Foreign income return form guide

  • This document has changed over time. View its history.

Chapter 1: Attribution of the current year profit of a controlled foreign company (CFC)

This chapter explains the accruals tax system for residents with interests in foreign companies.

The accruals tax system applies to Australian residents who have a substantial interest in a foreign company controlled by Australians - referred to as a controlled foreign company (CFC) . The system operates to include a taxpayer's share of specified income and gains of a CFC in the taxpayer's assessable income. This is called attribution. Subject to some modifications, the income and gains of CFCs are worked out using the same tax rules that apply for residents.

Part 1

Are you subject to the CFC measures?

Part 2

Is the CFC largely exempt because it is primarily engaged in a genuine active business?

Part 3

Working out attributable income and the amount to include in your assessable income

Part 1 - Are you subject to the CFC measures?

The accruals tax system may apply to you if you are an Australian resident who has a substantial interest in a CFC. This part explains:

  • when a foreign company is a CFC
  • the types of interests in a foreign company that are taken into account in testing whether that company is a CFC
  • the size of an interest in a CFC you need before you must include an amount in your assessable income
  • how to determine the size of your interest in a CFC
  • whether income of a CFC is to be included in your assessable income for the current income year.

Summary of part 1

Section 1

Is there a CFC?

 

Section 2

Are you an attributable taxpayer?

 

Section 3

Is the CFC's income generally exempt from accruals taxation?

 

Section 4

What types of attribution can apply?

Dividend attribution on change of residence

Section 5

Do you have to work out the attributable income of a CFC?

Refer to chapter 3 and appendix 3

Section 1 - Is there a CFC?

Three control tests

A CFC is a non-resident company that satisfies one of three control tests. Whether a company is a resident of a foreign country is determined according to the Australian tax law as modified by double taxation agreements with other countries.

The three control tests are the:

  • strict control test
  • assumed controller test
  • de facto control test.

Strict control test

A foreign company will be treated as a CFC under the strict control test if a group of five or fewer Australian 1 per cent entities, together with their associates, own or are entitled to acquire a control interest of at least 50 per cent in the foreign company.

An Australian 1 per cent entity is an Australian entity that, together with its associates, holds an interest of at least 1 per cent in the foreign company.

An Australian entity is an Australian partnership, an Australian trust, or an entity - other than a partnership or trust - that is a Part X Australian resident. A Part X Australian resident is a resident of Australia who is not treated solely as a resident of another country under a double taxation agreement between Australia and that country.

The associate-inclusive control interest of an entity is the sum of interests held by the entity and its associates in the foreign company. Interests that the entity and its associates are entitled to acquire are also taken into account.

Example 1:

Strict control test

  • This test will be satisfied if three Australian residents each hold interests of 30 per cent, 10 per cent and 10 per cent respectively in a foreign company.
  • Assumed controller test

A foreign company will normally be treated as a CFC under the assumed controller test if a single Australian entity owns, or is entitled to acquire, an associate-inclusive control interest of at least 40 per cent in the foreign company. An entity's associate inclusive control interest in a foreign company is the sum of the interests held in the company by the entity and the associates of the entity. A foreign company will not be treated as a CFC under the assumed controller test, however, if the company is controlled by a party or parties unrelated to the single resident or its associates.

Example 2:

Assumed controller test

  • If an Australian entity holds 45 per cent of the interests in a foreign company and the remaining 55 per cent is held by several non-residents, it would be assumed under this test that the Australian controls the foreign company.

De facto control test

A foreign company will be treated as a CFC under the de facto control test if a group of five or fewer Australian entities, either alone or with associates, effectively control the foreign company.

Example 3:

De facto control test

  • If an Australian entity can control the appointment of the directors of a foreign company, the Australian entity will generally be taken to have de facto control of that foreign company.
When is control measured?

A statutory accounting period of a CFC is a period of 12 months ending 30 June, unless the CFC makes an election to use another period. The control test is applied at the end of a CFC's statutory accounting period to check whether income of the CFC is to be attributed.

It may also be necessary to measure control at the time a CFC pays a dividend to another CFC or to a controlled foreign trust or at the time a CFC changes residence.

Election to change a CFC's statutory accounting period

A CFC can make an election to change its statutory accounting period only if the accounting period is:

  • regularly used by the CFC for complying with the tax law of a foreign country or
  • regularly used by the CFC for reporting to its shareholders.

A CFC may also elect in writing to adopt a statutory accounting period ending on a date other than 30 June if the period is regularly used for complying with the tax laws of the CFC's country of residence or is regularly used for reporting to the CFC's shareholders. You may make this election on behalf of a wholly owned CFC.

A CFC may subsequently elect another statutory account period ending on any date, including 30 June, provided the above conditions are satisfied.

Where a CFC chooses another statutory accounting period, it must complete the current statutory accounting period. The intervening statutory accounting period-from the last day of the current period to the beginning of the new period-will be less than twelve months. The new and subsequent statutory accounting periods will be of twelve months duration.

Example 4:

Statutory accounting periods

  • If a company with a statutory accounting period ending 30 June 1995 elected on 30 August 1994 to change to a statutory account period ending 30 September, it would have statutory accounting periods of:
  • 1 July 1994 to 30 June 1995
  • 1 July 1995 to 30 September 1995
  • 1 October 1995 to 30 September 1996 and
  • subsequent 12 month statutory accounting periods ending 30 September.

It is not necessary for a CFC to complete the current statutory accounting period before beginning a new period if the election is made when the CFC first comes into existence or where a company first becomes a CFC.

What interests in a foreign company are taken into account in the control tests?

In most cases, an interest in a foreign company will be held in the form of shares. This interest can be held either directly or indirectly through other entities. At a particular time, your interests in a foreign company include the interests you hold in the company as well as the interests you are entitled to acquire.

The interests of your associates in a foreign company are also relevant for determining whether you have an interest in the company.

Direct control interest in a foreign company

Your direct control interest in a foreign company is the greatest of the percentages that you hold, or are entitled to acquire, of the following:

  • total paid-up share capital in the foreign company
  • total rights to vote, or to participate in any decision making, in relation to:
    • the distributions of capital or profits
    • the changing of constituent documents
    • the varying of share capital of the company
  • total rights to distributions of capital or profits of the company on winding-up or
  • total rights to distributions of capital or profits of the company other than on winding-up.

Example 5:

Direct control interest in a foreign company

  • A foreign company is established issuing 100 ordinary shares. An Australian taxpayer purchases 50 of these shares which entitle the taxpayer to 50 per cent of the income, voting and capital rights of the company. The direct control interest of the Australian taxpayer in the foreign company is 50 per cent.

Example 6:

Direct control interest in a foreign company where shares confer different rights

  • An Australian company has a 50 per cent voting interest and a 75 per cent income interest in a foreign company. The direct control interest of the Australian company in the foreign company is 75 per cent.

How is a direct control interest measured if the test time occurs before the end of an accounting period?

A taxpayer's direct control interest in a company has to be measured at a point in time-referred to as the test time.

However, in some cases it may not be possible to measure the percentage a taxpayer holds of the total rights to the profits of a company, or to a distribution of capital on winding up of the company, before the end of the accounting period of the company.

This would be the case, for example, if some shareholders are entitled to a fixed return of capital or profits.

In these cases, the taxpayer's rights to capital or profits are measured at the end of the accounting period of the company. It is assumed for this purpose that the rights held by the taxpayer at the test time are held at the end of the accounting period of the company.

Exclusion of eligible finance shares

Eligible finance shares are not taken into account in working out an entity's direct control interest in a company. Broadly, these are shares issued under preference share financing arrangements with Australian financial intermediaries-for example, banks-and their subsidiaries. In effect, the shares are issued in place of loans.

Foreign income return form guide update 1999-2000

The two paragraphs under the heading Exclusion of real estate investment trust shares were added to this guide by an update in June 2000.

Exclusion of real estate investment trust shares

Real estate investment trust shares are not taken into account - except for section 459 of the Income Tax Assessment Act 1936 - in working out an entity's direct control interest in a United States real estate investment trust that derives income or holds assets principally in the United States. Control interests held through a United States real estate investment trust will still be taken into account in determining whether a subsidiary of the trust qualifies as a controlled foreign company (CFC). This will attribute income from a real estate investment trust subsidiary where a taxpayer has a direct interest in the subsidiary.

This exemption applies to statutory accounting periods of CFCs ending on or after 2 July 1998.

Indirect control interest in a company

A taxpayer may hold a direct control interest in an entity-entity A-which holds a direct control interest in another entity-entity B. In this case, the taxpayer has an indirect control interest in entity B.

A taxpayer's indirect control interest in entity B is obtained by multiplying the direct control interest of the taxpayer in entity A by the entity's direct control interest in entity B.

This process of multiplication is continued where there are further entities in the chain.

Indirect control interest may only be traced through a controlled foreign entity

An indirect control interest in a foreign entity can be traced only through controlled foreign entities (CFEs). These are CFCs, controlled foreign partnerships (CFPs) and controlled foreign trusts (CFTs)

A CFP is a partnership which does not have a resident partner and has at least one CFC or a CFT as a partner. A CFT is a trust, other than a resident trust:

  • that has an eligible transferor-see appe ndix 2

    or
  • where five or fewer residents and their associates hold, or are entitled to acquire, 50 per cent or more of the income or capital of the trust.

Deeming rules for tracing an indirect control interest

For determining the indirect control interest in an entity-but not for working out the amount of the income to be attributed to a taxpayer-a resident or an interposed CFC is deemed, in the following specified circumstances, to own a 100 per cent interest in a lower tier entity.

The control tracing interest of an entity will be treated as 100 per cent if, together with associates, the entity:

  • has an interest of at least 50 per cent in a foreign company
  • satisfies the assumed controller test in relation to a foreign company
  • actually controls the foreign company - is a partner in a partnership that is not an Australian partnership
  • is an eligible transferor in relation to a trust or
  • has an interest of at least 50 per cent in a trust that is not an Australian trust.

Example 7:

Indirect control interest

  • A resident company holds a 60 per cent interest in a foreign company, FC1, which holds a 35 per cent interest in another foreign company, FC2. FC2 holds a 60 per cent interest in foreign company FC3. Another resident holds a 20 per cent interest in FC2.

    The indirect control interest of the resident company in FC3 is worked out as follows:

Resident company

Direct control interest

%

Control tracing interest

%

FC1

60

100

FC2

35

35

FC3

60

100

  • The indirect control interest of the resident in FC3 is therefore:

    100% X 35% X 100% = 35%

    It is possible to trace interests through FC2 because it is a CFC. FC3 is also a CFC because the resident company has an indirect control interest of 35 per cent in FC3 and another resident has an indirect control interest of 20 per cent in FC3-that is, 20 per cent in FC2 x 100 per cent interest for tracing control of FC2 in FC3.

Associate inclusive control interest

Your associate-inclusive control interest in a foreign company is the sum of:

  • your direct control interests in the foreign company
  • your indirect control interests in the foreign company
  • the direct and indirect control interests of your associates in the foreign company.

To avoid double counting, an indirect control interest is not taken into account when determining a direct control interest or another indirect control interest which have been counted.

Section 2 - Are you an attributable taxpayer?

If you have an interest in a CFC you must determine if you are an attributable taxpayer. You are only required to include an amount of attributable income from a CFC in your assessable income if you are an attributable taxpayer in relation to the CFC.

You will be an attributable taxpayer if:

  • you have an associate-inclusive control interest of 10 per cent or more in a CFC or
  • all of the following rules apply:
    • the CFC is a CFC because of the application of the de facto control test
    • you are an Australian 1 per cent entity
    • you are part of a group of five or fewer Australian entities who, alone or with associates-regardless of whether the associates are Australian entities-control the CFC.
What share of the attributable income of a CFC must you include in your assessable income?

If you are an attributable taxpayer, you may be attributed a share of a CFC's attributable income. Your share is called an attribution percentage and is based on your rights to profits from the CFC.

Working out your attribution percentage

Your attribution percentage in a CFC is the sum of your:

  • direct attribution interest in the CFC and
  • indirect attribution interests in the CFC.

The interests of your associates are not included.

Direct attribution interest in a CFC

Your direct attribution interest in a CFC is the greatest of the percentages that you hold or are entitled to acquire, of the following:

  • total paid up share capital in the CFC
  • total rights to vote, or to participate in any decision making, in relation to:
    • the distributions of capital or profits
    • changing of constituent documents
    • varying of share capital of the CFC
  • total rights to distributions of capital or profits of the CFC on winding-up or
  • total rights to distributions of capital or profits of the CFC other than on winding-up.

Test time

Your direct attribution interest in a CFC is measured at a point in time called a test time. The test time may occur during the accounting period of a CFC.

In some cases, it may not be possible to measure the percentage you hold of the total rights to the profits of a company or to a distribution of capital on winding-up of the company before the end of the company's accounting period.

In these cases, your rights to capital or profits are measured at the end of the accounting period of the company. It is assumed for this purpose that the rights you held at the test time are held at the end of the company's accounting period.

