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Tax Laws Amendment (Foreign Source Income Deferral) Bill (No. 1) 2010

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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)

 



T able 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

 



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



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.



C hapter 1     

Repeal of the foreign investment fund and deemed present entitlement rules

Outline of chapter

1.1                   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) .

1.2                   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.

1.3                   This chapter explains:

•        the effect of the repeal on certain areas of the taxation law; and

•        the consequential amendments.

1.4                   All legislative references are to the ITAA 1936 unless otherwise stated.

Context of amendments

1.5                   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).

1.6                   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.

1.7                   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.

1.8                   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.

1.9                   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

1.10               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.

1.11               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 

1.12               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.

1.13               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.

1.14               This Schedule repeals the FIF rules and the deemed present entitlement rules in relation to the 2010-11 and later income years.   [Schedule 1, item s 9 and 37, Part XI and sections 96B and 96C]

Section 96A

1.15               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.

1.16               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).

1.17               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).

1.18               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.

1.19               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

1.20               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.

1.21               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. 

1.22               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]

1.23               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

1.24               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.

1.25               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

1.26               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.

1.27               This Schedule inserts new section 23B to preserve the effect of section 613.  [Schedule 1, item 7, section 23B]

1.28               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

1.29               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

1.30               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.

1.31               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

1.32               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. 

1.33               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

1.34               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

1.35               This Schedule amends subsections 830-10(2) and 830-15(5) to maintain an election made under subsection 485AA(1) prior to its repeal.

1.36               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

1.37               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.

1.38               Similarly, subsection 830-15(1) provides that certain companies are foreign hybrid companies where the conditions in that subsection are met.

1.39               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).

1.40               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. 

1.41               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)]

Example 1.1

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.

Example 1.2  

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

1.42               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)]

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)]

1.44               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

1.45               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

1.46               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

1.47               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

1.48               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]

1.49               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)]

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]

1.51               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)]

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]

1.53               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]

1.54               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]



 

C hapter 2     

Regulation impact statement

Background

2.1                   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.

2.2                   The attribution rules provide integrity to Australia’s residence based taxation system whereby Australian residents, in general, are taxable on their worldwide income.

2.3                   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.

2.4                   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.

2.5                   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

2.6                   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.

2.7                   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.

2.8                   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.

2.9                   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.

2.10               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.

2.11               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

2.12               In light of the problems and issues outlined above, the former government announced on 10 October 2006, a review of the attribution rules.

2.13               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.

2.14               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.

2.15               In September 2008 the Board handed to Government its report which contained recommendations to address the terms of reference.

Implementation

2.16               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).

2.17               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.

2.18               The Government decided not to proceed with the Board’s recommendation of a listed public company exemption.

2.19               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

2.20               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. 

2.21               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). 

2.22               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

2.23               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. 

2.24               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

2.25               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.

2.26               For these taxpayers compliance cost reductions will occur as a result of the introduction of improved exemptions.

2.27               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. 

2.28               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.)

2.29               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. 

2.30               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

2.31               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.

2.32               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.

2.33               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

2.34               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.

2.35               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

2.36               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

2.37               The Board conducted extensive consultation with stakeholders throughout the review process. 

2.38               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.

2.39               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. 

2.40               Further, targeted consultations were also held with particular taxpayers throughout the review period.

2.41               Written submissions were also sought by the Board in response to their discussion paper and, again, in response to their position and issues papers. 

2.42               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.

2.43               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.

2.44               Stakeholders were also in agreement in seeking more modern, high level exemptions; and a range of exemption options.

2.45               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.

2.46               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.

2.47               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

2.48               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).

2.49               The above analysis shows that this approach would result in significant compliance cost savings for affected taxpayers when compared to the existing regimes. 

2.50               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

2.51               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.

2.52               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.

2.53               Once introduced, the Treasury and the ATO will monitor this taxation measure on an ongoing basis.

 



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 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

1.48

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 96C

1.14

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

1.53

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)

1.49

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

1.50

Items 40 to 46, sections 10-5, 11-55 and 12-5 of the ITAA 1997

1.54

Item 49, subsection 230-460(12)

1.31

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

1.52

Item 62, subsection 768-533(1)

1.33

Items 75 to 78, subsections 830-10(1) and (2), and subsections 830-15(1) and (5)

1.41

Items 76, 78 and 96, subsections 830-10(2) and 830-15(5)

1.36, 1.47

Items 88 to 91, subsections 401(1) and (3), subsections 461(1) and (3)

1.29

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