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 6 - Consequential changes and transitional rules

Overview

6.1 The amendments will give effect to the following consequential changes and transitional rules:

·
the taxation of a CFC's retained profits under section 457 will be modified in cases where the CFC is treated as changing residence because of changes to the list(s) of countries;
·
taxpayers will have the option of treating states emerging from the dissolution of Czechoslovakia, the USSR and Yugoslavia as listed countries:

-
for statutory accounting periods of CFCs and years of income of transferor trusts commencing before the release of the IP (ie, 24December 1996); and
-
prior to the release of the IP for the purposes of applying exemptions under the FTCS and other provisions dealing with taxation on the repatriation of profits;

·
exempting profits will be able to arise for a CFC in the SlovakRepublic or a state arising from the dissolution of Yugoslavia or the USSR for the part of a statutory accounting period remaining following the release of the IP;
·
the Czech Republic and Vietnam will be treated as listed countries from the release of the IP for the purposes of applying provisions that ensure low taxed profits are comparably taxed at some point prior to repatriation to Australia (ie, sections 47A, 458 and 459):

-
the Czech Republic will also be treated as a listed country from the release of the IP for the purposes of exemptions under the FTCS;

·
it will be clarified that Hong Kong is still an unlisted jurisdiction following the establishment of the HongKong Special Administrative Region of the People's Republic of China on 1 July 1997;
·
an amount will generally be included in the attributable income of a CFC in:

-
a limited-exemption listed country if the amount was not derived from sources within the country and was not subject to tax in a listed country; and
-
a broad-exemption listed country if the amount is adjusted tainted income, was not derived from sources within the country and was not subject to tax in a broad-exemption listed country;

·
an amount derived by an unlisted country company through a branch in a limited-exemption listed country will be an exempting receipt if the amount is not adjusted tainted income and is also taxed in a listed country;
·
subsection431(4) will not operate to deny a CFC's prior year losses if the CFC is treated as changing residence solely as a result of changes to the list(s) of countries;
·
a credit is to be available for foreign tax forgone on income subject to accruals taxation under the CFC measures in circumstances where tax sparing provisions in a double taxation agreement require that a credit be provided;
·
paragraph436(1)(b) will not operate to exclude amounts from the active income test which are derived in a CFC's country of residence; and
·
amendments to the Income Tax Regulations giving effect to the changes to the foreign source income measures will be able to apply from the commencement of the changes to the Principal Act.

Treatment of residence changes arising from changes to the list(s) of countries

Summary of the amendments

Purpose of the amendments

6.2 The amendments will modify the operation of section 457 where an unlisted country CFC is treated as having changed residence to a listed country as a result of the unlisted country becoming listed. In this case, section 457 will not apply to tax the retained profits of a CFC if the CFC was a resident of the newly listed country for three or more years prior to the country becoming listed. Where a CFC has been a resident of a newly listed country for less than three years, section 457 will continue to apply but only to the realised profits of the CFC. Gains on the disposal of assets held at the residence change time will be included in the attributable income of the CFC when they are realised.

Date of effect

6.3 The modifications to section 457 will apply for residence changes occurring on or after 1 July 1997. [Subitem 126(9)]

Background to the legislation

6.4 The Australian controllers of a CFC are normally taxed under section 457 on the CFC's accumulated profits if the CFC changes residence from an unlisted to a listed country. The profits are taxed at the residence change time because they are likely to be low taxed and can be distributed as exempt dividends after the CFC becomes a resident of a listed country.

6.5 Modifications are to be made to ameliorate the impact of section457 where a CFC becomes a resident of a listed country as a result of the country becoming listed (eg, on the listing of the Czech Republic or Vietnam as limited-exemption countries from 1 July 1997). Less stringent rules can be applied to the change of residence of a CFC in these circumstances because the change is involuntary. More robust rules are required for voluntary changes of residence to ensure the changes occur for commercial reasons and not for tax planning purposes.

Explanation of the amendments

6.6 New subsection 457(3) will modify the operation of section 457 where a CFC ceases to be a resident of an unlisted country and becomes a resident of a listed country on the listing of a country (new paragraphs457(3)(a) & 457(3)(b)). The modifications to the application of section 457 on the residence change will depend on the period that a CFC was previously resident of the newly listed country.

