Second Reading
Mr Miles (Braddon--Parliamentary Secretary [Cabinet] to the Prime Minister) (5.23 p.m.)--I move:That the Bill be now read a second time.
The Taxation Laws Amendment (Foreign Income Measures) Bill 1997 will amend the Income Tax Assessment Act 1936 to give effect to proposed changes to the rules for taxing foreign source income that were announced in the 1997-98 budget.
While the government considers that the broad structure of the system for taxing foreign source income is appropriate, it has become evident that there are problems with the list of countries used for providing exemptions.
These problems have arisen because the current list of countries has been used for two distinct purposes that would have been best served by separate lists. The list has been used for the purpose of determining when income should be exempt from accruals taxation under the controlled foreign company and transferor trust measures. The list has also been used to determine when dividends and branch profits derived by resident companies should be exempt under the foreign tax credit system.
The current list, comprising over 50 countries, is unsuitable for the purpose of providing exemptions from accruals taxation because there are many countries on the list that do not consistently levy tax on a comparable basis to Australia.
A more robust list of closely comparable tax countries is required for the purpose of providing exemptions from accruals taxation. The accruals taxation rules apply to amounts derived from investments that are likely to be significantly influenced by taxation considerations. Amounts derived from these types of investments are treated as `tainted' and include interest income, royalties and certain amounts derived from arrangements involving related parties. Accruals taxation of these tainted amounts is crucial to ensure investments offshore are not favoured over similar investments in Australia for purely taxation reasons.
To address the problems with the current list, the bill will create a new list of seven `broad-exemption countries' for the purposes of providing exemptions from accruals taxation under the controlled foreign company and transferor trust measures. The list will comprise Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States of America. These countries will be designated in the Income Tax Regulations as broad- exemption listed countries.
A shorter list will also make the task of designating tax concessions more manageable. Efforts to designate tax deferral opportunities in listed countries have had only limited success and are made more difficult by the large number of countries that must be monitored. The risks to the revenue associated with not designating a tax deferral opportunity are significant because tainted income by its nature can be diverted to take advantage of the opportunity.
The current list of countries is also to be updated and will continue to be used for the purposes of exemptions under the foreign tax credit system. The current list is still considered suitable for the purposes of providing exemptions under the foreign tax credit system because the exemptions apply to amounts derived from investments that are less sensitive to taxation considerations.
Countries that are listed for the purposes of the foreign tax credit system and not for accruals taxation purposes will be designated in the Income Tax Regulations as `limited-exemption listed countries'. Countries on either the limited-exemption list or the broad-exemption list will be treated as listed for the purposes of the foreign tax credit system.
The bill will also modify the existing exemption under the foreign tax credit system for amounts derived by a branch in a listed country so that it can continue to apply to amounts derived through a branch in a limited-exemption listed country. The exemption will generally continue to be available for branch income other than tainted income.
An active income test will be provided for branches in limited- exemption listed countries to help reduce compliance costs. The test will allow branches in these countries to derive up to five per cent of gross turnover as tainted income and still receive a full exemption for branch income.
An exclusion from tainted income will also be provided for banking income derived by branches of Australian financial institutions in limited-exemption countries. This exemption is broadly consistent with the exclusion from tainted income provided under the controlled foreign company measures for subsidiaries of Australian financial institutions.
There will be no changes to the treatment of branches in broad- exemption listed countries. These branches will continue to be generally exempt on amounts that have been taxed at full rates in those countries.
Measures to help reduce compliance costs
Another feature of the bill is amendments to help reduce compliance costs under the controlled foreign company measures. the amendments will help keep compliance costs for legitimate business operations offshore at a minimum and are largely made possible by the creation of a new list of broad-exemption countries.
The amendments will make the following changes to help reduce compliance costs:
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- the more generous active income test for controlled foreign companies in unlisted countries will be extended to companies in listed countries;
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- the thin capitalisation and debt creation rules will no longer apply when calculating the attributable income of a controlled foreign company;
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- the transfer pricing rules will no longer apply to non-arms-length transfers involving controlled foreign companies resident in the same broad-exemption listed country;
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- the rules for making elections under the controlled foreign company measures will be relaxed; and
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- amounts derived by a controlled foreign company from an associated controlled foreign company resident in the same country will generally not be treated as tainted services or tainted rental income.
General maintenance of the rules for taxing foreign source income
The other amendments made by the bill are required for the general maintenance of the system for taxing foreign source income. Transitional rules will apply to deal with uncertainty arising from the dissolution of a number of listed countries. These rules will operate from the time of dissolution of the countries.
Amendments will also operate to reduce the extent to which taxpayers may be disadvantaged by changes to the lists of countries. In this regard, the Czech Republic and Vietnam are to be added to the list of limited-exemption countries with effect from 1 July 1997.
The bill will also repeal the exemption in the foreign investment fund measures for approved country funds. The exemption was originally provided to allow portfolio diversification in emerging markets that do not allow direct investment by Australian residents. There is now little justification for the exemption following recent reforms in emerging markets that have resulted in substantial investment liberalisation.
The new two-list approach will generally apply from 1 July 1997 for the purposes of exemptions under the foreign tax credit system. To avoid the need to calculate attributable income for a part period, the two-list approach will first apply for statutory accounting periods of controlled foreign companies and years of income of transferor trusts commencing after 30 June 1997. In some cases this will defer revenue collected from the changes by up to 12 months.
The measures to help reduce compliance costs under the controlled foreign company measures which are made possible or are required because of the creation of a short-list for accruals taxation purposes will apply for statutory accounting periods of controlled foreign companies commencing after 30 June 1997. The measures to reduce compliance costs that are not linked with the creation of a new list will apply prospectively from the time the amending bill receives the royal assent.
The transitional rules dealing with uncertainty arising from the dissolution of a number of listed countries will generally apply from the time of dissolution of the countries. The exemption from the foreign investment fund measures for approved country funds will be repealed with effect for notional accounting periods of foreign investment funds commencing on or after 1 January 1997.
There have been two rounds of public consultation on the proposed changes. The first round was on policy issues following the release of an information paper by the Treasurer on 24 December 1996. Submissions were also invited on measures to reduce compliance costs under the controlled foreign company measures whilst still meeting the government's objectives for taxing foreign source income.
The views expressed in submissions on the information paper were taken into account in settling the changes announced in the 1997- 98 budget. The measures in this bill for reducing compliance costs under the controlled foreign company measures were adopted following consideration of the submissions.
The second round of consultation was on legislation giving effect to the changes that was released in draft form on 1 July 1997. The bill currently before the House is essentially the same as the draft bill.
The likely annual revenue gain from the changes made by this bill is estimated to be $125 million in the 1998-99 financial year and $100 million for subsequent years. It is expected that a significant proportion of the revenue will arise due to changes in investment behaviour and be collected under the general provisions of the Income Tax Assessment Act 1936 rather than directly under the controlled foreign company or transferor trust measures.
Full details of measures in the bill are contained in the explanatory memorandum circulated to honourable members.
I commend the bill to the House.