Exclusion of eligible finance shares

In working out your direct attribution interest in a CFC, eligible finance shares in the CFC are not taken into account.

Indirect attribution interest in a CFC

You may hold an attribution tracing interest in an entity - entity A - which holds an attribution tracing interest in another entity-entity B.

Your indirect attribution interest in entity B is obtained by multiplying your attribution tracing interest in entity A by that entity's attribution tracing interest in entity B.

This process of multiplication is continued where there are further CFEs in the chain of entities.

Attribution tracing interests in a CFC

Your attribution tracing interest in a CFC is equal to your direct attribution interest in the CFC - the deemed 100 per cent rule for tracing control does not apply when tracing your attribution percentage.

Attribution tracing interest in a CFP

The attribution tracing interest of a partner in a partnership is the percentage the partner holds or is entitled to acquire of the profits of the partnership or of the partnership property. Where the two percentages differ, the attribution tracing interest will be the greater of those percentages.

Attribution tracing interest in a CFT

The attribution tracing interest that a beneficiary of a trust holds in the trust is the percentage of the income or property of the trust to which the beneficiary is presently entitled. The beneficiary's attribution tracing interest also includes a percentage of the income or property of the trust which the beneficiary is entitled to acquire. If the percentage of the income and the percentage of the property differ, the higher percentage is treated as the attribution tracing interest.

An eligible transferor has an attribution tracing interest in the CFT equal to 100 per cent. Refer to part 1 of chapter 2 to determine whether you are an eligible transferor.

Reduction of the attribution percentage where the total percentage is more than 100 per cent

In some cases, the total of the attribution percentage of all attributable taxpayers may be more than 100 per cent. In these cases, the aggregate is reduced to 100 per cent by reducing proportionately the interest of each attributable taxpayer.

Example 8:

Reduction where attribution percentage is more than 100 per cent

  • A foreign company has two classes of shares on issue. Class A carries the right to vote but no income rights. Class B carries the right to income and is non-voting. An Australian resident - Res1 - owns 25 per cent of the Class A shares and 75 per cent of the Class B shares. Another resident owns the remaining shares in each class. The foreign company is a CFC and both residents are attributable taxpayers.

Res1's attribution percentage

(greater of 25% and 75% )

75%

Res2's attribution percentage

(greater of 75% and 25% )

75%

Total interest of residents

150%

  • Each attributable taxpayer's attribution percentage is reduced in proportion, so that the aggregate interests of all attributable taxpayers is 100 per cent.

Res1's reduced

attribution percentage

=

              attribution percentage              

total interest of attributable taxpayers

 

=

75/150 = 50%

Res2's reduced

attribution percentage

=

              attribution percentage              

total interest of attributable taxpayers

 

=

75/150 = 50%

Section 3 - Is the CFC's income generally exempt from accruals taxation?

A number of exemptions from accruals taxation are provided for amounts taxed in a comparable tax country listed in the Income Tax Regulations. Before 1 July 1997, the same list was also used to provide exemptions under the foreign tax credit system. There are now separate lists for the exemptions.

Countries listed for accruals taxation purposes are called broad-exemption listed countries. These countries are listed in part 1 of attachment A in appendix 1. Countries not listed for accruals taxation purposes are called non-broad-exemption listed countries.

Countries listed for the purposes of the foreign tax credit system but not for accruals taxation purposes are called limited-exemption listed countries. These countries are listed in part 2 of attachment A in appendix 1. Countries on either the broad-exemption or limited-exemption lists are treated as listed for the purposes of the foreign tax credit system. Countries not on either list are called unlisted countries.

Summary of the terms used to refer to countries

Broad-exemption listed countries

The term broad-exemption reflects that amounts taxed at full rates by countries on the broad-exemption list are generally exempt from both accruals taxation and taxation on repatriation to Australia.

Limited-exemption listed countries

The term limited-exemption reflects that amounts taxed at full rates by countries on the limited-exemption list are generally exempt from tax on repatriation to Australia. An exemption from accruals taxation is not available, however, for amounts taxed in a limited-exemption listed country.

Listed countries

Listed countries are countries on the list of broad-exemption countries or on the list of limited-exemption countries.

Unlisted countries

Unlisted countries are countries that are not on either the broad-exemption or limited-exemption lists.

Non-broad-exemption listed countries

Non-broad-exemption listed countries are countries that are not on the list of broad-exemption countries. They comprise unlisted countries and countries on the list of limited-exemption countries.

Transitional rules

The broad-exemption and limited-exemption lists apply for statutory account periods of CFCs commencing on or after 1 July 1997. Unless otherwise stated, references to broad-exemption listed countries in this guide are to be treated as references to countries on the original list in working out the attributable income of a CFC for a statutory accounting period commencing before 1 July 1997. Countries on the original list are listed in part 3 of attachment A in appendix 1 .

When is a CFC a resident of a broad-exemption listed country?

A CFC is treated as a resident of a broad-exemption listed country if:

  • the CFC is not a Part X Australian resident and
  • the CFC is treated as a resident of the broad-exemption listed country under the tax laws of that country.

A CFC that is a resident of both a broad-exemption listed country and another country is treated as a resident of a broad-exemption listed country.

When is a CFC a resident of a limited-exemption listed country?

A CFC is treated as a resident of a limited-exemption listed country if:

  • the CFC is not a Part X Australian resident and
  • the CFC is treated as a resident of the limited-exemption listed country under the tax laws of that country.

A CFC that is a resident of both a limited-exemption listed country and an unlisted country is treated as a resident of a limited-exemption listed country.

When is a company a resident of an unlisted country?

A company is treated as a resident of an unlisted country if the company is neither a Part X Australian resident nor a resident of a listed country.

Rules that determine the particular country of residence

In some cases, it is necessary to determine whether a company is treated as a resident of a particular unlisted country-for example, for determining the active income test.

A company is treated as a resident of a particular unlisted country if :

  • the company is treated as resident under a tax law of the unlisted country and
  • the company is not treated as resident of any other unlisted country under the tax law of that country.

If a company is treated as a resident of more than one unlisted country under the tax laws of those countries and is incorporated in one of those countries, it is treated as resident in the country of incorporation.

If a company is not treated as a resident under the tax law of any unlisted country, it will be a resident of the unlisted country in which its management and control is solely or principally located.

If a company is not treated as a resident under the tax law of any unlisted country and does not have its central management and control solely or principally in an unlisted country, it will be a resident of the unlisted country in which it is incorporated.

Section 4 - What types of attribution can apply?

Sections 1 and 2 asked the following questions:

  • is the foreign company a CFC?
  • are you an attributable taxpayer?

If the answer to both of these questions is yes, the next step is to determine whether you must include an amount in your assessable income. There are three types of attribution.

Dividend attribution

If you were an attributable taxpayer of a CFC resident in an unlisted country and the CFC paid a dividend while you were an attributable taxpayer, you may be subject to dividend attribution.

Attribution on change of residence.

If you were an attributable taxpayer of a CFC resident in an unlisted country and the CFC changed its residence to a listed country or to Australia while you were an attributable taxpayer, you may be subject to attribution on your share of the accumulated profits of the CFC.

Attribution of current year profits

If you are an attributable taxpayer of a CFC at the end of the CFC's statutory accounting period, you may need to include the whole or a part of the profits of that period in your assessable income.

The attribution of current year profits of a CFC may be reduced if you have been subject to dividend attribution or attribution on change of residence by the CFC. Read chap te r 3 and appen dix 3 to see whether either of these apply to you.

Section 5 - Do you have to work out the attributable income of a CFC?

This section will tell you whether you need to work out the attributable income of the CFC. A brief description of the calculation follows.

Overview of the calculation

If you are an attributable taxpayer, your assessable income may include a share of the profit, if any, from certain types of income and gains of the CFC. The profit of the CFC is called attributable income and is worked out before taking into account your share of the profit-called your attribution percentage.

You work out attributable income based on the existing rules for working out the taxable income of a resident company. However, not all of the profits of a CFC are taken into account in working out the attributable income of the CFC.

The general rule

The general rule is that only amounts that arise from certain transactions which are classified as prone to tax minimisation are taken into account-called tainted income. These will only be taken into account if a CFC is not mainly engaged in genuine business activities-that is, where the CFC fails the active income test.

Exception for a listed country

An exception to the general rule is made for a CFC that is a resident of a listed country and derives certain untaxed income or gains from sources outside the listed country. These amounts are taken into account whether or not the CFC passes the active income test.

Exception for trust amounts

Another exception to the general rule is for certain trust amounts derived by a CFC. These will be taken into account whether or not the CFC passes the active income test.

Exception for foreign investment fund income

Income arising under the foreign investment fund (FIF) measures will also be taken into account even if the CFC passes the active income test.

Exception for comparably taxed amounts

Further, amounts are only taken into account if they are not taxed in full in Australia or comparably taxed in a broad-exemption listed country. Amounts arising in a broad-exemption listed country are assumed to be comparably taxed if they do not qualify as eligible designated concession income described in the Income Tax Regulations and in appendix 1 of this guide.

Relevant period

An amount will normally only be included in your assessable income if the CFC's statutory accounting period ends in your income year.

Example 9:

Taxpayer with a standard year of income

  • A taxpayer whose income year ends on 30 June has a CFC with a statutory accounting period which also ends on 30 June. For the taxpayer's income year ending 30 June 1998, the taxpayer must include a share of the attributable income of the CFC for the statutory accounting period ending 30 June 1998.

Example 10:

Taxpayer who balances early

  • A taxpayer whose income year ends on 31 March has a CFC with a statutory accounting period ending 30 June. For the taxpayer's income year ending 31 March 1998, the taxpayer must include a share of the attributable income of the CFC for the statutory accounting period ending 30 June 1997. The CFC's attributable income for the period 1 July 1997 to 30 June 1998 would not be included in the taxpayer's assessable income until the income year ending 31 March 1999.

Special rule for companies that cease to exist

If a company that was a CFC at the beginning of its statutory accounting period ceases to exist before the end of that period, the end of the company's statutory accounting period is deemed to be immediately before it ceased to exist.

Example 11:

Shortened statutory accounting period when a company ceases to exist

  • A CFC elects a statutory accounting period that aligns with its usual accounting period of 1 January to 31 December. The company members pass a resolution to wind up the company on 1 August 1995 and it is finally de-registered on 2 November 1995 in accordance with the corporation law in the company's country of residence. As the company ceased to exist during what was its statutory accounting period, the company's statutory accounting period is taken to be from 1 January 1995 to 2 November 1995.
Conditions to be met before you work out attributable income

You only need to work out attributable income if a foreign company is a CFC at the end of the foreign company's statutory accounting period. In addition, you will only need to work it out if you are an attributable taxpayer at the end of the period.

If you have an interest in a CFC at the end of the CFC's statutory accounting period, you must work out the attributable income of the CFC for the entire period, not just for the time you held the interest.

Example 12:

Disposal of a CFC before the end of a statutory accounting period

  • A resident individual with an income year ending 30 June has a CFC with a statutory accounting period that coincides with the individual's income year. On 31 December 1997 the individual disposes of the CFC to an unassociated resident company.

    In this case, the resident individual will not be an attributable taxpayer for the CFC's statutory accounting period ending 30 June 1998. Consequently, the resident individual will not include in their assessable income any of the attributable income of the CFC for the period.

Example 13:

Acquisition of a CFC part way through a statutory accounting period

  • Taking the facts from the previous example, the resident company would be an attributable taxpayer for the CFC's statutory accounting period ending 30 June 1998. The company would therefore be taxed on the attributable income of the CFC for the entire period even though the company owned the foreign company for only the second half of that period.

Note that, where there is an arrangement that is designed to avoid the CFC measures by selling an interest before the end of a CFC's statutory accounting period and acquiring the interest after the end of the period, you will be treated as if the interest were not sold.

If you were an attributable taxpayer at the end of the CFC's statutory accounting period, read on.

If you were not an attributable taxpayer at the end of the CFC's statutory accounting period, you do not need to work out attributable income and do not need to read on.

Part 2 - Is the CFC largely exempt because it is primarily engaged in a genuine active business?

Part 2 deals with the normal operation of the active income test. Special rules for banks, other financial institutions and insurance companies are not included.

Section 1

What is the purpose of the active income test?

Section 2

Is the CFC a resident of a foreign country?

Does the CFC have a permanent establishment in its country of residence?

Does the CFC keep proper records?

Have the substantiation requirements been met? (Refer to chap te r 4 p art 2 for a description of these requirements.)

Section 3

Is the tainted income ratio less than 5%?

Section 4

Explanation of the terms used in this part.

Section 5

Tainted income ratio for listed country CFCs for statutory accounting periods commencing before 1 July 1997.

Section 1 - What is the purpose of the active income test?

The active income test is used to determine whether a CFC is predominantly engaged in carrying on an active business. An exemption from accruals taxation is available for certain amounts if the test is satisfied.

To determine whether the CFC is mainly engaged in carrying on an active business, the first step is to determine amounts that are likely to be earned in a low tax jurisdiction to defer Australian tax. These amounts are compared to the CFC's total income to determine the proportion of potential tax deferral activities. Only if this proportion is less than 5 per cent will the CFC be taken to be mainly engaged in genuine business activities.