6.7 Section457 will not apply in cases where a CFC was a resident of a country for three or more years prior to the country's listing (new paragraph 457(3)(c)). In other cases (ie, where a CFC has been a resident of the country for less than three years), section 457 will apply but only to the realised profits of the CFC (new paragraph 457(3)(d)). There will therefore be no deemed disposal of assets held by the CFC in calculating the amount to which section 457 will apply (new subparagraph 457(3)(d)). [Item56]

6.8 Gains on the disposal of assets held at the residence change time by a CFC that was resident of a country for less than three years prior to the country's listing will be included in the attributable income of the CFC when the gains are realised (new paragraphs 384(2)(e) and 385(2)(e)). These gains are to be included in attributable income even though the CFC may satisfy the active income test. [Items 36, 37, 40 & 41]

6.9 Sections 160ZFB and 422 will not apply on the disposal of assets held at the residence change time if new subsection 457(3) applied at that time. The sections normally operate to make adjustments on the disposal of assets held at the residence change time to prevent taxation under both section457 and PartIIIA of pre residence change gains. These adjustments will be unnecessary where new subsection 457(3) applies because unrealised gains would not be taxed under section 457 at the residence change time. [Items 17 & 48]

Election to treat new states as listed countries

Summary of the amendments

Purpose of the amendments

6.10 The amendments will allow taxpayers the option of treating states emerging from the dissolution of Czechoslovakia, the USSR and Yugoslavia as listed countries prior to the release of the IP.

Date of effect

6.11 The election can be made after the amending Act receives the Royal Assent. [Clause 2] The election will apply:

·
for statutory accounting periods of CFCs and years of income of transferor trusts commencing prior to the release of the IP; and
·
prior to the release of the IP for the purposes of applying exemptions under the FTCS and other provisions dealing with taxation on the repatriation of profits.

[Item 129

Background to the legislation

6.12 The current list of countries requires updating following the unification of Germany and the dissolution of Czechoslovakia, the USSR and Yugoslavia. The unification of Germany only requires the removal from the list of the reference to the German Democratic Republic. The references to Czechoslovakia, the USSR and Yugoslavia are also to be removed. Transitional rules are required because of uncertainty prior to the IP regarding whether the newly formed states should be treated as listed or unlisted countries. Additional rules are required for the Czech Republic which are discussed later in this Chapter(page 56) because the Czech Republic is to be included on the list of limited-exemption countries from 1 July 1997.

Explanation of the amendments

6.13 Technically the states that emerged on the dissolution of Czechoslovakia, the USSR and Yugoslavia are unlisted countries. As a transitional arrangement, the amendments will provide taxpayers with the option of treating the new states as listed countries. The option is to be available for statutory accounting periods of CFCs and years of income of transferor trusts ending after the dissolution of the relevant countries and commencing prior to 24 December 1996 (ie, the release of the IP). Where the option is exercised, the states will also be treated as listed prior to 24December 1996 for the purposes of exemptions under the FTCS (sections 23AH, 23AJ & 380) and other provisions dealing with taxation on the repatriation of profits (sections 47A, 457, 458 and 459). [Item129]

6.14 The following states are designated as countries that emerged from former Czechoslovakia, the former USSR and former Yugoslavia. The states are referred to as "designated countries". [Subitem 129(1)]

Countries emerging from former Czechoslovakia, the former USSR and former Yugoslavia
Armenia Georgia Slovenia Slovak Republic
Azerbaijan Kazakstan Tajikistan Turkmenistan
Belarus Kyrgyzstan Czech Republic Ukraine
Bosnia and Herzegovina Latvia Federal Republic of Yugoslavia Uzbekistan
Croatia Lithuania Former Yugoslav Republic of Macedonia
Estonia Moldova Russian Federation

6.15 An election to treat these countries as listed during the transitional period will only be valid if made in writing. [Subitem129(2)] The election is to be retained by a taxpayer and provided if requested by the Commissioner of Taxation. The election will only be valid for a company taxpayer where all Australian resident companies that are related to the company also make the election. [Subitem 129(3)] A related company for this purpose is defined in section 160G. In broad terms a related company is a wholly owned group company. [Subitem129(9)] Where an election is made it will be irrevocable. [Subitem129(10)]

6.16 The election will operate to treat all designated countries as listed countries during the transitional period. The period prior to the IP will be the transitional period for the purposes of applying the dividend and branch profit exemptions for companies under the FTCS and for other provisions dealing with taxation on the repatriation of profits. [Subitem129(5)] Statutory accounting periods of CFCs and years of income of transferor trusts commencing before 24 December 1996 will be the transitional period for the purposes of determining attributable income under the CFC and transferor trusts measures. [Subitems129(4) & (6)]

6.17 The following table summarises the effect of the election for the Slovak Republic and states formed from the dissolution of Yugoslavia and the USSR. Further transitional arrangements apply in the case of the CzechRepublic which are summarised on page 59.

