Commonwealth of Australia Explanatory Memoranda Commonwealth of Australia Explanatory Memoranda[Index] [Search] [Download] [Bill] [Help]
2008-2009-2010
THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA
HOUSE OF REPRESENTATIVES
tax laws amendment (foreign source income deferral) bill (No. 1) 2010
EXPLANATORY MEMORANDUM
(Circulated by the authority of the
Treasurer, the Hon Wayne Swan MP)
Table of contents
Glossary 1
General outline and financial impact 3
Chapter 1 Repeal of the foreign investment fund and deemed present
entitlement rules 7
Chapter 2 Regulation impact statement 19
Index 29
Glossary
The following abbreviations and acronyms are used throughout this
explanatory memorandum.
|Abbreviation |Definition |
|ATO |Australian Taxation Office |
|CFC |controlled foreign company |
|CGT |capital gains tax |
|FIF |foreign investment fund |
|ITAA 1936 |Income Tax Assessment Act |
| |1936 |
|ITAA 1997 |Income Tax Assessment Act |
| |1997 |
|the Board |Board of Taxation |
General outline and financial impact
Repeal of the foreign investment fund and deemed present entitlement rules
Schedule 1 to this Bill repeals the foreign investment fund (FIF)
and the deemed present entitlement rules contained in the Income
Tax Assessment Act 1936 (ITAA 1936).
This Schedule also makes consequential amendments to the ITAA 1936,
the Income Tax Assessment Act 1997 (ITAA 1997) and to the
Superannuation Industry (Supervision) Act 1993 as a result of the
repeal of the FIF and deemed present entitlement rules.
Date of effect: The amendments generally apply in respect of the
2010-11 and later income years.
However, some of the amendments have earlier commencement dates to
correct anomalies that exist in the current tax laws. These
amendments do not disadvantage taxpayers as they ensure double
taxation does not occur in respect of previously taxed amounts.
Proposal announced: This measure was announced as part of a
package of reforms to the foreign source income anti-tax-deferral
(attribution) rules in the 2009-10 Budget (see the then Assistant
Treasurer and Minister for Competition Policy and Consumer Affairs'
Media Release No. 049 of 12 May 2009).
Financial impact: This measure forms part of a wider package of
reforms that were announced in the 2009-10 Budget. The financial
impact of the reforms to the foreign source income attribution
rules is estimated as being unquantifiable but not significant.
Compliance cost impact: The reforms to the foreign source income
attribution rules, of which the repeal of the FIF and deemed
present entitlement rules form part, are expected to result in
overall medium compliance cost savings. This is comprised of a
medium transitional start-up cost impact estimated to be between
$40 million to $80 million, offset by a medium decrease in ongoing
compliance costs estimated to be between $40 million to $80 million
per annum.
Summary of regulation impact statement
Regulation impact on business
Impact: Reforms to the foreign source income anti-tax-deferral
(attribution) rules will affect taxpayers with non-controlling
interests in foreign entities, managed funds, superannuation funds,
taxpayers with controlling interests in foreign entities, tax
practitioners and other intermediaries.
Overall, the Government's reforms will result in significant
compliance cost savings for affected taxpayers when compared to the
existing regimes.
Furthermore, the reforms also align the attribution rules to
changes in the business environment that have occurred as a result
of globalisation and provide flexibility when compared to the
current regimes, recognising that many offshore investment
decisions are not motivated by tax deferral reasons.
Main points:
. Taxpayers with non-controlling interests in foreign
entities (unless they hold an interest in a roll-up fund)
will benefit from significant compliance costs savings as
they will no longer be subject to the requirements of the
attribution rules. Similarly, managed funds and
superannuation funds would also have significant
compliance cost savings.
. Taxpayers with controlling interests in foreign entities
should also benefit from a reduction in their compliance
costs from the modernisation of the attribution rules to
better cater for active foreign businesses that derive
passive income as part of that active business.
. The Australian Taxation Office (ATO) may incur initial
costs associated with system and tax form changes and the
need to provide additional advice to taxpayers and tax
practitioners, including by way of tax rulings. Costs may
also be incurred in retraining staff. The ATO has
estimated that the ongoing administrative cost would be in
the order of $1.3 million per annum.
. The economic benefits of implementing the reforms:
- For Australian managed funds, the abolition of the FIF
rules will significantly reduce their compliance costs
which in turn will enhance their global competitiveness
and attractiveness to foreign investors.
- For Australian corporates, modernising and better
targeting the rules by abolishing the FIF and base
company income rules, together with updating the
definitions of what constitutes active and passive
income, will improve their competitiveness and
productivity. More accessible and flexible exemptions,
including a more effective exemption for complying
superannuation funds, will significantly reduce
compliance costs for eligible taxpayers.
- For taxpayers generally, and administrators, the
abolition of the FIF and deemed present entitlement
rules, in conjunction with rewriting the controlled
foreign company rules into the ITAA 1997 will simplify
and scale back the volume of law, as well as bringing
the prospect of consolidating the two income tax Acts a
significant step closer.
Chapter 1
Repeal of the foreign investment fund and deemed present entitlement rules
Outline of chapter
1. Schedule 1 to this Bill repeals the foreign investment fund (FIF)
and the deemed present entitlement rules in the Income Tax
Assessment Act 1936 (ITAA 1936).
2. This Schedule also makes consequential amendments to the ITAA 1936,
the Income Tax Assessment Act 1997 (ITAA 1997) and to the
Superannuation Industry (Supervision) Act 1993 as a result of the
repeal of the FIF and deemed present entitlement rules.
3. This chapter explains:
. the effect of the repeal on certain areas of the taxation
law; and
. the consequential amendments.
