Edited version of your written advice

Authorisation Number: 1051462172966

Date of advice: 18 December 2018

Ruling

Subject: Foreign hybrid company

Question 1

Will Company A be treated as a foreign hybrid company under section 830-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will Company B be treated as a foreign hybrid company under section 830-15 of the ITAA 1997?

Answer

Yes.

Question 3

Will Company C and Company D be treated as foreign hybrid companies under section 830-15 of the ITAA 1997?

Answer

Yes.

Question 4

Pursuant to section 830-35 of the ITAA 1997, is the Australian Entity taken to have an interest in the Property?

Answer

No.

Relevant facts and circumstances

An Australian Entity holds x% of the interests in Company A, a US resident limited liability company (‘LLC”). The remaining interests in Company A are held by an unrelated non-resident entity.

Company A holds y% interests in Company B, a US resident LLC. The remaining interests in Company B are held by non-resident entities which are not associates of the Australian Entity.

Company B wholly owns Company C and Company D, US resident LLCs. Company A, Company B, Company C and Company D were incorporated in a US State.

Company C and Company D are owners of a portfolio of overseas properties (‘the Property’).

For the purposes of US income tax law:

● Company C and Company D are single member LLCs which have elected to be treated as disregarded entities under US income tax law.

● Company A and Company B have elected to be treated as partnerships under the US ‘check-the-box’ regulations for the purposes of US income tax law.

Company A, Company B, Company C and Company D are not residents of a foreign country other than the US.

Company A, Company B, Company C and Company D are not Australian residents.

Company A has made an election pursuant to subsection 830-15(5) to treat its interest in Company B as an interest in a foreign hybrid company.

Company B has made an election pursuant to subsection 830-15(5) to treat its interests in Company C and Company D as an interest in a foreign hybrid company.

Relevant legislative provisions

Section 340 of the Income Tax Assessment Act 1936

Section 352 of the Income Tax Assessment Act 1936

Section 353 of the Income Tax Assessment Act 1936

Section 356 of the Income Tax Assessment Act 1936

Section 361 of the Income Tax Assessment Act 1936

Section 362 of the Income Tax Assessment Act 1936

Section 470 of the Income Tax Assessment Act 1936

Section 481 of the Income Tax Assessment Act 1936

Subsection 483(1) of the Income Tax Assessment Act 1936

Section 485 of the Income Tax Assessment Act 1936

Section 485AA of the Income Tax Assessment Act 1936

Subsection 485AA(1) of the Income Tax Assessment Act 1936

Subsection 485AA(2) of the Income Tax Assessment Act 1936

Paragraph 830-10(2)(b) of the Income Tax Assessment Act 1997

Subsection 830-10(4) of the Income Tax Assessment Act 1997

Section 830-15 of the Income Tax Assessment Act 1997

Subsection 830-15(1) of the Income Tax Assessment Act 1997

Paragraph 830-15(1)(a) of the Income Tax Assessment Act 1997

Paragraph 830-15(1)(b) of the Income Tax Assessment Act 1997

Paragraph 830-15(1)(c) of the Income Tax Assessment Act 1997

Paragraph 830-15(1)(d) of the Income Tax Assessment Act 1997

Subsection 830-15(2) of the Income Tax Assessment Act 1997

Paragraph 830-15(5)(b) of the Income Tax Assessment Act 1997

Section 830-15(7) of the Income Tax Assessment Act 1997

Subparagraph 830-15(7)(a)(i) of the Income Tax Assessment Act 1997

Paragraph 830-15(7)(b) of the Income Tax Assessment Act 1997

Section 830-20 of the Income Tax Assessment Act 1997

Section 830-25 of the Income Tax Assessment Act 1997

Section 830-35 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1, Question 2 and Question 3

Subsection 830-15(1) provides the definition of foreign hybrid company as:

Subject to subsection (5), a company is a foreign hybrid company in relation to an income year if:

(a) at all times during the income year when the company is in existence, the partnership treatment requirements for the income year in subsection (2) or (3) are satisfied; and

(b) at no time during the income year is the company, for the purposes of a law of any foreign country that imposes *foreign income tax (except *credit absorption tax or *unitary tax) on entities because they are residents of the foreign country, a resident of that country; and

(c) at no time during the income year is the company an Australian resident; and

(d) disregarding this Division, in relation to the same income year of another taxpayer:

i. the company is a *CFC at the end of a *statutory accounting period that ends in the income year; and

ii. at the end of the statutory accounting period, the taxpayer is an *attributable taxpayer in relation to the CFC with an *attribution percentage greater than nil.

The application of each of the conditions as set out in paragraphs 830-15(1)(a) to (d) of the ITAA 1997 to each Company is discussed below:

Paragraph 830-15(1)(a) - Partnership Treatment Requirement

Paragraph 830-15(1)(a) of the ITAA 1997 sets out the first of a number of conditions for a company to be a foreign hybrid company, which is that the ‘partnership treatment requirements’ in subsections 830-15(2) or 830-15(3) of the ITAA 1997 must be satisfied.

Relevantly, subsection 830-15(2) which applies to US LLCs provides that the ‘partnership treatment requirement’ for the purposes of paragraph 380-15(1)(a) are satisfied if:

(a) the company was formed in the United States of America; and

(b) for the purposes of the law of that country relating to *foreign income tax (except *credit absorption tax or *unitary tax) imposed by that country, the company is a limited liability company that:

(i) is treated as a partnership; or

(ii) is an eligible entity that is disregarded as an entity separate from its owner.

Company A, Company B, Company C and Company D meets all of the conditions in subsection 830-15(2) so as to satisfy the partnership treatment requirements in paragraph 380-15(1)(a) for the following reasons:

1. Each Company is a company within the meaning of that term under section 995-1 of the ITAA 1997; and was formed or incorporated in the USA. Consequently, the terms of paragraph 830-15(2)(a) of the ITAA 1997 are met.

2. Paragraph 830-15(2)(b) of the ITAA 1997 requires that each LLC be treated under US income tax law as a partnership or as an eligible entity that is disregarded as an entity separate from its owner.

Company A and Company B, which are both multi-member LLCs, have elected to be treated as a partnership under the US ‘check-the-box’ regulations for the purposes of US income tax law. Consequently, both of these companies satisfy the partnership requirement under subparagraph 830-15(2)(b)(i) of the ITAA 1997 and, therefore meet the ‘partnership treatment requirement’ under paragraph 380-15(1)(a).

Company C and Company D are single member LLCs that have elected to be treated as disregarded entities for US income tax purposes. In ATO Interpretative Decision ATO ID 2010/77 Income Tax Foreign hybrid company: US limited liability company, it was accepted that single member US LLCs which are disregarded or ignored for US tax purposes (with the members subject to tax on LLC income) can satisfy the partnership treatment requirement under subparagraph 830-15(2)(b)(ii) of the ITAA 1997.

In this case, Company C and Company D are treated as disregarded entities for US tax purposes. Consequently, these companies meet the requirements of subparagraph 830-15(2)(b)(ii) and therefore the partnership treatment requirement under paragraph 380-15(1)(a) is also met.

Paragraph 830-15(1)(b) – Residency of a Foreign country

Company A, Company B, Company C and Company D are not residents of a foreign country other than the US; and thereby the second condition in paragraph 830-15(1)(b) is met.

Paragraph 830-15(1)(c) - Australian Residency

The third condition in paragraph 830-15(1)(c) is satisfied as Company A, Company B, Company C and Company D are not Australian residents.

Paragraph 830-15(1)(d) - CFC Attributable taxpayer requirement

For paragraph 830-15(1)(c) to be satisfied, it requires that the company must be a CFC with at least one ‘attributable taxpayer' having an ' attribution percentage’ greater than nil.