The meaning of special terms used in the following commentary are contained in section 4 of th is part .

Section 2 - Conditions to be met to satisfy the test

A CFC has to satisfy the following five conditions to pass the active income test.

Condition 1-Is the CFC a resident of a foreign country?

The CFC must be a resident of a particular country throughout the statutory accounting period. A change of residence of the CFC does not mean that the CFC will fail the active income test. However, it must have been a resident of a particular country both before and after the change.

New companies

If a CFC was in existence for only part of a statutory accounting period, it must be a resident of a particular country throughout the period in which it existed-that is, in the period from incorporation to the end of the statutory accounting period.

Treatment of dormant companies

The term in existence does not include a company that is dormant within the meaning of Part VI of the Companies Act 1981 . A CFC that is dormant for the whole of the statutory accounting period will fail the active income test. However, because the CFC is dormant, it will have no income or gains and will have no attributable income.

If the CFC is resident in a particular country, read on.

If the CFC is not a resident in a particular country, it has failed the active income test. Go straight to part 3 .

Condition 2-Does the CFC have a permanent establishment in its country of residence?

The CFC must carry on business through a permanent establishment in its country of residence for the whole of a statutory accounting period in which it is in existence.

What is a permanent establishment?

The definition of permanent establishment is contained in section 6 of the Act. Broadly, the term includes a place at or through which normal business activities are carried on. However, it specifically excludes a place where a person:

  • is engaged in business dealings through a commission agent or broker who is acting in the ordinary course of business and receiving customary rates of remuneration or
  • is carrying on business through an agent who does not have or does not usually exercise a general authority to negotiate or conclude contracts or to fill orders from stock situated in the country or
  • maintains the place solely for the purpose of purchasing goods or merchandise.

Partnership with a permanent establishment

Even if the CFC did not carry on business at or through a permanent establishment, the CFC will satisfy this condition if any partnership in which it is a member carried on business at or through a permanent establishment in the country of residence of the CFC.

If the CFC directly or indirectly through a partnership, carried on business through a permanent establishment in its country of residence, read on.

If the CFC did not carry on business through a permanent establishment in its country of residence, it has failed the active income test. Go straight to part 3 .

Condition 3-Does the CFC keep proper records?

The figures used in the active income test are mainly drawn from accounting records and, in general, are not adjusted to comply with tax law concepts. Therefore, the accounts of the company must be properly prepared.

The accounts must be prepared in accordance with commercially accepted accounting principles. Where there are commercially accepted accounting principles in the country of residence of the CFC, it is acceptable if the accounts of the CFC comply with those principles. In other cases, it is acceptable if the accounts of the CFC comply with Australian commercially accepted accounting principles.

The documents you must take into consideration are:

  • the profit and loss statement and balance sheet
  • any ledgers or journals
  • any notes, statements or reports that are attached to, or meant to be read with, these accounts.

The accounts of a CFC for a statutory accounting period must give a true and fair view of the financial position of the CFC. If the accounts are prepared in accordance with commercially accepted accounting principles but do not give a true and fair view, the CFC will fail the active income test.

Treatment of partnerships

Where a CFC is a partner in a partnership, the CFC's share of the partnership income must be taken into account. This means that the partnership must also keep proper accounts. If the partnership does not keep proper accounts, the CFC will fail the active income test.

If both the CFC and every partnership in which it was a partner kept proper accounts that give a true and fair view, read on.

If the CFC and every partnership did not keep proper accounts, the CFC has failed the active income test. Go straight to part 3 .

Condition 4-Have the substantiation requirements been met

A CFC must have, and be able to produce, accounts to substantiate your claim that the CFC has passed the active income test. If the CFC is a partner in a partnership, that partnership must also keep accounts to substantiate amounts derived by the partnership. If the CFC or partnership does not have the accounts, or does not produce them, the CFC is taken to have failed the active income test. See chap ter 4 for details of the substantiation requirements and the procedures.

If the CFC and any partnership in which the CFC is a partner is able to substantiate your claim, read on.

If the CFC or the partnership cannot substantiate your claim, the CFC has failed the active income test. Go straight to part 3 .

Condition 5-Tainted income ratio less than 5 per cent

To pass the active income test, the tainted income ratio of a CFC for a statutory accounting period must be less than 0.05-that is, less than 5 per cent. If both the bottom line and the top line of the relevant formula is nil, the CFC is taken to have passed the active income test.

Section 3 - Is the tainted income ratio less than 5 per cent?

The tainted income ratio for a CFC is worked out as follows:

gross tainted turnover

gross turnover

A different tainted income ratio applies for statutory accounting periods of listed country CFCs commencing before 1 July 1997. The ratio is discussed in section 5 .

Gross turnover

Broadly, the gross turnover of a CFC is the sum of the company's net gains and gross revenue. Work out the gross turnover using the following five steps:

  • identify the total gross revenue derived by the CFC
  • exclude certain comparably taxed amounts
  • exclude the proceeds of certain asset disposals
  • add back net gains arising from certain asset disposals
  • add the CFC's share of the gross turnover of each partnership in which it was a partner.

The figures used are mainly drawn from the accounts of the CFC. If the accounts are prepared in a foreign currency, there is no need to translate the amounts to Australian dollars.

Step 1 - Identify total gross revenue

The total gross revenue is the sum of amounts shown in the accounts of a CFC as gross revenue - that is, deductions are not taken into account. Do not include amounts that have not been brought to account in the period. For example, an amount may not be recognised in the accounts because its receipt is extremely doubtful. This amount would not be included in gross revenue. The exclusion of the amount must, however, be in accordance with commercially accepted accounting principles and give a true and fair view of the CFC's financial position.

Step 2 - Exclusion of comparably taxed amounts

Certain comparably taxed amounts are excluded from the active income test. They are:

  • a franked dividend
  • an amount included in the CFC's assessable income in any year of income, unless the amount is subject only to dividend or interest withholding tax or is not fully taxed - for example, certain shipping income or insurance premiums
  • an amount arising from the disposal of a taxable Australian asset - refer to section 3 o f p art 3 for an explanation of a taxable Australian asset
  • an amount that is an attribution account payment to the extent the profits from which the payment was made have previously been attributed to you
  • an amount derived through a branch in a broad-exemption listed country if the amount is taxed in that country - the exclusion does not apply to amounts derived in a CFC's country of residence or to amounts of eligible designated concession income
  • a non-portfolio dividend derived from a company resident in a listed country
  • a non-portfolio dividend derived from a company resident in an unlisted country if the underlying profit from which the dividend was paid has been taxed in a listed country - this is called the exempting profits part of the dividend.

Because trust amounts arising to a CFC are attributed regardless of whether the CFC passes the active income test, they are also excluded from the test. So too are any dividends paid by an unlisted country CFC.

Step 3 - Exclusion of proceeds from certain asset disposals

Amounts that arise from asset disposals are excluded from the gross revenue. However, this exclusion does not extend to disposals of trading stock. Amounts included in gross revenue from currency exchange rate fluctuations and commodity investments are also excluded.

Step 4 - Add back net gains

The amounts that were excluded under step 3 are brought back into gross turnover as net amounts. There are three separate net amounts:

  • the net gain from the disposal of commodity investments
  • the net gain from currency exchange rate fluctuations
  • the net gain from the disposal of other assets that are not trading stock or commodity investments.

In each case, to determine the net gain, the sum of the individual gains is reduced by the sum of the losses. If there is a net loss, the amount is ignored - it does not reduce the gross turnover. It is important to note that there is a separate calculation of net gain for each of the categories. Do not take comparably taxed amounts into account.

Consideration paid or received for asset disposals must be included at market value. Where an amount has been written down in the accounts, the write-down is to be ignored.

Step 5 - Inclusion of partnership turnover

A CFC's share of the gross turnover of a partnership must be added to the CFC's gross turnover. This is done for each partnership in which the CFC is a partner. This means that you must go through the same process - steps 1 to 4 - for each partnership.

In working out the total, treat the partnership as if it were a CFC. The partnership is assumed to be a resident of the same country as the CFC.

Result of steps 1 to 5

Add the amounts at steps 2 and 3. Take this total away from the total revenue at step 1. The balance is the gross revenue after exclusions.

Add the totals of steps 4 and 5. This is the CFC's gross turnover.

Gross tainted turnover

Gross tainted turnover is the part of the gross turnover that is either passive income, tainted sales income or tainted services income.

Broadly, passive income includes:

  • dividends
  • tainted interest income
  • annuity income
  • tainted rental income
  • tainted royalty income
  • amounts derived as consideration for the assignment in whole or part of any copyright, patent, design, trade mark or other like property or right
  • net gains on the disposal of tainted asset
  • income derived in carrying on a business of trading in tainted assets
  • net tainted commodity gains
  • net tainted currency exchange gains.

Tainted sales income and tainted services income are, broadly, income from certain transactions with, or originating from, associates or Australian residents.

The gross tainted turnover is worked out using the following five steps:

Step 1

Identify the part of gross revenue that is passive income.

Step 2

Add the part of gross revenue that is tainted services income.

Step 3

Add the part of gross revenue that is tainted sales income.

Step 4

Add the part of the gross turnover that is net tainted gains.

Step 5

Add the CFC's share of the gross tainted turnover of each partnership in which it was a partner.

Steps 1, 2 and 3 - Identify the tainted part of gross revenue

Identify which parts of the gross revenue are passive income, tainted sales income or tainted services income-that is, determine the tainted part of the result after step 3 of the calculation of gross turnover.

Step 4 - Identify tainted net gains

Identify the parts of the net gains that are tainted-that is:

  • the part of the net gain from the disposal of commodity investments that is tainted
  • the part of the net gain from currency exchange rate fluctuations that is tainted
  • the part of the net gain from the disposal of assets-other than trading stock or commodity investments-that is tainted.

Each of the net tainted gains is calculated separately and cannot exceed the amount of the net gain to which it relates. To do this you will need, in each case, to calculate the net gain and the net tainted gain. If the net tainted gain is greater than the net gain, use the net gain instead of the net tainted gain.

Step 5 - Identify the CFC's share of a partnership's gross tainted turnover

Go through steps 1 to 4 for each partnership in which a CFC was a partner. The CFC's share of the gross tainted turnover of each partnership is then added to the CFC's tainted income that was derived directly.

Working out the ratio

The tainted income ratio is worked out by dividing the gross tainted turnover of a CFC by the gross turnover of the CFC.

The following is a simple example of how to work out the tainted income ratio.

Example 14:

Working out the active income test ratio

  

$HK

shown in accounts

Interest - passive

 

2m

Royalty - passive

 

1m

Business income - from goods manufactured in Hong Kong

 

60m

Manufacturing expenses

 

40m

Tainted income ratio

= Gross tainted turnover gross turnover

 
 

= 3m/63m

 
 

= 4.8%

 
  • Therefore, the CFC passes the test.

If the tainted income ratio is less than 5 per cent, the CFC has passed the active income test. If the tainted income ratio is 5 per cent or more, the CFC has failed the active income test. Go to part 3 .

S ection 4 - Explanation of terms used in this part

Meaning of passive income

Dividends

Passive income includes all dividends. The term dividend includes:

  • unit trust dividends received from a corporate unit trust or a public trading trust
  • a distribution made by a liquidator which is deemed to be a dividend.

Interest income

Passive income includes tainted interest income, which is all interest income except for interest derived through an offshore banking unit. It also specifically includes:

  • amounts in the nature of interest - for example, discounts
  • income earned from hire purchase and other property financing transactions
  • accrued interest on discounted and other deferred interest securities issued after 16 December 1984
  • interest deemed to be derived where a CFC assumes the rights of a lender through the purchase of securities through a secondary market
  • factoring income.

Tainted rental income

There are three categories of tainted rental income.

  • Rent from associates
    • Income from any leases between a CFC and an associate and any income that arises where rent is paid to the CFC by an associate.
  • Lease of land
    • Income from related party lease transactions and income from leases of land-including all fixtures-except where the land is located in the same country as the CFC is resident. The income from the lease of the land will not be tainted if the CFC provides labour-intensive property management by directors or employees of the CFC.
  • Ships and aircraft
    • Income from the lease of ships or aircraft, cargo containers for use on ships or aircraft or plant or equipment for use on board ships, unless the income relates to the provision of operating crew in relation to ships and aircraft or maintenance or management services by the CFC's directors or employees.

Excluded rental income

An amount of rental income will not be treated as tainted if the following three requirements are satisfied:

  • the amount is derived from an associated CFC resident in the same country
  • the amount is subject to the normal company rate of tax in that country
  • the payment of the amount did not wholly or partly give rise to a notional allowable deduction for the associated CFC.

The second requirement is based on whether an amount has been subject to the normal company rate of tax in a country. For an amount to be treated as taxed at a country's normal company rate, the amount must be taxed at the same rate applicable to the company's other income or at a higher rate. In addition, there can be no entitlement to a credit, offset or tax concession in the taxation of the amount.