4. All legislative references are to the ITAA 1936 unless otherwise
stated.
Context of amendments
5. Following a comprehensive review by the Board of Taxation, the
Government announced in the 2009-10 Budget its intention to repeal
the FIF and deemed present entitlement rules (see the then
Assistant Treasurer and Minister for Competition Policy and
Consumer Affairs' Media Release No. 049 of 12 May 2009).
6. The repeal of the FIF and deemed present entitlement rules is the
first instalment in a package of reforms designed to improve the
operation of the foreign source income anti-tax-deferral
(attribution) rules. The remaining reforms, which were also
announced by the Government in the 2009-10 Budget, will modernise
the controlled foreign company (CFC) rules and improve the
effectiveness of the transferor trust rules. It is anticipated
that these measures will be introduced into Parliament as soon as
practicable together with a specific anti-roll-up fund rule that
was also announced by the Government as part of these reforms.
7. For taxpayers that have exposure to the FIF and deemed present
entitlement rules, their repeal will considerably simplify
compliance with the law. Repealing the FIF rules also contributes
to achieving the Government's objective to promote Australia as a
financial hub in our region and supports Australian jobs by
reducing complexity and compliance costs associated with the making
of foreign investments.
8. The managed fund sector, in particular, has contended that the FIF
regime imposes significant costs and an uncompetitive tax burden on
Australian fund managers. These changes will make the handling of
their foreign investments much simpler.
9. In the absence of the FIF and deemed present entitlement rules,
resident beneficiaries holding interests in foreign trusts will
need to turn to the ordinary trust rules contained in Division 6
and the transferor trust provisions in Division 6AAA in order to
determine their tax obligations. The ordinary trust rules will
also continue to apply in precedence to the transferor trust rules.
This outcome is largely consistent with the arrangements that
applied prior to the introduction of the FIF and deemed present
entitlement regimes in 1992.
Summary of new law
10. Part 1 of this Schedule:
. repeals section 96A, Part XI (the FIF rules) and sections
96B and 96C (the deemed present entitlement rules) of the
ITAA 1936;
. makes consequential amendments to the ITAA 1936 and the
ITAA 1997 as a result of the repeal of these rules; and
. preserves the effect of certain elections that are
currently linked to the operation of the FIF rules.
11. Part 2 of this Schedule ensures the provisions dealing with the
disposal of interests in foreign entities where amounts have been
previously attributed will continue to operate as intended.
Detailed explanation of new law
Amendments to the Income Tax Assessment Act 1936
Rules being repealed
FIF and deemed present entitlement rules
12. The FIF rules currently apply to Australian residents with non-
controlling shareholdings in foreign companies or with interests in
foreign trusts. These rules apply to approximate a resident
taxpayer's share of the undistributed profits of a FIF and to
assess the taxpayer on those profits. The FIF rules also apply to
Australian residents with an interest in a foreign life assurance
policy.
13. The deemed present entitlement rules currently apply to interests
in closely held foreign trusts and other interests in foreign
trusts that are exempt from the FIF rules. These rules deem
beneficiaries to be presently entitled to a share of profits
accumulated in a foreign trust based on their rights to receive
distributions from the trust in the future.
14. This Schedule repeals the FIF rules and the deemed present
entitlement rules in relation to the 2010-11 and later income
years. [Schedule 1, items 9 and 37, Part XI and sections 96B and
96C]
Section 96A
15. Section 96A is designed to alleviate possible double Australian tax
in relation to taxation under the FIF regime, and to reduce the
compliance burden on small investors in resident public unit
trusts.
16. Subsection 96A(1) excludes from the assessable income of a
presently entitled resident beneficiary of a non-resident trust,
the beneficiary's share of the net income of the trust estate which
is attributable under the FIF regime (or, but for Division 8 or 11A
of Part XI, would have been attributed under the FIF regime).
17. The effect of subsection 96A(1) is two-fold:
. to ensure amounts attributable under the FIF regime are
not subject to tax under Division 6 of Part III of the
ITAA 1936; and
. to ensure that section 97 does not apply where a
beneficiary of a trust is specifically exempted from
attribution under the FIF regime (where Division 8 or 11A
of Part XI apply).
18. Subsection 96A(1A) also prevents double taxation of a trust's
income. The broad effect of this subsection is that an amount
(other than an amount relating to an interest in a FIF to which
Division 8 of Part XI applies) which is not assessable to a
beneficiary under section 97 by subsection 96A(1), is also not
assessable under sections 99 and 99A (for the trustee), and
section 102AAU (for a transferor). The reference to Division 8
limits the circumstances where subsection 96A(1A) reduces the
assessable income (Australian source income) of a trustee.
19. Subsection 96A(2) provides that the impact of the FIF measures will
not apply in the calculation of a taxpayer's share of net income of
a resident public unit trust where the taxpayer is a natural person
with not more than $50,000 invested in foreign companies, trusts,
life policies and resident public unit trusts
20. Subsections 96A(3A) and 96A(3B) ensure that taxation does not arise
under both the CFC and FIF measures where a beneficiary in a non-
resident trust estate has an interest in a CFC which is held
through that trust. In this regard, double taxation may only arise
in relation to non-resident trust estates where they are also
controlled foreign trusts for the purposes of the CFC measures.
Taxation under the CFC measures is given priority and the net
income of the trust does not include any FIF amount.
21. As a consequence of repealing the FIF rules, this Schedule repeals
section 96A as there is no longer a need to deal with the
possibility of double taxation that this section deals with.
