House of Representatives

Taxation Laws Amendment Bill (No. 8) 1999

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 1 - CFCs and capital gains tax

Overview

1.1
Schedule 1 to this Bill will amend the controlled foreign company (CFC) measures contained in Part X of the Income Tax Assessment Act 1936 (ITAA 1936) to give effect to the changes to the interaction of the CFC measures and capital gains tax (CGT) provisions that were announced in the 1997-98 Budget Statement.
1.2
The CFC measures use (after modification) the CGT rules in the ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997) to work out the attributable income of a CFC. For assessments for the 1998-99 and later income years, the CFC provisions apply the CGT rules in Parts 3-1 and 3-3 of the ITAA 1997. For earlier years of income, the CGT provisions in Part IIIA of the ITAA 1936 are applied. The amendments made by this Bill only apply to deemed disposals after 7.30pm, by legal time in the Australian Capital Territory, on 13 May 1997. As this is prior to the 1998-99 year of income, the CFC provisions in the ITAA 1936 will need to be amended so that the CGT rules in the ITAA 1936 and the ITAA 1997 are modified to give effect to the announced measures.
1.3
Part 1 of Schedule 1 amends Part X of the ITAA 1936. The amendments will modify references to the CGT provisions in the ITAA1936 so as to give effect to the proposed changes to the interaction between the CFC and CGT rules.
1.4
Part 2 of Schedule 1 to this Bill makes consequential changes to Part X to reflect the inclusion of the CGT provisions in the ITAA 1997. The amendments replace references to the CGT provisions in the ITAA1936 with the appropriate provisions in the ITAA 1997. In addition, some minor wording changes are also made.

Summary of amendments

Purpose of amendments

1.5 The purpose of the amendments is to remove anomalies preventing the intended Australian taxation of capital gains arising on deemed disposals of tainted assets of a CFC where that CFC ceases to be a member of a group and has previously benefited from CGT roll-over relief.

1.6 The amendments will modify the CFC rules to:

·
include in attributable income of a CFC tainted income consisting of capital gains on tainted assets deemed to have been disposed of by a CFC on ceasing to be a member of a group, or where it ceases to be a CFC;
·
ensure that capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group are taken into account in applying the active income test to a CFC;
·
include in designated concession income of a CFC capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group;
·
ensure that, when working out the amount to be included in attributable income, the taxation of capital gains on the deemed disposal of tainted assets is not avoided or minimised by arrangements designed to dilute the Australian taxpayers attribution percentage in the CFC that holds tainted assets that have received CGT roll-over relief; and
·
ensure that, when working out the amount to be included in attributable income, a company that ceases to be a CFC in relation to a particular attributable taxpayer does not avoid the taxation of capital gains on the deemed disposal of tainted assets that have received CGT roll-over relief.

Date of effect

1.7 The amendments made by Part 1 of Schedule 1 will apply in determining the attributable income of a CFC if a deemed disposal occurred due to a CFC ceasing to be a member of a group after 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997.

1.8 The amendments made by Part 2 of Schedule 1 will apply to the 1998-99 and later income years.

Background to the legislation

Broad overview of the operation of the CFC measures

1.9 The CFC measures require Australian taxpayers to pay tax, on a current year basis, on income or gains earned by foreign companies in which they have a controlling interest, even though the income or gains have not yet been derived by the taxpayers. The Australian controllers of a CFC are called attributable taxpayers .

1.10 An attributable taxpayer is required to include in assessable income its share of the attributable income of the CFC (section 456 of the ITAA 1936). Subject to some modifications, the attributable income of a CFC is calculated using the same tax rules applying to Australian resident companies. The amount of a CFCs attributable income depends on whether the CFC is resident of a broad-exemption listed country or a non-broad exemption listed country and on whether the CFCs activities are such that it may take advantage of the exemption for active income.

