Foreign income return form guide

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Chapter 3: Taxation of foreign dividends and branch profits, and explaining the foreign tax credit system

This chapter explains the taxation treatment of foreign dividends and of branch profits derived by Australian companies. It also explains the rules for claiming a foreign tax credit.

Summary of chapter 3

Part 1

Taxation of foreign dividends

Part 2

Taxation of branch profits

Part 3

What credit can you claim for foreign tax?

Part 1: Taxation of foreign dividends

This part explains how dividends paid by a foreign company are taxed in Australia. This can occur in two ways:

  • when a resident taxpayer is taxed on a dividend received from a non-resident company, or
  • when an attributable taxpayer in relation to a controlled foreign company (CFC) or a controlled foreign trust is liable to tax on the taxpayer's share of a dividend paid by an unlisted country CFC directly or indirectly to another CFC or controlled foreign trust.

Summary of part 1

Section 1

How do you treat a dividend received from a non-resident company?

Section 2

What if a CFC receives a dividend from another CFC?

Section 3

When is a CFC deemed to have paid a dividend?

S ection 1: How do you treat a dividend received from a non-resident company?

This section sets out the basis for taxing dividends received by a resident from a non-resident company.

Non-portfolio dividends

Definition of non-portfolio dividends

The concept of a non-portfolio dividend is central to the scheme of taxation of foreign dividends. A dividend is a non-portfolio dividend if six conditions are met. These are:

  • the dividend is paid to a company  
  • the company receiving the dividend has a 10% or greater voting interest in the voting power of the company that paid the dividend  
  • the voting power in a company is the maximum number of votes that can be cast on a poll at a general meeting of the company at which all matters that can be referred to such a meeting are decided  
  • the shareholder is the beneficial owner of the shares that carry the required voting interest  
  • the voting interest is held at the time the dividend is paid, and  
  • there is no arrangement in force at that time by which any person is in a position - or may become in a position - to affect the voting right.

Non-portfolio dividends received from a foreign company

Non-portfolio dividends received by a resident company from a company that is a resident of a listed or unlisted country are non-assessable non-exempt income, because:

  • they are paid out of profits of a CFC that have been previously attributed to the resident company under the accruals tax measures (section   23AI), and/or  
  • they are received from a foreign company (section   23AJ).
Example 1

Non-portfolio dividend paid partly from profits taxed on an accruals basis
Resco, a resident company, wholly owns a CFC in a listed country. Attributable income of $10,000 from the CFC was included in Resco's assessable income for the 2004-05 income year.
The CFC then paid a non-portfolio dividend of $25,000 to Resco on 1 August 2005.
Resco can treat part of the non-portfolio dividend - $10,000 - as non-assessable non-exempt income under section   23AI, as it is a distribution out of previously attributed income.
The $15,000 balance of the non-portfolio dividend can be treated as non-assessable non-exempt income under section   23AJ.

Non-portfolio dividends received by a resident individual from a company that is a resident of a listed or unlisted country may also be treated as non-assessable non-exempt income if they are paid out of profits of a CFC that have been previously attributed to the resident individual under the accruals tax measures (section   23AI).

Distributions of attributed income - maintaining records to support a claim that an amount is not assessable

Attribution accounts

To be able to work out what distributions out of a CFC's attributed income are non-assessable non-exempt income, you will need to keep certain records called attribution accounts.

You must maintain an attribution account for:

  • each CFC from which income is attributed to you. This account will contain a record of:
    • income attributed to you from the CFC, and
    • income distributed to you by the CFC which is treated as distributed from attributed income
  • each entity through which the income of that CFC is distributed to you. These entities may be
    • partnerships
    • trusts, or
    • companies that are not Part X Australian residents
  • each foreign investment fund (FIF) where an amount of FIF income is included in the notional assessable income of the CFC
  • each CFC that has changed residence from an unlisted country to Australia. Dividends paid by a company out of profits which were attributed to you before the company becoming a resident of Australia are non-assessable non-exempt income.

These accounts are used to keep track of profits that have been taxed on an accruals basis so that you determine what amounts are non-assessable non-exempt income when you receive a distribution from those profits.

Example 2

Attribution accounts
A resident company - Resco - owns all the share capital of a CFC that is a resident of an unlisted country. The CFC commenced business on 1   July 2004. For the 2004-05 income year, its only income was attributable income of $2,500. It paid no tax. On 1   August 2005, it paid a dividend of $2,500 to Resco.
Attribution credit:
Resco will open an attribution account for the CFC and credit it with $2,500 on 30   June 2005 because this amount was included at that time in Resco's assessable income under the CFC measures. The CFC is called an attribution account entity.
Attribution debit:
Resco will debit $2,500 to the attribution account for the CFC on 1   August 2005 because of the dividend paid by the CFC. The debit is referred to as an 'attribution debit'. The amount of the debit cannot be more than the credit balance in the account - called the 'attribution surplus' - at the time the debit is made. In this case, the debit could not be more than $2,500.

The dividend received by Resco is non-assessable non-exempt income to the extent the dividend gave rise to an attribution debit. In this case, Resco can claim the whole amount of the dividend as non-assessable non-exempt income in the 2005-06 income year. The effect is that Resco only pays tax on the CFC's income when it is attributed, and not again when it is distributed.

An attribution account maintained by you for a CFC is specific to you. This means that when you sell shares in a CFC, you cannot transfer the attribution account to the purchaser of the shares.

Tracing the path of distributions of attributed income

There are a number of ways you can receive amounts that were paid from profits that have previously been attributed to you. In general, these amounts will be distributed to you as a dividend. The dividend may be distributed to you directly, or indirectly through a chain of companies, partnerships, or trusts.

When are attribution account payments made?

To work out your exemption, you will need to know the date on which attribution account payments are taken to have been made.

The following table sets out:

  • the types of attribution account payments that can occur
  • the entities that are treated as making and receiving an attribution account payment
  • the date on which the payment is taken to be made.

Type of attribution payment

Entity making payment

Entity receiving payment

Date payment made

Dividend

paying company

shareholder

on date dividend is paid

Partner's share in the net income of a partnership

partnership

partner

at the end of the income year of the partnership

Share of the net income of a trust estate equal to the beneficiary's present entitlement

trust

beneficiary

at the end of the income year of the trust

Whole or part of the net income of a trust estate is assessable to the trustees. Sections   99 or   99A

trust

trustee

at the end of the income year of the trust

Other distribution of accumulated trust income

trust

beneficiary

income year in which the distribution was made

What accounting entries should you make?

As mentioned earlier, attribution accounts link distributions a CFC has made to you - either directly or through other entities - to the income of the CFC that has already been attributed to you. The link is made when you:

  • debit the attribution account of the entity that makes the payment, and
  • credit the account of the entity that receives the payment.

Continue this process down a chain of entities until you receive a distribution made by the CFC.

Example 3

Distribution of attributed income
A resident company - Resco - owns all of the shares of CFC1, which owns all of the shares of CFC2. The CFCs are residents of unlisted countries.
CFC2 commenced business on 1   July 1997 and for the 2004 income year CFC2 derived $100 which was attributed under the CFC measures. The company paid no tax on the attributed amount. On 1   August 2004 the company paid its first dividend of $100 to CFC1, which paid the dividend to Resco on the same day.
All the entities close accounts to 30   June 2005.

Attribution accounts

CFC2

Debit

Credit

1 August 2004 dividend to CFC1

$100

30 June 2004 amount attributed to Resco

$100

CFC1

Debit

Credit

1 August 2004 dividend to Resco

$100

30 June 2004 amount attributed to CFC2

$100

As the $100 attributed from CFC2 to Resco on 30   June 2004 was included in Resco's 2004 assessable income, and as the distribution Resco received on 1   August 2004 is no more than the income already attributed, Resco will treat the dividend as non-assessable non-exempt income.

