Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 2 - Measures to deal with abuse of foreign tax credits
2.1 Schedule 2 to the Bill will amend the Income Tax Assessment Act 1936 (the ITAA36) to enable the general anti-avoidance provisions contained in Part IVA of the ITAA36 to apply to schemes designed to acquire or generate foreign tax credits, which have been entered into after 4 pm, by legal time in the Australian Capital Territory, on 13 August 1998. The penalty provisions in Part VII of the ITAA36 will be amended to ensure penalties which currently apply to Part IVA schemes will also apply to foreign tax credit schemes.
Summary of the amendments
Purpose of the amendments
2.2 The overall purpose of the amendments is to deny the availability of foreign tax credits which have been acquired or generated through a scheme with the sole or dominant purpose of obtaining a tax benefit. The amendments extend the application of the general anti-avoidance provisions contained in Part IVA of the ITAA36 to include schemes in relation to foreign tax credits, and brings such arrangements within the penalty tax provisions of Part VII of the ITAA36.
Date of effect
2.3 The amendments will apply to arrangements entered into after 4 pm, by legal time in the Australian Capital Territory, on 13 August 1998.
Background to the legislation
2.4 Australian taxpayers are subject to Australian income tax on all Australian sourced and foreign sourced income, except where a specific exemption applies. Generally, Australian taxpayers with assessable foreign sourced income may claim a credit for tax imposed by foreign jurisdictions against their Australian income tax liability on that foreign sourced income.
2.5 Arrangements which promote the purported acquisition of foreign tax credits by Australian taxpayers have come to the attention of the Australian Taxation Office. These arrangements are structured to acquire or generate foreign tax credits to be offset against tax payable on other foreign sourced income of the Australian taxpayer.
2.6 A foreign tax credit scheme operates on the basis that foreign income is earned which gives rise to an entitlement to foreign tax credits. A scheme is entered into whereby a foreign income stream is acquired. Where the acquisition cost of the income stream is deductible, those deductions largely cancel out the foreign income received. The major portion of the foreign tax credits which relate to that foreign income stream are then available to offset tax payable on the taxpayer's other foreign income of the same class or to carry forward any excess to future years.
2.7 At 4 pm on 13 August 1998, the Treasurer announced that the Government would introduce measures to amend the general anti-avoidance provisions in Part IVA to counter schemes entered into after the announcement which are designed to acquire or generate foreign tax credits that can be used to shelter low-taxed foreign sourced income from Australian tax.
Explanation of the amendments
2.8 Schedule 2 to the Bill amends Part IVA of the ITAA36 so that it can be applied to the acquisition of foreign tax credit entitlements in the year in which the entitlement to the foreign tax credit arises.
2.9 Item 1 amends subsection 177A(1), which defines certain terms for the purposes of Part IVA, to provide that a foreign tax credit has the same meaning as in Division 19 of Part III of the ITAA36. Division 19 refers to credits allowable by virtue of:
- Divisions 18 (credits in respect of foreign tax), 18A (credits in respect of overseas tax paid on certain film income) and 18B (credits in respect of overseas tax paid on certain shipping income); or
- the International Tax Agreements Act 1953.
2.10 Part IVA of the ITAA36 contains the general anti-avoidance provisions which confer on the Commissioner the power to cancel tax benefits when certain objective criteria set out in the Part are met.
2.11 A tax benefit is defined for the purposes of Part IVA in subsection 177C(1). Currently a tax benefit includes:
- the non-inclusion in assessable income of an amount that, but for the scheme, might reasonably be expected to have been included;
- a deduction being allowable that, but for the scheme, might reasonably be expected not to have been allowable; or
- Schedule 1 to the Taxation Laws Amendment Act (No 2) 1998 proposes to apply Part IVA to a capital loss incurred in an income year that, but for the scheme, it might reasonably be expected that no capital loss would have been incurred.