Broadly, a foreign resident company is a ‘CFC’ within the meaning of that term under section 340 of the Income Tax Assessment Act 1936 (ITAA 1936) where it satisfies one of following three control tests:

● strict control test (section 340(a) of the ITAA 1936)

● assumed controller test (section 340(b) of the ITAA 1936)

● de facto control test (section 340(c) of the ITAA 1936)

The control test relevant to this case is the strict control test. Under the strict control test in section 340(a), a foreign company will be treated as a CFC if a group of five or fewer Australian '1% entities' have or are entitled to acquire at least 50% associate-inclusive control interest in the foreign company.

An entity’s associate-inclusive control interest in a foreign company is the aggregate of its direct control interests, indirect control interests and the direct control interests of their associates in the foreign company (see section 349 of the ITAA 1936).

An Australian resident entity will qualify as an ‘attributable taxpayer’ where its associate-inclusive interest in the CFC is greater than 10% (see section 317 and paragraph 361(1)(a) of the ITAA 1936). The attribution percentage of an attributable taxpayer is the sum of the taxpayer’s direct attribution interest and indirect attribution interest held in the CFC (sections 356 and 362 of the ITAA 1936).

The conditions which are set out in paragraph 830-15(1)(c) about being a CFC with an attributable taxpayer as it applies to each Company is discussed below:

Company A

In relation to Company A, an Australian resident entity – the Australian Entity, holds a x% interest in this company. Specifically, it controls x% of the voting rights in this company.

Consequently, the Australian Entity has x% direct control interest in the Company A. Its associate-inclusive interest in Company A will also be x%.

Company A’s qualifies as a CFC of the Australian Entity under section 340(a).

As the Australian Entity’s associate-inclusive interest in Company A is greater than 10%, the Australian Entity will be an ‘attributable taxpayer’ under section 361. The Australian Entity’s attribution percentage in Company A is x% being its direct attribution interest in the LLC (sections 356 and 362).

Therefore, the fourth condition in paragraph 830-15(1)(d) of the ITAA 1997 is satisfied as Company A is a CFC and the Australian Entity, an Australian resident entity is an attributable taxpayer of this LLC with an attributable percentage greater than nil.

Accordingly, as Company A satisfies all of the conditions in subsection 830-15(1), Company A qualifies as a foreign hybrid company.

Company B

As a consequence of applying the provisions of section 339, 352, and 353 of the ITAA 1936, it is determined that the Australian Entity does not hold the requisite level of control in Company B for the purposes of section 340. Therefore, Company B cannot qualify as a CFC under section 340 of the ITAA 1936.

Consequently, as Company B is not a CFC, it will not meet the requirements of paragraph 830-15(1)(d).

Company C and Company D

Company B holds 100% interest in both Company C and Company D. Under the CFC rules, neither Company C nor Company D qualify as CFCs of the Australian Entity as the Australian Entity does not hold the requisite level of control in each company. Consequently, the requirements of paragraph 830-15(1)(d) will also not be met with respect to each of these companies.

In conclusion, Company B, Company C and Company D will satisfy the conditions in paragraphs 830-15(1)(a) to (c) but not the conditions in paragraph 830-15(1)(d).

Subsection 830-15(5) - Election

Where a foreign company does not meet the requirements of paragraph 830-15(1)(d) but satisfies the remaining conditions in subsection 830-15(1), it may be treated as a foreign hybrid company entity where the terms of subsection 830-15(5) are met.

Subsection 830-15(5) provides:

If a shareholder is not an ^* attributable taxpayer in relation to a company, then, for the purposes of applying the Income Tax Assessment Act 1936 and this Act in relation to the shareholder’s ^*share or shares in the company, the company is a foreign hybrid company in relation to an income year for the shareholder if, and only if, the shareholder:

(a) has made an election under former subsection 485AA(1) of the Income Tax Assessment Act 1936; or

(b) makes an election under this paragraph;

in relation to the shareholder's share or shares in the company.