1.11 Generally, all income of a tainted nature derived by a CFC resident in a non-broad exemption listed country is attributable if the CFC fails the active income test. In contrast, the attributable income of a broad-exemption listed country CFC normally includes only concessionally taxed amounts of narrowly defined tainted income (ie. designated concession income or eligible designated concession income EDCI) that is also tainted under the broader definition of tainted income in the CFC measures (ie. adjusted tainted income). Gains made on the disposal of tainted assets are included in the definition of adjusted tainted income. The rules for determining whether an amount is EDCI are provided in section 317 of the ITAA 1936 and Part 8A of the Income Tax Regulations.

Interaction of the CFC measures and CGT provisions

1.12 The CFC measures include capital gains on the disposal of tainted assets in the attributable income of a CFC. The CGT provisions are modified by Subdivision 7C of Part X of the ITAA 1936.

1.13 Under the CGT provisions in the ITAA 1936, in certain circumstances, a CGT liability may be deferred on the disposal of an asset from one member of a wholly owned group of companies to another. This is known as roll-over relief. Under the current CGT arrangements, the company acquiring the asset is taken to have done so at the cost base, indexed cost base or reduced cost base that applied to the company disposing of the asset. The company disposing of the asset will not be subject to CGT liability because of the transfer.

1.14 If a company holding an asset that has received this roll-over relief ceases to be a member of a group, the company is deemed to have disposed of the asset and immediately re-acquired it for its market value. The deemed disposal and re-acquisition means that any gains made on the asset at the time the company ceases to be a member of the group would be subject to tax at that time.

1.15 These CGT roll-over rules are contained in sections 160ZZO and 160ZZOA of the ITAA 1936 for the 1997-98 and earlier income years. For later years, equivalent roll-over rules are contained in Subdivision 126-B and CGT event J1 (section 104-175) of the ITAA 1997.

1.16 It is intended that these rules would apply to CFCs that roll-over assets within a wholly owned group of companies. Accordingly, section419 of ITAA 1936 modifies the operation of the normal CGT roll-over rules to ensure that they apply appropriately to CFCs. For example, the availability of roll-over relief under the CFC measures will depend on the place of residence of both the company disposing of the asset and the company receiving the asset. In certain situations the availability of roll-over relief also depends on whether the asset has been used in connection with a permanent establishment of a CFC.

1.17 For the purposes of the CFC measures, it has been argued that a disposal of an asset does not include deemed disposals arising for a CFC under section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997 on its ceasing to be a member of a group.

1.18 If this argument were correct, capital gains accruing on the deemed disposal of tainted assets (when a CFC ceases to be a member of a group) may not be included in the attributable income of a CFC. A CFC may cease to be a member of a group as a result of a restructuring of the group, or by issuing shares to persons outside the group.

1.19 This outcome would be inconsistent with the general operation of the CGT provisions under which Australian residents and the non-resident holders of taxable Australian assets (assets that have a necessary connection with Australia) may be subject to capital gains accruing when an asset is rolled-over to a member of a company group that subsequently leaves that group.

1.20 The amendments proposed in this Bill will ensure that the deemed disposals under section 160ZZOA of the ITAA 1936 or CGT event J1 of the ITAA 1997 are applied to work out attributable income of a CFC that holds a rolled-over tainted asset and has ceased to be a member of a group.

1.21 In addition, the amendments will prevent deliberate abuse of the CFC rules by preventing taxpayers avoiding taxation of capital gains on the disposal of tainted assets by using arrangements designed to dilute the Australian taxpayers attribution interest in the CFC that holds tainted assets that have received CGT roll-over relief.

Explanation of the amendments

1.22 The amendments are contained in 2 parts to Schedule 1. Part 1 of Schedule 1 amends Part X of the ITAA 1936 to modify references to the CGT provisions in the ITAA 1936. These amendments will apply to deemed disposals occurred due to a CFC ceasing to be a member of a group after 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997.

1.23 Part 2 of Schedule 1 to this Bill makes consequential changes to Part X of the ITAA 1936 to reflect the inclusion of the CGT provisions in the ITAA 1997. The amendments in Part 2 of Schedule 1 replace references to the CGT provisions in the ITAA 1936 with the appropriate provisions in the ITAA 1997. In addition, some minor wording changes are also made. These will apply to the 1998-99 and later income years.