Proportionate interests in the CFC and in interposed entities

A resident taxpayer might hold only a proportion - that is, less than 100% - of the interests in a CFC. That interest may be held directly or indirectly through interests in other foreign entities.

If you hold an interest of less than 100% in a CFC, only a proportion of the attributable income of the CFC is included in your assessable income. The proportion you use depends on the interest - called the attribution percentage - you have in the CFC - see chapter   1 .

When tracing a distribution made by a CFC through a chain of interposed entities to yourself, note any proportionate interests you have in any of these entities.

Your interest in the CFC - and in each interposed entity - is called your attribution account percentage. This interest may differ from your attribution percentage in an entity. The foreign entities in the chain along which the attributed income of the CFC is later distributed to you need not necessarily be controlled foreign entities.

If you have both direct and indirect attribution account interests in an entity, then your attribution account percentage in that entity is the sum of the interests as follows:

Attribution account percentage

=

direct attribution account interest

+

indirect account attribution interest

How do you work out your direct attribution account interest in an entity?

Your direct attribution account interest in an entity will depend on the type of entity it is.

If the entity is a foreign company, your direct attribution account interest in the company is the same as your direct attribution interest in that company.

If the entity is a partnership of which you are a partner, your direct attribution account interest is the percentage that you hold - and any percentage you are entitled to acquire - of either the partnership's profits or the partnership's property. If the two percentages differ, use the higher percentage as your direct attribution account interest.

Your interest in a partnership is measured at the end of the accounting period in which the dividend is distributed through the partnership to you. The date of the dividend payment is called the test time. You should assume that you held the same interest in the profits and property of the partnership throughout the accounting period that you held at the test time. When working out your interest in the profits, use the amount of profit for the whole of the period.

Example 4

Attribution account interest in a partnership

It is necessary to measure the direct attribution account interest of CFC   1 in the partnership in order to measure the attribution account percentage of the resident individual in the partnership when the dividend is paid.

If the entity is a trust of which you are a beneficiary, your interest in the trust is the percentage of either the income or property of the trust to which you are presently entitled - and any percentage you are entitled to acquire. If the two percentages differ, use the higher percentage as your attribution account interest.

As in the case of an interest in a partnership, your interest in a trust is measured at the end of the accounting period of the trust in which the dividend is distributed through the trust to you. The date of this payment is called the test time. You should assume that you held the same interest in the income or property of the trust throughout the accounting period as you held at the test time. When working out your interest in the income, use the amount of income earned for the whole period.

How do you work out your indirect attribution account interest in an entity?

Your attribution account percentage in an entity is the sum of your direct and indirect interests in that entity. To work out your indirect interest in an entity - Entity   B - which is held through another entity - Entity   A - multiply your direct interest in Entity   A by Entity A's direct interest in Entity   B.

If there are more than two entities in a chain, continue the process of multiplication along the chain until you reach the entity in which you are measuring your indirect interest.

Example 5

Attribution account interest

In this case, the resident taxpayer's attribution account percentage in CFC2 is 61% - that is, the taxpayer has a direct attribution account interest of 25% plus an indirect attribution account interest of 36%.
Example 6

Direct and indirect attribution account percentage
The following example shows how to work out direct and indirect interests and the attribution account percentage in an entity.
A resident company owns 50% of the share capital of CFC1 and CFC1 owns 50% of the share capital of CFC2. The CFCs are residents of unlisted countries. CFC2 commenced business on 1   July 2004. For the 2004-05 financial year the only income of CFC2 was attributable income of $100. On 1   August 2005, CFC2 paid a dividend of $50 to CFC1.

The resident company's attribution percentage in CFC2 is 25% - that is, 50% of 50%. The resident company's share of the attributable income of the CFC is therefore $25 - that is, 25% of $100.
The dividend of $50 paid to CFC1 is an attribution account payment. When the dividend is paid to CFC1 it is necessary to measure how much of the dividend can be treated as a distribution of CFC2's previously attributed income. The amount is worked out by applying the attribution account percentage of the resident company in CFC1 to the dividend paid to CFC1.
The direct attribution account interests will be as follows:

Direct attribution account interest of the resident company in CFC1

= 50%

Direct attribution account interest of CFC1 in CFC2

= 50%

The indirect attribution account interest is obtained by multiplying the direct attribution interests along the chain. The indirect attribution account interest of the resident in CFC2 will be 25% (50%   x   50%). Up to $25 of the dividend can therefore be treated as paid from previously attributed income.
Example 7

Attribution debit
A resident individual has a direct attribution account interest of 80% in CFC1. CFC1 has a direct attribution interest of 90% in CFC2. The CFCs are resident in unlisted countries.
CFC2 commenced business on 1   July 2004. For the 2005 income year, its only income was attributable income of $100. It paid no tax. On 1   August 2005 it distributed its 2005 income. On the same day, CFC1 distributed the full amount of the dividend it received from CFC2.

Attribution accounts

CFC2

Debit

Credit

1 August 2005 dividend to CFC1 (note   2)

$72

30 June 2005 attributed income (note   1)

$72

CFC2

Debit

Credit

1 August 2005 dividend to Resco (note   4)

$72

30 June 2005 dividend from CFC2 (note   3)

$72

Note 1: This represents CFC2's attributable income of $100 multiplied by the resident's attribution percentage in CFC2 - that is, 80% (interest of the resident in CFC1) x 90% (interest of CFC1 in CFC2) x $100 = $72.
Note 2: This represents the resident's attribution account percentage in the dividend received by CFC1 - that is, 80% of the $90 dividend.
Note 3: The resident's attribution account percentage in the dividend received by CFC1 - worked out as in note 2.
Note 4: The dividend paid by CFC1 to the resident.
The dividend of $72 received by the resident is non-assessable non-exempt income to the extent of the attribution debit that arose when the dividend was paid. As this debit was also $72, the entire dividend is non-assessable non-exempt income.

When should you make a credit in an attribution account?

You must make a credit in an attribution account if you include an amount in your assessable income because:

  • an amount of the CFC's income has been attributed to you - section   456. The credit amount will be the amount of the attributed income included in your assessable income under section   456 without any addition for foreign or Australian tax paid by the CFC on that income. You must enter the credit at the end of the CFC's statutory accounting period. Where a company is a CFC at the beginning of its statutory accounting period but ceases to exist during that period, the statutory accounting period is deemed to end immediately before the company ceases to exist. However, in this circumstance the credit arises at the beginning of the statutory account period

     
  • an amount of FIF income is included in the attributable income of a CFC. In this case a credit arises in relation to the FIF equal to the amount included in your assessable income under section   456 that is referable to the FIF income. The credit that would otherwise arise for the CFC is reduced by the amount that arises for the FIF. If a FIF has an interest in another FIF and the calculation method applies to determine the FIF income of the first FIF, a credit will arise for the second FIF. The FIF income is based on the FIF income of the first FIF referable to the FIF income of the second FIF. In this case, the attribution credit for the first FIF is reduced by the credit that arises for the second FIF

     
  • the CFC has both:
    • ceased to be a resident of an unlisted country, and
    • become a resident of a listed country or of Australia.

The amount of the credit will be the amount you included in your assessable income under section   457 without any addition for foreign or Australian tax the CFC paid on that amount. You must normally enter the credit at the time the CFC changed residence. However, you have the option to defer the credit to the extent it relates to an amount included in attributable income under section   457 for an unrealised gain on a tainted asset.

The credit may be deferred until the CFC pays a dividend out of profits arising from the subsequent disposal of the asset.

You must also make a credit in an entity's attribution account if:

  • that entity receives an attribution account payment from another entity, and
  • the payment gives rise to an attribution debit for the paying entity.

The credit amount will be the same as the attribution debit. You must enter the credit on the date of the attribution account payment.