Summary of the treatment of the Slovak Republic and states formed from the dissolution of Yugoslavia and the USSR
  Period
Treatment Prior to dissolution Dissolution - 23 Dec 1996 24 Dec 1996 - 30 Jun 1997 From 1 Jul 1997
For the purposes of determining attributable income for statutory accounting periods of CFCs and years of income of transferor trusts commencing during the period Listed Listed if an election is made. Unlisted if no election is made. Unlisted Unlisted
For the purposes of exemptions under the FTCS (sections 23AH, 23AJ & 380) Listed Listed if an election is made. Unlisted if no election is made. Unlisted Unlisted
For the purposes of provisions dealing with taxation on the repatriation of profits (sections 47A, 457, 458 & 459) Listed Listed if an election is made. Unlisted if no election is made. Unlisted Unlisted

Exempting profits for CFCs in successor states

Summary of the amendments

Purpose of the amendments

6.18 The amendments will ensure that exempting profits can arise for a company in the Slovak Republic or a state arising from the dissolution of Yugoslavia or the USSR for the part of a statutory accounting period remaining following the release of the IP. The affected states are designated in new subitem129(1) and are referred to as "designated countries" (a list of the countries is provided on page 56).

Date of effect

6.19 The transitional arrangements will only apply if an election was made to treat states emerging from the dissolution of Czechoslovakia, the USSR and Yugoslavia as listed countries prior to the release of the IP. The election can be made after the amending Act receives the Royal Assent. [Clause 2] If the election is made, the transitional arrangements will apply to amounts derived by a company on or after 24December 1996 (ie, from the release of the IP) until the end of the accounting period in which that date occurs. [Subitem 129(5)]

Background to the legislation

6.20 Transitional arrangements are required for exempting profits derived by companies in designated countries because there may be a period where a company is treated as a resident of a listed country for accruals taxation purposes and as an unlisted country for the purposes of the dividend exemption under section 23AJ. This can only occur during the part of a statutory accounting period remaining following the release of the IP and then only if a taxpayer elects to treat a designated country as a listed country prior to the release of the IP. Exempting profits (Division6 of Part X) are profits that have been taxed in Australia or a listed country and can be distributed as exempt dividends by a company in an unlisted country.

6.21 In the absence of transitional rules, exempting profits could not arise for a company in a designated country for the portion of a statutory accounting period remaining following the release of the IP if an election was made to treat the designated country as a listed country. This is because exempting profits can only arise for an unlisted country company whereas the election will result in the designated country being treated as a listed country for accruals taxation purposes. The net result would be that the company could not distribute comparably taxed profits derived during the remaining part of a statutory accounting period following the release of the IP as exempt dividends. This result is illustrated by the following example.

Example A CFC resident in the Russian Federation has a statutory accounting period from 1 July to 30 June. If an attributable taxpayer elects for the CFC to be treated as a resident of a listed country, dividends paid by the CFC will cease to be exempt from 24 December 1996 (ie, from the release of the IP) even though for accruals taxation purposes the CFC will not be treated as unlisted until 1 July 1997 (ie, after the end of the statutory accounting period in progress when the IP was released).Subsection378(3) would provide that profits derived by the CFC on or before 24 December 1996 are exempting profits and can therefore be distributed as exempt dividends (section 23AJ and paragraph 380(b)). Exempting profits could not arise, however, for amounts derived during the part of a statutory accounting period remaining following the release of the IP because the CFC will be treated as a resident of a listed country. There is no problem after the end of the statutory accounting period (ie, 30June 1997) because the CFC will be treated as a resident of an unlisted country for accruals taxation purposes and can therefore derive exempting profits.

Explanation of the amendments

6.22 The transitional rules will only apply in cases where a company is affected by an election to treat a designated country as a listed country. The amendments will ensure that exempting profits can arise for a company during the part of a statutory accounting period remaining following the release of the IP even though the company may be treated as a resident of a listed country for accruals taxation purposes during the period [Subitem129(4)] . This will be achieved by treating the company as a resident of an unlisted country for the purposes of applying Division 6 of Part X during the part of a statutory accounting period remaining following the release of the IP. [Subitem129(5)]

Transitional rules for the listing of the Czech Republic and Vietnam

Summary of the amendments

Purpose of the amendments

6.23 The amendments will provide transitional arrangements for the listing of the CzechRepublic and Vietnam from 1 July 1997 as limited-exemption countries. The Czech Republic is also to be treated as a listed country from the release of the IP until 30 June 1997 for the purposes of exemptions under the FTCS (sections 23AH, 23AJ and 380).