Attributable income of a CFC to include tainted income from capital gains on tainted assets deemed to be disposed of by a CFC on ceasing to be a member of a group

1.24 Schedule 1 ensures that tainted income consisting of capital gains on tainted assets deemed to be disposed of by a CFC on its ceasing to be a member of a group (as a result of the operation of section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997) is included in the attributable income of the CFC.

1.25 The need for this amendment arose because the definition of disposal in Part X of the ITAA 1936 arguably does not include a deemed disposal (under section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997) of a tainted asset of a CFC that ceases to be a member of a group after receiving CGT roll-over relief.

1.26 Part 1 of Schedule 1 to this Bill will repeal the definition of disposal in section 317 of the ITAA 1936 and insert a new definition which specifically includes a disposal that would be taken to occur under section 160ZZOA of the ITAA 1936. A CFC, in working out the attributable income, can be taken to have disposed of an asset under section 160ZZOA of the ITAA 1936 because of the assumption in paragraphs 383(a) to (c) of the ITAA 1936 that the company is a taxpayer and a resident. [Item 2]

1.27 Consistent with the amendment of the definition of disposal the definitions of tainted commodity gain [item 3] and tainted commodity loss [item 4] in section 317 are both amended so that the CFCs attributable income will include any such gains or losses if there is a deemed disposal under section 160ZZOA of the ITAA 1936.

1.28 The amendment to the definition of disposal in section 317 of the ITAA 1936 will also operate to amend the definition of disposal for the purposes of Part 8A of the Income Tax Regulations (see Income Tax Regulation 152A). This ensures that references to disposal in the Income Tax Regulations will be consistent with that contained in the ITAA 1936.

1.29 Items 15 to 18 of Part 2 of Schedule 1 modify the amendments made by Part 1 of Schedule 1 to replace references to the CGT provisions in the ITAA 1936 with corresponding references in the CGT provisions in the ITAA 1997.

Capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group taken into account when applying the active income test

1.30 The active income test (section 432 of the ITAA 1936) provides a threshold test to determine whether certain tainted income and gains of the CFC will be attributed back to its Australian resident shareholders. However, certain income of a CFC will be attributed regardless of whether the CFC passes or fails the active income test.

1.31 The active income test is determined by using the CFCs recognised accounts. If there is no actual disposal, but a deemed disposal of assets, an amount from the deemed disposal may not be reflected in the CFCs accounts and therefore may not be included in applying the active income test.

1.32 The new section 317 (definition of disposal) (discussed above) will enable paragraphs 434(1)(b) and 434(1)(c) of the ITAA 1936 to include deemed disposals in accordance with section 160ZZOA of the ITAA 1936 (or because of CGT event J1 of the ITAA 1997). However, as section 434 refers to the recognised accounts, amounts in respect of gains from a deemed disposal may not be reflected in the accounts of the CFC. Accordingly, Part 1 of Schedule 1 inserts new subsection 434(1A) which will apply to include gains and losses of the kind specified in paragraphs 434(1)(b) and 434(1)(c) that may arise because of the operation of section 160ZZOA of the ITAA 1936 in the calculation of gross turnover. [Item 6]

1.33 It is also necessary to ensure that deemed gains or losses are taken into account in determining the gross tainted turnover of a CFC. Gross tainted turnover is so much of the gross turnover of the CFC as consists of passive income, tainted sales income and tainted services income. Passive income is defined in section 446 of the ITAA 1936 and includes under paragraph 446(1)(k) net gains that accrued to the company in the statutory accounting period in respect of the disposal of tainted assets. Part 1 of Schedule 1 inserts new subsection 445(2) to ensure that gains or losses arising from the operation of section 160ZZOA of the ITAA 1936 are included in the calculation of net gains. [Item 7]

1.34 Items 21 and 22 of Part 2 of Schedule 1 ensures that the amendments made by Part 1 of Schedule 1 apply the CGT provisions in the ITAA 1997 for the 1998-99 and later income years. Item 21 includes gains and losses of the kind specified in paragraphs 434(1)(b) and 434(1)(c) of the ITAA 1936 that may arise because of the happening of CGT event J1 of the ITAA 1997 in the calculation of gross turnover. Item 22 ensures that gains or losses arising because of the happening of CGT event J1 of the ITAA 1997 are included in the calculation of net gains.

