Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Glossary of terms
Accruals taxation is the taxation of Australian residents on profits derived through a foreign company or trust as they are earned by the company or trust. Normally the profits would not be taxed in Australia until they are distributed to the taxpayer as a dividend or trust distribution.
The active income test ensures that small amounts of tainted income derived by a CFC are exempt from taxation. An exemption is provided from accruals taxation for most amounts derived by a CFC if the test is satisfied.
- Current test : The test for a CFC resident in an unlisted country is that the gross tainted turnover of the CFC must be less than 5% of its gross turnover (excluding certain specified amounts). In the case of a listed country CFC, the tainted eligible designated concession income of the CFC must be less than 5% of its eligible designated concession income.
- New test : The test for all CFCs is that currently applied to unlisted country CFCs.
Adjusted tainted income is the basis of the attributable income of a CFC. It comprises passive, tainted sales and tainted services income.
An approved country fund is a fund listed in Schedule 11 of the Income Tax Regulations. Investment in these funds are exempt from the FIF measures. This exemption was introduced to ensure that the FIF measures do not unreasonably hinder the portfolio diversification of Australian investors in emerging markets with restrictive investments rules.
Broadly, an associate of a company is:
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- a partner of the company or a partnership in which the company is a partner;
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- a trustee of a trust in which the company holds a beneficial interest;
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- any controllers of the company; and
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- any company controlled by the original company (subsection318(2)).
Amounts taxed on an accruals basis under the CFC, transferor trust or FIF measures.
An attributable taxpayer is an Australian entity who is liable to pay tax on attributable income.
The process by which income is taxed on an accruals basis under the CFC, transferor trust or FIF measures.
The attribution percentage is the pro rata share of a CFC's attributable income that will be attributed to a particular taxpayer's assessable income.
An AFI subsidiary is a subsidiary of an Australian financial institution (section 326).
Australian financial institution (AFI)
Broadly, an AFI is an Australian bank or financial institution (section317).
See permanent establishment.
Broad-exemption listed country
A country listed in the Income Tax Regulations as a broad-exemption country. The list of broad-exemption countries will be used for the purposes of exemptions from accruals taxation under the CFC and transferor trust measures. The list comprises Canada, France, Germany, Japan, NewZealand, the United Kingdom and the United States. These countries are also treated as listed for the purposes of exemptions under the FTCS.
The CFC measures deal with the accruals taxation of Australian residents that have a controlling interest in a foreign company.
Controlled foreign company (CFC)
Broadly, a CFC is a company that is not a resident of Australia and is controlled by five or fewer residents (section 340).
Debt creation rules deny an interest deduction on debt used to finance the transfer of assets from one related company to another where the buyer and seller are at least 50% controlled by a non-resident or a related non-resident. The rules ensure that profits are not effectively transferred from one company to another through the creation of an interest expense.
Designated concession income (DCI)
Income or profits of a kind specified in the Income Tax Regulations that are not comparably taxed because of a specified feature in the tax law of:
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- a listed country (currently); or
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- a broad-exemption listed country (after the changes).
Double taxation agreement (DTA)
A double taxation agreement is an agreement made between the Australian Government and another State under the International Tax Agreements Act (1953).
Eligible designated concession income or EDCI
Currently eligible designated concession income is designated concession income from a listed country that is not subject to full tax in any other listed country.
After the changes eligible designated concession income will be designated concession income from a broad-exemption listed country that is not subject to full tax in any other broad-exemption listed country.
The total of the exempting receipts held as distributable profits by a company resident in an unlisted country.
Exempting receipts are, generally, amounts earned by a company resident in an unlisted country that can be distributed as exempt dividends.
The FIF measures deal with the accruals taxation of Australian residents that have a non-controlling interest in a foreign company or foreign trust.
Financial intermediary business
A banking business or a business whose income is principally derived from the lending of money.
A FIF is any foreign company or foreign trust (other than a deceased estate).
Generally a FLP is a life assurance policy issued by an entity that is not a resident of Australia.
