This Digest was prepared for debate. It reflects the legislation as
introduced and does not canvass subsequent amendments. This Digest
does not have any official legal status. Other sources should be
consulted to determine the subsequent official status of the
Taxation Laws Amendment (Foreign Income Measures) Bill
Date Introduced: 4 September 1997
House: House of Representatives
Commencement: Royal Assent
The main effect of the Bill will be to create lists that
represent countries with a compatible foreign income taxation
system as that operating in Australia and another, more extensive,
list of countries that has a taxation system such that tax paid in
that country will be eligible to be offset against tax payable in
respect of Controlled Foreign Companies payable in Australia. Under
the first list, income from Controlled Foreign Companies operating
in that country will be treated in such a manner as to ensure that
the income is treated more favourably with foreign tax being
treated as if Australian tax had been paid. The Bill also contains
provisions designed to reduce compliance costs and to take account
of changes in the composition of various countries.
As the name of the Bill suggests, the measures contained in the
Bill relate to the taxation of Australian residents on income
earned overseas. This area of the tax law is very complex due to
the large number of methods that can be used to disguise overseas
income and to use various overseas entities to channel funds so
that the calculation of the actual amount of income and its sources
are often very difficult. As a result of the complexity of the
various methods that may be used to minimise tax, the legislation
is correspondingly complex.
The foreign income taxation scheme depends on a number of key
Accrual taxation:This is a method of
calculating the income of a body, usually a trading company, that
is deemed to have earned income as it becomes due. This may be
contrasted with the system generally applicable to individuals
where income is taxed only upon receipt. Using the later method in
relation to companies, especially trading companies, would allow
the timing of the receipt of income to be manipulated to minimise
the tax payable, eg. through delaying the receipt of income to a
later financial year when lower income will be received.
Controlled Foreign Company (CFC):A CFC is, as
the term implies, a non-resident company in which Australian
resident entities have a sufficient interest to be considered to be
in control of the CFC. Associated interests are also included in
determining the degree of control in certain circumstances. The
definition of a CFC contained in section 340 of the Income Tax
Assessment Act 1936 (ITAA) provides that in general circumstances
control will be taken to be where 5 or fewer Australian entities
have control of at least 50% of the interests in the company, or
40% in certain circumstances where there is no other controller of
the company. The matters that may be taken into consideration when
determining whether an entity has a controlling interest include
voting rights in the company, the right to receive the
distributions (eg. dividends) from the entity and the right to the
capital of the company if it is wound-up. There are also
circumstances in which an Australian entity will be deemed to be in
control of a foreign company and Part X of the ITAA contains a
number of other provisions designed to prevent avoidance of the
rules relating to CFCs.
Similar rules will also apply to controlled foreign trusts and
partnerships to include such entities in the general regime
designed to prevent the use of low tax foreign entities to avoid
Australian tax. If such entities were not included in the regime,
it would be possible to arrange the flow of funds so that a trust
or partnership was used rather than a company to achieve the same
results of minimising the amount of Australian tax payable.
Listed Country:In relation to CFCs, the
Australian taxation of the entity depends on whether the country in
which the CFC resides is a listed or unlisted country. A listed
country is one which has been determined to have a taxation regime
that in substantially similar to Australia's in regard to the
prevention of avoidance by the use of low tax regimes. There are
currently approximately 60 countries which are defined to be listed
countries, although the list contains a number of countries which
have ceased to exist, such as the USSR, and is need of updating.
The question of whether all of the countries on the list truly have
comparable taxation regimes to Australia in relation to this issue
has also been asked and the major amendments contained in the Bill
relate to the status of listed countries (see below).
Tainted Income:As noted, the CFC regime is
designed to prevent the use of low tax countries to minimise
Australian tax. The measures are not directed at normal commercial
operations carried out overseas by Australian controlled companies
and there is a distinction between active and tainted income, with
the CFC regime applying principally to the later type of income.
Examples of tainted income include royalties, dividends and rent.
As tainted income is generally more portable than active income
(ie. it can be directed so that the country in which it is earned
can be reasonably easily changed to take advantage of lower tax
rates), tainted income is more often used in tax minimisation
schemes. The distinction between tainted and active income is
particularly important in relation to earnings in unlisted
countries, where the income is fully attributed to the Australian
controllers except to the extent that it is active income.
Foreign Tax Credits:The foreign tax credits
system (FTCS) provides that where foreign source income is included
in an Australian residents income, a credit is allowed for the
amount of foreign tax, if any, paid on the income overseas. In
relation to income from a CFC, depending on the status of the
country in which the country is earned and the nature of the
income, an amount will be attributed to the Australian resident.
The amount of tax payable on the income is then calculated and the
amount of tax payable is then reduced by the amount of foreign tax
paid. The FTCS does not apply where the foreign source income is
specifically exempt under Australian law, which are principally
dividend and branch profit income derived in a listed country. The
exemption is based on the foreign company having to pay comparable
tax as it is derived in a listed country.
Foreign Investment Fund:A foreign investment
fund (FIF) is a non-resident company or trust in which a resident
has an interest. Income of the FIF is attributed to the resident
based on the interest they hold in the FIF and, as with CFCs,
certain types of income, such as active income, are not attributed
to the taxpayer. The FIF regime is similar in effect to the CFC
regime but applies where the resident does not have a controlling
interest in the non-resident entity.
