House of Representatives

Income Tax Assessment Amendment (Foreign Investment) Bill 1992

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

General Outline and Financial Impact

Purpose of the Bill

The Income Tax Assessment Amendment (Foreign Investment) Bill 1992 implements the Government's 1991-92 Budget announcement to complete the third element of its tax reform agenda to develop a comprehensive system for taxing foreign source income. The first element was the Foreign Tax Credit System which, from the 1987-88 income year, replaced the general exemption in Australia of income earned offshore and subjected to foreign tax. The second element was the introduction of the Foreign Source Income (FSI) measures which took effect from the 1990-91 income year.

The FSI measures apply where Australian residents have substantial interests in Controlled Foreign Companies ( CFC), or had transferred property to certain foreign trusts for less than full value. They address the tax deferral problem where these entities are used to shelter income from Australian tax by accumulating it in low-tax or tax free jurisdictions. Such income is now taxed as it accrues.

The Foreign Investment Funds ( FIF) measures will apply to income and gains accumulating in foreign companies that are not Australian controlled or foreign trusts that fall outside the scope of the FSI measures. The measures will also apply to certain foreign life assurance policies ( FLPs) that have an investment component, such as life bonds.

In addition, the Bill will amend the existing trust provisions in Divisions 6 and 6AAA of the Principal Act in their application to non-resident trust income. The principal change is to the way in which a person's share of the net income from such non-resident trusts is ascertained. This will be aligned with the way in which a person's share of foreign investment fund income is determined under the FIF measures.

The Bill will also make some amendments to the controlled foreign company measures in Part X of the Principal Act and to the trust measures introduced as part of the FSI changes.

Administration

The Bill will be administered by the Commissioner of Taxation.

Commencement date

The provisions of the Bill will apply from 1 January 1993 for all taxpayers who will be subject to the FIF measures. The amendments to the trust provisions in Divisions 6 and 6AAA of the Principal Act will apply from the 1992-93 income year. Some of the other amendments have separate dates of effect.

Coverage of the Foreign Investment Funds measures

The FIF measures will apply to Australian taxpayers who, at the end of an income year, have an interest in a foreign company or a foreign trust. Taxpayer with a foreign life assurance policy at any time in their income year will generally be subject to the measure.

The measures provide several categories of exemption from FIF taxation. The exemptions include:

Active business exemption

The active business test ensures there is no tax hindrance to portfolio diversification or joint venture participation by Australians who wish to invest directly into a foreign company that is principally engaged in active business. A direct investment in a foreign company which is not principally engaged in one of the listed business activities ('the black list') as listed in Schedule 4 or future regulations will not attract FIF taxation.

Most business activities are treated as active. Investments in foreign companies that principally derive passive income by investing in other entities will not be active. Business activities such as banking, financial services, investment, life insurance business and general insurance business, and activities in connection with real property are not generally included as active businesses.

There are two methods of showing that a foreign company is an active business and therefore exempt from the FIF measures. The stock exchange listing method uses stock exchange categorisation or international sectoral classifications to establish a company's principal activity. If the principal activity is not on the 'black list' then the company is treated as active. The balance sheet method, on the other hand, establishes a company's principal activity by reference to the company's balance sheet. Where at least 50 per cent of assets are not for use in a 'black list' business activity the company will pass the active business test.

Exemptions for certain interests in foreign banks, general insurance companies, life insurance businesses and real property companies.

Although some activities such as banking, insurance and real estate are listed as non-eligible activities for purposes of the active business test, there are specific exemptions provided for certain publicly listed and widely held investments in these industries.

Exemption for interest in a foreign company principally engaged in several activities

In cases where a taxpayer has an interest in a foreign company that is listed on a approved stock exchange and undertakes two or more types of business activities, an exemption will apply if the principal activities of the company are not 'black list' activities.

Exemption for interest in certain foreign trusts

Investment, through certain trusts, on stock exchanges in countries that prohibit direct investment will be excluded from the FIF measures. This will ensure that Australian investors are not disadvantaged by investing in emerging markets through certain trusts listed in free-market countries.

Foreign employer-sponsored superannuation exemption

An exemption from the FIF measures is provided to a natural person with an interest in a foreign employer- sponsored superannuation fund, provided the person is an employee or past employee of the employer. An interest in a non-resident superannuation fund sponsored by a company associated with the employer will also be exempt. The fund must be managed by the employer or an associate company on behalf of current or past employees.

Exemption for interest in a FIF that is trading stock

An exemption from FIF taxation is provided to a taxpayer who holds FIF interests as trading stock and elects to bring all FIF interests that are trading stock to account at market value.

Exemption for certain interests of Underwriting Members of Lloyd's

A taxpayer who is an underwriting member of Lloyd's and who has an interest in assets that form part of a Lloyd's Premiums Trust Fund will be exempted from taxation in respect of foreign investment fund income from that interest.

Small investor exemption

FIF income will not be included in a taxpayer's assessable income where the taxpayer is a resident natural person who holds a direct interest in a FIF and the total value of the taxpayer's interests in foreign companies, trusts and foreign life policies does not exceed $A50,000 at the end of the taxpayer's income year.

To test whether this exemption applies, the taxpayer will be required to aggregate the taxpayer's interests and the interests of the taxpayer's associates in all non-resident companies, trusts and foreign life policies. Associates would include, for example, the immediate relatives of the taxpayer, a company in which the taxpayer holds a majority of the voting shares, a trust controlled by the taxpayer, and a partnership in which the taxpayer is a partner.

In addition, an extension of the exemption is provided where the taxpayer's interests (together with those of associates) in foreign companies, trusts, foreign life policies and interests in resident public unit trusts at the end of the year of income do not exceed $A50,000. In this case, the FIF taxation measures will not apply even in relation to the taxpayer's share of net income from the resident public unit trusts.

Exemption of certain visitors to Australia

In the absence of a specific exemption, the FIF measures would apply to the offshore investments of visitors who are short term residents of Australia. It is unlikely that those investments would provide significant opportunity to defer Australian tax. Consequently, there will be an exemption from the FIF measures for visitors who hold a temporary entry permit granted under the Migration Act 1958,allowing no more than a 4 year stay and have not applied for, or been given, permanent residency in Australia.

attributable taxpayer exemption

The existing FSI measures consist of two components - the controlled foreign company ( CFC) measures and the transferor trust measures. These attribute specified income and gains of foreign companies and trusts to certain Australian residents ( attributable taxpayers). The FIF measures may overlap with the CFC measures or the transferor trust measures. Where this occurs the CFC measures or the transferor trust measures will apply and the FIF measures will, in general, have no application. However, the FIF measures will apply in calculating the income of a CFC or trust which holds interests in FIFs.

Exemption for interests in FIFs the value of which is not more than 5% of value of all taxpayer's interests in FIFs

Where at the end of the notional accounting period only 5 per cent or less of the aggregate of a taxpayer's interests in FIFs, excluding CFCs, controlled foreign trusts and employer sponsored superannuation, gives rise to FIF taxation then that interest will also be exempt from the FIF measures along with the other 95 per cent or more that is exempt under other exemption provisions.

Calculation of the tax

Where none of the exemptions apply, the amount of FIF income will be determined under one of the following three taxing methods:

he market value method;
he deemed rate of return method;
he calculation method; or

in the case of FLPs, the amount of FIF income will be determined under the cash surrender value method or the deemed rate of return method.

Under these methods, the taxpayer's interest in a FIF is measured in relation to the notional accounting period of the FIF that is deemed to commence on 1 January 1993 and for subsequent periods. The notional accounting period of a FIF is generally the taxpayer's income year. However, a taxpayer can elect to use the period for which the annual accounts of the FIF are made.

The assessable income arising under the FIF measures will be included in the taxpayer's assessable income for the income year in which the notional accounting period of the FIF ends.

Amendments to trust provisions

The Bill will also amend the existing trust provisions in Divisions 6 and 6AAA of the Principal Act in their application to non-resident trust income. These amendments will supplement the FSI measures in areas where the FIF measures will not apply.

They will:

i)
liminate any double taxation that could otherwise arise through concurrent application of the FIF measures and the existing trust provisions in Division 6;
ii)
rovide an extension of the small investor exemption to apply where the taxpayer's interests (together with those of associates) in foreign companies, trusts, interests in resident public unit trusts and foreign life policies at the end of the year of income do not exceed $A50,000. In this case, the FIF measures will not apply even to the taxpayer's share of net income from the resident public unit trusts;
iii)
et out the way in which a beneficiary's share of the income of non-resident trust estates is to be calculated;
iv)
xempt a taxpayer from an interest charge on distributions from the estate of a foreign deceased person made within three years after the date of death of a that person;
v)
xempt a taxpayer from an interest charge on certain amounts received, or on amounts which have been applied for the taxpayer's benefit. The amounts must be attributable to the income or profits of a trust estate which, at all times during the year, was a public unit trust and was not a controlled foreign trust; and
vi)
equire taxpayers to show that distributions out of accumulated profits of a foreign trust have been comparably taxed offshore before that amount will be exempt from the interest charge on distribution.

These amendments will have effect from the 1992-93 year of income.

Amendment to taxation of Foreign Source Income

The Bill will also make a technical amendment to the Controlled Foreign Company measures in Part X of the Principal Act. The amendment to section 399 corrects an anomaly in the method of calculating the net income of a partnership or trust which is to be included in the attributable income of a Controlled Foreign Company.

Financial impact

The revenue gains for the Foreign Investment Fund measures will generally be realised after the end of the 1992-93 income year.

It is estimated that these measures will yield a revenue of $90 million in the 1993-94 financial year, $200 million in the 1994-5 financial year and $220 million in the 1995-6 financial year.

Who is Covered by the Foreign Investment Fund Measures?

Overview

This chapter explains:

hat is a FIF or a FLP;
hat constitutes an interest in a FIF or a FLP; and
hose interest in a FIF or a FLP will be subject to the FIF measures.

Explanation

What is a FIF?

A FIF is any foreign company or foreign trust. [Subsection 481(1)]

A company is a foreign company if it is not a resident of Australia. Whether a company is a resident of Australia is a question of fact which must be determined by reference to the definition of a "resident of Australia" in subsection 6(1) of the Principal Act and the residency provisions of any relevant double taxation agreement.

A trust estate is a foreign trust if the trust estate:

s not an Australian trust or a resident Part IX entity; and
id not result from:

will, a codicil or an order of a court that varied or modified the provisions of a will or a codicil; or
ntestacy or a court order that varied or modified the application of the provisions of the law relating to the distribution of the estates of persons who die intestate. [Subsection 481(3)]

What is an Australian trust?

A trust estate will be an Australian trust at a particular time if:

ithin the past 12 months, the trustee was a resident of Australia or the central management and control of the trust was in Australia. (It is a question of fact whether a trustee is a resident of Australia. This issue is to be determined by reference to the definition of a "resident of Australia" in subsection 6(1); or
he trust is a corporate unit trust for the purposes of Division 6B of Part III or a public trading trust for the purposes of Division 6C of Part III, and in either case, a resident unit trust (broadly, for taxation purposes, corporate unit trusts and public trading trusts are treated in the same way as companies). [Section 473]

What is a resident Part IX entity?

A trust estate is a resident Part IX entity at a particular time if the trust estate:

as established in Australia; or
ad its central management and control in Australia at any time during the past 12 months,

and the trust estate would have been an eligible entity for the purposes of Part IX. [Section 477]

What is an eligible entity for the purposes of Part IX?

An eligible entity for the purposes of Part IX is:

fund that is a complying or non-complying approved deposit fund;
fund that is a complying or a non-complying superannuation fund; or
unit trust that is a pooled superannuation trust.

Bare Trusts

Where an interest in a FIF is held by a trustee for a person who has an absolute entitlement to that interest, which may be exercised against the trustee, the interest in the FIF is considered to be vested in the person who has the absolute entitlement and not as vested in the trustee. Also, any acts of the trustee are deemed to be the acts of the person who has the absolute entitlement. [Subsection 484(1)]

Where a person would have been absolutely entitled to the interest in the FIF as against the trustee, but has a legal disability (for example, due to a physical or mental infirmity, or as a minor) that person will nevertheless be taken to be absolutely entitled to the interest in the FIF. [Subsection 484(2)]

What is a FLP?

A FLP is a life assurance policy issued by an entity that was a non-resident of Australia at any time in the year of income other than an Australian policy subject to the life assurance provisions of the Principal Act. [Subsection 482(2)]

A life assurance policy is a policy which provides for a payment of money upon death, other than death by accident or specified sickness, or the happening of a specified event which relates to the ending or continuing of a human life. A life assurance policy also includes an instrument which grants an annuity for a term dependent upon human life. [Subsection 482(2)]

The measures will only apply to certain life policies. The three categories of policies to be excluded are:

hose which provide life cover, or life and permanent disability cover only;
hose policies issued before 1 July 1992 which cannot, after this date, be cancelled, surrendered or redeemed and for which the terms have not, after this date, been altered in a material respect; and
contract of reinsurance of pure life cover between a resident insurer and a non-resident reinsurer. [Subsection 482(2)]

What is an interest in a FIF?

Meaning of 'an interest in a foreign company'

An interest in a foreign company is:

share in the company including an ordinary, a preference, a bonus, a deferred and a redeemable preference share other than an eligible finance share; or
n instrument that confers an entitlement to acquire such a share (including an entitlement arising from an option or convertible note). [Subsection 483(1)]

Eligible finance shares

Shares held by banks as substitutes for debt will not be subject to the FIF measures. These debt substitutes are referred to as 'eligible finance shares' and are excluded from being an interest in a FIF. [Paragraph 483(1)(a)]

The definition of what constitutes an eligible finance share is provided by section 327 of the Principal Act. Section 327 notes that a share in a company is an eligible finance share if all the following conditions are satisfied:

a)
he shareholder is an Australian Financial Institution (AFI) or an AFI subsidiary;
b)
he share was issued to the shareholder by the company in the ordinary course of business carried on by the shareholder;
c)
he shareholder is not an associate of the company; and
d)
aving regard to:

i)
he manner in which the amount of dividends in respect of the share are to be calculated; and
ii)
he conditions applicable to the payment of dividends in respect of the share; and
iii)
ny other relevant matters;

the payment of the dividends in respect of the share may reasonably be regarded as equivalent to the payment of interest on a loan where the interest accrues at intervals not exceeding 12 months and is paid not later than 12 months after it accrues.

Meaning of 'an interest in a foreign trust'

An interest in a foreign trust is:

n interest in the corpus or income of the trust (including a unit in a unit trust); or
n instrument that confers an entitlement to acquire such an interest (including an entitlement arising from an option or convertible note). [Subsection 483(2)]

What is an interest in a FLP?

A taxpayer has an interest in a FLP if the taxpayer is the person who has the legal title to the FLP.[Subsection 483(3)]

Taxpayers whose interests in a FIF or FLP will be subject to the FIF measures

The FIF measures will apply to a taxpayer's interest in a FIF for a notional accounting period that ended in the taxpayer's year of income (see Chapter 2 for an explanation of a notional accounting period) if:

he taxpayer had an interest in a FIF at the end of the year of income (the year of income ending on or after 30 June 1993); and
he taxpayer was a resident at any time in that year of income. [Subsection 485(3)]

The measures will apply to a taxpayer's interest in a FLP if the taxpayer had the interest at any time during the notional accounting period of the FLP that ends in the taxpayer's year of income and the taxpayer was a resident at any time in that year of income. [Subsection 485(4)]

The measures will not apply to an interest in a FLP if the taxpayer disposes of that interest before 30 June 1993. [Subsection 485(5)]

For the purposes of the above residency test only, a taxpayer who is a trustee of a:

orporate unit trust that is also a resident unit trust;
public trading trust that is also a resident unit trust; or
resident Part IX entity,

is treated as a resident of Australia. [Subsection 485(6)]

Where a taxpayer is a resident throughout a part or parts of the year of income in which the notional accounting period of the FIF or FLP ended, then the amount of foreign investment fund income assessable to the taxpayer is worked out using the following formula:

Foreign Investment Fund Income * (Number of days of residence / Total number of days)
Where:

Foreign investment fund income means the amount of foreign investment fund income that accrued to the taxpayer from the FIF or FLP during the notional accounting period;
Number of days of residence means the number of days throughout the year of income in which the taxpayer was a resident of Australia; and
Total number of days means the total number of days in the year of income (usually 365). [Paragraph 529(2)(b)]

Clause making the amendment

Clause 27: Inserts Part XI containing the Foreign Investment Fund measures.

Key Concepts

Overview

This chapter explains some of the key concepts used in the Foreign Investment Fund ( FIF) measures. The chapter includes an explanation of:

he measurement period for an interest in a FIF (the notional accounting period);
he acquisition and disposal of an interest in a FIF;
istributions made by a FIF;
he meaning of 'entitled to acquire';
he meaning of 'quoted price'; and
he operative provision.

Explanation

notional accounting period of a FIF

The FIF measures will apply by reference to an accounting period of the FIF called the notional accounting period. The notional accounting period provides a measurement point for the application of the FIF provisions. Reference to a notional accounting period will be made for a variety of purposes including the application of the various methods of taxation and for some of the exemptions.

The notional accounting period of the FIF will generally coincide with the taxpayer's year of income. [Subsection 486(2)]

For a company or trust that was incorporated, established or brought into existence before 1 January 1993 the first notional accounting period of a FIF commences on 1 January 1993. The first notional accounting period of a FIF, which comes into existence on or after 1 January 1993, commences on the day on which it came into existence. [Subsection 486(7)]

If the period for which the FIF prepares its accounts is different to the taxpayer's year of income and this period does not exceed 12 months, then the taxpayer may elect for the notional accounting period of the FIF to coincide with the period for which the accounts of the FIF are prepared. [Subsection 486(3)]

If the taxpayer chooses to align the notional accounting period of the FIF with the period for which the accounts of the FIF are prepared, the election will continue to be in force so long as the taxpayer has an interest in the FIF. [Subsection 486(4)]

When the taxpayer elects to use the period for which the accounts of the FIF are prepared, the first accounting period that begins during the year of income in which the election is made, is a notional accounting period. This is referred to in the explanations in the following two paragraphs as the 'first period'. [Paragraph 486(5)(a)]

The period that is from the beginning of the year of income in which the taxpayer elects to change the FIF's notional accounting period to the beginning of the first period is a notional accounting period. [Paragraph 486(5)(b)]

Example 1 Assume that the period for which a FIF prepares its accounts is 1 January to 31 December each year.On 1 August 1993 the taxpayer elects to change the notional accounting period of the FIF from his/her year of income to 1 January to 31 December.The notional accounting periods of the FIF are:

1)
January 1993 - 30 June 1993;
2)
July 1993 - 31 December 1993; and
3)
January 1994 - 31 December 1994 and every year following.

The acquisition and disposal of an interest in a FIF

Effect of change in ownership

If there is a change in ownership of an interest in a FIF, this change constitutes a disposal by the person who had the interest in the FIF immediately before the change and an acquisition by the person who owns it immediately after the change. A change in ownership is treated as having occurred only if there is a change in the beneficial ownership of the interest in the FIF in addition to a change in its legal ownership. [Subsections 488(2) and (3) ]

The circumstances in which a change in the ownership of an interest in a FIF can take place include:

xecution of an instrument;
ntering into a transaction; and
ransfer by the operation of law.

[Subsection 488(4)]

In addition, a change in ownership will be taken to have occurred by:

declaration of trust in relation to the interest in the FIF under which the beneficiary is absolutely entitled to the interest rather than the trustee;
he release, discharge, satisfaction, surrender, forfeiture, expiry, abandonment or extinction, at law or in equity, of the interest in the FIF; or
he redemption or buy-back, in whole or in part, or the cancellation, of the interest. [Subsection 488(5)]

An issue to a person of an interest in a FIF is an acquisition of the interest by that person. [Subsection 488(6)]

There is no acquisition or disposal of an interest in a FIF if a right is exercised for which no consideration is paid or payable or if there has been an exchange of an interest in a FIF for another interest in that FIF of the same value. [Subsection 488(7)]

Time of disposal or acquisition

If an interest in a FIF was acquired or disposed of under a contract, the time of making the contract is the time of acquisition or disposal. If there is no contract, the acquisition or disposal takes place when the change in ownership occurs. [Section 489]

Consideration for the acquisition or disposal of a FIF

Where the acquisition or disposal of an interest in a FIF is for no consideration or for inadequate consideration, the taxpayer is required to treat the market value as the consideration. Acquisitions and disposals are treated as being for inadequate consideration where:

o consideration is given or received; or
oth of the following conditions apply;

he amount given or received was greater or less than the market value of the interest; and
he acquisition or disposal was not at arm's length.

When the acquisition or disposal of an interest in a FIF was for inadequate consideration an amount equal to the market value of the interest at the time of the acquisition or disposal is used as the consideration. [Section 490]

Example 2 An interest in a FIF with a market value of $41,000 is gifted by a mother to her daughter. The daughter would be required to use $41,000 as the market value of her FIF interest.

Distributions by a FIF

A distribution made by a FIF to a person who has an interest in a FIF is any amount paid or credited, or any property distributed by the FIF to the person that constitutes income derived, or a receipt of capital by the person. A distribution by a FIF includes the issue by a FIF to a person of a further interest in the FIF in consideration of the person's entitlement to a payment by the FIF. [Section 474]

Meaning of 'entitled to acquire'

A person is taken to be 'entitled to acquire' anything that the person is absolutely or contingently entitled to acquire. The entitlement to acquire can arise from any constituent document of a company, the exercise of any right or option or for any other reason. [Section 475]

Meaning of 'quoted price'

An interest in a FIF is sometimes valued by reference to the quoted price of the interest in the FIF. The quoted price is that price, for the class of interests in which the FIF interest is included, which is quoted on a particular day on a stock market. [Subsection 476(1)]

When there is more than one transaction on a stock market on the particular day on which the value of the FIF interests is required, the quoted price is the last published price for which such an interest was traded. If, on the particular day, there was no published price or there were no transactions on the stock market for interests in that class, the quoted price is the last price at which an offer was made on that day to buy such an interest. [Subsection 476(2)]

The Operative Provision - section 529

The operative provision provides for the foreign investment fund income to be included in the taxpayer's assessable income for the taxpayer's year of income in which the notional accounting period of the FIF ends. [Section 529]

The operative provision also apportions the amount of foreign investment fund income that is included in the taxpayer's assessable income according to the number of days throughout the year that the taxpayer is a resident of Australia. [Paragraph 529(2)(b)]

Exemption for Attributable Taxpayer

Overview

In order to avoid double taxation, a taxpayer with an interest in a Foreign Investment Fund ( FIF) will not be subject to the FIF measures if that interest is subject to the existing CFC or transferor trust measures. Further, an attributable taxpayer in a controlled foreign trust (CFT) will be subject to the existing trust provisions instead of the FIF measures. This Chapter will explain the exclusion of amounts taxed under the existing CFC and transferor trust measures from a taxpayer's attributable income under the FIF measures.

Background to the CFC measures

The FIF measures are designed as an adjunct to the accruals tax measures for the taxation of offshore entities. If Australian residents have substantial interests in a non-resident company, the accruals tax system may include certain income and gains derived by that company in the residents' assessable income. A non-resident company that is subject to these accruals measures is called a controlled foreign company ( CFC).

Where a taxpayer is subject to attribution in respect of an interest in a CFC or a controlled foreign trust, the FIF measures will not apply to that interest. In particular, the FIF measures will not override the exemptions from accruals taxation provided under the CFC measures, for instance, where the CFC passes the active income test.

Explanation

Exemption of attributable taxpayer referred to in section 456

The income and gains of a CFC that may be included under section 456 in the assessable income of resident taxpayers is called attributable income. That income is calculated, subject to some modifications, as if the CFC were a resident of Australia.

There are two tests for determining whether a taxpayer's interest in a CFC is to be excluded from the calculation of the taxpayer's attributable FIF income because section 456 also applies to that interest. [Section 494]

The first test is used where the statutory accounting period of the CFC coincides with the notional accounting period of the FIF. In this case, no amount will be included in respect of the taxpayer's interest in the CFC under the FIF measures if section 456 applies to the interest at the end of that period [subsection 494(1)] . This exemption will not apply where, at the end of the company's statutory accounting period, the company ceases to be a CFC or if the taxpayer ceases to be an attributable taxpayer of the CFC. The exemption would, however, apply where a company became a CFC during its notional accounting period for the purposes of the FIF measures.

The second test is used where the statutory accounting period of the CFC does not coincide with the notional accounting period of the FIF. In this case, no amount will be included in respect of the taxpayer's interest in the CFC under the FIF measures if section 456 applies to that interest in both of the CFC's statutory accounting periods which overlap the FIF's notional accounting period (i.e., the statutory accounting period of the CFC which ends and the period which commences during the notional accounting period of the FIF). [Subsection 494(2)]

Both of the above tests require that section 456 applies to the taxpayer's interest in the CFC. Section 456 is taken to apply to a taxpayer's interest in a CFC even if no amount was included in the taxpayer's attributable income for a statutory accounting period. For example, a CFC which passes the active income test might not have any attributable income. Therefore, no amount would be included in the attributable income of a taxpayer under section 456. In this case, section 456 will still be taken to apply to the attributable taxpayer's interest in the CFC.

Reduction of attributable income where section 457 applies

Where a CFC changes residence from an unlisted country to a listed country or Australia, a resident attributable taxpayer must include a certain amount of the distributable profits of the CFC in attributable income (section 457).

Section 457 is an anti-avoidance provision to prevent an unlisted country CFC distributing its profits in a tax free form by simply changing its residence.

An amount which is included in a taxpayer's assessable income under section 457 that relates to an interest in a FIF is treated as a FIF attribution payment by the FIF to the taxpayer for the purposes of subsection 530(2). This means that the attributable income of the taxpayer referable to that FIF interest will be reduced to the extent that an amount was included in the taxpayer's assessable income under section 457. The attribution payment arises at the residence change time of the CFC and is therefore relevant for the purposes of calculating the FIF's attributable income for the notional accounting period of the FIF during which the change in residence of the CFC occurred. [Section 530]

The amount which is included in a taxpayer's assessable income under section 457 that relates to an interest in a FIF is only treated as a FIF attribution payment for the purposes of subsection 530(1). It does not give rise to a FIF attribution payment for the purposes of Division 19 of Part XI which provides for the operation of FIF attribution accounts (refer to Chapter 21 for an explanation of the operation of FIF attribution accounts). Consequently, the amount which is included in the taxpayer's assessable income under section 457 does not have any affect on the FIF attribution accounts of the company although a credit would arise in the attribution accounts of the company as a CFC.

It should be noted that the above treatment will only apply in a few instances. Normally, a taxpayer's interest in a CFC will be excluded from the calculation of a taxpayer's attributable FIF income when that interest is included in the taxpayer's assessable income under section 456. The above treatment would be relevant, however, where a CFC changes residence and:

hen ceases to be a CFC (for instance, due to an Australian resident selling shares to a non-resident); or
he taxpayer ceases to be an attributable taxpayer of the CFC under the CFC measures but still maintains an interest in the CFC (this may happen where a taxpayer only disposes of part of his interest in the CFC).

controlled foreign trusts

Under the existing foreign source income measures there is a distinction between foreign trusts that are controlled by residents of Australia and other foreign trusts. There are two types of controlled foreign trust (CFT):

trust estate to which an Australian has transferred certain property or services to which Division 6AAA applies; or
controlled foreign trust as defined in Part X. These are, broadly, trust estates where five or fewer Australian residents have 50 per cent or more of the interests in either the income or the corpus of the trust.

If a taxpayer is an attributable taxpayer in respect of either type of controlled foreign trust during the notional accounting period of the trust for FIF purposes, the taxpayer will be excluded from the FIF measures in respect of any interest in that trust estate [section 493]. Instead, they will be required to calculate the net income of the trust for the purposes of Division 6 (using a modified attribution percentage calculation), or the attributable income of the controlled foreign trust for the purposes of Division 6AAA of Part III of the Principal Act.

Even though an attributable taxpayer in a controlled foreign trust to which Part X applies will not be subject to the FIF measures in respect of the interest in the controlled foreign trust, it is possible that trust estate will have an interest in another entity which is a FIF. Where the taxpayer, through the controlled foreign trust, is not an attributable taxpayer in respect of the lower tier FIF (be it a company or a trust estate), the FIF measures apply in the calculation of the net income or attributable income of the controlled foreign trust (refer to Chapter 25).

Exemption for Active Business

Overview

This chapter describes the exemption for interests a taxpayer has in foreign companies principally engaged in eligible active business. The purpose of the exemption is to ensure there is no tax hindrance to portfolio diversification or joint venture participation by Australians who wish to invest directly into a non-resident company that is principally engaged in active business.

Introduction

The active business exemption (ABE) will exempt a taxpayer from taxation under the FIF measures for interests the taxpayer has in foreign companies principally engaged in certain active business, known as eligible activities. [Section 497]

The active business exemption will not apply to any interest in a non-resident trust, even though the trust's underlying investments may be principally active. However, the exemption will apply when calculating the net income of a resident trust estate where the trust estate invests directly in a foreign company engaged in an active business. This is because the trust is treated under subsection 95(1) as a resident taxpayer and qualifies for all the exemptions provided to a resident taxpayer under the FIF measures.

The active business exemption will also apply when calculating the FIF income of a controlled foreign company ( CFC) or a controlled foreign trust ( controlled foreign trust). In this case again, the FIF income is calculated by treating the CFC or controlled foreign trust as a resident taxpayer.

Active business

A company will be considered to be carrying on an active business if it is principally engaged in one or more eligible activities.

Meaning of 'eligible activities'

To satisfy the exemption, the taxpayer must establish that the foreign company was at the test time, principally engaged in one or more eligible activities. [Section 497]

All activities that are not named in Schedule 4 are defined as 'eligible activities' under [subsection 496(1)] and may qualify for the ABE.

The business activities that are not eligible activities for the purposes of the ABE are:

a)
anking and the provision of finance.
b)
inancial intermediation services.
c)
nvestment in tainted assets, or tainted commodity investments, within the meaning of section 317.
d)
ife insurance business.
e)
eneral insurance business.
f)
anagement of funds.
g)
ctivities in connection with real property.

It should be noted that although banking, life insurance, general insurance and real property are listed as non-eligible activities, specific exemptions from FIF taxation in Divisions 4 to 7 will provide limited exemptions for investment in those industry groups.

Schedule 4 will have effect until regulations are made specifying activities that are not eligible for the ABE.

The 'black list' approach in Schedule 4 of specifying non-eligible activities benefits a taxpayer because the scope of the measures are narrowed through specifying activities which are targeted by the FIF measures. Consequently, interpretation issues and compliance costs are kept to a minimum.

Methods to determine whether a foreign company carries on active business

There are two methods by which a taxpayer may establish whether a foreign company is principally engaged in eligible activities:

he stock exchange listing method; and
he balance sheet method.

If both methods are capable of being applied to a particular company the taxpayer must choose the method to be used. The ABE will not be available if it is not possible to satisfy either one of the tests. [Section 498]

Test time

For a taxpayer to qualify for the active business exemption, the foreign company itself must be principally engaged in active business at the test time. [Section 497]

For the stock exchange listing method, the test time is the end of the notional accounting period of the foreign company. This is usually at the end of the taxpayer's year of income (refer to the notes on notional accounting periods in Chapter 2). [Paragraph 497(2)(a)]

For the balance sheet method, the test time is the end of the period for which the company prepares its annual accounts for reporting to its shareholders that falls within the taxpayer's year of income. [Paragraph 497(2)(b)]

Stock exchange listing method

The stock exchange listing method is one method by which a taxpayer may determine if a foreign company is principally engaged in eligible activities. The stock exchange listing method [section 499] may only be used if the taxpayer can establish that, at the test time, the foreign company is listed on either:

n approved stock exchange [Schedule 3] ; or
n approved international sectoral classification system [Schedule 5] ,

under a classification or designation that describes an eligible activity.

There are one hundred and thirteen approved stock exchanges listed in Schedule 3. The approved stock exchanges are spread throughout 48 countries.

Schedule 5 lists five (5) approved international sectoral classification systems namely:

loomberg's Information Systems;
inancial times - Actuaries World Index;
organ Stanley Capital International Index;
alomon Russell Global Equity Index; and
tandard and Poor's Composite Index (S&P 500).

The lists in Schedules 3 and 5 will have effect until regulations are made for the purpose of listing approved stock exchanges and international sectoral classification systems. [Section 470 and sub-subparagraph 499(2)(a)(ii)(B)]

A foreign company is not considered to be principally engaged in eligible activities if at the test time it is classified or designated by each approved stock exchange and international sectoral classification system which it is listed as engaged in a class of activities of an 'unclassified' or 'miscellaneous' kind. [Subsection 499(3)]

However, where a company is designated or classified by a stock exchange or an international sectoral classification system under a heading similar to 'conglomerate' or 'multi-industry', the company will not be considered to be listed as engaged in a class of activities of an 'unclassified' or 'miscellaneous' kind.

