Bills Digest no. 159 2009–10
Tax Laws Amendment (Foreign Source Income Deferral) Bill
(No. 1) 2010
WARNING:
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
Bill.
CONTENTS
Passage history
Purpose
Background
Financial implications
Main provisions
Contact officer & copyright details
Passage history
Tax Laws Amendment (Foreign Source Income
Deferral) Bill (No. 1) 2010
Date introduced: 13 May 2010
House: House
of Representatives
Portfolio: Treasury
Commencement: Sections 1–3, and
Parts 1 and 3 of Schedule 1 commence on Royal
Assent; Part 2 of Schedule 1 commences
retrospectively immediately after the commencement of Schedule 1 to
the Tax Laws Amendment (Repeal of Inoperative Provisions) Act
2006.[1]
Links: The
links to the Bill, its Explanatory Memorandum and second
reading speech can be found on the Bills page, which is at http://www.aph.gov.au/bills/.
When Bills have been passed they can be found at ComLaw, which is
at http://www.comlaw.gov.au/.
The Bill repeals the foreign
investment fund provisions and the deemed present entitlement rules
in the Income Tax Assessment Act 1936 (ITAA 1936) as part
of a general review of the accruals taxation system.[2] The rules will be
replaced with a more narrowly defined anti-avoidance rule that
targets Australian residents’ foreign source income while
also encouraging Australian investment in foreign investment
funds.
There are three main types of rules in the accruals taxation
system: the foreign investment fund (FIF) measures; the transferor
trust measures; and the controlled foreign company (CFC)
rules. As the Bill only deals with the FIF measures (and the
related ‘deemed present entitlement’ (DPE)
rules for foreign trusts), the discussion in this Digest will
be confined to those rules.
A FIF is a foreign company or a foreign trust. The FIF
provisions are contained in Part XI of the ITAA 1936 (sections 469
to 624), which deals solely with ‘foreign investment funds
and foreign life assurance policies’. The FIF
provisions are designed to reduce tax avoidance opportunities and
apply to Australian residents who accumulate passive income in
offshore investment funds over which they have no control (often in
low tax or tax-free countries). The FIF provisions are
intended to reduce the opportunity for Australian resident
investors to minimise or defer the payment of Australian taxation
on those foreign source earnings (particularly if the taxpayer is
able to convert the income into capital gains).[3]
The FIF measures apply to a taxpayer who was an Australian
resident at any time in a particular income year and had an
interest in either a FIF at the end of the income year (or at any
time during the income year) or an interest in a foreign life
assurance policy (FLP) at any time during that income year.
However, instead of the usual income year period, a taxpayer may
elect to use the period covered by the FIF’s annual accounts
as a notional accounting period (noting that the financial or
income years of many countries do not commence on 1 July and
therefore do not issue the necessary financial statements on 30
June each year).[4] If the taxpayer was an Australian resident for the
whole of the income year (or the notional accounting period), the
taxpayer’s assessable income (for Australian income tax
purposes) must include the whole of the FIF income which accrued to
the taxpayer during that period. If the taxpayer is an
Australian resident for only part of the income year (or notional
accounting period), only a proportion of the taxpayer’s FIF
income is included in the taxpayer’s assessable
income.[5]
The taxpayer’s FIF income is calculated by one of three
methods:[6] the
market value method;[7] the deemed rate of return method;[8] or the calculation method.[9] The
taxpayer’s FIF amount must be converted into Australian
currency before being included in the taxpayer’s assessable
income.[10]
Other legislative measures apply to prevent the deferral of
Australian tax on trust income accumulated in a non-resident trust
for the benefit of an Australian resident beneficiary. If an
Australian resident taxpayer has a beneficial interest in a
non-resident trust, the ‘deemed present entitlement’
rules apply. The taxpayer is deemed to be presently entitled
to any income of the trust which can be legally available for
distribution to the taxpayer (under the trust deed and relevant
law), even though the trustee may not actually be able to
distribute the income at the relevant time.[11] The taxpayer is assessed to pay
tax on his or her share of the net income of the trust.[12]
The Government announced its intention to reform the foreign
source income anti-tax-deferral (attribution) rules in the
2009–10 Budget.[13] The announcement follows a lengthy review by the
Board of Taxation (the Board) of the foreign source
anti-tax-deferral regimes. The review was initiated by the
Howard Government on 10 October 2006 and involved targeted
consultations and a discussion paper that was released on 25 May
2007. The Board also released a position paper and several issues
papers too. Finally, in September 2008, the Board released
its report to the Assistant Treasurer and Minister for Competition
Policy and Consumer Affairs.[14]
In relation to the FIF provisions, the Board recommended that
the FIF provisions be repealed and replaced with ‘specific
anti-roll-up fund measures targeting accumulation funds that
reinvest interest-like returns’.[15] It also recommended that
closely held fixed trusts should be brought into the controlled
foreign company (CFC) rules and that the deemed present entitlement
rules should be repealed.[16]
The Board’s recommendations demonstrate a desire to
increase Australia’s attractiveness as a financial services
hub (by enhancing Australia’s offshore investment and
encouraging Australian businesses to be more productive and
competitive) and reduce compliance costs for the managed funds
industry and other investors. In this regard, the Board
commented:
The reforms proposed by the Board will ensure
Australia has a world-class attribution regime and that the
reformed rules keep abreast of changes occurring in the global
business environment. The proposals will provide significant
scope to reduce red-tape and compliance costs while maintaining the
integrity of Australia’s tax base. In particular:
- The recommendations will have a positive impact on
Australia’s offshore investment performance and enhance the
productivity of Australian businesses and improve their
international competitiveness.