How are credits made when the taxpayer is an Australian partnership or Australian trust?

Only the taxpayer who is actually liable to tax on the attributed income of the CFC can obtain an exemption from tax for distributions of that income. Whilst the Australian partnership is the attributable taxpayer and has attributable income included in its net income, it is the partners of the partnership that are liable for tax in respect of this income as their assessable income includes their share of the net income of the partnership.

A similar result applies in relation to presently entitled trust beneficiaries where the net income included in a presently entitled trust beneficiary's assessable income includes income attributed to the trust under the CFC provisions.

The attribution accounts are intended to ensure that only the relevant partners or trust beneficiaries are entitled to the exemption on distributions of previously attributed income. In these cases the partners or beneficiaries keep attribution accounts in respect of the relevant CFCs and partnerships or trusts. For attribution account purposes these entities are known as 'attribution account entities'.

This means that if the income of a CFC is attributed to an Australian partnership (which may include a foreign hybrid limited partnership or foreign hybrid company) or Australian trust, the credit made in the CFC's account is for the partner of the partnership or for the trust beneficiary who is presently entitled to the trust income. If there is no such beneficiary, the credit arises for the trustee.

The credit does not normally arise directly for the partnership or trust itself. There is an exception where the trust is a corporate unit trust, a public trading trust, an approved deposit fund, an eligible superannuation fund or a pooled superannuation trust. There is also an exception for Australian corporate limited partnerships which are treated as Australian companies for tax purposes.

The amount of the credit made for the partner of a partnership is equal to the increase in the amount included under section 92 of the ITAA 1936 in the partner's assessable income, resulting from attributed income being included in the partnership net income. For a trust beneficiary, the credit equals the increase in the amount included under section 97, 98A or 100 of the ITAA 1936 in the beneficiary's assessable income, resulting from attributed income being included in the trust net income. The amount so calculated is called the 'tax detriment'.

When should you make debits in attribution accounts?

You must make an attribution debit in an entity's attribution account if that entity makes an attribution account payment to either:

  • an attributable taxpayer, or
  • another attribution account entity.

There are, however, two rules you must observe. These are:

  • you can only make a debit if there is an attribution surplus in the attribution account at the time the attribution account payment is made - that is, the account balance must be more than nil
  • the debit cannot be more than the amount of the surplus in the account at the time.

What is the amount of the attribution debit?

There are, again, two rules to observe:

  • if an entity makes an attribution account payment to a resident taxpayer, the debit is the same as the amount of the payment
  • if the entity makes an attribution account payment to another entity, the debit will equal the resident taxpayer's attribution account percentage of the payment received by the second entity.

How are debits made when the attributable taxpayer is an Australian partnership or Australian trust?

If a CFC makes an attribution account payment to an Australian partnership, an attribution debit will arise for the CFC in relation to a partner in the partnership, provided that immediately before the payment is made, there is an attribution account surplus for the CFC in relation to the partner.

The amount of the attribution debt is the lesser of:

  • the attribution surplus for the CFC in relation to the partner, and
  • the partner's attribution account percentage (in the partnership) of the attribution account payment.

Similarly, an attribution account payment made by a CFC to an Australian trust will give rise to an attribution debit for the CFC in relation to a beneficiary of the trust where there is an attribution account surplus for the CFC in relation to the trust. In this case, the attribution debit will be the lesser of the attribution account surplus for the CFC in relation to the beneficiary, and the beneficiary's attribution account percentage (in the trust) of the attribution account payment.

Where such a debit is made for a CFC in relation to a partner in a partnership or beneficiary in a trust, a corresponding attribution credit must also be made for the partnership in relation to the partner or the trust in relation to the beneficiary. This is so that, when calculating the partner's share of the partnership net income, or the beneficiary's share of the trust net income, at year end, there is an attribution account surplus against which to debit the attribution account payment arising from that calculation.

Example 8

Attribution account entries for interest in a CFC held by a foreign hybrid limited partnership
A resident company - Oz Co - has a 50% interest in the net income of a foreign hybrid limited partnership - FHLP - which owns all of the shares of a CFC. The CFC is a resident of an unlisted country. The unlisted country does not impose tax on these entities. FHLP is an Australian partnership as Oz Co is a partner. All the entities close their accounts to 30 June.
In the 2006 income year the CFC derived a profit of $200 which was attributed to the foreign hybrid limited partnership under the CFC measures. On 1   August 2006 the CFC paid a dividend out of these profits of $200 to FHLP, to which Oz Co is entitled to 50%, that is, $100.

Attribution accounts

CFC

Debit

Credit

1 August 2006 Dividend to FHLP (note 2)

$100

30 June 2006 Attributed income (note 1)

$100

FHLP

Debit

Credit

30 June 2007

Share of net partnership income (note 4)

$100

1 August 2006 Dividend from CFC (note 3)

$100

Note 1: This represents the tax detriment to Oz Co resulting from income being attributed to FHLP ($200). The income attributed to FHLP gives rise to an attribution credit for the CFC in relation to Oz Co of $100 [subsection 371(6)].
Note 2: This represents Oz Co's attribution account percentage in the dividend paid by CFC to FHLP on 1 August 2006 - that is, 50% of the $200 dividend. Oz Co's attribution account percentage of the dividend gives rise to an attribution debit for the CFC in relation to Oz Co of $100 [subsection 372(2)].
Note 3: This represents the attribution credit for FHLP in relation to Oz Co corresponding to the debit for CFC in relation to Oz Co arising as a result of CFC's dividend [subsection 371(1)(d)].
Note 4: This represents the calculation of Oz Co's share of the net partnership income of FHLP. The debit arises at the end of the year of income [subsections 365(1)(b) and 372(1) and (2)].
Oz Co's share of the net partnership income is an attribution account payment by FHLP to Oz Co. As FHLP has an attribution account surplus in relation to Oz Co equal to the amount of the attribution account payment, Oz Co will treat the entire attribution account payment as non-assessable non-exempt income.
Dividends other than non-portfolio dividends

Portfolio dividends are generally taxable unless they are paid from profits taxed previously on an accruals basis. Portfolio dividends are dividends that do not qualify as non-portfolio dividends.

You must maintain an attribution account for each CFC from which income is attributed to you. An explanation of how these accounts are maintained was provided earlier in this part.

S ection 2: What if a CFC receives a dividend from another CFC?

Non-portfolio dividends paid by a foreign company to a CFC are non-assessable non-exempt income of the CFC. Therefore, such dividends cannot form part of the attributable income of the CFC in relation to which an attributable taxpayer may be assessable under section   456.

Section 3: When is a CFC deemed to have paid a dividend?

It is possible that a resident taxpayer with an interest in an unlisted country CFC may try to minimise Australian tax by arranging for the CFC to distribute benefits in a form other than dividends to its shareholders or their associates.

There are rules to prevent this form of tax avoidance in section   47A. These rules deem certain transfers and payments made by an unlisted country CFC to be dividends. These dividends are then taxed in the normal way.

For section 47A to apply, a CFC must provide a benefit to:

  • a resident who is a shareholder or an associate of a shareholder of the CFC, or
  • another CFC or controlled foreign trust, directly or through other entities, where the first entity that received the dividend is a shareholder or an associate of a shareholder of the CFC.
When should you deem a dividend to have been paid by a CFC?

Types of benefits that are covered under section 47A

The following seven types of benefits provided by a CFC could be treated as dividends:

1.

the waiver by the CFC of a debt owed by another entity

2.

the grant by the CFC of a non-arm's length loan to another entity

3.

the grant by the CFC of a loan - whether at arm's length or not - to another entity to facilitate, directly or indirectly, the payment by that entity of a dividend that would be non-assessable non-exempt income

4.

the transfer by the CFC to another entity of property or services for no consideration, or for inadequate consideration

5.

a payment made by the CFC for allotment of:

  • shares in a company
  • rights or options to acquire shares
  • units in a unit trust, or
  • rights or options to acquire units

6.

a payment made by the CFC in respect of calls on shares in another company

7.

the grant by the CFC of a loan - whether at arm's length or not - to another entity to facilitate a transaction of the type referred to in any of the above points.