In the Explanatory Memorandum Taxation Laws Amendment Bill (No 7) 2003 at paragraph 9.41 it is considered that a member of a LLC can be a shareholder of a LLC, notwithstanding that a LLC may not actually issue shares to its members. A member of a LLC is equivalent to stockholders of a corporation. Such an interest-holder will fall within the definition of a ‘shareholder’.

In the present circumstances, Company A is a member or shareholder of Company B (a LLC); and Company B is the sole member or shareholder of Company C and Company D (each a LLC).

Company A and Company B are not attributable taxpayers (as defined in section 361(1)) as the companies in which they hold interests or shares are not CFCs nor does Company A and Company B meet the Australian residency requirement in section 361.

Therefore, Company A and Company B (as shareholders) satisfies the preliminary requirements in subsubsection 830-15(5) about not being an attributable taxpayer.

For a company to be treated as a foreign hybrid company, subsection 830-15(5) also requires that a shareholder (member) has either:

● made an election in relation to their share or shares in the company under former section 485AA;

● or makes an election under paragraph 830-15(5)(b).

Each of these provisions are discussed below:

Former section 485AA election

Former section 485AA of the ITAA 1936 was repealed as part of the repeal of the foreign fund investment (FIF) legislation in Part XI of the ITAA 1936 (applicable to 2010/2011 and later income years). Amendments were made to section 830-15 (and also to section 830-10 for foreign hybrid limited partnerships) to maintain the effect of elections made by shareholders of foreign companies (and partners of limited partnerships) for foreign hybrid treatment prior to the repeal of section 485AA (see paragraph 1.35 and 1.36 of Explanatory Memorandum Tax Laws Amendment (Foreign Source Income Deferral) Bill (No. 1) 2010 (EM TLAB (No.1) 2010).

From 2010/11 income year onwards, an election is to be made under new paragraph 830-15(5)(b) for shareholders of foreign companies (or paragraph 830-10(2)(b) for limited partnerships). Paragraph 1.36 of EM TLAB (No.1) 2010 further explains in discussing both the foreign hybrid company and limited partnership elections that the conditions required for making an election are the same as those required under former section 485AA. This was to ensure that the election would continue to operate as intended.

An election by Company A and Company B for foreign hybrid treatment of each of the relevant companies will therefore need to be considered under paragraph 830-15(5)(b).

New paragraph 830-15(5)(b)

Section 830-15(7) set out the requirements for making an election under paragraph 830-15(5)(b). Section 830-15(7) reads as follows:

An election can only be made under paragraph 5(b) if:

(a) in relation to the income year in which the election is made, the company:

(i) is a FIF (within the meaning of former Part XI of the Income Tax Assessment Act 1936 ); and

(ii) satisfies paragraphs (1)(a) to (c); and

(b) at the end of the income year in which the election is made, the shareholder's interest in the FIF consists of one or more *shares in the FIF.

The condition in subparagraph 830-15(7)(a)(ii) is met as Company B, Company C and Company D satisfies paragraphs 830-15(1)(a) to (c), as explained earlier in this report.

At issue here is whether the requirements in subparagraph 830-15(7)(a)(i) and paragraph 830-15(7)(b) are met.

Subparagraph 830-15(7)(a)(i) requires that each LLC in question be a FIF within the meaning of former Part XI of the ITAA 1936. Paragraph 830-15(7)(b) that the shareholder's interest in the FIF consists of one or more *shares in the FIF.

A ‘FIF’ is defined in former Part XI to mean ‘a foreign company’ (see former section 481 of the ITAA 1936. An ‘interest in the FIF’ is defined to mean ‘a share in the company’ (see subsection 483(1) of the ITAA 1936).

