Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)
General Outline and Financial Impact
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.
The Bill will be administered by the Commissioner of Taxation.
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.
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:
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
- liminate any double taxation that could otherwise arise through concurrent application of the FIF measures and the existing trust provisions in Division 6;
- 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;
- et out the way in which a beneficiary's share of the income of non-resident trust estates is to be calculated;
- 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;
- 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
- 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.
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.
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.