22. The practical effect of the repeal of section 96A is that certain
amounts that are excluded from taxation under Division 6 of Part
III of the ITAA 1936 (specifically, income explicitly exempt from
the FIF rules under Divisions 8 and 11A of Part XI of the ITAA
1936) may now be taxed under that Division. [Schedule 1, item 9,
section 96A]
23. The repeal of section 96A applies in relation to the 2010-11 year
of income for a taxpayer and later income years. [Schedule 1, item
9 and subitem 93(1), section 96A]
Substantive amendments
Amounts paid out of attributed FIF income is not assessable
24. Section 23AK prevents double taxation in relation to amounts paid
out of attributed FIF income. A FIF attribution account payment
received by a taxpayer from a trust, partnership, foreign life
assurance policy or non-resident company is exempt from tax to the
extent of the attribution surplus in the relevant FIF attribution
account.
25. This Schedule substitutes a new section 23AK so that amounts
previously taxed under the FIF rules will continue to be exempt
from further tax upon their subsequent distribution. [Schedule 1,
item 7, section 23AK]
Reduction of disposal consideration if FIF attributed income is not
distributed
26. Existing section 613 within Part XI ensures there is no double
taxation in relation to a disposal of an interest in a FIF where
the income of the FIF has been attributed but not distributed
before the disposal. The section operates to reduce the proceeds
from a capital gain where the taxpayer has an attribution surplus
in relation to that FIF.
27. This Schedule inserts new section 23B to preserve the effect of
section 613. [Schedule 1, item 7, section 23B]
28. This Schedule also corrects a technical deficiency that
inappropriately prevented the consideration from being reduced
where the asset is held on revenue account (as opposed to capital
account). This amendment applies from the 2006-07 and later income
years, the moment when the defect first arose (being the
application of the amendments made by the Tax Laws Amendment
(Repeal of Inoperative Provisions) Act 2006). [Schedule 1, items
92 and 94, section 613]
Reduction of disposal consideration if CFC attributed income is not
distributed
29. Amendments similar to those made to section 613 have been made to
sections 401 and 461, for interests in CFCs. The future of those
sections will depend on the rewrite of the CFC provisions.
[Schedule 1, items 88 to 91, subsections 401(1) and (3),
subsections 461(1) and (3)]
Amendments to the Income Tax Assessment Act 1997
Interaction with Division 230
30. In broad terms, Division 230 of the ITAA 1997 applies to gains and
losses arising from a financial arrangement unless a specific
exception applies. One of these exceptions includes interests in
FIFs (which, importantly, includes CFC interests) and foreign life
assurance policies (subsection 230-460(12)). This has the effect
that the FIF and CFC rules apply in precedence to Division 230.
31. In the absence of the FIF rules it follows that an amendment is
required to Division 230. The effect of this amendment will be
that direct participation interests of an attributable taxpayer in
a CFC will be excepted from the operation of Division 230. Other
interests in foreign companies (whether FIFs or CFCs), foreign
trusts and foreign life assurance policies will not to be
explicitly exempted from the coverage of Division 230. [Schedule
1, item 49, subsection 230-460(12)]
Foreign companies that are a FIF and use the CFC calculation method
32. Under the existing FIF rules, a taxpayer can elect to have the FIF
income calculated by using the CFC provisions, with the FIF
afforded treatment as an Australian financial institution
subsidiary. Where that election has been made, section 768-533 of
the ITAA 1997 currently provides similar recognition of the special
nature of bank subsidiaries when the taxpayer disposes of its
interest in the FIF.
33. An amendment to subsection 768-533(1) will ensure that, with the
repeal of the FIF rules, taxpayers will continue to be able to take
advantage of electing to use the CFC provisions (and thereby treat
the FIF as an Australian financial institution subsidiary) when it
comes to determining any reduction in a capital gain or capital
loss arising from a CGT event that happens in relation to a share
in a foreign company. [Schedule 1, item 62, subsection 768-533(1)]
Foreign hybrid limited partnerships and foreign hybrid companies
34. Amendments to sections 830-10 and 830-15 of the ITAA 1997 (which
treat certain entities as foreign hybrids and therefore taxed like
partnerships) are made to ensure that:
. following the repeal of section 485AA, taxpayers can
continue to rely on an election made under that section
(before its repeal), and can make an election under
subsections 830-10(2) or 830-15(5) (subsequent to the
repeal of section 485AA); and
. the interaction of subsections 830-10(1) and 830-15(1)
(automatic treatment of an entity as a foreign hybrid)
with the new election for foreign hybrid treatment
continue to operate as intended.
Election for foreign hybrid treatment
35. This Schedule amends subsections 830-10(2) and 830-15(5) to
maintain an election made under subsection 485AA(1) prior to its
repeal.
36. Further, this Schedule inserts a new election mechanism so that,
going forward, taxpayers will be able to elect for hybrid treatment
(that is, treatment as a partnership) despite the repeal of section
485AA. The conditions required for making this election are the
same as those required under the former section 485AA. [Schedule
1, items 76, 78 and 96, subsections 830-10(2) and 830-15(5)]
Interaction of an election for foreign hybrid treatment and
automatic foreign hybrid treatment
37. Subsection 830-10(1) of the ITAA 1997 provides that a limited
partnership is a foreign hybrid limited partnership in relation to
an income year only if it satisfies five conditions:
. the limited partnership must be formed in a foreign
country;
. foreign income tax is imposed under the law of the foreign
country on the partners, not the limited partnership in
respect of the income or profits of the partnership;
. at no time, during the year of income is the limited
partnership, for the purposes of the tax law of any
foreign country, treated as a resident of that country;
. the limited partnership must not be an Australian resident
at any time during the income year; and
. the limited partnership is a CFC with at least one
attributable taxpayer having an attribution percentage
greater than nil.