For the third requirement, it is assumed that the associated CFC failed the active income test. The requirement will not be satisfied if a payment would have resulted in a notional allowable deduction for an associated CFC if the CFC had been required to work out its attributable income.

This exclusion applies only for statutory accounting periods of CFCs commencing on or after 1 July 1997.

Tainted royalty income

Tainted royalty income includes income derived from assigning any copyright, patent, trademark or other like property or right.

Specifically excluded from tainted royalty income are royalties received from unrelated persons in the course of carrying on a business where the CFC substantially develops or improves the property or right for which the royalty is paid. For example, if a CFC develops software and licenses it to an unrelated party, the royalty income is not tainted.

Net gains on the disposal of tainted assets

The net gain-that is, the sum of gains less losses-from the disposal of tainted assets is included in passive income.

What is a tainted asset?

Tainted assets include:

  • all shares, interests in trusts and interests in partnerships
  • most financial instruments-such as loans, forward and futures contracts, swaps, other securities and life assurance policies
  • rights or options over any of the above.

An asset will also be tainted if it is held by a CFC to derive tainted rental income. In order to determine whether an asset is used to produce tainted rental income, you must look at the use of the asset over the whole time of ownership. If the purpose changed during that period, the asset will be treated as being used to produce tainted rental income if this was the purpose for the majority of the period of ownership.

An asset will be treated as a tainted asset if it is not trading stock and is not used solely in carrying on business.

Exclusion of commodity investments

Commodity investments are not tainted assets. They are treated separately when working out net tainted commodity gains.

Proceeds from trading in tainted assets

Income derived in carrying on a business of trading in tainted assets is included in passive income.

Net tainted commodity gains

The net gain on the disposal of tainted commodity investments is included in passive income.

What is a tainted commodity gain?

A tainted commodity gain or loss arises from the disposal of a tainted commodity investment.

What is a tainted commodity investment?

Commodity investments that are tainted include futures or forward contracts for a commodity-or a right or option on such a contract-unless the company carries on a business of producing or processing the commodity or uses the commodity as a raw material. To be excluded, the contract right or option must relate to the carrying on of that business and the resultant physical sale of the commodity must not be tainted sales income.

Net tainted currency exchange gains

A net tainted currency gain is the sum of the tainted currency exchange gains less the sum of the tainted currency exchange losses. If this is positive there is a net gain. If not, the amount is ignored.

What is tainted currency exchange gain or loss?

A gain or loss from a currency exchange fluctuation will be tainted unless it falls within one of the following categories:

  • the underlying transaction was for the purchase of goods from an unassociated person or
  • the underlying transaction was for the purchase or sale of depreciable plant or equipment that was used mainly to produce income that is not passive, tainted sales or tainted services or
  • the underlying transaction was a hedge for one of the preceding transactions or
  • the CFC was carrying on business as a currency trader and no other party to the transaction was an associate or an Australian resident.
Meaning of tainted sales income

The tainted sales income of a CFC includes that part of gross turnover that represents sales income where the goods sold were purchased from or sold to:

  • an associate who is a Part X Australian resident or
  • an associate who is not a Part X Australian resident but carried on business in Australia through a permanent establishment.

Sales which result in tainted sales income

 

Purchased from

Tainted sales?

Sold to anyone

Associated Australian

Yes

Associated non-resident

(via Australian branch)

Yes

Unassociated Australian

No

Associated non-resident

(not via Australian branch)

No

Unassociated non-resident

No

Purchases which result in tainted sales income on sale

 

Sold to

Tainted sales?

Purchased from anyone

Associated Australian

Yes

Associated non-resident

(via Australian branch)

Yes

Unassociated Australian

No

Associated non-resident

(not via Australian branch)

No

Unassociated non-resident

No

Exclusions from tainted sales income

Manufacturing exclusion

The main exclusion from tainted sales income is sales where the CFC manufactures, extracts, produces or substantially alters the goods sold. This would include, for example, sales from mining and quarrying operations.

This exclusion will apply only where the goods sold were manufactured, produced or substantially altered by the directors or employees of the CFC. The packaging and labelling of goods is not considered to be a substantial alteration of those goods.

The exclusion will not be available where the CFC subcontracts the manufacture, production or substantial alteration to agents or subcontractors. However, the fact that a CFC subcontracts some operations will not disqualify it from the manufacturing exclusion if directors or employees of the CFC carry out a substantial part of the manufacture, production or substantial alteration.

Hospitality exclusion

Also excluded from tainted sales income are sales that, broadly, arise from the tourism and hospitality industry. These are sales provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.

Passive income exclusion

Amounts of passive income are excluded from tainted sales income. This prevents double counting.

Meaning of tainted services income

Tainted services income, in broad terms, means income derived from the provision of services to either:

  • an associate of the CFC
  • a resident of Australia or
  • in connection with a permanent establishment in Australia.

Services includes any benefit, right or privilege provided under an arrangement for the performance of work or the provision of facilities for example, performance of technical, managerial or transport work.

Tainted services income

Provided to

Tainted services?

Associated Australian

Yes

Associated non-resident

(via Australian branch)

Yes

Unassociated Australian

Yes

Associated non-resident

(not via Australian branch)

Yes

Unassociated non-resident

(via Australian branch)

Yes

Unassociated non-resident

(not via Australian branch)

No

Exclusions from tainted services income

General exclusions

Tainted services income does not include:

  • royalties
  • any income in respect of a lease of land
  • any income from trading in tainted assets
  • gains from currency exchange rate fluctuations, commodity investments and assets.

Manufacturing exclusion

There is an exclusion from tainted services income where the service relates to goods manufactured by a CFC. For example, payments for after sales service or income derived under a service contract for equipment manufactured by a CFC.

Hospitality exclusion

Also not included in tainted services income are services that, broadly, arise from the tourism and hospitality industry. These amounts are services provided in connection with a hotel, motel, guesthouse, restaurant, bar or other place of entertainment or recreation.

Passive and tainted services income exclusion

Tainted services income does not include passive income or tainted sales income. This prevents double counting.

Exclusion for services income derived from a CFC resident in the same country

Amounts of services income will not be treated as tainted if the following three requirements are satisfied:

  • the amounts are derived from an associated CFC resident in the same country
  • the amounts are subject to the normal company rate of tax in that country and
  • the payment of the amounts did not wholly or partly give rise to a notional allowable deduction for the associated CFC.

For more information on these requirements, refer to the exclusion for rental income discussed earlier in this section.

This exclusion is available only for statutory accounting periods of CFCs commencing on or after 1 July 1997.

S ection 5 - Tainted income ratio for listed country CFCs for statutory accounting periods commencing before 1 July 1997

The following tainted income ratio is used to determine the active income test for a CFC in a country on the original list for statutory accounting periods commencing before 1 July 1997:

tainted eligible designated concession income

eligible designated concession income

Countries on the original list are shown at attachment A in appendix 1 .

Eligible designated concession income (EDCI) is the part of gross turnover that is both:

  • designated as a concession by the Income Tax Regulations - see app endi x 1
  • is not taxed in any listed country other than under a designated concession.

Tainted EDCI is EDCI that is also passive income, tainted sales income or tainted services income.

Part 3 - Working out attributable income and the amount to include in your assessable income

This part explains how to work out the attributable income of a CFC. Your share of the attributable income is included in your assessable income.

Even if the CFC passes the active income test, you will still need to read on. Passing the test will eliminate many, but not all, types of attributed income and gains.

Summary of part 3

Section 1

General assumptions for working out the attributable income of a CFC

  • modifications for non-broad-exemption listed company
  • modifications for broad-exemption listed company

Section 2

General modifications

Other modifications

Section 3

Capital gains

Section 4

Deductions and losses

Section 5

Partnerships

Section 6

Trusts

Section 7

Interim dividends

Section 8

Relief from double accruals taxation

Section 9

How much is included in assessable income?

Section 1 - General assumptions for working out the attributable income of a CFC

Attributable income is included directly in your assessable income. It is not necessary to aggregate amounts of attributable income as you trace through a chain of CFCs.

Example 15:

Attribution directly to taxpayer

Assume you wholly own a foreign company which, in turn, wholly owns another foreign company. Also assume that the first company has $300,000 attributable income and the second company has $200,000 attributable income.

You include an amount in your assessable income as follows:

Like this

Not like this

Attributable income is taxable income

Attributable income is a hypothetical amount. It is the amount that would be the taxable income of a CFC, based on certain assumptions. These are explained below.

Assume the CFC is a resident taxpayer

To work out attributable income it must first be assumed that the CFC is both a resident of Australia and a taxpayer for the whole of a statutory accounting period. You can then work out the attributable income in the same way as you work out the taxable income of a resident company. Amounts derived by a CFC from all sources will be taken into account because residents are taxable on their world wide income and gains.

To distinguish the calculation of attributable income from a 'real' calculation of taxable income, the amounts used to work out attributable income are called notional amounts. Thus, attributable income is the amount by which the notional assessable income is greater than notional allowable deductions. Income that is not notional assessable income is notional exempt income.

The assumption that a CFC is a resident of Australia does not change the nature of the activities of the CFC - that is, events that occur in a foreign country will not be taken to have occurred in Australia.

Modifications in working out the attributable income of a CFC

In applying the Act to work out a CFC's hypothetical taxable income, assume that certain modifications have been made to the Act and read the Act as if those modifications were incorporated.

In some cases, provisions are ignored because the application is not appropriate. In other cases, provisions have been replaced with similar provisions that are tailored to the way the attributable income is worked out.

In addition, provisions have been included that are not comparable to other provisions of the Act. These modifications are explained later in this part.

Some provisions of the Act clearly cannot apply when working out attributable income - for example, Part IV, which deals with the making of returns or assessments. Although these provisions of the Act are not specifically excluded from the calculation, for practical purposes they have no effect and can be ignored.

Accounting period is the year of income

Taxable income is worked out for a period called an income year. To apply the Act, the statutory accounting period of a CFC is assumed to be an income year. The particular income year referred to in working out attributable income will be the income year of the attributable taxpayer in which the statutory accounting period ends.

Example 16

  • Assume you are working out the amount to be included in assessable income for the year ending 30 June 1997 and the statutory accounting period of the CFC ended on 30 September 1996. The attributable income of the CFC for that statutory accounting period is to be worked out in accordance with the provisions of the Act that applied for the year ended 30 June 1997.

Work out attributable income separately

You must work out your attributable income for a CFC separately to other attributable taxpayers. Different taxpayers may work out different amounts of attributable income for a CFC - that is, the amount included in assessable income may be different for each attributable taxpayer even if they have the same attribution percentage in the CFC.

There are differences in working out attributable income depending on whether a CFC is a resident of a broad-exemption or non-broad-exemption listed country.

Modifications for a non-broad-exemption listed country

The notional assessable income of a CFC includes only amounts that fall into specified categories. All other amounts are treated as notional exempt income.

The excluded amounts depend on whether the CFC passed or failed the active income test.

What if a CFC fails the active income test?

If a CFC fails the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

  • adjusted tainted income derived by the CFC directly
  • adjusted tainted income derived by the CFC indirectly as a partner in a partnership
  • trust amounts arising directly
  • trust amounts arising indirectly because the CFC is a partner in a partnership
  • foreign investment fund (FIF) income derived by the CFC directly or indirectly as a partner in a partnership
  • low-taxed third country income derived by a CFC in a limited-exemption listed country.

What if a CFC passes the active income test?

If a CFC passes the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

  • FIF income derived by the CFC directly or indirectly as a partner in a partnership
  • trust amounts arising to the CFC directly
  • trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership
  • low-taxed third country income derived by a CFC in a limited-exemption listed country.

These amounts are explained in sections 5 and 6. Any other income is notional exempt income

Diagram of amounts taken into account

What is adjusted tainted income?

Adjusted tainted income is based on the definition of tainted income used for the active income test. Broadly, it comprises amounts that are either passive income, tainted sales income or tainted services income.

The main difference in the definition of tainted income for the active income test and the definition for working out attributable income is that net gains are included in determining the active income test whereas the entire consideration on disposal of an asset is included when working out attributable income.

Low-taxed third country income

The notional assessable income of a CFC in a limited-exemption listed country includes amounts derived from sources outside the CFC's country of residence if the amounts are not subject to tax in a listed country. This rule does not apply to amounts of adjusted tainted income - these amounts are included in attributable income if the CFC fails the active income test. The source of an amount is to be determined according to the laws of the CFC's country of residence.

FIF income

The FIF rules apply in working out the attributable income of a CFC because of the assumption that the company is a resident of Australia. However, rules apply to prevent double taxation where a company FIF is also a CFC. These rules provide an exemption from the FIF measures for an interest held by a CFC in a company FIF if a share of the attributable income of the company FIF is included in your assessable income under the CFC measures for:

  • a statutory accounting period coinciding with the notional accounting period of the company FIF for FIF taxation purposes or
  • statutory accounting periods ending and commencing during the notional accounting period of the company FIF.

For the purposes of the above tests, the ATO will accept that a share of the attributable income of a company FIF has been included in your assessable income if no amount was included solely because the company FIF had no attributable income. Refer to Taxation Determination TD 93/ 167 for further assistance.

