Edited version of your written advice

Authorisation Number: 1013123661884

Date of advice: 15 November 2016

Ruling

Subject: Attribution of income from a company overseas

Question 1

Is your attribution percentage 50%?

Answer

Yes

Question 2

Is the income of Y Ltd attributable to you and included in your assessable income in Australia?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20WW

Year ended 30 June 20XX

Year ended 30 June 20YY

Year ended 30 June 2020

The scheme commences on:

1 July 20UU

Relevant facts and circumstances

In 20VV you started a manufacturing business in an overseas country with F.

F is a resident of the overseas country.

You and F set up a company in the overseas country named Y Ltd (Y Ltd) on the advice of an accountant in the overseas country.

You and F intended to jointly operate the business through the Y Ltd.

At the time of setting up the arrangement F did not want their name to appear in the Y Ltd records or documents.

At the suggestion of the overseas accountant you agreed to hold in trust the shares in the Y Ltd. 50% of the shares were to be held for F and 50% of shares were to be held by the X Trust.

There was no formal agreement entered into initially, however, there was a mutual understanding that Y Ltd was jointly owned and still is.

You have provided a statutory declaration signed in Australia by you which states “We had an understanding and always agreed that any decisions would be made jointly as if they were also a director and shareholder. We have always followed this agreement and still continue today.”

You have also provided a declaration from F notarised by a public notary in the overseas country which states “We always had an understanding and always agreed that any decision relating to the operation of the company would be made jointly as if we were both joint directors and shareholders. We have always followed this agreement and this still continues today.”

F is now in the process of restructuring their affairs so that the shares in Y Ltd can be transferred out of trust and into their own name.

The shares held by the X Trust will be transferred to you at the same time.

The Y Ltd

The Y Ltd runs a manufacturing business in an overseas country. F runs the day to day operations of the business in the overseas country as they have the knowledge, manufacturing contacts, speaks the local language and provided the upfront capital needed.

The Y Ltd operates a number of factories and an office in the overseas country where F and the staff work. The Y Ltd prepares financial statements and files annual taxation returns prepared by a reputable accountant in the overseas country. Y Ltd has kept accounts for the statutory accounting period in accordance with commercially accepted accounting principles and those accounts give a true and fair view of the financial position of the company. Y Ltd keeps general accounting records to record and explain the matters, transactions, acts and operations that are relevant to the preparation of the recognized accounts of the company. General accounts records are kept to enable the preparation of the recognized accounts of Y Ltd. The company will retain these accounts for the prescribed period. If required by the Commissioner the company will be able to produce the recognised accounts, general accounting records of the company, calculation of the tainted income ratio within the time specified in the notice from the Commissioner. All of the income derived by the Y Ltd is from conducting business with unrelated worldwide parties.

There is minimal tainted income, that is, less than five percent from interest or other related income.

X Trust

The X Trust conducts a business in Australia and provides work to Y Ltd and other worldwide customers. X trust is an Australian resident trust. You, through the X Trust, source the international buyers, manage international customers and deal with the financial operations of the business. The work performed by the X Trust is billed to the Y Ltd at market rates. All of this income has been declared by the X Trust and taxed accordingly.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1936 Part X

Income Tax Assessment Act 1936 Section 317

Income Tax Assessment Act 1936 Section 320

Income Tax Assessment Act 1936 Section 340

Income Tax Assessment Act 1936 Section 361

Income Tax Assessment Act 1936 Section 362

Income Tax Assessment Act 1936 Section 381

Income Tax Assessment Act 1936 Section 432

Income Tax Assessment Act 1936 Section 456

Income Tax Regulations 1936 Sub-regulation 152C(1)

Income Tax Regulations 1936 Schedule 10

Reasons for decision

Section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) includes amounts that are not ordinary income but are included by other provisions about assessable income, also known as statutory income.

Included in the lists of statutory income provisions contained in section 10-5 of the ITAA 1997 are sections 456 to 459A of the ITAA 1936 dealing with the attribution of income.

The controlled foreign company (CFC) provisions are contained in Part X of the Income Tax Assessment Act 1936 (ITAA 1936). The accruals system applies to Australian residents who have a substantial interest in a foreign company controlled by Australians. The system operates to include a taxpayer's share of specified income and gains of a CFC in the taxpayer's assessable income: this is called attribution. This is achieved by attributing tainted income to the Australian resident controllers of the CFC.