38. Similarly, subsection 830-15(1) provides that certain companies are
foreign hybrid companies where the conditions in that subsection
are met.
39. However, if a particular partner in a limited partnership (or a
shareholder in a foreign company) is not an attributable taxpayer
in relation to that foreign entity (either because the entity is
not a CFC, or because they do not hold a sufficient interest in an
entity that is a CFC to be an attributable taxpayer), then the
partner (shareholder) can choose whether or not that interest held
is treated as an interest in a foreign hybrid limited partnership
(or company).
40. Amendments to section 830-10 and 830-15 ensure that, with the
inclusion of the election for foreign hybrid treatment in
subsections 830-10(2) and 830-15(5), those sections operate as
intended.
41. That is, where the taxpayer is not an attributable taxpayer in
relation to a foreign limited partnership (or company), the
taxpayer will have the right to choose whether partnership
treatment is to apply to its interest in the limited partnership
(or company). Where such election is not made, the normal tax
treatment will continue to apply (for example, they may be treated
as holding a share in a company). This will be the case despite
the fact that there may be another taxpayer that is an attributable
taxpayer in relation to the foreign limited partnership (or
company) that is a CFC. [Schedule 1, items 75 to 78, subsections
830-10(1) and (2), and subsections 830-15(1) and (5)]
1.
On 1 July 2011 Jess, an Australian resident taxpayer,
acquires a 2 per cent interest in US LLC. At 30 June 2012
Andy (an Australian resident taxpayer) holds a 10 per cent
interest in US LLC (which is a CFC with Andy an attributable
taxpayer in relation to US LLC).
For the 2011-12 income year US LLC meets all of the
requirements of subsection 830-15(1) and is therefore a
foreign hybrid company in relation to the 2011-12 income
year. Andy's interest in the CFC is therefore treated as an
interest in a partnership.
Jess does not make an election under subsection 830-15(5)
for her interest to be treated as an interest in a foreign
hybrid company. Although the US LLC is treated as a foreign
hybrid company because of Andy's interest, the fact that
Jess has not made an election under subsection 830-15(5)
means that Jess's interest is not treated as an interest in
a foreign hybrid company.
2.
Assume the same facts as in Example 1.1, but Andy does not
hold any interest in US LLC. Also, no other Australian
resident taxpayer is an attributable taxpayer in relation to
US LLC. US LLC does not meet all of the requirements of
subsection 830-15(1) and therefore is not a foreign hybrid
company in relation to the 2011-12 income year.
In relation to the 2011-12 income year, all of the
requirements in subsection 830-15(7) are satisfied. On or
before the day on which Jess lodges her income tax return
for the 2011-12 year, Jess makes an election under
subsection 830-15(5) for her interest in US LLC to be
treated as an interest in a foreign hybrid company. Jess's
interest in US LLC is treated as an interest in a
partnership.
This election is in force during the 2011-12 income year and
all later income years and is irrevocable.
Application and saving provisions
Application of Part 1 amendments
42. The amendments made by items 2 to 7, 9, 37, 39, 47 to 49, 51, 54 to
56, 59 to 80 and 82 to 87 apply in relation to the 2010-11 and
later income years for taxpayers. [Schedule 1, subitem 93(1)]
43. The amendments made by items 10 to 13 apply in relation to the 2010-
11 and later income years for trust estates. [Schedule 1, subitem
93(2)]
44. The amendments made by items 14 to 36 apply in relation to
statutory accounting periods ending in the 2010-11 and later income
years. [Schedule 1, subitem 93(3)]
Application of Part 2 amendments
45. The amendments made by Part 2 apply to assessments for the 2006-07
income year and later income years. These are backdated because
the amendments reverse the effect of the Tax Laws Amendment (Repeal
of Inoperative Provisions) Act 2006 and are consistent with the
application date of that Act. [Schedule 1, item 94]
Savings provisions
Saving of regulations relating to stock exchanges
46. The first of the savings provisions prevents the definition of
'approved stock exchange' being affected by the repeal of Part XI
(item 37) and provides that regulations made for the purposes of
that definition that were in force immediately before this item
commences continue in force on and after that commencement as if
those regulations had been made for the purposes of the new
definition of 'approved stock exchange' in the ITAA 1997 as
inserted by item 81 of this Schedule. [Schedule 1, item 95]
Saving of elections relating to foreign hybrids
47. The second of the savings provisions ensures that, despite the
repeal of section 485AA, elections made under subsection 485AA(1)
continue to have effect as if the repeal had not happened. This is
consistent with the new paragraphs 830-10(2)(a) and 830-15(5)(a).
[Schedule 1, items 76, 78 and 96, subsections 830-10(2) and 830-
15(5)]
Consequential amendments
48. As a result of the repeal of Part XI, many consequential amendments
arise, particularly where sections contain references to 'Part XI',
or to terms in that Part. [Schedule 1, items 1 and 2, 6, 8, 10, 12
and 13, 17 to 19, 35, 38, 48, 50 and 51, 63, 66 to 68, 74, 81 and
82 and 87, subsection 6(1) (definition of 'approved stock
exchange'), subsection 6(1)(paragraph (l) (definition of 'passive
income'), subsection 6AB(1), subsection 82 KZL(1) (definition of
'approved stock exchange'), paragraphs 102AAU(1)(b),
subparagraphs 102AAU(1)(c)(ix), subsections 102AAU(7) to (9),
subsection 317(1)(definition of 'grossed-up amount'), subparagraphs
356(4B)(b)(ii) and 356(4C)(b)(ii), subsection 402(4),
subsection 272-140(1) in Schedule 2F (definition of 'approved stock
exchange'), subsections 116-10(7) (note 1) of the ITAA 1997,
subsections 703-75(4) (note) and 715-660(1) ( items 1 and 2 in the
table) of the ITAA 1997, sections 768-900, 770-135 (heading),
subsections 770-135(1), (2) and (6) to (8), subsection 995-1(1)
(definition of 'approved stock exchange'), subsection 995-1(1)
(definition of 'attribution percentage') of the ITAA 1997 and
subsection 66(5) (paragraph (b) of the definition of 'listed
security') of the Superannuation Industry (Supervision) Act 1993]
49. Other consequential amendments repeal various definitions which are
no longer required as a result of the repeal of Part XI.