Treat the fifth and sixth types of payments as dividends only if:

  • a shareholder of the CFC - or shareholder's associate - holds any direct interest, or later acquires any direct interest, in any of the shares of the company in which the CFC acquired shares or in the unit trust in which the units were acquired, or
  • the company - or unit trust - uses the proceeds of the issue to facilitate a transaction providing any of the above types of benefits.

Entities providing and receiving the benefit

For a benefit to be treated as a deemed dividend, the benefit must be provided by the CFC to a shareholder or an associate of a shareholder.

The benefit must be provided by either:

  • an unlisted country CFC, or
  • another entity under an arrangement with the CFC, where the CFC has transferred property or services in consideration for the benefit to:
    • the other entity, or
    • any other entity.

These transfers of property or services are referred to as arrangement transfers.

The time the benefits are deemed to have been provided

The following table sets out some of the types of benefits provided by a CFC that are subject to section   47A, the time at which they are taken to be provided and the amount of the benefit.

Type of benefit

Time

Amount

Waiver of a debt

time the debt was waived

amount of the debt

Non-arm's length loan

time the loan was made

amount of the loan

Transfer of property for no consideration

time the property was transferred

market value at time of transfer

Transfer of property or services for a consideration less than market value

time the property or services were transferred

difference between the market value of the property or services and the consideration paid

Payment or transfer of property for the allotment of shares or units

time the payment or transfer was made

amount paid or market value of the property transferred

Benefit provided by another entity under an arrangement with the CFC - if there is one 'arrangement transfer'

time the CFC made the arrangement transfer

amount of the arrangement transfer or market value of arrangement transfer

Benefit provided by another entity under an arrangement with the CFC - if there are several arrangement transfers

time the agreement to make the arrangement transfers was entered into

total amount of the arrangement transfers or the total market value of the arrangement transfers

Working out the amount of the deemed dividend

The amount of a benefit that can be treated as a dividend paid by a CFC cannot be more than the CFC's profits at the time the benefit was provided.

In this context, 'profits' do not mean distributable profits. 'Profits' in this situation mean 'commercial profits' of either an income or capital nature that the company has at the time the benefit is provided. Work out these profits at the time the company provided the benefit.

If the CFC provided a benefit by transferring property or services at less than their market value, work out the CFC's profits at the time the benefit was provided as if the property or services were transferred for their full market value.

Effect of deeming a benefit to be a dividend

A deemed dividend paid to a resident taxpayer is generally treated the same as other dividend payments. For example, a deemed dividend that is a non-portfolio dividend paid by an unlisted country CFC to an Australian company is treated as non-assessable non-exempt income.

Disclosure of deemed dividends

You will be denied access to certain credits and concessions in relation to a section   47A deemed dividend if you:

  • do not disclose the deemed dividend in your tax return, and  
  • do not notify the Tax Office of the deemed dividend within one year of the end of the income year in which the dividend is deemed to have been paid.

The credits and concessions you lose are:

  • any credit for foreign taxes you have paid on the dividend, and  
  • any possibility that a part of the deemed dividend may qualify as non-assessable non-exempt income under section   23AI.

The deemed dividend will also not give rise to an attribution credit.

Other deemed dividends - section 108

Under section 108 of the Act, the Tax Office may treat as a dividend:

  • an amount paid by a private company to a shareholder - or a shareholder's associate - by way of an advance or loan, or
  • an amount paid or credited on behalf of, or for the individual benefit of, a shareholder or a shareholder's associate.

To deem these payments to be dividends, the Tax Office must be of the opinion that the payments and credits represent a distribution of profits.

Section 108 will not apply to an amount paid or credited after 2   June 1990 by an unlisted country CFC if that amount is deemed, under section   47A, to be a dividend.

Part 2: Taxation of branch profits

Foreign branch income of a resident company that is not assessable

Which resident companies qualify?

Two broad groups qualify to have certain branch profits treated as non-assessable non-exempt income. These are resident companies that either:

  • carry on business through a permanent establishment - for example, a branch, or  
  • are partners of a partnership or are presently entitled beneficiaries of a trust - and that partnership or trust carries on business through a permanent establishment.

Non-assessable non-exempt income treatment does not apply to resident taxpayers, other than companies, with foreign permanent establishments.

What is a permanent establishment?

A permanent establishment of an Australian resident company is a place through which the business of the company is carried on. The term 'permanent establishment' is defined in section   6 of the Act.

If the listed country is one with which Australia has a double taxation agreement, the meaning of the term permanent establishment is determined by the agreement.

Permanent establishments are referred to as branches in this part.

What income is non-assessable non-exempt?

Whether branch profits are treated as non-assessable non-exempt income depends on whether the branch is in a listed or unlisted country.

Non-assessable non-exempt income treatment

Branches in listed countries

In general, non-assessable non-exempt income treatment is available for income derived by a resident company through a branch in a listed country if:

  • the income is from carrying on a business in the listed country, and  
  • the branch satisfies an active income test.

Non-assessable non-exempt income treatment is not available for income derived through a branch in a listed country if:

  • the branch does not satisfy the active income test, and  
  • the income is both adjusted tainted income and eligible designated concession income.

You must test each item of income individually against these criteria to see if it is non-assessable non-exempt income.

Branches in unlisted countries

Non-assessable non-exempt income treatment is generally available for income derived by a resident company through a branch in an unlisted country if:

  • the income is from carrying on a business in the unlisted country, and  
  • the branch satisfies an active income test.

Non-assessable non-exempt income treatment is not available for income derived through a branch in an unlisted country if:

  • the branch does not satisfy the active income test, and  
  • the income is adjusted tainted income.

The same concept of adjusted tainted income is used for this purpose as that used in determining the attributable income of a CFC. The following modifications apply, however, in determining the adjusted tainted income of a branch:

  • the passive income of a branch conducting life assurance activities is not reduced under subsection   446(2)  
  • a branch and its Australian head office are treated as separate legal entities for the purpose of determining whether the branch has derived tainted sales income, and  
  • branches of Australian financial institutions are provided with an exemption for banking income broadly consistent with the exclusion from accruals taxation available under the CFC measures for Australian financial institution's subsidiaries.

An active income test concession is provided to allow branches in both listed and unlisted countries to derive up to 5% of gross turnover as tainted income and still obtain non-assessable non-exempt income treatment under section   23AH for income amounts.

Broadly, this active income test is the same as that for CFCs. The following modifications are made to the test for branches:

  • the only amounts taken into account are those derived through the branch  
  • the income year of the company with the branch is used for the purposes of the test  
  • those conditions of the active income test relating to the existence and residency of a CFC do not apply because they are not relevant to branches, and  
  • the modifications to the adjusted tainted income of a branch referred to above also apply in determining the adjusted tainted income of the branch for the purposes of the active income test.
What branch capital gains are non-assessable non-exempt income?

Permanent establishment in a listed country

A resident company includes in the calculation of its net capital gains any capital gain or capital loss as a result of a capital gains tax (CGT) event happening in relation to a tainted asset that is used in carrying on a business through a permanent establishment in a listed country if:

  • the gain is also eligible designated concession income, or  
  • there is a loss but there would have been eligible designated concession income if the loss had instead been a gain.

Permanent establishment in an unlisted country

A resident company includes in the calculation of its net capital gains any capital gain or capital loss arising as a result of a CGT event happening in relation to a tainted asset that is used in carrying on a business through a permanent establishment in an unlisted country.