On a literal reading of these provisions, it could be argued that Company A and Company B holds the requisite interest in a FIF because they each hold share/s in a company (LLC) which is a foreign company; and as such satisfy the requirements in section 830-15(7) to make an election. (The term ‘share’ is defined to include ‘stock’: s.995-1 of the ITAA 1997)

However, statutory interpretation principles require that the relevant sections be considered in context, having regard to the existing state of the law, and the mischief the statute was intended to remedy.

These principles were applied in Tax Determination TD 2017/25 Income tax: can a foreign resident elect to treat their interest in a limited partnership as an interest in a foreign hybrid limited partnership under paragraph 830-10(2)(b) of the Income Tax Assessment Act 1997?. It is considered that the views expressed in this TD are also applicable to the question of whether a foreign resident shareholder/ member can make an election for foreign hybrid treatment of their interest in a company under subsection 830-15(5). In this regard, the choice to make an election for foreign hybrid treatment of a partner’s interest in a limited partnership in the terms of paragraph 830-10(2)(b), subsection 830-10(4) and former subsection 485AA(1) of the ITAA 1936 is set out in similar terms to the election provisions relating to foreign companies in paragraph 830-15(5)(b), subsection 830-10(7)and former section subsection 485AA(2) of the ITAA 1936.

In TD 2017/25, the Commissioner concluded that a foreign resident cannot elect to treat their interest in a limited partnership as an interest in a foreign hybrid limited partnership under paragraph 830-10(2)(b). The TD does not apply:

● if the foreign resident is a CFC (with an Australian investor) or was taken to be a Part XI Australian resident under former Part XI of the ITAA 1936; or

● for the purposes of calculating the net income of a partnership or trust estate (see paragraphs 1(a) to (b) of TD 201725).

At paragraphs 10 to 11 of TD 2017/25 it is explained that the election available under section 485AA was limited to Part XI Australian residents who would otherwise be subject to the operation of the FIF rules (see also sections 485 and 529 of the ITAA 1936). Generally, a foreign resident was not subject to the FIF rules and it could not make an election under section 485AA.

However, in certain circumstances foreign residents were subject to the former FIF rules. In footnote 14 of the TD it is stated that certain taxpayers were taken to be Part XI Australian residents (see subsection 485(6) of the ITAA 1936). Also the former FIF rules applied in the calculation of the notional income of a CFC, and in the calculation of the net income of a partnership or trust estate (section 485A of the ITAA 1936).

At paragraphs 13 to 14, the TD goes on to explain that amendments made to Division 830 upon the repeal of the FIF rules did not broaden the scope of the election; the conditions required to make an election under paragraph 830-10(2)(b) are the same as those under former section 485AA of the ITAA 1936. It is worthwhile to note that at footnote 15, the TD comments that the wording of subsection 830-10(4) and subsection 485AA(1) is the same in all relevant aspects.

Accordingly, the TD considers that an election for foreign hybrid treatment is only available to partners who have an interest in a FIF to which Part XI of the ITAA 1936 applied, being partners who are Part XI Australian residents. Foreign residents who were not subject to the former FIF rules cannot make an election under subsection 830-10(2).

In light of the Commissioner’s view expressed in TD 2017/25, it is considered that foreign hybrid treatment under subsection 830-15(5) is only available to shareholders (members) of companies which have an interest in a FIF to which Part XI of the ITAA 1936 applied (but for its repeal), being shareholders (members) who are Part XI Australian residents. Foreign residents who were not subject to the former FIF rules cannot make an election under this provision.

However, as TD 2017/25 has shown, in certain circumstances foreign residents could be subject to the former FIF rules; and therefore not precluded from making a section 485AA election. This includes a foreign resident that is a CFC (with an Australian investor) or was taken to be a Part XI Australian resident under former Part XI of the ITAA 1936; or where the former FIF rules applied for the purposes of calculating the net income of a partnership or trust estate.

