Commonwealth Numbered Regulations - Explanatory Statements

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INCOME TAX REGULATIONS (AMENDMENT) 1997 NO. 368

STATUTORY RULES 1997 No. 368

Issued by Authority of the Treasurer

INCOME TAX ASSESSMENT ACT 1936

Income Tax Regulations (Amendment)

GENERAL OUTLINE

Purpose of the amendments

Amendments of the Income Tax Regulations are required to give effect to changes to the rules for taxing foreign source income announced in the 1997/98 Budget. Broadly, the amendments will:

designate a list of seven countries (called "broad-exemption listed countries") for the purposes of exempting amounts from accruals taxation under the controlled foreign company (CFC) and transferor trust measures;

*        designate a list of "limited-exemption countries" which will be used together with the list of broad-exemption countries for the purposes of providing exemptions under the foreign tax credit system;

*        replace references to listed countries in the regulations with references to broad-exemption listed countries as required;

*        update Schedule 9 which specifies types of entities in listed countries that are likely to qualify for concessional tax treatment;

*        declare relevant provisions of New Zealand's rewritten taxation laws as "accruals tax laws" for the purposes of providing relief from double taxation;

*        repeal the list of approved country funds in Schedule 11 following the removal of the exemption from the foreign investment fund (FIF) measures for interests held in these country funds; and

*       update the list of approved stock exchanges which is used for the purposes of the FIF measures.

Unless otherwise stated, references to "the regulations" are to the Income Tax Regulations and references to the "Principal Act" are to the Income Tax Assessment Act 1936.

Matters covered by the regulations

Part 8A of the regulations and associated schedules deal with the taxation of foreign source income. The provisions:

*       contain rules for determining whether an amount is designated concession income (regulations 152A to 152E, 152G, 152I, and Schedule 9);

*       specify when capital gains are taken to have been subject to tax for the purposes of the CFC measures, the transferor trust measures and the exemption for branches of Australian companies in listed countries (regulations 152F and 152G);

*       declare those countries that are to be treated as listed (regulation 152J and Schedule 10);

*       set out the accruals tax laws of other countries that are recognised for the purposes of providing relief from double accruals taxation under section 456A of the Principal Act (regulation 152HA);

*       provide that Swiss Cantonal taxes are to be treated as Federal taxes for the purposes of the CFC measures (regulation 152K); and

*       specify amortisation rates, country funds, approved stock exchanges and qualifying sectoral classification systems for the purposes of the FIF measures (regulations 152L to 152P, Schedules 11, 12 and 13).

Overview of the changes to the rules for taxing foreign source income

Changes to the rules for taxing foreign source income were outlined in an Information Paper released by the Treasurer on 24 December 1996: The Government's final decisions were announced on Budget night (13 May 1997) by Treasurer's press release No.49 and "Budget Paper No.2: Budget Measures 1997-98". Amendments of the Principal Act giving effect to the changes were made by the Taxation Laws Amendment (Foreign Income Measures) Act 1997. Broadly the legislative changes:

*       limit exemptions from accruals taxation under the CFC and transferor trust measures to countries designated as broad-exemption listed countries (the exemptions are currently available for all countries listed in Schedule 10 of the regulations);

*        include measures to help reduce compliance costs under the CFC measures;

*       make a number of changes to the rules for taxing offshore permanent establishments (ie, branches) of Australian companies; and

*       make two minor changes to the FIF measures.

A number of consequential amendments are required to the regulations as a result of the above legislative changes. These amendments are discussed in the following section.

AMENDMENTS OF THE REGULATIONS TO GIVE EFFECT TO A TWO LIST APPROACH FOR TAXING FOREIGN SOURCE INCOME

Overview

Amendments of the regulations are required to create a list of broad-exemption countries. The list, comprising seven countries, will be used to determine whether amounts have been comparably taxed and should therefore be exempt from accruals taxation under the CFC or transferor trust measures (Part X and Division 6AAA of the Principal Act respectively).

Countries on the current list (Schedule 10) that are to be treated as listed for the purposes of the foreign tax credit system and not for accruals taxation purposes will be designated in the regulations as "limited-exemption listed countries". Countries on either the limited-exemption list or the broad-exemption list will be treated as listed for the purposes of the foreign tax credit system.

Terminology

The new terms for classifying countries will be defined in section 320 of the Principal Act which currently defines "listed" and "unlisted" countries. The new terms are summarised below.

Broad-exemption listed countries

The term "broad-exemption" reflects that amounts taxed at full rates by countries on the list are generally exempt from both accruals taxation and taxation on repatriation to Australia.