Effect of non-assessable non-exempt income treatment on a resident company's deductions, losses and foreign tax credits

A deduction is not allowable for:

  • outgoings or expenses connected to branch income and gains that are non-assessable non-exempt income  
  • capital losses on the disposal of a branch asset if, had there been a profit on the disposal, the profit would have been non-assessable non-exempt income.

Current year losses or carried forward losses of a resident company are not reduced by branch income or gains that are non-assessable non-exempt income.

Foreign tax credits are not allowed for foreign taxes paid on branch income that is non-assessable non-exempt income.

Part 3: What credit can you claim for foreign tax?

This part explains the general foreign tax credit rules for Australian residents and the rules that apply specifically to Australian companies.

Summary of part 3

Section 1

Foreign tax credits available to all Australian residents

Section 2

Credits available only to Australian resident companies

The general rule is that:

  • if you are an Australian resident for taxation purposes, you may be entitled to a credit for the foreign tax you have paid, and  
  • if you are an Australian company, you may also be entitled to a credit for foreign underlying tax paid by a CFC on your share of assessable, attributable income.

Section 1: Foreign tax credits available to all Australian residents

Partnerships

Partners can claim a credit for their share of foreign tax paid on foreign income derived through a partnership. The amount of foreign income and the credit for foreign tax paid should be included in each partner's return.

Trusts

Where an amount of trust income is included in the return of a beneficiary, that beneficiary may claim a credit for the foreign tax paid by the trust.

The trust's income must be divided into the appropriate classes of income. The beneficiary's share of the trust income must also be divided into the appropriate classes of income.

The trustee has to show in the trust tax return the amount of foreign income and attributed foreign income.

The trustee is also required to show in the trust tax return:

  • the sum of the foreign tax paid and deemed paid in respect of the part of the net income to which beneficiaries are presently entitled (and assessable), and
  • the foreign tax credit allowable in respect of the part of the net income on which the trustee is assessable.

On the distribution statement, the trustee has to show the portion of foreign tax that relates to the share of foreign income to which each beneficiary is presently entitled (and assessable).

The trustee also has to show the amount of foreign income included in net income on which the trustee is assessable and the foreign tax credit allowable in respect of that income.

A credit is not available for foreign tax paid in respect of income that is attributed to a transferor as a result of the transferor trust measures. For details on the transferor trust measures, see chapter   2 .

Unit trusts

The foreign income of a unit trust is treated in the same manner as foreign income of any other trust.

For which types of foreign tax is a credit allowable?

Creditable foreign taxes include:

  • foreign tax equivalent in nature to Australian income tax - for example, a tax on net income or capital gains
  • foreign withholding tax similar to Australian withholding tax on interest and dividends
  • foreign taxes listed in Australia's double taxation agreements.

Taxation Ruling IT   2507 - Income tax: foreign tax credit system - foreign taxes eligible for credit against Australian income tax , provides a list of creditable taxes. The list in the ruling is not exhaustive. If you wish to seek credit for foreign taxes not identified in the list you should ask for a ruling from the Tax Office, using the format set out in Taxation Ruling IT   2507 .

You are not allowed a credit for penalties, fines, interest, and unitary or credit absorption taxes.

Taxation Ruling IT   2507 - Income tax: foreign tax credit system - foreign taxes eligible for credit against Australian income tax, which you will find on our website, provides a list of creditable taxes.

Credit for notional tax forgone by developing countries

Certain double taxation agreements with developing countries provide for 'tax sparing'. Tax sparing preserves taxation incentives which are provided by a treaty partner to promote economic development. If tax sparing applies to a tax incentive, you can claim a credit for tax forgone by a treaty partner under the incentive. The double taxation agreements list the taxes for which tax sparing is provided.

Foreign tax credit allowable for a dividend paid from income which has previously been attributed

Dividends derived by all Australian residents for tax purposes (including individuals) from profits that have been taxed on an accruals basis are non-assessable non-exempt income. A credit is available for foreign tax paid by the Australian resident on these dividends even though they are not assessable.

Credit for foreign taxes paid after your assessment

You are allowed a credit only for foreign tax which you have actually paid or which you are deemed to have paid. You will need to request that a determination of your foreign tax credit entitlement be made or amended if you wish to claim a credit for foreign tax paid after your original assessment. Your assessment may also need to be amended to gross up your foreign income for any additional foreign tax credit you claim.

For further information please see Taxation Ruling IT   2529 - Income tax: foreign tax credit system - foreign tax credit determinations. Note that the three-year period for claiming a credit referred to in the ruling has since been extended to four years.

Refunds of foreign tax

You cannot claim a credit for foreign tax refunded to you or to another person. Nor can you claim a credit where any other benefit is provided as a result of the payment of the foreign tax.

Two types of benefits will not result in the denial of a tax credit:

  • a general benefit which arises as a result of the payment of foreign tax - a general benefit is a benefit not directly linked with the payment of foreign tax  
  • a benefit which is a reduction of a tax liability.

A credit will therefore not be denied solely because a country provides an imputation credit, a rebate of tax or a foreign tax credit for the foreign tax.

Evidence of foreign tax paid

The following documents will be acceptable as evidence of payment of foreign tax:

  • a notice of assessment and receipt for the tax paid  
  • a statement from a foreign tax authority setting out particulars normally recorded on a notice of assessment and receipt for payment  
  • a certificate for deduction of withholding tax issued by the person who pays the interest, dividends or any other income that is subject to a deduction of foreign tax.

In all cases, retain the original documents because the Tax Office may need to see them at a later date.

If the documentary evidence is in a foreign language, you will need a translation of the documents.

For further information see Taxation Ruling IT   2527 - Income tax: foreign tax credit system -.procedures in relation to claims for foreign tax paid.

Working out your foreign tax credits

You must work out your foreign tax credit entitlement separately for each class of foreign income. This is called quarantining. Your foreign tax credit for each class cannot be more than the Australian tax applicable to that class of your taxable foreign income.

Note: This guide applies only to the year ending 30 June 2008. New rules will apply from 1 July 2008. For more information about the new rules, refer to Changes to foreign loss quarantining and foreign tax credit calculation rules - Update September 2007 - Fact sheet .

What are the classes of foreign income?

Foreign income is divided into four classes for the purpose of allowing a foreign tax credit:

  • passive income
  • offshore banking income
  • certain lump sum payments from foreign non-complying superannuation funds
  • other income.

What is passive income?

Passive income includes dividends, interest, annuities, rental income, royalties, amounts received for the assignment of a patent, copyright, capital gains, passive commodity gains and amounts included in assessable income under the CFC, FIF or transferor trust measures.

Capital gains

An assessable gain or profit of a capital nature is deemed to be foreign income for working out a foreign tax credit if it is derived from a source in a foreign country. Capital gains are included in the 'passive' class of foreign income.

For further details on credits for foreign tax paid on capital gains, please see Taxation Ruling IT   2562 - Income tax: foreign tax credit system - interaction of foreign tax credit provisions with capital gains and capital losses provisions of part IIIA.

What is offshore banking income?

Offshore banking income includes:

  • interest, fees, commissions or similar income derived from offshore banking transfers   , and
  • dividends paid by a company out of profits derived from offshore banking transfers.

What are lump sum payments from foreign non-complying superannuation funds?

These lump sum payments included in assessable income under section   305-70 of the ITAA 1997 are treated as a separate class of income.

What is other income?

Other income is income that does not belong to any of the other classes of income. For instance, it would include income from commercial activities, salary or wages and most pensions.

Working out the amount of assessable foreign income for creditable foreign taxes

Your assessable foreign income for each class is 'grossed up' by the amount of foreign tax credit you can claim for that class of income. A company must also include an amount equal to any credit allowable for foreign underlying tax.