- The managed funds industry and other investors affected by the
FIF rules will achieve significant reductions in compliance
costs. This is consistent with the Government’s
commitment to develop Australia as a financial services hub and to
cut red-tape.
- The modernisation of the active/passive definitions will
benefit Australian businesses operating offshore by reducing their
compliance costs and improving their competitiveness and
productivity in global markets.
- The repeal of the FIF rules in conjunction with the relocation
of the CFC rules into the [Income Tax Assessment Act 1997]
will provide scope to both simplify the tax law and take a
significant step towards consolidating the two income tax
Acts.[17]
On 18 December 2009, Senator Nick Sherry (Assistant Treasurer)
released exposure draft legislation for public
consultation.[18] The Treasury received eight written submissions
but also conducted consultations and discussions with key
stakeholders and interested parties, most of whom support the
repeal of the FIF provisions.[19]
On 13 May 2010, the Senate Selection of Bills Committee resolved
to recommend that the Bill not be referred to a committee.[20]
The Government estimates that the financial impact of the repeal
of the FIF measures is ‘unquantifiable but not
significant’.[21] It also estimates that there will be
‘overall medium’ compliance cost savings to affected
taxpayers compared with compliance costs under the current
rules. In this regard, the Government estimates that there
will be a start-up cost impact of between $40 million and $80
million, offset by a decrease in ongoing compliance costs of
between $40 million and $80 million per annum.[22]
Item 7 repeals existing section 23AK of the
ITAA 1936 and substitutes proposed
section 23AK in its place. Both provisions are
intended to prevent double taxation in relation to amounts paid out
of attributed FIF income. Such amounts are exempt from
taxation to the extent of any attribution surplus in the relevant
FIF attribution account. The revision to section 23AK is
consequential upon the repeal of the FIF rules.
Proposed section 23AK will ensure that
amounts previously taxed under the FIF rules will continue to be
exempt from further taxation if it is further distributed.
Similarly, item 7 also inserts proposed
section 23B which deals with the situation where the
income of the FIF has been attributed but not distributed before
the disposal of the taxpayer’s interest in the FIF. It
largely replicates current section 613 of the ITAA, which ensures
that proceeds from a capital gain are reduced where the taxpayer
has an attribution surplus in relation to the particular
FIF.[23]
Item 9 repeals current sections 96A, 96B and
96C of the ITAA 1936. Section 96A is intended to avoid double
Australian taxation in relation to foreign source income derived
under a FIF. It specifically excludes from the assessable
income of a presently entitled Australian resident beneficiary of a
non-resident trust, the beneficiary’s share of net income of
a trust which is otherwise attributable under the (current) FIF
measures. As mentioned earlier in this Digest, sections 96B
and 96C set out the deemed present entitlement rules.
Item 37 repeals Part XI of the ITAA 1936 in its
entirety.
The balance of the items in Schedule 1 to the
Bill makes consequential amendments to the ITAA 1936, the
Income Tax Assessment Act 1997 and the Superannuation
Industry (Supervision) Act 1993. Some of these
provisions warrant some discussion here.
Item 49 amends Division 230 of the ITAA 1997,
which deals with the taxation of financial arrangements (unless
specific exceptions apply). Currently, Division 230 does not
apply to interests in FIFs (including CFC interests) and foreign
life assurance policies. However, following the proposed
repeal of the FIF rules, Division 230 needs to be amended so
interests in FIFs are no longer exempt from its operation.
The ‘direct participation interests’ of an attributable
taxpayer in a CFC will continue to be exempt from the operation of
Division 230.
Under current section 559A of the ITAA 1936, a taxpayer may
(provided certain conditions are met) elect to have his or her FIF
income calculated by using the CFC provisions in Part X of the ITAA
1936.[24]
Following the repeal of section 559A (as part of the general repeal
of Part XI of the ITAA 1936), item 62 amends
existing section 768 of the ITAA 1997 to ensure that taxpayers can
continue to take advantage of the election.[25]
Items 75–78 amend sections 830-10 and
830-15 of the ITAA 1997. These provisions treat certain
partnerships and companies as foreign hybrids, with the result they
are taxed like partnerships. The amendments are required
following the repeal of section 485AA of the ITAA 1936, which
deals with the right of taxpayer to elect to exclude interests in
foreign hybrids from the operation Part XI of the ITAA
1936.[26] The
Explanatory Memorandum provides two useful examples of the
operation of the revised provisions.[27]
Members, Senators and Parliamentary staff can obtain further
information from the Parliamentary Library on (02) 6277 2795.
Morag Donaldson
1 June 2010
Bills Digest Service
Parliamentary Library
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