Balance sheet method

The balance sheet method is the second method for a taxpayer to establish whether a company is principally engaged in eligible activities. [Section 500]

It tests whether a company was principally engaged in eligible activities by reference to the foreign company's balance sheet and if appropriate, the balance sheets of its subsidiaries. [Subsection 500(1)]

A company is principally engaged in eligible activities if, at the test time, 50 per cent or more of the gross value of the company's assets were for use in eligible activities (50% assets test). [Subsection 500(2)]

This percentage is calculated as follows:

(the gross value of the company's assets used in eligible activities / the gross value of all of the company's assets) x (100/1)

The gross value of an asset of the company is the value shown in the balance sheet of the company prepared at the test time for reporting to the shareholders on an annual basis. The balance sheet test cannot be used if the balance sheet for the company was not prepared in accordance with commercially accepted accounting principles or if it does not give a true and fair view of the financial position of the company. [Subsection 500(9)]

In calculating the gross value of the company's assets for use in eligible activities, the gross value of assets which are not for use solely in eligible activities must be reduced proportionally to the extent that those assets were for use for other purposes [Subsection 500(11)]

The gross value of the company's assets for use in eligible activities includes assets of the company which are for use by:

he company's employees or directors in eligible activities; and
he assets for use by sub-contractors or other persons engaged in active business on behalf of the company under a contract or arrangement. [Subsection 500(13)]

Balance sheet method - 'look-through' rule extended to lower-tier companies

An offshore holding company may not satisfy the active business exemption in its own right under the balance sheet test since such companies frequently would not have any active business of their own. To prevent this result, the ABE allows the first-tier foreign holding company to look through to the underlying assets of certain subsidiaries. Only companies in which the first tier foreign holding company holds directly, indirectly or directly and indirectly 50 per cent or more of the paid up share capital are treated as subsidiaries for this purpose.[Subsections 500(3) and (6)]

Where a first-tier foreign holding company has a 50 per cent or greater interest in the paid-up share capital of a lower-tier company, the 'look-through' rule will allow the first-tier foreign holding company to 'look-through' to its share of the underlying assets of the second-tier company.[Subsection 500(3) and (6)]

The first-tier foreign holding company will treat its share of the underlying assets of the lower-tier company as its own in order to assist it to pass the 50 per cent assets test. [Subsection 500(2)]

There is no limit to the number of tiers that a first-tier foreign holding company may 'look-through', provided the first-tier foreign holding company has an effective interest of 50 per cent or greater in the lower-tier company.

A company's indirect interest in another company will be measured by rules provided in section 501. The 'look-through' rule will aggregate any direct interest determined under [subsection 501(3)] with any indirect interest calculated by section 501 and included in the aggregate interest by subsection 500(6).

The following diagram and table illustrate which subsidiaries a first-tier foreign holding company may 'look-through' to and use the underlying assets of the subsidiary to assist it to pass the 50 per cent assets test.

First Tier Foreign Holding Company

First-tier foreign holding company's interest in Direct Interest Indirect Interest Total Less than 50% Use in Bal Sheet Test
Sub 1 100 - 100 Yes Yes
Sub 2 40 - 40 No No
Sub 3 100 - 100 Yes Yes
Sub 4 100 - 100 Yes Yes
Sub 5 90 - 90 Yes Yes
Sub 6 - 100 100 Yes Yes
Sub 7 - 40 40 No No
Sub 8 - 80 80 Yes Yes
Sub 9 - 30+50.4 80.4 Yes Yes
Sub 10 - 72 72 Yes Yes
Sub 11 - 70 70 Yes Yes
Sub 12 - 42+16 58 Yes Yes
Sub 13 5 36 41 No No
Sub 14 43 7 50 Yes Yes

How to determine the gross value of a subsidiary's assets

Once it has been determined if a first-tier foreign holding company may 'look through' to a lower-tier company the following formulas in [subsection 500(3)] are used to determine the amount to be included in:

he gross value of the holding company's total assets; and
he gross value of the holding company's assets for use in eligible activities.

The gross value of the holding company's assets for use in eligible activities includes the amount which is calculated as follows:

Gross value of subsidiary's eligible assets x (Interest in share capital / Total share capital)

The gross value of all the holding company's assets includes an amount which is calculated as follows:

Gross value of all of subsidiary's assets x (Interest in share capital / Total share capital)

In the above formulas:

Gross value of subsidiary's eligible assets means the gross value at the test time of the subsidiary company's assets for use in one or more eligible activities (i.e., assets for use in active business);

Gross value of subsidiary's assets means the gross value at the test time of all the subsidiary company's assets;

Interest in share capital means the amount of the share capital of the subsidiary company that was directly or indirectly owned by the holding company;

Total share capital means the total amount of the issued share capital of the subsidiary company.

Total share capital example

Australian Investor
|
| 5%
|
First Tier foreign holding company (FHC)
| |
| 100% | 60%
| |
2nd Tier Sub No1 2nd Tier Sub No2

X% = the percentage of the paid up share capital held by the higher-tier company in the immediate succeeding lower-tier company.

The published accounts of the group show that the assets of the foreign holding company (FHC), and Subsidiaries Nos 1 and 2 but not including FHC's investments in Subsidiaries Nos 1 and 2 are:

  Gross Assets $ Active Business Assets $
FHC 2 million nil
Subsidiary No1 12 million 10 million
Subsidiary No2 20 million 15 million

The gross value of the first-tier foreign holding company's (FHC) assets for use in eligible activities includes an amount calculated as follows because of its interest in subsidiary companies Nos 1 and 2:

Subsidiary No 1

Gross value of subsidiaries eligible assets x (Interest in share capital / Total share capital)
= $10M x (100 / 100) = $10M

Subsidiary No 2

Gross value of subsidiary's eligible assets x (Interest in share capital / Total share capital)
= $15M x (60 / 100) = $9M

Foreign Holding Company

(Gross value of subsidiary's No. 1 & 2 eligible assets + Gross value of FHC eligible assets) x (100 / 1)
= (($10M + $9M) + $0M x 100) / ((($12M x 100) / 100) + ($20M x 60 / 100)) + $2M 1)
= ($19M / $26M) x (100/1) = 73%

Therefore, in this example, the first-tier foreign holding company passes the 50 per cent assets tests and a taxpayer who holds an interest in FHC is exempt from taxation under the FIF regime under the ABE through the balance sheet method.

Balance sheet test - intercompany indebtedness

Wherever the 'look- through' rule applies under Division 3 any intercompany indebtedness in relation to the assets that are taken into account are to be disregarded. [Subsection 500(5)]

In the case where a debt or amount is payable to a company by a lower-tier company the debt or amount is to be disregarded to the extent of the company's notional interest in the underlying assets of the lower-tier company.

In the reverse situation when an amount or debt is payable to a lower-tier company by a company that has an interest in the paid-up share capital of the lower-tier company, the extent to which the indebtedness is to be disregarded is 100 per cent.

Application of 'look-through' rule to Australian subsidiaries

The 'look-through' rule may be applied to an Australian subsidiary of a foreign company or a subsidiary in a different jurisdiction to the first-tier foreign holding company. [Subsection 500(7)]

Balance sheet test - partnership

Where a company is a partner in a partnership, the gross value of the company's assets includes the gross value of the company's interest in each of the assets of the partnership instead of the company's net interest in the partnership. [Subsection 500(8)]

The 'look-through' rule for a partnership is different from the 'look-through' rule for companies in subsections 500(3) and (6).

Where the 'look-through' rule is applied to a company the second and lower-tier company's assets are disregarded where the first-tier foreign holding company's interest in the lower-tier company is less than 50 per cent.

By contrast, where the 'look-through' rule is applied to a partnership it treats the partnership as a conduit entity. In all cases, where a foreign company has an interest in a partnership, the company is considered to own its share of the underlying assets of the partnership, regardless of the size of the company's interest in the partnership.

Therefore, where a foreign company has any interest in a partnership, the gross value of the partnership assets proportional to the interest the company has in the partnership is included in the gross value of all the first-tier foreign holding company's assets.

In addition, where the partnership has assets for use in eligible activities, the gross value of those assets proportional to the interest the company has in the partnership is included in the gross value of the first-tier foreign holding company's assets for use in eligible activities.

The gross value of a asset in which a company has an interest as a partner in a partnership is the value of the asset shown in the balance sheet of the partnership at the test time. The balance sheet must be prepared in accordance with commercially accepted accounting principles and give a true and fair view of the financial position of the partnership. [Subsection 500(10)]

The 'look-through' rule for partnerships benefit a taxpayer who has:

n interest in a foreign company which has an interest in a partnership; or
n interest in a first-tier foreign holding company which has a 50 per cent interest in another lower-tier company which in turn has an interest in a partnership that uses a majority assets in eligible activities.

Balance sheet method - asset valuation

The measurement of assets under the balance sheet method is undertaken in the currency in which the company's balance sheets are prepared. Where accounts of a subsidiary or partnership are prepared in a currency different from the company being tested, the value of assets of the subsidiary or partnership must be converted, at the rate of exchange prevailing at the test time, to the currency used by the first-tier foreign holding company at its balance date. [Subsection 500(12)]

The value of the assets of a subsidiary or partnership are to be determined by a balance sheet of the subsidiary or partnership prepared as at the balance day of the first tier foreign holding company.

Clauses making the amendments

Clause 27: Inserts Part XI containing the Foreign Investment Fund measures.

Clause 28: Inserts Schedules 3 to 6 which list the approved stock exchanges, ineligible business activities and country fund trusts, respectively, for the purpose of the FIF measures.

Exemption for Interest in a Foreign Bank

Overview

Banking is not an eligible activity for the purposes of the active business exemption (ABE). The opportunity to invest in a foreign bank without attracting FIF taxation will be provided on a restricted basis through a specific exemption for an interest consisting of shares in a publically listed bank and a holding company of a bank, whose shares are widely held.

Explanation

The banking exemption in Division 4 applies to an interest in a FIF that is a share in a foreign company that carries on banking or a foreign holding company of a foreign bank.

Foreign bank - approved stock exchange

The shares an Australian resident investor holds in a foreign bank must be of a class of shares listed on a stock exchange approved in Schedule 3. There are 113 stock exchanges listed throughout 48 countries. Unlisted shares issued by some banks as a substitute for deposits with the bank would not satisfy this criteria.

Foreign bank - taxpayer's interest in foreign bank

Where a taxpayer holds shares in a bank which are listed on an approved stock exchange as well as shares that are either:

ot quoted on the stock market of any stock exchange, or
re quoted on a stock market of a non-approved stock exchange,

then, only that part of the interest in the bank comprising the taxpayer's shares that are quoted on the stock market of an approved stock exchange will be exempt from the FIF measures, provided the other requirements of paragraph 503(a) are satisfied.

Foreign bank - trading requirement

An additional requirement is that shares of the foreign company must be 'widely held and actively traded on a regular basis' on a stock market of an approved stock exchange during the period in which the exemption applies to the relevant taxpayer. [Subparagraph 503(b)(i)]

The term 'widely held' does not have the same meaning as the term 'widely distributed' used in section 327A of the Principal Act. It has a much higher threshold than the term 'widely distributed' which only requires that 20 per cent of the share holders must not hold more than 75 per cent of the share capital.

The requirement that the shares in the foreign company are 'widely held' by the public at large will ensure that the exemption does not apply to shares in closely held or privately owned companies.

The term 'widely held' must also be read in connection with the requirement that the shares be actively traded on a regular basis.

The phrase 'actively traded on a regular basis' is viewed in the context of the trading pattern and volume of the particular stock market. In times of recession the degree of trade required to satisfy this criteria will be considerably less than in a bullish market.

To satisfy this requirement it will be necessary that for the majority of the time in which the exemption operates in respect of a particular taxpayer there was an active market in the shares of the foreign bank on any stock market of an approved stock exchange on which the shares in the foreign bank were listed.

The foreign company must be authorised under the law of its place of residence to carry on banking business [subparagraph 503(b)(ii)] . This requirement will ensure that the company meets any regulatory requirements for banking business imposed by its country of residence.

Foreign bank - principally engaged in the active carrying on of banking business

The additional requirement imposed by subparagraph 503(b)(iii) that the foreign company is, during the period in which the exemption applies to the taxpayer, 'principally engaged in the active carrying on of banking business' requires that:

he foreign company's main activity is banking business; and
he foreign company is not only nominally conducting banking business.

Exemption for interest in a foreign holding company of a foreign bank

It is not uncommon for the banking business to be structured so that shares in the licenced bank are held by a holding company. Members of the public invest in the bank by the acquisition of publicly listed shares in the holding company. To allow for these investments, the exemption for certain shares in a publicly listed foreign bank will be extended to an interest that an Australian resident holds in a foreign holding company with a wholly-owned subsidiary which is a foreign bank. [Section 504]

Foreign holding company - approved stock exchange or sectoral classification system

The exemption will apply to shares held by a taxpayer in a foreign holding company which is classified as either a 'bank' or under 'banks' or as engaged in 'banking' on either:

stock exchange approved in Schedule 3, or
n international sectoral classification system in Schedule 5.

The shares the taxpayer holds in the foreign holding company must be of a class quoted on any stock market of an approved stock exchange.

Foreign holding company - trading requirement

During the period in which the exemption applies to a taxpayer, shares in the foreign holding company that are quoted on the stock market on an approved stock exchange must be 'widely held and actively traded on a regular basis'. [subparagraph 504(b)(i)] This phrase has the same meaning as the phrase used in subparagraph 503(b)(i) discussed under the subheading 'Foreign Bank - trading requirement'.

The subsidiary or subsidiaries of the holding company must be wholly-owned. [Subparagraph 504(b)(ii)]

Foreign holding company - wholly-owned subsidiaries

A definition of "wholly-owned" subsidiary is contained in section 479. The following diagrams illustrate wholly-owned subsidiaries of a foreign holding company. [Section 479]

X% = percentage of share capital held by company in immediate succeeding lower-tier company.

Foreign Holding Company (FHC)
|
| 100%
|
Sub No.1
Sub No.1 is a wholly-owned subsidiary of FHC

Foreign holding company - wholly owned subsidiaries - example 1

Foreign holding company - wholly owned subsidiaries - example 2

Foreign holding company - wholly owned subsidiaries - example 3

Foreign holding company - wholly owned subsidiaries - example 4

Foreign holding company - one wholly owned subsidiary

Where the foreign holding company owns only one wholly-owned subsidiary, the subsidiary must be:

uthorised under the law of its country of residence to carry on banking business; and
rincipally engaged in the "active carrying on" of banking business. [Subparagraph 504(b)(iii)]

One wholly owned subsidiary - principally engaged

The phrase 'principally engaged in the active carrying on of banking business' [sub-subparagraph 504 (b)(iii)(B)] has the same meaning as in subparagraph 503(b)(iii). See the discussion under the heading 'Foreign Bank - principally engaged in the active carrying on of banking business'.

Foreign holding company - two or more wholly owned subsidiaries

Where the foreign holding company owns two or more wholly owned subsidiaries the principal activities of the companies in the group taken together as an economic unit must be the active carrying on of banking business. [Subparagraph 504(b)(iv)]

This requires that:

he activities of the group, when viewed as a single unit, are mainly banking business;
large majority of the activities conducted by the group are banking business; and
he group is not just nominally conducting banking business.

The requirement that the group be principally engaged in banking business will allow for some wholly-owned subsidiaries in the group to engage in the conduct of banking related business such as financial services, funds management, or insurance activities that are incidental to and related actively to banking.

Test time

To determine if the banking exemption applies to the share that the investor holds in the foreign bank or holding company of a bank, the taxpayer will test for the requirement discussed above at the end of the notional accounting period of the foreign company that ends during the taxpayer's year of income.

The definition of a notional accounting period of a foreign company that is a FIF is set out in section 486. Generally, it is the year of income of the taxpayer unless the taxpayer elects for the accounting period of the company.

However, the following requirements must be satisfied throughout the period in which the taxpayer holds shares in a foreign bank or foreign holding company:

here there is a direct shareholding in a bank, the foreign company must be principally engaged in the active carrying on of the banking business; and
here there is a holding company of a foreign bank, the principal activities of the foreign holding company and all of its wholly-owned subsidiaries must be banking business; and
he shares in the foreign bank and foreign holding company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange.

Exemption for Certain Life Insurance Business

Overview

Life insurance is not an eligible activity for the purposes of the active business exemption (ABE). The opportunity to invest in a foreign life assurance company without attracting FIF taxation will be provided on a restricted basis through a specific exemption.

Explanation

The life insurance exemption in Division 5 applies to a taxpayer's interest a foreign company that is engaged in life insurance business.

A foreign company will only be considered to be engaged in life assurance business at the test time if the company is authorised in its country of residence to carry on life business and the balance sheet of the company shows that at least 50 per cent of the gross value of the company's assets were for use in carrying on life assurance business as defined in section 4 of the Life Insurance Act 1945.

Definition of 'life insurance business'

Section 470 defines 'life insurance business' by reference to section 4 of the Life Insurance Act 1945.

Life insurance business means:

ife business, including

ife insurance business under ordinary policies,
ife insurance business under industrial policies,
uperannuation business;

ontinuous disability insurance;
inking fund business;

Life insurance business does not include:

usiness in relation to the benefits provided by a friendly society or trade union for its members or their dependants;
usiness in relation to the benefits provided for members or their dependants by an association of employees;
usiness in relation to any scheme or arrangement whereby superannuation benefits, pensions or payments to employees or their dependants upon retirement, disability or death, are provided by an employer or his employees, or by both, wholly through an organisation established by the employer or his employees or by both;
n the case of a person who issues policies to his employees, and not to any other persons, the business of, or in relation to , the issuing of, or the undertaking of liability under, those policies; or
usiness in relation to a scheme or arrangement for the provision of benefits consisting of -

i)
he supply of funeral, burial or cremation services, with or without the supply of goods connected with such services; or
ii)
he payment of money, upon the death of a person, for the purpose of meeting the whole or part of the expenses of, and incidental to, the funeral, burial or cremation of that person,

and no other benefits, except benefits incidental to the scheme or arrangement.

Sinking fund business means business in relation to the issuing of, or the undertaking of liability under sinking fund policies which ensure payment of a sum, or series of sums, of money on a future date or dates in consideration of one or more premiums.

Superannuation business means life insurance business, being business of, or in relation to , issuing of, or the undertaking of liability under, superannuation policies.

Fifty per cent assets test for FIF

One of the requirements for exemption is that the gross value of the foreign company's assets for use in carrying on life insurance business was 50 per cent or more of the gross value of all the companies assets (50 per cent assets test). [Paragraph 507(2)(b)]

Authorised to carry on life insurance business

In addition, the foreign company must be authorised under the law of its country of residence to carry on life insurance business. [Paragraph 507(2)(a)]

Principally engaged in life insurance business

If the 50 per cent assets test, and the authorisation requirement is satisfied, the foreign company is taken to be principally engaged in carrying on life insurance business. As a consequence, any interest that a taxpayer holds in a foreign company principally engaged in carrying on life insurance business is exempt from the FIF measures [section 506] regardless of whether or not that interest consists of a share in a publicly listed company.

'Look-through' rule

The life company may have an interest in a subsidiary company. It is therefore necessary to provide a 'look-through' rule to the subsidiary's assets to determine whether the foreign life insurance company passes the 50 per cent assets test. The rule is applied in a similar manner to the 'look-through' rule which is applied under the balance sheet test in the ABE.

Subsections 507(3) and (6) will allow the 'look-through' rule to be applied where the foreign life insurance company has a direct, indirect or direct and indirect interest of 50 per cent or more in the paid-up share capital of a lower-tier company. The shares that the foreign life insurance company (first-tier company) holds in the lower-tier company are ignored under the test and the first-tier foreign company is considered to own its proportionate share of the underlying assets of the lower-tier company.

The interest which the foreign life insurance company holds in the lower-tier company is calculated by multiplying the direct interest each company interposed between the first-tier company and the bottom-tier company holds in the succeeding company. [Subsections 507(3) and (6)]

[Subsection 507(7)] will allow the 'look-through' rule to be applied to a lower-tier company incorporated in any country including Australia. This corresponds with the provisions in the balance sheet test in the ABE.

Assets for use in carrying on life insurance business

The assets that may be taken into account for the 50 per cent assets test [(paragraph 507(2)(b))] and the look-through rule (subsection 507(3) and (6)) are:

he assets of the company directly engaged in life insurance activities such as office furniture, computers etc;
hose assets used to support the life insurance activities, such as real property owned by the company in which the life insurance business is conducted; and
ssets that represent the life insurance statutory funds.

Valuation of assets

The gross value of an asset for the purposes of the 50 per cent asset test in paragraph 507(2)(b) or the 'look-through' rule in subsections 507(3) and (6) is determined by reference to the value of that asset shown in the balance-sheet of the company which owns the asset. Under [subsection 507(8)] the balance sheet must be prepared in accordance with commercially accepted accounting principles and give a true and fair view of the company's financial position. This valuation requirement is in accordance with the provisions in the ABE.

Currency for valuation of assets

For the purposes of the 'look-through rule' in subsections 507(3) and (6) the valuation of an asset is to be undertaken in the currency in which the foreign life insurance company's (referred to in subsection 507(1)) balance-sheet is prepared. Where the accounts of a lower-tier company are prepared in a different currency from that of the foreign life insurance company (first-tier company) the value of the lower-tier company's assets must be converted to the currency used by the life insurance company as at its balance date at the rate of exchange prevailing at that time. [Subsection 507(10)]

Funds Management

For the purpose of this exemption only, the interest that a foreign company holds in a foreign funds management company will be considered to be an asset used in the life insurance business.

Therefore, for the purpose of Division 5 only, where a foreign company owns shares in a FIF which is a funds management company that:

s not a resident of Australia; and
anages funds of the foreign life insurance company which are similar to statutory funds defined in Division 3 of Part III of the Life Insurance Act 1945,

then the gross value of those shares are to be included in the numerator and the denominator of the 50 per cent assets test in paragraph 507(2)(b). [Subsection 507(11)]

Management of funds

A company is considered to 'manage funds', or be a funds management company, where it accepts pools of capital from investors and conducts discretionary investment activities on their behalf.

Statutory funds

A 'statutory fund' of a life insurance business is a basket of monies, liabilities and assets which are demarcated from the company's other monies, liabilities and assets. A particular 'statutory fund' is the sum of all amounts received by the company in respect of a particular class or classes of life insurance contracts entered into by the company.

The amount of assets within a particular 'statutory fund' is designated to meet the liabilities and expenses in relation to the particular class or classes of life insurance policies for which the statutory fund was established. In addition, each statutory fund includes any assets that provide security for the writing of the life insurance contracts under which the company has undertaken liability.

Assets used jointly for life insurance activities and other activities

Where a company's asset is used in the carrying on of a life insurance business and also for some other purpose the value of the asset to be included in the 50 per cent assets test in paragraph 507(2)(b) and the 'look through' test is proportional to the use of the asset in the carrying on of a life insurance business. This aligns with the balance sheet test in the ABE.

Test Time

An Australian resident must look at the end of the notional accounting period of the foreign company that ends during his or her year of income to determine if the exemption applies to the taxpayer's interest in the foreign company.

The definition of a notional accounting period is set out in section 486. Generally, it is the year of income of the taxpayer unless the taxpayer elects for the company's accounting period.

Treatment of a foreign life insurance company that is a controlled foreign company under Part X

Under Division 2, where a taxpayer has an interest in a FIF which is also a controlled foreign company ( CFC) and the taxpayer is an attributable taxpayer of the CFC as defined under Part X of the Principal Act, the CFC measures will apply to the exclusion of the FIF measures. However, the FIF measures may apply to a non- CFC FIF held by the CFC.

[Subsection 402(2A)] will be inserted into Part X of the Principal Act. It provides, subject to the conditions below, that income of the CFC from a FIF that is a funds management company will be exempt from the FIF measures. The conditions are:

hat the CFC was authorised under the law of its country of residence to carry on life insurance business; and
he CFC has 50 per cent or more of the gross value of its assets for use in carrying on a life insurance business; and

he FIF was principally engaged in the management of funds of other persons; and
he FIF managed funds of the CFC similar to statutory funds in Division 3 of Part III of the Life Insurance Act 1945.

Life Insurance business

The phrase life insurance business is defined by section 470 by reference to section 4 of the Life Insurance Act 1945.

Valuation of assets under the 50 per cent assets test for CFC

For the purposes of applying the 50 per cent asset test in subsection 402(2A) to the CFC, the assets to be taken into account are those disclosed on the balance sheet prepared for the relevant statutory accounting period of the CFC.

The valuation of the assets taken into account for the purposes of the 50 per cent asset test are to be as shown in the balance sheet for the relevant statutory accounting period of the CFC.

Management of funds

The phrase 'management of funds' reflects the same meaning as the phrase 'manage funds' in subsection 507(11) and as discussed under the same subheading above.

Principally engaged

A FIF will be 'principally engaged' in the management of funds where a large majority of its activities are funds management.

Statutory funds

The term 'statutory funds' has the same meaning as in subsection 507(11) and as discussed above under the same subheading.

Assets used jointly in funds management activities and other activities.

Where a company's asset is used in the carrying on of a life insurance business and also for some other purpose, the value of the asset to be included in the numerator of the 50 per cent assets test in paragraph 507(2)(b) and in the 'look through' rule under subsections 507(3) and (6) is proportional to the use of the asset in the carrying on of a life insurance business.

Clauses making the amendments

Clause 25: Inserts subsections 402(2A) to (2C) which exempts from the FIF measures an interest of a CFC in a funds management company.

Clause 27: Inserts Part XI which contains the exemption for certain life assurance business.

Exemption for Interest in a Foreign General Insurance Company

Overview

General insurance is not an eligible activity for the purpose of the active business exemption (ABE).

However, an interest in shares in a publicly listed general insurance company may be exempted from FIF taxation through a specific exemption provided in Division 6.

Explanation

Division 6 will exempt an Australian resident from FIF taxation on shares in a foreign company which conducts general insurance business.

General insurance business

The phrase' general insurance business' has a wide meaning. It is defined by section 470 to mean any insurance business other than life insurance business as defined by section 4 of the Life Insurance Act 1945.

Therefore, general insurance business does not include:

ife business,

ife insurance business under ordinary and industrial policies,
uperannuation business;

ontinuous disability insurance business; and
inking fund business.

Please see Chapter 6 for a general discussion of 'superannuation business' and 'sinking fund business'.

Approved stock exchange

The shares in a foreign company in which a taxpayer holds an interest must be of a class listed on any stock market of a stock exchange approved in Schedule 3. There are 113 approved stock exchanges spread throughout 48 countries.

Taxpayer's share - quoted on an approved stock exchange

Where a taxpayer holds shares in a foreign company that is quoted on the stock market of an approved stock exchange and other shares in the same company which are either:

ot quoted on the stock market of any stock exchange, or
uoted on a stock market of a non-approved stock exchange,

then, only that part of the interest in the foreign company comprising the taxpayer's shares that are quoted on the stock market of an approved stock exchange will be exempt from the FIF measures, provided the other requirements are satisfied. [Section 509]

Trading requirement

The shares of the foreign company must be 'widely held and actively traded on a regular basis' on a stock market of an approved stock exchange during the period in which the exemption applies to the relevant taxpayer. [Paragraph 509(b)(i)]

The term 'widely held' does not have the same meaning as the term 'widely distributed' used in section 327A of the Principal Act. It denotes a much wider spread of shareholding than the term 'widely distributed' which only requires that 20 per cent of the share holders must not hold more than 75 per cent of the share capital.

The requirement that the shares in the foreign company are 'widely held' by the public at large will ensure that the exemption does not apply to closely held or privately owned companies.

The term 'widely held' must also be read in connection with the requirement that the shares be 'actively traded on a regular basis'.

The phrase 'actively traded on a regular basis' is viewed in the context of the trading pattern and volume of the particular stock market. In times of recession the degree of trade required to satisfy this criteria will be considerably less than in a bullish market.

To satisfy this requirement it will be necessary that for the majority of the time in which the exemption operates in respect of a particular taxpayer there was an active market in the shares of the foreign company on any stock market of an approved stock exchange on which the shares in the foreign company was listed.

Authorised under the law of its country of residence to carry on general insurance business

The general insurance company must be 'authorised under the law of its place of residence to carry on' general insurance business. This requirement will ensure that the company meets regulatory requirements for general insurance businesses in its country of residence. [Subparagraph 509(b)(ii)]

Principally engaged in the active carrying on of general insurance business

The additional requirement imposed by subparagraph 509(b)(ii) that the general insurance company is principally engaged in the active carrying on of general insurance business during the period in which the exemption applies to the relevant taxpayer requires that:

he foreign company's main activity is general insurance business; and
he foreign company is not only nominally conducting general insurance business.

Test time

An Australian resident investor must look at the end of the notional accounting period of the foreign company that ends during the taxpayer's year of income to determine if the shares in the general insurance company are listed on an approved stock exchange.

The definition of a notional accounting period is set out in section 486. Generally, it is the year of income of the taxpayer unless the taxpayer elects for the accounting period of the company.

However, the following requirements must be satisfied throughout the period in which the taxpayer holds shares in the foreign company:

he foreign company must be principally engaged in the active carrying on of the general insurance business; and
he shares in the foreign company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange.

Exemption for Interest in a Foreign Real Property Company

Overview

Investment in real property companies is not an eligible activity for the purpose of the active business exemption (ABE). A specific exemption is provided for an interest consisting of shares in a publicly listed company whose activities are connected with commercial real property and whose shares are widely held.

Explanation

The exemption in Division 7 will apply to an interest in a FIF consisting of shares in a foreign company that carries certain activities in relation to commercial real property.

Approved stock exchange

The shares held by the taxpayer must be of a class of shares listed on any stock market of a stock exchange approved in Schedule 3. There are 113 approved stock exchanges spread throughout 48 countries. [Section 511]

Taxpayer's shares - quoted on an approved stock exchange

The Australian resident's investment must be in shares in the foreign company of a class that is quoted on the stock market of any approved exchange upon which the foreign company is listed. [Section 511]

Where a taxpayer holds shares in a foreign company that are quoted on the stock market of an approved stock exchange and shares in the same company which are either:

ot quoted on the stock market of any stock exchange, or
uoted on a stock market of a non-approved stock exchange,

then, only that part of the interest in the foreign company comprising the taxpayer's shares that are quoted on the stock market of an approved stock exchange will be exempt from taxation under the FIF measures, provided the other requirements are satisfied. [Paragraph 511(a)]

Trading requirement

The shares of the foreign company must be 'widely held and actively traded on a regular basis' on a stock market of an approved stock exchange during the period in which the exemption applies to the relevant taxpayer. [Subparagraph 511(b)(i)]

The term 'widely held' does not have the same meaning as the term 'widely distributed' used in section 327A of the Principal Act. The term 'widely held' denotes a more widespread holding of shares than 'widely distributed' which only requires that 20 per cent of the share holders must not hold more than 75 per cent of the share capital.

The requirement that the shares in the foreign company are 'widely held' by the public at large will ensure that the exemption does not apply to foreign companies which do not have a substantial public shareholding.

The term 'widely held' must also be read in connection with the requirement that the shares be 'actively traded on a regular basis'. The phrase 'actively traded on a regular basis' must be viewed in the context of the trading pattern and volume of the particular stock market. In times of recession the degree of trade required to satisfy this criteria will be considerably less than in a bullish market.

To satisfy this requirement it will be necessary that for the majority of the time in which the exemption operates in respect of a particular taxpayer there was an active market in the shares of the foreign real property company on any stock market of an approved stock exchange on which the foreign real property company was listed.

Foreign company principally engaged in the active carrying on of real property activities

During the period in which the exemption applies to the relevant taxpayer the foreign company must be 'principally engaged in the active carrying on' of one or more of certain activities connected with real property. [Subparagraph 511(b)(ii)]

The phrase 'principally engaged in the active carrying on' requires that:

he foreign company's main activity is one or several of the specified activities in subparagraph 511(b)(ii);
large majority of the business conducted by the foreign company is one or several of the specified activities in subparagraph 511(b)(ii); and
he foreign company's business associated or connected with real property is not dormant.

Activities connected with real property

The specified activities connected or associated with real property are:

onstruction;
evelopment of real property through capital improvement;
eceipt of rental income from commercial real property owned by the foreign company where the management, maintenance, and security services for the commercial property are principally provided by directors or employees of the foreign company or by a wholly owned subsidiary that is principally engaged in providing those services through its directors and employees;
rovision of management services through directors or employees of the foreign company in relation to real property that it does not own;
cting as agent for the sale or purchase of commercial real property. [Subparagraph 511(b)(ii)]

Test time

An Australian resident investor must look at the end of the notional accounting period of the foreign company that ends during his or her year of income to determine if the exemption applies to the investor's shares in the foreign company.

The definition of a notional accounting period is set out in section 486. Generally, it is the year of income of the taxpayer unless the taxpayer elects for the accounting period of the company.

However, the following requirements must be satisfied throughout the period in which the taxpayer holds shares in the foreign company:

he foreign company must be principally engaged in the active carrying on of the specified activities connected with real property; and
he shares in the foreign company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange.

Exemption for Interest in Certain Foreign Trusts

Overview

Investment through trusts to countries which prohibit direct investment on stock exchanges in those countries will be excluded from the FIF measures. This will ensure that Australian investors are not disadvantaged by investing in emerging markets through country fund trusts listed in free-market countries.

Explanation

A taxpayer is exempt from the FIF measures in respect of an interest in certain specified foreign trusts established in India, the Republic of Korea or Taiwan. These countries prohibit direct foreign investment on their stock exchanges. The list of approved trusts is in Schedule 6. [Section 513]

Exemption for Interest of Less than $50,000

Overview

This chapter explains the exemption from taxation under the FIF measures for natural persons (other than trustees) with small levels of offshore investments. Where the total of the taxpayer's interest together with the interests of associates, in foreign companies, trusts and life policies is not more than $A50,000, the FIF taxation provisions will not apply to the taxpayer's investments. [Section 515]

In addition, if the interests of the natural person (other than a trustee) and associates in foreign companies, trusts and life policies and interests in resident public unit trusts do not exceed $A50,000 the impact of the FIF taxation provisions will not apply in calculating the taxpayer's share of net income of the resident public unit trust. [Subsection 96A(2)]

Explanation

Introduction

The small investor exemption is only available to a taxpayer who is a natural person. The taxpayer may apply one or both of the tests given below at the end of the year of income to determine what interests (if any) are excluded from FIF taxation.