Amounts not included

Some amounts that would normally be assessable if derived by a resident company are treated as notional exempt income in working out the attributable income of a CFC. Certain exemptions are also disregarded when working out attributable income. These exemptions have been replaced with similar provisions that are tailored for working out attributable income.

Amounts taxed in Australia

Amounts that have been taxed in full in Australia are not included in notional assessable income. Amounts will be treated as taxed in full if they have been included in a CFC's assessable income - for example, income sourced in Australia from a CFC's branch in Australia would normally be included in the CFC's assessable income in Australia. Amounts that will not be considered fully taxed, although subject to Australian taxation, are:

  • amounts subject to interest or dividend withholding tax
  • certain shipping income, film and video tape royalties and insurance premiums.

Dividends that are franked under the imputation provisions are treated as notional exempt income.

Branch in a broad-exemption listed country

An amount derived by a CFC in an unlisted country from carrying on business through a permanent establishment - for example, a branch - in a broad-exemption listed country is excluded, provided that the amount has been comparably taxed. An amount will be treated as comparably taxed if it is subject to tax in a broad-exemption listed country and is not eligible designated concession income.

Exclusion of dividends

Most dividends paid to the CFC by a foreign company are not included in the notional assessable income of the CFC. The only dividends you must include for a CFC resident in an unlisted country are:

  • dividends that are not non-portfolio dividends-see chap ter 3 -paid to the CFC
  • non-portfolio dividends paid to the CFC by a non-CFC that was a resident of an unlisted country when the dividends were paid unless the dividends were paid from profits taxed in a listed country.

The only dividends you must include for a CFC resident in a limited-exemption listed country are:

  • dividends - other than non-portfolio dividends - paid to the CFC by a company that was a resident of an unlisted country when the dividends were paid
  • non-portfolio dividends paid to the CFC by a non-CFC that was a resident of an unlisted country when the dividends were paid, unless the dividends were paid from profits taxed in a listed country.

These dividends will not be included in notional assessable income if they are paid from profits which have previously been attributed to you.

Modifications for a broad-exemption listed country

Working out attributable income for a CFC in a broad-exemption listed country is similar to working out attributable income for a CFC in a non-broad-exemption listed country. However, more exemptions are provided for CFCs in broad-exemption listed countries.

What if a CFC fails the active income test?

If a CFC fails the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

  • eligible designated concession income that is adjusted tainted income
  • low-taxed third country income
  • trust amounts arising to the CFC directly that are not subject to tax in a broad-exemption listed country
  • trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership, provided that the amounts are not subject to tax in a broad-exemption listed country
  • FIF income derived by the CFC directly or indirectly as a partner in a partnership.

Any other amounts of income are notional exempt income.

What if a CFC passes the active income test?

If a CFC passes the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

  • low-taxed third country income
  • trust amounts arising to the CFC directly that are not subject to tax in a broad-exemption listed country
  • trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership, provided that the amounts are not subject to tax in a broad-exemption listed country
  • FIF income derived by the CFC directly or indirectly as a partner in a partnership.

Any other income is notional exempt income.

Diagram of amounts taken into account

Adjusted tainted income

Adjusted tainted income is based on the definition of tainted income used for the active income test. Broadly, it comprises amounts that are either passive income, tainted sales income or tainted services income.

The difference in the definition of tainted income for the active income test and the definition for working out attributable income is that net gains are included in determining the active income test whereas the entire consideration on disposal of an asset is included when working out attributable income.

Low-taxed third country income

The notional assessable income of a CFC in a broad-exemption listed country includes amounts derived from sources outside the CFC's country of residence if the amounts are not taxed in a listed country. This rule does not apply to amounts of eligible designated concession income-these amounts may be included if the CFC fails the active income test.

Amounts of adjusted tainted income derived from sources outside a CFC's country of residence will also be included if they have not been taxed in a broad-exemption listed country. The source of an amount is to be determined according to the laws of the CFC's country of residence.

FIF income

The FIF rules apply when working out the attributable income of a CFC because of the assumption that the company is a resident of Australia. However, rules apply to prevent double taxation where a company FIF is also a CFC. These rules provide an exemption from the FIF measures for an interest held by a CFC in a company FIF if a share of the attributable income of the company FIF is included in your assessable income under the CFC measures for:

  • a statutory accounting period coinciding with the notional accounting period of the company FIF for FIF taxation purposes or
  • statutory accounting periods ending and commencing during the notional accounting period of the company FIF.

For the purposes of the above tests, the ATO will accept that a share of the attributable income of a company FIF has been included in the assessable income of an attributable taxpayer if no amount was included solely because the company FIF had no attributable income. Refer to Taxation Determination TD 93/ 167 for further assistance.

Amounts taxed in Australia

Amounts that have been taxed in full in Australia are not included in notional assessable income. Amounts will be treated as taxed in full if they have been included in a CFC's assessable income. Amounts that will not be considered fully taxed, although subject to Australian taxation, are:

  • amounts subject to Australian interest or dividend withholding tax
  • certain shipping income, film and video tape royalties and insurance premiums.

Dividends that have been franked under the imputation provisions are treated as notional exempt income.

Dividends not included

Most dividends paid to a CFC by a foreign company are not included. The only dividends you must include are:

  • dividends - other than non-portfolio dividends - paid to the CFC by a company that was a resident of an unlisted country when the dividends were paid and
  • non-portfolio dividends paid to the CFC by a non-CFC that was a resident of an unlisted country when the dividends were paid unless the dividends were paid from profits taxed in a listed country.

These amounts will not be included in notional assessable income if the profits from which the dividends were paid have previously been attributed to you. They will also not be included in notional assessable income where they are subject to tax in the listed country.

Exemption for small amounts

An exemption applies for CFCs in broad-exemption listed countries if the total of:

  • eligible designated concession income
  • low-taxed foreign source income and
  • FIF income

is not greater than a threshold amount. There is no similar exemption for a CFC that is a resident of a non-broad-exemption listed country.

Threshold amount

If the CFC has a gross turnover of $1 million or more, the threshold amount is $50,000 - that is, the exemption will only apply if the total of the amounts is $50,000 or less.

If a CFC has a gross turnover of less than $1 million, the threshold amount is 5 per cent of the CFC's gross turnover - that is, the exemption will only apply if the sum of the amounts is less than or equal to 5 per cent.

How does the exemption operate?

If the threshold is not exceeded, a CFC's eligible designated concession income, low-taxed foreign source income and FIF income are not included in the notional assessable income of the CFC. The general anti-avoidance provisions of the Act may apply where attempts are made to split income among a number of CFCs to take advantage of the exemption.

Section 2 - General modifications to the law

This section explains a number of general modifications to the taxation law which apply when working out the attributable income of a CFC. There are also modifications to:

  • the treatment of gains and losses made by a CFC on the disposal of a capital asset
  • the treatment of losses incurred by a CFC, including the quarantining of deductions
  • the treatment of amounts derived through a partnership.

These modifications are dealt with in section 3 , section 4 and section 5 of part 3.

Elections to be made by the taxpayer

You can make most elections on behalf of a CFC in working out its attributable income. You must make the elections when you lodge your return. The Australian Taxation Office may extend the time for making the elections.

Lodgment of elections

In the case of companies and superannuation funds, no notice of the election is to be sent to the ATO. Only give notice if a taxation officer requests you to do so.

Exception to the rule

An election for roll-over relief under the capital gains tax provisions must normally be made by a CFC, although you can make the election for a wholly-owned CFC. The rules for making these elections are explained in sectio n 3 of part 3 .

Foreign currency conversion rules

You must express all amounts in Australian dollars. There are no special rules for converting capital amounts. The conversion is made using the rules that apply for converting capital amounts under the usual operation of the Act. Amounts that are taken into account in determining the cost base of an asset are converted at the time the costs were incurred. Amounts arising from the disposal of an asset are converted at the time of disposal.

The following rules apply for the conversion of income or expenses of a revenue nature.

Accounts kept in a foreign currency

A CFC may keep its records in one foreign currency or predominantly in one foreign currency. These amounts must be converted to Australian dollars for the purposes of working out the attributable income of the CFC. The amounts can be converted using the average exchange rate that prevailed during the CFC's statutory accounting period. The average rate may take into account a weighted average rate determined on the volume of transactions involved. Alternatively, you may elect to use the rate that prevailed on the last day of the CFC's statutory accounting period.

If there is a predominant currency and there are one or more other currencies, the other currencies are to be converted into the predominant currency on any reasonable basis and then converted into Australian dollars using one of the two methods outlined above.

Where there is no single or predominant currency and the amount being converted is not a foreign tax, any reasonable basis can be used to convert the amounts.

Whether a basis for conversion is reasonable depends on the facts of each case and you must consider the nature of the amount. Depending on the situation, it may be reasonable to convert on a transaction by transaction basis-for example, where the CFC receives a small number of interest payments. If the CFC conducts a business with a large number of transactions, it would be more appropriate to use a weighted average rate. The same method should be used for both CFCs when converting a payment made by one CFC to another CFC.

For help on particular transactions, contact the tax office where you lodge your tax return.

Election to use the end rate

If you want to use the exchange rate applicable at the end of a CFC's statutory accounting period, you must elect to do so-in your tax return-for the first year that you are required to include an amount of attributable income in your assessable income. The ATO may extend the time for making this election. The election applies for all future years-that is, the election cannot be changed even though the circumstances of the CFC have changed. Where there is no single or predominant currency, the election cannot be made.

Foreign exchange gains and losses

Foreign exchange gains and losses of a CFC may be worked out by reference to the currency in which it generally transacts business and keeps accounts. The net gain or loss is then translated into Australian currency on the basis of the rules provided above.

Example 17

  • On 1 January 1994, a CFC in country X borrowed $US1 million. On that date, country X's exchange rate is 100 florins to $US1.
  • The CFC keeps its accounts in the currency of country X - florins.
  • On 1 April 1998, the $US1 million loan was repaid at an exchange rate of 90 florins.
  • This results in an exchange gain of 10 million florins.
  • The exchange gain of 10 million florins is converted into Australian dollars using the conversion method adopted for the CFC.

Self-assessment - lodgment of elections

Under Ruling IT 2624 , companies and superannuation funds should not send a notice of election to the Australian Taxation Office (ATO). Only give notice if the ATO requires you to.

What about foreign taxes?

Foreign taxes are converted using the exchange rate applicable on the day the payment was made.

Treatment of foreign and Australian taxes

Deduction for taxes

A notional allowable deduction is available for foreign or Australian tax paid on amounts included in the attributable income of a CFC. An Australian tax is defined to be a withholding or income tax. It does not include additional taxes such as late payment penalties. If the tax is paid in a subsequent year, the earlier year's assessment can be amended subject to the time limits for amendments to allow a deduction for the tax.

Example 18:

Taxes paid directly by a CFC

  • Assume a CFC - CFC Co - owns 20 per cent of the voting shares in a company - Unlist Co. Unlist Co is a company resident in an unlisted country and is not a CFC. Unlist Co pays CFC Co a dividend of $180,000. CFC Co receives $162,000 because tax of $18,000 is withheld. Unlist Co has no profits that have been taxed in a listed country or in Australia

.

  • Because of the dividend, the notional assessable income of CFC Co will include $180,000 - the dividend before withholding tax - and a notional allowable deduction may be claimed for the $18,000 tax paid by CFC Co.

What about underlying tax?

Where a non-portfolio dividend is included in the notional assessable income of the CFC, a corporate taxpayer may claim a notional allowable deduction for taxes paid on the profits from which the dividend was paid. This tax is called underlying tax. Where the profits from which the dividend was paid include a dividend from a related company or that has passed through a number of related companies, the underlying tax may also include tax paid by the related companies. See chapter 3, p ar t 3 , for an explanation of related companies and for further information on working out underlying tax.

The notional allowable deduction for underlying tax is used to work out the foreign tax credit you can claim. The notional allowable deduction is effectively reversed because the dividend to which the underlying tax relates is increased by the amount of the underlying tax. If, for instance, a CFC receives a $100 dividend and is taken to have paid $20 underlying tax on the dividend, the amount of the dividend is increased to $120 to work out attributable income. A notional allowable deduction of $20 is then available for the underlying tax.

Example 19:

Underlying taxes

  • Assume a corporate taxpayer wholly owns a CFC - CFC Co. CFC Co in turn owns 20 per cent of the voting shares in a company - Unlist Co. Unlist Co is a company resident in an unlisted country and is not a CFC. Unlist Co has accumulated profits of $900,000 and has paid tax of $100,000. It distributes all of the profits. CFC Co receives $162,000 because tax of $18,000 is withheld. None of Unlist Co's profits have been taxed in a listed country or in Australia

The underlying tax would be20 per cent of $100,000

$20,000

  • A notional allowable deduction may be claimed for the $20,000 tax deemed paid by CFC Co as well as for the $18,000 withholding tax. The dividend is increased by the amount of the underlying tax deemed paid-that is, $20,000. The amount included in notional assessable income as a result of the dividend payment would therefore be $200,000.