Limited-exemption listed countries

Limited-exemption listed countries are countries on the current list (with minor updating) other than the seven countries to be included on the list of broad-exemption listed countries. The term "limited-exemption" reflects that amounts which are taxed at full rates by countries on the list are generally exempt from tax on repatriation to Australia. An exemption from accruals taxation will not be available, however, on the basis that an amount has been taxed in a limited-exemption listed country.

Listed countries

Listed countries are countries on the list of broad-exemption countries or on the list of limitedexemption countries.

Unlisted countries

Unlisted countries are countries that are not on either list.

Non-broad-exemption listed countries Non-broad-exemption listed countries are countries that are not on the list of broad-exemption countries. They comprise unlisted countries or countries on the list of limited-exemption countries.

Listing of broad-exemption and limited-exemption countries

Changes to regulation 152J

Regulation 152J currently provides that countries specified in Schedule 10 are listed countries. A new Schedule 10 is to be inserted to specify broad-exemption and limited-exemption listed countries. Regulation 152J will therefore be amended to refer to both broad-exemption listed countries and limited-exemption listed countries and to the parts of new Schedule 10 where the lists can be found. [Regulation 7]

Creation of a list of broad-exemption countries

Part 1 of new Schedule 10 will specify the list of broad-exemption countries. The list will comprise:

Canada

France

Germany

Japan

New Zealand

United Kingdom of Great Britain and Northern Ireland

United States of America

[Regulation 9]

Creation of a list of limited-exemption countries

Part 2 of new Schedule 10 will specify the list of limited-exemption countries. The list will comprise countries on the current list that are not on the list of broad-exemption countries. The following countries will not be included following political developments in Central and Eastern Europe:

Czechoslovakia

German Democratic Republic

USSR

Yugoslavia

It will also be made clear that Hong Kong remains an unlisted jurisdiction following the establishment of the Hong Kong Special Administrative Region of the People's Republic of China on 1 July 1997. This will be achieved by inserting "(except the .Hong Kong Special Administrative Region)" after the reference to "China". The change is being made to remove uncertainty regarding the treatment of the Hong Kong Special Administrative Region from 1 July 1997.

The Czech Republic and the Socialist Republic of Vietnam will also be added to the list.

The list of limited-exemption countries will therefore comprise:

	Austria	Myanmar
	Bangladesh	Netherlands
	Belgium	New Caledonia
	Brazil	Norway
	Brunei	Pakistan
	Bulgaria	Papua New Guinea
	China*	Philippines
	Czech Republic	Poland
	Denmark	Portugal
	Fiji	Romania
	Finland	Saudi Arabia
	French Polynesia	Singapore
	Greece	Solomon Islands
	Hungary	Spain
	Iceland	Sri Lanka
	India	Sweden
	Indonesia	Switzerland
	Ireland	Taiwan
	Israel	Thailand
	Italy	Tokelau
	Kenya	Tonga
	Kiribati	Turkey
	Korea, Republic of	Tuvalu
	Luxembourg	Vietnam
	Malaysia	Western Samoa
	Malta	Zimbabwe

* The reference to China does not include the Hong Kong Special Administrative Region.

[Regulation 9]

Update of terminology in Part SA of the regulations

The amendments will replace references to "listed countries" with references to "broad-exemption listed countries" in provisions of the regulations dealing with the determination of designated concession income. [Regulation 8] The changes are being made because the concept of designated concession income will only be relevant for amounts derived by entities in broad-exemption listed countries. The provisions affected by the changes are summarised in the following table.

Table of provisions in which references to listed countries will be replaced with references to broad-exemption listed countries

Affected provision	Outline of the provision's effect
Regulation 152A	General definitions
Regulation 152B	Identification of capital gains
Regulation 152C	Rules for determining whether income or profits have been subject to a reduction of tax in a listed country
Regulation 152D	Rules for determining designated concession income
Regulation 152E	Identification of exempt capital gains
Regulation 152H	Amounts will not be treated as subject to a reduction of tax if foreign tax forgone on the amounts is regarded as having been paid under a double taxation agreement or by regulations made for the purposes of section 160AFF of the Principal Act
Regulation 152HA	Accruals tax laws recognised for the purposes of section 456A of the Principal Act which reduces attributable income for amounts taxed under an accruals tax law of another country
Regulation 1521	Links subregulation 152D(1) with the definition of designated concession income in section 317 of the Principal Act

Capital gains taken to have been subject to tax

There will be no change to references to "listed countries" in regulations 152F and 152G. These regulations will continue to be relevant for the purposes of determining whether capital gains derived in limited-exemption listed countries are subject to tax.