If, the interests exceed $A50,000 under both tests then the exemption is not available.

For the purpose of applying the tests, the value of the taxpayer's interests in a foreign company or trust that is a Foreign Investment Fund ( FIF), a foreign life assurance policy ( FLP) or a resident public unit trust is the higher of the cost incurred by the person in acquiring the interest or the market value of the interest at the end of the year of income. [Subsections 515(2) and 96A(3)]

First test

The first test measures only the direct interests of the taxpayer and associates in FIFs and FLPs. Where these are not greater than $A50,000 the FIF taxation provisions do not apply in the year of income to the taxpayer's interests in the FIFs and FLPs. [Subsection 515(1)]

Meaning of 'associate'

For the purposes of the small investor exemption an associate of a taxpayer, who is a natural person, includes the following:

spouse of the taxpayer, but not including a spouse who, although legally married to the taxpayer, has been living separately and apart from the taxpayer for at least 12 months;
child of the taxpayer whether or not the child lives with the taxpayer;
step-child who lives with the taxpayer;
partner of the taxpayer, including a spouse and child of the partner, of a partnership in which the taxpayer is a partner;
trustee of a trust, other than a public unit trust or an eligible Part IX entity, if the taxpayer or an associate benefits under the trust; and
company in which the taxpayer and associates have a majority voting interest or which is sufficiently influenced by the taxpayer and associates.

If the taxpayer is under 18 years of age the associates of the person include, in addition to the above:

parent of the taxpayer; and
brother or sister of the taxpayer. [Section 491]

Second test

The second test may operate to exclude the effect of the FIF taxation provisions in relation to the taxpayer's interest in a resident public unit trust that effectively represents an indirect offshore investment by the taxpayer. [Subsection 96A(2)]

Interest in a 'resident public unit trust'

An interest in a resident public unit trust means a unit in the trust or an entitlement to acquire such a unit. [Subsection 96A(5)]

Example A natural person (A) has an interest in a resident public unit trust (B) which has an interest in a foreign trust FIF. A has a right to a share of the trust's income for the year.The FIF measures will apply to B in the calculation of the net income of the trust for the year of income. A would be subject to tax on a share of the net income of B (section 97).Where the second test is satisfied then subsection 96A(2) will modify the calculation of A's share of the net income of B to exclude the effect of the FIF taxation measures in relation to A.

The second test measures the interests of the taxpayer and associates in FIFs, FLPs and resident public unit trusts. Where these are not greater than $A50,000 the modification to the trust provisions illustrated by the above example will apply to the calculation of the taxpayer's share of the net income of the resident public unit trust. [Subsection 96A(2)]

A unit trust is a resident public unit trust where it is:

public unit trust as defined in section 102AAF for the whole year of income; and
either
he central management and control of the unit trust was in Australia; or
resident or residents held more than 50 per cent of the beneficial interests in the income of the unit trust or the beneficial interests in the property of the unit trust.[Subsection 96A(4)]

Clauses making the amendment

Clause 11: Inserts section 96A. Subsection 96A(2) will provide that the impact of the FIF measures will not apply in the calculation of a taxpayer's share of net income of a resident public unit trust where the taxpayer is a natural person with not more than $50,000 in foreign companies, trusts, life policies and resident public unit trusts.

Clause 27: Inserts Part XI which contains the exemption for interest of less than $50,000.

Exemption for Certain Visitors to Australia

Overview

This chapter describes the exemption from the Foreign Investment Fund ( FIF) measures which is available to certain visitors to Australia.

Introduction

The FIF measures aim to reduce the scope for deferral of Australian tax where Australian residents hold interests in foreign entities that fall outside the scope of the foreign source income (FSI) measures.

However, in the absence of a specific exemption, the FIF measures would apply to the offshore investments of short term residents of Australia. It is unlikely that those investments would provide significant opportunity to defer Australian tax. There is also concern that skilled foreign nationals may be discouraged from working in Australia if the FIF measures applied to their offshore investments.

Consequently, there will be an exemption from the FIF measures for natural persons who are visitors to Australia.

Meaning of 'visitor'

The FIF measures will not apply to a natural person who is a resident of Australia for a year of income if all of the following conditions are satisfied:

he person has a temporary entry permit granted under the Migration Act 1958;
he period of time from the issue date of the current permit until its expiry date is four years or less or where the current permit was issued as an extension of an earlier permit the period of time from the issue date of the earliest permit until the expiry date of the current permit is four years or less; and
he person is not awaiting the outcome of an application for a permanent entry permit under the Migration Act 1958.

For the purposes of the above tests, a new entry permit issued under the Migration Act 1958 as an extension of the original entry permit is considered to be an extension of the original permit. [Section 517]

Exemption for Foreign Employer-Sponsored Superannuation

Overview

This chapter explains the exemption that is available from the Foreign Investment Fund ( FIF) measures where a resident natural person has an interest in a foreign employer-sponsored superannuation fund.

Explanation

The foreign employer-sponsored superannuation exemption is available to a taxpayer that is a natural person who, at the end of the notional accounting period of the FIF, had an interest in a FIF that is an employer-sponsored superannuation fund. The FIF must be a superannuation fund maintained by an employer, or the employer's associate, for the benefit of the employees of that employer. The taxpayer should be an employee or former employee of the employer. [Subsection 519(1)]

The term 'employee' includes a director of a company. [Subsection 519(2)]

Meaning of 'associate of employer'

The definition of 'associate' in section 318 applies except where it is modified for the purposes of the FIF measures. [Section 491]

Broadly, for the purposes of the foreign employer sponsored superannuation exemption, the following are considered associates of an employer who is a natural person:

relative;
partnership in which the employer is a partner;
trustee of a trust if the employer benefits under the trust; and
company, if:

he company is sufficiently influenced by the employer; or
majority voting interest in the company is held by the employer.

If the employer is a company, other than in the capacity of a trustee, its associates include:

ntities that would be treated as associates of the company under any of the dot points relating to natural persons; and
ny 'controlling entity'.

A company has a 'controlling entity' if:

he company is sufficiently influenced by that entity, either alone or together with other entities; or
majority voting interest in the company is held by that entity.

The associates of a trustee are any entities that benefit under the trust. The term trust in this context does not include a public unit trust or an eligible Part IX superannuation fund.

The associates of a partnership are the partners in the partnership. [Subsection 491]

Exemption for interest in a FIF that is a Trading Stock

Overview

In some cases, a taxpayer's interest in a FIF may form part of the trading stock of the taxpayer. Under the existing trading stock provisions, a taxpayer can elect to value each item of trading stock at the lowest of cost, replacement value or net realisable value.

Where the taxpayer values trading stock consistently using market value the tax effect is similar to the application of the market value method of taxation provided under the FIF measures. The trading stock provisions however, have less compliance cost for taxpayers because there is no need for attribution accounts of the kind required for the FIF measures.

An exemption from FIF taxation will be provided to a taxpayer who elects to bring all FIF interests that are trading stock to account at market value.

For taxpayers who bring interests in FIFs to account as trading stock but do not avail themselves of the election, a change to the valuation methods available in the trading stock provisions will apply. The change will prevent movement between the methods of valuation and will require closing stock for the 1991-92 and subsequent years of income to be valued consistently at cost.

Explanation of exemption

The exemption in Division 12 will apply where the taxpayer elects under subsection 31(5) to use market value to value all interests in FIFs as trading stock in respect of a year of income. [Section 521]

However, the exemption is only available if the taxpayer elects under subsection 31(5) to account for all interests in FIFs that are trading stock at market value.

The election is to be made before the taxpayer furnishes an income tax return in respect of FIF income for the first relevant period. Once the election is made the market value is to apply, to value all FIF interests that are trading stock for the income year to which the election first applies and all subsequent years. [Subsection 31(6)]

Value of closing stock

Changes will also be made to the trading stock provisions in section 31. These will apply to a taxpayer's FIF interests if the taxpayer does not exercise the election described above.

For the purposes of the trading stock provisions, an interest in a FIF will generally be brought into closing value at cost for the 1991-92 and subsequent income years. [Subsection 31(4)]

Transitional provision

As a transitional measure, if a taxpayer used market value or replacement value for the opening value of a FIF interest at the start of the 1991-92 income year the taxpayer must use the same value for the closing value of that interest of the 1991-92 income year and all subsequent years of income. [Subsection 31(7)]

Clauses making the amendments

Clause 7: Inserts proposed subsections 31(4) to (8) to modify the trading stock provisions of the Principal Act.

Clause 27: Inserts Division 12 which will exempt a taxpayer from taxation under the FIF measures where the taxpayer elects to use market value to value all interests in FIFs that are trading stock in respect of a year of income.

Exemption for Interest in a Multi-Industry Foreign Company

Overview

An exemption is provided for an interest a taxpayer holds in a foreign company which is principally engaged in multiple activities of a kind that would individually be exempt through either one of Divisions 3,4,5,6,or 7. The opportunity to invest in a multi-industry foreign company without attracting FIF taxation will be provided on a restricted basis through a specific exemption.

Explanation

A taxpayer's interest in a multi-industry foreign company will be exempted under Division 13 provided the foreign company is principally engaged in the aggregate of two or more of the activities approved in:

he active business exemption; or
ne of the specified industry exemptions.

Approved stock exchange

The first condition is that the foreign company in which a taxpayer holds an interest, must be listed on a stock market of any approved stock exchange in Schedule 3. There are 113 approved stock exchanges spread throughout 48 countries. [Paragraph 523(a)]

Taxpayer's shares - quoted on an approved stock exchange

The Australian resident's shares in the foreign company must be of a class that is quoted on a stock market of any approved stock exchange upon which the foreign company is listed.

Where a taxpayer holds shares in a foreign company that are quoted on the stock market of an approved stock exchange and other shares in the same company which are either:

ot quoted on the stock market of any stock exchange, or
uoted on a stock market of a non-approved stock exchange,

only that part of the interest in the foreign company comprising the shares that are quoted on the stock market of an approved stock exchange will be exempt from the FIF measures, provided the other requirements of Division 13 are satisfied. [Paragraph 523(a)]

Trading requirement

In addition, the shares of the foreign company must be 'widely held and actively traded on a regular basis' on a stock market of an approved stock exchange during the period in which the exemption applies to the relevant taxpayer. [Subparagraph 523(b)(i)]

The term 'widely held' does not have the same meaning as the term 'widely distributed' used in section 327A of the Principal Act. It denotes a much wider spread of shareholding than 'widely distributed' which only requires that 20 per cent of the share holders must not hold more than 75 per cent of the share capital.

The requirement that the shares in the foreign company are 'widely held' by the public at large will ensure that the exemption does not apply to foreign companies which are closely held or privately owned companies.

'Widely held' must also be read in connection with the phrase 'actively traded on a regular basis'.

The phrase 'actively traded on a regular basis' is viewed in the context of the trading pattern and volume of the particular stock market. In times of recession the degree of trade required to satisfy this criteria will be considerably less than in a bullish a market.

To satisfy this requirement it will be necessary that for the majority of the time in which the exemption operates in respect of a particular taxpayer there was an active market in the shares of the foreign shares in the foreign multi-industry company on any stock market of an approved stock exchange on which shares in the foreign company were listed.

Foreign company principally engaged in the active carrying on of multi-industry activities

During the period in which the exemption applies to the relevant taxpayer the foreign company must be 'principally engaged in the active carrying on' of two or more activities of a kind that may qualify a taxpayer for exemption from the FIF measures under Divisions 3, 4, 5, 6 or 7. [Subparagraph 523(b)(ii)]

The phrase 'principally engaged in the active carrying on' requires that, during the period in which the exemption applies to the relevant taxpayer:

he foreign company is mainly engaged in two or more of the relevant activities;
he foreign company actually carries on each relevant activity which contributes to the foreign company being principally engaged in the relevant multi-industry activities; and
he foreign company's business in each relevant activity is not dormant.

Multi-industry activities

The relevant multi- industry activities are:

onstruction;
evelopment of real property through capital improvement;
eceipt of rental income from commercial real property owned by the foreign company where the management, maintenance, and security services for the commercial property are principally provided by directors or employees of the foreign company or by a wholly owned subsidiary that is principally engaged in providing those services through its directors or employees;
rovision of management services through directors or employees of the foreign company in relation to real property that it does not own;
cting as agent for the sale or purchase of commercial real property;
eneral insurance business of a kind that the company was authorised under the law of its place of residence to carry on;
ife insurance business of a kind that the company was authorised under the law of its place of residence to carry on;
ligible activities within the meaning of Division 3. [Sub-subparagraphs 523(b)(ii)(A) to (H)]

The phrase 'principally provided' in this context has a similar meaning to the phrase 'principally engaged' in subparagraph 523(b)(ii) discussed above.

Test time

An Australian resident must look at the end of the notional accounting period of the foreign company that ends during his or her year of income to determine if the share that the investor holds in the foreign company satisfies the listing requirement. [Paragraph 523(a)]

The definition of a notional accounting period is set out in section 486. Generally, it is the year of income of the taxpayer unless the taxpayer elects for the accounting period of the company.

However, the following requirements must be satisfied throughout the period in which the taxpayer holds his or her interest in the foreign company:

he foreign company must be principally engaged in the active carrying on of two or more of the multi-industry activities; and
he shares in the foreign company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange. [Paragraph 523(b)]

Exemption for Balanced Investment Portfolio in FIFs

Overview

Taxpayers who invest in a wide spread of shares in foreign companies - for example, by following one of the international indices, may generally find that very few of their investments are subject to FIF taxation. This occurs because the range of eligible activities for the active business exemption and the specific exemptions for shares in certain banking, real estate and insurance companies will exempt most companies on the index. Investments in non-eligible activities may typically be less than 5 per cent of the investor's investment portfolio. Because these cases of portfolio diversification involve minimal scope for deferral but otherwise require substantial compliance costs, an exemption is to be provided for investments if non-eligible activities are not more than 5 per cent of the taxpayer's total investments in FIFs.

Explanation

Division 14 provides an exemption for the taxpayer's interests in FIFs which would otherwise be subject to FIF taxation if the value of those interests is not more than 5 per cent of the taxpayer's total portfolio of FIF interests (excluding those interests exempted by Divisions 2 and 11). [Section 525]

There are no restrictions on the type of FIFs that are eligible for this 'balanced portfolio' exemption. The FIFs may include non-eligible activities such as financial services or may not be listed on any stock exchange, approved or otherwise. They may also include trusts.

Test time

An Australian resident must look at the end of the notional accounting period of each FIF that ends during his or her year of income to determine if the interest in the FIF would be subject to FIF taxation if the exemption provided by this Division did not apply. [Subsection 525(1)]

The definition of a notional accounting period of a FIF is set out in section 486. Generally, it is the year of income of the taxpayer unless the taxpayer elects for the FIF's accounting period.

To measure whether the interests in FIFs that would be subject to FIF taxation are more than 5% of the taxpayer's total interests in FIFs the value of each FIF is taken at the higher of its cost or its market value at the end of the taxpayer's year of income. [Subsection 525(2)]

Market Value Method

Overview

This chapter explains the procedure for determining by the market value method whether any Foreign Investment Fund ( FIF) income is to be included in the taxpayer's assessable income. This income is calculated by taking into account changes in the market value of the interest in the FIF.

The amount attributed to the taxpayer under the market value method is calculated in two stages.

he first stage is to measure the income taking into account the movement in the market value of the taxpayer's interest in the FIF.
f there was a market value increase, the second stage reduces the market value increase by any FIF loss carried forward from prior years in relation to that FIF interest.

Generally, the amount arising under the market value method will be included in the taxpayer's assessable income for the income year which coincides with the notional accounting period of the FIF.

Explanation

Introduction

The market value method will be applied if it is practicable to do so and the taxpayer has not chosen to apply the calculation method. [Subsection 535(1)]

If it is practicable to ascertain the market value for an interest or class of interests in a FIF at the relevant measurement point (usually the end of the year of income) then the market value method may be used.

This Chapter is divided into two parts. The first part relates to the foreign investment fund income calculation. The second part explains how to ascertain the market value.

Part 1 - Calculating the FIF income

The amount of the foreign investment fund income is determined in two steps. The first step calculates the movement in the market value, generally between two annual reporting dates. The second step allows for the recoupment of any unapplied previous years' FIF losses against any increase in market value in the current year in relation to the same FIF. The result of these calculations is the amount of foreign investment fund income that is to be included in the assessable income of the taxpayer.

Step 1 - Calculating the movement in the market value

The movement in the market value of the taxpayer's interests in the FIF, which have a market value at the end of the notional accounting period, that is, the foreign investment fund amount is calculated in the following five applications. [Section 538]

First application

Determine the market value of the taxpayer's interests in the FIF on the last day of the notional accounting period.

The currency used for the market valuation on the first application is to be used for the amount ascertained in each of the following four applications.[Subsection 538(3)]

Second application

Add the value of distributions by the FIF to the taxpayer during the notional accounting period in respect of the interests referred to in the first application.

Third application

If the taxpayer disposed of any interest in the FIF during the notional accounting period, add the value of any distributions by the FIF in respect of the interests andthe proceeds of any interests in the FIF which the taxpayer disposed of during the notional accounting period.

Fourth application

Deduct the opening market value (this is the same as the value at the end of the previous notional accounting period) of the interests at the commencement of the notional accounting period.

Fifth application

Deduct the cost of any interests in the FIF which the taxpayer acquired during the notional accounting period.

The aggregate of these five applications will give the foreign investment fund amount.

Example 1 Assume the opening value of an FIF interest was HK$50,000, and at the end of the notional accounting period the closing value of the interest was HK$53,000. There were no acquisitions, disposals or distributions during the notional accounting period. The increase in market value, the FIF amount, would be HK$3,000.

Example 2 Assume the opening value of a FIF interest was HK$50,000, and at the end of the notional accounting period the closing value of the interest was HK$45,000. There were no acquisitions, disposals or distributions during the accounting period. The decrease in market value, the FIF amount, would be a FIF loss of HK$5,000.

Gross FIF income

If the foreign investment fund amount is positive, the amount represents the gross foreign investment fund amount. [Section 540]

FIF loss

If the foreign investment fund amount is negative a FIF loss has occurred. [Section 541]

This FIF loss may be used to offset assessable income of the taxpayer but only to the extent that the taxpayer has previously been subject to foreign investment fund taxation from the income of that FIF. [Section 532]

Step 2 - Calculating the amount included in assessable income

The second step is to determine the amount to be included in assessable income - the FIF income. [Section 542]

The FIF income is calculated by subtracting from the gross FIF income the total of any 'unapplied previous FIF losses'. [subsection 542(2)].

If the result is positive there will be FIF income is converted to Australian dollars at the rate of exchange applicable at the end of the notional accounting period and that FIF income is included in the taxpayer's assessable income.

Meaning of 'unapplied previous FIF losses'

The meaning of any 'unapplied previous FIF losses' is the amount by which the undeducted amount of a foreign investment fund loss exceeds the sum of any gross FIF income applying to a taxpayer's interest in a FIF, regardless of whether the operative provision did not apply because of any of the Divisions 2 to 9 and 11 to 15. [Subsection 542(5)]

In calculating the unapplied previous FIF losses, the undeducted amount of a FIF loss is so much of a FIF loss that has not been allowed as a deduction from the assessable income of the taxpayer. [Subsection 542(6)]

Once a FIF loss has been used in ascertaining if there was, for any notional accounting period, an unapplied previous FIF loss, then that loss cannot be taken into account again for the purposes of ascertaining an unapplied previous FIF loss for later notional accounting periods. [Subsection 542(7)]

Also, in determining the gross FIF income that is used in calculating the unapplied previous FIF losses, only that gross FIF income accruing after the notional accounting period in which the loss was incurred and before the current notional accounting period in which the taxpayer has a gross FIF income is applied. [Subsection 542(5)]

Part 2 - Ascertaining market value

In order to apply the market value method, a taxpayer must first ascertain the market value of the taxpayer's interests in the FIF. [Section 539]

The means by which a market value is determined is by reference to:

he quoted market values for shares, options and rights;
he quoted market values for units in a listed unit trust;
he quoted market values of convertible notes;
he quoted market values of any similar interests.

Only quotations from an approved stock exchange will be accepted (see Schedule 3 for the list of approved stock exchanges).

For unlisted funds, the officially quoted buy-back or redemption price of units will be used.

More than one specific quoted price

Shares, units and other instruments of a particular class of interest in a FIF may be quoted on a number of approved stock exchanges. When two or more approved stock markets provide a quoted price for the taxpayer's interest, the taxpayer chooses the stock market from which the market value will be taken. [Subsection 539(5)]

Can the approved stock exchange be changed?

Once the taxpayer selects a approved stock exchange for measurement of the market value that exchange will be used for all future market value calculations for that FIF interest. It will not matter that the size of the taxpayer's total interest in the FIF has been increased by acquisitions from other exchanges or markets. However, if it is no longer practicable to use that market, the taxpayer will be able to elect to use another approved market or approved exchange. This may occur where, for example, the market or stock exchange ceases to operate or the class of interest is delisted on that exchange, but it is still listed on another exchange. [Subsection 539(6)]

What if quoted prices are not available?

If the quoted values are not available to the taxpayer at the times market values are to be determined, either the calculation method or the deemed rate of return method is to be used. [Section 537]

If a class of interest in a FIF does not have a quoted value (for example, the taxpayer has both preference and ordinary shares in a company and the preference shares are not quoted whilst ordinary shares are quoted) and the taxpayer does not elect for the calculation method then the taxpayer's interests relating to the different classes must be split. The deemed rate of return method will be used for those interests of the class which is not quoted.

Special rule where there is no quoted value at the start of the FIF measures

The opening market value, at the commencement of a particular notional accounting period, will generally be determined by the value of the interest at the end of the previous notional accounting period. This rule will be modified where a FIF has a history of market quotations, but is not quoted immediately prior to the commencement of the FIF measures on 1 January 1993 and, in the case of a trust, did not have a unit buy-back or redemption price on that date. In these circumstances, the opening value will be the average of the value on the last reporting day before 1 January 1993 and the value on the next reporting day. [Subsection 539(4)]

The reporting day means:

n the case of a foreign company, the day the directors reported to the members on the financial position of the company; or
n the case of a foreign trust, the day the trustee or manager of the trust reported to the holders of interests in the trust on the financial position of the trust.[Subsection 539(7)]

This averaging will only apply where the post 1 January 1993 reporting date is not more than 12 months after 1 January 1993 and the reporting dates are not more than 12 months apart.

deemed rate of return method

Overview

This chapter explains the procedure for determining the amount to be included in the taxpayer's assessable income based on the deemed rate of return method.

This chapter only discusses the application of the deemed rate of return method to an interest in a FIF. The procedure for determining the amount to be included in the taxpayer's assessable income in relation to a foreign life policy is covered in Chapter 19.

Explanation

Introduction

The deemed rate of return method applies if it is not practicable to apply the market value method (see Chapter 16) and the taxpayer has not chosen the calculation method (see Chapter 18). [Section 535(2)]

Using this method there are four steps.

he first step is to determine the taxpayer's interests in the Foreign Investment Fund ( FIF) and whether any of the interests constitute a group.
he second step is to determine the opening value of the interests. Different procedures are adopted for determining the opening value at the beginning of the FIF measures and for periods occurring after the first notional accounting period of the FIF measures.
he third step calculates the movement in the value of interest in the FIF throughout the notional accounting period. This is called the FIF amount.
he fourth step converts the FIF amount to Australian currency and determines the amount that will be included in the taxpayer's assessable income. This is called the FIF income.

There are two sections in this chapter. The first section explains the steps in the application of the deemed rate of return method. The second section shows how to calculate the opening value for the current year.

Section 1: Application of the deemed rate of return method

Step 1 - Groups of Interests

The deemed rate of return method is applied separately to each group of interests held by the taxpayer. It is necessary therefore, to determine the group or groups of interests in a FIF held by the taxpayer at the end of the relevant period. [Section 544]

Meaning of a 'group of interests in a FIF'

If a taxpayer had only one interest in a FIF during the notional accounting period that interest is a group. [Subsection 544(2)]

Interests in a FIF that are of the same class (for example, two parcels of A class shares held during the same period) are considered as a group of interests. However, if interests are of different classes (for example, A and B class shares with different rights) then each class would be treated as a separate group. Likewise, shares and options in a FIF would form different groups. [Subsections 544(4) and (5)]

If a taxpayer had two or more interests in a FIF that are not of the same group of interests the deemed rate of return method is applied separately to each group. [Subsection 544(3)]

Step 2 - Calculating the opening value

This step determines the opening value of the interest in the FIF as measured at the beginning of the notional accounting period. There are different procedures to be applied for the beginning of the FIF measures and for periods following the first notional accounting period of the FIF measures. These procedures are explained in detail in the second section.

Step 3 - Calculating the movement in the value of the FIF (the FIF amount)

Once the opening deemed value has been ascertained, the FIF amount, that is, the movement in the value of the FIF for the notional accounting period, is calculated by applying the following formula: [Section 555]

Opening value x (deemed rate of return + 4%) x (Number of days held / 365)
Where:

Opening value means the amount determined in Step 2 of this chapter.

Deemed rate of return means the rate of interest applicable in accordance with section 10 of the Taxation (Interest on Overpayments) Act 1983 for the taxpayer's year of income, increased by 4 percentage points. If there is more than one interest rate the weighted average of those rates is used. The current rate of interest on overpayments is 10 per cent.

Number of days held means the number of days in the notional accounting period in which the taxpayer had the interests in the group.

Example 1 Assume an investor holds 2,000 A class shares and 1,000 B class shares in a Cayman Islands company. Each class of shares is a different group. On 1 July 1993, the parcel of A class shares had a value of $CI200,000 and the parcel of B class shares had a value of $CI100,000. At the end of the FIF's notional accounting period there is no market value for either class of share. Further, assume the deemed rate of return is 10 per cent.For the first year, under the deemed rate of return method it will be necessary to multiply the opening value by the deemed rate of return for each group as follows.

A class shares: $CI200,000 x (10% + 4%) x 365/365 = $CI28,000
B class shares: $CI100,000 x (10% + 4%) x 365/365 = $CI14,000

The FIF amounts for the groups will be $CI28,000 and $CI14,000. The opening deemed value of the parcel of A class shares for the following notional accounting period would be $CI228,000 and the opening deemed value of the parcel of B class shares for the following notional accounting period would be $CI114,000.

Example 2 Assume 1,000 C class shares are acquired 150 days into the FIF's notional accounting period for $CI240,000. Application of the deemed rate of return method for the group constituted by the C class shares would be as follows:

$CI240,000 x (10% + 4%) x (365-150)/365 = $CI19,792

The FIF amount is $CI19,792. The opening deemed value of the C class shares for the following notional accounting period would be $CI259,792 ($CI240,000 + $CI19,792).

Step 4 - Determining the amount to be included in assessable income (the FIF income)

The final step in applying the deemed rate of return method is to determine the amount attributed to the taxpayer, that is, the FIF income. To do this the FIF amount (as calculated in step 3) is converted to the corresponding amount in Australian currency. [Sections 556 and 557]

The rate of exchange that applied at the end of the notional accounting period is used to convert each group of interests to the corresponding amount in Australian currency. If there is only one group of interests, the FIF income will be the amount converted into Australian currency. If there is more than one group, the FIF income will be the sum of the amounts already converted into Australian currency. [Section 556]

Example 3 In the above example assume that an exchange rate of $A1.00 = $CI6.00 operates. The FIF income for the three groups constituted by the A, B and C class shares would be the sum of:

Class A shares: $CI28,000/6 = $A4,667
Class B shares: $CI14,000/6 = $A2,333
Class C shares: $CI19,792/6 = $A3,299
$A10,299
The taxpayer will need to include $A10,299 in assessable income. [Section 529]

Section 2: Calculating the opening value

Special rule for the start of the FIF measures

In the first year of application of the FIF measures, all FIFs will be treated as if their first notional accounting period commenced on 1 January 1993. Accordingly, this will mean that a taxpayer to whom the deemed rate of return method is to apply in the first year will be required to calculate a deemed value for each FIF interest as at that date. This will represent the opening value of the FIF interest.

There will be three methods of calculating the opening deemed value in the first year of the FIF measures. Use of the second method will only be required if the first cannot be used. Similarly, the third method will only be used if the first and second methods cannot applied. [Subsections 547(1) , 548(1) and 549(1)]

(1) Previous quotation on approved stock exchange

The first method of valuation will apply where the FIF interest has been quoted on an approved stock exchange. When two or more approved stock markets provide a quoted price, the taxpayer chooses the stock market from which the opening value will be taken. The list of approved stock exchanges is at Schedule 3. [Subsection 547(5)]

If the FIF interest has been quoted on an approved stock exchange on 1 January 1993 then that quoted price is taken to represent the opening value. [Subsection 547(1)]

If the FIF interest is not quoted on an approved stock exchange on 1 January 1993 but an approved stock market value is available at any time during the preceding 12 months, the valuation on the latest quoted date will be used as the deemed value as at 1 January 1993. [Subsection 547(2)]

In the case of an interest in a trust that was not quoted on 1 January 1993 or during the preceeding 12 months, but for which there was on 1 January 1993 a buy-back or redemption price offered by the trustee or manager of the trust, then that offer represents the opening value. If there was not a buy-back or redemption price on 1 January 1993, the latest price within the preceeding 12 months may be used. [Subsection 547(3)]

(2) Fair market value of investment

The second method of valuation uses a fair market value at 1 January 1993 as the opening value. To take advantage of this method, a taxpayer will use an independent valuation of the FIF interest. The valuation must be within a three month period either side of, and including, 1 January 1993. The valuation supplied will form the basis for the opening value. [Subsection 548(2)]

(3) Initial investment indexed at deemed rate of return

Under the third method of valuation, the initial investment is increased by a deemed rate of return for each year between the acquisition date and the first actual application of the deemed rate of return method. [Section 549]

Calculating the opening value for periods following the start of the FIF measures

There are three methods for determining the opening value of the interest in the FIF in periods following the start of the FIF measures.

(1) Opening value where the deemed rate of return method has applied in the previous year

When the deemed rate of return has applied in the immediately previous year the opening value is calculated as outlined in the following three steps. [Section 551]

Step one

Determine the deemed value at the commencement of the previous notional accounting period, and add the value of any interests acquired after the commencement of the previous notional accounting period.

Step two

Add the FIF income for the previous notional accounting period.

Step three

Deduct any distributions made by the FIF in the previous notional accounting period in relation to the FIF interest.

(2) Opening value where the calculation method or an exemption has applied in the previous year

Where the calculation method (see Chapter 18) or an exemption from FIF taxation applied in the immediately previous year the opening value for the current period will be ascertained by one of two valuation methods. [Subsection 552(1)]

The first method of valuation will apply where the FIF interest has been quoted on an approved stock exchange at some time in the previous notional accounting period, but does not have a market value at the end of that notional accounting period. In order to approximate the closing value, should a market value be available at any time during the previous notional accounting period, that valuation will be used as the deemed value as at the end of that previous notional accounting period. If more than one market value exists, then the latest market value for that notional accounting period is to be used as the deemed value as at the end of the notional accounting period. [Subsection 552(2)]

Under the second method of valuation, the starting point for entry into the deemed rate of return method is ascertained by increasing the initial investment by the deemed rate of return as discussed above. This method will only be used where the first method is not applicable. [Subsection 552(3)]

(3) Opening value where the market value method has applied in the previous year

If the market value method has applied in the immediately previous notional accounting period, then the opening value for the current year will be the market value of the interest in the FIF at the end of the previous notional accounting period. [Section 553]

Opening value where the interests in a FIF were acquired during a notional accounting period

If the interests in a FIF were acquired during the notional accounting period, the value of the interests is the consideration paid or given by the taxpayer for the acquisition. [Section 554]

Calculation Method

Overview

This chapter explains the calculation method of determining whether any Foreign Investment Fund ( FIF) income accrued to the taxpayer.

The general scheme for the calculation method

The starting points for determining the calculated profit or loss are the general provisions for the recognition of income and capital gains [section 560] and for the recognition of expenditure and other losses [section 567] . These provisions must be viewed together.

The notional income of the FIF for a particular notional accounting period includes any gross income derived by the FIF during that period. While the term 'gross income' encompasses the concept of gross receipts it is not limited to gross receipts and, in appropriate circumstances, will include a revenue profit. To determine how an amount is taken into account - that is, on a gross receipts basis or on a profit basis - regard must be had to the deduction provisions.

As a general rule, where expenditure is allowed as it is incurred, the income to which the expenses relate will be brought to account on a gross receipts basis. However, where expenditure is not brought to account as it is incurred, the income will be brought to account on a profit basis.

The general provision for deductions refers to the allowance of losses or outgoings incurred during the notional accounting period. The provision does not require that the amount be incurred in the production of notional income. There is also no exclusion of amounts that are of a capital or private nature.

It is intended that the general deduction provision would, subject to the exclusion of certain categories of outgoings etc, allow an amount as it is incurred. For example, expenditure on most trading stock would be immediately deductible. The inference is that the gross proceeds of the sale of trading stock would be brought into notional income. This can be distinguished from the case where the expenditure on trading stock is not immediately deductible, as is the case where the trading stock is land which is excluded from immediate deductibility in all cases. In this case, the inference is that the 'gross income' arising on the sale of the land would be the profit on disposal of the land, and not the gross proceeds on disposal.