There are modifications to the attributable income where the CFC is located in a country that taxes income in a similar way to Australia. The attributable income is also modified where the CFC has significant income from actively carrying on business.

Section 456 of the ITAA 1936 provides that where a CFC has attributable income for a statutory accounting period in respect of an attributable taxpayer, the taxpayer's attribution percentage of the attributable income is included in the assessable income for the year of income in which the CFC's statutory accounting period ends.

Is Y company a controlled foreign company?

Section 340 of the ITAA 1936 contains the definition of CFC. The determination of the status of a foreign company as a CFC arises from a consideration of the direct and indirect control interests held by Australian entities in the company.

The following factors need to be established in order for a company to be a CFC:

1. Is the entity a company?

You have stated that the Y Ltd is a company.

2. Is the company a non-resident company?

The company has its management and control in an overseas country. As the company is not resident in Australia it is a non-resident company.

3. Does the company meet one of the three control tests?

Section 340 of the ITAA 1936 contains the detail of the three control tests. Although it is only necessary to pass one of the tests we will consider the application of all three.

a. Does the company meet the strict control test? That is, is there a group of five or fewer Australian 1% entities, the aggregate of whose associate inclusive control interests in the company, is not less than 50%.

Section 349 of the ITAA 1936 describes the associate inclusive interest is the sum of the direct and indirect interests held by the entity and its associates in the foreign company. An associate includes relatives and a trustee of the trust estate where the person benefits or is capable of benefiting, under the trust either directly or through interposed companies, partnerships or other trusts (section 318 of the ITAA 1936).

You control 50% of Y Ltd, as trustee of X Trust, and you hold 50% of the company on trust for F. Your associate inclusive interest is not less than 50%. Consequently the company meets the strict control test.

b. Does the company meet the assumed controller test? That is, are both of the following points satisfied:

i. There is a single Australian entity (assumed controller) whose associate-inclusive control interest in the company is not less than 40%?

A foreign company will normally be treated as a CFC under the assumed controller test if a single Australian entity owns, or is entitled to acquire, an associate-inclusive control interest of at least 40% in the foreign company. An entity's associate-inclusive control interest in a foreign company is the sum of the interests held in the company by the entity and the associates of the entity.

X trust is an Australian resident trust. You, through the X Trust, own 50% of Y Ltd.

ii. The company is not controlled by a group of entities not being or including the assumed controller or any of its associates?

A foreign company will not be treated as a CFC under the assumed controller test if the company is controlled by a party or parties unrelated to the single resident or its associates.

X trust is an Australian resident trust. You, through the X Trust, own 50% of Y Ltd. You hold the other 50% of Y Ltd on trust for F.

There are no other owners.

Consequently, the Y Ltd will meet the assumed controller test.

c. Does the company meet the de facto control test? That is, the company is controlled by a group of five or fewer Australian entities, either alone or together with associates (whether or not any associate is also an Australian entity).

You hold 100% ownership of Y Ltd, that is, 50% as trustee for the X Trust, which is an Australian resident, and 50% as trustee for F. Consequently, Y Ltd is controlled by a group of five or fewer Australian entities and their associates the company will meet the de facto control test.

As the Y Ltd meets all three tests at least one of the tests is met. Consequently, the Y Ltd is a controlled foreign company.

Are you an attributable taxpayer?

You are only required to include an amount of attributable income from a CFC in your assessable income if you an attributable taxpayer in relation to the CFC.

You will be an attributable taxpayer if:

● You have an associate inclusive control interest of 10% or more in a CFC, or

● All of the following apply -

● The CFC is a CFC because of the application of the de facto control test

● You are an Australian 1% entity, and

● You are part of a group of five or fewer Australian entities who, alone or with associated (regardless of whether the associates are Australian entities) controls the CFC.

As you, as trustee for X Trust own 50% of Y Ltd your associate-inclusive control interest will be greater than 10%. Consequently you will be an attributable taxpayer.

What is the attribution percentage?

If you are an attributable taxpayer, your assessable income may include a share of the CFC's attributable income, which broadly, is the CFC's income and gains. Your share is called an attribution percentage and is based on your rights to profits from the CFC.

Section 362 of the ITAA 1936 provides that the attribution percentage of an attributable taxpayer in relation to a CFC at a particular time is the sum of the direct attribution interest and the indirect attribution interest held by that taxpayer at that particular time.