Definition of normal company tax rate

The amendments insert a new definition of "normal company tax rate" into subregulation 152A(2) to remove the special rules that currently apply for cantonal taxes paid in Switzerland. [Regulation 5] These rules are no longer required because Switzerland will not be a broad-exemption listed country. In this regard, the definition of normal company tax rate is used solely for the purposes of determining designated concession income which is only relevant for broad-exemption listed countries.

Removal of the reference to the accruals tax laws of Sweden in regulation 152HA

Section 456A of the Principal Act prevents double accruals taxation by reducing the attributable income of a CFC for amounts taxed under an accruals tax law of a listed country specified in regulation 152HA. This reduction is in future to be available only for accruals tax laws of broad-exemption listed countries. Paragraph (f) of regulation 152HA which refers to the accruals tax laws of Sweden will therefore be omitted because Sweden will not be on the list of broad-exemption countries. [Regulation 6]

Commencement

The amendments discussed above giving effect to a two list approach for taxing foreign source income (ie, regulations 5, 6, 7, 8 & 9) will apply from the time of amendments made by Schedule 1 of Taxation Laws Amendment (Foreign Income Measures Act 1997. [Regulation 10] The amendments made by the regulations will therefore apply from 1 July 1997 for the purposes of provisions in the following table.

7

Table of provisions for which the amendments made by regulations 5, 6, 7, 8 and 9 will apply from 1 July 1997

Affected provision(#)	Outline of the provision's effect	Items making the changes (*)
Section 23AH	Exemption for certain foreign branch profits of Australian companies	Subitems 120(3) & (4)
Section 23AJ	Exemption for non-portfolio dividends received by resident companies	Subitem 121
Sections 47A and 108	Deemed dividend rules for benefits provided by companies	Subitem 122
Division 18 of Part III	Calculation of a credit that can be claimed for foreign tax	Subitem 124(1)
Subsections 160M(1.2A), (12AB) and (12B)	Modifications to the rules for taxing the disposal of assets by a former CFC where the assets were held prior to the company becoming a resident of Australia	Subitem 125(1)
Section 160ZFB	Reduction of a capital gain derived by a CFC on disposal of a taxable Australian asset to the extent the gain has been taxed previously under section 457 of the Principal Act	Subitem 125(2)
Section 380	Rules for determining the extent to which a dividend paid to an Australian resident company can be exempt under section 23AJ of the Principal Act	Subitem 126(4)
Subsection 456(2)	Reduction of attributable income for amounts taxed under section 457 of the Principal Act	Subitem 126(6)
Section 457	Accruals taxation of a CFC's distributable profits where the CFC changes residence from an unlisted country to a listed country or Australia	Subitems 126(9) & (10)
Section 458	Accruals taxation of non-portfolio dividends paid by an unlisted country CFC to a listed country CFC (or to certain trusts and partnerships) where the dividends are not taxed in the listed country at the normal company tax rate	Subitem 126(11)
Section 459	Accruals taxation of deemed dividends under section 47A of the Principal Act that are taken to have been paid by an unlisted country CFC to a listed country CFC (or to certain trusts and partnerships)	Subitem 126(11)

(#)References are to provisions in the Principal Act.

(*)Item references are to provisions in Part 5 of Schedule 1 of Taxation Laws Amendment (Foreign Income Measures) Act 1997.

The amendments made by regulations 5, 6, 7, 8 and 9 will apply for statutory accounting periods of CFCs and years of income of transferor trusts commencing on or after 1 July 1997 for the purposes of the provisions in the following table relating to the accruals taxation of foreign income.

Table of provisions for which regulations 5, 6, 7, 8 and 9 will apply for statutory accounting periods of CFCs and years of income of transferor trusts commencing on or after 1 July 1997

Affected provision(#)	Outline of the provision's effect	Items making the changes(*)
Division 6AAA	The transferor trust measures attribute the income of a non-resident trust to an Australian resident who has, directly or indirectly, transferred value to the trust. An interest charge is also applied on distributions paid from low taxed profits accumulated in a non-resident trust.	Item 123
Provisions in Part X for the purposes of calculating attributable income	The Australian controllers of a CFC may be accruals taxed on certain income derived by the CFC	Subitem 126(1)
Sections 377 and 378	Rules for identifying and tracing profits that can be distributed by unlisted country companies as exempt dividends under section 23AJ of the Principal Act	Subitem 126(3)
Provisions in Part X relevant to determining the active income test	The active income test ensures that small amounts of tainted income derived by a CFC are exempt from taxation. An exemption is provided from accruals taxation for most amounts derived by a CFC if the test is satisfied Subitem 126(5)
Section 456A	Reduces attributable income for amounts that have been taxed under an accruals tax law of another country Subitems 126(7) & (8)

(#)References are to provisions in the Principal Act.