2.12 Items 2 and 3 provide for the insertion of new paragraph 177C(1)(bb) to extend the definition of tax benefit to include a foreign tax credit allowable where it might reasonably be expected that, but for the scheme, no foreign tax credit would have been allowable. Broadly, a foreign tax credit is allowable where the taxpayer satisfies the criteria for entitlement to a foreign tax credit (see section 160AF) and the Commissioner determines that the credit so claimed is allowable (see section 160AI) or is deemed to have made such a determination (see section 160AJA). The taxpayer may make a self-determination as to their eligibility for a foreign tax credit and the amount (see section 160AIA). The Commissioner may, in his determination, accept the self-determination made by the taxpayer (see section 160AIB).
2.13 The amount of the 'tax benefit' in such a case is so much of the foreign tax credit as would not have been allowable if the scheme had not been entered into [new paragraph 177C(1)(f) inserted by Item 4
2.14 Subsection 177C(2) sets out specific exclusions from the definition of a tax benefit to which Part IVA applies. This provision prevents the application of Part IVA where a tax benefit is attributable to the making of a declaration, agreement, election, selection or choice, giving of a notice or exercising of an option under a provision of the ITAA36. Subsection 177C(2) only applies where the scheme was not entered into for the purpose of creating the conditions necessary for the making of the declaration, election, selection or choice, or the giving of a notice or exercising of an option.
2.15 Item 5 inserts new paragraph 177C(2)(d) which provides that the allowance of a foreign tax credit which is the result of the making of a declaration, agreement, election, selection or choice, or the giving of a notice or exercising of an option under a provision of an Act will not in itself constitute a tax benefit. New paragraph 177C(2)(d) only applies if the scheme was not entered into for the purpose of creating the conditions necessary for the declaration, election, etc. to be made. [New subparagraph 177C(2)(d)(ii)
2.16 Subsection 177C(3) deems the non-inclusion of an amount in assessable income or the allowance of a deduction to be attributed expressly to a declaration, election, selection, choice, giving of a notice or exercising of an option if, but for those actions, the amount would have been included in assessable income or the deduction not allowed. The provisions provide that the allowability of a foreign tax credit will be attributable to a declaration, election, selection or choice, giving of a notice or exercising of an option if the foreign tax credit would not have been allowable if those actions had not been taken. [Items 6 to 9
Cancellation of Tax Benefits
2.17 If a scheme has been entered into for the sole or dominant purpose of obtaining a tax benefit then the Commissioner is authorised by subsection 177F(1) to cancel the whole or part of the tax benefit. The Commissioner may also make compensating adjustments in favour of any taxpayer if it is fair and reasonable to do so (see subsection 177F(3)). The Commissioner is given the power to make a compensating adjustment in case a tax benefit is denied in accordance with Part IVA but, if the scheme had not been entered into, a different tax benefit would have arisen.
2.18 Items 10 and 11 enable the Commissioner to cancel a tax benefit which is referable, in whole or in part, to a foreign tax credit. Subsection 177F(1) empowers the Commissioner to take whatever action is necessary to give full and proper reconstructive effect to the determination. [New paragraph 177F(1)(d)
2.19 Where the Commissioner has made a determination under new paragraph 177F(1)(d) , new paragraph 177F(3)(d) authorises the making of a compensating adjustment in favour of a taxpayer, should the need arise. [Items 12 and 13 Where the Commissioner is of the opinion that the person concerned would have been allowed a foreign tax credit but for the scheme, an adjustment may be made to allow the whole or part of the foreign tax credit, where it is fair and reasonable to do so.
2.20 A taxpayer is able to object against a determination relating to assessable income or allowable deductions, as the determination will be reflected in the relevant notice of assessment or amended assessment. A determination in relation to a foreign tax credit is not reflected in a notice of assessment or amended assessment. However, by virtue of section 160AL, a person dissatisfied with a determination on the amount of foreign tax credits allowable may object against it, as set out in Part IVC of the Taxation Administration Act 1953 . This will extend to a determination on foreign tax credits made to give effect to a determination made under new paragraph 177F(1)(d) . [Item 11
2.21 Generally, determinations of claims for foreign tax credits made under sections 160AI and 160AJA may be amended by the Commissioner at any time within 4 years of the date of the original determination (see section 160AK). New subsection 177H(1) extends the time in which the Commissioner may amend a foreign tax credit determination from 4 years to 6 years after the date of the original foreign tax credit determination. [Item 14 This is consistent with the current structure of Part IVA (see section 177G) which enables the Commissioner to amend an assessment within 6 years to give effect to subsection 177F(1).
