Commonwealth Numbered Regulations - Explanatory Statements

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INCOME TAX REGULATIONS (AMENDMENT) 1992 NO. 38

EXPLANATORY STATEMENT

STATUTORY RULES 1992 No. 38

Issued by Authority of the Treasurer

Income Tax Assessment Act 1936

Income Tax Regulations (Amendment)

GENERAL OUTLINE

These Statutory Rules relate to the accruals system of taxation of foreign income that was introduced with general effect from the 1990-91 income year. Attachment A of this Statement contains an outline of the basic concepts of the accruals taxation of foreign income and the function of the Income Tax Regulations in relation to the accruals tax system.

The Statutory Rules will amend Part 8A (the 'Foreign Income provisions) of the Income Tax Regulations (the Regulations) to :

(a)       provide relief to taxpayers by taking into account losses incurred by a controlled foreign company (CFC) resident in a listed (comparable tax) country or a group company in that country when calculating the income of the CFC that is taxed to resident taxpayers (see amending regulation 3); and

(b)       insert a new regulation to list tax laws of certain foreign countries that correspond to Australia's CFC law to provide relief to taxpayers from double taxation (see amending regulation 4).

Amending regulation 3 provides relief to taxpayers by removing an unintended consequence resulting from the way in which designated concession income was defined in the Regulations. The definition had the effect that concessionally taxed income of a CFC resident in a listed country was calculated without reference to the losses, if any, incurred by the CFC or by a group company resident in the same country. The calculation will now be modified to take those losses into account in determining whether an amount of income is concessionally taxed.

The losses that are taken into account in determining whether a particular kind of income derived by a CFC is concessionally taxed income are losses incurred by the CFC or by a group company that is resident in the same listed country as the CFC.

A group company is defined, in broad terms, as a 60 percent owned subsidiary. A company is taken to be a 60 percent owned subsidiary of another company if that other company owns 60 percent or more of its paid up capital or voting shares, or would be entitled to 60 percent or more of its distributions. The provisions also treat as a group a chain of 60 percent owned companies.

The company which transfers the losses to the CFC must also be a CFC and resident in the same listed country as the CFC to which the losses are transferred.

For a CFC to be able to take group company losses into account, the conditions set out below must be satisfied:

(a)       the listed country in which the CFC and the group company are resident must allow the transfer of the loss from the company making the loss to the CFC;

(b)       the CFC must have a resident attributable taxpayer from the commencement of the period in which a loss is transferred to the CFC to the end of the period (offset period) in which the loss is used by the CFC to reduce its income;

(c)       the company that incurred the loss must have been a CFC in relation to the same attributable taxpayer during the period from when the loss was incurred to the end of the offset period or when the company ceased to exist.

Amending regulation 4 lists the accruals tax provisions of the tax laws of foreign countries where those countries have an accruals system similar to Australia's. The listing by regulation of such countries will facilitate the inclusion of countries that introduce accruals tax measures comparable to Australia's without the need for an amendment of the Act. Where such a country is listed in the regulations, Australian taxpayers are provided with relief from double taxation if amounts derived by a CFC are subject to tax under the accruals system of that country as well as that of Australia.

DETAILED NOTES ON THE REGULATIONS

Regulation 1 - Commencement

The dates from which the amending regulations are to take effect are contained in amending regulation 1. The early commencement date of amending subregulations 3.3, 3.5, 3.6 and 4.1 will benefit the taxpayer. Thus, they will not contravene subsection 48(2) of the Acts Interpretation Act 1901 which prohibits the retrospective operation of regulations which affect the rights of, or impose liabilities on, taxpayers.

Regulation 2 - Amendment

Amending regulation 2 provides that the amending regulations will amend the Income Tax Regulations.

Regulation 3 - Regulation 152C (When are income or profits subject to a reduction of tax?)

Subregulation 3.1

Subregulation 152D(1) lists the kinds of income that are tested to determine whether they are concessionally taxed in a listed country. The test to be applied for this purpose is set out in subregulation 152C(1).

The insertion of the words 'of a kind specified in subregulation 152D(1)' is to assist in differentiating between an item (or kind) of income or profits specified in subregulation 152D(1) which is subject to a reduction of tax under subregulation 152D(1) and all of the income or profits derived by an entity referred to in new subregulations 152C(3) and (3A).

Subregulation 3.2

The words 'provides, or has the effect' are being inserted into subregulation 152C(1), i.e., the 'subject to a reduction of tax' test, to clarify the Government's original intention outlined in the explanatory statement to Statutory Rules No.20 of 1991 that the test is intended to cover both tax concessions specifically provided in the tax law of a listed country as well as concessions implied in the law.

Subregulation 3.3

This amending subregulation simply reflects that paragraph 152C(1)(g) will now be modified by two subregulations, namely, 152C(3) and (3A).