Company A

As concluded earlier in this document, Company A qualifies as a foreign hybrid company under section 830-15(1). Where a company qualifies as a foreign hybrid company, section 830-20 of the ITAA 1997 will apply to treat the company as if it were a partnership. This means that as a partnership, the provisions of section 90 of the ITAA 1936 will apply to determine the net income of the Company A partnership as if the partnership was a resident taxpayer.

As a partnership, the former FIF rules (but for its repeal) would apply to the Company A partnership in the calculation of the net income of the partnership in respect of any amount from its FIF interest in Company B - see former sections 485, 485A and 529 of the ITAA 1936. For this purpose, section 485A will regard the Company A partnership as a taxpayer who is a Part XI Australian resident.

Consequently, as the former FIF rules applied to the Company A partnership, as explained above, Company A will be eligible to make an election to treat its interest in Company B as an interest in a foreign hybrid company.

Company A has made such an election in relation to its interest in Company B under subsection 830-15(5). Accordingly, Company B can be regarded as a foreign hybrid company under section 830-15.

Company B

Company B is not an Australian resident under section 6(1) of the ITAA 1936 and therefore would not qualify as a Part XI Australian resident as defined in former Part XI of the ITAA 1936.

As a foreign hybrid company, Company B is treated as a partnership under section 830-20 for the purposes of the ITAA 1936 and ITAA 1997. As such, the provisions of section 90 of the ITAA 1936 will apply to determine the net income of the Company B partnership as if the partnership was a resident taxpayer.

The former FIF rules will apply in the same way to Company B partnership as with Company A partnership. That is, the FIF rules will apply in the calculation of the net income of the Company B partnership in respect of any amount from its FIF interests in Company C and Company D - see former sections 485, 485A and 529 of the ITAA 1936. For this purpose, section 485A will regard the Company B partnership as a taxpayer who is a Part XI Australian resident.

Consequently, as Company B partnership was subject to the former FIF rules, this partnership will be eligible to make an election to treat its interest in Company C and Company D as an interest in a foreign hybrid company.

Company B has made such an election in relation to its interests in Company C and Company D under subsection 830-15(5). Accordingly, Company C and Company D can also be regarded as foreign hybrid companies under section 830-15.

Question 4

Interest in the Property

As mentioned previously in this document, where a foreign company qualifies as a ‘foreign hybrid company’ under Division 830, the foreign hybrid tax provisions apply to treat the company as if it were a partnership (see section 830-20 of the ITAA 1997). Section 830-25 of the ITAA 1997 treats the shareholders in the company as partners of the partnership.

Under subsection 830-35(1) of the ITAA 1997 each partner is deemed to have an interest in the assets of the partnership. That interest is equal to the percentage of the capital of the company (i.e foreign hybrid company treated as a partnership) which the partner could reasonably be expected to receive (as a shareholder) on a winding up of a company at the relevant year of income – see subsection 830-35(2) of the ITAA 1997.

Company C and Company D are the owners of the portfolio of overseas properties, referred to as ‘the Property’. It was concluded previously that Company C and Company D were foreign hybrid companies; and therefore both LLCs will be treated as partnerships under section 830-20.

In accordance with section 830-25, Company B which is the sole shareholder / member of the Company C and Company D partnerships will also be treated as a partner of each of the partnerships.

Pursuant to subsection 830-35(1), Company B as partner of the Company C and Company D partnerships will be deemed to have an interest in the assets of each of these companies which is equal to the amount of capital that Company B could reasonably expected to receive as the sole shareholder/ member upon the winding up of each of these companies.

The Australian Entity, being a shareholder/ member of Company A, which is a foreign hybrid company, is deemed to be a partner of the Company A by virtue of section 830-25. The interest held by the Australian Entity under section 830-35 is restricted to the assets of Company A (of which it is a partner / shareholder of) and is equal to the percentage of the Australian Entity’s entitlement to the capital of Company A upon the winding up of this company.

In conclusion, the Australian Entity does not have an interest in any of the assets of Company C and Company D, including those assets referred to as the Property under section 830-35.

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