The second limb of the general provision for calculating the notional income of a FIF for a notional accounting period is that profits and gains of a capital nature will also be brought to account when derived. In this case, it is expected that the amount will usually be brought to account as a net amount.

However, an amount cannot be effectively deducted twice. Thus, the net amount brought to account will exclude any amount previously taken into account. [Subsections 560(2) and 574(2)]

Why is there a departure from the general provisions of the Principal Act ?

The scheme for the determination of a calculated profit is markedly different to the general scheme of the Principal Act that arises in subsections 25(1) and 51(1). There are two reasons for this.

Firstly, on the income side, the objective is to make as little distinction as is practical between profits on revenue account and profits on capital account. This is because all profits need to be taken into account in determining the amount available for distribution.

Secondly, it is intended that the calculation be kept as simple as is possible, having regard to the scope for deferral. Thus, on the income side, there is little distinction between how revenue amounts and capital amounts are taken into account. At the same time, profits accumulating in lower tier entities and certain discounts are taken into account as they accrue to prevent unacceptable deferral of the recognition of the income.

On the deductions side, distinctions for deductibility on the basis of whether or not an item is on revenue account would preclude most taxpayer's from using the calculation method. For example, determining whether legal expenses were on capital account or revenue account would be very difficult. It is simpler to allow all expenditure immediately. This is limited only in the identified cases where the allowance of the expenditure would result in unacceptable deferral - for example, by reinvesting profits in securities - or the expenditure should be amortised and the amortisation should be readily ascertainable from the accounts.

Explanation

Introduction

The calculation method will be used only if the taxpayer elects that it applies. [Section 535]

This method involves a taxpayer determining the calculated profit or calculated loss of a FIF for a notional accounting period. If there is a calculated loss, it may be carried forward and taken into account for subsequent notional accounting periods. If there is a calculated profit, the taxpayer's share of the calculated profit must be determined. This share is determined by multiplying the calculated profit of the FIF for the notional accounting period by the taxpayer's percentage interest in the FIF at the end of that period (attribution percentage). The resulting amount will be included in the taxpayer's assessable income for the year of income in which the notional accounting period of the FIF ends. [Section 558]

Determining the calculated profit or calculated loss of the FIF

In determining the calculated profit or calculated loss of a FIF, the first step is to work out the notional income of the FIF. The second step is to work out the notional deductions from that notional income. If the notional income is greater than the notional deductions then the excess is the calculated profit of the FIF for the notional accounting period. If the notional income is less than the notional deductions then the difference is the calculated loss of the FIF for the notional accounting period. [Section 559]

Application of anti-avoidance rules

Specific anti-avoidance rules to ensure that there is no avoidance in the calculation of the FIF income will not be included in these measures. Instead, reliance will be placed on the general anti-avoidance rules of Part IVA of the Principal Act.

Converting foreign currency

The calculations used in determining the calculated profit or calculated loss of a FIF will be done in the currency in which the FIF keeps its accounts. Amounts derived or incurred by a FIF that are expressed in another currency may be converted to the FIF's currency on any reasonable and appropriate basis. [Subsections 559(5) and (6)]

The calculated profit of a FIF will then be converted to Australian dollars using the exchange rate prevailing on the last day of the FIF's notional accounting period. [Subsection 559(7)]

The calculated loss will be carried forward in the foreign currency.

Step 1 - Determining the notional income of a FIF

The notional income of a FIF will take into account the gross income and profits and gains of a capital or revenue nature, that are derived during the FIF's notional accounting period. [Subsection 560(1)]

Discounted securities

The provisions of Division 16E of Part III will apply if the FIF holds a discounted security. Its purpose here is to determine whether an amount in relation to discounted securities is to be included in the notional income of the FIF of the notional accounting period. However, if an amount in relation to a discounted security is recognised in the accounts of the FIF on an accruals basis in accordance with the accounting standards of the country in which the FIF is established then the amount shown in the accounts is to be used in preference to a Division 16E application.

If the FIF was a partner in a partnership the notional income of the FIF includes its interest in any net income of the partnership calculated for the accounting period of the partnership which ends in the notional accounting period of the FIF (which ends during the year of income). The net income of the partnership is the amount by which the notional income of the partnership exceeds the notional deductions of the partnership for an accounting period of the partnership. It is calculated as though the partnership were a FIF and the accounting period of the partnership were a notional accounting period.

First tier FIF with an interest in a second tier FIF or a FLP

Where a first tier FIF has an interest in a second tier FIF, during the notional accounting period of the first tier FIF that ended during the taxpayer's year of income, generally an amount of second tier FIF income will be included in the notional income of the first tier FIF as if it was a resident. [Section 576]

In applying the FIF measures to the second tier FIF, the taxpayer will be able to elect for the calculation method to apply to that second tier FIF. To make this election the taxpayer must have elected to use the calculation method in respect of the first tier FIF which has an interest in the second tier FIF. [Subsection 577(1)]

A taxpayer will not be able to make the election to use the calculation method in respect of the third tier FIF where the first tier FIF is a CFC. Instead, the taxpayer will use either the market value or the deemed rate of return method for the third tier FIF. The following diagram illustrates this. [Section 577(2)]

Example 1 for Section 577(2)

Example 2 for Section 577(2)

If the taxpayer does not make an election to use the calculation method in respect of the second tier FIF, the FIF income arising from the second tier FIF is to be calculated in accordance with the market value method or the deemed rate of return method, as illustrated. [Section 535]

Example for Section 535

Where the taxpayer has made an election to use the calculation method in respect of the second tier FIF the notional income of the second tier FIF will include FIF income from a third tier FIF or a FLP, as illustrated. [Section 579]

Example for Section 579

The notional income of the FIF in respect of the notional accounting period which ended during the year of income does not include any dividend or distribution paid to the FIF by another FIF. [Section 564]

The existing rules for constructive receipt of income, profits or gains will be incorporated in the calculation. Any amount that is reinvested, accumulated, capitalised, carried to a reserve, sinking fund or insurance fund will be taken to have been derived by the FIF. Income, profits or gains will be taken into account in calculating the notional income of the FIF even where the income, profit or gains are not actually paid to the FIF but are dealt with on behalf of the FIF or on its direction. [Section 565]

An amount included in the notional income of the FIF is to be included as a pre-tax amount. [Section 566]

Step 2 - Determining the notional deductions

Most expenses of the taxpayer will be deductible in the notional accounting period in which they are incurred, provided that the expenses relate to income and profits or gains of a revenue nature included in the determination of the notional income of the FIF. [Section 567]

Expenditure on trading stock will be a notional deduction in the period in which it is incurred. [Section 568]

A notional deduction will not be allowed for expenditure of a capital nature in the acquisition of shares or interests in shares in a company, interests in a trust, or other securities. Instead, the cost will be taken into account in determining any profit or loss on disposal of the interest. [Section 569]

Expenditure on the purchase of certain assets will be amortised over the effective life of the asset. This will apply to assets such as plant and equipment, licences, patents and any other assets prescribed by regulation. The amount shown in the accounts of a FIF will be deducted if:

he accounts conform with generally accepted accounting principles;
he accounts give a true and fair view of the financial position of the FIF; and
he accounting principles provide for the amount to be amortised over the effective life of the asset - that is, the value of the asset is not written off immediately the expenditure is incurred. [Subsection 570(1)]

Expenditure on the acquisition of any other property will not be amortised. [Subsection 570(2)]

The interest of a FIF in a partnership loss will be allowed as a notional deduction where the FIF was a partner in a partnership at the end of the accounting period of the partnership which ends in the notional accounting period of the FIF. A partnership loss is the amount by which the notional deductions of the partnership exceed the notional income of the partnership for an accounting period of the partnership. The amount is calculated as though the partnership were a FIF and the accounting period of the partnership were a notional accounting period. [Section 571]

Calculated losses of a first tier FIF arising in previous notional accounting periods, that have not been allowed as a notional deduction can be recouped in the current notional accounting period against the calculated profit of the first tier FIF [subsection 572(1)]. These loss deductions are used in the order in which they occurred. [Subsection 572(2)]

Similarly, calculated losses of a second tier FIF arising in previous notional accounting periods, that have not been allowed as a notional deduction can be recouped, in the current notional accounting period of the second tier FIF, against the calculated profit of a second tier FIF. These loss deduction are allowed in the order in which they occurred. [Section 578]

A notional deduction will be allowed from the notional income of the FIF for Australian tax and foreign taxes paid by the FIF to the extent that the tax relates to the income or gains included in the calculation of the notional income of the FIF. [Section 573]

A notional deduction is not allowed from the income of the FIF for expenditure incurred by the FIF during the notional accounting period in respect of the acquisition of:

lant, articles or industrial or other property referred to in paragraph 570(1)(a);
and or buildings;
oodwill;
old, silver or other precious metals; or
ny other capital assets. [Subsection 574(1)]

However, expenditure which is associated with these, for example, legal fees, is not precluded by this subsection. There is a further exclusion for all expenditure incurred in the repayment of debts.

An amount is not allowed as a notional deduction from the notional income of the FIF in respect of the notional accounting period of the FIF to the extent to which:

he deduction has been taken into account in calculating a net amount that has been, or will be, included in the notional income of the FIF for the notional accounting period or of a previous notional accounting period; or
he deduction would have been taken into account in calculating a net amount that would have been, or would be, included in the notional income of the FIF for a previous notional accounting period had the taxpayer been required to calculate the notional income for that previous notional accounting period.

The purpose of this subsection is to prevent the same expenditure being allowed more than once as a notional deduction. [Subsection 574(2)]

Step 3 - Calculate the taxpayer's attribution percentage in respect of interests in the FIF

A taxpayer's attribution percentage in respect of interests in a foreign company

The taxpayer has to include in assessable income the taxpayer's attribution percentage of a FIF's calculated profit. The attribution percentage will reflect the greatest of the taxpayer's rights in relation to the FIF to receive income or capital or to participate in decision making. [Subsection 581(1)]

At the end of the relevant period, a taxpayer's FIF attribution percentage in relation to a company will be equal to the percentage that the taxpayer holds or is 'entitled to acquire' (see Chapter 2 - Key Concepts) in:

he total paid-up share capital of the company;
he total rights to vote, or to participate in decision making, in relation to distributions of profit or capital of the company;
he total rights to vote, or to participate in decision making, in relation to the constituent document of the company;
he total rights to vote, or to participate in decision making, in relation to a variation to the share capital of the company; or
he total rights to distributions of profits or capital on winding-up, or at any other time.

Where different percentages arise under the different types of rights described above then the FIF attribution percentage will be the greatest of those percentages. [Subsections 581(1) and (2)]

The attribution percentage is worked out on the basis of the:

apital of the company at the end of the notional accounting period; or
he profits of the company for the notional accounting period. [Paragraph 581(3)(a)]

It is assumed that the taxpayer's 'rights' in relation to the FIF at the end of the relevant period applied at all times throughout the applicable period. [Paragraph 581(3)(b)]

Attribution percentage applicable to a taxpayer's interests in a foreign trust

If the beneficiaries of the trust are presently entitled to, or if the trustee distributes or allocates to the beneficiaries, all of the income, profits or gains of a foreign trust that arise during the trust's notional accounting period, then the taxpayer's attribution percentage will be calculated by reference to the present entitlement and the amount distributed to the taxpayer out of the income, profits or gains. [Subsection 582(2)]

The distributions have to be made within the notional accounting period or within two months of the end of the notional accounting period.

The income, profits or gains referred to are not the net income for Division 6 purposes. Instead they are the accounting income, profits or gains of the trust.

If the income, profits or gains of the foreign trust are not fully distributed or allocated to beneficiaries, as described above, then the taxpayer's attribution percentage will be equal to the greater of the percentages of the taxpayer's interest in, and entitlement to acquire:

he income of the trust; or
he corpus of the trust. [Subsection 582(7)]

The attribution percentage is worked out on the basis of the:

ncome of the trust for the period; or
he corpus of the trust at the end of the period. [Subsection 582(6)]

It is assumed that the taxpayer's rights in relation to the foreign trust at the end of the relevant period applied at all times throughout the year of income. [Paragraph 582(7)]

Step 4 - Determining the amount to be included in the taxpayer's assessable income

Taxpayer's FIF interest does not change

In general, the amount to be included in the taxpayer's assessable income will be determined by multiplying the calculated profit of the FIF for the notional accounting period by the taxpayer's percentage interest in the FIF at the end of that period (attribution percentage). [Sections 580 and 582]

Taxpayer's share of FIF income = Calculated profit x Attribution percentage

Example 1 Assume a taxpayer has a one per cent interest in a FIF for the entire notional accounting period for which the calculated profit of the FIF is $A10 million. Assume also the FIF fails the active business exemption and that the taxpayer elects to use the calculation method. The taxpayer would include $A100,000 in assessable income as follows:

$A10 million x 1% = $A100,000

Part year holding

If the taxpayer acquired an interest in a FIF during a notional accounting period, the above formula is modified by multiplying it by the proportion of the number of days throughout the period in which the taxpayer held the interest [subsections 580(3) and 582(5)]. The calculation method will only apply to an interest or interests in a FIF held at the end of the relevant period. [Subsections 580(5) and 582(9)]

Taxpayers share of income = Calculated profit x Attribution percentage x (Number of days held / Total number of days)

Example 2 As in the previous example, assume a taxpayer has a one per cent interest in a FIF. However, the interest was acquired 60 days into the FIF's notional accounting period and was still held at the end of that period. The calculated profit of the FIF is $A10 million. Assume also that the FIF fails the active business exemption and that the taxpayer elects to use the calculation method. The taxpayer would include $A83,561 in assessable income as follows:

$A10 million x 1% x (365-60/365) = $A83,561

Where a taxpayer holds an interest in a FIF during a notional accounting period and adds to, or reduces, that interest during the period, the amount included in assessable income will be altered to reflect the changing size of the attribution percentage.

Example 3 Assume that a taxpayer has a one per cent interest in a FIF at the beginning of the FIF's notional accounting period, and buys another two per cent 100 days into the period. There are no disposals by the end of therelevant period. Assume also that the FIF fails the active business exemption, the taxpayer elects for the calculation method and the calculated profit of the FIF is $A10 million. The taxpayer would include A$245,205 in assessable income as follows:

$A10 million x 1% + (2% x 265/365)] = $A245,205

Example 4 Assume the same facts as in the previous example except that the taxpayer sells half of the one per cent interest 100 days into the FIF's notional accounting period, and acquires the two per cent interest 50 days before the end of the period. The amount included in assessable income would be A$77,397, calculated as follows:

$A10 million x [0.5% + (2% x 50/365)]
= $A10 million x 0.77397%
= $A77,397

Example 5 The facts differ from those in the previous example in that the taxpayer sells all of the one per cent interest 100 days into the FIF's notional accounting period. As the one per cent interest was disposed of before the end of therelevant periodit is not taken into consideration under the FIF measures. The assessable income of the taxpayer under the FIF measures would include $27,397 in respect of the two per cent interest acquired 50 days before the end of the period, calculated as follows:

$A10 million x [2% x 50/365] = $A27,397

Foreign Life Policies

Overview

This chapter explains the application of the Foreign Investment Fund ( FIF) measures to taxpayers who have an interest in a Foreign Life Assurance Policy ( FLP).

The chapter will examine the meaning of a FLP and when a taxpayer is considered to have an interest in a FLP. In order to apply the FIF measures to the interest in a FLP, this chapter will also explain the period over which the interest in the FLP is taxable, the notional accounting period, and the two methods of taxation that are applicable to a taxpayer's interest in a FLP, the cash surrender value method and the deemed rate of return method.

Explanation

Meaning of a 'foreign life assurance policy'

A FLP in relation to a taxpayer for a year of income is a life assurance policy which has been issued by an entity that was a non-resident at any time in that year of income. A FLP does not include an Australian policy issued by a foreign company that is authorised to carry on life insurance business in Australia. [Subsection 482(1)]

A life assurance policy is a policy which provides for the payment of benefits upon death, other than death by accident or specified sickness, or on the happening of a specified event which relates to the ending or continuing of a human life. A life assurance policy also includes an instrument which grants an annuity for a term dependent upon a human life. [Paragraphs 482(2)(a) to 482(2)(d)]

These measures will not apply to certain life policies that are excluded. The three categories of policies to be excluded are:

hose which provide for payment of benefits on death, or death or permanent disability only;
hose policies issued before 1 July 1992 which cannot, after that date, be cancelled, surrendered or redeemed and for which the terms have not, after that date, been altered in a material respect; or
contract of reinsurance between a resident insurer and a non-resident reinsurer in relation to life assurance policies which provide only life cover.[Paragraphs 482(2)(e) and 482(2)(f)]

Policy issued by a non-resident

These measures will only apply to a FLP that was issued by a non-resident. If however, a resident of Australia issues a life policy and then transfers it to a non-resident insurer with a view to avoiding these measures the Commissioner of Taxation may apply the anti-avoidance provisions of Part IVA of the Principal Act to defeat the arrangement.

Meaning of 'an interest in a FLP'

A person will have an interest in a FLP if that person has a legal title to the FLP. [Subsection 483(3)]

Taxpayers whose interest in a FLP will be subject to taxation

A taxpayer's assessable income for the year of income will include foreign investment fund income if the taxpayer had the interest in a FLP at any time during the notional accounting period of the FLP that ends in the taxpayer's year of income and the taxpayer was a resident at any time in that year of income. [Subsection 485(4)]

The measures will not apply to an interest in a FLP if the taxpayer disposes of that interest before 30 June 1993. [Subsection 485(5)]

Treatment of bare trusts

A bare trust arises when a taxpayer has a beneficial interest in the property of a trust and the trustee does no more than hold legal title to the property. Where the property of a bare trust consists of an interest in a FLP, the FIF measures will look through the trust arrangements and the taxpayer will be treated as holding an interest in the FIF. [Section 484]

Exempt visitor to Australia

Provision has been made to exempt from FIF taxation a taxpayer's interest in a FLP if the taxpayer is a short term visitor to Australia for not more than four years - see Chapter 11 for an explanation of this exemption from the FIF measures. [Section 517]

The acquisition and disposal of an interest in a FLP

Effect of change in ownership

If the interest in a FLP undergoes a change in ownership, this change constitutes a disposal by the person who had the interest in the FLP immediately before the change and an acquisition by the person who owns it immediately after the change. For there to be a change in ownership there must be a change in the beneficial ownership of the interest in the FLP in addition to a change in its legal ownership. [Subsections 488(2) and (3)]

A change in the ownership of an interest in a FLP can take place in any of the following ways:

y the execution of an instrument;
y the entering into of a transaction;
y the transfer of the interest in the FLP by the operation of law;
y the doing of any other act or thing; or
y the occurrence of any event. [Subsection 488(4)]

A change in ownership will be taken to have occurred where one of the following occurs:

declaration of trust in relation to the interest in the FLP under which a beneficiary is absolutely entitled to the interest in the FLP rather than the trustee;
he release, discharge, satisfaction, surrender, forfeiture, expiry, abandonment or extinction, at law or in equity, of the interest in the FLP; or
he redemption or buy-back, in whole or in part, or the cancellation, of the interest in the FLP.[Subsection 488(5)]

An issue to a person of a interest in a FLP is treated as an acquisition of the interest in the FLP by that person. [Subsection 488(6)]

The acquisition or disposal of an interest in a FLP does not take place when there has been an exchange of an interest in one FLP for another interest in a FLP of the same value. The crediting of a bonus on a life policy without the payment of consideration is not an acquisition of an interest in a FLP. [Subsection 488(7)]

Time of disposal or acquisition

If an interest in a FLP is acquired or disposed of under a contract, the time of making the contract is the time of acquisition or disposal. If there is no contract, the acquisition or disposal takes place when the change in ownership occurs. [Section 489]

Consideration for the acquisition or disposal of a FLP

Where inadequate or no consideration is given for the acquisition or disposal of an interest in a FLP, the law will deem that consideration equal to the market value of the interest in the FLP has been paid or received as the case may be. Consideration given is not treated as adequate if:

he amount given or received was greater or less than the market value of the interest; and
he acquisition or disposal was not at arm's length.[Section 490]

Distributions by a FLP

A distribution made under a FLP to the FLP policy holder is any amount paid or credited, or any property distributed in relation to the FLP to the person that constitutes income derived, or a receipt of capital by that person. A distribution by a FLP includes any payment to a person of a bonus or a refund of premium in respect of the FLP. [Section 474]

Meaning of ' notional accounting period of a FLP'

The foreign investment fund income (that which is to be included in the taxpayer's assessable income) is calculated for a ' notional accounting period' of the FLP.

A notional accounting period of a FLP will generally coincide with the taxpayer's year of income, being the period of 12 months ending on 30 June. [Subsection 487(2)]

If the FLP existed before 1 January 1993, then the first notional accounting period of the FLP commences on 1 January 1993 and ends on 30 June 1993. If the policy came into existence on or after 1 January 1993 then the first notional accounting period commences on the day on which it came into existence and ends on the following 30 June. [Subsection 487(7)]

Electing a notional accounting period

If the cash surrender values for an interest in a FLP are available on a day during the same month in each calendar year, then the taxpayer may elect that the end of the notional accounting period of the FLP coincides with the end of the month for which the cash surrender value is available on an annual basis. [Subsection 487(3)]

This election will generally need to be made if the taxpayer wishes to apply the cash surrender value method of taxation to the interest in the FLP.

If the taxpayer chooses to align the notional accounting period of the FLP with the end of the month for which the cash surrender values are available on an annual basis, the election will remain in force so long as the taxpayer has an interest in the FLP. [Subsection 487(4)]

When the taxpayer elects to use the period for which cash surrender values for the FLP are available, the first notional accounting period begins immediately after the end of the month in which the first cash surrender value is provided before the election day. The period ends at the end of the same month in the next calendar year being a month in which the next cash surrender value is provided. [Subsection 487(5)]

Example 1 Assume that the issuer of the FLP provides a cash surrender value for the taxpayer's interest in the FLP in October each year.The taxpayer is able to apply the cash surrender value method of taxation and on 1 April 1993 elects to change the notional accounting period of the FLP from his/her year of income to coincide with the month during which the cash surrender value of the interest in the FLP is provided.The notional accounting periods of the FLP are:

1)
January 1993 - 30 June 1993;
2)
July 1993 - 31 October 1993;
3)
November 1993 - 31 October 1994 and every year following.

notional accounting period reverting to year of income

If, following the making of an election to change the notional accounting period of a FLP, a cash surrender value is not available for the taxpayer during the appropriate month, the notional accounting period of the FLP will revert to the taxpayer's year of income. The period beginning on 1 July that is before the period of 12 months during which the cash surrender value is not available and ending on 30 June is a notional accounting period as is every following 12 month period. [Subsection 487(6)]

Example 2 Assume the taxpayer in Example 1 is unable to provide a cash surrender value during the month of October 1996. The following are the notional accounting periods of the FLP:

1)
November 1994 - 30 October 1995;
2)
November 1995 - 30 June 1996;
3)
July 1996 - 30 June 1997 and every year following.

Calculating the income attributable to a FLP

A taxpayer who has an interest in a FLP is required to calculate the foreign investment fund income from each interest in a FLP using either:

he deemed rate of return method; or
he cash surrender value method.

Electing the cash surrender value method

Generally, the deemed rate of return method will be applicable to a taxpayer's interest in a FLP. However, the taxpayer may elect to apply the cash surrender value method if the deemed rate of return method has not previously been applied to the taxpayer's interest in the FLP in respect of the notional accounting period. [Subsection 536(2)]

Electing for the cash surrender value method will also require the taxpayer to elect a notional accounting period for the FLP to coincide with the period for which the cash surrender values are available. [Subsection 536(3)]

An election to apply the cash surrender value method is irrevocable. [Subsection 536(5)]

It will, however, not be possible to apply the cash surrender value method when the taxpayer cannot provide cash surrender values for the beginning and the end of a notional accounting period. In this situation, the deemed rate of return method is applied as follows.

Method of taxation reverting to deemed rate of return

When reverting to the deemed rate of return method, following the application of the cash surrender value method, the tax treatment differs according to when the interest in the FLP was issued to the taxpayer.

(1) Interest in the FLP issued on or before 3 November 1992

If the FLP was issued on or before 3 November 1992, the deemed rate of return method is applied on the same basis as if the cash surrender value had never been applied for any previous notional accounting periods. The notional accounting period from which the deemed rate of return method is applied is determined according to those measures previously outlined in this chapter (see notional accounting period reverting to year of income). [Subsection 536(8)]

(2) Interest in the FLP issued after 3 November 1992

If the FLP was issued after 3 November 1992, the amount of foreign investment fund income that the taxpayer accrued under the cash surrender value method cannot be less than the amount that would have accrued if the deemed rate of return method had been applied for those periods. Accordingly, the following formula is applied to ascertain the amount, if any, by which the foreign investment fund income accrued to the taxpayer under the cash surrender value method should be increased in the year of change over to the deemed rate of return method. [Subsection 536(9)]

The notional FIF income - The actual FIF income

The notional FIF income means the amount of foreign investment fund income that would have accrued to the taxpayer if the deemed rate of return method had always applied.

The actual FIF income means the amount of foreign investment fund income that accrued to the taxpayer under the cash surrender value method.

Example Assume a taxpayer accrued foreign investment fund income of $150 (the actual FIF income) from the application of the cash surrender value for an interest in a FLP issued after the date of Introduction. Further, assume that the taxpayer could not provide a cash surrender value and is required to revert to the deemed rate of return. The taxpayer calculates that if the deemed rate of return method had always applied to the interest in the FLP, the foreign investment fund income that would have accrued is $200 (the notional FIF income).Accordingly, the foreign investment fund income that has accrued to the taxpayer under the cash surrender value method must be increased by $50 (that is, $200 - $150 = $50).

deemed rate of return method

Four steps are used in the deemed rate of return method. [Subdivision 18E]

he first step is to determine the number of 'interests' in a FLP the taxpayer has.
he second step is to determine the opening value of the taxpayer's interest in the FLP. Different procedures are adopted for determining the opening value which applies at the beginning of the FIF measures and for periods occurring after the start of the first notional accounting period.
he third step calculates the movement in the value of the taxpayer's interest in the FLP during the notional accounting period. This is known as the FIF amount.
he fourth step converts the FIF amount to Australian currency and determines the amount that will be included in the taxpayer's assessable income. The amount included in assessable income is called the FIF income.

Step 1 - Interests in a FLP

The first step is to ascertain whether the taxpayer had only one interest, or had two or more interests, in the FLP during the notional accounting period. If the taxpayer has two or more interests that were acquired at different times during the notional accounting period, then the deemed rate of return method is applied separately for each such interest for the period from when the acquisition occurred. [Section 585]

Step 2 - Calculating the opening value

This step determines the opening value of the FLP. If the taxpayer had the interest in the FLP at the beginning of the notional accounting period, the opening value is the value on the day before the first day of the period. [Paragraph 586(a)]

If the taxpayer acquired the interest in the FLP during the notional accounting period, the opening value is the value on the day on which the interest was acquired. [Paragraph 586(b)]

There are different methods to be applied for calculating the opening value at the beginning of the FIF measures and for later periods.

Special rule for calculating the opening value at the start of the FIF measures

For the beginning of the FIF measures, the opening value for a FLP is the amount the taxpayer would be given for surrendering the interest in the FLP on the commencement day of the FIF measures. However, the taxpayer may elect for the opening value of the interest in the FLP at the start of the FIF measures to be the cost of acquiring the interest in the FLP. [Section 588]

Calculating the opening value for later periods

When the deemed rate of return method has applied in the immediately previous year, the opening value is calculated as outlined in the following four steps:

Step one

Determine the deemed value of the FLP at the commencement of the previous notional accounting period;

Step two

Add the FIF income for the previous notional accounting period;

Step three

Add the value of any premiums paid during the previous notional accounting period; and

Step four

Deduct any distributions made by the FLP in the previous notional accounting period. [Section 590]

Opening value where the interest in the FLP was acquired during a notional accounting period

If the FLP was acquired during the notional accounting period, the value of the FLP is the cost to the taxpayer of the acquisition if the taxpayer has paid the full consideration for the FLP. In any other case, the value is the amount of the first premium paid. [Section 591]

Step 3 - Calculating the movement in the value of the FLP ( FIF amount)

Once the opening deemed value has been ascertained, the FIF amount (that is, the movement in the value of the FLP for the notional accounting period) is calculated by applying the following formula:

Opening value of interest x Deemed rate of return x (Number of days held / 365)

Opening value means the amount determined in Step 2.

Deemed rate of return means the rate of interest applicable in section 10 of the Taxation (Interest on Overpayments) Act 1983 for the taxpayer's year of income, increased by 4 percentage points.

If there is more than one interest rate the weighted average of those rates is used. The existing rate of interest on overpayments is 10 percent.

Number of days held means the number of days in the notional accounting period in which the taxpayer had the interest in the FLP.

Example 1 Assume that at the commencement date of the FIF measures an investor holds a FLP to the value of $HK250,000. Further, assume the statutory interest rate is 10 per cent.For the first year, under the deemed rate of return method it will be necessary to multiply the opening value by the deemed rate of return as follows.

$HK250,000 x (10% + 4%) x (181/365) = $HK17,356

The FIF amount for the FLP will be $HK17,356.

Example 2 Assume a second premium of $HK10,000 is paid in respect of the FLP in the previous example 200 days into the FLP's first notional accounting period. This premium will be added to the opening value for the previous notional accounting period plus the FIF amount to get the opening value of the FLP for the next period as follows:

$HK250,000 + $HK17,356 + $HK10,000 = $HK277,356

Step 4 - Determining the amount to be included in assessable income ( FIF income)

The final step in applying the deemed rate of return method is to determine the amount attributed to the taxpayer, that is, the FIF income. To do this the FIF amount (as calculated in step 3) is converted to the corresponding amount in Australian currency. The rate of exchange that applied at the end of the notional accounting period is used to convert each amount of FIF income to the corresponding amount in Australian currency. [Sections 593 and 594]

Example 3 In the above example assume there is an exchange rate of $A1.00 = $HK5.00.Accordingly, the FIF income for the FLP would be:

$HK17,356/5 = $A3,471

FIF income is $A3,471.

cash surrender value method

This method of determining whether any foreign investment fund income accrues to a taxpayer from an interest in a FLP is applied by taking into account changes in the cash surrender value of the interest in the FLP.

The amount attributed to the taxpayer under the cash surrender value method is calculated in two steps.

he first step measures the foreign investment fund amount, which takes into account the movement in the cash surrender value of the taxpayer's interest in the FLP.
f there was a cash surrender value increase, the second step calculates the amount to be included in the assessable income of the taxpayer.

The cash surrender value method applies if it is practicable to ascertain the cash surrender value of the interest of a taxpayer in a FLP. [Subsection 595(1)]

Step 1 - Calculating the movement in the cash surrender value of the interest in the FLP

The movement in the cash surrender value of the taxpayer's interest in the FLP, that is, the foreign investment fund amount, is calculated by applying the following five applications. [Section 596]

First application

Determine the cash surrender value of the taxpayer's interests in the FLP at the end of the notional accounting period.

The currency used for the cash surrender valuation on this first application is to be used for the amount ascertained in each of the following four applications.[Subsection 596(3)]

Second application

Add the amount or value of each distribution (if any) for the interest in the FLP that was made to the taxpayer during the notional accounting period.

Third application

If the taxpayer disposed of any interest in the FLP during the notional accounting period, add the value of any distributions by the FLP in respect of the interests andthe proceeds of any interests in the FLP which the taxpayer disposed of during the notional accounting period.

Fourth application

Deduct the opening cash surrender value of the interests at the commencement of the notional accounting period (this is the same as the value at the end of the previous notional accounting period).

Fifth application

Deduct the cost of any interests in the FLP which the taxpayer acquired during the notional accounting period.

The aggregate of these five applications will give the foreign investment fund amount.

Example 1 Assume the opening cash surrender value of an interest in a FLP was HK$50,000, and at the end of the notional accounting period the closing value of the interest was HK$53,000. There were no acquisitions, disposals or distributions during the notional accounting period. The increase in cash surrender value, the FIF amount, would be HK$3,000.

Example 2 Assume the opening value of a FIF interest was HK$50,000, and at the end of the notional accounting period the closing value of the interest was HK$45,000. There were no acquisitions, disposals or distributions during the accounting period. The decrease in cash surrender value, the FIF amount, would be a FIF loss of HK$5,000.

Gross FIF income

If the foreign investment fund amount is positive, the amount represents the gross foreign investment fund income. [Section 598]

FIF loss

If the foreign investment fund amount is negative a FIF loss has occurred. [Section 599]

This FIF loss may be used to offset assessable income of the taxpayer but only to the extent that the taxpayer has previously been subject to foreign investment fund taxation from the income of that FIF. [Section 533]

Special rule for determining the cash surrender value at the start of the FIF measures

At the start of the FIF measures, 1 January 1993, a cash surrender value for the day preceding the first day (31 December 1992) may not be available.