A corporate taxpayer can claim a foreign tax credit for both the direct tax paid by the CFC and the underlying tax. However, when working out the attributable income, only a deduction is allowed. The subsequent claim for a credit reverses this deduction because the attributable income is grossed up-that is, increased-by the amount of the foreign tax credit. This is explained in part 3 of chapter 3.

Trading stock provisions

Valuation is cost only

In working out attributable income you must value trading stock at cost. The normal rules for determining the cost of trading stock are to apply.

What happens to obsolete stock?

In working out taxable income, a special valuation is allowed for obsolete stock. This valuation is not allowed when working out attributable income.

Depreciation provisions

Basis for depreciation

Generally, the normal depreciation rules apply for working out the attributable income of a CFC. This means you can choose to depreciate assets by the diminishing value method or the prime cost method. In addition, the rates of depreciation that apply for working out taxable income will also apply in working out attributable income.

Example 20:

Deduction for depreciation

  • A CFC purchased a depreciable asset on 1 July 1997 and uses it solely for the production of notional assessable income. For the statutory accounting period ended 30 June 1998, depreciation would be worked out as follows using the diminishing value method.

Cost at 1 July 1997

$20,000

Depreciation - 20% X 20,000

$4,000

Written down value at 30 June 1998

$16,000

Depreciation in 1997 - 98

$4,000

Apportionment for exempt usage

A notional allowable deduction for depreciation must be reduced if an asset is only partially used for the production of notional assessable income. The normal rules apply in working out the reduction.

Example 21:

Apportionment of deduction for depreciation

  • A CFC purchased a depreciable asset on 1 July 1997 and used it for the production of income. For the statutory accounting period ended 30 June 1998, only 50 per cent of the usage was for the production of notional assessable income. Depreciation, using the diminishing value method, would be worked out as follows.

Cost at 1 July 1997

$20,000

20% depreciation to 30 June 1998

$4,000

Written down value at 30 June 1998

$16,000

Depreciation in 1997 - 98 (50% of $4000)

$2 000

Asset used in a non-attributable period

Special rules apply for an asset held by a CFC during a period for which it was either:

  • not necessary to work out the attributable income of the CFC or
  • not necessary to take depreciation on the asset into account in working out the attributable income of the CFC.

In such cases, the depreciation rules apply as if the asset were held solely for the production of notional assessable income during the period.

Example 22:

Deduction for depreciation in non-attributable period

  • A CFC purchased a depreciable asset on 1 July 1996 and used it for the production of income. It was not necessary to work out the attributable income of the CFC for the period ending 30 June 1997. For the statutory accounting period ended 30 June 1998, only 50 per cent of the usage was for the production of notional assessable income. In working out the depreciation for the 1997 - 98 period using the diminishing value method, the first step is to notionally depreciate the asset to the beginning of the income year.

Cost at 1 July 1996

$60,000

20% depreciation to 30 June 1997

$4,000

Notional written down value at 30 June 1997

$16,000

  • The next step is to determine the depreciation for the 1997-98 income year

 

$

Notional written down value at 30 June 1997

$16 000

20% depreciation to 30 June 1998

$3 200

Notional written down value at 30 June 1998

$12 800

  • The last step is to apportion the depreciation because the asset is not used wholly for the production of notional assessable income.

Depreciation in 1997-98 (50% of $3200)

$1 600

Sale of a depreciable asset

Under the normal operation of the Act, a deduction for the difference may be allowed where an asset is sold for less than the notional depreciated value of the asset. This deduction is also allowable in working out the attributable income of a CFC.

Example 23:

Deduction on disposal

  • In the next statutory accounting period the depreciable asset in example 22 was again used for 50 per cent of the time to derive notional assessable income. At the end of the year it was sold for $9000. The depreciation calculation would be as follows.

Notional written down value at 30 June 1998

$12 800

20% depreciation to 30 June 1999

$2 560

Notional written down value at 30 June 1999

$10 240

Proceeds of sale

$9 000

Notional loss

$1 240

Depreciation in 1998 - 99 (50% of $2560)

$1 280

Deduction for loss (50% of $1240)

$620

An amount may also be included in notional assessable income as a result of the sale of the asset.

Example 24

Notional assessable income on disposal

  • Use the same facts as in example 23, but assume that the asset was sold for $18,000. In this case an amount would be included in notional assessable income as follows.

 

$

Cost at 1 July 1996

20,000

Depreciation allowed

2,800

Actual written down value at 30 June 1999

17,120

Proceeds of sale

18,000

Actual written down value

17,120

Notional assessable income on disposal

880

Contact the tax office where you lodge your return for further details.

What about other capital deductions?

There are other provisions of the Act that allow for a deduction of the capital amounts and these may apply when working out attributable income - for example, Division 10 of Part III. Where the assets were used in a non-attributable income period, the Australian Taxation Office (ATO) must determine the amount of the deduction allowed or the recoupment included in notional assessable income. However, it is not expected that this will often occur. Contact the tax office where you lodge your tax return for further details.

Transfer pricing rules

The Act contains measures to counter arrangements designed to move profits from one entity to another. These arrangements are commonly called transfer pricing or profit shifting. Broadly, the transfer pricing rules allow the ATO to increase a taxpayer's assessable income or decrease allowable deductions to negate the effect of the arrangement - see Division 13 of Part III.

International agreement

The rules apply only where there is an international agreement. For the purpose of applying the definition of an international agreement, the CFC is treated as a resident of a foreign country. The result is that the transfer pricing rules apply to most non-arm's length arrangements involving the CFC.

Example 25

CFC in an unlisted country

  • Unlist Co1, which you wholly own, is a CFC resident of an unlisted country. In turn, Unlist Co1 wholly owns another CFC in an unlisted country - Unlist Co2. Unlist Co1 lends Unlist Co2 $1 million and there is no interest payable on the loan. The market interest rate is 10 per cent.

  • Unlist Co1 will be taken to have received $100,000 on the loan. This amount will be tainted interest income and will be included in the tainted income of the company. If the company fails the active income test, the notional assessable income of Unlist Co1 will include $100,000.

Application of the transfer pricing rules to non-arm's length arrangements involving CFCs resident in the same broad-exemption listed country

The transfer pricing rules do not apply to arrangements involving CFCs resident in the same broad-exemption listed country at any time when an international agreement is in force.

Impact on the active income test

The ATO can make adjustments reflecting arm's length values to amounts used in determining whether a CFC has passed the active income test. An adjustment can be made if, in working out the attributable income of a CFC, the ATO would make a transfer pricing adjustment in relation to the acquisition or supply of property by the CFC.

Requests for rulings

You can request a ruling from the ATO on whether Division 13, as modified, applies to an arrangement.

Compensating adjustments

To avoid double taxation, the ATO may make adjustments in the assessment of another taxpayer to compensate for a transfer pricing adjustment. A compensatory adjustment may be required, for instance, where a transfer pricing adjustment is made to decrease the amount of a royalty payment made to a related company. In this case, a compensatory adjustment could be made to reduce the amount included in the assessable income of the related company as a result of the royalty payment.

As with the usual operation of the transfer pricing rules, where one CFC's notional assessable income or notional allowable deductions are adjusted, the ATO may make a compensating adjustment to:

  • a taxpayer's allowable deductions or assessable income
  • another CFC's notional assessable income or notional allowable deductions or
  • the attributable income of a transferor trust estate.

Similarly, compensating adjustments may be made to the attributable income of a CFC when the transfer pricing rules have been applied to:

  • a taxpayer's allowable deductions or assessable income or
  • the attributable income of a transferor trust estate.
Deduction for eligible finance shares

A deduction is not normally available for the payment of a dividend. A notional allowable deduction is available, however, for an eligible finance share dividend paid by a CFC. Broadly, this is a dividend paid on a share issued under a preference share financing arrangement with an Australian financial intermediary - for example, a bank - and its subsidiaries. In effect, the issue of eligible finance shares is treated as a type of loan.

Dividends on eligible finance shares are treated as an interest expense. A notional allowable deduction is available for the dividends to the extent a notional allowable deduction would have been payable if the dividends had been an interest outgoing.

Deduction for widely distributed and transitional finance shares

A deduction, similar to that provided for eligible finance shares, is available for dividends paid by a CFC on widely distributed finance shares. Widely distributed finance shares include shares issued by a CFC as a public issue under a preference share financing arrangement to persons who are not associates of the CFC and who have provided finance on arm's length terms. To qualify, the shareholders should have no interest in the CFC apart from ensuring repayment of the funds and regular payment of the dividends in a form which is, in effect, a substitution for interest on a loan.

A deduction is also available for dividends paid by a CFC on transitional finance shares. Transitional finance shares are shares issued by a CFC to a related CFC and paid for by the related CFC out of funds raised by the issue of widely distributed finance shares. The transitional finance shares must be issued under similar terms to the widely distributed finance shares.

The deduction for dividends paid on transitional finance shares is only available where the shares were issued before 12 April 1989. A sunset clause is provided so that a deduction for dividends paid on transitional finance shares is only available for dividends paid by the CFC prior to 1 July 1998.

Diagram 1 - Operation of widely distributed finance share measures

CFC B

< -

funds may be lent

< -

CFC A

< -

funds raised by public issue of widely distributed finance shares

< -

members of the public

Diagram 2 - Operation of transitional finance share measures

CFC B

< -

funds provided through share issue

< -

CFC A

< -

funds raised by public issue of widely distributed finance shares

< -

members of the public

In each of the diagrams, a deduction is available from the attributable income of CFC A for dividends paid on its widely distributed finance shares.

In diagram 1, CFC B is allowed a deduction for interest paid to CFC A on the loan from that company.

In diagram 2, a deduction is available from the attributable income of CFC B for dividends paid on shares that it issued to CFC A on substantially the same terms as widely distributed finance shares issued by CFC A.

S ection 3 - Modifications to the treatment of capital gains and losses

The operation of the capital gains tax provisions of the Tax Acts is modified for working out the attributable income for a controlled foreign company (CFC).

Assets included in the calculation

Capital gains and losses taken into account in working out attributable income for a CFC are those arising on:

  • the disposal of non-taxable Australian assets for the purposes of Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936), and
  • 'non-CGT assets having the necessary connection with Australia' for the purposes Subdivision 136A of Chapter 3 of the Income Tax Assessment Act 1997 (ITAA 1997).

(A capital gain or loss on the disposal of a taxable Australian asset or a CGT asset having the necessary connection with Australia will be taken into account in working out the real assessable income of the CFC as a non-resident taxpayer and is therefore excluded from the calculation of the CFC's attributable income. Note: This exclusion applies even where the relevant asset is not subject to capital gains tax because it was acquired before 20 September 1985.)

What is a taxable Australian asset and a CGT asset having the necessary connection with Australia?

In determining whether an asset is a taxable Australian asset or a CGT asset having the necessary connection with Australia, the assumption that the CFC is a resident of Australia is ignored. In almost all cases, however, the residency assumption will make no difference.

Broadly, a taxable Australian asset or a CGT asset having the necessary connection with Australia is:

  • land or buildings in Australia
  • assets used in carrying on business through a permanent establishment in Australia
  • a share, or an interest in a share, in a company which was a resident private company in the income year in which the disposal took place
  • a share, or an interest in a share, of a company which was an Australian resident and not a private company and at any time in the preceding 5 years a taxpayer or an associate, alone or together, owned 10 per cent of the issued capital of the company
  • an interest in an Australian resident trust
  • a unit in a unit trust which was an Australian resident where, at any time in the preceding 5 years, a taxpayer or an associate, alone or together, owned 10 per cent of the units in the unit trust
  • an option or right to acquire an asset referred to above
  • certain assets that have been transferred under the roll-over provisions
  • certain rights that have a connection with Australia.

Note

  • The specific list of CGT assets having the necessary connection with Australia is set out in section 136-25 of ITAA 1997.
Assets used to produce notional exempt income

In working out taxable income, the capital gains tax provisions do not normally apply to the disposal of assets used solely for the production of exempt income. However, in working out attributable income, capital gains or losses on the disposal of assets used to derive notional exempt income can be taken into account.

Removal of exemption of pre-20 September 1985 assets

When applying the capital gains tax provisions in working out attributable income, all non-taxable Australian assets and non-CGT assets having the necessary connection with Australia that a CFC owned at 30 June 1990 are deemed to have been acquired by the CFC on 30 June 1990 regardless of the date the asset was acquired.

Cost base of assets for companies which become CFCs after 30 June 1990

The cost base of assets owned by a company that became a CFC after 30 June 1990 is market value of those assets at the time the company became a CFC.

Example 26

  • Cost base of asset

    A company that became a CFC on 1 March 1993 disposes of an asset on 1 October 1995. The asset was acquired on 1 May 1992.

    Consequences

    The asset will be deemed to have been acquired for market value on 1 March 1993 - that is, when the company became a CFC. The capital gain or loss is therefore worked out using the change in the asset's value between 1 March 1993 and 1 October 1995.