Inclusion of amounts in notional assessable income to be subject to the active income test

1.35 Income will only be included in the attributable income of a CFC because of a deemed disposal under either section 160ZZOA of the ITAA 1936 or CGT event J1 of the ITAA 1997 if the CFC fails the active income test in section 432 of the ITAA 1936.

Capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group are included in designated concession income

1.36 The attributable income of a broad-exemption listed country CFC normally includes only concessionally taxed amounts of narrowly defined tainted income (ie. designated concession income or EDCI) that is also tainted under the broader definition of tainted income in the CFC measures (ie. adjusted tainted income). Gains made on the disposal of tainted assets are included in the definition of adjusted tainted income. The rules for determining whether an amount is EDCI are provided in section 317 of the ITAA 1936 and Part 8A of the Income Tax Regulations.

1.37 The new definition of disposal contained in Schedule 1 will ensure that capital gains arising from deemed disposals in accordance with section 160ZZOA of the ITAA1936 or because of CGT event J1 of the ITAA 1997 will be included in the kinds of capital gains specified as designated concession income.

1.38 The current definition of designated concession income broadly deals with income that is not taxed or is concessionally taxed in the overseas country because of a feature of that countries tax laws. Because a deemed disposal under section 160ZZOA of the ITAA 1936 creates a gain under Australian tax law, it is unlikely the current definition of designated concession income would apply.

1.39 Item 1 of Part 1 of Schedule 1 replaces the existing definition of designated concession income with a new definition that includes deemed capital gains arising from the operation of section 160ZZOA of the ITAA 1936.

1.40 Items 12 to 14 of Part 2 of Schedule 1 apply these amendments to the CGT provisions of the ITAA 1997 for the 1998-99 and later income years.

Reductions in attribution percentage to be ignored in certain circumstances

Effect of reducing section 160ZZOA or CGT event J1 amount

1.41 Arrangements have been identified where an attributable taxpayer may enter schemes or arrangements to reduce their attribution percentage in a CFC that holds tainted assets that have received CGT roll-over relief. Where a capital gain accrues from a deemed disposal of a tainted asset under section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997, the attribution percentage of the attributable taxpayer or attributable taxpayers may have reduced since the roll-over of the asset. Where the attribution percentage in the CFC is less than the attribution percentage in the CFC at the time the asset was originally rolled-over the total amount of Australian tax that was deferred on the roll-over of the asset will not be recouped.

1.42 Part 1 of Schedule 1 inserts new section 460A that will prevent the taxation of capital gains on the deemed disposal of tainted assets being avoided or minimised by attributable taxpayers (or their associates) entering schemes or arrangements that have the effect of and are intended to dilute the Australian taxpayers attribution percentage in the CFC that holds tainted assets that have received CGT roll-over relief. [Item8]

1.43 New section 460A also ensures that a company that ceases to be a CFC (regardless of any intention to reduce their attribution percentage) in relation to a particular attributable taxpayer does not avoid the taxation of capital gains on the deemed disposal of tainted assets that have received CGT roll-over relief.

When will section 460A apply?

1.44 New section 460A will apply if there has been a deemed disposal under section 160ZZOA of the ITAA 1936 and either of the following apply:

·
the attributable taxpayer or an associate of the attributable taxpayer enters one or more schemes or arrangements that have the effect of reducing the attribution percentage of the attributable taxpayer in a CFC, and are intended by the attributable taxpayer or their associate to have that effect; or
·
a company ceases to be a CFC in relation to the attributable taxpayer.