The current status of the foreign income tax rules was examined
in an Information Paper, titled Proposed Changes to the Taxation of
Foreign Source Income, released by the Treasurer in December 1996.
The first matter to be examined was the uses to which the list of
countries is put. As noted above, the list is used for both CFC and
FTCS purposes and the Information Paper found that this was
inappropriate as not all countries on the list had truly comparable
tax rates and systems and that the number of countries on the list
for CFC purposes should be reduced. It was not considered
appropriate to abandon the list as this would increase compliance
costs for people showing that they had been comparably taxed
overseas.(1) In relation to the use of the list for FTCS, the
Retaining a long list of countries for the purposes of exempting
distributions of income from the FTCS is considered acceptable.
These exemptions primarily apply to distributions of active income.
Providing this income has already been subject to comparable
taxation offshore, the risk to revenue and the economy from not
subjecting distributions of income to the FTCS is relatively
The result of this recommendation will be that the exemption of
dividend income for non-portfolio distributions and branch profits
will remain for those countries on the extended list (which is
substantially the same as the current list but takes into account
recent changes in certain countries and areas) while the more
liberal CFC rules will continue to apply to a reduced range of
listed countries where the taxation system is considered to be
truly comparable to Australia's. The use of the lists is, in the
opinion of the Information Paper, also designed to continue to
allow taxpayers with interests in listed countries to reduce their
compliance costs. However, the reduction of the list for CFC
purposes will increase compliance costs for those entities resident
in a country which has lost its listing status for CFC purposes.
The explanatory memorandum to the Bill estimates that: 'The initial
costs of compliance for companies and trusts in limited-exemption
listed countries [ie. those that are listed for FTCS purposes but
not for CFC purposes] is estimated to be less than $5
The Information Paper proposes that the list of countries for
CFC purposes will be Canada, France, Germany, Japan, New Zealand,
the United Kingdom and the United States. These countries are
considered to have a comparable CFC regime to Australia's and the
listing of these countries is also proposed on the basis that while
some of these countries have more relaxed rules for some categories
of tainted income, 'their listing .... would be justified given the
significant amount of Australian investment to those
In relation to the need to update the list of countries that
will continue to apply for dividends and branch profits, the
Information Paper foreshadows the renaming of countries to reflect
changes in the former Germanys, Soviet Union and Yugoslavia.
Transitional provisions were also envisaged to cope with the
situation where a country may maintain its listing status as a
former component of the Soviet Union or Yugoslavia but its future
status is in doubt due to changes in their tax laws since the
dissolution of the former countries. It is also envisaged that the
larger list will also be amended to include Vietnam and the Czech
Republic, with which Australia has recently signed a Double
Taxation Agreement (which deals with the rate of tax on a number of
sources of repatriated income and allows a degree of confidence
that the overseas tax system is compatible in regard to dividends
and branch profits).
Part 2 of Schedule 1 of the Bill will amend the ITAA to change
references of listed countries to references to broad exemption
listed country in the provisions listed in the Part. The amendments
are part of the creation of the two-list system with different uses
for the two lists as described above. Similarly, Parts 3 and 4 of
the Schedule will change references to unlisted countries to
non-broad-exemption listed countries.
Part 1 of the Schedule contains general amendments. Section 23AH
of the ITAA provides for certain foreign source income to be
exempt. This is basically where the income is derived from a
business in a listed country where the income is not eligible
designated concessional income. Items 1, 2 and 3 will amend this
section to provide for different treatment of income from the two
lists. The exemption will be removed for income that is not
adjusted tainted income, or active income,from limited exemption
Items 26 and 27 insert the definition of broad-exemption listed
country and limited-exemption listed country. The countries in each
group are to be fixed by regulation.
There are also provisions to reduce compliance costs, such as
the changes to the active income test, simplified methods for
calculating income of associated companies within a listed country
and transfer pricing rules will not apply to transfers between CFCs
in the same listed country.
Transitional provisions largely relate to the treatment of
countries from the former Soviet Union and Yugoslavia and the Czech
Republic and Vietnam.
- Proposed Changes to the Taxation of Foreign Source Income,
December 1996, p. 3.
- Ibid., p. 4.
- Explanatory memorandum, p. 8.
- Proposed Changes to the Taxation of Foreign Source Income,
December 1996, p. 5.
8 December 1997
Bills Digest Service
Information and Research Services
This paper has been prepared for general distribution to
Senators and Members of the Australian Parliament. While great care
is taken to ensure that the paper is accurate and balanced, the
paper is written using information publicly available at the time
of production. The views expressed are those of the author and
should not be attributed to the Information and Research Services
(IRS). Advice on legislation or legal policy issues contained in
this paper is provided for use in parliamentary debate and for
related parliamentary purposes. This paper is not professional
legal opinion. Readers are reminded that the paper is not an
official parliamentary or Australian government document.
IRS staff are available to discuss the paper's contents with
Senators and Members
and their staff but not with members of the public.
© Commonwealth of Australia 1997
Except to the extent of the uses permitted under the
Copyright Act 1968, no part of this publication may be
reproduced or transmitted in any form or by any means, including
information storage and retrieval systems, without the prior
written consent of the Parliamentary Library, other than by Members
of the Australian Parliament in the course of their official
Published by the Department of the Parliamentary Library,
Back to top