(*)Item references are to provisions in Part 5 of Schedule 1 of Taxation Laws Amendment (Foreign Income Measures) Act 1997.

Transitional arrangements in Taxation Laws Amendment (Foreign Income Measures) Act 1997 allow the consequential amendments of the regulations to take effect prior to the date they are notified in the Commonwealth Gazette (item 127 of Schedule 1 of the Act). This overrides the general rule in subsection 48(2) of the Acts Interpretation. Act 1901 that normally limits the circumstances where regulations can operate from an earlier date to instances where they do not disadvantage anyone.

The departure from the general rule is necessary to provide particulars of listed countries and designated concession income for the purposes of amendments made to the Principal Act by the Taxation Laws Amendment (Foreign Income Measures) Act 1997.

REVISED LIST OF CONCESSIONS SPECIFIED FOR BROAD-EXEMPTION LISTED COUNTRIES

The amendments will update Schedule 9 of the regulations which specifies types of entities in listed countries that are likely to qualify for concessional tax treatment. Income derived by these entities is treated as designated concession income if it is subject to a reduction of tax in a listed country (paragraph 152D(1)(c)).

The following entities are to be included in Schedule 9 from the time of notification in the Commonwealth Gazette. [Regulation 11]

Table summarising concessions to be designated in Schedule 9

Canada	An entity that operates in Canada as an international banking centre under a law of Canada.
Canada	An entity that operates in Canada as a non-resident owned investment corporation under a law of Canada.
France	An entity that operates in France as a headquarters or coordination entity, or as a logistics centre under a law of France or by virtue of an administrative arrangement with the French authorities.
France	An entity that operates in France as a societe d'investissement a capital variable (SICAV) or as a societe de capital risque (SCR) under a law of France.
Germany	An entity that operates in Germany as a headquarters or coordination entity under a law of Germany or by virtue of an administrative arrangement with the German authorities.

Schedule 9 can also be significantly shortened following the changes to the rules for taxing foreign source income because it will only be necessary to designate entities that are likely to be concessionally taxed in a broad-exemption listed country. References to entities in other countries will be removed from the Schedule from 1 July 1998. This will be achieved by inserting a new Schedule 9 which will comprise only the entities listed above. [Regulation 14]

UPDATE OF THE REFERENCE TO THE ACCRUALS TAX LAWS OF NEW ZEALAND IN REGULATION 152HA

The reference in Regulation 152HA to New Zealand's accruals taxation laws requires. updating following the rewrite of New Zealand's taxation laws. Regulation 152HA currently declares sections 245C to 245Q of the Income Tax Assessment Act 1976 of New Zealand as accruals tax laws for the purposes of providing relief from double taxation under section 456A of the Principal Act. New paragraph 152HA(ea) will be inserted to declare that the rewritten equivalent of these provisions (ie, paragraph CG 1(a) and sections CG 2 to CG 13 of the Income Tax Act 1994 of New Zealand) are accruals tax laws for the purposes of section 456A. [Regulation 3] The amendment will have effect from 1 April 1995 (ie, from the commencement of the Income Tax Act 1994 of New Zealand). [Subregulation 1.1]

CHANGES RELATING TO THE FIF MEASURES

Consequential changes following the repeal of the country fund

The amendments will repeal the list of approved country funds (Schedule 11) and also regulation 152M which refers to the list. These provisions are only relevant to the operation of the country fund exemption from the FIF measures (ie, section 513 of the Principal Act) which is to be repealed for notional accounting periods of FIFs commencing on or after 1 January 1997. [Regulations 12 & 13]

The repeal of Schedule 11 and regulation 152M will apply from 1 January 1998. The provisions will cease to have any practical effect from this time following the repeal of section 5 13 with effect for notional accounting periods of FIFs commencing on or after 1 January 1997.

Addition of new stock exchanges to the list of approved stock exchanges

The amendments will include the Bogota, Colombo, Zimbabwe and Bratislava stock exchanges on the list of approved stock exchanges (Schedule 12 of the regulations). The Belgrade stock exchange will also be listed under "Yugoslavia, Federal Republic of' following political developments in former Yugoslavia. [Regulation 4]

The list of approved stock exchanges serves two purposes. First, the value of FIF interests quoted on an approved stock exchange can be used as a valuation method for the market value method, one of three methods allowed under the FIF measures for determining FIF income. Secondly, the sectoral classifications provided by approved stock exchanges offer a simple method of qualifying for the active business exemption in the FIF measures.

The stock exchanges will be added to the list of approved stock exchanges with effect from 24 December 1996 (ie, from the time of announcement that the stock exchanges would be included on the list). The amendments will benefit taxpayers and can therefore apply prior to notification in the Commonwealth Gazette. [Subregulation 1.2]