Schemes or arrangements

1.45 The new section 460A will apply in determining the attribution percentage that will be used in working out the amount of attributable income of a CFC to be included in the assessable income of an attributable taxpayer as a result of a deemed disposal under section 160ZZOA of the ITAA 1936. It applies to ignore any reductions in the attribution percentage since the time of roll-over that are the result of a scheme or arrangement intended to reduce the attribution percentage.

1.46 If at any time after the roll-over relief was obtained one or more schemes or arrangements have the effect, and are intended to have the effect, of reducing the attribution percentage of the attributable company in relation to the CFC, those reductions are to be ignored for the purposes of determining the attribution percentage of the attributable taxpayer. This will ensure that attribution of the amount of any capital gain that was deferred on obtaining roll-over relief is not subsequently avoided from being included in the attributable income of the CFC.

Company ceases to be a CFC

1.47 New section 460A will also apply where a CFC that has obtained CGT roll-over relief ceases to be a CFC before the end of the statutory accounting period in relation to a particular accounting period, whether or not there was an intention to reduce the attribution percentage.

1.48 Any reduction in the attribution percentage of an attributable taxpayer that results in the CFC ceasing to be a CFC in relation to that attributable taxpayer is to be ignored for the purposes of determining their attribution percentage to be used in working out the amount of the attributable income of the CFC to be included in their assessable income as a result of a deemed disposal under section 160ZZOA of the ITAA1936.

1.49 New subsection 460A(2) also requires the attributable taxpayer to ignore any reductions in the attribution percentage that have occurred since the roll-over of the tainted asset that are a result of a scheme or arrangement that is covered by new paragraph 460A(1)(a) .

1.50 New section 460A enables section 456 of ITAA 1936 to operate in relation to the attributable income arising from the operation of section 160ZZOA of ITAA 1936 at the end of the statutory accounting period as though the CFC had not ceased to exist.

1.51 Without the operation of new section 460A the attributable taxpayer would not have any amount included in the attributable income because at the end of the statutory accounting period the taxpayer would no longer be an attributable taxpayer in relation to the company.

1.52 Items 23 and 24 of Part 2 of Schedule 1 ensure that the new section 460A introduced by Part 1 of Schedule 1 apply the CGT provisions of the ITAA 1997 for the 1998-99 and later income years.

Reduction of disposal consideration where attributed income not distributed

1.53 Sections 401 and 461 of the ITAA 1936 currently prevent potential double taxation when an attributable taxpayer disposes of an interest in an attribution account entity (as defined in section 363 of the ITAA1936) such as a CFC that holds tainted assets. Broadly, section 461 reduces the consideration from the disposal of the interest in a CFC to the extent that profits of the CFC have been previously attributed. Section 401 provides a similar result in determining the attributable income of a CFC.

1.54 Sections 401 and 461 of the ITAA 1936 currently reduce the consideration in such cases by reference to the attribution surplus immediately before the disposal. Broadly, the attribution surplus is the amount of profits that have previously been included in assessable income of the attributable taxpayer.

1.55 Sections 401 and 461 of the ITAA 1936 will be amended so that the attribution of an amount due to a disposal under section 160ZZOA of the ITAA 1936 will be included in the attribution surplus that is used to work out the reduction in the disposal consideration from the sale of an interest in the CFC. [Part 1 of Schedule 1 Items 5 and 9]

1.56 The amendments ensure that any amount included in an attributable taxpayers assessable income because of the application of section 160ZZOA of the ITAA 1936 will be included in any attribution surplus existing immediately before the disposal for the purposes of sections 401 and 461 of the ITAA 1936.

1.57 Where the attribution percentage in a CFC is reduced proportionally both sections 401 and 461 of the ITAA 1936 operate to include only that proportion of the attribution surplus in determining the amount of the reduction of the consideration.