If this is the case, the taxpayer must use as the opening value for the notional accounting period the average of two cash surrender values. These two values must not be greater than 12 months apart and refer to the values on:

he latest day on which a cash surrender value is available prior to 31 December 1992; and
he earliest day on which a cash surrender value is available after 31 December 1992.[Section 597]

Step 2 - Calculating the amount included in assessable income

The second step is to determine the amount to be included in the assessable income of the taxpayer- the FIF income. [Subsection 600(1)]

The FIF income is calculated by subtracting from the gross FIF income the total of any 'unapplied previous FIF losses'. [Subsection 600(2)]

If the result is positive the FIF income is converted to Australian dollars at the rate of exchange applicable at the end of the notional accounting period and that FIF income is included in the taxpayer's assessable income. [Subsections 600(3) and (4) ]

Meaning of 'unapplied previous FIF losses'

The meaning of any 'unapplied previous FIF losses' is the amount by which the undeducted amount of a foreign investment fund loss exceeds the sum of any gross FIF income applying to a taxpayer's interest in a FLP, regardless of whether the operative provision did not apply because of any of Divisions 2 to 9 and 11 to 15. [Subsection 600(5)]

In calculating the unapplied previous FIF losses, the undeducted amount of a FIF loss is so much of a FIF loss that has not been allowed as a deduction from the assessable income of the taxpayer. [Subsection 600(6)] Once a FIF loss has been used in ascertaining if there was, for any notional accounting period, an unapplied previous FIF loss, then that loss cannot be taken into account again for the purposes of ascertaining an unapplied previous FIF loss for later notional accounting periods. [Subsection 600(7)]

Also, in determining the gross FIF income that is used in calculating the unapplied previous FIF losses, only that gross FIF income accruing after the notional accounting period in which the loss was incurred and before the current notional accounting period in which the taxpayer has a gross FIF income is applied. [Subsection 600(6)]

Record keeping

For an explanation of the procedure to be followed for keeping records see Chapter 23.

Reduction of FIF Income for Distributed Profits

Overview

This Chapter will describe how the amount of FIF income to be included in a taxpayer's assessable income for a notional accounting period of a FIF will be reduced to take account of a distribution of income made by the FIF to that taxpayer during that notional accounting period.

Background

Where a FIF makes a distribution of income during a notional accounting period of the FIF, the attributable taxpayer would, in the absence of specific rules to provide relief, be taxable on the taxpayer's share of the distribution as well as on a share of the FIF income. Section 530 ensures that such double taxation will not arise by reducing the amount of the attributable income of the FIF for that period.

Explanation

The amount of FIF income for a notional accounting period of the FIF that is to be included in the assessable income of a taxpayer under the FIF measures for a year of income is to be reduced by the amount of income distributed by the FIF to the taxpayer during the notional accounting period. The amount to be included under the FIF measures is to be reduced to the extent that the payment was included in the taxpayer's assessable income or was exempt under section 23AJ [subsection 530(1)]. The amount of the reduction of FIF income which is available under subsection 530(1) cannot exceed the amount which would otherwise be included in the taxpayer's assessable income under section 529.

Example A taxpayer, Ms Thompson, had an interest in a FIF at the end of her year of income and her interest was not exempt from the FIF measures. Ms Thompson used the market value method to determine the amount to be included in her assessable income under the FIF measures for the notional accounting period of the FIF that ended in her year of income. The FIF income calculated under that method was $20,000. The FIF paid an assessable dividend of $10,000 to her on the last day of the FIF's notional accounting period.Normally, Ms Thompson's FIF income would be $20,000. However, because of subsection 530(1), her FIF income is reduced by the amount of the dividend - that is, from $20,000 to $10,000. The $10,000 dividend would also be included in her assessable income.A reduction will also be made where the taxpayer has had an amount included in assessable income under section 457. This only applies where the FIF was previously a CFC (refer to Chapter 26 for a description of the operation of 457). [Subsection 530(2)]

Attribution accounts - General

Overview

This chapter deals with the prevention of potential Australian double taxation that could arise where, after having been subject to FIF taxation under these measures, a taxpayer later:

eceives a distribution of income and/or gains from a FIF of FLP; or
isposes of the interest in a FIF or FLP.

The system of attribution accounts described in this chapter is similar in its operation to the CFC attribution accountsystem in Divisions 4 and 5 of Part X of the Principal Act.

The Chapter does not deal with cases where the FIF measures apply in the calculation of the attributable income of a CFC under existing Part X, or the calculation of the net income of a foreign trust for the purposes of the existing Division 6 or Division 6AAA of the Principal Act. These cases are dealt with in Chapters 25, 26 and 27.

Background to the taxation of distributions

Taxation of dividends received from foreign companies

Under the Principal Act, a dividend paid by a foreign company directly to a resident taxpayer is generally included in the assessable income of the taxpayer. The three exceptions to this rule are:

ividends paid to any taxpayer where the dividend is paid out of profits that have been previously attributed to that taxpayer under the CFC measures;
ividends paid by a company resident in a listed country to an Australian company that has a non-portfolio interest (with at least 10 per cent of the voting interest) in the foreign company; and
ividends paid by a company resident in an unlisted country to an Australian company that has a non-portfolio interest in the foreign company. This applies only to the extent that the dividend is paid out of profits that have been taxed in Australia or are comparably taxed in a listed country.

Taxation of distributions from foreign trusts

Under the Principal Act, the foreign income and gains of a foreign trust may be taxed when:

taxpayer is presently entitled to a share of the net income of the trust estate; or
n amount is paid to the taxpayer or applied for the benefit of the taxpayer out of certain income of the trust of the current, or a previous, year of income that has not been subject to Australian tax by assessment.

Objectives of the legislation

Relief from double taxation

(i) Exemption of distributions

A distribution made by a FIF or FLP to a taxpayer will be exempt to the extent that the distribution was paid out of profits which were previously attributed to the taxpayer.

(ii) Reduction of consideration on disposal of a FIF interest

The disposal consideration of a taxpayer's interest in a FIF or FLP will be reduced by the amount of any profits retained in the FIF or FLP at the time of disposal that have been previously included in the assessable income of the taxpayer under the FIF measures.

(iii) Adjustments in relation to FIF losses that have been used to reduce other assessable income

The amount of the previously taxed profits of a FIF or FLP that are available to exempt distributions from the FIF or FLP or to adjust the consideration on disposal the FIF or FLP interest are to be reduced to the extent that any FIF or FLP losses were used by the taxpayer to offset other assessable income.

FIF attribution accounts

For the purposes of (i), (ii) and (iii) above, a taxpayer will need to keep records of:

ncome attributed to the taxpayer from a FIF or FLP;
ncome distributed to the taxpayer by a FIF or FLP either directly or through interposed entities;
he amount of any reduction of consideration the taxpayer can claim on disposal of an interest in the FIF or FLP; and
he amount of any deduction the taxpayer claims because of a FIF loss.

These records are called " FIF attribution accounts".

FIF attributed tax accounts

In addition to FIF attribution accounts, taxpayers who have claimed a foreign tax credit at the attribution stage (only certain taxpayers using the calculation method to determine the FIF income of a FIF will be able to do this) for tax paid by the FIF will need to maintain " FIF attributed tax accounts". These accounts are maintained in order that the foreign tax credit that is normally allowed on a distribution of profits which have been subject to tax under the FIF measures is reduced by the tax credit which the taxpayer was able to claim when those profits were attributed to the taxpayer.

Explanation

Terminology

Explanations of the terms " FIF attribution accountpayment", " FIF attribution surplus", " FIF attribution credit", " FIF attribution debit" and " FIF attribution accountpercentage" used in relation to FIF attribution accounts are given below.

FIF attribution accountpayments

FIF attribution accountpayments include:

a)
dividend paid by a company to a shareholder;
b)
n amount of interest paid to the noteholder on a convertible note;
c)
partner's share of the net income of a partnership of the year of income;
d)
beneficiary's share of the net income of a trust estate of the year of income;
e)
n amount included in the assessable income of a beneficiary under section 99B during the year of income in relation to a distribution made by a trust estate;
f)
n amount of the income, profits or gains of the trust estate on which the trustee would be assessable under section 99 or 99A; and
g)
payment made by the person who issued a FLP to a person who has an interest in the FLP. [Section 603]

When are FIF attribution accountpayments made?

To calculate the taxpayer's exemption, the taxpayer will also need to know when the FIF attribution accountpayments are taken to have been made. The following table sets out:

he types of FIF attribution accountpayments that can occur along the chain of entities between the FIF and the taxpayer;
he entities that are treated as making and receiving a FIF attribution accountpayment; and
he time when the payment is taken to be made.

Timing of FIF attribution payments

Type of payment Entity making payment Entity receiving payment Time of payment
Dividend Paying company Shareholder Date of dividend
Interest paid on a covertible note Paying company Note holder Date of interest payment
Partner's share of net income of a partnership Partnership Partner End of income year of p'ship
Share of net income of a trust estate equal to the beneficiary's present entitlement trust beneficiary End of income year of trust
Whole or part of net income of trust estate assessable to trustee (s99 or 99A) trust trustee End of income year of trust
Other distribution of accumulated trust income (if liable to Aust tax if beneficiary was a resident) trust beneficiary End of income year in which distribution was made

FIF attribution surplus

The surplus in a FIF attribution accountat the time of a FIF attribution accountpayment is the excess of the credits (called ' FIF attribution credits') over the debits (called ' FIF attribution debits') in that account. [Section 604]

FIF attribution credits

A FIF attribution credit arises for a taxpayer if an amount is included in the taxpayer's assessable income under the FIF measures in relation to a FIF or FLP.

A FIF attribution credit will also arise for a FIF attribution account entity (that is, a company that is not a resident of Australia, a partnership, a trust or a FLP [section 601] ) in relation to a taxpayer if it receives a FIF attribution accountpayment which gives rise to a FIF attribution debit for another FIF attribution account entity in relation to the taxpayer. [Paragraph 605(1)(d)]

Normally, the amount of the FIF attribution credit is equal to the amount included in the assessable income of the taxpayer under the FIF measures or the amount of the FIF attribution debit which arises for the other FIF attribution account entity [subsection 605(2)]. Special rules apply for determining the amount of the FIF attribution credit which arises where the taxpayer holds an interest in a FIF or FLP through an Australian partnership or Australian trust or if the taxpayer uses the calculation method to determine the foreign investment fund income of a FIF which has an interest in another FIF or FLP. These special rules are discussed later.

FIF attribution debits

A FIF attribution debit arises for a FIF attribution account entity in relation to a taxpayer where:

he entity makes a FIF attribution account payment to the taxpayer or to a FIF attribution account entity in which the taxpayer has an interest; and
mmediately before the payment is made, the entity making the FIF attribution accountpayment has a FIF attribution surplus in relation to the taxpayer. [Subsection 606(1)]

The FIF attribution debit arises when the FIF attribution accountpayment was made [subsection 606(3)]. The amount of the FIF attribution debit is the lesser of the FIF attribution surplus and:

f the FIF attribution accountpayment was made to the taxpayer, the FIF attribution accountpayment; or
n any other case, the taxpayer's FIF attribution accountpercentage of the FIF attribution accountpayment. [Subsection 606(2)]

FIF attribution accountpercentage

A taxpayer's FIF attribution accountpercentage in a FIF attribution account entity is the interest the taxpayer has directly or indirectly through one or more interposed FIF attribution accountentities in the income or profits of the entity. [Section 602]

FIF attribution accounts specific to each taxpayer

The FIF attribution accountmaintained by the taxpayer for a FIF or FLP is specific to the taxpayer. For instance, if a taxpayer sells the shares comprising the taxpayer's interest in a FIF, the taxpayer cannot transfer the FIF attribution accountsurplus to the purchaser of the shares. Consequently, the purchaser of the shares cannot use the vendor's FIF attribution surplus to receive exempt distributions from the FIF.

Examples showing the operation of FIF attribution accounts where a taxpayer holds an interest in a FIF directly

Example 1 Assume that a resident individual (Ms Smith) has an interest in a foreign company (Forco) that is not a CFC. Forco's notional accounting period ends on 30 June, as does the taxpayer's year of income. In the year ended 30 June 1994, Ms Smith had FIF income in respect of Forco of $5,000. The $5,000 would be included in Ms Smith's assessable income under section 529.In this case, Ms Smith will be exempt in respect of the next $5,000 of dividends paid by Forco. To achieve this, Ms Smith would credit the FIF attribution accountin respect of Forco with the $5,000 at the end of the notional accounting period of Forco as follows:

Ms Smith's FIF attribution account(Forco)
30.6.94 Attribution $5,000

Example 2 Assume that in the year ended 30 June 1995, Ms Smith's FIF income in respect of the interest in Forco was $4,000 and that on 31 December 1994, Forco paid a dividend of $3,000 to Ms Smith.The dividend is a FIF attribution accountpayment at the time the dividend is paid. Ms Smith would debit the FIF attribution accountin respect of Forco with the $3,000 at the time the dividend was paid as follows:

Ms Smith's FIF attribution account(Forco)
31.12.94 Dividend $3,000 30.6.94 Attribution $5,000
The $3,000 dividend received by Ms Smith would be exempt income. The $4,000 FIF income in respect of Ms Smith's interest in the FIF would be included in her assessable income under section 529. Ms Smith would credit the FIF attribution accountin respect of Forco with $4,000 at the end of the notional accounting period of Forco as follows:
Ms Smith's FIF attribution account(Forco)
31.12.94 Dividend $3,000 30.6.94 Attribution $5,000
30.6.95 Attribution $4,000

Example 3 Assume that on 30 June 1996, Forco paid a dividend to Ms Smith of $7,000 and that there was no FIF income in that year. Ms Smith would debit the FIF attribution accountwith $6,000 (the lesser of the dividend and the surplus in the account) at the time the dividend was paid.

Ms Smith's FIF attribution account(Forco)
31.12.95 Dividend $3,000 30.6.94 Attribution $5,000
balance $6,000 30.6.95 Attribution $4,000
30.6.96 Dividend $6,000 31.12.95 Surplus $6,000
The excess of the amount of the dividend over the amount debited to the FIF attribution account($1,000) would be included in Ms Smith's assessable income.

Attribution to an Australian partnership or trust

It could also be the case that the taxpayer was a beneficiary of an Australian trust or a partner in an Australian partnership and the FIF income was attributed indirectly to the taxpayer because of the interest in the partnership or trust.

As mentioned, the FIF attribution accounts are specific to a particular taxpayer. In line with this treatment, where the FIF or FLP attribution is to an Australian partnership or an Australian trust, the FIF attribution credit does not attach to the partnership or the trust. Instead, the FIF attribution credit attaches to the person paying the tax - that is, the partner, the beneficiary or the trustee (as the case may be). Where there are multiple trusts or a chain of partnerships and trusts, the credit attaches to the person who ultimately pays the tax. [Subsection 605(8)]

This is achieved using the concept of a 'tax detriment'. A tax detriment is the effect on the assessable income of a person of the inclusion of an amount in the net income of an Australian partnership or an Australian trust. [Section 478]

Where there is such a tax detriment, a FIF attribution credit that arises because of FIF or FLP attribution does not arise to the Australian partnership or the Australian trust [subsection 605(8)]. The credit will instead arise to the partner, beneficiary or trustee and it will arise at the same time that the credit would have arisen to the partnership or trust. [Paragraph 605(8)(d)]

The above treatment does not apply to:

a)
esident public unit trusts; and
b)
esident trusts that are not subject to the general trust provisions in Division 6 of the Principal Act - that is, corporate unit trusts, public trading trusts and eligible entities within Part IX of the Act.[Subsection 605(11)]

For these trusts, the trustee receives the FIF attribution credit rather than the beneficiaries.

When the FIF or FLP subsequently makes a distribution to the Australian partnership or Australian trust, the taxpayer debits the FIF attribution accountby the taxpayer's share of that distribution. That share is worked out by multiplying the amount of the distribution by the taxpayer's FIF attribution percentage in the Australian partnership or trust receiving the distribution. The FIF attribution percentage is the percentage of the taxpayer's entitlement to the income or profits of the Australian partnership or Australian trust.

FIF Attribution credits for partners and beneficiaries

Person with detriment Why tax detriment occurs Person with credit Amount of credit
A partner The taxpayer's share of the net income of a partnership increases because of the inclusion of FIF income. That partner The amount of the increase
A partner The taxpayer's share of the net loss of a partnership decreases because of the inclusion of FIF income. That partner The amount of the decrease
A partner The taxpayer changes from having a share of the net loss of a partnership to having a share of the net income of a partnership. That partner The sum of the reduction in the share of the net loss and the increase in the share of the net income.
A beneficiary The amount included in the beneficiary's assessable income increases because of the inclusion of FIF income in the calculation of the net income of the trust. That beneficiary The amount of the increase.
The trustee The amount on which the trustee was assessed increases because of the inclusion of the FIF income in the calculation of the net income of the trust. The trustee The amount of the increase.

Example of the operation of FIF attribution accounts where a taxpayer holds an interest in a FIF through a trust

Example 4 Assume two residents, Mr and Mrs Smith, are equal beneficiaries in a trust (Austrust) that is a resident of Australia. The trust deed gives the beneficiaries present entitlement, in equal proportions, to Austrust's income. Assume that Austrust has an interest in a foreign company (Forco) that is not a CFC. Forco's notional accounting period ends on 30 June, as do Austrust's and Mr and Mrs Smith's years of income. In the year ended 30 June 1994, Austrust had FIF income in respect of Forco of $5,000, plus other income of $2,000. The trust incurred no expenses. In addition to the $2,000 other income, the $5,000 FIF income from Forco would be included in the calculation of Austrust's net income under section 95 of the Principal Act. The assessable income of each of Mr and Mrs Smith would include $3,500 in respect of Austrust, being half of the net income of $7,000. There is a tax detriment for Mr and Mrs Smith by virtue of FIF income being included in the calculation of Austrust's net income.In this case, Mr and Mrs Smith will each be exempt in respect of the next $2,500 of dividends paid by Forco. There would be no FIF attribution credit for Austrust in respect of the FIF.In order to gain the exemption for subsequent distributions, Mr Smith would credit his FIF attribution accountin respect of Forco with the $2,500 as follows:

Mr Smith's FIF attribution account(Forco)
30.6.94 Attribution $2,500
(Note that a similar set of accounts would be kept by Mrs Smith.)

Assume that in year two, Austrust had no FIF income and that during the second notional accounting period, Forco paid a dividend of $3,000 to Austrust on 31 December 1994. The trust had no other income or deductions.

The dividend would give rise to a FIF attribution accountpayment at the time the dividend is paid. Mr Smith would debit the FIF attribution accountin respect of Forco with his share of the dividend - that is, the amount calculated by multiplying the dividend paid by Forco by Mr Smith's FIF attribution accountpercentage in Austrust. The result will be a debit of $1,500 (50% x $3,000) as follows:

Mr Smith's FIF attribution account(Forco)
31.12.94 Dividend $1,500 30.6.94 Attribution $2,500

Mr Smith would also open a FIF attribution accountfor Austrust as follows:

Mr Smith's FIF attribution account(Austrust)
31.12.94 Dividend $1,500

In calculating the net income of Austrust, the dividend would be included in that calculation - that is, the net income of Austrust would be $3,000 (assuming that it did not derive any other income).

Mr Smith's share of that net income would be $1,500. This amount is a FIF attribution accountpayment from Austrust to Mr Smith. Therefore, Mr Smith would, at the end of the Austrust's year of income, debit his FIF attribution accountfor Austrust by the lesser of the payment and the surplus as follows:

Mr Smith's FIF attribution account(Austrust)
30.6.95 Share of net income 1,500 31.12.94 Dividend $1,500

In determining the amount to be included in Mr Smith's assessable income, the share of the net income of Austrust ($1,500) would be reduced by the amount of the debit to his FIF attribution accountfor Austrust ($1,500). In respect of Austrust, no amount would be included in assessable income.

FIF attribution credit for FIF income where a FIF has an interest in another FIF

Under the calculation method, an interest held by a FIF (the interposed FIF) in another FIF or FLP is taken into account when calculating the notional income of the interposed FIF. A FIF attribution credit may arise for an interposed FIF in relation to a taxpayer because an amount of FIF income is included in a taxpayer's assessable income under section 529. To the extent that the credit arises as a result of the interposed FIF's interest in another FIF or a FLP, the credit will be made to the FIF attribution accountof the other FIF or the FLP [subparagraph 605(1)(b) and subsection 605(3)]. The credit will arise at the end of the notional accounting period of the other FIF or the FLP. [Paragraph 605(7)(b)]

A formula is provided for determining the amount of the FIF attribution credit which will arise for the FIF or FLP (the "eligible entity") held by the interposed entity under paragraph 605(1)(b) [subsection 605(3)]. The formula helps to determine how much of the FIF income included in a resident taxpayer's assessable income comes from the lower tier FIF or FLP. The formula is as follows:

(FIF income x Section 529 amount) / Notional income
In the formula:

' FIF income' means the amount of the foreign investment fund income of a FIF which is referable to an interest held in the eligible entity;
'Section 529 amount' means the amount included in the taxpayer's assessable income under the FIF measures in relation to the FIF which has an interest in the eligible entity;
' Notional income' means the notional income of the FIF which has an interest in the eligible entity.

The above formula is to be applied to each FIF or FLP in which the interposed FIF has an interest. Further, the FIF attribution credit which would otherwise arise for the interposed FIF under paragraph 605(1)(a) is to be reduced by the sum of the amounts of the FIF attribution credits which arise under subsection 605(3) for FIFs and FLPs in which the interposed FIF has an interest. [Subsection 605(5)]

Example 5 A resident company taxpayer (Ausco) has a 10 per cent interest in FIF1 and FIF1 has a 25 per cent interest in FIF2.Assume that Ausco uses the calculation method to determine the FIF income of FIF1. Under that method, FIF1 is calculated to have derived $50,000 profits, not including an increase in the unrealised value of its shares in FIF2 of $100,000. Assuming Ausco uses the market value method to calculate FIF1's interest in FIF2, the FIF income of FIF1 will be $150,000 ($50,000 + $100,000).Consequently, Ausco will be taxed under the FIF measures on its share of the $150,000 profits of FIF1, that is, $15,000 (10% x $150,000). Calculation of the FIF attribution credit which arises for FIF2 The FIF attribution credit which arises for FIF2 in relation to the Ausco is calculated as follows:

$100,000 (FIF2 income) x $15,000 (Section 529 amount) / $150,000 (Notional income) = $10,000

This formula is used to calculate how much of the amount included in Ausco's assessable income because of its interest in FIF1 is referable to FIF1's interest in FIF2. Calculation of the FIF attribution credit which arises for FIF 1 The FIF attribution credit which arises for FIF1 in relation to Ausco would be $15,000 if not for the FIF attribution credit which arises for FIF2. However, FIF1's FIF attribution credit is to be reduced by the amount of the credit which arose for FIF2. Consequently, only a FIF attribution credit of $5,000 (that is, $15,000 - $10,000) will arise for FIF1 in relation to Ausco.

FIFs held by a second tier FIF

Separate FIF attribution accounts are required to be maintained by a taxpayer for each FIF or FLP held by the taxpayer through a second tier FIF if the calculation method is used to determine the attributable income of the second tier FIF.

These accounts are required to allocate the FIF income that was included in the taxpayer's assessable income to the different FIFs or FLPs in the chain of FIFs and FLPs.

An attribution credit will arise for a FIF or FLP (referred to in section 605 as the "eligible entity") if all of the following conditions are satisfied:

i)
n amount was included in a taxpayer's assessable income under section 529 ("the section 529 amount") in relation to a FIF ("the first tier FIF"); [Subparagraph 605(1)(c)(i)]
ii)
hat amount is referable to another amount which was included in the notional income of the first tier FIF under section 576 because the first tier FIF had an interest in another FIF attribution account entity ("the second tier FIF"); [Subparagraph 605(1)(c)(ii)]
iii)
he section 576 amount was calculated by reference to an amount that under section 579 ("the section 579 amount") was included in the notional income of the second tier FIF because the second tier FIF had an interest in the eligible entity (that is, the FIF or FLP for which the FIF attribution credit will arise under paragraph 605(1)(c)). [Subparagraph 605(1)(c)(iii)]

The diagram on the next page illustrates the entities in a chain of FIFs to which the terms used in paragraph 605(1)(c) relate.

Terms used in paragraph 605(1)(c)

Amount of credit arising for the eligible entity

The following formula is to be used to determine the amount of the FIF attribution credit which will arise for the eligible entity under paragraph 605(1)(c): [Subsection 605(4)]

FIF income x Section 529 amount / Notional income of the first tier FIF
In the formula:

" FIF income" means the amount worked out using the formula:

Section 579 amount x Section 576 amount / Notional income of the second tier FIF
where:

"Section 579 amount" means the amount included in the notional income of the second tier FIF under section 579 because of an interest it holds in the eligible entity;
"Section 576 amount" means the amount included in the notional income of the first tier FIF under section 576 because of the interest it holds in the second tier FIF;
"Notional income of the second tier FIF" means the notional income of the second tier FIF for the notional accounting period of the second tier FIF that was used in calculating the section 576 amount;

"The section 529 amount" means the amount included in the taxpayer's assessable income under section 529 because the taxpayer has an interest in the first tier FIF;
"Notional income of the first tier FIF " means the notional income of the first tier FIF for the notional accounting period of the first tier FIF which ends during the taxpayer's year of income.

This formula will apply to each FIF or FLP in which the second tier FIF has an interest. Further, the FIF attribution credit which would otherwise arise for the second tier FIF under paragraph 605(1)(b) is to be reduced by the sum of the FIF attribution credits which arise for the entities in which it has an interest. [Subsection 605(6)]

Example 6 Assume that a resident taxpayer (Ms Gray) has a 5 per cent interest in a first tier FIF ( FIF1) which has a 25 per cent interest in a second tier FIF ( FIF2) which in turn has an interest in another FIF ( FIF3). The calculation method is used for FIF1 and FIF2.During the relevant period, FIF1 does not derive any income whereas FIF2 derives $10,000 income. In addition, under the market value method, FIF2 is taken to have derived $20,000 FIF income from FIF3. Also assume that FIF2 has a past calculated loss of $10,000. (i) Calculation of the amount to be included in Ms Gray's assessable income because of her interest in FIF 1 FIF2 has notional income of $30,000 (that is, $10,000 + $20,000 (section 579 amount)). FIF2's calculated profit would be $20,000 (that is, $30,000 less its past calculated loss of $10,000). FIF1's notional income will include $5,000 (25% x $20,000) FIF income under section 576, being its share of FIF2's calculated profit. The calculated profit of FIF1 would be $5,000.Ms Brown's assessable income would include an amount of $250 (that is, 5% x $5,000) under the FIF measures as a result of her interest in FIF1. (ii) FIF attribution credits FIF 3 FIF3's " FIF income" (a component used in the formula for determining the FIF attribution credit which arises for FIF3 in relation to Ms Gray) would be calculated using the following formula:

Section 579 amount x Section 576 amount / Notional income of the second tier FIF
FIF3's "FIF income" = ($20,000 x $5,000) / $30,000 = $3,333.33

This result indicates that of the $5000 of FIF2's income that is included in FIF1's income, $3,333.33 is referable to FIF2's interest in FIF3.The FIF attribution credit which would arise for FIF3 in relation to Ms Gray is calculated using the following formula:

FIF income x Section 529 amount / Notional income of the first tier FIF

This formula is used in calculating the part of the FIF income included in Ms Gray's assessable income that can be attributed to FIF3.

FIF3's FIF attribution credit = ($3,333.33 x $250) / $5,000 = $166.66

FIF 2 If FIF2's notional income was $30,000 without including FIF3's income, the FIF attribution credit which would arise for FIF2 in relation to Ms Brown would be calculated using the formula:

FIF2 income included in FIF income x Section 529 amount / Notional income of FIF1
= ($5,000 x $250) / $5,000 = $250

This amount must be reduced by the amount of the FIF attribution credit which would arise for FIF3. Consequently, a FIF attribution credit of $83.34 ( that is, $250 - $166.66) would arise for FIF2 in relation to Ms Gray. FIF1 Normally a FIF attribution credit of $250 would arise for FIF1 in relation to Ms Gray. However, this credit must be reduced by the amount of the unmodified credit which would arise for FIF2 [subsection 605(3)] . Consequently, the FIF attribution credit which arises for FIF1 is nil (that is, $250 - $250).

FIF attributed tax accounts

Overview

FIF attributed tax accounts ensure that a credit a taxpayer can claim for foreign tax paid by a FIF when an amount is included in the taxpayer's assessable income under the FIF measures cannot be claimed again by the taxpayer when the taxpayer receives a distribution from the FIF. In other words, they ensure that a taxpayer cannot claim a foreign tax credit twice in relation to the same amount of foreign tax paid by a FIF.

Broadly, the circumstances where a taxpayer will need to maintain FIF attributed tax accounts are where:

he taxpayer uses the calculation method for determining the amount to be included in the taxpayer's assessable income under the FIF measures; and
either:
he FIF is a company which is related to the company taxpayer [Section 160AFCE/Section 160AFCF] ; or
he taxpayer is a beneficiary of a FIF which is a trust estate [Section 160AFCG/Section 160AFCH] .

The system for the maintenance of FIF attributed tax accounts parallels that for FIF attribution accounts described earlier in this Chapter. When income which has been previously attributed is distributed to a taxpayer, the foreign tax credit the taxpayer can claim is initially calculated on the basis that no foreign tax credit was allowed for foreign tax paid on the attributed income at the time it was attributed. The foreign tax credit calculated in this way is then reduced by the foreign tax credit allowed at the time the attributable income of the FIF was included in the assessable income of the taxpayer.

The FIF attributed tax accounts trace the foreign tax credit that was allowed at the attribution stage so that this reduction may be made. The purpose of FIF attributed tax accounts is to determine the formula component "AT" in section 160AFCJ (refer to the notes on section 160AFCJ in chapter 22). Formula component "AT" is deducted from the foreign tax credit referable to the distribution of profits which have been subject to tax under the FIF measures.

Where a taxpayer's share of the attributable income of a FIF is attributed to the taxpayer and credited ( FIF attribution credit) to the taxpayer's FIF attribution accountfor the FIF, the FIF attributed tax account for that FIF is also credited with a corresponding amount of foreign tax if the taxpayer can claim a credit in relation to the amount attributed.

When the FIF makes a FIF attribution accountpayment, the payment is debited ( FIF attribution debit) to the relevant FIF attribution account, and the corresponding FIF attributed tax account is debited with an amount representing the foreign tax attributable to the FIF attribution debit.

As in the case of FIF attribution accounts, the amount of the debit to a FIF attributed tax account cannot exceed the amount standing to the credit of the account (referred to as the FIF attributed tax account surplus) at the time of the FIF attribution accountpayment. The surplus represents, at a particular time, the maximum amount of foreign tax that relates to the income already attributed to the taxpayer.

FIF attributed tax account surplus

An attributed tax account surplus will exist at a particular time for a FIF if the total of the FIF attributed tax account credits for the FIF to that time exceed the total of the FIF attributed tax account debits for the FIF up to that time. [Section 608]

FIF attributed tax account credit

This provision is required to ensure that a taxpayer cannot claim a foreign tax credit twice in respect of the same amount of foreign tax paid by a FIF.

A FIF attributed tax account credit arises for a FIF in relation to a taxpayer where:

company is taken under section 160AFCE or section 160AFCF to have paid and to have been personally liable for an amount of foreign tax paid by a related company FIF on an amount included in the company's assessable income under the FIF measures; or
taxpayer is taken under section 160AFCG or section 160AFCH to have paid and to have been personally liable for an amount of foreign tax paid by a trust estate on an amount included in the taxpayer's assessable income under the FIF measures. [Subsections 609(1) and 610(1)]

A FIF attributed tax account credit only arises for the foreign tax paid by the FIF and not for Australian tax paid.

The amount of the FIF attributed tax account credit that arises for a FIF is equal to the amount of foreign tax that the taxpayer is taken to have paid under section 160AFCE, 160AFCF, 160AFCG or 160AFCH [subsections 609(2) and 610(2)] . The FIF attributed tax account credit arises for a FIF at the end of the FIF's notional accounting period. [Subsections 609(3) and 610(3)]

FIF attributed tax account credit flowing through more than one FIF

A FIF attributed tax account credit will arise for a FIF attribution account entity which receives a FIF attribution accountpayment from another FIF attribution account entity. The amount of the FIF attributed tax account credit is to equal the FIF attributed tax account debit which arises for the other FIF attribution account entity as a result of making the relevant FIF attribution accountpayment. [Section 611]

Attributed tax account debit

A FIF attributed tax account debit may arise for a FIF in relation to a taxpayer where:

he FIF makes a FIF attribution accountpayment to the taxpayer or to a FIF attribution account entity; and
he FIF attribution accountpayment gives rise to a FIF attribution debit for the FIF in relation to the taxpayer. [Subsection 612(1)]

The FIF attributed tax account debit is calculated by using the following formula:

(FIF attribution debit x FIF attributed tax account surplus) / FIF attribution surplus
[Subsection 612(2)]Where:

FIF attribution debit means the amount of the FIF attribution debit which arises for the FIF on making the FIF attribution accountpayment.
FIF attribution surplus means the amount of the FIF attribution surplus for the FIF making the FIF attribution accountpayment in relation to the taxpayer immediately before the FIF attribution debit arises for the FIF.
FIF attributed tax account surplus means the FIF attributed tax account surplus of the FIF in relation to the taxpayer.

The FIF attributed tax account debit arises when the FIF attribution accountpayment was made by the FIF.[Subsection 612(3)]

Relief from double taxation

Exemption of distributions to a taxpayer

A FIF attribution accountpayment received by a taxpayer from a FIF attribution account entity may be exempt from tax. [Section 23AK]

The amount of the FIF attribution accountpayment that will be exempt when received by a taxpayer will be determined by the FIF attribution surplus in the FIF attribution accounts of the FIF making the distribution in relation to the taxpayer. If the payment exceeds the surplus, the part of the payment equal to the surplus will be exempt.

