Edited version of your written advice

Authorisation Number: 1051279503000

Date of advice: 13 September 2017

Ruling

Subject: Controlled foreign company

Question 1

Will the Company X be a controlled foreign company (CFC)?

Answer

Yes

Question 2

Is the income of the CFC attributable to Company A and included in the assessable income in Australia?

Answer

No

Question 3

Will the equity distribution from the CFC to Company A be non-assessable non-exempt income (NANE)?

Answer

Invalid question – advice provided

Question 4

Are loans to directors by the CFC subject to Division 7A rules?

Answer

Invalid question – advice provided

This ruling applies for the following periods:

Year ending 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

Company A was incorporated in Australia and is a resident of Australia for taxation purposes.

Company A is considering incorporating Company X in foreign country.

Company X will be 100% owned by Company A.

Company X will be a resident of foreign country.

Company X will be set up for the purposes of manufacturing and exporting products.

Company X will be involved in International export trading, trading between enterprises and trading agencies. The products are for display, marketing and promotional items for International customers who prefer to purchase directly.

All products are produced in foreign country and exported directly to the customer.

Company X will have its own business premises, staff, and accounting and meet all other necessary business requirements.

Company X will have minimal tainted income as the main income derived would be from the sales of products.

It is expected that any interest income and net currency exchange gains/losses derived by the Company X that may be regarded as tainted income, will be less than 5% of the gross turnover in a given financial year.

Company X has an accountant in foreign country.

Company X will prepare financial statements and file annual taxation returns prepared by the accountant.

Company X will keep accounts for the statutory accounting period in accordance with commercially accepted accounting principles, which will give a true and fair view of the financial position of the company.

Company X will keep general accounting records to record and explain the matters, transactions, acts and operations that are relevant to the preparation of the recognised accounts of the company.

Company X will retain records of the general accounting records and recognised accounts of the company for the retention period.

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 432

Income Tax Assessment Act 1936 Section 456

Income Tax Assessment Act 1936 Subdivision D

Income Tax Assessment Act 1997 Subdivision 768-A

Income Tax Assessment Act 1936 Section 350

Income Tax Assessment Act 1936 Section 109BC

Income Tax Assessment Act 1936 Section 109H

Income Tax Regulations 1936 Schedule 10

Reasons for decision

Question 1

Section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income includes some 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 Income Tax Assessment Act 1936 (ITAA 1936) dealing with the attribution of income.

The controlled foreign company (CFC) provisions are contained in Part X of the 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.

Will the Company X be a CFC?

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?

Company X will be a company.

2. Is the company a resident of either a listed country or an unlisted country?

Listed country

Schedule 10 of the Income Tax Regulations 1936 specifies the countries that are listed countries. The countries that are listed countries are Canada, France, Germany, Japan, New Zealand, United Kingdom of Great Britain and Northern Ireland and the United States of America.

Unlisted country

An unlisted country means a foreign country which is not a listed country. China is not a listed country; therefore, it is an unlisted country.

A company is treated as a resident of an unlisted country if the company is neither a Part X Australian resident nor a resident of a listed country.

Subsection 317(1) of the ITAA 1936 defines a Part X Australian resident is a resident of Australia who is not treated solely as a resident of a treaty partner country under a double-taxation agreement between Australia and that country.

Subsection 6(1) of the ITAA 1936 defines an Australian company resident for taxation purposes as a company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia.

In this case, Company X will be a resident of an unlisted country.

3. 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%? (strict control test)

Company A holds 100% ownership of the Company X.

4. Are both of the following points satisfied? (assumed controller test)

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

Yes

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

Yes

5. 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). (de facto control test)

Company A holds 100% ownership of Company X.

Accordingly, Company X will be a CFC.

Question 2

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.

Subsection 361(1) of the ITAA 1936 states that an entity will be an attributable taxpayer in relation to a CFC where the entity:

a) is an Australian entity whose associate-inclusive control interest in the CFC is at least 10%; or

b) all of the following apply:

i. the CFC is a CFC only because of paragraph 340(c) of the ITAA 1936;

ii. the CFC is controlled by any group of 5 or fewer Australian entities; and

iii. is an Australian 1% entity and is included in the group of 5 or fewer Australian entities.

In this case, as Company A has 100% ownership of the CFC, the associate-inclusive control interest will be greater than 10%. Consequently Company A will be an attributable taxpayer.

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 in the CFC held by the taxpayer and the aggregate of the indirect attribution interest in the CFC held by that taxpayer at that particular time.

