part III Calculation of a credit that can be claimed for foreign tax
Subsections 160M(12A), (12AB) and (12B) Modifications to the rules for taxing the disposal of assets by a former CFC where the assets were held prior to the company becoming a resident of Australia
Section 160ZFB Reduction of a capital gain derived by a CFC on disposing of a taxable Australian asset to the extent the gain has been taxed previously under section 457
Section 324 Rules for determining whether an amount has been subject to tax in a listed country
Section 325 Rules for determining whether an amount has been taxed at the normal company rate
Subsection 371(8) Election to defer attribution credit for amounts included in assessable income under section 457
Sections 377, 378 and 379 Rules for identifying and tracing profits that can be distributed by unlisted country companies as exempt dividends under section 23AJ
Section 380 Rules for determining the extent to which a dividend paid to an Australian resident company can be exempt under section 23AJ
Paragraph 403(b) Exemption from accruals taxation for a non-portfolio dividend received from a CFC resident in a listed country
Section 404 Exemption from accruals taxation for dividends received from a CFC resident in a listed country
Section 422 Reduction of a capital gain derived by a CFC on disposing of a non-taxable Australian asset to the extent the gain has been taxed previously under section 457
Paragraph 436(1)(e) Exclusion from the active income test for non-portfolio dividends derived from listed country companies
Subsection 456(2) Reduction of attributable income for amounts taxed under section 457
Section 457 Accruals taxation of a CFCs distributable profits where the CFC changes residence from an unlisted country to a listed country or Australia
Section 458 Accruals taxation of non-portfolio dividends paid by an unlisted country CFC to a listed country CFC (or to certain trusts and partnerships) where the dividends are not taxed in the listed country at the normal company tax rate
Section 459 Accruals taxation of deemed dividends under section 47A that are taken to have been paid by an unlisted country CFC to a listed country CFC (or to certain trusts and partnerships)

Interpretative provisions

3.20 References to "listed countries" will also not change in provisions outlined in the following table. These provisions are largely interpretative and have no substantive effect of themselves.

Table of interpretative provisions that refer to listed countries
Affected provision Outline of the provision's effect
Definition of "law" (section 317) The term is used in the definition of tax law
Definition of "tax accounting period" (section 317) Refers to the accounting period used for determining whether tax is imposed or levied under the tax law of a listed country
Definition of "tax law" (section 317) The term is relevant to the definitions of "subject to tax" and "tax accounting period"
Section 321 Each listed and unlisted country is to be treated as a separate country
Section 323 Allows State taxes designated in the Income Tax Regulations to be treated as Federal taxes
Section 333 Rules for determining whether a company is a resident of a listed or an unlisted country
Section 340 Definition of a "CFC"
Section 395 Assumption that attributable income has been calculated in previous years for the purposes of determining whether outgoings are allowable deductions
Section 399 Modifications of net income of partnerships and trusts for the purposes of determining attributable income
Subsection 402(1) Additional notional exempt income

3.21 Definitions of "broad-exemption listed country" and "limited exemption listed country" are also to be inserted into section23AH. [Items 5 & 6]

Commencement

3.22 The two list approach will operate for statutory accounting periods of CFCs and years of income of transferor trusts commencing on or after 1 July 1997 for the purposes of applying the following provisions.

Table of provisions for which the two list approach will apply for statutory accounting periods of CFCs and years of income of transferor trusts commencing on or after 1 July 1997
Affected provision Outline of the provision's effect Items making the changes
Division 6AAA The transferor trust measures attribute the income of a non-resident trust to an Australian resident who has, directly or indirectly, transferred value to the trust. An interest charge is also applied on distributions paid from low taxed profits accumulated in a non-resident trust. Item 123
Provisions in Part X for the purposes of calculating attributable income The Australian controllers of a CFC may be accruals taxed on certain income derived by the CFC Subitem 126(1)
Sections 377 and 378 Rules for identifying and tracing profits that can be distributed by unlisted country companies as exempt dividends under section 23AJ Subitem 126(3)
Provisions in Part X relevant to determining the active income test The active income test ensures that small amounts of tainted income derived by a CFC are exempt from taxation. An exemption is provided from accruals taxation for most amounts derived by a CFC if the test is satisfied. Subitem 126(5)
Section 456A Reduces attributable income for amounts that have been taxed under an accruals tax law of another country Subitems 126(7) & (8)

3.23 The two list approach will operate from 1 July 1997 for the purposes of applying the following provisions.

Table of provisions for which the two list approach will apply from 1 July 1997
Affected provision Outline of the provision's effect Items making the changes
Section 23AH Exemption for certain foreign branch profits of Australian companies Subitems 120(3) & (4)
Section 23AJ Exemption for non-portfolio dividends received by resident companies Subitem 121
Sections 47A and 108 Deemed dividend rules for benefits provided by companies Subitem 122
Division 18 of Part III Calculation of a credit that can be claimed for foreign tax Subitem 124(1)
Subsections 160M(12A), (12AB) and (12B) Modifications to the rules for taxing the disposal of assets by a former CFC where the assets were held prior to the company becoming a resident of Australia Subitem 125(1)
Section 160ZFB Reduction of a capital gain derived by a CFC on disposing of a taxable Australian asset to the extent the gain has been taxed previously under section 457 Subitem 125(2)
Section 380 Rules for determining the extent to which a dividend paid to an Australian resident company can be exempt under section 23AJ Subitem 126(4)
Subsection 456(2) Reduction of attributable income for amounts taxed under section 457 Subitem 126(6)
Section 457 Accruals taxation of a CFCs distributable profits where the CFC changes residence from an unlisted country to a listed country or Australia Subitems 126(9) & (10)
Section 458 Accruals taxation of non-portfolio dividends paid by an unlisted country CFC to a listed country CFC (or to certain trusts and partnerships) where the dividends are not taxed in the listed country at the normal company tax rate Subitem 126(11)
Section 459 Accruals taxation of deemed dividends under section 47A that are taken to have been paid by an unlisted country CFC to a listed country CFC (or to certain trusts and partnerships) Subitem 126(11)


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