Date of effect

6.24 The transitional arrangements will treat:

·
the Czech Republic and Vietnam as listed countries from the release of the IP until 30 June 1997 for the purposes of applying sections 47A, 458 and 459; and
·
the Czech Republic as a listed country from the release of the IP until 30 June 1997 for the purposes of applying sections 23AH, 23AJ and 380. [Subitem 128(1)]

Background to the legislation

6.25 Transitional arrangements are required to prevent the exempt transfer of low taxed profits to CFCs resident in Vietnam and the Czech Republic that could occur to take advantage of the imminent listing of those countries. In the absence of these rules, low taxed profits could be transferred to the Czech Republic or Vietnam and distributed as exempt dividends under section23AJ after the countries are treated as listed for the purposes of exemptions under the FTCS. This result would be inappropriate because the exemptions should only be available for amounts that have been taxed in a listed country.

6.26 Transitional arrangements will also operate to provide continuity in the application of exemptions under the FTCS for amounts derived in the Czech Republic. In the absence of transitional rules, the Czech Republic could be treated as a listed country prior to 24 December 1996 (if a taxpayer makes an election under item 129), as an unlisted country from 24 December 1996 to 30June 1997 and then as a limited-exemption listed country from 1 July 1997. Under the transitional arrangements, the Czech Republic will be treated as a listed country for the purposes of exemptions under the FTCS during the period 24 December 1996 to 30June 1997.

Explanation of the amendments

6.27 The amendments provide that the Czech Republic and Vietnam will be treated as listed countries from the release of the IP until 30 June 1997 for the purposes of applying sections 47A, 458 and 459. These provisions operate to accruals tax amounts derived by a listed country CFC from sources outside that country if the amounts have not been taxed in a listed country. [Subitems128(1) & (2)]

6.28 The amendments also provide that the Czech Republic is to be treated as a listed country from the release of the IP until 30 June 1997 for the purposes of applying sections 23AH, 23AJ and 380. These provisions provide an exemption under the FTCS for certain profits derived through a branch in a listed country and an exemption for dividends derived by resident companies from listed country subsidiaries. [Subitem 128(3)]

6.29 The following tables summarise the treatment of Vietnam and the Czech Republic under the transitional arrangements.

Summary of the treatment of Vietnam
  Period
Treatment Prior to 24 Dec 1996 24 Dec 1996 - 30 Jun 1997 From 1 Jul 1997
For the purposes of determining attributable income for statutory accounting periods of CFCs and years of income of transferor trusts commencing during the period Unlisted Unlisted Unlisted
For the purposes of exemptions under the FTCS Unlisted Unlisted Listed (limited-exemption listed)
For the purposes of applying provisions which ensure that low tax profits are comparably taxed at some point prior to repatriation to Australia (sections 47A, 458 and 459) Unlisted Listed Listed (limited-exemption listed)

Summary of the treatment of the Czech Republic
  Period
Treatment Prior to 1 Jan 1993 1 Jan 1993 - 23 Dec 1996 24 Dec 1996 - 30 Jun 1997 From 1 Jul 1997
For the purposes of determining attributable income for statutory accounting periods of CFCs and years of income of transferor trusts commencing during the period Listed Listed if an election is made. Unlisted if no election is made. Unlisted Unlisted
For the purposes of exemptions under the FTCS Listed Listed if an election is made. Unlisted if no election is made. Listed Listed (limited-exemption listed)
For the purposes of applying provisions which ensure that low tax profits are comparably taxed at some point prior to repatriation to Australia (sections 47A, 458 and 459) Listed Listed if an election is made. Unlisted if no election is made. Listed Listed (limited-exemption listed)

Treatment of Hong Kong from 1 July 1997

Summary of the amendments

Purpose of the amendments

6.30 Amendments will be made to the Income Tax Regulations to clarify that Hong Kong is still an unlisted jurisdiction following the establishment of the Hong Kong Special Administrative Region of the People's Republic of China on 1 July 1997.