Foreign Tax Credit System (FTCS)
Under the FTCS, foreign source income derived by Australian residents (apart from certain salary and wages) is generally subject to Australian tax. A credit for foreign tax paid is allowed against the Australian tax payable, up to the amount of the Australian income tax referable to the foreign income.
Limited-exemption listed country
A country listed in the Income Tax Regulations as a limited-exemption country. These countries will basically comprise the current list of countries in Schedule 10 of the Income Tax Regulations, excluding broad-exemption listed countries. The list will be updated by adding the CzechRepublic and Vietnam, and removing countries which no longer exist.
A country listed for the purposes of dividend and branch profit exemptions under the FTCS. Prior to the changes, listed countries were designated in Schedule 10 of the Income Tax Regulations. Following the changes, listed countries comprise those countries on either the list of broad-exemption countries or limited-exemption countries.
Non-broad-exemption listed country
A country that is either a limited-exemption listed country or an unlisted country.
Broadly, non-portfolio dividends are dividends paid to a company where that company has a 10 per cent or greater voting interest in the company paying the dividend.
A notional accounting period is the period used to determine the attributable income of a FIF or a FLP.
The assessable income of a CFC for the purposes of determining the CFC's attributable income.
Passive income includes certain types of dividend, interest, royalty, annuity, and rental income (section 446). It also includes gains on the disposal of assets that produce passive income or that are not used solely in carrying on a business.
A permanent establishment is widely defined in subsection 6(1). Generally it can be described as a place through or at which an entity in Australia conducts its business in another country. A permanent establishment has been referred to as a branch in this explanatory memorandum.
Generally, an Australian company is related to a foreign company for the purposes of the FTCS when:
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- the companies are both group companies; and
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- the Australian company has a voting interest (direct or indirect) of at least 5% in the foreign company (section 160AFB).
There is also a definition of related company in section 160G of the capital gains tax provisions that will apply for the purposes of determining whether a valid election has been made by a resident company to treat states arising from the dissolution of Czechoslovakia, Yugoslavia and the USSR as listed countries. A related company for the purposes of section160G is broadly a wholly owned group company.
Special excluded rental income
Rental income derived from an associated CFC in the same country that is subject to normal company tax and is not deductible to the associate (section 317).
A statutory accounting period is the period used to determine the attributable income of a CFC.
These are countries formed after the dissolution of the USSR, Czechoslovakia and Yugoslavia.
Tainted eligible designated concession income
Tainted eligible designated concession income is tainted income that is also eligible designated concession income.
Tainted income includes passive income, tainted sales income and tainted services income.
Tainted rental income includes rental income of a CFC where:
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- land is leased to an associate, or the rent is paid by an associate; or
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- land is leased by a company not resident in the same country.
- It can also include rental income from particular leases on ships, aircraft, or cargo containers.
Tainted sales income is income of a CFC from the sale of goods purchased from or sold to:
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- an associate who is an Australian resident; or
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- an associate who is not an Australian resident but carries on business in Australia through a permanent establishment.
Tainted services income is income derived from the provision of services by a CFC to:
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- an associate of the CFC;
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- a resident of Australia; or
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- in connection with a permanent establishment in Australia.
Tax sparing deems tax forgone by a foreign country in providing a specified concession to an Australian resident to be foreign tax paid for the purposes of Australia's foreign tax credit rules. The Australian resident may therefore be entitled to claim a credit for the tax forgone by the foreign country.
The thin capitalisation rules deny an interest deduction where the foreign controllers of a company do not maintain a specified debt to equity ratio.
Transfer pricing rules are contained in Division 13 Part III. This Division seeks to impose 'arms-length' consideration on agreements for the sale of property between Australians and non-residents when there is a possibility that the agreement effectively moves income from Australia.
A non-resident trust to which a resident has made, or is deemed to have made, a transfer of property or services (Division 6AAA of Part III).
The transferor trust measures deal with the accruals taxation of Australian residents who have directly or indirectly transferred value to a non-resident trust. Broadly the rules operate to accruals tax the undistributed income of the trust.
An unlisted country is a country which is not on either list of countries.
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