[Schedule 1, items 14 to 16 and 83 to 86, definition of 'FIF
attribution account entity', 'FIF attribution account payment',
'FIF attribution debit' in subsection 317(1) of the ITAA 1936,
definition of 'FIF', 'foreign life assurance policy', 'foreign
investment fund' and 'notional accounting period' in subsection
995-1(1)]
50. Further consequential amendments repeal provisions that are no
longer required as a consequence of the repeal of Part XI and the
deemed present entitlement rules. [Schedule 1, items 20, 22 to 24,
26, 28, 31, 34, 36, 39, 47, 64 and 65, 70, 72 and 73 and 80,
paragraphs 371(1)(aa) and 371(1)(ab), subsections 371(2A) to (2D),
paragraphs 371(5)(aa), 371(5)(ab) and 384(2)(ca), subparagraph
384(2)(d)(iv), paragraph 385(2)(ca), subparagraph 385(2)(d)(v),
subsections 402(2A) to (2C), Subdivision E of Division 7 of Part X,
Schedules 3 to 5 to the ITAA 1936, sections 70-70, 768-965 and 768-
975 of the ITAA 1997, paragraphs 770-135(3)(c), 770-135(5)(c), 770-
135(5) (note) and 960-50(10)(d) of the ITAA 1997]
51. Definitions have also been inserted into subsection 6(1) for 'post
FIF abolition credit', 'post FIF abolition debit', and 'post FIF
abolition surplus' as a consequence of the repeal of Part XI.
[Schedule 1, items 3 to 5, subsection 6(1)]
52. Various provisions and headings in Subdivisions 717-D and E are
amended to allow the head company or the leaving member to continue
to take advantage of the section 23AK exemption or the section 613
reduction of capital proceeds on disposal of an interest in the
FIF. [Schedule 1, items 52 to 61, Subdivision 717-D of Part 3-90
(heading), section 717-200, paragraph 717-205(c), sections 717-220
and 717-230, Subdivision 717-E of Part 3-90 (heading), section 717-
235, paragraph 717-240(c), sections 717-255 and 717-265 of the ITAA
1997]
53. There are also a number of further consequential amendments to
reflect changes resulting from the repeal of Part XI. [Schedule 1,
items 11, 21, 25, 27, 29 and 30, 32 and 33, 69 to 71 and 79, sub-
subparagraphs 102AAU(1)(c)(viii)(B), subsection 371(2),
subparagraph 384(2)(d)(iii), paragraphs 385(2)(a), (b) and (d), sub-
subparagraph 385(2)(d)(iv)(B), subsection 385(4), paragraph 389(a),
paragraphs 770-135(3)(b) and (c), 770-135(5)(b) and 960-50(10)(c)
of the ITAA 1997]
54. Several items update the checklists in sections 10-5, 11-55 and 12-
5 of the ITAA 1997. [Schedule 1, items 40 to 46, sections 10-5, 11-
55 and 12-5 of the ITAA 1997]
Chapter 2
Regulation impact statement
Background
55. This regulation impact statement relates to the Board of Taxation's
(the Board) recommendations following its review of the foreign
source income anti-tax-deferral (attribution) regimes.
56. The attribution rules provide integrity to Australia's residence
based taxation system whereby Australian residents, in general, are
taxable on their worldwide income.
57. Australia's attribution rules apply to ensure Australian residents
cannot avoid or defer Australian tax by accumulating income
offshore in a foreign entity. The attribution rules achieve this
by taxing Australian residents on a current basis on their share of
certain income accumulated in a foreign entity in which they hold
an interest.
58. The current attribution rules - the controlled foreign company
(CFC), foreign investment fund (FIF), transferor trust and deemed
present entitlement regimes - were introduced in the early 1990s.
Each regime applies to different kinds of interests and entities.
In summary:
. The CFC regime applies to Australian residents with a
controlling interest in a foreign company.
. The FIF regime applies to Australian residents with
interests in foreign trusts or non-controlling interests
in foreign companies and also applies to Australian
residents with interests in foreign life assurance
policies.
. The transferor trust regime applies where an Australian
resident has made a transfer of property or services to a
foreign trust for no, or insufficient, consideration.
. The deemed present entitlement regime applies to an
Australian resident with an interest, including a future
or contingent interest, in a foreign trust.
59. In general terms, the attribution rules target that income
classified as being passive income. Passive income is generally
considered to be highly mobile income, for example, interest,
dividends, and royalties. The rules also currently target certain
income from related-party transactions.
Problem
Background
60. Australia's attribution rules were introduced progressively during
the early 1990s, but are based on United States' rules developed in
the 1960s. Since the attribution rules were introduced,
globalisation has significantly affected the business environment
faced by Australian businesses and seen them increasingly competing
in the world economy. The changing business environment has led to
the current rules being outdated, potentially impacting on offshore
investment decisions that are not motivated by tax deferral
reasons.