1.58 Items 19 and 20 of Part 2 of Schedule 1 ensure that the amendments to section 401 of the ITAA 1936 introduced by Part 1 of Schedule 1 apply the CGT provisions of the ITAA 1997 for the 1998-99 and later income years. Also, Items 25 and 26 of Part 2 of Schedule 1 ensure that the amendments to section 461 of the ITAA 1936 introduced by Part 1 of Schedule 1 apply the CGT provisions of the ITAA 1997 for the 1998-99 and later income years.

Transitional application of section 460A

1.59 The proposed measures will require attributable taxpayers to work out their attribution percentage in a CFC at the time of roll-over of assets within a group. The current rules generally only require this percentage to be worked out at the end of the statutory accounting period.

1.60 To minimise the record keeping requirements on taxpayers Part 1 of Schedule 1 introduces a transitional measure that will apply to assets that have received group roll-over relief prior to the time of announcement of these measures (7.30pm, by legal time in the Australian Capital Territory, on 13May1997). [Item 11]

1.61 Taxpayers may elect to work out any reductions in their attribution percentage (for the purposes of new section 460A ) by reference to the attribution percentage at the end of the statutory accounting period in which the roll-over occurred, rather than the attribution percentage at the time of roll-over.

1.62 For CGT roll-overs occurring after the time of announcement taxpayers will be required to work out their attribution percentage at the time of the roll-over when applying new section 460A .

Regulation Impact Statement

1. Specification of policy objective

1.63 The policy objective of the amendments (announced in the 1997-98 Budget) is to remove anomalies preventing the intended Australian taxation of capital gains arising on certain deemed disposals of tainted assets of a CFC. The anomalies arise when a CFC has taken advantage of roll-over relief in the CGT provisions.

Background

1.64 Several anomalies have been identified in the interaction of the CFC and the CGT provisions. These anomalies result in uncertainty as to how the CGT and CFC provisions apply to capital gains made by a CFC on the disposal or deemed disposal of a tainted asset. In some cases the anomalies could result in the avoidance of Australian taxation. These anomalies arise because:

·
there is uncertainty as to whether tainted income consisting of capital gains on assets deemed to be disposed of by a CFC on its ceasing to be a member of a group, or ceasing to be a CFC, is included in the attributable income of the Australian resident controllers;
·
capital gains on the deemed disposal of tainted assets are not taken into account in determining whether a CFC passes the active income test;
·
it is uncertain whether designated concession income of a CFC includes capital gains on the deemed disposal of assets by a CFC on ceasing to be a member of a group; and
·
the taxation of capital gains on disposal of tainted assets can be avoided or minimised by arrangements intended to dilute an Australian taxpayers attribution interest in a CFC holding tainted assets that have received roll-over relief.

2. Identification of implementation option(s)

1.65 It is necessary to amend the ITAA 1936 to correct these anomalies. The proposed amendments are the only viable option for implementing the Governments policy objective (announced in the 1997-98 Budget).

1.66 The CFC provisions are contained in Part X of the ITAA 1936. These provisions use (after modification) the CGT rules in the ITAA 1936 and the ITAA 1997 to work out the attributable income of a CFC. For assessments for the 1998-99 and later income years, the CFC provisions apply the CGT rules in Parts 3-1 and 3-3 of the ITAA 1997. For earlier years of income, the CGT rules in Part IIIA of the ITAA 1936 are applied.

1.67 The proposed amendments apply to disposals (including deemed disposals) of tainted assets occurring after 13 May 1997. As this is prior to the 1998-99 year of income, the CFC provisions in the ITAA 1936 will need to be amended so that the CGT rules in the ITAA 1936 and the ITAA 1997 are modified to give effect to the announced measures.

1.68 The substantive CGT rules in the ITAA 1936 and the ITAA 1997 are not proposed to be amended. The proposed amendments will only modify the application of those rules for the purposes of the CFC measures.

Amendment to include certain deemed capital gains in attributable income

1.69 This amendment will apply to deemed disposals of tainted assets which have previously received roll-over relief under the CGT provisions under section 160ZZO of the ITAA 1936 or section 126-45 of the ITAA 1997 because the tainted asset was transferred within a wholly-owned company group. The amendment will ensure that tainted assets that have previously received this roll-over relief will be included in the notional assessable income of a CFC (under section 384 or 385 of the ITAA 1936) if the CFC ceases to be a member of that company group. This amendment will effectively bring the CFC treatment of these deemed disposals in line with the taxation treatment given to domestic companies.