Example 9

Creditable foreign taxes
A company resident in New Zealand pays a dividend of $100 to an Australian resident individual. As New Zealand deducts $15 withholding tax, the taxpayer actually received $85. The taxpayer's assessable foreign income for that dividend will be $100 - that is, the amount of the dividend before the payment of withholding tax.
What deductions are allowable?

You may claim the following deductions for each class of assessable foreign income:

  • expenses directly related to that class of foreign income
  • other deductions relating to that class of foreign income
  • a share of the apportionable deductions - that is, deductions that cannot be related to a particular type of income - for example, gifts
  • unused quarantined foreign losses from prior years
  • prior year domestic losses, if you make an election to offset those losses against a class of foreign income
  • if your allowable deductions for the current year are more than your domestic source income, the amount by which those deductions are more than your domestic source income.

See appendix 2 of this guide and Taxation Ruling IT 2446 - Income tax: foreign tax credit system: allowable deductions referable to foreign income for more information on allowable deductions.

Conversion of foreign amounts

All foreign income, deductions and foreign tax paid must be expressed in Australian dollars (unless a functional currency election is in effect). The following table shows how to convert certain amounts.

Type of foreign income

Convert foreign income to Australian dollars at*:

Foreign employment income, pensions and annuities

the exchange rate that applied at the time you were paid or had the income applied or dealt with on your behalf or as you directed (such as into a bank account), even if no amount was remitted to Australia

Foreign business income, dividends, interest and other income

the exchange rate that applied at the earlier of when you received or derived the income (or, for statutory income, the earlier of when you received the income or were first required to include it in your assessable income)

Foreign capital gains

the exchange rate that applied at the time of the transaction or event for each transaction or event involving an amount of foreign currency (or the market value of property expressed in a foreign currency). For example, if an amount included in the cost base of an asset is expressed in foreign currency, convert that amount into Australian currency on the date that the expenditure was incurred. Convert capital proceeds on the date of the CGT event

Foreign tax paid

the exchange rate that applied at the time the foreign tax was paid

Foreign deductions (other than capital allowances)

the exchange rate applicable at the earlier of when the amount was paid or when it became deductible

Depreciating assets

the exchange rate that applied at the earlier of when you began to hold the asset or satisfied your obligations for it (that is, when you paid for it). This converted cost is then used to calculate the capital allowance deductible.

* At the time of publication, the tax law did not permit the use of average rates. However, there is a regulation-making power under which methods of conversion other than those set out above may be specified. For more information on converting foreign amounts to Australian dollars see the Tax Office fact sheet Foreign exchange (forex): The general translation rule .
Working out your Australian tax payable

The foreign tax credit you are allowed for each class of foreign income is limited to the Australian tax payable on that class of income. Therefore, you must first work out the Australian tax payable.

To do this, multiply your average rate of Australian tax by your adjusted net foreign income. Deduct any rebates which apply to that income - apart from a rebate under an Act fixing the rates of income tax or under an Act imposing income tax. Expressed as a formula, the calculation is as follows:

ATP = AR X ANFI

ATP

= Australian tax payable

AR

= average rate of Australian tax

ANFI

= adjusted net foreign income

How is the average rate of Australian tax worked out?

The average rate of Australian tax (AR) is worked out by dividing the gross tax on your taxable income less certain rebates by your taxable income. Expressed as a formula, the calculation is as follows:

AR

=

gross tax + Medicare levy + Medicare levy surcharge - qualifying tax offsets

taxable income

For this calculation, deduct concessional, zone or overseas service rebates.

What is adjusted net foreign income?

Adjusted net foreign income (ANFI) is your net foreign income adjusted for apportionable deductions. Apportionable deductions are deductions of a concessional nature that do not relate directly to income producing activities - for example, gifts.

Net foreign income is your gross assessable foreign income less:

  • allowable deductions relating exclusively to your foreign income  
  • any domestic loss carried forward that you have elected to use against your foreign income  
  • deductions allowed as being appropriately related to your foreign income.

How is adjusted net foreign income determined?

Your adjusted net foreign income is determined as follows.

  • If your net foreign income exceeds the sum of your taxable income plus apportionable deductions, your adjusted net foreign income will equal your taxable income.  
  • If your net foreign income consists of two or more classes of income - that is, quarantining applies - and your combined net foreign income from all classes is more than the sum of your taxable income plus apportionable deductions, your ANFI for each class will equal your taxable income. ANFI is divided proportionately, as shown in example   9, into:
    • passive income
    • offshore banking income
    • lump sum payments assessable under section 305-70 of the ITAA 1997, and
    • other income.  
  • In any other case, your adjusted net foreign income is your net foreign income multiplied by your taxable income divided by the total of your taxable income and apportionable deductions. Expressed as a formula, the calculation is as follows:

ANFI =

NFI x

          TI          

TI + AD

ANFI

= adjusted net foreign income

NFI

= net foreign income of a class

TI

= taxable income

AD

= apportionable deductions

Example 10

Working out adjusted net foreign income

An individual has:

 

$

domestic source income

7,000

allowable deductions from domestic source income

10,000

net passive foreign income

2,000

net other foreign income

5,000

apportionable deductions

100

taxable income

($7,000 - $10,000 + $2,000 + $5,000 - $100)

3,900

taxable income plus apportionable deductions

($3,900 + $100)

4,000

net foreign income

($2,000 + $5,000)

7,000

The net foreign income is greater than the taxable income plus apportionable deductions. Therefore, the adjusted net foreign income is taken to equal taxable income. As there are two classes of foreign income, it is necessary to apportion the adjusted net foreign income into the relevant classes - that is, passive income and other income.
The taxpayer's passive income is 2/7 and other income 5/7 of the combined net foreign income. The adjusted net foreign income for each class is as follows:

$

ANFI - passive income

(2/7 of the taxable income of $3,900)  

1,114

ANFI - other income

(5/7 of the taxable income of $3,900)

2,786

Example 11

Working out adjusted net foreign income

An individual has:  

$

domestic income

7,000

passive foreign income

2,000

other foreign income

5,000

apportionable deductions

100

First work out ANFI for passive income:

the taxpayer's taxable income

($7,000 + $2,000 + $5,000 - $100)  

13,900

ANFI - passive income

 

2,000       x

          13,900          

(13,900+100)

 

1,986

then work out ANFI for other income:

ANFI - other income

 

5,000       x

          13,900          

(13,900+100)

 

4,964

Working out the credit

Your foreign tax credit entitlement for a class of foreign income is the lesser of:

  • the creditable foreign tax which you have paid on that class of income, and  
  • the Australian tax payable on that class of income, worked out using the above procedure.

The following example shows the steps to use to work out your foreign tax credit.

Example 12

Working out the foreign tax credit

An individual has:  

$

domestic income

7,000

passive income - net of foreign tax

2,000

foreign tax paid - passive income

200

other income - net of foreign tax

5,000

foreign tax paid - other income

1,000

apportionable deductions

100

Step 1
Work out taxable income.
Gross up foreign income by the amount of creditable foreign tax paid:
 

$

Assessable passive income (2,000 + 200)

2,200

Assessable other income (5,000 + 1,000)

6,000

Taxable income (7,000 + 2200 + 6,000 - 100)

15,100

Step 2
Work out the average rate (AR) of Australian tax

AR

=

gross tax + Medicare levy + Medicare levy surcharge - qualifying tax offsets

taxable income

Gross tax on 15,100

1,365.00

Medicare levy

0

Medicare levy surcharge

0

Qualifying tax offsets

0

AR

=

1,365 + 0 + 0 - 0

15,100

0.09

Step 3
Work out adjusted net foreign income.
For the passive class of income:

ANFI (passive income)     =

NFI x TI

TI + AD

NFI - net foreign passive income

2,200

TI - taxable income

15,100

AD - apportionable deductions

 

100

ANFI (passive income) =

2,200 x 15,100

  15,100 + 100

2,185.53

For the other class of income:

NFI - net foreign passive income

6,000

TI - taxable income

15,100

AD - apportionable deductions

 

100

ANFI (other income)         =

6,000 x 15,100

  15,100 + 100

5,960.53

Step 4
Work out the Australian tax payable (ATP) on each class of income.
For foreign passive income:
ATP = AR x ANFI (passive income)
ATP = 0.09 x 2,185.53 = 197.57
For foreign other income:
ATP = AR x ANFI (other income)
ATP = 0.09 x 5,960.53 = 536.45
Step 5
Determine allowable foreign tax credit for each class of foreign income.