61. The Board in its discussion paper identified a number of problems
with the existing attribution rules. These problems were
classified under the following broad headings:
. coordination and distortionary problems - primarily as a
result of multiple regimes applying concurrently, together
with inconsistent rules applying to equivalent entity
types;
. targeting problems - poorly targeted provisions, both in
terms of distinguishing between passive and active income
and identifying income that carries the greatest deferral
risk;
. compliance cost problems - compliance costs that are
disproportionate to the integrity risk; and
. complexity problems - the regimes are exceedingly complex.
62. In terms of complexity the rules were drafted at a time when a
prescriptive black-letter law approach to the general design of the
tax laws applied. As a result, they occupy around 400 pages of
legislation and nearly 1,000 subsections (or approximately 25 per
cent of the Income Tax Assessment Act 1936). The Board concluded
that the volume of law needed and the accompanying level of
complexity is disproportionate to the common policy outcome the
regimes all set out to achieve - to identify and attribute to
resident taxpayers their share of passive income derived by foreign
entities in which they hold an interest.
63. The complexity of the attribution regimes, as well as the lack of
high level and more immediately accessible exemptions, has resulted
in high compliance costs for many Australian residents with foreign
investments even where they ultimately have little or no
attributable income to report.
64. These costs can also potentially impact on the competitiveness of
Australians doing business offshore. For example, Australian-owned
companies with offshore marketing hubs may be subject to tax on a
current basis on their share of income accumulated in these hubs
(attribution taxation) whereas their foreign-owned competitors may
not be subject to similar attribution taxation in their home
jurisdiction.
65. A further example is in the managed funds sector. To avoid the
compliance costs associated with the FIF rules, fund managers often
sell FIF interests immediately before the end of the year and
reacquire them in the next moment in the following income year.
Although this has the effect of bringing forward the taxing point
on what would have otherwise been an unrealised gain, the savings
in compliance costs are of such a magnitude that managed funds
seldom refrain from this sell and buy-back practice.
Policy objective
66. In light of the problems and issues outlined above, the former
government announced on 10 October 2006, a review of the
attribution rules.
67. The terms of reference for the review were:
. to identify ways to reduce the complexity and compliance
costs associated with the current foreign source income
anti-tax-deferral regimes, including whether the regimes
can be collapsed into a single regime; and
. to examine whether the anti-tax-deferral regimes strike an
appropriate balance between effectively countering
deferral and unnecessarily inhibiting Australians from
competing in the global economy.
68. The review was conducted by the Board. The Board is an
independent, non-statutory body established to advise government on
various aspects of the Australian taxation system.
69. In September 2008 the Board handed to Government its report which
contained recommendations to address the terms of reference.
Implementation
70. The Government announced in the 2009-10 Budget its response to
recommendations from the Board following its review of the
attribution rules (see the Assistant Treasurer's Press Release No.
049 of 12 May 2009).
71. In summary, the Government agreed that:
. the CFC provisions be retained as the primary set of rules
designed to counter tax deferral arrangements:
- the CFC provisions be modernised by updating the
definitions of what constitutes active and passive
income together with the removal of the base company
income rules;
- the existing exemptions within the CFC rules be
retained, including the listed country and Australian
financial institution subsidiary exemptions, and an
additional exemption introduced for complying
superannuation entities;
- a choice of attribution methods apply (the branch-
equivalent calculation, market value, and deemed rate of
return methods) where taxpayers are required to include
attributable income in their assessable income; and
- the CFC provisions are rewritten in the Income Tax
Assessment Act 1997 (ITAA 1997);
. the FIF provisions be repealed and replaced with a
specific anti-roll-up fund measure targeting accumulation
funds that reinvest interest-like returns;
. in the absence of FIF rules, closely held fixed trusts are
brought into the rewritten CFC rules;
. the deemed present entitlement rules are repealed; and
. the transferor trust rules are retained with amendments to
enhance their effectiveness and improve their integrity.
72. The Government decided not to proceed with the Board's
recommendation of a listed public company exemption.
73. The Assistant Treasurer's Press Release No. 117 of 18 December 2009
announced the release for public consultation exposure draft
legislation to repeal the FIF and deemed present entitlement rules.
Legislation to give effect to the remaining reforms to modernise
the CFC and transferor trust rules is being developed separately.
Assessment of impacts
Impact group identification
74. The most recent data from the Australian Taxation Office (ATO)
indicates that the number of taxpayers currently subject to the
attribution regimes are:
. for the 2006-07 year - 2,000 individuals declared that
they received FIF income, 600 declared they were in
receipt of CFC income and 50 included transferor trust
income; and
. for the 2005-06 year - 3,000 businesses, superannuation
funds and other entities declared they were in receipt of
CFC and/or FIF income.
75. The above numbers do not take account of managed funds and their
investors that effectively operate outside of the attribution rules
because of 'bed and breakfast' transactions undertaken by fund
managers (referred to in paragraph 2.11).
76. Implementation of the Government's announcement will impact on all
of these taxpayers and their advisors. The benefits and costs of
the announced reforms are explained in more detail below.
Analysis of costs/benefits
Compliance costs
Taxpayers with non-controlling interests in foreign entities
77. Implementation of these reforms will have the biggest impact on
those resident taxpayers with non-controlling interests in foreign
investments. These taxpayers, unless they hold an interest in a
roll-up fund, will benefit from significant compliance cost savings
as they will no longer be subject to the requirements of the
attribution rules.
78. Similarly, managed funds and superannuation funds would also have
significant compliance cost savings. The repeal of the FIF regime
would mean these entities would no longer be required to either
maintain separate attribution accounts for each resident investor
or undertake 'bed and breakfast' transactions (referred to in
paragraph 2.11) in order to meet the requirements of the balanced
portfolio exemption.
Taxpayers with controlling interests in foreign entities
79. Taxpayers with controlling interests in foreign entities should
also benefit from a reduction in their compliance costs. The
majority of these taxpayers are currently subject to the
requirements of the existing CFC regime.