Subregulation 3.4

This amendment is consequent upon the amendment of subregulation 152C(1) by amending subregulation 3.2. Amending subregulation 3.2 qualifies each of the paragraphs 152C(1)(d) to (h). Amending subregulation 3.4 removes the redundancy that would occur if paragraph 152C(1)(h) was not amended. The redundancy would arise by the words 'has the effect' appearing twice in subregulation 152C(1).

Subregulation 3.5

Amending subregulation 3.5 removes an unintended consequence resulting from the way in which designated concession income is identified in the Regulations.

Under the previous rules in paragraph 152C(1)(g), as modified by subregulation 152C(3), certain categories of listed country income, such as interest and royalties, were treated as 'subject to a reduction of tax' (i.e., concessionally taxed) where expenses or losses incurred by a CFC in deriving other categories of income can be deducted from that income. In other words, the previous provisions of subregulation 152C(3) had the effect of quarantining expenses or losses to a particular category of income.

New subregulation 152C(3)

Amending subregulation 3.5 will remove the unintended consequence by amending subregulation 152C(3) to provide that a reduction of a particular category of income of a CFC by expenses or losses incurred by that CFC in deriving other income does not by itself make the category of income 'subject to a reduction of tax'.

New subregulation 152C(3A)

The amending subregulation will also insert new subregulation 152C(3A) which will provide that a reduction of a particular category of income, of a CFC resident in a listed country that is a member of a company group, by the transfer of a loss from another group member resident in the same listed country does not by itself make the income 'subject to a reduction of tag.

The CFC in subregulation 152C(3A) which is being tested to ascertain if it has derived designated concession income is referred to as 'the entity' which, of course, is the same entity referred to in subregulation 152C(1).

The group company which transfers the losses to the entity is referred to as the 'loss company'. The rules relating to loss companies are contained in new subregulation 152C(3C).

In order for an entity to obtain the benefit of the group loss transfer provisions in subregulation 152C(3A) by having the loss incurred by a group company offset against the entity's income, the entity must be a CFC and a resident of the relevant listed country (i.e., the listed country referred to in subregulation 152C(1)) during the period set out in new subregulation 152C(3B).

A group company is defined in new subregulation 152C(3D).

New subregulation 152C(3B)

Ibis subregulation defines the period, referred to in subregulation 152C(3A), during which the entity must be a CFC and a resident of the relevant listed country to obtain the benefit of the group loss transfer provisions in subregulation 152C(3A).

The period starts at the beginning of the transfer period and ends on the last day of the offset period. The transfer period is the relevant period, e.g., statutory accounting period, in which the losses or outgoings are transferred from the loss company to the entity. The offset period is the period in which the losses are deducted from the income or profits derived by the entity. Depending upon the provisions of the tax law of the listed country, including the way in which losses are permitted to be transferred between group companies under that law, the transfer and offset periods may be the same period or different periods.

New subregulation 152C(3C)

This subregulation outlines the rules relating to loss companies. Basically, it provides that an entity may only obtain the benefit of the loss transfer provisions in subregulation 152C(3A) if the loss company satisfies certain rules.

Paragraph 152C(3C)(a) provides that a loss company must be:

(a)       a CFC in relation to the same Australian entity referred to in subregulation 152C(3A); and

(b)       a resident of the listed country referred to in subregulation 152C(1),

at all times during the loss period as defined in new subregulation 152C(7).

Paragraph 152C(3C)(b) sets out the nexus that must exist between the entity availing itself of the group loss transfer provisions in subregulation 152C(3A) and the loss company which transfers the losses to the entity. It provides that the entity and the loss company must be members of the same company group (as defined in subregulation 152C(3D)) during either the period:

(a)       referred to in subregulation 152C(3A) as defined in subregulation 152C(3B) (see earlier notes on those subregulations); or

(b)       that part of the period referred to in (a) above where the loss company was in existence.

Paragraph 152C(3C)(c) provides that the only losses or outgoings incurred by the loss company which may be deducted from the income or profits derived by the entity are those which have not previously been allowed as a deduction against the income or profits of that or any other entity.

New subregulation 152C(3D)

This subregulation sets out the main circumstances in which a CFC will be a group company in relation to another CFC for the purposes of paragraph 152C(3C)(b).

Basically, the group company test requires 60% ownership which is set out in paragraph 152C(3D)(b). The ownership requirement, referred to in paragraph 152C(3D)(b) as the ownership of a 'dominant parcel of shares' and defined in subregulation 152C(8), may be satisfied in one of three ways. The parent company is required to own:

(a)       shares representing at least 60% of the paid-up share capital; or

(b)       shares conferring at least 60% of:

(i)       voting rights; or

(ii)       rights to distributions on winding up and otherwise than on winding up,

in a subsidiary company.