Exemption under section 23AK for previously attributed FIF income derived through a partnership or trust

Where the distribution from a FIF or FLP is received through an interposed partnership or trust, the exemption will operate where:

he taxpayer, after the distribution of an amount from the FIF to the partnership or trust, would be required to include an amount in respect of the trust or partnership in the taxpayer's assessable income; and
t the time of that distribution, the taxpayer had a FIF attribution surplus in relation to the FIF.

The distribution to the partnership or trust will still be included in the calculation of the net income of the trust or partnership. However, once the taxpayer's share of that net income is determined, the amount will be exempt to the extent of the attribution surplus.

Reduction of disposal consideration if FIF attributed income not distributed

The disposal of an interest in a FIF attribution account entity will normally be taken into account in the calculation of a taxpayer's assessable income under the existing provisions of the Principal Act either as income under subsection 25(1) or under the capital gains tax provisions in Part IIIA. Further, the disposal consideration of a FLP is used to determine the amount to be included in a taxpayer's assessable income under the FIF measures in the year of disposal of the FLP. To avoid double taxation, the consideration received on the disposal of an interest in a FIF attribution account entity which is to be taken into account for the purposes of the relevant assessment provision will be deemed to be reduced by any amount previously attributed to a taxpayer that has not been distributed to the taxpayer.

The amount which will be taken into account in determining the assessable income of a taxpayer on the disposal of an interest in a FIF attribution account entity cannot exceed the disposal consideration. [Paragraph 613(1)(c)]

Where a taxpayer disposes of only part of an interest in a FIF attribution account entity, the taxpayer's FIF attribution surplus in relation to the FIF that can be used to reduce the consideration on disposal is reduced proportionately. [Subsection 613(3)]

Broadly, the disposal of an interest in a FIF attribution account entity will be treated in the same way as a FIF attribution accountpayment made directly to the taxpayer who holds that interest. Consequently, a FIF attribution debit is taken to arise at the time of the disposal of the taxpayer's interest in the FIF attribution account entity. [paragraph 613(1)(d)] The amount of the FIF attribution debit is the amount of the FIF attribution surplus that was taken into account in reducing the consideration received on disposal of the FIF interest. [Paragraph 613(1)(e)]

FIF attribution debit for amount of loss used to reduce assessable income

A FIF or FLP loss that arises under the market value method in the case of a FIF or the cash surrender value method in the case of a FLP can be used to reduce a taxpayer's assessable income to the extent that there is a FIF attribution surplus for the FIF or FLP in relation to the taxpayer [section 532 / section 533] . Where the amount of a loss is used to offset assessable income, a FIF attribution debit arises for that amount in relation to the FIF or FLP. [Section 607]

Example of the operation of FIF attribution accounts

The following example shows how FIF attribution credits, FIF attribution debits and FIF attribution surpluses may arise over a number of income years where a taxpayer has a direct interest in a FIF. In this example, the taxpayer is using the market value method to calculate the amount to be included in the taxpayer's assessable income under the FIF measures.

Year Opening value Distribution Disposal Closing value FIF amount* FIF income FIF loss
1992/93 100,000(1.1.93) 10,000 nil 110,000 +20,000 10,000 nil
1993/94 110,000 10,000 nil 111,000 +11,000 11,000 nil
1994/95 111,000 20,000 nil 102,000 +11,000 2,000 nil
1995/96 102,000 nil nil 92,000 -10,000 nil 10,000
1996/97 92,000 nil 120,000 nil nil nil nil
* A positive FIF amount represents gross FIF income; a negative FIF amount represents a FIF loss.

FIF Attribution accounts

Year attribution credit attribution debit Attribution Surplus Assessable Distribution Total Assessable FIF Income
1992/93 10,000 nil 10,000 10,000 10,000
1993/94 11,000 10,000 11,000 nil 11,000
1994/95 2,000 11,000 2,000 9,000 2,000
1995/96 nil 2,000 nil nil nil
1996/97 nil nil nil nil nil

During the 1992/93 income year and before the end of the notional accounting period of the FIF, there was a distribution of $10,000, being profits arising before the current notional accounting period. As there was no FIF attribution credit available in the FIF attribution accountat the time of distribution the taxpayer is assessed on the distribution. The taxpayer is also assessed on the FIF income of $10,000 (that is, the FIF income calculated using the market value method {$110,000 (closing value) + $10,000 (distribution) - $100,000 (opening value)} less $10,000 (assessable distribution [subsection 530(1)] )). This gives rise to a FIF attribution credit of $10,000.

During the 1993/94 income year there was a distribution of $10,000 which is made against a FIF attribution accountbalance of $10,000. The FIF income of $11,000 (that is, {$111,000 (closing value) + $10,000 (distribution) - $110,000 (opening value)} - nil (assessable distribution)) would be included in the assessable income of the taxpayer. This gives rise to a corresponding FIF attribution credit of $11,000. The FIF attribution accountbalance then stands at $11,000.

During the 1994/95 income year there was a distribution of $20,000, of which $11,000 is made against the FIF attribution accountbalance of $11,000. The balance of the distribution of $9,000 is assessed to the taxpayer. The FIF income was $2,000 (that is, {$102,000 (opening value) + $20,000 (distribution) - $111,000 (opening value)} - $9,000 (assessable distribution)) which would be included in the assessable income of the taxpayer. This gives rise to a corresponding FIF attribution credit of $2,000. The FIF attribution surplus then stands at $2,000. Thus, the taxpayer will be assessed on $11,000 for the year being the FIF income of $2,000 and assessable distribution of $9,000.

During the 1995/96 income year a FIF loss of $10,000 is computed. A deduction from the assessable income of the taxpayer is available for the loss to the extent of the FIF attribution surplus, that is, $2,000. A FIF attribution debit arises to the extent of the deduction which is available.

During the 1996/97 income year the taxpayer disposed of the entire interest in the FIF for $120,000. There will be no FIF income in the year in which the disposal occurs. Assuming the sale is within Part IIIA and the indexed cost base of the FIF interest was $105,000, the disposal would give rise to a capital gain of $15,000 (that is, ($120,000 (disposal consideration) - nil ( FIF attribution surplus)) - $105,000 (indexed cost base)).

Clauses making the amendment

Clause 5: Inserts section 23AK to exempt from taxation a distribution received by a taxpayer out of previously attributed FIF income.

Clause 27: Inserts Part XI which contains the provisions giving effect to the FIF attribution accountsystem.

Relief for Foreign Taxes

Introduction

Under the Principal Act, relief from international double taxation is dealt with in two ways:

he income may be included in a taxpayer's assessable income and a credit allowed for the foreign tax under the foreign tax credit system (FTCS); or
he income may be exempt from Australian tax.

This chapter deals with these credits and exemptions. A brief explanation of the FTCS, and the exemptions associated with it, follows. Those readers already familiar with the operation of the existing credits and exemptions in respect of foreign income should go to section two of this Chapter.

Section 1: Background to the FTCS

Under the FTCS, foreign source income derived by Australian residents (apart from certain salary and wages) is generally subjected to Australian income tax. A credit for foreign tax paid, up to the amount of the Australian income tax referable to the foreign income, is allowed against the Australian tax payable. Credit is allowable for foreign taxes imposed by central, state and local governments, provided that the taxes are equivalent in nature to Australia's income tax.

Inter-corporate related company dividends

Where the whole or a part of a dividend received from a non-resident company is included in the assessable income of a resident taxpayer (whether corporate or non-corporate) the taxpayer is entitled to a credit for the direct foreign tax - for example, dividend withholding tax - paid in respect of that dividend. However, an Australian resident company that receives a dividend from a related foreign company is also allowed a credit for the foreign company taxes on that portion of the profits from which the dividends are paid - that is, the underlying foreign tax.

A foreign company is related to an Australian company if the Australian company has a direct voting interest of at least 10 per cent of the voting power of the foreign company. This relationship could extend through any number of tiers of foreign companies if each company in the chain has at least a 10 per cent voting interest in the company in the tier below, and the Australian company has a direct or indirect voting interest of at least 5 per cent in the foreign company.

Relief for foreign tax paid by a trust

Where the assessable income of a beneficiary includes foreign income derived by the trust, the beneficiary is entitled to a credit for the proportionate part of the foreign tax paid by the trustee.

No credit is allowed for underlying foreign taxes paid in respect of a dividend - that is, underlying tax credits do not flow through trusts. This rule applies even where shares in the foreign company are held by the trust as nominee for a resident company which is the sole beneficiary of the trust.

Quarantining of credits

The credit allowable for foreign tax paid on foreign income is calculated separately for:

assive income - which includes dividends, interest, royalties, annuities, rents, commodity gains, certain deemed dividends, attributed income of a controlled foreign company and certain net capital gains;
ffshore banking income - which includes interest, fees, commissions and other amounts derived from the offshore transactions of an offshore banking unit and dividends paid by an offshore banking unit; and
ther income.

Excess foreign tax credits

Prior to the 1990-91 income year, where the amount of foreign tax paid on foreign source income of a class of income exceeded the Australian tax payable on that income, the excess was not available to be carried forward or carried back.

For the 1990-91 and later income years, excess foreign tax credits can be carried forward for 5 years and applied against Australian tax payable on foreign income of the same class.

Excess foreign tax credits can also be transferred within wholly-owned company groups.

The impact of accruals taxation

With the introduction of the CFC measures, the FTCS was modified and certain new exemptions were introduced for the purposes of relief from double taxation.

Credit is available to a resident company for tax paid by a related CFC against any amount of the CFC's attributable income that is included in the resident company's assessable income. The credit is allowed on a similar basis as credit is allowed for taxes paid on dividends received by a resident company from a related foreign company.

Amounts of income of the CFC that have already been taxed in full in Australia - for example, Australian sourced income derived by a branch of the CFC and taxed by assessment in Australia - are excluded from the calculation of the CFC's attributable income.

Attributed income is treated as foreign income. The foreign tax and Australian tax paid by the CFC on that amount are creditable foreign taxes. This effectively allows any Australian withholding tax paid by the CFC to be creditable on attribution for foreign tax credit purposes if the resident taxpayer is entitled to the foreign tax credit.

Dividends from income previously attributed

A dividend that is paid out of income that has been previously attributed to a resident taxpayer is exempt in the hands of that taxpayer. Direct foreign taxes on such a dividend (for example, dividend withholding taxes) are creditable taxes, notwithstanding that the dividend is exempt from tax.

No credits in respect of foreign tax on certain exempted dividends

Non-portfolio dividends paid to a resident company by a related company resident in a listed country - that is, a country whose taxation system is broadly comparable to Australia's - are exempt from tax in Australia. Any part of a non-portfolio dividend paid to a resident company by a company resident in an unlisted country out of profits that have been taxed by assessment in Australia or in a listed country is also exempt from tax in Australia. No foreign tax credits are allowable on these exempt dividends.

Section 2 - Objectives of the changes to the FTCS - company FIFs

Credits on attribution from corporate FIFs

Credits where the market value method is used

Where the market value method is used to determine the FIF income, no credit will be allowed for foreign tax paid by the FIF. Instead, all taxpayers will be allowed an effective deduction for tax paid by, or accrued to, the FIF. This will occur because the closing market value implicitly takes into account any payment of, or liability for, taxes.

Credits where the calculation method is used

Where a resident company and a FIF are related companies and the resident company has used the calculation method to determine the FIF income for the company's interest in the FIF, a foreign tax credit may be allowed in accordance with the FTCS for a share of the foreign tax paid by the FIF (the first tier FIF) on its income and gains.

Furthermore, a credit for tax paid by the second tier FIF may be given where the resident company has used the calculation method to determine the FIF income of the second tier FIF, and the taxpayer, and the first and second tier FIFs are companies and the taxpayer is related to both the first and second tier FIFs. In this case, a foreign tax credit may be allowed in accordance with the FTCS for a share of the foreign tax paid by the second tier FIF on its income and gains. This foreign tax credit is in addition to any foreign tax credit allowed in relation to an interest in a first tier FIF.

A credit will only be allowed where the resident company and the FIF or FIFs are related companies. This is consistent with the general treatment of foreign taxes paid on underlying income under the FTCS and is also consistent with the CFC measures.

Credits for deemed rate of return method

No credit (or deduction) for foreign taxes will be allowed under the deemed rate of return method.

Credits on distribution from corporate FIFs

The allowance of credits on distribution will follow the credits allowed under the existing FTCS. In addition, a taxpayer will be allowed a credit where the dividend is exempt because the profits out of which the dividend has been paid have been subject to attribution in a previous year. The credit will be allowed on a similar basis to the credit allowed where a dividend is assessable, but will be limited to the amount not already allowed as a credit.

Further, the provisions of the Principal Act which allow for excess foreign tax credits to be carried forward for up to 5 years will also apply where excess foreign tax credits arise in relation to an interest in a FIF and, where appropriate, an indirect interest in a second tier FIF. As under the existing FTCS, there will be no carry back of credits.

How the objectives are achieved in the law

Credits on attribution

calculation method at first tier FIF only

Where an amount of FIF income is included in the assessable income of a resident company, the company may be allowed a credit for the taxes paid by the FIF. The credit will only be allowed where:

he resident company is related to the FIF at the end of the FIF's notional accounting period; and
he resident company used the Calculation Method to determine the amount to be included in its assessable income under the FIF measures.

The credit allowed will be equal to the resident company's share of the taxes paid by the FIF that were allowed as a notional deduction in the calculation of the FIF's calculated profit. The FIF's notional deductions consist of the foreign and Australian taxes paid by the FIF in respect of amounts included in the FIF's notional income (refer to Chapter 18).

To achieve this, income under the FIF measures will be treated as foreign income. [Subsection 6AB(1)]

In addition, the resident company will be deemed to have been personally liable for, and to have paid the amount of foreign tax claimed as a credit.[Subsection 6AB(3A), section 160AFCE]

As with the normal operation of the FTCS, the foreign income must be grossed up to include the foreign tax. [Subsection 6AC(6)]

Example 1 An Australian resident company (Ausco) has a 20% interest in a company FIF resident in an unlisted country (Forco). Forco is not a CFC and has never been a CFC. For the notional accounting period, Forco's details were as follows:

Notional income $200,000
Notional deduction for the tax paid on the notional income $17,000
Other notional deductions $30,000 $ 47,000
calculated profit $153,000
Taxpayer's FIF income (20% x $153,000) $ 30,600

Ausco is deemed to have paid the following amount of tax on the attributed income:

attribution percentage x notional deduction
= 20% x $17,000 = $3,400

Ausco must gross up its assessable foreign income by this amount - that is, the $30,600 is increased by the $3,400 to $34,000. Ausco can then claim a foreign tax credit for $3,400 (subject to the usual limitation in the law which states that the credit being claimed cannot exceed the Australian tax payable in respect of the foreign income).

Calculation method at the second tier FIF

Where the calculation method is used at the second tier and an amount of second tier FIF income is included in the notional income of a first tier FIF, a resident company may be allowed a credit for a share of the taxes paid by the second tier FIF. The credit will only be allowed where:

he resident company is related to the first tier FIF and the second tier FIF at the end of the second tier FIF's notional accounting period;
he resident company used the calculation method to determine the amount of first tier FIF income to be included in its assessable income under the FIF measures;
he resident company used the calculation method to determine the amount of second tier FIF income to be included in the notional income of the first tier FIF;
n amount of second tier FIF income is included in the notional income of the first tier FIF and an amount of FIF income is included in the assessable income of the resident company; and
n amount of foreign tax is a notional deduction from the notional income of the second tier FIF. [Section 160AFCF]

The credit allowed will generally be equal to the resident company's share of the taxes paid by the second tier FIF that were allowed as a notional deduction in the calculation of the second tier FIF's calculated profit.

The resident company's share of calculated profit of the second tier company FIF is that part of the first tier FIF income included in the resident company's assessable income that relates to an amount of second tier FIF income included in the notional income of the first tier FIF. [Subsection 160AFCF(3)]

The second tier FIF's notional deductions consist of the foreign and Australian taxes paid by the second tier FIF in respect of amounts included in the FIF's notional income (refer to Chapter 18). To achieve this, income under the FIF measures will be treated as foreign income. [Subsection 6AB(1)]

A new provision has been inserted into the law to allow taxpayers to claim a foreign tax credit. The taxpayer is deemed to have been personally liable for, and to have paid an amount of the foreign tax paid by the second tier FIF. [Subsection 6AB(3A) and section 160AFCF]

As with the normal operation of the FTCS, the foreign income must be grossed up to include the foreign tax deemed paid under section 160AFCF. [Subsection 6AC(6)]

Example 2 An Australian resident company (Ausco) has a 20% interest in a company FIF resident in an unlisted country (Forco). Forco is not a CFC and has never been a CFC. Forco in turn has a 30% interest in a second FIF (Secco) that is not a CFC.For Secco's notional accounting period which ends during the notional accounting period of Forco, Secco's details were as follows:

Notional income $650,000
Notional deduction for the tax paid on the notional income $100,000
Other notional deductions $150,000 $250,000
calculated profit $400,000
Secco FIF income included in Forco's notional income (30% x 400,000) $120,000*
The gross deductible amount for taxes paid is $100,000.
* This is included in Notional Income in Example 1.

The calculated profit of Secco is $400,000. The amount of Secco's FIF income included in the notional income of the first tier FIF is $400,000 x 30% =$120,000.

Ausco's share of the calculated profit of Secco is

= $120,000 x 20% = $24,000.

Ausco is deemed to have paid the following amount of tax in respect of Secco:

= Gross deductible amount x (Ausco's share of calc profit of Secco / Calculated profit of Secco)
= $100,000 x $24,000/$400,000 = $6,000

Ausco must gross up its assessable foreign income that is $30,600 (from Example 1) by the amount of foreign tax deemed paid under sections 160AFCE ($3,400) - see example 1 - and 160AFCF($6,000) that is, $9,400. Ausco can then can claim a foreign tax credit for $9,400 (subject to the usual limitation in the law which states that the foreign tax paid cannot exceed the Australian tax payable in respect of the foreign income).

Credits on dividends received where there was attribution

Where a resident receives a dividend from a foreign company the following may occur:

ll or a part of the dividend may be exempt because there was previous attribution to the taxpayer in respect of the FIF; and
f the resident is a company, all or part of the dividend may be exempt because the profits from which the dividend was paid were comparably taxed in a listed country.

The part of the dividend which is assessable may qualify for a foreign tax credit under the existing FTCS. That credit will continue to be available.

In addition, a taxpayer may be allowed a credit for the foreign tax paid on that portion of the dividend that is exempt because of previous attribution under the FIF measures.

As under the existing FTCS, no credit will be available for foreign taxes that relate to that part of a dividend that is exempt because the underlying profits were comparably taxed.

The rest of this section discusses the credit in greater detail.

Taxpayers other than resident companies

Where a resident taxpayer receives a dividend from a foreign company, the resident is usually only allowed a credit for foreign taxes paid by the resident or on the resident's behalf. Taxes paid by the company on the profits from which the dividend was paid are not allowed as a credit. This will continue to be the rule under the FIF measures.

Foreign tax credits are usually allowed only where the dividend is included in assessable income. As with dividends that are exempt because there has been attribution under the CFC measures, an exception will be made to this rule where the dividend is exempt because there has been attribution under the FIF measures. [Section 160AFCJ]

However, section 160AFCJ will only operate where a taxpayer receives a dividend which is exempt under [section 23AK] . The formula that determines the credit is as follows:

(EP x DT) + (AEP x UT) - AT.

The only components of the formula that are relevant to a taxpayer other than a company are the EP x DT parts, since the rest of the formula will always equal nil (the rest of the formula is explained under the next heading). The EP x DT component of the formula allocates the direct tax paid by the taxpayer evenly over the part of the dividend that is exempt and the rest of the dividend. In effect, it allows all of the direct tax to be claimed as a credit.

Example 3 A resident individual (J Smith) has 20% of a company FIF (Forco) which is resident in an unlisted country. Forco is not a CFC and has never been a CFC. Forco had distributable profits of $153,000 on which it has paid foreign tax of $17,000. J Smith has a FIF attribution credit balance in relation to Forco of $30,600.On 1 August 1993, Forco pays a dividend of $30,600 to J Smith. The unlisted country levies dividend withholding tax at the rate of 10%.J Smith will not need to include the dividend in assessable income as it was paid out of previously attributed income. Despite this, J Smith is deemed to have included the dividend in assessable income for the purpose of granting a foreign tax credit for the dividend withholding tax. J Smith can claim a credit for EP x DT = 100% x $3,060 = $3,060.This credit is subject to the usual limit of the Australian tax payable, and can only be claimed if J Smith has other foreign income. If not, J Smith can carry the amount forward to claim a credit in a future year.

Example 4 Assume the same facts as in the previous example except that:

he distributable profits of Forco are $200,000; and
n 1 August 1993, Forco paid a dividend of $40,000.

Because J Smith was previously taxed on $30,600, an exemption will be allowed up to that amount. The excess of the dividend over $30,600 (that is, $9,400) will need to be included in his assessable income.To work out the foreign tax credit J Smith will apply the formula as follows:

EP = $30,600 / $40,000
EP x DT = 76.5% x $4,000 = $3,060

J Smith would be allowed a credit for the rest of the dividend withholding tax ($940) in accordance with the existing provisions of 160AF. In total, the credit is $4,000; the same amount that would be allowed if the dividend were wholly assessable.

Resident companies

In general, resident companies will be treated the same as other taxpayers. However, there is one exception to this rule. The exception is where the resident company receives a non-portfolio dividend from a related foreign company.

As with other dividends, a non-portfolio dividend received by an Australian resident company from a related foreign company will be exempt to the extent that the dividend has been paid out of previously attributed income, and the company will be allowed a credit for the foreign dividend withholding tax paid.

The difference is that in the case of a non-portfolio dividend paid by a related foreign company, a credit will also be allowed for the tax paid by the foreign company on the profits out of which the dividend was paid (that is, the foreign underlying tax), but only to the extent that underlying tax has not yet been allowed as a credit at the attribution stage.

This exception is also achieved by [section 160AFCJ] . However, in addition to the EP x DT part of the formula the taxpayer would use the (AEP x UT) part of the formula. This part of the formula allocates the tax paid by the company out of which the dividend was paid to the part of the dividend that is exempt because of previous attribution under the FIF measures.

Where the taxpayer has not claimed a credit under [section 160AFCE or 160AFCF] , the AT component will be nil (the operation of the AT component is shown in the second example).

Example 5 Ausco owns 20% of a foreign company (Forco) which is resident in an unlisted country and derived only unlisted country income. Forco is not a CFC and has never been a CFC. Forco had distributable profits of $153,000 in respect of which it has paid foreign tax of $17,000. Ausco did not have sufficient information to use the calculation method and relied on the market value method to determine the FIF income. The amount of the attribution surplus on 31 July 1993 is $30,600.On 1 August 1993, Forco pays a dividend of $30,600 to Ausco. The unlisted country levies dividend withholding tax at the rate of 10%.The dividend will be exempt from tax for Ausco as it was paid out of previously attributed income. At the attribution stage, Ausco received no credit for the foreign tax paid by Forco.Again, even though the dividend is not included in assessable income of Ausco, it is deemed to be so included for the purpose of granting a foreign tax credit. Ausco can claim a credit for the dividend withholding tax and for the underlying tax as though the dividend was paid from income that had not been attributed to Ausco.The EP x DT component is calculated as for other taxpayers - that is, it is $3,060 (refer to Example 3 for non-company taxpayers). The rest of the credit is calculated as:

AEP x UT = 100% x $3,400 = $3,400

The total foreign tax credit allowed is $6,460 ($3,060 + $3,400).

Example 6 Assume the same facts as in Example 5 except that:

he taxpayer used the calculation method to determine the FIF income; and
he FIF income was $30,600 and, the attribution surplus on 31 July 1994 was $30,600.

The EP x DT component would be the same. However, there would now be an amount that was previously allowed as a foreign tax credit (20% x $17,000 = $3,400). Ausco would use the rest of the formula as follows:

(AEP x UT) - AT = 100% x $3,400 - $3,400 = 0

The credit allowed would be $3,060 only.

Credit for accruals taxes of foreign countries

Other countries may also impose accruals type taxes. These will be treated in the same manner as other foreign taxes. That is, where an Australian company is allowed a credit for underlying taxes paid by the company FIF, the accruals type tax will be allowable as a foreign tax credit.

Dividends exempt under section 23AJ

Section 23AJ of the Principal Act may exempt from tax a non-portfolio dividend received by a resident company. Broadly, the exemption applies where the profits out of which the dividend is paid are taxed in a listed (comparable tax) country. The FIF measures will not deny the existing section 23AJ exemption (see Chapter 24).

Objectives of the changes to the FTCS - trust FIFs

Credits on attribution from trust FIFs

Under the FTCS, the treatment of foreign taxes paid by the trustee of a foreign trust is different to that of companies, since the beneficiary of the trust is deemed to have paid the foreign tax paid by the trustee. In general, this distinction will be maintained for taxpayers with an interest in a trust FIF.

Credits where the calculation method is used at first tier

Consistent with the treatment of company FIFs, where the taxpayer has used the calculation method of calculating attributable income of a trust FIF a foreign tax credit will be allowed for the foreign tax paid by the trustee of the trust on the income and gains of the trust FIF. The calculation will be made in the same way as for a related company FIF.

Credits where the calculation method is used at second tier

Where the taxpayer has used the calculation method for the second tier trust FIF a foreign tax credit will be allowed for the foreign tax paid by the trustee of the trust on the income and gains of the trust FIF. The calculation will be made in the same way as for a related company FIF.

Credits for market value or deemed rate of return methods

No credit will be allowed on attribution under the market value or deemed rate of return methods. This is consistent with the treatment of company FIFs.

Credits on distribution from trust FIFs

The allowance of credits on distribution will be similar to the credits under the existing FTCS. Broadly, this means that, if the amount of the distribution is included in assessable income, both companies and other taxpayers will be allowed a credit for foreign taxes paid:

irectly by the taxpayer (for example, a withholding tax on a dividend); and
y the trustee of the trust (including accruals type taxes in respect of lower tier entities).

In addition to the normal operation of the FTCS, a taxpayer will be allowed a credit where the trust distribution is exempt because it has been subject to attribution in a previous year. This will be limited to the amount not already allowed as a credit where the calculation method was used.

How the objectives are achieved in the law

Credits on attribution

First tier foreign trust

Where a resident trust used the calculation method to determine the amount to be included in its assessable income under the FIF measures the trust may be allowed a credit for the taxes paid by the FIF.

The credit allowed will be equal to the resident trust's share of the taxes paid by the FIF that were allowed as a notional deduction in the calculation of the FIF's calculated profit. The FIF's notional deductions consist of the foreign and Australian taxes that were paid by the FIF in respect of amounts included in the FIF's notional income. [Section 160AFCG]

Second tier foreign trust

Calculation method at the second tier FIF

Where the calculation method is used at the second tier and an amount of second tier FIF income is included in the notional income of a first tier foreign trust, the taxpayer may be allowed a credit for a share of the taxes paid by the second tier FIF. The credit will only be allowed where:

he taxpayer used the calculation method to determine the amount of first tier FIF income to be included in its assessable income under the FIF measures;
he taxpayer used the calculation method to determine the amount of second tier FIF income to be included in the notional income of the first tier FIF;
n amount of second tier FIF income is included in the notional income of the first tier foreign trust and an amount of FIF income is included in the assessable income of the taxpayer; and
n amount of foreign tax is a notional deduction from the notional income of the second tier foreign trust. [Section 160AFCH]

The credit allowed will generally be equal to the resident company's share of the taxes paid by the second tier FIF that were allowed as a notional deduction in the calculation of the second tier FIF's calculated profit.

The taxpayer's share of calculated profit of the second tier foreign trust is that part of the first tier FIF income included in the taxpayer's assessable income that relates to an amount of second tier FIF income included in the notional income of the first tier FIF. [Subsection 160AFCH(3)]

The second tier FIF's notional deductions consist of the foreign and Australian taxes paid by the second tier FIF in respect of amounts included in the FIF's notional income (refer to Chapter 18). To achieve this, income under the FIF measures will be treated as foreign income. [Subsection 6AB(1)]

New provisions have been inserted into the law to allow taxpayers to claim a foreign tax credit. The taxpayer is deemed to have been personally liable for, and to have paid the amount of foreign tax claimed as a credit.[Subsection 6AB(3A) , section 160AFCG and section 160AFCH]

As with the normal operation of the FTCS, the foreign income must be grossed up to include the foreign tax. [Subsection 6AC(6)]

Credits on distribution from trust FIFs

In addition to the normal operation of the FTCS, a taxpayer will be allowed a credit where the trust distribution is exempt because it has been subject to attribution in a previous year. This will be limited to the amount not already allowed as a credit where the calculation method was used. [Section 160AFCJ]

Clauses making the amendments

Clause 3: Amends section 6AB to include FIF income in foreign income and to treat certain taxes paid by a FIF as foreign tax.

Clause 4: Amends section 6AC to provide for grossing-up of foreign income for the purpose of allowing a foreign tax credit.

Clause 13: Inserts additional definitions into section 160AE which are relevant to the calculation of foreign tax credits under the FIF measures.

Clause 15: Inserts sections 160AFCE, 160AFCF, 160AFCG, 160AFCH and 160AFCJ to enable taxpayers subject to FIF attribution to claim a foreign tax credit on attribution of FIF income and distributions made to them by the FIF.

Record Keeping and Related Prosecution Provisions

Overview

Record keeping provisions are required in order to ensure the effectiveness of the FIF measures and to protect taxpayers on audit by ensuring that they have the necessary records to support their assessment of, or exemption from FIF taxation. However, as was stated on page 6 of the Information Paper "the Government recognises that Australian resident investors with non-controlling interests in offshore funds will generally have access to only a limited amount of information about the investment." The record keeping requirements are therefore less onerous than the requirements for controlled foreign companies and controlled foreign trusts in Division 11 of Part X.

Explanation

Who must keep records?

A taxpayer who has an interest in a FIF at the end of the year of income or an interest in a FLP during the year of income must make and keep records in Australia. This includes a foreign branch of an Australian company which has an interest in a FIF or FLP. [Section 614]

An attributable taxpayer in respect of a CFC or controlled foreign trust that holds an interest or interests in a FIF or FLP is subject to similar record keeping requirements in relation to the CFC or controlled foreign trust. These requirements are in Division 11 of Part X.

What records must be kept?

A taxpayer who has an interest or interests in a FIF or FLP must make and keep records of:

he acts, transactions and other circumstances that resulted in the person having an interest in the FIF at the end of a year of income or an interest in the FLP during the year of income; and
n the case of a taxpayer who is not wholly exempt from the FIF measures, the basis of the calculation of the taxpayer's interest or interests in the FIF or FLP for the notional accounting period which ended during the taxpayer's year of income. [Section 615]

Record keeping for the different methods of assessment for FIFs

The extent of the records required for a particular taxpayer in relation to amounts of foreign investment fund income included in assessable income, will depend on which method of assessment is used to determine the foreign investment fund income.

Market value method

Where the market value method is used, the taxpayer is to make and keep records detailing the basis of the calculation of:

i)
ny foreign investment fund income that accrued to the taxpayer from an interest in the FIF for the current period and any unapplied previous foreign investment loss; or
ii)
ny foreign investment fund loss that was incurred by the taxpayer from the interest in the FIF for the current period. [Section 616]

Previous year losses

Where the taxpayer has an unapplied foreign investment fund loss from an interest in a FIF, the unapplied loss may be carried forward to be offset against any market value increase from the same FIF in subsequent periods. Records of these losses should be made and kept.

deemed rate of return method

Where the deemed rate of return method of taxation is used, the taxpayer is to create and maintain records detailing the basis of the calculation of the foreign investment fund income that accrued to the taxpayer from an interest in the FIF for the notional accounting period. [Section 617]

Taxpayer exempt from FIF measures in previous year

A taxpayer may have to apply the deemed rate of return method in the current year of income to an interest in a FIF that was exempt from taxation in the previous income year. In this case, the taxpayer will require certain records to determine the opening value of the interest for the current year. The opening value will be determined either by the market value at the end of the previous year or by notional application of the deemed rate of return method to the value at the beginning of the previous year [section 552]. Records must be made and kept in relation to these matters.

Special rules for the commencement of the FIF measures

It should be noted that special rules apply for the commencement of the FIF measures [sections 545-549] which may require different records to be made and kept from 1 January 1993.

Previous year losses

No losses arise under the deemed rate of return method of taxation.

The calculation method

Calculation method at the first tier

A taxpayer who elects to use the calculation method for the taxpayer's interest in a FIF (a the first tier FIF) is to create and maintain records detailing the basis of the calculation of:

i)
ny first tier calculated profit for the notional accounting period and any unapplied first tier calculated losses of previous periods; and
ii)
ny foreign investment fund income that accrued to the taxpayer from an interest in a first tier FIF in respect of the first tier FIF's notional accounting period. [Section 618]

Calculation method at the second tier

Where a first tier FIF has an interest in another FIF (a second tier FIF) the taxpayer may elect to use the calculation method at the second tier. The taxpayer is to create and maintain records detailing the basis of the calculation of:

i)
ny calculated profit of the second tier FIF for the notional accounting period and any unapplied calculated losses of the second tier FIF of previous periods; and
ii)
ny foreign investment fund income that accrued to the taxpayer from the first tier FIF's interest in the second tier FIF in respect of the relevant period [section 618]. For the calculation of this FIF income it would be necessary to have details of FIF income from an indirect interest in a second tier FIF. Where there is an additional (third tier) level of investment, details of third tier FIF income will also be required for the calculations of second and first tier FIF income.