80. For these taxpayers compliance cost reductions will occur as a
result of the introduction of improved exemptions.
81. Other changes that modernise the active/passive income divide to
better recognise the changing global business environment that has
evolved since the attribution rules were first developed, will also
improve the competitiveness and productivity of Australian
businesses with offshore operations.
82. Overall, the ATO's compliance cost assessment is that the proposed
changes will have an on-going compliance cost savings for taxpayers
of between $40 million to $80 million per year. (Transitional
costs associated with implementation are estimated to cost between
$40 million to $80 million.)
83. However, according to the ATO, the estimates of potential
compliance cost impacts are conservative and do not represent the
total compliance cost impact. For instance, no estimates are
provided on the impact on professional fees that a taxpayer might
be required to pay. This is due to the limitations of the data
available and the more complex interaction of variables that
influence the use of professional services and the setting of those
fees.
84. Nor does the estimate of potential compliance cost impacts include
savings for individual investors in managed funds who might have
incurred costs associated with undertaking 'bed and breakfast'
arrangements. Impacts on these individual investors are an
indirect saving that the ATO's quantifications do not include.
Tax practitioners and other intermediaries
85. Tax practitioners representing entities in either the Large or
Small Medium Enterprise markets will be the most directly affected
by the proposed changes. It is entities operating in these markets
that tend to conduct offshore business, with larger businesses
tending to have the greatest exposure.
86. It is estimated that 400 registered tax agents service these
markets. These tax agents may initially incur additional costs
when familiarising themselves with the new rules. However, this is
not expected to be significant given that the new rules are based
on the retention of the existing CFC rules and the repeal of the
FIF rules.
87. The impact on the tax agents representing the remaining markets
sectors would depend on their clients' exposure to the new rules,
but this is not expected to be significant.
Administrative costs
88. As a result of implementing these changes the ATO may incur initial
costs associated with system and tax form changes and the need to
provide additional advice to taxpayers and tax practitioners,
including by way of tax rulings. Costs may also be incurred in
retraining staff. This is not expected to be significant as the
CFC rules are being retained and the FIF rules are being repealed.
The ATO has indicated that these costs would be $3.1 million for
the 2010-11 income year.
89. Although it was anticipated that the new regime would result in
ongoing administration costs savings, the ATO has estimated that
the ongoing administrative cost would be in the order of $1.3
million per year.
Economic benefits
90. The Board's recommendations will provide a number of economic
benefits across a number of fronts:
. For Australian managed funds, the abolition of the FIF
rules will significantly reduce their compliance costs
which in turn will enhance their global competitiveness
and attractiveness to foreign investors.
. For Australian corporates:
- modernising and better targeting the rules by abolishing
the FIF and base company income rules, together with
updating the definitions of what constitutes active and
passive income, will improve their competitiveness and
productivity; and
- improved exemptions, including a more effective
exemption for complying superannuation funds, will
significantly reduce compliance costs for eligible
taxpayers.
. For taxpayers generally, and administrators:
- abolition of the FIF and deemed present entitlement
rules, in conjunction with rewriting the CFC rules into
the ITAA 1997 will simplify and scale back the volume of
law, as well as bringing the prospect of consolidating
the two income tax Acts a significant step closer.
Consultation
91. The Board conducted extensive consultation with stakeholders
throughout the review process.
92. Initially, targeted consultation sessions were held with selected
representatives from industry and the professional tax bodies, as
well as the Treasury and the ATO, to help develop the Board's
discussion paper. Public consultation meetings were then held in
both Melbourne and Sydney following the release of that paper and,
again, following the release of the Board's position and issues
papers. The public consultations forums were advertised in the
press as well as on the Board's website.
93. Consultation was conducted early in the review so that interested
parties could comment on policy and design issues underlying the
foreign source income attribution rules.
94. Further, targeted consultations were also held with particular
taxpayers throughout the review period.
95. Written submissions were also sought by the Board in response to
their discussion paper and, again, in response to their position
and issues papers.
96. Appendices A and B of the Board's Report contains the list of
organisations or individuals who either made submissions to the
Board or attended consultations meetings.
97. Stakeholders were unanimous in seeking changes to the existing
rules. Changes were sought on the basis that the rules were
outdated, complex, compliance intensive, and distortionary.
98. Stakeholders were also in agreement in seeking more modern, high
level exemptions; and a range of exemption options.
99. Public consultation meetings were also held in Sydney and Melbourne
following the release of the Treasury discussion paper in
June 2009. Written submissions were also sought from interested
parties in response to the Treasury's discussion paper.
100. An exposure draft of the legislation giving effect to the
Government's decision to repeal the FIF and the deemed present
entitlement rules was released for public consultation on
18 December 2009 and interested parties provided comments on the
exposure draft Bill.
101. A consultation paper on the reform of the CFC rules was released in
January 2010, with submissions due by 1 March 2010.
Conclusion and recommended option
102. The Government announced reforms to the attribution rules as part
of the 2009-10 Budget. The Government agreed to implement all of
the Board's recommendations other than the listed public company
exemption (recommendation 2).
103. The above analysis shows that this approach would result in
significant compliance cost savings for affected taxpayers when
compared to the existing regimes.
104. The approach also aligns the rules to changes in the business
environment that have occurred as a result of globalisation. The
Government's approach provides flexibility when compared to the
current regimes, recognising that many offshore investment
decisions are not motivated by tax deferral reasons.
Implementation and review
105. Consistent with the Government's commitment for consultation with
stakeholders in accordance with the Tax Design Review Panel's
report Better Tax Design and Implementation, draft legislation to
implement these reforms will involve consultation with affected
stakeholders. The repeal of the FIF and deemed present entitlement
rules has already been the subject of such consultation.