$

Foreign tax paid on passive income

200

Australian tax payable

197.57

As the Australian tax payable is less than the foreign tax, the foreign tax credit is

197.57

Foreign tax paid on other income

1,000

Australian tax payable

536.45

As the foreign tax paid is more than the Australian tax payable, the foreign tax credit is limited to the extent of the Australian tax payable on the foreign income - that is, $536.45.
The excess foreign tax credit can be carried forward for offset in later years against Australian tax payable on the same class of foreign income.
Carry forward of excess foreign tax credits

The following relates to amounts carried forward to the 2008 income year. For amounts to be carried forward from the 2008 income year, the new rules will apply.

You will have an excess foreign tax credit for an income year if the amount of foreign tax you have paid in respect of a class of foreign income exceeds the Australian tax payable on that class of foreign income.

You may carry forward an excess foreign tax credit for the five years immediately following the income year in which it arose. You may use an excess credit for a class of foreign income only if there is a credit shortfall for the same class of foreign income in a later year. A credit shortfall occurs if the credit allowed for a class of income is less than the Australian tax payable on that class of income.

If you incur a loss for a class of foreign income, you cannot claim a foreign tax credit for that class of income in that income year because the Australian tax payable for that class is nil. You may, however, carry forward the foreign tax credit to a later income year to apply to the same class of foreign income.

You are required to keep your own records of your excess foreign tax credits if you are carrying the credits forward to a later date.

Note that this carry forward amount is subject to the new rules that apply to income years commencing on or after 1 July 2008. For more information refer to Changes to foreign loss quarantining and foreign tax credit calculation rules - Update September 2007 - Fact sheet .

Section 2: Credits available only to Australian resident companies

Australian resident companies are entitled to a foreign tax credit as worked out in section   1. In addition, in some circumstances a company - other than a company in the capacity of trustee - may be:

Credits available to resident companies for direct and underlying tax
  • An Australian resident company which receives a dividend from a related company may be entitled to a credit for the direct foreign tax - for example, withholding tax - on the dividend received.
This credit will generally be available only if the dividend is included in assessable income. The only exception is where a dividend is received from a related foreign company and is treated as paid out of income previously attributed to the resident company under the accruals tax system. A tax credit can be claimed for both the direct foreign tax and underlying tax on these non-assessable non-exempt dividends.
  • An Australian resident company that is related to a CFC may also be entitled to a foreign tax credit in relation to the assessable, attributable income.
Related foreign companies

Under section 160AFB , an Australian company is treated as related to any number of linked foreign companies provided that:

  • each company in the chain - starting with the Australian company - has at least a 10% voting interest in the company in the tier below it, and
  • the Australian company has a direct or indirect interest of at least 5% in the voting shares of each foreign company that is a member of the chain.

A chain of related companies cannot include a trust or partnership - that is, the chain will be broken by the interposition of a trust or partnership.

Example 13

Related foreign companies
Australian company   A has a 50% voting interest in foreign company   B, which in turn has a 10% voting interest in foreign company   C. Both B and C will be treated as related to A.
Step 1
Are the companies members of the same group?
Yes - each company in the chain, starting with the Australian company, has at least a 10% voting interest in the company in the tier below it.
Step 2
Does Australian company A have a 5% or more direct or indirect voting interest?
Yes - Australian company A has a voting interest of 50% (50% x 100%) in foreign company   B and a voting interest of 5% (50% x 10%) in foreign company C.
Step 3
Are the companies related?
Yes - both tests are satisfied for both foreign companies B and C. Therefore, they are both related to Australian company   A.
Credits available to resident companies for attributed income

Working out the foreign tax credit when income is attributed

If a company is related to a CFC at the end of the CFC's statutory accounting period and the assessable income of the company includes a share of the attributable income of the CFC - see chapter   1 - the company is allowed a credit for an amount of tax equal to its attribution percentage of the CFC's notional allowable deductions for taxes paid.

A CFC can claim a notional deduction for foreign or Australian tax paid by the CFC on amounts included in the CFC's notional assessable income.

Example 14

Foreign tax credit for attributed income
An Australian resident company AustCo has a 60% interest in a CFC, ForCo, a resident of an unlisted country
ForCo

Profits from a foreign branch (not attributable income)

$2,000

Tax paid in the foreign country on the foreign branch income

$600

Income derived in an unlisted country (attributable income)

$10,000

Tax paid in the unlisted country on all income (including foreign branch income)

$1,200

AustCo is deemed to have paid the following amount of tax on the attributed income:

Attribution percentage 60%

 

Tax paid on attributed income

(10,000/12,000) x 1,200

$1,000

Tax deemed paid by AustCo

(1,000/60) x 100

$600

AustCo must gross up its assessable foreign income by this amount. AustCo can claim a foreign tax credit for $600.

Credits where dividends are deemed to have been paid to an Australian resident taxpayer

If a benefit provided by a CFC to a resident taxpayer is deemed to be a dividend paid to that taxpayer under section   47A, credit for foreign tax paid will be allowed only if:

  • the amount of the deemed dividend is included in the taxpayer's assessable income in their return lodged in the year of the distribution, or would be so included apart from section   23AI, or  
  • the taxpayer notifies the Tax Office, in writing, within 12   months after the end of the income year in which the benefit was provided.

Credits where income is attributed due to a change in residence of a CFC

A resident company is allowed a credit for foreign tax paid by a CFC if an amount of income is attributed to it because the CFC changed its residence from an unlisted country to a listed country or to Australia. However, the credit is available only if the resident company is related to the CFC at the time of the change of residence - see section   160AFCB. The company is allowed a credit for the foreign tax and the Australian tax paid by the CFC on the attributed amount.

Working out a foreign tax credit when a dividend is paid from income that was previously attributed to an Australian resident company

A dividend paid out of income previously attributed to an Australian resident is non-assessable non-exempt income - see part   1 of this chapter. In addition, an Australian resident company is allowed a credit for foreign tax - including foreign underlying tax - paid on a non-portfolio dividend from attributed income. The credit for the underlying tax is limited to the amount by which the section   23AI part of the dividend would have been greater if no foreign tax had been paid.