Amendment to include certain deemed capital gains in the active income test

1.70 This amendment applies to CFCs that have received roll-over relief for tainted assets that are transferred within a wholly-owned group of companies. This proposed amendment will ensure that the active income test will include capital gains arising from the deemed disposal of those tainted assets if the CFC ceases to be a member of a wholly-owned group of companies.

Amendment to include certain deemed capital gains in designated concession income

1.71 This amendment also only applies to CFCs that have received roll-over relief for tainted assets that are transferred within a wholly-owned group of companies. A CFC that is resident in a broad-exemption listed country must include tainted income that is also eligible designated concession income in its notional assessable income if it fails the active income test. Eligible designated concession income is broadly designated concession income that has not been comparably taxed in another broad-exemption listed country.

1.72 The proposed amendment will ensure that capital gains arising from the deemed disposal of tainted assets when a CFC ceases to be a member of the wholly-owned group of companies will be included in designated concession income in section 317 of the ITAA 1936. This will mean that these deemed gains are capable of being included in the notional assessable income of a CFC resident in a broad-exemption listed country in accordance with section 385 of the ITAA 1936.

Amendment to ensure that the taxation of certain deemed gains is not avoided or minimised by either arrangements designed to dilute the Australian taxpayers attribution percentage or where the CFC ceases to be a CFC in relation to the attributable taxpayer

1.73 These amendments ensure that taxation of capital gains on disposal of tainted assets is not avoided or minimised by arrangements designed to dilute the Australian taxpayers attribution interest in the CFC that holds tainted assets that have received roll-over relief.

1.74 In addition, it is also proposed to ensure that the taxation of capital gains on disposal of these tainted assets is not avoided or minimised by the CFC ceasing to be a CFC (in relation to the attributable taxpayer) due to the reduction in the attribution percentage of Australian resident shareholders.

1.75 The proposed amendments also provide a transitional arrangement that applies to CFCs that have had a group roll-over disposal (within the meaning of section 160ZZOA of the ITAA 1936) before the time the measures were announced. Attributable taxpayers can elect to work out their attribution percentage at the time of roll-over under section 160ZZOA using either the actual attribution percentage at that time, or the attribution percentage at the end of the statutory accounting period in which the roll-over happened. This ensures that taxpayers will be able to identify whether there has been a dilution, if any, of their attribution percentage for the purposes of these amendments.

3. Assessment of impacts (costs and benefits) of each option:

Impact group identification

1.76 The primary impact of the amendments will be on Australian residents that have an attribution interest in a CFC that has obtained roll-over relief for the inter group transfer of tainted assets, and the CFC is subsequently deemed to have disposed of those tainted assets when it ceases to be a member of that wholly-owned company group. Taxpayers who are to be subject to the changes could broadly be described as Australian based multinationals.

1.77 The issues may arise in corporate reconstructions involving CFCs where roll-over relief is utilised. These reconstructions are relatively uncommon. The proposed amendments are unlikely to significantly affect taxpayers unless a group had been intending to make use of the identified anomalies to avoid payment of Australian tax.

1.78 Other impact groups that may be affected include the Australian Taxation Office (ATO) and taxpayers and their advisers who need to have an understanding of the proposed amendments and their application.

Amendment to include certain deemed capital gains in attributable income

1.79 Capital gains made on tainted assets deemed to be disposed of by a CFC on its ceasing to be a member of a wholly-owned group are to be included in the calculation of attributable income. This will achieve consistent treatment with the requirement for resident companies to value their assets and determine whether a capital gain or capital loss has arisen on the deemed disposal of assets which have received roll-over relief on ceasing to be a group company.