Examples of records required to be kept by taxpayers using the calculation method include:

he basis of the calculated profit or loss in respect of the first tier FIF for the notional accounting period which ended during the year of income;
opies of the published accounts used in these calculations; and
record of the election(s) to use the calculation method.

In addition, the taxpayer will also need access to the underlying accounts and accounting records of the FIF. On audit these may be called for to support the amounts shown in the published accounts and any other amounts on which the taxpayer relied for the calculations.

Exempt in previous year

Where a taxpayer's interest in a FIF was exempt in a previous year of income, and for the current year the taxpayer elects to use the calculation method, it is necessary for the taxpayer to have details of any previous years' losses which are to be offset against FIF income in the current year of income.

Previous year loss at the first tier

A calculated loss of a previous year is generally allowed as a notional deduction against notional income of the first tier FIF of the current period [subsection 572(1)]. A taxpayer who wishes to claim a loss against notional income of the first tier FIF is to keep a record of the calculation of that loss.

Previous year loss at the second tier

A calculated loss of a previous year of a second tier FIF is likewise allowed as a notional deduction against notional income of the second tier FIF of the current period [section 578]. A taxpayer who wishes to claim a loss against notional income of the second tier FIF is to keep a record of the calculation of that loss.

Exemption from FIF measures in the current year

Where a taxpayer's interest in a FIF is wholly or partly exempt from FIF taxation in the year of income, the taxpayer is to make and keep records in Australia containing details of the basis on which the exemption applied, including any acts, transactions, calculations and other circumstances relevant to the application of the exemption. [Section 620]

Active business exemption

There are two methods of satisfying the active business exemption for a direct interest in a foreign company.

Stock exchange listing method

For taxpayers claiming an exemption from the FIF measures under the active business exemption using the stock exchange listing method, examples of records to be maintained include:

he listing on a particular approved stock exchange of the class of interests to which the taxpayer's FIF interest belongs; and
he stock exchange or international sectoral classification of the FIF under eligible business activities.

Balance sheet method

For taxpayers claiming an active business exemption from the FIF measures using the balance sheet method, records are to be kept, for example, of the gross value of all of the company's assets shown in the balance sheet and to what extent the assets are held at the balance date for use in eligible activities. This does not include off balance sheet assets.

Foreign employer-sponsored superannuation fund exemption

A taxpayer claiming exemption from the FIF measures for the taxpayer's interest in an employer-sponsored foreign superannuation fund is to maintain details such as the name and location of the foreign superannuation fund, the relationship between taxpayer and the employer, that is, past employee, employee, director or associate.

Exclusion of a FIF that is a CFC, controlled foreign trust or a transferor trust

A taxpayer who has an interest in a FIF which is also a CFC or controlled foreign trust to which Part X of the Principal Act applies is required under Part X to keep records for the CFC measures.

Exemptions for certain interests in foreign banks, general insurance companies, life insurance businesses and real property companies, trading stock, foreign companies engaged in several activities, Lloyds of London etc

Although some industries such as banking, insurance and real estate are listed as ineligible activities for purposes of the active business test there are specific exemptions provided for certain publicly listed and widely held investments in these industries. [Divisions 4 to 7]

Specific exemptions are also provided for certain interests in FIFs that are trading stock, multi-industry foreign companies and Lloyd's of London. A taxpayer's interests in FIFs are exempt from the measures where the total value of the taxpayer's interests in FIFs is 5 per cent or less of the total value of the taxpayer's interests in FIFs. [Divisions 12 to 15]

Where a taxpayer claims exemption on the basis of one or more of these provisions records will need to be maintained of how the FIF interest satisfied the conditions of the particular exemption.

Country trust funds exemption

Those taxpayers claiming an exemption from the FIF measures for an interest in a country trust fund need to keep records of the interest in the specified trust fund.

Small investor exemption

For the small investor exemption, it is necessary to record the basis of the calculation of the aggregate interests of the taxpayer and associates in foreign companies, trusts and foreign life policies that shows that the aggregate amount of those interests is less than $50,000 at the end of taxpayer's year of income.

Exemption for certain visitors to Australia

A short term resident claiming exemption from the FIF measures as an exempt visitor is to maintain the contract of employment, passport and visa information, and details of the date of arrival in Australia.

Record keeping for FLPs

cash surrender value method

Where the cash surrender value method is used, the taxpayer is to make and keep records detailing the basis of the calculation of:

i)
ny foreign investment fund income that accrued to the taxpayer from an interest in the FLP for the current period and any unapplied previous foreign investment fund loss; or
ii)
ny foreign investment fund loss that was incurred by the taxpayer from the interest in the FLP for the current period. [Section 619]

Previous year losses

Where the taxpayer has an unapplied foreign investment fund loss from an interest in a FLP from a previous notional accounting period, the unapplied loss may be carried forward to be offset against any increase in cash surrender value from the same FLP in subsequent periods. Records of these losses should be made and kept.

deemed rate of return method

Where the deemed rate of return method of taxation is used, the taxpayer is to create and maintain records detailing the basis of the calculation of the foreign investment fund income that accrued to the taxpayer from an interest in the FLP for the notional accounting period. [Section 619]

Taxpayer's interest in a FLP exempt in previous year

A taxpayer may have to apply the deemed rate of return method in the current year of income to an interest in a FLP that was exempt from taxation in the previous income year. In this case, the taxpayer will require certain records to determine the opening value of the interest for the current year. The opening value will be determined either by the cash surrender value at the end of the previous year or by a notional application of the deemed rate of return method to the value at the beginning of the previous year. Records must be made and kept in relation to these matters.

Special rules for the commencement of the FIF measures

The special rules which apply for the commencement of the FIF measures, [sections 545-549] and which may require different records to be made and kept from 1 January 1993, will also apply in respect of FLPs.

Previous year losses

No losses arise under the deemed rate of return method of taxation.

Exemption from FIF measures in the current year

Where a taxpayer's interest in a FLP is wholly or partly exempt from FIF taxation in the year of income, the taxpayer is to make and keep records in Australia containing details of the basis on which the exemption applied, including any acts, transactions, calculations and other circumstances relevant to the application of the exemption. [Section 620]

Elections

As a result of self assessment the majority of elections are no longer required to be made in writing and lodged with the Commissioner.

However, some elections and notifications affecting the taxation treatment of future transactions or events, or which cause the Commissioner to take some action in relation to an assessment, are still required to be in writing and lodged with the Commissioner.

A taxpayer electing to use the calculation method will not be required to lodge a written notice of the election with the Commissioner. The process of making an election will involve the taxpayer deciding which provision of the Principal Act is to be applied in calculating a component of taxable income and keeping a record which verifies the calculation. Whether or not a taxpayer has made an election will be evident from these records and in the calculation of taxable income as disclosed in the tax return.

Time for keeping records

The existing provisions will apply in relation to the retention of records subsections 262A(4) and (5). Records are generally to be kept for five years.

Manner of keeping records

Records will be required to be made and kept:

n the English language or if not in written form (e.g., magnetic tape or computer disc) in a form which is readily accessible and convertible into writing in English; and
o as to allow the person's liability to tax to be readily ascertained. [Section 622]

Prosecution provisions

Prosecution provisions are required to ensure compliance with the FIF record keeping measures. These provisions generally correspond with the record keeping provisions of the CFC measures. Like the CFC measures there is to be no retrospective application in a year of income before Royal Assent in relation to these measures.

A taxpayer who does not comply with the record keeping provisions may be prosecuted. A maximum penalty of $3000 may be imposed by the court on conviction for a breach of the record keeping requirements. [Section 621]

In a prosecution of a taxpayer who failed to keep records of underlying accounts and accounting records in relation to the calculation method the taxpayer may rely, in certain circumstances, on a statutory defence. The defence will apply to the taxpayer who has made reasonable efforts to obtain the required documents but cannot get them. [Section 623]

While a taxpayer who does not have access to the required information should not use the calculation method, section 623 is intended to apply to a taxpayer who has access to the information but it is provided by the FIF or a third party and the taxpayer has insufficient control to access the underlying accounts of the FIF after making reasonable attempts.

A partnership will be treated as a person for the purpose of the record keeping provisions. This allows the record keeping and the related prosecution provisions to apply to the partnership [subsection 624(1)]. Accordingly, an offence committed by the partnership is treated as having been committed by each of the partners [subsection 624(2)]. However, in a prosecution of a partner for an offence it is a defence if the partner proves that the partner did not aid, abet, counsel or procure the act or omission by which the offence was taken to have been committed and was not in any way knowingly concerned in the commission of the offence. [Subsection 624(3)]

Miscellaneous

Overview

This chapter deals with a number of miscellaneous matters including:

i)
xempt life business;
ii)
mendment to the dividend exemption under section 23AJ;
iii)
efinition of passive income:
iv)
xemption for certain interests of underwriting members of Lloyd's;
v)
mendments to the loss quarantining provisions;
vi)
mounts to be included in a taxpayer's assessable foreign income where the taxpayer is deemed to have paid and to have been personally liable for an amount of foreign tax under section 160AFCJ; and
vii)
he treatment of exempt distributions under section 23AK for the purposes of calculating the cost base of a beneficiary's interest in a trust estate.

(i) Exempt life business

The Foreign Source Income measures have special provisions for calculating the income of Australian life companies which conduct insurance business offshore through a permanent establishment of the resident life company or a permanent establishment of a CFC.

Income from the investment of assets that cover life policies issued to unrelated non-resident policy holders by an offshore branch of an Australian resident life assurance company or a permanent establishment of a trust or CFC is generally not taxed in Australia.

Legislation that currently provides this relief will also apply to a FIF held by a foreign permanent establishment of a resident life assurance company, or a foreign permanent establishment of a CFC where the FIF represents an investment by the foreign branch of non-resident policy holder funds.

(ii) Amendment to the dividend exemption under section 23AJ

Background

Section 23AJ of the Principal Act provides an exemption for a non-portfolio dividend paid by a company resident in a listed country to a company resident in Australia.

Section 23AJ may also provide an exemption for a part of a non-portfolio dividend paid by a company resident in an unlisted country to a company resident in Australia. The exemption applies where the companies are related companies within the meaning of section 160AFB. The section operates on the basis of identifying the amount of the dividend that is an 'exempting receipt' (defined in Division 6 of Part X). The concept of an exempting receipt is different depending on whether the foreign company is resident in a listed country (paragraph 380(a)) or an unlisted country (paragraph 380(a) and the associated provisions of sections 377 to 379).

An Australian company can get a credit for foreign taxes paid on exempt income only if the dividend is exempt under section 23AI. To ensure that an amount is exempt under section 23AI and not 23AJ, the concept of an exempting receipt excludes attribution account payments that require an attribution debit (subparagraphs 380(a)(i) and 377(1)(d)(i)).

The Change

Similarly, taxpayers will get a credit for foreign taxes paid in respect of a dividend that is exempt under section 23AK. In order that the dividend is exempt under section 23AK and not section 23AJ, FIF attribution account payments which carry FIF attribution credits will be excluded from the definition of an exempting receipt.

(iii) Definition of passive income

Background

Section 160AEA of the Principal Act contains the definitions of 'passive income' and 'modified passive income'. The concept of passive income is relevant to the computation of the foreign tax credit, allowable under section 160AF, on a class of income basis.

Under the existing law, the foreign tax credit allowable to a taxpayer is computed separately for each of three classes of income - passive income, offshore banking income and other income.

The concept of 'modified passive income' is relevant to the operation of the foreign loss quarantining provisions of section 79D and to the computation of a foreign loss under section 160AFD.

The Change

In general, FIF income will belong to the passive income or modified passive income class for foreign tax credit and foreign loss quarantining provisions of the Principal Act.

Passive income is generally quarantined separately from business income. However, certain assets may be held as an essential part of the taxpayer's insurance business. Quarantining in such cases would produce inequitable results.

Therefore, in cases of this type, the FIF income from these assets will be treated as part of the overall business profits derived from the insurance business carried on by the taxpayer. The effect of this will be to provide relief to taxpayers by including that FIF income as part of the business profits for the purposes of the calculation of foreign tax credits and the quarantining of losses against foreign income.

This exception will only apply in relation to an insurance business actively carried on by a taxpayer.

(iv) Exemption for certain interests of underwriting members of Lloyd's

A taxpayer who is an underwriting member of Lloyd's and who has an interest in assets that form part of a Lloyd's Premiums Trust Fund will be exempt from taxation in respect of foreign investment fund income from that interest. Funds which qualify as Premiums Trust Funds are referred to in section 83 of the Insurance Companies Act 1982 of the United Kingdom. [Section 527]

(v) Loss quarantining provisions

The amendments proposed to the loss quarantining provisions are of a technical nature only.

They will ensure that in calculating a loss for the purposes of section 79E or section 80, the income that is exempt by virtue of section 23AK (income previously attributed under the FIF measures) will not affect the calculation of a loss incurred in a year of income or the amounts of a loss incurred in a previous year of income that may be carried forward to be deducted from a taxpayer's assessable income.

(vi) Amount to be included in assessable income

Background

Under the foreign tax credit system, an amount equal to the credit a taxpayer can claim for foreign tax paid by another entity is included in the taxpayer's assessable foreign income (that is, the taxpayer's assessable foreign income is "grossed up" by the amount of the foreign tax credit that the taxpayer can claim [section 6AC] ). This treatment is required to ensure that the foreign tax credit relief a taxpayer can claim is calculated with regard to pre-tax (that is, 'gross') amounts of foreign income.

Section 23AK, introduced by the Bill, will exempt distributions paid out of profits which gave rise to an amount being included in a taxpayer's assessable income under the FIF measures.

If the taxpayer's assessable income is not increased to include an amount of foreign underlying tax paid by the entity making the distribution or by another entity for which the taxpayer will be able to claim a foreign tax credit, the taxpayer would receive too much relief from double taxation. To achieve the correct result, an amount equal to the amount of the credit the taxpayer can claim for the foreign tax paid by the other entity will be included in the taxpayer's assessable income.

Amendments

Section 26D will include in a taxpayer's assessable income, an amount equal to the credit the taxpayer can claim on an exempt distribution under section 23AK for foreign tax paid by another entity. This amount is determined by components (AEP x UT) - AT of the formula in proposed subsection 160AFCJ(3). Broadly, these components have the following meanings.

'AEP' [Adjusted exempt percentage] means the percentage of the relevant distribution which is exempt under section 23AK. For the purposes of this calculation, the relevant FIF attribution account payment is to be reduced to the extent that it is exempt under section 23AJ.

'UT' [Underlying Tax] means the credit for underlying tax that the taxpayer would be able to claim in relation to the relevant distribution which is exempt under 23AK. For the purposes of this calculation, the relevant distribution is to be treated as assessable income.

'AT' [Attributed Tax] means the amount of any FIF attributed tax account debit arising for the relevant FIF attribution account entity in relation to the taxpayer on the making of the FIF attribution account. The amount of the FIF attribution account debit cannot exceed the amount of the formula component AEP x UT . Formula component AT is basically a measurement of the credit the taxpayer received for foreign tax paid when an amount (relating to the profits from which the distribution was paid) was included in the taxpayer's assessable income under the FIF measures.

Consistent with the treatment of amounts included under section 529, amounts included in a taxpayer's assessable income under section 26D are to be treated as amounts of foreign income. [Subsection 6AB(1)]

In addition, amounts included in a taxpayer's assessable income under section 26D will be treated as passive income for the purposes of the foreign tax credit and foreign loss provisions of the Principal Act. [Paragraph 160AEA(1)(n)]

Example Assume that a resident company (Ausco) has an interest in a foreign company ( FIF1) which is a resident of an unlisted country. Year 1: Using the market value method, it was determined that FIF1 had FIF income of $5,000 in relation to Ausco. Consequently, an amount of $5,000 was included in Ausco's assessable income under section 529 and a FIF attribution credit of $5,000 arose for FIF1 in relation to Ausco. Year 2: FIF1 makes a distribution of $20,000 to Ausco. This distribution gives rise to a $5,000 FIF attribution debit for FIF1 in relation to Ausco. Accordingly, $5,000 of the $20,000 distribution to Ausco is exempt under section 23AK.Assume that if no part of the $20,000 distribution had been exempt under section 23AK, Ausco would have been taken to have paid $10,000 foreign underlying tax under section 160AFC in relation to the distribution. Calculation of the amount to be included in the taxpayer's foreign assessable income under section 26D The amount which would be included in Ausco's foreign assessable income (passive class of income) under proposed section 26D would be calculated as follows:

(AEP x UT) - AT
where:

'AEP' = 25%(that is, $5,000/$20,000 x 100)
'UT' = $10,000
'AT' = nil

(AEP x UT) - AT = (25% x $10,000 - nil = $2,500

Consequently, $2,500 would be included in Ausco's assessable income under section 26D. Note that Ausco would also be taken to have paid, and to be personally liable for, foreign tax of $2,500 under section 160AFCJ in relation to the amount of the distribution received by Ausco that was exempt under section 23AJ (refer to Chapter 22 for an explanation of the operation of section 160AFCJ).

(vii) Return of capital on an investment in a trust estate

Background

Section 160ZM provides that, for the purposes of Part IIIA (the capital gains tax provisions), where the trustee of a trust estate pays an amount to a taxpayer in respect of an interest, or units, in the trust estate that is not assessable income of the taxpayer, that payment will be treated as a return of capital and the cost base of the interest or units in the trust estate are to be reduced by the amount of the payment. The reduction of the cost base of the interest or units in the trust estate may, on the disposal of the interest or units, have the effect of increasing the taxpayer's capital gains tax liability or reducing the extent of a capital loss.

Amendment

A reference to section 23AK will be inserted in subsection 160ZM(1A) so that distributions from a trust estate which are exempt under section 23AK will not reduce the cost base of the beneficiary's interest or units in the trust estate.

Clauses making the amendments

Subclause 3(a): Will insert a reference to section 26D into subsection 6AB(1) so that amounts included in a taxpayer's assessable income under section 26D will be treated as amounts of foreign income.

Clause 6: Will insert section 26D into the Principal Act which will operate to include an amount equal to the foreign underlying tax which a taxpayer is taken to have paid and to have been personally liable for under section 160AFCJ in the taxpayer's assessable foreign income.

Clauses 8 and 9: Amend sections 79E and 80 of the Principal Act respectively to ensure that income previously subject to attribution under the FIF measures does not reduce the amount of a loss that may be allowed as a deduction when calculating the taxpayer's assessable income.

Subclause 14(a): Will insert a reference to section 26D into paragraph 160AEA(1)(n) so that amounts included in a taxpayer's assessable income under section 26D will be treated as amounts of passive income.

Subclause 14(c): Amends section 160AEA of the Principal Act to treat passive income arising from assets treated as an essential part of a taxpayer's insurance business as business profits.

Clause 16: Will include a reference to section 23AK in subsection 160ZM(1A) so that distributions from a trust which are exempt under section 23AK will not reduce the cost base of the beneficiary's interest in the trust for the purposes of Part IIIA of the Principal Act (that is, the capital gains tax provisions).

Clause 19: Amends section 380 of the Principal Act to ensure that a dividend is first exempt to the extent possible under proposed section 23AK and then under section 23AJ.

Taxation of Non-Resident Trusts

Overview

This chapter describes the changes in the taxation of Australian beneficiaries of non-resident trust estates.

Introduction

Prior to the commencement of the foreign source income (FSI) measures, which had effect, generally, from the 1990-91 income year, the taxation of the income of a non-resident trust estate was broadly the same as for a resident trust estate. Formerly, where a resident beneficiary who was not under a legal disability was presently entitled to any income of a non-resident trust estate, that income was included in the beneficiary's assessable income (section 97). If the resident beneficiary was under a legal disability, the trust income to which the beneficiary was presently entitled was assessed to the trustee on the beneficiary's behalf (section 98).

Where the non-resident trust estate derived income to which no beneficiary was presently entitled (broadly, accumulating income), only so much of that income that had an Australian source was taxed to the non-resident trustee (sections 99 and 99A). Accumulated foreign source income of the non-resident trust estate was subject to tax in the hands of the resident beneficiary only if and when it was paid to or applied for the benefit of that beneficiary (section 99B).

The FSI measures changed substantially the taxation of the income of non-resident trusts. These measures apply to certain types of trusts to which Australian residents have transferred assets (transferor trusts) and operate to attribute for tax purposes the income accumulated in such trusts to those transferors.

However, avenues still remain even after the implementation of the FSI measures for the deferral of Australian tax on trust income from foreign sources until that income is paid to an Australian resident. If the resident does receive the trust income, an interest charge is applied to compensate the revenue for that deferral. In some cases, it is clear that the trust income is accumulating for the benefit of residents and it is these cases that will be addressed by the FIF measures.

The amendments described in this chapter supplement the objective of the FSI measures in preventing the deferral of Australian tax. The amendments will:

i)
nsure that an amount is not included in the assessable income of:

n Australian beneficiary under section 97; or
trustee, under subsection 98(1) or (2), on behalf of an Australian beneficiary under a legal disability;

in relation to the income of a non-resident trust estate where the FIF measures apply to the beneficiary's interest in that trust estate;
ii)
xclude from the calculation of a beneficiary's share of the net income of a public unit trust the effect of the FIF measures on the trust's net income where all the interests of the beneficiary and associates of the beneficiary in FIFs, FLPs and resident public unit trusts at the end of the year of income do not exceed $50,000;
iii)
et out the way in which the income of non-resident trust estates is to be calculated and attributed to their Australian beneficiaries;
iv)
xempt a taxpayer from an interest charge on an amount received, or applied for the taxpayer's benefit, that is attributable to the income or profits of an estate of a deceased person where that amount was paid to, or applied for the benefit of, the taxpayer within three years after the death of that person;
v)
xempt a taxpayer from an interest charge on an amount received, or applied for the taxpayer's benefit, that is attributable to the income or profits of a trust estate which at all times during the year was a public unit trust for the purposes of Division 6AAA and was not a controlled foreign trust within the meaning of Part X; and
vi)
equire taxpayers to show that an amount, being property of a trust estate, that was paid to, or applied for the benefit of the taxpayer, was paid out of accumulated profits which are referable to income other than:

n the case of a listed country trust estate, eligible designated concession income; or
n the case of an unlisted country trust estate, income that has not been subject to tax in any listed country,

before that amount will be exempt from the interest charge on distribution.

These amendments will have effect from the 1992-93 year of income.

Explanation

Excluded taxpayers

Section 97 includes in the assessable income of an Australian beneficiary, who is not under a legal disability, so much of the share of the net income of a trust estate to which the beneficiary is presently entitled as is attributable to a period when the beneficiary was a resident of Australia.

Subsections 98(1) and (2) include in the assessable income of a trustee so much of the share of the net income of a trust estate as is referable to a period when:

beneficiary under a legal disability was a resident of Australia; or
s referable to a period when a beneficiary, who is deemed to be presently entitled to a share of the income of the trust estate under subsection 95A(2) because the beneficiary has a vested and indefeasible interest in the income of the trust estate, was a resident of Australia.

The proposed amendments will ensure that an amount is not included in the assessable income of an Australian beneficiary under section 97 where the FIF measures apply to the beneficiary's interest in a non-resident trust estate and section 529 applies to include an amount in the assessable income of the beneficiary. [Subsection 96A(1)]

A trustee will also not be assessed under subsection 98(1) or (2) on behalf of an Australian beneficiary of a non-resident trust estate where the beneficiary is under a legal disability. [Subsection 96B(2)]

The only instances where the FIF measures will not apply to an Australian beneficiary's interest in a non-resident trust estate are those specifically set out under the FIF measures. For instance, where:

a)
he taxpayer is an attributable taxpayer of the trust under the transferor trust measures (that is, Division 6AAA) [Paragraph 493(a)] ;
b)
he taxpayer is an attributable taxpayer of a controlled foreign trust under the CFC measures (that is, Part X) [Paragraph 493(b)] ;
c)
he total of the values of all interests held by a taxpayer who is a natural person (including interests held by associates) in FIFs, FLPs and resident public unit trusts at the end of the year of income do not exceed $50,000 [Section 515] ;
d)
he taxpayer is a natural person who has an interest in a trust estate which is a foreign employer-sponsored superannuation fund maintained by an employer, or an associate of the employer, for the benefit of the taxpayer as an employee [Section 519] ;
e)
he taxpayer is a beneficiary of a designated publicly listed trust estate which invests in a country for which direct investment on a stock exchange is prohibited [Section 513] ; or
f)
he taxpayer qualifies for the exempt visitor exclusion from the FIF measures. [Section 517]

Taxpayer's with interests of less than $50,000

Certain small investors are excluded from the FIF measures. Consistent with this exclusion, the proposed amendments will exclude foreign investment fund income from the assessable income of a resident public unit trust when calculating a small investor's share of the net income of the trust estate. This exclusion will apply where the sum of the values of all the interests of the small investor and associates (as defined in section 491) in FIFs, FLPs and resident public unit trusts at the end of the year of income do not exceed $50,000 [subsection 96A(2)]. (Refer to the notes on the exemption for interests of less than $50,000 in Chapter 10.) [Section 515]

In calculating the beneficiary's share of the net income of the trust estate in a subsequent year of income, the trust estate's net income is to be calculated ignoring attribution credits which arose during the years of income when the beneficiary was exempt because of subsection 96A(2). This will mean that the beneficiary will not benefit from the exemption which applies for previously attributed amounts (section 23AK) or for a reduction in the disposal consideration of the FIF interest because of an unused FIF attribution account surplus (section 613) where that benefit would otherwise arise because of amounts which were included in the trust estate's attributable income in a year of income when the beneficiary was exempt from attribution because of subsection 96A(2). [Paragraph 96A(2)(d)]

Attribution of trust income

From the 1992-93 year of income, the share of the income of an Australian beneficiary of a non-resident trust, who is not assessed under the FIF measures, will be calculated on a new basis. [Section 96B]

There are two methods by which the beneficiary's share of trust income will be calculated. The first method applies where all of the trust's accounting income, profits and gains are income, profits and gains to which the beneficiary is presently entitled or which are distributed to the beneficiary within two months of the end of the income year.

The terms "income, profits or gains" have their normal meaning and relate to the ordinary accounting and trust law concepts of trust income. For this purpose, an amount that was credited to, or applied for the benefit of a beneficiary of the trust estate is treated as paid to the beneficiary.

Where these conditions are met, the following formula is used to calculate the share of a beneficiary in the net income of the trust estate:

Net income x Attribution percentage

Net income means the net income of the trust estate. The net income of a trust estate is, broadly, the assessable income of the trust estate calculated under the Principal Act as if the trustee were a taxpayer and a resident of Australia and deducting allowable deductions. It would include, for instance, assessable FIF income from interests that the trustee holds in a lower tier FIF. (Subsection 95(1))

Attribution percentage means the percentage of the total income, profits and gains of the trust estate to which the beneficiary is presently entitled or that was paid to or applied for the benefit of the beneficiary in the year of income of that trust or within 2 months after the end of the year of income. [Subsection 96C(1)]

Where the conditions for application of the method are not met, the beneficiary's share of the net income of the trust estate is determined by three steps as follows:

Step 1

Calculate the share of the net income referable to interests held in a trust estate for the whole year.

Calculate the part of the beneficiary's share of the net income of the trust estate that is attributable to any interest the beneficiary had in the trust estate throughout the whole year of income using the following formula.

Net income x Attribution percentage

(These terms are described below.)

Step 2

Calculate the share of the net income referable to interests held in a trust estate for only part of the year.

Calculate the part or parts of the beneficiary's share of the net income of the trust estate that is attributable to any interest the beneficiary had throughout a particular part of the year of income using the following formula;

Net income x Attribution percentage x (Number of days held / Total number of days)

(These terms are described below.).

Step 3

Calculate the total share of the net income referable to interests held in a trust estate.

Total the amounts calculated in steps 1 & 2 to determine the beneficiary's share of the net income of the trust estate. [Subsections 96C(2) to (5)]

Meaning of the terms in the formulas:

Net income means the net income of the trust estate.

Attribution percentage means the greater of:

a)
he percentage of the income of the trust estate to which the beneficiary was entitled, or was entitled to acquire, because of the beneficiary's interest in the trust estate (that is, any interest in the income of the trust estate that the beneficiary had or was entitled to acquire); or
b)
he percentage of the corpus of the trust estate to which the beneficiary was entitled, or was entitled to acquire, because of the beneficiary's interest in the trust estate (that is, any interest in the corpus of trust estate that the beneficiary had or was entitled to acquire).

A beneficiary is entitled to acquire anything that the beneficiary is absolutely or contingently entitled to acquire, whether because of the exercise of any right or option or for any other reason. [Subsection 95C(5)]

The attribution percentage for a taxpayer is to be reduced if the sum of the attribution percentages of all resident taxpayers in the trust estate exceed 100 per cent. In this case, the taxpayer's attribution percentage is to be reduced by the same proportion as the sum of the attribution percentages of all resident taxpayers in the trust estate exceeding 100 per cent. [Subsection 96C(6)]

Number of days held means the number of days in the part of the year of income throughout which the beneficiary had an interest in the trust estate.

Total number of days means the number of days in the year of income.[Subsection 95C(5)]

Deceased estates

An interest charge applies to amounts that are included in the assessable income of a beneficiary under section 99B (section 102AAM). In broad terms, section 99B includes in the assessable income of a beneficiary who was a resident at any time in a year of income any property of a trust estate, that is paid to, or applied for the benefit of, that beneficiary in the year of income. However, section 99B does not apply to amounts which have previously been subject to tax in Australia either in the hands of the trustee or of the beneficiary.

The amendments will exempt a beneficiary from the interest charge on amounts received from the estate of a deceased person which would otherwise have been assessable under section 99B where those amounts are paid to, or applied for the benefit of, the beneficiary within three years after the death of that person. [Subsection 102AAM(1B)]

Public unit trusts

The transferor trust measures (Division 6AAA) do not apply to arm's length transfers to non-resident public unit trusts (subparagraph 102AAT(1)(a)(i)(B)). Consistent with this treatment, the amendments will exempt a taxpayer from an interest charge on amounts received, or which have been applied for the taxpayer's benefit, that are attributable to the income or profits of a trust estate which at all times during the year:

as a public unit trust for the purposes of the transferor trust measures (Division 6AAA); and
as not a controlled foreign trust within the meaning of Part X. [Subsection 102AAM(1C)]

Section 102AAF specifies the basic criteria for determining whether a unit trust is to be regarded as a public unit trust for the purposes of the transferor trust measures. Broadly, a unit trust will be a public unit trust if, at any time during the year, any of the units in the unit trust were listed on a stock exchange in Australia or elsewhere or were offered to the public. In addition, a unit trust will be a public unit trust if, at all times during the year, the units in the unit trust were held by 50 or more persons. However, a unit trust will not be treated as a public unit trust where 20 or fewer persons hold 75 per cent or more of the beneficial interests of the income or property of the trust.

The following considerations must be taken into account in determining whether a unit trust is a public unit trust at all times during the year of income:

n entity and its associate or associates (defined in section 102AAB to have the same meaning as described in section 318) are taken to be one person; and
here units in the trust are held by the trustee of another trust estate that is a public unit trust at all times during the year of income, a person who has a beneficial interest in the property of that other trust estate that consists of those units is taken to hold those units. [Subsection 102AAF(3)]

Section 342 specifies the criteria for determining whether a trust estate is a controlled foreign trust within the meaning of Part X. A trust estate will be a controlled foreign trust within the meaning of Part X if there is an eligible transferor in respect of the trust - that is, broadly, if an Australian entity or, a controlled foreign partnership, controlled foreign trust or controlled foreign company, transferred value to the trust estate:

n the case of a discretionary trust estate, at any time (section 347); or
n the case of a non-discretionary trust estate, after 12 April 1989 for non-arm's length consideration (section 348).

A trust estate will also be a controlled foreign trust within the meaning of Part X if there is a group of five or fewer Australian 1 per cent entities (defined in section 317) with associate-inclusive control interests (defined in section 349) in the trust estate totalling 50 per cent or more (section 342).

Interest charge exemption - amounts which have been taxed at comparable rates

Where a non-resident trust estate is a listed country trust estate (defined in section 102AAE) in a year of income, only distributions from certain concessionally taxed income of the trust estate will be subject to the interest charge under section 102AAM. Where a non-resident trust estate is not a listed country trust estate in a year of income, a distribution made from the income and profits of the trust estate of that year of income will be subject to the interest charge to the extent that the amount has not been subject to tax in any listed country in a tax accounting period:

nding before the end of the non-resident trust's year of income; or
ommencing during the non-resident trust's year of income.[Paragraph 102AAM(1)(b)]

Before that amount will be exempt from the section 102AAM interest charge on distribution, a taxpayer will have to show that an amount (being property of a trust estate) that was paid to or applied for the benefit of the taxpayer was paid out of accumulated profits which are referable to:

n the case of a listed country trust estate, income other than eligible designated concession income; or
n the case of an unlisted country trust estate, income that has been subject to tax in any listed country.[Subsection 102AAM(1A)]

Clauses making the amendments

Clause 10: Inserts subsection 95(3) which defines a "non-resident trust estate" for the purposes of Division 6.

Clause 11: Inserts section 96A. Subsection 96A(1) will exclude income referable to an interest held by taxpayer in a non-resident trust estate which has been taxed under the FIF measures from being assessed to the taxpayer again under section 97. Subsection 96A(2) deals with the small investor exclusion from the FIF measures as they relate to resident public unit trusts.

It also inserts sections 96B and 96C which will set out the new method of calculating the shares of the net income of beneficiaries of non-resident trusts.