The formula to work out the foreign tax for which a credit is due when a dividend is received from previously attributed income is:

 

FTP = (EP x DT) + (AEP x UT) - AT

 

FTP

foreign tax paid on previously attributed income for which a credit is now allowable

EP

percentage of the payment which is non-assessable non-exempt because the income has been previously attributed

DT

amount of foreign tax which the taxpayer is taken to have paid, and to have been personally liable for, in relation to the attribution account payment

AEP

percentage that would be EP if the attribution account payment were reduced by any part of the payment that is non-assessable non-exempt income under section   23AJ

UT

where the taxpayer is a company and the attribution account payment is a non-portfolio dividend, UT equals the amount by which the section   23AI non-assessable non-exempt part would have been greater if an attribution account entity had not paid foreign tax on its profits

AT

amount of the attributed tax account debit arising from the payment of the dividend that is equal to or less than AEP x UT

Example 15

Credit for foreign taxes on a dividend paid from profits attributed to an Australian company
Austco has a wholly owned subsidiary, Subco, in an unlisted country. Subco had distributable profits of $10,000 on which it paid foreign tax of $1,000. These profits have previously been attributed to Austco.
On 1   August 2004, Subco paid a dividend of $10,000 to Austco. The unlisted country levied dividend withholding tax at a rate of 10%.
The dividend received by Austco is non-assessable non-exempt income because it was paid from previously attributed income. At the attribution stage, Austco would have received a credit of $1,000 for foreign tax paid.
Even though the dividend is not included in Austco's assessable income, a foreign tax credit is available for withholding tax and underlying tax relating to the dividend. This is because the profits out of which the dividend was paid were attributed to Austco and taxed in Australia.
The method by which this credit is granted is as follows.
Work out the foreign tax credit for dividend withholding tax and for underlying tax on the dividend as though the dividend was paid from income that had not been attributed to Austco.
The formula for working out the foreign tax credit Austco can claim is as follows:
FTP = (EP x DT) + (AEP x UT) - AT
This formula can be broken down as follows:

EP x DT

= percentage of the dividend paid from previously attributed income x tax paid on the dividend

 

= 100% x $1,000 (dividend withholding tax)

 

= $1,000

AEP x UT

= adjusted exempt percentage of the dividend x underlying tax paid on the dividend (excluding tax paid under a foreign accruals regime)

 

= 100% x $1,000

 

= $1,000

AT

= tax for which a credit was allowed when the income of the unlisted country CFC was attributed to Austco

 

= $1,000

FTP

= foreign tax paid on previously attributed income for which a credit is now allowable

 

= $1,000 + $1,000 - $1,000

 

= $1,000

In this example, when the income of $10,000 was attributed to Austco and a credit was given for $1,000, Austco would have opened accounts as follows:

Attribution account for Subco

Attributed tax account for Subco

Attributed income

$10,000

Tax credited

$1,000

When the dividend is received, Austco will debit the attribution account $10,000 and treat the dividend as non-assessable non-exempt income. It will also debit $1,000 to the attributed tax account.
This debit is the amount referred to as AT. Attributed tax accounts are dealt with below.
Evidence of underlying tax paid

Your company should retain full particulars of the material on which its underlying tax credit has been worked out. Obtain a statement from the company which paid the dividend, certifying the amount of tax paid on the distributable profits out of which the dividend was paid. When underlying tax paid is traced down a chain of related foreign companies, such details will be required for each company in the chain.

Attribution accounts relevant to foreign tax credits for companies

Attributed tax accounts

What is the purpose of attributed tax accounts?

A resident company can claim a foreign tax credit for dividend withholding tax and certain underlying taxes on a non-assessable non-exempt dividend paid from previously attributed profits.

The credit is initially worked out on the basis that no foreign tax credit was allowed at the time the profits were attributable. The foreign tax credit worked out in this way is then reduced by the credit allowed at the time the attributable income of the CFC was included in the assessable income of the resident company. The attributed tax accounts trace the foreign tax credit allowed at the attribution stage so that this reduction can be made.

Who should maintain attributed tax accounts?

Attributed tax accounts are to be maintained by a resident company to which the attributable income of a related foreign company has been attributed under the CFC measures. Other taxpayers need not maintain these accounts.

Attributed tax account credits

An attributed tax account credit can arise in relation to a CFC where an amount is attributed under any of the following sections:

  • section 160AFCA where the attribution of income of the CFC arises under section   456, or
  • section 160AFCB where the attribution of income of the CFC on a change of residence arises under section   457.

Each time a credit is made to an attribution account - as explained in part 1 of this chapter - a corresponding credit must be made to an attributed tax account for the entity for which the attribution account is operated.

Attributed tax account debits

An attributed tax account debit must be made each time the attribution account entity pays a dividend. The attributed tax account debit is worked out using the following formula.

Attributed tax account debit

=

    attribution debit    

attribution surplus

x

attributed tax account surplus

In order to claim a credit for foreign tax paid on income that was previously attributed, the amount of attributed tax account debit must be verifiable. The attributed tax accounts for each of the relevant entities in respect of the taxpayer claiming the credit must be available or a credit will not be allowed.

Example 16

Credit for foreign tax reduced by credits previously allowed
Forco1 is a resident of an unlisted country and is a wholly owned subsidiary of Ausco. Forco1 derived income of $16,500 from sources in its country of residence, all of which is attributed to Ausco, and pays foreign tax of $1,500.
Forco1 has distributable profits of $15,000 ($16,500 - $1,500).
It pays a dividend of $10,000 to Ausco in the following year, from which withholding tax of $1,500 was deducted - the net dividend is therefore $8,500.
The dividend Ausco received is non-assessable non-exempt income. Ausco is also entitled to a credit for foreign tax paid on the income which was previously attributed. The credit is reduced, however, to the extent a credit for foreign tax was allowed when the income was attributed to Ausco. The non-assessable non-exempt income is not included in working out the Australian tax payable on the foreign income and thus does not increase Ausco's foreign tax credit limit.
The credit is worked out as follows:
 

FTP = (EP x DT) + (AEP x UT) - AT

 

FTP

foreign tax paid on previously attributed income for which a credit is now allowable

EP

percentage of the payment which is non-assessable non-exempt income because the income has been previously attributed. In this example EP is 100% as the dividend is paid from previously attributed income

DT

amount of foreign tax which the taxpayer is taken to have paid, and to have been personally liable for, in relation to the attribution account payment - in this example, $1,500 withholding tax

AEP

percentage that would be EP if the attribution account payment were reduced by any amount of that payment which is non-assessable non-exempt income under section   23AJ

UT

foreign underlying tax credit allowable for the attribution account payment, other than CFC-type foreign tax - that is, foreign tax arising from laws that generally correspond with Australia's accruals measures

 

(dividend/distributable profits) x tax on distributable profits

 

($10,000/$15,000) x $1,500

$1,000

AT

amount of the attributed tax account debit for the tax credit previously allowed on the attributed income that is equal to or less than AEP   x   UT. The attributed tax account debit is equal to:

 

Attribution debit  

attribution surplus

X

attributed tax account surplus

 

($10,000/$15,000) x $1,500

$1,000

Note: When $15,000 income was attributed to Ausco, Ausco would have credited an attribution account for Forco1 with $15,000. It would also have credited $1,500 tax to the attributed tax account for Forco1 - that is, tax for which a credit was allowed at the attributed stage. When the dividend was paid by Forco, this would have remained as an attribution surplus. The dividend of $10,000 is an attribution account payment.

FTP

$1,500 + $1,000 - $1,000

$1,500

Transfer of excess foreign tax credits

A resident company that is a member of a company group may transfer an excess credit to another member of the group if:

  • there is 100% common ownership within the group
  • there is a shortfall of foreign tax credits in a class of income for the company receiving the transfer
  • the shortfall is for income of the same class as that for which there is an excess foreign tax credit in the company transferring the credit
  • both companies retain a record of the transfer showing the credit transferred.

The transfer of an excess credit may include credit carried forward from five previous years as well as the current year. The transfer operates only for the following two classes of income:

  • passive income, and  
  • other income - excluding offshore banking income.

A company can transfer only an amount equal to the credit shortfall for that class of income - that is, the transferee cannot carry forward the transferred amount.

Note: The grouping provisions for wholly owned groups were removed as part of the introduction of the consolidations tax regime. From July   1 2003 unconsolidated wholly owned groups are generally no longer able to transfer excess foreign tax credits between entities in the group.

Carry forward of foreign losses by companies

An overall foreign loss for a class of assessable foreign income may be carried forward indefinitely and used to reduce a future year's assessable foreign income for that class.

Losses incurred by a company before the 1990 income year can be carried forward only for seven years and are therefore no longer available.

ATO references:
NO NAT 1840

Foreign income return form guide
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