106. The Board in delivering its report to Government, noted that the
Treasury, when developing any legislation, should involve both the
Board and the other stakeholders who participated in the review's
consultation process. The repeal of the FIF and deemed present
entitlement rules has been conducted in accordance with this
advice.
107. Once introduced, the Treasury and the ATO will monitor this
taxation measure on an ongoing basis.
Index
Schedule 1: Repeal of the FIF and deemed present entitlement rules
|Bill reference |Paragraph |
| |number |
|Items 1 and 2, 6, 8, 10, 12 and 13, 17 to |1.48 |
|19, 35, 38, 48, 50 and 51, 63, 66 to 68, 74,| |
|81 and 82 and 87, subsection 6(1) | |
|(definition of 'approved stock exchange'), | |
|subsection 6(1)(paragraph (l) (definition of| |
|'passive income'), subsection 6AB(1), | |
|subsection 82 KZL(1) (definition of | |
|'approved stock exchange'), paragraphs | |
|102AAU(1)(b), | |
|subparagraphs 102AAU(1)(c)(ix), | |
|subsections 102AAU(7) to (9), subsection | |
|317(1)(definition of 'grossed-up amount'), | |
|subparagraphs 356(4B)(b)(ii) and | |
|356(4C)(b)(ii), subsection 402(4), | |
|subsection 272-140(1) in Schedule 2F | |
|(definition of 'approved stock exchange'), | |
|subsections 116-10(7) (note 1) of the ITAA | |
|1997, subsections 703-75(4) (note) and | |
|715-660(1) ( items 1 and 2 in the table) of | |
|the ITAA 1997, sections 768-900, 770-135 | |
|(heading), subsections 770-135(1), (2) and | |
|(6) to (8), subsection 995-1(1) (definition | |
|of 'approved stock exchange'), subsection | |
|995-1(1) (definition of 'attribution | |
|percentage') of the ITAA 1997 and subsection| |
|66(5) (paragraph (b) of the definition of | |
|'listed security') of the Superannuation | |
|Industry (Supervision) Act 1993 | |
|Items 3 to 5, subsection 6(1) |1.51 |
|Item 7, section 23AK |1.25 |
|Item 7, section 23B |1.27 |
|Item 9 and subitem 93(1), section 96A |1.23 |
|Item 9, section 96A |1.22 |
|Items 9 and 37, Part XI and sections 96B and|1.14 |
|96C | |
|Items 11, 21, 25, 27, 29 and 30, 32 and 33, |1.53 |
|69 to 71 and 79, | |
|sub-subparagraphs 102AAU(1)(c)(viii)(B), | |
|subsection 371(2), | |
|subparagraph 384(2)(d)(iii), | |
|paragraphs 385(2)(a), (b) and (d), | |
|sub-subparagraph 385(2)(d)(iv)(B), | |
|subsection 385(4), paragraph 389(a), | |
|paragraphs 770-135(3)(b) and (c), | |
|770-135(5)(b) and 960-50(10)(c) of the | |
|ITAA 1997 | |
|Items 14 to 16 and 83 to 86, definition of |1.49 |
|'FIF attribution account entity', 'FIF | |
|attribution account payment', 'FIF | |
|attribution debit' in subsection 317(1) of | |
|the ITAA 1936, definition of 'FIF', 'foreign| |
|life assurance policy', 'foreign investment | |
|fund' and 'notional accounting period' in | |
|subsection 995-1(1) | |
|Items 20, 22 to 24, 26, 28, 31, 34, 36, 39, |1.50 |
|47, 64 and 65, 70, 72 and 73 and 80, | |
|paragraphs 371(1)(aa) and 371(1)(ab), | |
|subsections 371(2A) to (2D), paragraphs | |
|371(5)(aa), 371(5)(ab) and 384(2)(ca), | |
|subparagraph 384(2)(d)(iv), paragraph | |
|385(2)(ca), subparagraph 385(2)(d)(v), | |
|subsections 402(2A) to (2C), Subdivision E | |
|of Division 7 of Part X, Schedules 3 to 5 to| |
|the ITAA 1936, sections 70-70, 768-965 and | |
|768-975 of the ITAA 1997, | |
|paragraphs 770-135(3)(c), 770-135(5)(c), | |
|770-135(5) (note) and 960-50(10)(d) of the | |
|ITAA 1997 | |
|Items 40 to 46, sections 10-5, 11-55 and |1.54 |
|12-5 of the ITAA 1997 | |
|Item 49, subsection 230-460(12) |1.31 |
|Items 52 to 61, Subdivision 717-D of Part |1.52 |
|3-90 (heading), section 717-200, paragraph | |
|717-205(c), sections 717-220 and 717-230, | |
|Subdivision 717-E of Part 3-90 (heading), | |
|section 717-235, paragraph 717-240(c), | |
|sections 717-255 and 717-265 of the | |
|ITAA 1997 | |
|Item 62, subsection 768-533(1) |1.33 |
|Items 75 to 78, subsections 830-10(1) and |1.41 |
|(2), and subsections 830-15(1) and (5) | |
|Items 76, 78 and 96, subsections 830-10(2) |1.36, 1.47 |
|and 830-15(5) | |
|Items 88 to 91, subsections 401(1) and (3), |1.29 |
|subsections 461(1) and (3) | |
|Items 92 and 94, section 613 |1.28 |
|Subitem 93(1) |1.42 |
|Subitem 93(2) |1.43 |
|Subitem 93(3) |1.44 |
|Item 94 |1.45 |
|Item 95 |1.46 |