Working out a gain or loss on disposal

You work out the amount to include in a CFC's notional assessable income in broadly the same way as for the usual operation of the capital gains tax provisions. That is, you must determine the excess of a CFC's capital gains over the CFC's capital losses and include that excess - the net capital gain - in the CFC's notional assessable income. A net loss can only be carried forward to be offset against future capital gains. However, there are certain modifications to the capital gains tax provisions that apply when working out attributable income.

Valuation date for assets owned on 30 June 1990

An unrealised gain that accumulated before 1 July 1990 will not be taxed. Correspondingly, any unrealised loss accumulated up to that date will not be allowed. This is done by valuing the assets on 30 June 1990 and, in general, using that value as the consideration paid.

However, where an asset had decreased in value before 1 July 1990, the gain using the market value as the consideration paid could be bigger than the actual gain. Similarly, where the asset had appreciated in value before 1 July 1990, the loss using the market value as the consideration paid could be greater than the actual loss. In either of these cases, only the actual gain or loss is taken into account. To achieve this result, you must use as the consideration paid for such assets either the market value of the asset at 30 June 1990 or the actual cost base of the asset, whichever produces the smaller gain or loss. That is:

  • in working out a gain, use the greater of the unindexed cost base and the market value on 30 June 1990
  • in working out a loss, use the lower of the unindexed cost base and market value on 30 June 1990.
Indexation of the cost base

The cost base of an asset is indexed for inflation and only the amount of the consideration that is more than the indexed cost base is treated as a capital gain. Generally, an asset must be held for 12 months before indexation applies.

Indexation factor

The indexation factor used is the same as that normally used under the capital gains tax provisions. You can obtain the indexation factor from the Australian Bureau of Statistics in your capital city or from any tax office.

Adjustment to the cost base

In some cases, the cost base of an asset will need to be adjusted. This would occur where, for example, there was a return of capital on shares or a tax free distribution from a unit trust. For further information, contact the tax office where you lodge your return.

Examples of how to work out a gain or loss

Example 27

Capital gain - market value more than cost

  • A CFC bought shares on 1 January 1980 for $100,000. On 30 June 1990 the shares were valued at $400,000. On 31 December 1990 the shares were sold for $600,000.
  • Since the market value of the shares on 30 June 1990 is greater than their actual cost, the market value is used to work out the capital gain.

 

$

Consideration

600,000

Less cost base - indexation factor 1.034

413,600

Capital gain

186,400

Example 28

Capital gain - cost more than market value

  • A CFC bought shares on 1 January 1980 for $500,000. On 30 June 1990 the shares were valued at $400,000. On 31 December 1990 the shares were sold for $600,000.

    Since the actual cost of the shares is greater than their market value on 30 June 1990, the actual cost is used to work out the capital gain.

 

$

Consideration

600,000

Less cost base - indexation factor 1.034

517,000

Capital gain

83,000

Example 29

Capital loss - cost more than market value

  • A CFC bought shares on 1 January 1980 for $100,000. On 30 June 1990 the shares were valued at $80,000. On 31 December 1990 the shares were sold for $50,000.

    Since the actual cost of the shares is greater than their market value on 30 June 1990, the actual cost is used to work out the capital loss.

 

$

Cost base

80,000

Less consideration

50,000

Capital loss

30,000

Example 30

Capital loss - cost more than market value

  • A CFC bought shares on 1 January 1980 for $100,000. On 30 June 1990 the shares were valued at $120,000. On 31 December 1990 the shares were sold for $50,000.

    Since the market value of the shares on 30 June 1990 is greater than their actual cost, the actual cost is used to work out the capital loss.

 

$

Cost base

100,000

Less consideration

50,000

Capital loss

50,000

Provisions for profit making ventures

The provisions of the Act that include in assessable income a gain from the disposal of an asset purchased for profit making by sale or from carrying out a profit making undertaking or that allow a deduction for a loss - that is, sections 25A and 52 - do not apply in working out the attributable income of a CFC.

Treatment of a net capital loss under the capital gains tax provisions

In working out taxable income, capital losses are offset against capital gains to determine the net capital gain to include in assessable income. Where there is a net capital loss, you cannot use the loss to reduce assessable income. The same rules apply in working out attributable income.

A CFC cannot use a net capital loss under the CGT provisions to reduce its notional assessable income. It can only carry the loss forward for offset against capital gains in subsequent years.

You cannot transfer a loss, for example, you cannot use the loss of one CFC to reduce the notional assessable income of another CFC or your own assessable income.

In working out attributable income you cannot take into account a capital loss incurred on the disposal of an asset where the disposal occurred before 1 July 1990.

Where a company becomes a CFC after 30 June 1995, asset disposals made before it became a CFC are not taken into account when working out attributable income.

This ensures that a capital loss is not available where it is incurred prior to a company becoming a CFC.

Roll-over of assets under the capital gains provisions
Forced disposals

The capital gains tax provisions allow you to defer working out a gain or loss where the disposal was:

  • as a result of a breakdown of marriage
  • caused by the loss or destruction of the asset
  • from certain resumptions of property
  • from the disposal of certain mining leases.

These roll-over provisions will apply in working out the attributable income because of the assumption that the CFC is a resident.

Most of these provisions require that the person disposing of the asset must make an election. You can make the election on behalf of a wholly owned CFC. For more details, read Procedures for election that the roll-over provisions apply .

Group transfers

The CGT roll-over provisions allow companies that have 100 per cent common ownership to defer, in certain circumstances, capital gains or losses on assets transferred between companies in the group. In the case of asset transfers between CFCs with 100 per cent common ownership the circumstances under which the roll-over provisions apply are modified.

Transfer by a CFC in a broad-exemption listed country

The group roll-over rules are available where the transferor CFC is a resident of a broad-exemption listed country and the transferee is either:

  • a CFC resident of the same broad-exemption listed country or
  • an Australian resident company or
  • a CFC resident of a particular non-broad-exemption listed country and immediately before the disposal, the asset was used in connection with a permanent establishment of the transferor in a non-broad-exemption listed country at or through which the transferor carried on a business.
Roll-overs permitted for a CFC transferor resident in a broad-exemption listed country

Transferor

Asset

Transferee

CFC in a broad-exemption listed country

Any asset

CFC in the same country

Any asset

Australian company

Assets usedby a branch in a non-broad-exemption listed country

CFC in a non-broad-exemption listed country

Transfer by a CFC in a non-broad-exemption listed country

The group roll-over provisions will also apply where the transferor CFC is a resident of a non-broad-exemption listed country and the transferee is either:

  • a CFC resident of a non-broad-exemption listed country or
  • an Australian resident company.

Roll-overs permitted for a CFC transferor resident in a non-broad-exemption listed country

Transferor

Asset

Transferee

CFC in a broad-exemption listed country

Any asset

CFC in any non-broad-exemption listed country

Any asset

Australian company

The assumption that a CFC is a resident of Australia is ignored in determining its residence for the group transfer provisions.

Procedures for electing that the roll-over provisions apply

How to elect for roll-over relief

If an election for roll-over relief is required, a CFC - or in the case of group roll-overs, both the transferor and transferee - must elect in writing that the particular roll-over provision applies.

The CFC must normally make the election. An attributable taxpayer may, however, make an election on behalf of a wholly owned CFC.

Timing of elections

An election must be lodged with the ATO on or before the lodgment of a return by an attributable taxpayer that is affected by the election. If more than one attributable taxpayer is affected, the election will be valid if made on or before the lodgment of the affected tax returns.

Self-assessment - extension of time to make an election

The self-assessment guidelines do not apply to an election by a CFC for roll-over relief and Taxation Ruling IT 2624 does not authorise an extension of time in which to make the election. If an extension of time is required, the CFC or its agent should approach the ATO. For convenience, the request should go to the tax office where the tax return of the largest attributable taxpayer is lodged. If this is not readily apparent, the request can be lodged at any tax office.

Which officer makes the election?

The person who acts for the CFC should make the election. In Australia, that person would normally be the public officer of the company. However, foreign laws may require a different officer to act for the company. Whoever is authorised - whether under the foreign law or, if no law governs this, under the constituent document of the CFC - may make the election.

Election by an agent in Australia

The requirement that a CFC make an election will also be satisfied where an agent makes the election for or on behalf of the CFC, provided that the person is authorised by the CFC to do so. For example, the Australian parent of the CFC or the CFC's tax agent in Australia, if authorised, could make the election.

Reduction of disposal consideration where attributable income is not distributed

An adjustment will be made to the consideration received by a CFC in respect of the disposal of an interest in an attribution account entity if the income or profits of that entity have been attributed to you but have not been distributed. The adjustment only applies where the consideration is included in working out notional assessable income - whether under the capital gains tax provisions or any other provision.

The adjustment is mandatory and does not depend on any finding that the share price reflects the retained earnings. If you think that it applies to the CFC, you can contact the tax office where you lodge your return for more information.

S ection 4 - Quarantining of losses

Quarantining

Where a CFC's notional allowable deductions relating to a particular class are more than the notional assessable income of that class for an accounting period, the excess cannot be claimed against notional assessable income of another class or used to reduce a net capital gain under the capital gains tax provisions.

The excess loss of a class of income is carried forward and can be claimed as a notional allowable deduction against income of the same class.

What are the classes of income?

Notional assessable income is divided into four classes. The classes of income are interest, offshore banking, modified passive and other income.

The classes may include both income and gains of a capital nature. However, capital gains under the capital gains tax provisions are not included in any of the classes. In effect, these capital gains are treated as a separate class of income.

Interest

Most interest income including payments in the nature of interest, fall into the interest class.

Excluded are:

  • interest that falls in the offshore banking income class
  • interest that is received in the active conduct of a trade or business - for example, interest on receivables
  • interest derived from money lending - for example, a banking business.

Offshore banking income

Offshore banking income is income derived through an offshore banking unit. It is unlikely that a CFC will have this type of income.

Modified passive income

Modified passive income is passive income other than amounts that fall within the interest class or the offshore banking income class. As mentioned previously, capital gains under the capital gains tax provisions are not included. Passive income includes rent, royalties, dividends, annuities, capital gains and amounts derived from the assignment of, for example, copyrights.

Other income

The other income class comprises amounts that do not fall within the other classes.

Deductions for sometimes exempt income loss

You may claim a notional allowable deduction for a 'sometimes exempt income loss'. A sometimes exempt income loss can arise for a CFC in an accounting period if:

  • the CFC passed the active income test for the period or
  • the CFC gained the benefit of the de minimis exemption for the period

and the CFC has any expenses that are not notional allowable deductions but would have been if the CFC had not passed the active income test or gained the benefit of the de minimis exemption.

How is the sometimes exempt income loss worked out?

The sometimes exempt income loss is worked out by:

  • assuming that the CFC had passed the active income test and did not have the benefit of the de minimis exemption
  • working out the amounts that would be included in the notional assessable income - called the sometimes exempt income
  • working out notional allowable deductions that would be available if the sometimes exempt income were assessable - called sometimes exempt deductions.

If sometimes exempt deductions of a class of income are more than the sometimes exempt income of that class, the difference is a sometimes exempt income loss.

Deductions for previous year losses

You may claim a notional allowable deduction for a CFC's previous years' losses. Do this separately for each class of income. In determining the loss for a particular class of notional assessable income, only the notional allowable deductions that relate to that particular class and were derived in that period are taken into account. If the notional allowable deductions are more than the notional assessable income, the difference is set off against the sometimes exempt income gain of that class for the period. The amount that remains is the CFC's loss for that class for the period.

How is a sometimes exempt income gain worked out?

The sometimes exempt income gain for each class of income is the amount of sometimes exempt income that is more than the sometimes exempt deductions. The sometimes exempt income gain reduces a CFC's loss in a class of income. Losses in the current period are reduced before losses carried forward from a previous period.

Conditions before a loss is allowed

You are allowed a notional deduction for a previous year's loss only if the CFC was a CFC when the loss was incurred and at the end of each period until the loss is claimed.

In working out the previous years' losses of the CFC, you must assume that you were always an attributable taxpayer who was required to work out attributable income. Therefore, it is possible to carry forward a loss from a period when you were not an attributable taxpayer.

You cannot take into account any loss incurred in a statutory accounting period that commenced before 1 July 1983.

Residency requirement for losses

A notional deduction is not allowable for a previous year loss if a CFC does not satisfy the residency requirement in the period when the loss was incurred. The general rule is that a CFC resident in a broad-exemption listed country can only claim a notional deduction for a previous year loss if:

  • the loss was incurred in a statutory accounting period commencing on or after 1 July 1997 and the CFC was a resident of a broad-exemption listed country in that period or
  • the loss was incurred in a statutory accounting period commencing before 1 July 1997 and the CFC was a resident of a listed country in that period.

The general rule for a CFC resident in a non-broad-exemption listed country is that the CFC can only claim a notional deduction for a previous year loss if:

  • the loss was incurred in a statutory accounting period commencing on or after 1 July 1997 and the CFC was a resident of a non-broad-exemption listed country in that period or
  • the loss was incurred in a statutory accounting period commencing before 1 July 1997 and the CFC was a resident of an unlisted country in that period.