Date of effect

6.31 The amendments are to apply from 1 July 1997. [The Income Tax Regulations are to be amended]

Background to the legislation

6.32 Many submissions received on the IP commented on uncertainty regarding the status of Hong Kong for taxation purposes following its return to China's sovereignty on 1 July 1997. Some taxpayers are concerned that Hong Kong could be treated as part of a "listed country" (as defined in subsection 320(1)) from 1 July 1997 after becoming part of China (Hong Kong was formerly treated as an "unlisted country"). This change in status could potentially result in the taxation of the accumulated profits of a CFC in Hong Kong under section 457 because the CFC could be treated as having changed residence from an "unlisted" to a "listed country".

6.33 The proposed changes are being made to remove uncertainty regarding the treatment of the Hong Kong Special Administrative Region from 1 July 1997. The Commissioner's view of the current law is that the Hong Kong Special Administrative Region is not a "listed country" (Draft TD 97/D6).

Explanation of the amendments

6.34 The amendments to the Income Tax Regulations will clarify that the Hong Kong Special Administrative Region is not to be treated as part of a "listed country" as defined in subsection 320(1).

Accruals taxation of low taxed amounts derived offshore by a CFC in a listed country

Summary of the amendments

Purpose of the amendments

6.35 The amendments will include an amount in the attributable income of a CFC in:

·
a limited-exemption listed country if the amount is not derived from sources within the country and has not been subject to tax in a listed country; and
·
a broad-exemption listed country if the amount is adjusted tainted income (other than eligible designated concession income (EDCI)), is not derived from sources within the country and has not been subject to tax in a broad-exemption listed country.

Date of effect

6.36The changes will apply in calculating attributable income for statutory accounting periods of CFCs commencing on or after 1 July 1997. [Subitem 126(1)]

Background to the legislation

6.37 An amount is currently included in the attributable income of a listed country CFC if it is not EDCI, is not derived from sources within the listed country and has not been subject to tax in a listed country (subparagraph 385(2)(a)(ii)). Broadly EDCI is narrowly defined tainted income designated in the Income Tax Regulations that has been concessionally taxed in a listed country. Subparagraph 385(2)(a)(ii) does not apply to amounts of EDCI because these amounts are included in the notional assessable income of a CFC under subparagraph 385(2)(a)(i). A summary of the current operation of subparagraph 385(2)(a)(ii) is provided by the following diagram.

Current treatment of CFCs in listed countries under subparagraph 384(2)(1)(ii)

6.38 The accruals taxation of low taxed amounts derived by a listed country CFC from sources outside its country of residence protects the integrity of the dividend exemption under section 23AJ by ensuring the amounts are taxed at some point prior to repatriation to Australia. Similar rules are required to protect the dividend exemption for profits derived by CFCs in limited-exemption listed countries.

6.39 Modifications are also required to the rules for CFCs in broad-exemption listed countries to ensure that subparagraph 385(2)(a)(ii) can apply to amounts of adjusted tainted income that have only been taxed in a limited-exemption listed country. These tainted amounts should be included in attributable income because they have not been taxed by a broad-exemption listed country.

Explanation of the amendments

Treatment of CFCs in limited-exemption listed countries

6.40 The attributable income of a CFC in a limited-exemption listed country is to be determined according to the assumptions in section 384 that currently apply for unlisted country CFCs. New paragraph 384(2)(aa) will provide a further assumption for amounts derived by a CFC resident in a limited-exemption listed country from sources outside that country. The assumption will provide that an amount derived by the CFC will be included in notional assessable income if the amount is not adjusted tainted income, is not derived from sources within the CFC's country of residence and is not subject to tax in a listed country. [Item 34]

6.41 A summary of the operation of new paragraph 384(2)(aa) is provided by the following diagram.

Treatment of CFCs in limited-exemption listed countries

6.42 This treatment will also apply for amounts derived by a CFC in a limited-exemption listed country through a partnership (new subparagraph 384(2)(d)(ia)). [Item 35]

Treatment of CFCs in broad-exemption listed countries

6.43 The amendments will ensure that subparagraph 385(2)(a)(ii) can apply to amounts of adjusted tainted income derived by a CFC in a broad-exemption listed country if the amounts have only been taxed in a limited-exemption listed country. This will be achieved by replacing the current exclusion from subparagraph 385(2)(a)(ii) for amounts that have been taxed in a listed country (sub-subparagraph 385(2)(a)(ii)(C)) with an exclusion based on whether the amounts satisfy a test provided by new subsection 385(2A). Amounts that pass the test will generally be included in notional assessable income under subparagraph 385(2)(a)(ii). [Item 38]

6.44 The test in subsection 385(2A) will be passed for amounts that:

·
are not subject to tax in a listed country (new paragraph 385(2A)(a)); or
·
are adjusted tainted income and are not subject to tax in a broad-exemption listed country (new paragraph 385(2A)(b)).