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

The general rule is that only amounts that arise from certain transactions (tainted income) which are classified as 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.

There are a number of exemptions from the CFC provisions where amounts are taxed in a listed country. Amounts taxed at full rates in by listed countries are generally exempt from the CFC provisions.

Section 432 of the ITAA 1936 provides the active income test. A CFC has to satisfy the following five conditions to pass the active income test:

● 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.

The definition of permanent establishment is contained in section 6 of the ITAA 1936. The term includes a fixed place of business through which the CFC carries on business operations. However, it specifically excludes a place where a person:

● is engaged in business dealings through an independent commission agent or broker who is acting in the ordinary course of business and receiving customary rates of remuneration;

● is carrying on business through an agent who does not have, or does not usually exercise, a general authority to negotiate and conclude contracts or to fill orders from stock situated in the country on behalf of the person;

● maintains the place solely for the purpose of purchasing goods or merchandise.

In this case:

● Company X will be a resident of a foreign country;

● Company X will carry on a business at or through a permanent establishment in foreign country. None of the exclusions apply to Company X;

● Company X will keep proper records;

● Company X can substantiate that it will meet the active income test;

● the tainted income ratio is less than five percent.

As Company X satisfies all the conditions above, it passes the active income test.

Passing the active income test will eliminate many, but not all, types of attributed income and gains. 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 arising to the CFC directly or indirectly as a partner in a partnership (only where it is of a kind specified in the Income Tax Regulations 1936);

● trust amounts arising to the CFC directly that are not subject to tax in a listed country or are subject to tax and are designated concession income;

● trust amounts arising to the CFC indirectly because the CFC is a partner in a partnership, if the amounts are not subject to tax in a listed country or are subject to tax and are designated concession income;

● transferor trust amounts arising to the CFC directly or indirectly as a partner in a partnership.

Any other income is notional exempt income.

As Company X will have none of the types of income listed above and it passes the active income test there will be no attributable income to include in the Company A’s assessable income.

Question 3

Invalid question, the Commissioner can only provide a private ruling in response to a valid question. As no equity distribution has been made or planned to be made by the CFC in the foreseeable future, this issue does not set out a scheme or arrangement to which a relevant provision of the law might apply. The Commissioner can confirm that Company A satisfies the participation test (section 768-15 of the ITAA 1997).

Taxation ruling TR 2017/3 Income tax: distribution from foreign companies – meaning of ‘at the time the distribution is made’ when applying the participation test provides guidance on applying the participation test.

The Australian corporate tax entity must (amongst other things) have a direct or indirect participation interest in the foreign company, the sum of which is at least 10%.

The Australian corporate tax entity will satisfy the participation test if it has a sufficient direct control interest in the foreign company within the meaning of section 350 of the ITAA 1936.

Section 350 of the ITAA 1936 provides that the direct control interest that an entity 'holds' in another entity 'at a particular time' is equal to the percentage of share capital, rights to distribution or rights to vote that the entity 'holds' (or is 'entitled to acquire') in the other entity 'at that time.'

In this case, Company A is a company which was incorporated in Australia and is a resident of Australia for taxation purposes; the Company X will be 100% owned by Company A; Company A will not receive the distribution in the capacity of a trustee; or the entity receives the distribution in the capacity of a trustee of a corporate unit trust or public trading trust.

Accordingly, Company A satisfies the participation test.

General advice

Subdivision 768-A in the ITAA 1997 determines whether distributions from a foreign company are NANE. A foreign equity distribution on participation interests will be NANE for these purposes if:

● the entity receiving the distribution is an Australian resident corporate tax entity (including public trading trusts, corporate unit trusts, and corporate limited partnerships);

● the Australian corporate tax entity receiving the distribution has a 10% or greater participation interest in the foreign company that paid the distribution, and;

● the entity does not receive the distribution in the capacity of a trustee; or the entity receives the distribution in the capacity of a trustee of a corporate unit trust or public trading trust.

A foreign equity distribution is a distribution or non-share dividend, made by a company that is a foreign resident, in respect of an equity interest in the company. A non-share dividend is a dividend on a non-share equity interest. A non-share equity interest is an equity interest in a company that is not solely a share.

Question 4

Invalid question, Company A is the incorrect entity. It is the entity that takes out the loan that needs to apply for a private ruling regarding Division 7A issue.

Section 109BC of the ITAA 1936 specifically discusses how the Division 7A applies to non-resident company. Any private company loan to a related entity will potentially be caught by Division 7A.

Section 109H of the ITAA 1936 sets out rules about payments and loans that are not treated as dividends.

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