2.22 Where the Commissioner has decided to make a compensating adjustment in favour of a taxpayer under new paragraph 177F(3)(d) , the Commissioner is permitted to amend a foreign tax credit determination at any time. [New subsection 177H(2) inserted by Item 14
2.23 Where the Commissioner applies Part IVA and makes a determination under subsection 177F(1) to cancel a tax benefit and that determination was taken into account in calculating tax assessable to a taxpayer, additional tax by way of penalty is authorised by section 226. The additional tax is equal to 50% of the difference between the tax properly payable and the tax that would have been payable had Part IVA not been applied. This is reduced to 25% if it is reasonably arguable that Part IVA does not apply (see subsection 226(2)).
2.24 A foreign tax credit affects neither the taxable income of a taxpayer, nor the tax assessable on that taxable income, in a year of income. A foreign tax credit affects the amount of tax payable by the taxpayer. Item 17 inserts new section 226AA to extend the penalty provisions where the Commissioner has determined to cancel a foreign tax credit under subsection 177F(1). New section 226AA follows the same structure as section 226.
2.25 The definition of scheme section in subsection 222A(1) is amended to ensure that new section 226AA attracts the consequences of such a characterisation. [Item 15] Similarly, the definition of wrongful behaviour provisions is amended by item 16 so that it refers to the operative parts of new section 226AA . These amendments extend the application of sections 226B to 226F to a taxpayer affected by new section 226AA . Broadly, these sections permit the Commissioner to increase or reduce the amount of penalty tax payable depending upon the circumstances outlined in those sections, for example, in the event of disclosure or hindrance. Section 226A prevents additional tax, by way of a penalty, from being imposed where the taxpayer had applied for a private ruling. A private ruling cannot be given on questions of foreign credits and the amendment to paragraph 226A(a) by item 18 reflects this.
2.26 New subsection 226AA(1) provides for the imposition of a penalty on the excess of the amount of foreign tax credit allowable to a taxpayer after entering into or carrying out the scheme, over the foreign tax credit amount allowable after the Commissioner has exercised the cancellation power under subsection 177F(1).
2.27 New subsection 226AA(2) provides for the imposition of a penalty where the Commissioner has exercised the cancellation power under subsection 177F(1) and makes a foreign tax credit determination that the credit is not allowable to give effect to that Part IVA determination. The figure upon which the penalty can be imposed will be the amount of the foreign tax credit that would have been allowable to the taxpayer had the Commissioner not made a determination under Part IVA.
2.28 The amount of additional tax is calculated by application of the 'penalty percentage' and is consistent with that which applies to other Part IVA schemes by virtue of section 226. The penalty percentage is 25% of the amounts identified in new subsections 226AA(1) and (2) where it is reasonably arguable that Part IVA does not apply. In the absence of a reasonably arguable position, the penalty percentage is 50%. [New subsection 226AA(4)
2.29 New subsection 226AA(3) treats an amount of additional tax imposed under new subsection 226AA(1) or (2) , as being in respect of a year of income. This provision provides a reference point for the timing of the imposition of the additional tax liability, as well as for objection and appeal rights. [Item 17
2.30 These amendments apply in relation to schemes that were entered into after 4 pm, by legal time in the Australian Capital Territory, on 13 August 1998. [Item 19
2.31 If proposed changes to Part IVA as a result of the denial of the artificially created losses measures (Part 2 of Schedule 1 to the Taxation Laws Amendment Act (No 2) 1998 ) have not commenced by the time that these measures receive Royal Assent, then commencement of these measures will be delayed until immediately after the denial of artificially created losses measures commence.