6.45 The net effect of the test is that non-tainted amounts will be excluded from subparagraph 385(2)(a)(ii) if they are taxed in a listed country. Amounts of adjusted tainted income will only be excluded if they have been taxed in a broad-exemption listed country. [Item 42]

6.46 A summary of the operation of subparagraph 385(2)(a)(ii) following the changes is provided by the following diagram.

Treatment of CFCs in broad-exemption listed countries

6.47 This treatment will also apply for amounts derived through a partnership by a CFC in a broad-exemption listed country (new sub-subparagraph 385(2)(d)(ii)(C)). [Item 39]

Exempting profits derived through a branch in a listed country

Summary of the amendments

Purpose of the amendments

6.48 The amendments will provide that an amount derived by an unlisted country company through a branch in a limited-exemption listed country will be an exempting receipt if the amount is not adjusted tainted income and is also taxed in a listed country.

Date of effect

6.49 The changes will apply for accounting periods of companies commencing on or after 1 July 1997. [Subitem 126(2)]

Background to the legislation

6.50 Currently, an unlisted country company can distribute profits derived through a branch in a listed country as exempt dividends under section 23AJ providing the profits are not EDCI and are subject to tax in a listed country (paragraph 377(1)(a), subsection 378(1) and section 380). The concept of EDCI will not be applicable, however, for branches in limited-exemption listed countries. Rules are to be introduced to allow dividends paid from non-tainted profits derived by an unlisted country company through a branch in a limited-exemption listed country to be exempt if the profits are taxed in the limited-exemption listed country. This exemption is consistent with the general policy that non-tainted amounts that have been taxed in a listed country can be distributed as exempt dividends.

Explanation of the amendments

6.51 New subparagraph 377(1)(a)(ia) will allow exempting receipts to arise for amounts derived by an unlisted country company in carrying on a business through a branch in a limited-exemption listed country. [Item 33 Exempting receipts are amounts that can be distributed by an unlisted country company as exempt dividends under section 23AJ. Subparagraph 377(1)(a)(ia) will allow exempting receipts to arise for amounts derived by an unlisted country company through a branch in a limited-exemption listed country if the amounts are not adjusted tainted income and are subject to tax in a listed country. Non-tainted amounts derived through a branch in a limited-exemption listed country can therefore be distributed as exempt dividends if the amounts are taxed in a listed country.

Residence requirement for losses

Summary of the amendments

Purpose of the amendments

6.52 The amendments will preserve a CFC's prior year losses if the CFC is treated as changing residence solely as a result of changes to the list(s) of countries.

Date of effect

6.53 The changes will apply in calculating attributable income for statutory accounting periods of CFCs commencing on or after 1 July 1997. [Subitem 126(1)]

Background to the legislation

6.54 Losses from a previous year can currently only be offset in calculating the attributable income of a listed country CFC if the CFC was a resident of a listed country in the previous year. Corresponding treatment applies for CFCs in unlisted countries (subsection 431(4)). Transitional rules are required to ensure that CFCs are not affected by subsection 431(4) if they change residence solely as a result of the adoption of a two list approach or because of future changes to the list of broad-exemption listed countries.

Explanation of the amendments

6.55 New subsection 431(4) will provide rules for determining whether losses incurred in a statutory accounting period commencing before 1 July 1997 can be offset in a statutory accounting period commencing after that time. The general rule will be that carry forward losses arising in a statutory accounting period commencing before 1 July 1997 by a CFC in a broad-exemption listed country can be offset if the CFC was a resident of a listed country when the losses were incurred (new subparagraph 431(4)(a)(ii)). Losses arising in a statutory accounting period commencing before 1 July 1997 by a CFC in a non-broad-exemption listed country can be offset if the CFC was a resident of an unlisted country when the losses were incurred (new subparagraph 431(4)(b)(ii)).