Modifications to the general rule deal with cases where a company:

  • remains a resident of the same country
  • 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 - for example, as a result of the dissolution of a country.

In these cases, the losses incurred by a CFC in an earlier period are not denied solely because the listing status of a CFC's country of residence changes. The following table summarises the availability of losses incurred in statutory accounting periods commencing before 1 July 1997.

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*

Non-broad-exemption listed country

Generally not allowable

Allowable*
if the non-broad-exemption listed country arises from the dissolution of the listed country.

Allowable
if the non-broad-exemption listed country is the same country as the unlisted country.

Losses incurred by an unlisted country CFC in a statutory accounting period commencing before 1 July 1997.

Broad-exemption listed country

Generally not allowable

Allowable*
if the broad-exemption listed country is the same country as the unlisted country.

Non-broad-exemption listed country

Allowable*

Losses incurred by a 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*

Non-broad-exemption listed country

Generally not allowable

Allowable*
if the non-broad-exemption listed country arises from the dissolution of the last-mentioned listed country.

Allowable
if the non-broad-exemption listed country is the same country as the last-mentioned listed country.

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.

Non-broad-exemption listed country

Not allowable because the losses would have been denied previously.

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.

Non-broad-exemption listed country

Not allowable because the losses would have been denied previously.

Losses incurred by a broad-exemption listed country CFC in a statutory accounting period commencing after 1 July 1997.

Broad-exemption listed country

Allowable*

Non-broad-exemption listed country

Generally not allowable

Allowable*
if the non-broad-exemption listed country arises from the dissolution of the broad-exemption listed country.

Allowable
if the non-broad-exemption listed country is the same country as the broad-exemption listed country.

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

Allowable*
if the broad-exemption listed country is the same as the non-broad-exemption listed country.

Non-broad-exemption listed country

Allowable*

* The losses are not allowable if they were denied in an earlier statutory accounting period.

Losses confined to the CFC

Where a CFC has incurred a loss of a class of income, you cannot transfer the loss to reduce the notional assessable income of another CFC or your own assessable income. The loss is locked into the CFC.

Ordering

If there is more than one previous year's loss, the losses are claimed in the order in which they were incurred.

S ection 5 - Working out the net income of a partnership

The notional assessable income of a CFC includes the CFC's share of the net income of a partnership. You work out the net income of the partnership in accordance with the partnership provisions of the Act. However, it is assumed that:

  • the partnership derived only certain income and gains
  • the operation of the Act is modified.
Assumption about income and gains

The assumptions made for amounts derived by a partnership mirror the assumptions made for working out the income and gains of a CFC. The amounts taken into account in working out the net income of the partnership depends on whether the CFC passes the active income test. The amounts also depend on whether the CFC is a resident of a broad-exemption listed country or a non-broad-exemption listed country.

Non-broad-exemption listed country CFC passes the active income test

Where a non-broad-exemption listed country CFC passes the active income test, the only amounts taken into account in determining the net income of the partnership are trust amounts arising for the partnership and amounts of FIF income.

Non-broad-exemption listed country CFC fails the active income test

Where a non-broad-exemption listed country CFC fails the active income test, only the following amounts are taken into account in determining the net income of the partnership:

  • adjusted tainted income
  • trust amounts arising for the partnership
  • FIF income
  • if the CFC is a resident of a limited-exemption listed country, amounts of low-taxed third country income.

Broad-exemption listed country CFC passes the active income test

Where a broad-exemption listed country CFC passes the active income test, only the following amounts are taken into account in determining the net income of the partnership:

  • ow-taxed third country income
  • FIF income
  • trust amounts arising for the partnership that are not subject to comparable tax in a broad-exemption listed country.

Broad-exemption listed country CFC fails the active income test

Where a broad-exemption listed country CFC fails the active income test, only the following amounts are taken into account in determining the net income of the partnership:

  • eligible designated concession income that is adjusted tainted income
  • low-taxed third country income
  • FIF income
  • trust amounts arising for the partnership that are not subject to comparable tax in a broad-exemption listed country.
Assumption about modifications to the Act

The modifications that apply in working out the net income of a partnership are similar to those that apply for working out notional assessable income and notional allowable deductions of a CFC - refer to se ctions 3 to 5 .

Additional modifications to the Act

Three additional modifications are made in working out the net income of a partnership.

  • First, the partnership is treated as a resident of the same country as the CFC.
  • Secondly, a dividend will not be notional exempt income of a partnership unless the dividend is paid out of previously attributed income.
  • Thirdly, the capital gains tax provisions apply to assets acquired by a partnership after 19 September 1985 - the deemed acquisition of assets on 30 June 1990 for CFCs does not apply to assets held by partnerships.

Section 6 - Trust amounts

The notional assessable income of a CFC may include certain trust amounts arising for the CFC in the statutory accounting period. There are three types of trust amounts:

  • amounts derived as a beneficiary of a trust estate where the CFC is personally entitled to a share of the net income of the trust estate
  • other amounts paid to, or applied for the benefit of, the CFC by the trustee of a trust estate
  • amounts attributed to the CFC under the transferor trust measures.
CFC a beneficiary of a trust - present entitlement

Where the CFC is presently entitled to a share of the net income of a trust estate, the CFC must include the share of the net income in notional assessable income. The calculation of the net income of the trust estate is made under the existing trust provisions of the Act. The modifications that apply in working out the net income of a trust are similar to those that apply for working out notional assessable income and notional allowable deductions of the CFC - see sec tions 3 to 5 .

Additional modifications that apply when working out the net income of a trust are outlined below.

Trust is a resident of the same country as the CFC

A trust estate is treated as a resident of the same country as the CFC.

Dividends

A dividend will not be notional exempt income of a trust unless the dividend is paid out of previously attributed income.

Trust is treated as a resident trust estate

A trust is treated as an Australian resident trust estate or a resident unit trust for the purposes of the capital gains tax provisions.

Modifications to capital gains tax provisions

The modifications to the capital gains tax provisions - see section 4 - that provide for the removal of the exemption for assets acquired before 20 September 1985 do not apply in working out the net income of a trust. Consequently, the capital gains tax provisions apply to assets acquired by a trust after 19 September 1985.

Transferor trust measures

The transferor trust measures apply in working out the attributable income of a CFC. Refer to chap te r 2 to determine whether the CFC will have an amount attributed to it.

Section 7 - Reduction of attributable income because of interim dividends

The attributable income of a CFC is reduced if you are taxed on a dividend paid by the CFC out of current year profits. A dividend is treated as paid out of current year profits only after profits from previous years have been distributed. The amount of the reduction is equal to the attributable income of the CFC referable to the current year profits that were distributed. Your attributable income is also reduced in the same way if you are taxed on a non-portfolio dividend paid by the CFC out of current year profits to another entity you control.

Working out the reduction

Dividend paid to an attributable taxpayer

If the dividend is paid to you, the amount of the reduction in attributable income is worked out as follows:

Amount of the dividend assessed

Your attribution percentage in the CFC

Example 31

Dividend paid wholly out of attributed income

  • A taxpayer has a 50 per cent attribution percentage in a CFC resident of an unlisted country. The CFC has no profits from previous years and $1 million current year profits are distributed as a dividend. The dividend was paid wholly from profits referable to the attributable income of the CFC. The $500,000 received by the taxpayer is included in the taxpayer's assessable income.

The amount by which the attributable income would be reduced is worked out as follows:

$500,000/50% = $1 million

Example 32

Dividend paid partly out of attributed income

  • A taxpayer has a 50 per cent attribution percentage in a CFC resident of an unlisted country. The CFC has an accumulated profit of $2 million. The CFC pays a dividend of $2.2 million. The dividend would be taken to have been paid out of the accumulated profits first. The whole of the $200,000 component of the dividend paid from current year profits is referable to the attributable income of the CFC.

    The reduction would be: $100,000/50% = $200,000

Example 33

Dividend is exempt

  • A resident company has a 50 per cent interest in a CFC resident of a listed country. The CFC has no profits from previous years and distributes all of the current year profits as an exempt dividend.

    There is no reduction of attributable income in this case because the dividend was not assessable.

Dividend paid to another CFC or CFT

If a CFC resident in an unlisted country pays an interim dividend directly to either another CFC or CFT, the reduction is worked out as follows:

Amount of the dividend assessed

Your attribution percentage in the recipient

Dividend paid to a partnership or Australian trust

If a CFC resident in an unlisted country pays an interim dividend indirectly to either another CFC or CFT through either a partnership or an Australian trust, the reduction is worked out as follows:

Amount of the dividend assessed

Your attribution percentage in the dividend

Your indirect interest in the dividend is worked out by multiplying your interest in the partnership or trust by your attribution percentage in the CFC of CFT receiving the dividend.

Section 8 - Relief from double accruals taxation

If an amount of income or gain is to be included in your assessable income as a result of tracing control through a foreign entity and that foreign entity has also been taxed on that amount under the accruals tax laws of another country, you may reduce your assessable income by an amount calculated as follows:

Indirect attribution interests through a controlled foreign entity (CFE)

X

Foreign accruals-taxed attributable income

Your indirect attribution interest through a CFE is your attribution interest in a CFC traced through the CFE.

The foreign accruals-taxed attributable income is that part of an amount of income or gain derived by a CFC on which an interposed CFE has been taxed under an accruals tax law of a broad-exemption listed country. The income or gain must be taxed at that country's normal company rate of tax and during a tax accounting period which commences or ends either in your year of income or the statutory accounting period of the CFC.

Only countries listed in the Income Tax Regulations as having accruals tax laws are recognised for the purpose of granting this relief. They are:

  • Canada
  • France
  • Germany
  • Japan
  • New Zealand
  • United Kingdom
  • United States of America

Example 34

Reduction of an otherwise assessable section 456 amount

Scenario

  • Ausco owns 50 per cent of the share capital of US Co - a company resident in the United States - which in turn owns 50 per cent of the share capital of a company that is a resident of an unlisted country. Ausco also holds a direct interest of 25 per cent of the unlisted country company.

    Because of the interests Ausco holds in US Co and the unlisted country company, both foreign companies are CFCs.

    For the 1995-96 period, the unlisted country CFC's only item of income was interest income. The amount of this interest income was determined to be $8000 under Australia's income tax laws.

    The United States taxed US Co on an accruals basis on the item of interest income derived by the listed country CFC. US Co's interest in the unlisted country company was 50 per cent. Therefore, only half of the item of interest income was attributed to US Co by the United States.

    Australia applied the transfer pricing provisions to an interest free loan which the unlisted country company provided to a related CFC. Consequently, another $2000 interest income was included in the unlisted country CFC's attributable income under Australia's accruals tax laws. This amount was not included in the unlisted country CFC's attributable income under the accruals tax laws of the United States.

    Working out the amount to be attributed to Ausco

    Step 1 - Determine Ausco's otherwise assessable amount

    Ausco's attributed percentage of the attributable income of the unlisted country CFC is:

direct attribution interest

25%

indirect attribution interest

25%

attribution percentage

50%

  • Ausco's otherwise assessable amount is $5000 (50 per cent attribution percentage x ($8000 interest income plus $2000 interest income) ) arising from the application of the transfer pricing provisions.

    Step 2 - Determine Ausco's indirect attribution interests through US Co

    Ausco's indirect attribution interest through US Co in the unlisted country CFC is 25 per cent - that is, Ausco's 50 per cent direct interest in US Co multiplied by US Co's 50 per cent interest in the unlisted country CFC.

    Step 3 - Determine the unlisted country CFC's foreign accruals-taxed attributable income

    The unlisted country CFC's foreign accruals-taxed attributable income worked out under Australian accruals tax rules equals $8000. This amount is referable to the item of interest income included in the attributable income of the unlisted country CFC under the accruals tax laws of the United States. It is important to note that the amount is not necessarily the same as the amount worked out under the accruals tax laws of the United States.

    Step 4 - Determine the amount by which Ausco's otherwise assessable amount is to be reduced

    Reduce the otherwise assessable amount by $2000 - that is, step 2 multiplied by step 3.

    Step 5 - Determine Ausco's assessability in respect of the unlisted country CFC's attributable income

    Ausco's assessability for the unlisted country CFC's attributable income is $3000 - that is, step 1 minus step 4.

Section 9 - How much is included in assessable income?

You need to work out how much of the attributable income of the CFC to include in your assessable income. Multiply your attribution percentage in the CFC at the end of the statutory accounting period by the attributable income of the CFC. Include the result in your assessable income.

ATO references:
NO NAT 1840

Foreign income return form guide
  Date: Version:
You are here 1 July 2002 Original document
  1 July 2006 Updated document
  1 July 2007 Updated document
  1 July 2008 Updated document
  1 July 2009 Updated document
  1 July 2010 Updated document
  1 July 2011 Updated document
  1 July 2012 Updated document
  1 July 2013 Updated document
  1 July 2014 Updated document
  1 July 2015 Updated document
  1 July 2016 Updated document
  1 July 2017 Updated document
  1 July 2018 Current document

View full documentView full documentBack to top