Taxation Ruling

IT 2555

Income tax : foreign tax credit system - foreign tax credit entitlement of corporate beneficiaries of trusts

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PREAMBLE

The primary purpose of this Ruling is to address the foreign tax credit entitlement under the existing law of a resident corporate beneficiary of a trust estate where the beneficiary is presently entitled to a share of the net income of the trust for a year of income and that income includes dividend income from a foreign company.

2. The Ruling concludes that while it is clear that the corporate beneficiary would be entitled to a foreign tax credit in respect of the relevant portion of foreign tax paid that is directly attributable to the foreign dividend, such as a dividend withholding tax, it would not be entitled to a credit in respect of the foreign underlying tax paid by the foreign company on the profits out of which the dividend is paid.

3. Subsection 6B(1) of the Income Tax Assessment Act (the Assessment Act) specifies that where a person (including a company) derives income through a trust, and the trust income comprises dividend income, that person is deemed to derive income attributable to dividend income. Subsection 6B(2A) of the Assessment Act identifies the source of income derived by a beneficiary through a trust, and taken together, subsections 6B(1) and (2A) operate so that where a beneficiary derives income attributable to dividend income of a trust, the beneficiary is deemed to have derived the income from the same source as the trust.

4. Thus, where a dividend is effectively derived by an Australian company from a foreign company through an interposed trust estate, those provisions operate so that the Australian company is deemed to have derived an amount of foreign income attributable to that dividend income.

5. By subsections 6AB(3) and (4), the Australian company is deemed in those circumstances to have been personally liable for, and to have paid, the foreign tax paid (whether by deduction or by the trustee or any other person) in respect of the foreign dividend income. And by subsection 6AC(1), the amount of foreign income that the beneficiary is deemed to have derived in those circumstances is required to be treated, for the purposes of the Assessment Act, as the amount received as grossed up by the foreign tax paid.

6. The overall purpose of those provisions is to ensure the flow through to the beneficiary of a trust estate of a foreign tax credit entitlement attaching to foreign income derived by the trust when the beneficiary is assessable to Australian tax on the foreign income.

7. It is clear that this is the result in the case of foreign tax paid in respect of the foreign income derived by the trust. Thus, in the example given above, the Australian corporate beneficiary of the trust would be required to include in its assessable income its share of the foreign dividend income derived by the trust as grossed up by the proportion of the withholding tax or other foreign tax paid in respect of the dividend income that is attributable to that share. A foreign tax credit would be allowable to the corporate beneficiary pursuant to subsection 160AF(1) against the Australian tax payable in respect of that amount for that proportion of the foreign tax paid.

8. However, in considering whether that flow through of foreign tax credit extends to the underlying tax paid by the foreign company on the profits out of which the dividend is paid, it is necessary to also have regard to other provisions of the Assessment Act. Those provisions are sections 160AFB (Related Foreign Companies) and 160AFC (Foreign Underlying Tax), together with the associated definitions of "Australian company" and "company" in subsection 160AE(1). It is also relevant to consider the operation of the income grossing up provisions of subsection 6AC(2) in relation to foreign underlying tax.

RULING

9. Subsection 160AFC(1) sets out the conditions under which an Australian company in receipt of a dividend from a foreign company is deemed to have paid, and to have been personally liable for, the foreign underlying tax paid by the foreign company on the profits and of which the dividend is paid. Satisfaction of those conditions is a necessary pre-requisite to the allowance to the Australian company, pursuant to subsection 160AF(1), of a foreign tax credit for the foreign underlying tax. The primary condition is that an Australian company - which, by reason of the definition of "Australian company" in subsection 160AE(1) means a company that is a resident of Australia - has received the dividend.

10. In that respect, where a dividend is paid by a foreign company (also defined in subsection 160AE(1) to mean a company that is not a resident of Australia) not directly to an Australian company but to an interposed trust estate, it is the trust and not the corporate beneficiary which receives the dividend. FC of T v Angus (1961) 105 CLR 489 supports the view that what the beneficiary receives is not a dividend, but rather a distribution of trust income. Moreover, under subsection 6B(1), the corporate beneficiary is not deemed to have derived a dividend but an amount of income attributable to a dividend.

11. If a strict literal approach were to be applied to the interpretation and application of subsection 160AFC(1), it could not be said, therefore, that the corporate beneficiary has passed the primary condition for eligibility for an underlying tax credit in respect of the foreign dividend income. It could nevertheless be argued that when regard is had to the overall result in the interposed trust situation, a liberal interpretation should be applied, so that the corporate beneficiary should be treated as having (indirectly) received the dividend and thus as having met the primary condition of subsection 160AFC(1).

12. Be that as it may, another condition of subsection 160AFC(1) that needs to be satisfied before the corporate beneficiary would be entitled to underlying tax credit in respect of the foreign dividend income is that the foreign company that paid the dividend qualifies as being a company that was, at the time of payment of the dividend, related to the corporate beneficiary, according to the tests set out in section 160AFB.