6.56 Modifications to the general rule apply to deal with cases where a company remains a resident of the same country and is treated as changing residence from a listed country to an unlisted country or vice versa as a result of changes to the list(s) of countries or political developments (eg, as a result of the dissolution of a country). In these cases, the losses incurred by a CFC in an earlier period will not be denied under subsection 431(4) solely because the listing status of a CFC's country of residence changes (new subsections 431(4A), (4B) and (4C)). Carry forward losses will not be available, however, if the losses were denied in an earlier statutory accounting period because of a previous application of subsection 431(4) (new subsection 431(4D)). [Item 49]

6.57 The following table summarises the impact of new subsections 431(4), (4A), (4B), (4C) & (4D) on the availability of a CFC's carry forward losses from previous statutory accounting periods.

Impact of new subsections 431(4), (4A), (4B), (4C) & (4D) on carry forward losses
Scenario CFC's current country of residence Availability of losses for statutory accounting periods commencing after 1 July 1997
Losses incurred by a listed country CFC in a statutory accounting period commencing before 1 July 1997 Broad-exemption listed country Allowable* (subparagraph 431(4)(a)(ii))
Non-broad-exemption listed country Generally not allowable (subparagraph 431(4)(b)(ii)); Allowable* if the non-broad-exemption listed country arises from the dissolution of the listed country (subsection 431(4B)); Allowable* if the non-broad-exemption listed country is the same country as the listed country (subsection 431(4C))
Losses incurred by an unlisted country CFC in a statutory accounting period commencing before 1 July 1997 Broad-exemption listed country Generally not allowable (subparagraph 431(4)(a)(ii)); Allowable* if the broad-exemption listed country is the same country as the unlisted country (subsection 431(4A)) - this is unlikely to occur but is theoretically possible
Non-broad-exemption listed country Allowable* (subparagraph 431(4)(b)(ii))
Losses incurred by listed country CFC in a statutory accounting period commencing before 1 July 1997. The CFC subsequently changes residence to another listed country in a statutory accounting period commencing before 1 July 1997. Broad-exemption listed country Allowable* (subparagraph 431(4)(a)(ii))
Non-broad-exemption listed country Generally not allowable (subparagraph 431(4)(b)(ii)); Allowable* if the non-broad-exemption listed country arises from the dissolution of the last mentioned listed country (subsection 431(4B)); Allowable* if the non-broad-exemption listed country is the same country as the last mentioned listed country (subsection 431(4C))
Losses incurred by an unlisted country CFC in a statutory accounting period commencing before 1 July 1997. The CFC subsequently changes residence to a listed country in a statutory accounting period commencing before 1 July 1997. Broad-exemption listed country Not allowable because the losses would have been denied previously under subsection 431(4) (subsection 431(4D))
Non-broad-exemption listed country Not allowable because the losses would have been denied previously under subsection 431(4) (subsection 431(4D))
Losses incurred by a listed country CFC in a statutory accounting period commencing before 1 July 1997. The CFC subsequently changes residence to an unlisted country in a statutory accounting period commencing before 1 July 1997. Broad-exemption listed country Not allowable because the losses would have been denied previously under subsection 431(4) (subsection 431(4D))
Non-broad-exemption listed country Not allowable because the losses would have been denied previously under subsection 431(4) (subsection 431(4D))
Losses incurred by a broad-exemption listed country CFC in a statutory accounting period commencing after 1 July 1997 Broad-exemption listed country Allowable* (subparagraph 431(4)(a)(i))
Non-broad-exemption listed country Generally not allowable (subparagraph 431(4)(b)(i)); Allowable* if the non-broad-exemption listed country arises from the dissolution of the broad-exemption listed country (subsection 431(4B)); Allowable* if the non-broad-exemption listed country is the same country as the broad-exemption listed country (subsection 431(4C))
Losses incurred by a non-broad-exemption listed country CFC in a statutory accounting period commencing after 1 July 1997 Broad-exemption listed country Generally not allowable (subparagraph 431(4)(a)(i)); Allowable* if the broad-exemption listed country is the same country as the non-broad-exemption listed country (subsection 431(4A));
Non-broad-exemption listed country Allowable* (subparagraph 431(4)(b)(i))
(*) The losses will not be available if subsection 431(4) has applied previously to deny the losses (subsection 431(4D)).

Credit under tax sparing arrangements for foreign tax forgone

Summary of the amendments

Purpose of the amendments

6.58 The amendments will ensure that a credit is available for foreign tax forgone on income subject to accruals taxation under the CFC measures in circumstances where tax sparing provisions of a double taxation agreement require that a credit be provided.