Amendment to include certain deemed capital gains in the active income test

1.80 The inclusion of the capital gains on assets deemed to be disposed of by a CFC on its ceasing to be a member of a group in the active income test provides equitable treatment with other gains and profits that are included in the active income test for the purpose of determining whether or not the test is passed. CFCs will now be required to keep additional records so that they can include these gains in applying the active income test.

Amendment to include certain deemed capital gains in designated concession income

1.81 The amendment to include capital gains on assets deemed to be disposed of by a CFC on its ceasing to a be a member of a wholly-owned group will be achieved by including those capital gains in the definition of designated concession income in the ITAA 1936. CFCs will now be required to keep additional records so that they can include these gains in the designated concession income of the CFC.

Amendment to ensure that the taxation of certain deemed gains is not avoided or minimised by either arrangements designed to dilute the Australian taxpayers attribution percentage or where the CFC ceases to be a CFC in relation to the attributable taxpayer

1.82 These amendments may lead to some increased compliance costs for those Australian taxpayers undertaking complex arrangements to dilute their interest or avoid the taxation of tainted assets. Under the proposed measure taxpayers will be required to determine their attribution percentage at the time of the roll-over of the asset in order to be in a position to determine whether the attribution percentage has subsequently been reduced. In addition, Australian taxpayers that have an attribution percentage (interest) in a CFC that subsequently ceases to be a CFC in relation to that attributable taxpayer will have additional costs working out and keeping records of their attribution percentage at the time of roll-over.

1.83 A transitional measure is proposed to apply to assets transferred prior to the issue of the Treasurers Press Release No. 51 on 13 May 1997 to enable taxpayers to use the attribution percentage at the end of the statutory accounting period in which the asset was rolled-over. This will ensure that taxpayers are not required to create records that may not have been recorded at the time of the roll-over.

Compliance costs

1.84 The initial and recurrent compliance cost of the 4 amendments are not expected to be significant (that is, less than $1 million per annum). The compliance costs will mainly result from record keeping and anticipated increased adviser fees but are not expected to be significant. Compliance costs will not increase for all CFCs only those that have received roll-over relief and mainly where the CFC subsequently ceases to be a member of a group. Further, most of the costs will arise for companies which fail the active income test and therefore derive significant amounts of tainted income.

1.85 It is possible that the need to value assets in the company which ceases to be a member of a group will increase compliance costs. However, assets are likely to be revalued to determine the sale price of the company. Moreover, resident companies generally value their assets on ceasing to be a group company.

1.86 It could also be argued that the need to determine the attribution percentage at the time of roll-over would increase compliance costs. This compliance cost is not expected to be significant as the CFC receiving the roll-over relief will be a member of a wholly-owned group, making the calculation of the attribution percentage easier. The proposed transitional measure will operate to reduce these compliance costs for assets rolled-over prior to the announcement of the measures.

Taxation revenue

1.87 The measures will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of tax minimisation practices. In the absence of the measure, to the extent that the revenue base would not be protected, there would be a significant revenue loss compared to the forward estimates.

1.88 The proposed amendment to ensure the taxation of capital gains on disposal of tainted assets is not avoided or minimised, by arrangements designed to dilute the Australian taxpayers attribution interest in the CFC that holds tainted assets that have received CGT roll-over relief, will protect the revenue base by removing opportunities for tax minimisation practices.

Consultation

1.89 Consultation has been undertaken through the National Tax Liaison Group subcommittee on foreign source income. A number of submissions have also been received in relation to the Treasurers Press Release No.51 on 13 May 1997.

4. Conclusion

1.90 The proposed amendments will improve the effectiveness of the rules for the accrual taxation of foreign source income by removing anomalies that prevent the intended interaction of the CFC measures and the CGT provisions.

1.91 The additional compliance burden will be borne by those Australian taxpayers with interests in CFCs that hold tainted assets and which have taken advantage of roll-over provisions.

1.92 The Treasury and the ATO will continue to monitor the rules for taxation of foreign source income to ensure the rules are operating appropriately. The ATO's existing consultative arrangements include the National Tax Liaison Group.


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