A direct attribution interest (section 356 of the ITAA1936) is the largest of the percentages that you hold, or are entitled to acquire, of the following:

● total paid-up share capital in the CFC

● total rights to vote, or to participate in any decision making, in relation to

● the distributions of capital or profits

● changing of constituent documents

● varying of share capital of the CFC

● total rights to distributions of capital or profits of the CFC on winding up

● total rights to distributions of capital or profits of the CFC other than on winding up.

The attribution tracing interest that a beneficiary of a trust holds in the trust is the percentage of the income or property of the trust representing the share of the income or property to which the beneficiary is entitled, or is entitled to acquire.

An indirect tracing interest is defined in section 357 of the ITAA1936. Under subsection 357(3) of the ITAA1936 if there is only one interposed entity the indirect attribution interest is calculated by multiplying the attribution tracing interest that the bottom entity holds in the top entity.

You hold 100% of the shares in Y Ltd, 50% in trust for the X family trust and 50% for F. Consequently your attribution tracing interest will be 50% (ie 50% x 100%).

Section 381 of the ITAA 1936 provides that the attributable income of a foreign company is calculated where at the end of the company's statutory accounting period the company is a CFC; and there is at least one attributable taxpayer in relation to the CFC.

The types of income that will be included in the attributable income of a CFC depend on whether it is a resident in a listed country or unlisted country and whether it passes the active income test.

Is Y Ltd's income generally exempt from accruals taxation?

There are a number of exemptions from the CFC provisions where amounts are taxed in a comparable tax country. These comparably taxed countries are known as listed countries, and are listed in Schedule 10 of Income Tax Regulations 1936. Amounts taxed at full rates in by listed countries are generally exempt from the CFC provisions.

The overseas country is not one of the listed countries; consequently it is resident of an unlisted country.

What types of attribution can apply?

If you are an attributable taxpayer of a CFC at the end of the CFC's statutory accounting period, you may need to include the whole or a part of the profits of that period in your assessable income.

The attribution of a current year profits of a CFC may be reduced if you have been subject to dividend attribution or attribution on change of residence by the CFC.

Do you have to work out the attributable income of a CFC?

If you are an attributable taxpayer, your assessable income may include a share of the CFC's attributable income, which broadly, is the CFC's income and gains. You work out the CFC's attributable income first and then work out your share of it (called your attribution percentage).

You work out your attributable income based on the same rules for working out the taxable income of a resident company. However, not all profits of a CFC are taken into account in working out the attributable income of the CFC.

Generally only amounts that arise from certain transactions (called tainted income) which are considered to be prone to tax minimisation are taken into account. These will only be taken into account if a CFC is not mainly engaged in genuine business activities, that is, where the CFC fails the active income test.

Does Y Ltd satisfy the active income test?

A CFC has to satisfy five conditions to pass the active income test (Section 432 of the ITAA 1936):

● The CFC is a resident of a foreign country

● It carries on a business at or through a permanent establishment in its country of residence

● The CFC keeps proper records

● It can substantiate that it has met the active income test

● Its tainted income ratio is less than five percent.

A permanent establishment includes a fixed place of business through which the CFC carries on business operations. The definition of permanent establishment in section 6 of the ITAA 1936 makes a number of specific exclusions which do not apply to Y Ltd.

In your circumstances:

● The Y Ltd will be a resident of a foreign country.

● The Y Ltd carries on a business at or through a permanent establishment in an overseas country. None of the exclusions apply to Y Ltd.

● The Y Ltd keeps proper records.

● The Y Ltd can substantiate that it has met the active income test.

● You have stated that the tainted income ratio is less than five percent.

As you satisfy all the conditions above Y Ltd passes the active income test.

Passing the active income test will eliminate many, but not all, types of attributed income.

If a CFC passes the active income test, amounts that would be assessable if the CFC were a resident are included in attributable income to the extent they represent the following:

● Low taxed third country income of a kind specified in the Regulations

● Amounts included under the transferor trust provisions

● Trust amounts arising to the CFC that are not subject to tax in a listed country, or

● Any of the above amounts that are derived by the CFC through an interest in a partnership.

Any other income is notional exempt income.

As Y Ltd has none of the types of income listed above and passes the active income test there will be no attributable income to include in your assessable income.

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