13. In that respect, paragraph 160AFB(1)(a) stipulates that the basic test of whether a foreign company is "related" to an Australian company is if the Australian company has a voting interest in the foreign company amounting to at least 10% of the voting power of the foreign company. Paragraphs 160AFB(4)(a) and (b) specify that an Australian company is taken to have a voting interest in a foreign company if the Australian company is the beneficial owner of shares in the foreign company which carry the right to exercise the voting power in the other company (within the meaning of subsection 160AFB(6)), providing there is no arrangement in force by which any person is in a position to affect that right. Subsection 160AFB(5) effectively provides that a person is taken to be in a position to affect that right if that person has the power or could do anything that would prevent the company from exercising that right.

14. Subsection 160AFB(5) thus envisages the direct unencumbered exercise by an Australian company of the voting rights which attach to the shares in a foreign company that are beneficially owned by the Australian company. It therefore requires the Australian company to be the beneficial owner of at least 10% of the voting shares of the foreign company and that it is able to directly and freely exercise the voting rights attaching to those shares.

15. In the case of foreign dividend income derived through a group comprising two or more tiers of foreign related companies, subsection 160AFB(2) also requires for underlying tax credit purposes that the Australian recipient company should have (either directly or through one or more companies, whether members of the group or not) a voting interest amounting to at least 5% of the voting power of each of the other foreign companies in the group. The same requirements as to the exercise of the voting power by the Australian company which is the beneficial owner of the shares on which the dividends are paid also apply for those purposes.

16. In the typical unit trust, investment trust or other trust situation, it is the trustee who exercises the voting power attaching to shares owned by the trust, and the relationship between the trustee and the beneficiaries of the trust operates to prevent a corporate beneficiary from being treated as directly and freely exercising the voting rights in the shares held by the trust in a foreign company. It cannot be said, therefore, that the requirements of section 160AFB are satisfied.

17. It is relevant that the legislature has specifically provided for foreign underlying tax credit to be denied to a corporate trustee of a trust estate which receives a dividend from a foreign company i.e., where the trustee is assessable to Australian tax on the trust income. This is because subsection 160AE(1) clearly specifies that a reference to a "company" for the purposes of the foreign tax credit provisions of Division 18 of Part III of the Assessment Act (including sections 160AFB and 160AFC) does not include a company in the capacity of a trustee. It follows that a corporate trustee would not qualify to be deemed by section 160AFC to have paid an amount of foreign underlying tax in respect of the dividend and that therefore the dividend derived by the trust estate in those circumstances would not be grossed up for assessment purposes, pursuant to subsection 6AC(2), by the foreign underlying tax paid in respect of the dividends.

18. It is consistent with this legislative rule that section 160AFB should operate to deny to a corporate beneficiary of, or corporate unitholder in, a trust estate any underlying tax credit pursuant to section 160AFC in relation to the corporate beneficiary's or unitholder's share of a distribution by the trust of foreign dividend income, i.e., where it is the beneficiary and not the trustee who is assessable to Australian tax on that income. It follows that in no case need dividends derived by a trust estate from a foreign company be grossed up by foreign underlying tax when determining the net income of the trust. Nor should the relevant share of the net income of a trust to which a corporate beneficiary is presently entitled be grossed up for assessment purposes by any amount of foreign underlying tax.

19. Where a resident corporate beneficiary holds directly (in its own right) shares in the relevant foreign company which carry at least 10% of the voting power in that company, that shareholding would entitle the corporate beneficiary to foreign underlying tax credit only in relation to dividends it receives directly from the foreign company. It should not be treated as also entitling the corporate beneficiary to underlying tax credit in relation to any dividends paid by the foreign company that flow to the corporate beneficiary via the trust.

20. In finalising this Ruling, careful consideration was given to suggestions that in certain trust situations, e.g., in the case of a bare trust or where the shares in the foreign company are held by the trust as nominee for a resident company which is the sole beneficiary of the trust, it would be appropriate for the corporate beneficiary to be treated as effectively exercising the voting rights in the foreign company and as therefore qualifying for underlying tax credit in respect of the dividends derived by the corporate beneficiary via the trust. Given, however, the design features of the legislative scheme in relation to underlying tax credit addressed in this Ruling, and especially the essential circumstances which govern its application (as described in paragraph 14) it is considered that underlying tax credit must also be denied to corporate beneficiaries in those situations. The relevant provisions of the law thus preclude the anomalous situation arising of underlying tax credit being available to some corporate beneficiaries but not to others.

COMMISSIONER OF TAXATION
17 August 1989

References

ATO references:
NO L88/8170-7

Date of effect:
Immediate

Related Rulings/Determinations:

IT 2555W
IT 2445
IT 2556

Subject References:
FOREIGN TAX CREDIT SYSTEM
TRUST INCOME ATTRIBUTABLE TO DIVIDENDS
UNDERLYING TAX CREDIT AND CORPORATE BENEFICIARIES

Legislative References:
6AB(3),
(4)
6AC
6B(1)
6B(2A)
160AE(1)
160AF(1)
160AFB
160AFC

Case References:
FC of T v Angus
(1961) 105 CLR 489