Commonwealth Numbered Regulations - Explanatory Statements

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INCOME TAX AMENDMENT REGULATIONS 2003 (NO. 4) 2003 NO. 372

Section 266 of the Income Tax Assessment Act 1936 (the Act) provides that the Governor-General may make regulations, not inconsistent with the Act or the Income Tax Assessment Act 1997 (the ITAA 1997) prescribing all matters which by the Act or the ITAA 1997 are required or permitted to be prescribed, or which are necessary or convenient to be prescribed for giving effect to the Act or the ITAA 1997.

The Act authorises the declaration of broad-exemption and limited-exemption listed countries. Schedule 10 of the Income Tax Regulations 1936 (the Principal Regulations) contains a broad-exemption listed country (BELC) list for highly comparable countries as well as a limited-exemption listed country (LELC) list for sufficiently comparable countries. The lists reduce compliance and administrative costs arising from accruals taxation under the controlled foreign companies (CFC) measures, and from taxation under the foreign tax credit system on the repatriation of profits. The costs are reduced by exempting both active and tainted income from BELC countries, and active income from LELC countries.

Tainted income is broadly defined in the CFC measures to include passive income (e.g. interest, dividends and royalties) and certain income from transactions with related parties and Australian residents. The CFC measures focus on tainted income because it is the most mobile form of income and is thus easily diverted to avoid or defer Australian tax. The location of investments which generate active (i.e. income other than tainted income) income tend to be primarily influenced by considerations other than tax.

The Regulations are required to add the Russian Federation and Mexico to the LELC list in Schedule 10 to the Principal Regulations. The effect of this is to exempt from Australian company tax, non-portfolio dividends and branch profits remitted from the Russian Federation or Mexico to Australian companies. Exemption is granted on the basis that these payments have already incurred foreign tax comparable to Australian tax.

The listing of the Russian Federation also ensures that residents of the Russian Federation are able to gain access to the lower 5% rate of dividend withholding tax in Article 10 of the Australia-Russian Federation tax treaty. The lower rate of withholding tax is only available under Article 10 of the treaty if the dividends flowing from a company resident in the Russian Federation to an Australian company are exempt from Australian tax in Australia.

Australia recently completed tax treaties with the Russian Federation and Mexico. Through the completion of these treaties, the Russian Federation and Mexico are accepted as having tax systems sufficiently comparable to Australia.

Part 8A and associated Schedules of the Principal Regulations prescribe matters that give effect to Part X of the Act - the CFC measures. The objective of the CFC measures is to tax Australian shareholders on their pro rata share of a CFC's tainted income as earned, unless the income has either been comparably taxed offshore or the CFC satisfies an active income test. These measures ensure that offshore investments are not favoured over similar investments in Australia for purely taxation reasons.

The Act specifies no conditions that need to be met before the power to make the proposed Regulations may be exercised.

The Regulations commence on 1 January 2004, the expected date of effect of both the Australia-Russian Federation tax treaty and the Australia-Mexico tax treaty.