The requisite group relationship will exist between the two companies if.

(a) one company is the subsidiary of the other; or

(b) each company is a subsidiary of the same company.

The relationship must exist during the whole of the period set out in subregulation 152C(3B) or the part of that period which is referred to subparagraph 152C(3C)(b)(ii).

The status as a subsidiary of a company may be passed on by a subsidiary of that company to its subsidiary. This is provided for in subregulation 152C(3E).

New subregulation 152C(3E)

This subregulation provides that the status as a subsidiary of a company (established under the rules in paragraph 152C(3D)(b)) may be passed on by a subsidiary of that company to its subsidiary and so on down a chain of companies. For example, if company A is a subsidiary of company Y, company B is a subsidiary of company A and company C is a subsidiary of company B, this will result in company B and company C also being subsidiaries of company Y.

Subregulation 3.6

This amending subregulation will insert three definitions into regulation 152C for the purposes of the new subregulations inserted into regulation 152C by amending subregulation 3.5.

New subregulation 152C(6)

This subregulation provides that a deduction in subregulation 152C(3A) may arise by way of:

(a)       the transfer of losses or outgoings from the loss company to the entity; or

(b)       the following which would have the effect of transferring the losses or outgoings from the loss company to the entity:

(i)       the consolidation, for reporting purposes to the taxation authorities of the listed country, of the activities or operations of the entity and the loss entity; or

(ii)       a payment made by the entity to the loss company.

New subregulation 152C(7)

This subregulation defines the term 'loss period' for the purposes of paragraph 152C(3C)(a) -see earlier notes regarding that paragraph.

New subregulation, 152C(8)

This subregulation defines the term 'dominant parcel of shares' for the purposes of paragraph 152C(3D)(b). This definition was commented on previously in the notes under the heading relating to new subregulation 152C(3D).

Regulation 4 - New regulation 152HA

This amending regulation will insert a new regulation into Part 8A of the Regulations. It is made for the purposes of the definition of 'accruals tax law' in section 317 of the Income Tax Assessment Act.

The regulation lists the accruals tax provisions of the tax laws of foreign countries where those countries have an accruals system similar to Australia's.

The term 'accruals tax law' is relevant for the purposes of section 456A of the Act. This section provides relief in cases where the income of a CFC is subject to accruals taxation in Australia and another country. However, it is important to note that the relief is only available if the interest in the CFC is traced through an interposed entity located in the other country.

Regulation 5 - Application

The application provisions relate to amending subregulations 11, 3.2 and 3.4. Because these subregulations could impose liabilities on taxpayers, the application provisions ensure they do not operate retrospectively.

Attachment

TAXATION OF FOREIGN SOURCE INCOME: OVERVIEW OF THE EXISTING LAW

The accruals tax system - controlled foreign companies

If Australian residents have specified interests in a non-resident company, then the accruals tax system may include certain income and gains derived by that company in the residents' assessable income. A non-resident company that is subject to these measures is called a controlled foreign company (CFC).

Attributable income

The income and gains of a CFC that may be included in the assessable income of resident taxpayers is called attributable income. That income is calculated, subject to some modifications, as if the CFC is a resident of Australia.

The active income test

The CFC's income will generally not be included in the assessable income of resident taxpayers if the CFC is predominantly engaged in active business operations. An active income test determines whether a CFC is to be treated as predominantly engaged in active business operations.

A CFC fails that test if, in broad terms, 5 per cent or more of the gross turnover of the CFC consists of tainted income. Tainted income includes passive income and income from certain related party transactions.

Listed and unlisted countries

A listed country is a country that is treated as having a tax system that is generally comparable to Australia's. A list of these countries is contained in Schedule 10 of the Income Tax Regulations (the Regulations). An unlisted country is a country that is not listed in Schedule 10.

Attributable income of a listed country CFC

The attributable income of a CFC that is a resident of a listed country will include :

•       certain tainted income that is taxed at concessional rates in the listed country;

•       income from an unlisted country that is not taxed in the listed country; and

•       certain income that is derived, or treated as derived, from trusts.

The first type of income, called designated concession income, will be included in attributable income only if the CFC fails the active income test. A list of the income that is treated as taxed at concessional rates is contained in regulation 152D of the Regulations. The test which determines whether income is concessionally taxed in a listed country is contained in regulation 152C and is known as the 'subject to a reduction of tax' test. In other words, income is concessionally taxed if it is subject to a reduction of tax under the tax law of a listed country.

Attributable income of an unlisted country CFC

The attributable income of a CFC that is a resident of an unlisted country includes:

•       certain tainted income, if the CFC fails the active income test; and

•       certain income that is derived, or treated as derived, from trusts.


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