Date of effect

6.59 The changes will apply in determining foreign tax credits available against attributable income for statutory accounting periods of CFCs commencing on or after 1 July 1997. [Subitem 124(2)]

Background to the legislation

6.60 Tax sparing occurs where tax forgone by a country in providing certain tax concessions to Australian investors is deemed to be paid for the purposes of the FTCS. Tax sparing is currently only provided under Australia's double taxation agreements although there is also a regulation making power in section160AFF that could be used to provide tax sparing outside of an agreement. In the absence of the recognition of tax sparing, tax concessions provided by other countries could be negated because the FTCS normally only allows a tax credit for foreign tax actually paid. Additional Australian tax would therefore be paid in place of the foreign tax forgone.

6.61 There is currently no need to provide a credit against attributable income for foreign tax forgone under tax sparing arrangements because tax sparing has only been provided for listed countries. Moreover, tax spared amounts derived in a listed country are exempt from accruals taxation because they are excluded from EDCI by regulation 152H. This exclusion will cease to operate for limited-exemption listed countries because the concept of EDCI will generally not be relevant in determining the attributable income of CFCs resident in the countries.

Explanation of the amendments

6.62 Section 393 currently provides a deduction in calculating attributable income for foreign tax paid by a CFC. Where the attributable taxpayer is a company, foreign tax is deemed to be paid under section 160AFCA equal to the taxpayer's attribution percentage of the deduction available under section 393. The amendments will extend this treatment by deeming foreign tax to have been paid for foreign tax forgone under tax sparing arrangements. The amount of foreign tax taken to have been paid will be equal to the taxpayer's attribution percentage of the total of:

·
the section 393 amount; and
·
the amount of foreign tax not actually paid because of a particular provision of a law of a listed country that is deemed to have been paid under a double tax agreement or section 160AFF.

[Item 16]

Treatment of amounts derived in a CFC's country of residence for the purposes of the active income test

Summary of the amendments

Purpose of the amendments

6.63 The amendments will clarify that paragraph436(1)(b) does not operate to exclude amounts from the active income test which are derived in a CFC's country of residence.

Date of effect

6.64 The changes will apply in calculating the active income test for statutory accounting periods of CFCs commencing on or after 1 July 1997. [Subitem 126(1)]

Background to the legislation

6.65 An active income test provides an exemption from accruals taxation for small amounts of tainted income that are incidental to the overall operations of a CFC. In this regard, amounts derived in carrying on a business at or through a branch in a broad-exemption listed country are generally excluded from the active income test (paragraph 436(1)(b)).

6.66 Modifications are required to the exclusion following the extension of the active income test for CFCs resident in unlisted countries to all CFCs. The modifications are required to ensure the exclusion does not apply to amounts derived by a CFC in a broad-exemption listed country from carrying on a business in that country. The exclusion of these amounts would not be appropriate because it would distort the active income test.

Explanation of the amendments

6.67 The amendments will ensure that amounts derived in carrying on a business in a CFC's country of residence are not excluded from the active income test under paragraph436(1)(b). This will be achieved by inserting the phrase "(other than a broad-exemption listed country of which the company is a resident)" at the end of the paragraph. [Item 52]

Operation of the Income Tax Regulations

Summary of the amendments

Purpose of the amendments

6.68 The amendments will ensure that changes to the Income Tax Regulations necessary to give effect to the changes to the foreign source income measures can apply from the commencement of the changes to the Principal Act.

Date of effect

6.69 The amendments will apply to the first regulations made giving effect to the changes to the taxation of foreign source income. [Item127]

Background to the legislation

6.70 Subsection 48(1) of the Acts Interpretation Act 1901 provides that regulations take effect from the date of their notification in the Commonwealth Gazette, or an earlier date if specified in the regulations. Subsection 48(2) limits the circumstances where regulations can operate from an earlier date to instances where they do not disadvantage anyone. Modification is required to the general rule in subsection48(2) if the two list approach is to apply from 1 July 1997 because the two list approach could disadvantage some taxpayers and it will not be possible to make the amendments to the Income Tax Regulations before this time.

Explanation of the amendments

6.71 The amendments will provide transitional arrangements to allow changes to the Income Tax Regulations to take effect prior to the date they will be notified in the Gazette even though the changes may operate to the disadvantage of some taxpayers. These arrangements will not be affected by the Legislative Instruments Act 1997 which will deal with the application of regulations. [Item 127]


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