Clause 12: Amends section 102AAM to exempt taxpayers from the interest charge on certain amounts received under section 99B and to require taxpayers to establish that certain trust distributions are not subject to an interest charge.

Calculation of the Attributable Income of a CFC

Overview

It is possible that a Controlled Foreign Company ( CFC) will have an interest in another company or trust which is a FIF. This Chapter deals with the amendments to the calculation of the attributable income of the CFC to take account of the CFC's interest in the FIF.

Background to the CFC system

Where a foreign company is a CFC at the end of its statutory accounting period, its attributable income will be calculated separately for each attributable taxpayer. Broadly, the attributable income of a CFC is calculated using the rules that exist under the Principal Act for the calculation of taxable income on the assumption that the CFC was a taxpayer that was a resident of Australia. In making this hypothetical calculation of the taxable income, it must be assumed that a variety of modifications have been made to the Principal Act.

Although these assumptions are common for all CFCs, the amounts of income to be included in the calculation of attributable income for a particular period will differ depending on the residence of the CFC at the end of that period, and on whether or not the CFC passes the active income test in respect of that attributable taxpayer in respect of that period.

The active income test

The active income test determines whether a CFC is to be treated as predominantly engaged in active business operations.

A CFC fails that test if, in broad terms, 5 per cent or more of the gross turnover of the CFC consists of tainted income. Tainted income includes passive income and income from certain related party transactions.

Attributable income of an unlisted country CFC

Where, for a particular attributable taxpayer, a CFC that is a resident of an unlisted country fails the active income test, the attributable income of the CFC is calculated by taking into account the tainted income of the CFC. Also taken into account is any income derived from a trust, or attributable to the CFC because the CFC is a transferor to a non-resident trust. Where the CFC passes the active income test, the attributable income is calculated by taking into account only the trust amounts.

Attributable income of a listed country CFC

Where a CFC that is a resident of a listed country fails the active income test in respect of an attributable taxpayer, the attributable income of the CFC is calculated by taking into account the following amounts:

esignated concession income which is also passive income or amounts arising from certain related party transactions provided that, broadly, the amounts are not comparably taxed in a listed country or in Australia;
ncome derived from a trust provided that the income is not comparably taxed in a listed country or in Australia;
mounts attributable to the CFC as transferor to a non-resident trust; and
mounts derived from a source outside the listed country that are not comparably taxed in the listed country, in another listed country or in Australia.

In the case where a CFC is a resident of a listed country and passes the active income test, an exemption from attribution will be given for those amounts that are eligible designated concession income.

FIF measures in the calculation of a CFC's attributable income

The FIF measures will apply in the calculation of the attributable income of a CFC. As discussed, the major assumption under which the calculation of the attributable income of a CFC operates is that the attributable income of the CFC is the amount that would be the taxable income if the CFC were a resident of Australia for the whole of the statutory accounting period of the CFC (existing sections 382 and 383 of the Principal Act). This residency assumption has the effect that the FIF measures automatically apply in the calculation of the attributable income of a CFC.

Normally, a taxpayer may elect to use the calculation method of taxation both for the taxpayer's interest in a FIF (the first tier FIF) and for any interest of the first tier FIF in a second tier FIF. However, the FIF measures will be modified for the purpose of calculating the notional assessable income of a CFC. This modification will prevent a taxpayer from electing under subsection 535(3) to use the calculation method for a second tier FIF where the interest in the first tier FIF is held by a CFC [subsection 577(2)]. Instead, the market value or deemed rate of return method will be used for the second tier FIF.

The amount attributed from a FIF to the CFC will be included irrespective of whether the CFC is resident in a listed or unlisted country, and regardless of whether or not the CFC passes the active income test in respect of a particular attributable taxpayer. [Paragraph 384(2)(ca) and paragraph 385(2)(ca) ]

De minimis test

A de minimis exemption applies where the CFC is a resident of a listed country. There is no corresponding exemption for a CFC that is a resident of an unlisted country. The existing exemption will be modified to add to the categories eligible for the exemption amounts included in the CFC's income under the FIF measures from a direct interest in a FIF. In effect, this will mean that where a CFC has gross turnover of $1 million or more, the exemption will only apply if the sum of the

ligible designated concession income;
ncome or profits from sources outside the listed country that are not subject to tax in the listed country or in another listed country; and
FIF income arising to the CFC,

is $50,000 or less.

Where the CFC has a turnover of less than $1 million, the exemption will only apply where the sum of the amounts is less than 5 per cent of the gross turnover. [Subsection 385(4)]

Consequential amendments

It is necessary to modify the operation of Part XI as it applies to the calculation of the attributable income of a CFC, and a new Subdivision E in Division 7 of Part X has been inserted to achieve this. [Sections 431A and 431B]

Modifications to the operation of the FIF measures in the calculation of the attributable income of a CFC

Reduction of FIF income because of interim dividend etc

Under subsection 530(1), FIF income is reduced to take account of a distribution made by the FIF to the taxpayer during the notional accounting period of the FIF. Where a CFC has an interest in a FIF such double taxation is also to be prevented. However, where the attribution is under section 456, an attribution credit only arises at the end of the statutory accounting period of the CFC. For the calculation of the FIF income to take into account a dividend paid after the end of the notional accounting period of the FIF, it is necessary to exempt the dividend paid after the calculation of the FIF income. This will be done by modifying the operation of section 530.

Example A taxpayer owns 100% of a CFC which in turn has a 1% interest in a company (not a CFC) resident in an unlisted country. The accounting periods are as follows:

he taxpayer's year of income ends on 30 June 1995;
he CFC's statutory accounting period ends on 31 December 1994; and
he FIF's notional accounting period ends on 30 June 1993.

The interest in the FIF is not exempt from the FIF measures and the increase in the market value of the FIF interest for the period 1 January 1993 to 30 June 1993 was $20,000. The FIF paid a dividend to the CFC of $10,000 on 1 October 1993.In calculating the taxpayer's assessable income for the 1994/95 income year, the taxpayer would need to calculate the CFC's notional assessable income for the statutory accounting period of the CFC ending on 31 December 1994. This would include an amount in respect of the FIF income and also the dividend.Normally, the FIF income would be $20,000. However, because of the modification to section 530, the FIF income is reduced from $20,000 to $10,000.

Miscellaneous

The amendment of section 399 of the Principal Act corrects an anomaly in the method of calculating the net income of a partnership or trust which is to be included in the attributable income of a CFC.

The anomaly results in the following unintended consequences:

he exempting profits percentage of a non-portfolio dividend (broadly, the comparably taxed part of the dividend) paid by a company in an unlisted country (that is, a country which is not designated as a comparable tax country) to a partnership or trust was excluded from the partnership's or trust's net income instead of being included; and
mounts which had been taxed in Australia were included in the partnership's or trust's net income instead of being excluded.

Application date

The amendment to the calculation of the net income of a partnership or trust will apply as follows.

The inclusion in net income of the exempting profits part of a non-portfolio dividend will apply prospectively to dividends paid after the date of introduction of this Bill.

The deletion of the reference to listed country branch profits, will apply retrospectively for any calculation of the attributable income of a CFC, including the calculation of a loss that arose before the start of the CFC measures. This amendment will be to the taxpayer's advantage.

Clauses making the amendments

Clauses 21 and 22: Inserts paragraphs 384(2)(ca) and 385(2)(ca) to ensure that an amount of FIF income will be attributed whether a CFC is a resident of a listed or unlisted country and regardless of whether the CFC passes the active income test in respect of a particular attributable taxpayer.

Clauses 20, 21(a) and 22(a): Amend Division 7 of Part X to change references to Subdivisions B to D to Subdivisions B to E, to take account of the addition of Subdivision E.

Clause 23: Amends section 389 to exclude the operation of certain provisions of the Principal Act in the calculation of the attributable income of a CFC.

Clause 24: Amends section 399 of the Principal Act to correct an anomaly in the method of calculating the net income of a partnership which is included in the attributable income of a CFC.

Clause 25: Amends subsection 402(3) of the Principal Act to ensure that double taxation does not arise where previously attributed FIF income is distributed to a CFC.

Clause 26: Inserts Subdivision E in Division 7 of Part X of the Principal Act to modify the calculation of CFC attributable income consequential to the introduction of Part XI.

Attribution accounts - CFC

Overview

This chapter deals with the prevention of potential Australian double taxation that could arise where foreign investment fund income is included in the notional assessable income of a CFC under the CFC measures. As with the CFC measures, double taxation is to be prevented where a taxpayer later:

eceives a distribution of income and/or gains out of the attributed amount; or
isposes of the interest in the CFC.

This will be done by using the existing exemption for amounts previously attributed under the CFC measures, and the associated CFC attribution accounts.

Background

Dividends paid to a taxpayer out of income derived by a CFC that has been attributed to that taxpayer are exempt from tax (existing section 23AI). Further, the consideration on disposal of an interest in a CFC is reduced to take account of previous attribution (existing section 461).

To claim an exemption under section 23AI, or the reduction under section 461, the taxpayer is required to maintain an 'attribution account' in relation to the CFC which shows:

he amount of the income attributed to the taxpayer (recorded as an ' attribution credit'); and
mounts distributed to the taxpayer, for example, a dividend paid to the taxpayer by the CFC (recorded as an ' attribution debit').

Broadly, attribution credits arise in relation to a CFC if an amount is included in the assessable income of an Australian attributable taxpayer because:

n amount of the CFC's income is attributed to the taxpayer (existing section 456); or
he CFC has changed residence from an unlisted country to a listed country or Australia (existing section 457); or
n unlisted country CFC paid a non-portfolio dividend to a listed country CFC (existing section 458).

The amount of the exemption or reduction of consideration cannot exceed the ' attribution surplus' in the account. The attribution surplus is the amount by which attribution credits exceed attribution debits.

These accounts are similar to the FIF attribution accounts described in Chapter 21.

Attribution credit for FIF income attributed to a CFC

An attribution credit arises for a CFC in relation to a taxpayer if a share of the attributable income of the CFC is included in the taxpayer's assessable income (existing section 456).

An amount of FIF income that is included in the calculation of the CFC's notional assessable income will enter into the calculation of the amount included in the taxpayer's assessable income under section 456. However, without amendment of the current provisions, the attribution credit would wholly arise to the CFC.

Credit to arise to FIF

The current provisions will be modified so that the attribution credit that relates to the foreign investment fund income of a FIF in which a CFC has an interest will arise for the FIF rather than for the CFC. [Paragraph 371(1)(aa)]

Amount of credit arising to FIF

Where the CFC has an interest in a FIF, the taxpayer will need to keep an attribution account for that CFC as well as for the underlying FIF. This will allocate the attribution credit relating to the attributable income of the CFC that is included in the taxpayer's assessable income as follows:

n attribution credit will arise for the underlying FIF to the extent that the attribution under section 456 reflects the amount of FIF income included in the attributable income of the CFC; and
n attribution credit will arise for the CFC, for the remainder of the amount attributed under section 456.

Method of allocation of the credits

A formula will be used to determine the part of the amount attributed under section 456 that related to the application of the FIF measures in the calculation of the attributable income of a CFC. The formula allocates the attribution credit on a gross income basis. That is, it compares the amount that a particular FIF contributed to the notional assessable income of the CFC to the total notional assessable income of the CFC. The formula is as follows:

(FIF income x section 456 amount) / notional assessable income

The ' FIF income' is the amount that was included in that CFC's notional assessable income because of the CFC's interest in a particular FIF. The 'section 456 amount' is the amount that is attributed from that CFC to the taxpayer under section 456. The 'notional assessable income' is the total notional assessable income of the CFC.

This formula is applied to each FIF in which the CFC held an interest that gave rise to an amount of FIF income being included in the CFC's notional assessable income. [Subsection 371(2A)]

The remainder of the section 456 amount that has not been allocated to the underlying FIFs creates an attribution credit for the taxpayer in respect of the CFC.[Subsection 371(2C)]

Example Assume that a resident taxpayer (Mr Jones) has a 100 per cent interest in a CFC ( CFCco) which, in turn, has an interest in three FIFs. Mr Jones is not entitled to an exemption from the CFC measures, nor from the FIF measures in their application in the calculation of the notional assessable income for CFCco's statutory accounting period. CFCco derived untaxed royalty income (tainted) of $1,000,000 during its statutory accounting period and had allowable deductions of $2,000,000. The market value method is used to calculate the amount to be included in the attributable income of CFCco in relation to the FIFs and the market value increase for each of the underlying FIFs was as follows:

FIF One $500,000
FIF Two $700,000
FIF Three $300,000
This is illustrated on the next page.

Example of market value method

The calculation of the attributable income of CFCco would be as follows:

Notional assessable income $
Royalty derived by CFCco 1,000,000
FIF income from FIF1 500,000
FIF income from FIF2 700,000
FIF income from FIF3 300,000
2,500,000
Notional allowable deductions 2,000,000
Attributable income of CFCco 500,000

The amount included in Mr Jones' assessable income would be $500,000, being 100 per cent of the attributable income of CFCco. This means that the total of the credits to Mr Jones' attribution accounts must equal $500,000.

The attribution accounts for the FIFs will be credited in the proportion of the FIF income arising from each FIF compared to the gross notional assessable income arising to the CFC, as follows:

Attribution account(FIF1) = $0.5m/$2.5m x $500,000
= 20% x $500,000
= $100,000
Attribution account(FIF2) = $0.7m/$2.5m x $500,000
= 28% x $500,000
= $140,000
Attribution account(FIF3) = $0.3m/$2.5m x $500,000
= 12% x $500,000
= $60,000

The CFC's attribution account will be credited with the remainder, as follows:

Attribution account( CFC) = $500,000 - $100,000 -
$140,000 - $60,000
= $200,000

FIFs held by a CFC through an interposed FIF

Separate attribution accounts are required to be maintained by a taxpayer for each FIF held by a CFC through an interposed FIF if the calculation method is used to determine the attributable income of the interposed FIF.

An attribution credit will arise for a FIF (referred to in section 371 as the "eligible entity") held by a CFC through an interposed FIF if all of the following conditions are satisfied:

i)
n amount was included in a taxpayer's assessable income under section 456 in relation to a CFC (referred to in paragraph 371(1)(ab) as "the other entity"); [Subparagraph 371(1)(ab)(i)]
ii)
hat amount is referable to an amount which was included in the notional assessable income of the CFC under Part XI because the CFC had an interest in a FIF (this FIF is referred to in paragraph 371(1)(ab) as "the interposed entity"); [Subparagraph 371(1)(ab)(ii)]
iii)
he notional income (using the calculation method) of the interposed entity will include an amount referable to an interest that the interposed entity has in the eligible entity (that is, the FIF for which the attribution credit will arise under paragraph 371(1)(ab)). [Subparagraph 371(1)(ab)(iii)]

The diagram on the next page illustrates how the terms used in paragraph 371(1)(ab) relate to a structure of entities.

Terms used in paragraph 371(1)(ab)

Amount of credit arising for the eligible entity

The following formula is to be used to determine the amount of the attribution credit which will arise for the FIF under paragraph 371(1)(ab): [Section 371(2B)]

(FIF income x Section 456 amount) / Notional assessable income
In the formula:

" FIF income" means the amount worked out using the formula:

( FIF income of the eligible entity x Section 529 amount) / Notional income of the interposed entity
where:

" FIF income of the eligible entity" means the amount included in the notional income of the interposed FIF entity under section 576 because it had an interest in the 'eligible entity' that is a FIF (that is, the entity for which the attribution credit will arise);
"Section 529 amount" means the amount included in the notional assessable income of the CFC under section 529 because of the interest it holds in the interposed FIF entity;
"Notional income of the interposed entity" means the notional income of the interposed FIF entity;

" Section 456 amount" means the amount included in the taxpayer's assessable income under section 456 because the taxpayer has an interest in the CFC;
"Notional assessable income" means the notional assessable income of the CFC in relation to the taxpayer.

This formula will apply to each FIF in which the interposed entity has an interest. [Subsection 371(2B)]

The remainder of the section 456 amount that has not been allocated to an underlying FIF under paragraph 371(1)(ab) creates an attribution credit for the taxpayer in respect of the interposed entity or of the CFC. The amount of the credit that arises for the interposed entity under paragraph 371(1)(aa) is calculated under subsection 371(2A) and reduced by the attribution credits which arise for entities held through the interposed entity under paragraph 371(1)(ab) [subsection 371(2D)]. The attribution credit which would normally arise for the CFC under paragraph 371(1)(a) is reduced by the amount of the attribution credit which would arise for the interposed entity if not for the reduction of that FIF attribution credit for the attribution credits which arise for entities held through the interposed entity. [Section 371(2C)]

Example Assume that a resident taxpayer (Ms Brown) has a 50 per cent interest in a CFC ( CFCco) which has a 25 per cent interest in a FIF ("the interposed entity") which in turn has an interest in two FIFs ("FIF1" and "FIF2"). Refer to the diagram below.

Structure of Ms Brown's interest in foreign entities

During the relevant period, CFCco does not derive any income, whereas the interposed entity derives $10,000 income. In addition, under the market value method, the interposed entity is taken to have derived $20,000 FIF income from FIF1 and $40,000 FIF income from FIF2. Also, assume that the interposed entity has a past calculated loss of $30,000 and that the CFC has carried forward losses of $2,000 for the passive class of income. (i) Calculation of the amount to be included in Ms Brown's assessable income because of her interest in < CFCco The interposed entity has notional income of $70,000 (that is, $10,000 + $20,000 + $40,000). Its calculated profit would be $40,000 (that is, $70,000 less its past calculated loss of $30,000). CFCco's notional assessable income will include $10,000 FIF income under section 529, being its share of the interposed entity's calculated profit. The attributable income of CFCco would be $8,000 (that is, $10,000 less its carried forward loss of $2,000).Ms Brown's assessable income would include an amount of $4,000 (that is, 50% x $8,000) because of her interest in CFCco. (ii) Attribution credits FIF 1 FIF1's " FIF income" would be calculated using the following formula":

(FIF income of the eligible entity x Section 529 amount) / Notional income of the interposed entity
FIF1's "FIF income" = ($20,000 x $10,000) / $70,000
= $2,857.14

The attribution credit which arises for FIF1 in relation to Ms Brown would be calculated using the following formula:

FIF income x Section 456 amount / Notional assessable income
FIF1's attribution credit = ($2,857.14 x $4,000) / $10,000
= $1,142.86

FIF 2 FIF2's " FIF income" would be calculated using the following formula"

( FIF income of the eligible entity x Section 529 amount) / Notional income of the interposed entity
FIF2's "FIF income" = ($40,000 x $10,000) / $70,000
= $5,714.29

The attribution credit which arises for FIF2 in relation to Ms Brown would be calculated using the following formula:

(FIF income x Section 456 amount) / Notional assessable income
FIF2's attribution credit = ($5,714.29 x $4,000) / $10,000
= $2,285.72

The interposed entity

The unmodified attribution credit which arises for the interposed entity in relation to Ms Brown would be calculated using the formula:

(FIF income x Section 456 amount) / Notional assessable income
The interposed entity's unmodified attribution credit = ($10,000 x $4,000) / $10,000
= $4,000

This amount must be reduced by the amount of the attribution credits which arise for FIF1 and FIF2. Consequently, an attribution credit of $571.42 ( that is, $4,000 - ($1,142.86 + $2,285.72) arises for the interposed entity in relation to Ms Brown.

CFCco

Normally an attribution credit of $4,000 would arise for CFCco in relation to Ms Brown [paragraph 371(1)(a)]. However, this credit must be reduced by the amount of the unmodified credit which arises for the interposed entity [ Subsection 371(2D) / Subsection 371(2B) ]. Consequently, the attribution credit which arises for CFCco is nil (that is, $4,000 - $4,000).

Attributed tax account credits

Overview

Attributed tax accounts ensure that a credit arising for foreign tax when an amount is included in a taxpayer's assessable income under the CFC measures cannot be claimed again when the taxpayer receives a distribution of profits from the CFC.

An attributed tax account credit will arise in relation to a taxpayer for a FIF held by a CFC if:

i)
n amount is included in the assessable income of the taxpayer under section 456 in respect of a statutory accounting period of a CFC; and
ii)
he taxpayer was taken under section 160AFCK to have paid and to be personally liable for an amount of foreign tax paid by the FIF in relation to the section 456 amount. [Paragraph 375(1)(da)]

[Refer to the Chapter 28 for a description of the operation of new section 160AFCK.]

The amount of the attributed tax account credit which arises for the FIF in relation to the taxpayer is equal to the amount of foreign tax the taxpayer is taken to have paid and to be personally liable for under section 160AFCK as a result of the taxpayer's interest in the FIF which is held through the relevant CFC. [Subsection 375(2)]

Clauses making the amendments

Clause 17: Amends section 371 of the Principal Act to ensure that attribution credits arising because a CFC has an interest in a FIF are allocated to the FIF.

Clause 18: Amends section 375 of the Principal Act to ensure that an attributed tax account credit arises for a FIF in relation to a taxpayer to the extent that the taxpayer can claim a credit for foreign tax paid by the FIF in relation to an amount included in the taxpayer's assessable income under section 456.

Relief for Foreign Taxes paid by FIFs held through a CFC

Overview

Where a taxpayer has used the calculation method to determine the foreign investment fund income of a FIF, a foreign tax credit may be allowed in certain circumstances for foreign tax paid by the FIF on its income and gains (this treatment is discussed in the Chapter 22). This chapter deals with the credit a company taxpayer may claim in certain circumstances for foreign tax paid by a FIF where a resident company uses the calculation method to determine the foreign investment fund income of a FIF which is included in the notional assessable income of a CFC.

Background

Under the foreign tax credit system (FTCS) a taxpayer may claim a credit for foreign tax paid on foreign income if the taxpayer has paid and is personally liable for that foreign tax or is deemed to have paid and to have been personally liable for that tax. A resident company is taken to have paid and have been personally liable for tax paid by a CFC in relation to an amount included in the taxpayer's assessable income under the CFC measures. Consequently, the taxpayer will be able to claim a credit for foreign tax paid by the CFC in relation to the amount included in the taxpayer's assessable income under the CFC measures if the CFC is related to the taxpayer.

Consistent with the above treatment and the treatment of an interest held in a FIF directly, a resident company will be taken to have paid and to have been personally liable for an amount of foreign tax paid by a FIF which is held by a CFC in which the taxpayer has an interest. This treatment will apply only where the calculation method is used to determine the foreign investment fund income of the FIF which is to be included in the notional assessable income of the CFC.

Explanation

A resident company will be taken to have paid and to have been personally liable for foreign tax paid by a FIF where all of the following conditions are satisfied:

i)
n amount ("the section 529 amount") is included in the notional assessable income of the CFC under section 529 and
ii)
n amount ("the section 456 amount") is included in the assessable income of the taxpayer under section 456 in relation to the CFC; and
iii)
he calculation method was used to determine the amount included in the CFC's notional assessable income under section 529 because the CFC had an interest in the FIF; and
iv)
n amount ("the gross deductible amount") is a notional deduction under the calculation method from the FIF's notional income because the FIF paid an amount in respect of foreign tax; and
v)
f the FIF is a company, the CFC and the FIF were related to the taxpayer at the end of the notional accounting period of the FIF; and
vi)
f the FIF is not a company, the CFC is related to the taxpayer at the end of the notional accounting period of the FIF. [Subsection 160AFCK(2)]

The amount of foreign tax paid by the FIF which the taxpayer will be taken to have paid and to be personally liable for in respect of the section 456 amount is calculated using the formula:

(The gross deductible amount x ( Attribution credit arising for the FIF / calculated profit of the FIF
[Subsection 160AFCK(3)]In the formula:

"The gross deductible amount" means the foreign tax paid by the FIF which gave rise to a notional deduction from the FIF's notional income;
" Attribution credit arising for the FIF " means the attribution credit that arises for the FIF in relation to the taxpayer before reduction (if any) of that credit for an attribution credit which arises for another FIF in which the relevant FIF has an interest.
" calculated profit of the FIF " means the calculated profit of the FIF using the calculation method.

Example Assume that a resident taxpayer (Ms Rose) has a 100 per cent interest in a CFC ( CFCco) which has a 25 per cent interest in a ( FIF).During the relevant period, CFCco does not derive any income. However, using the calculation method, the CFC has notional income from FIF1 of $100,000 and claims a notional deduction for foreign tax paid of $20,000. If FIF1 does not have any other notional deductions, it will have a calculated profit of $80,000 (that is, $100,000 - $20,000) and $20,000 (that is, 25% x $80,000) will be included in CFCco's notional assessable income under section 529. (i) Calculation of the amount to be included in Ms Rose's assessable income because of her interest in CFCco Ms Rose's assessable income would include an amount of $20,000 (that is, 100% x $20,000) under section 456 because of her interest in CFCco. It would also include $5,000, being the amount of foreign tax that she is deemed to have paid in relation to that income (see item (iii)). (ii) attribution credits FIF1 The attribution credit which arises for FIF1 in relation to Ms Rose would be calculated using the formula:

(FIF incom x Section 456 amount) / Notional assessable income
= 9$20,000 x $20,000) / $20,000
= $20,000

CFCco Normally, under the CFC provisions, an attribution credit of $20,000 would arise for CFCco in relation to Ms Rose [paragraph 371(1)(a)]. However, this credit must be reduced by the amount of the credit which arises for FIF1 [subsections 371(2A) and 371(2B) ]. Consequently, the attribution credit which arises for CFCco is nil (that is, $20,000 - $20,000). (iii) Calculation of the foreign tax paid by FIF1 which Ms Rose is taken to have paid and for which she is taken to have been personally liable The amount of foreign tax paid by FIF1 which Ms Rose will be taken to have paid and to have been personally liable for in respect of the section 456 amount is calculated using the formula:

The gross deductible amount x ( Attribution credit arising for the FIF / Calculated profit of the FIF)
= $20,000 x 9$20,000 / $80,000)
= $5,000

Clauses involved in the amendments

Clause 15: Inserts section 160AFCK into the Principal Act.

Subclause 3(c): Inserts a reference to section 160AFCK into section 6AB in order that amounts of tax a taxpayer is taken to have paid and been personally liable for under section 160AFCK are treated as foreign tax for the purposes of the Principal Act.

Subclause 4(a): Inserts a reference to section 160AFCK into section 6AC in order that the amount included in a taxpayer's assessable income under section 456 is grossed up by the amount of foreign tax the taxpayer is taken to have paid and been personally liable for under section 160AFCK. The section 456 amount is not grossed up for the purposes of determining the attribution credit which arises for the taxpayer in relation to a CFC.

Glossary

Accounts Accounts means ledgers, journals, profit and loss accounts and balance sheets. It also includes statements, reports and notes attached to, or intended to be read with, any of the above items.
Active business exemption An exemption from taxation under the FIF measures for interests a taxpayer has in foreign companies that are principally engaged in eligible active business (see Chapter 4).
Approved exchanges / approved markets The stock exchanges and financial markets whose quoted market values are accepted for the market value method. The list of approved stock exchanges can be found at Schedule 3 of the Bill.
Arm's length amount This expression means the amount that might reasonably be expected to have been paid, or given in consideration, when parties are dealing independently with each other.
Attributable taxpayer A person who has, in general, a 10 per cent or greater interest in a Controlled Foreign Company or in a non-resident trust for the purposes of Part X of the Principal Act.
Attribution account An attribution account establishes a link between:

ncome that has been attributed to the taxpayer from an attribution account entity; and
ncome actually distributed to that taxpayer by the entity.

Attribution account entity An attribution account entity is an entity for which a resident taxpayer is to maintain an attribution account (in order to trace distributions of attributed income). An entity includes:

company that is not a Part X Australian resident;
partnership;
trust; and
FLP

Attribution credit When an amount is attributed to a taxpayer from an entity, the attribution account is credited (attribution credit) with the amount of the attributable income.
Attribution debit When an entity subsequently distributes income that has been attributed to a taxpayer, the amount of the distribution is debited (attribution debit) to the attribution account. The amount of the debit cannot exceed the balance of the account, which is referred to as the attribution surplus.
Attribution surplus An attribution surplus exists if the total of the attribution credits for an entity exceeds its attribution debits.
Bill, the The Income Tax Assessment Amendment (Foreign Investment) Bill 1992
Calculated loss The loss arising to a FIF in the FIF's notional accounting period as calculated under the FIF measures using the calculation method. It may be carried forward to reduce future calculated profits of that FIF.
Calculated profit The profit arising to a FIF in the FIF's notional accounting period as calculated under the FIF measures using the calculation method. The taxpayer's share of these profits is included in assessable income.
Calculation method An alternative method, available at the taxpayer's election, to determine the amount to be included in a taxpayer's assessable income under the FIF measures. The amount is calculated by determining a taxpayer's share of a FIF's profits. A FIF's profits are calculated using rules similar (but simpler than) those that apply for a resident taxpayer (see Chapter 18).
Cash Surrender Value Method Method of taxation applying to taxpayers who have an interest in a FLP. In general, the amount included in assessble income is calculated by measuring the increase, if any, in the cash surrender value of an interest in a FLP between the last day of the previous notional accounting period and the last day of the current notional accounting period, with an adjustment for acquisitions, disposals and distribution (see Chapter 19).
Closing market value The market value of a FIF interest at the end of the FIF's statutory accounting period - see Chapter 16.
Controlled foreign company or CFC A company that is not a resident of Australia and is controlled by five or fewer residents - see Part X of the Principal Act.
Controlled foreign trust or CFT A controlled foreign trust is a non-resident trust in which resident individuals, partnerships, companies or trusts hold specified interests. The term includes a non-resident trust to which a resident person has transferred property or services in certain circumstances. The meaning of the term controlled foreign trust is set out in section 342 of the Principal Act.
Country fund exclusion Investments through trusts in countries which prohibit direct investment on stock exchanges in those countries will be excluded from the FIF measures (see Chapter 9).
Deemed rate of return method The backup method to determine the amount to be included in the taxpayer's assessable income under the FIF measures. The amount is calculated by applying a deemed rate of return to the value of the FIF or FLP interest (see Chapter 17 for FIFs and Chapter 19 for FLPs).
Direct investment An investment to which the taxpayer has both beneficial and legal entitlement.
Exempting receipts Exempting receipts of an unlisted country company are amounts received by that company that have either:

een included in assessable income for Australian tax purposes; or
een taxed at comparable rates in a listed country.

FIF A Foreign Investment Fund (see Chapter 1).
FIF interest An interest in a Foreign Investment Fund.
FIF loss The market value or cash surrender value decrease of an interest in a FIF or FLP respectively for the notional accounting period of that FIF or FLP.
Foreign Investment Fund Amount The foreign investment fund amount is the change in market value or cash surrender value of an interest in a FIF or FLP respectively - after taking into account acquisitions, disposals and distributions - generally between the end of one notional accounting period and the end of the next.
Foreign Life Policy (FLP) A foreign life policy is a life assurance policy issued by a non-resident (see Chapter 19).
Foreign employer-sponsored superannuation exemption An exemption from taxation under the FIF measures where a resident natural person's FIF interest is in an employer-sponsored foreign superannuation fund (see Chapter 12).
Foreign Tax Credit System (FTCS) The Foreign Tax Credit System is the primary mechanism for relief from double taxation under the Principal Act (see Chapter 22).
Interest in a FIF The total of all instruments in a company held by the taxpayer (such as a share, option, convertible note etc.) or by a trust (such as a unit, option to acquire a unit, a note convertible into a unit) - see Chapter 1.
Listed country A listed country is a country that is treated as having a tax system that is generally comparable to Australia's. A list of these countries is contained in Schedule 10 of the Income Tax Regulations.
Market value method The primary method to determine the amount to be included in the taxpayer's assessable income under the FIF measures. In general, the amount is calculated by measuring the increase, if any, in the market value of a FIF interest between the last day of the previous notional accounting period and the last day of the current notional accounting period with adjustment for acquisitions, disposals and distributions (see Chapter 16).
Non-portfolio interest An interest of 10 per cent or more of the voting interests in a company.
Notional accounting period The period by reference to which the FIF measures will apply. In general, this will be the same as the taxpayer's year of income. The taxpayer may elect that the notional accounting period coincide with the accounting period that the FIF uses for reporting to shareholders or beneficiaries (see Chapter 2). In relation to FLPs, the taxpayer may elect that the notional accounting period of the FLP coincide with the period for which cash surrender values are available (se Chapter 19).
Operative provision The operative provision provides for the foreign investment fund income to be included in the taxpayer's assessable income for the taxpayer's year of income in which the notional accounting period of the FIF ends. The operative provision is found at section 529 of the Bill.
Portfolio interest An interest of less than 10 per cent of the voting interests in a company.
Principal Act the Principal Act is the Income Tax Assessment Act 1936
Related foreign companies Under section 160AFB, an Australian company is treated as related to any number of linked foreign companies provided that:

ach company in the chain (starting with the Australian company) has at least a 10 per cent voting interest in the company in the tier below it; and
he Australian company has a direct or indirect interest of at least 5 per cent in the voting shares of each foreign company that is a member of the chain.

Small investor exemption An exemption from taxation under the FIF measures where the taxpayer is a natural person who holds direct investments in foreign companies and trusts amounting to not more than $A50,000 in total (see Chapter 10).
Statutory accounting period The statutory accounting period is used as the measurement period of the CFC measures. It is a period of 12 months, ending on 30 June, unless the foreign company has elected a 12 month period ending on another day (section 319 of the Principal Act).
Transferor trust A non-resident trust to which a resident taxpayer has made, or is deemed to have made, a transfer of property or services under Division 6AAA of Part III the Principal Act.
Unlisted country An unlisted country means a foreign country which is not a listed country.

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