Executive summary
Introduction
On 10 October 2006 the former Treasurer asked the Board of Taxation to undertake a review of the foreign source income anti-tax-deferral rules. Following the announcement of the review, the Board conducted targeted consultations and, drawing from these consultations, developed a discussion paper, which was released on 25 May 2007.
Drawing on further consultations and submissions in response to the discussion paper, the Board released a position paper which set out the Board’s views on the high-level principles that should apply in the future design of the rules.
To assist in settling the detail underlying these principles, the Board released several issues papers which expanded on key topics in the Board’s position paper.
Since the foreign source income anti-tax-deferral rules were first introduced, globalisation has significantly affected the business environment faced by Australian businesses and seen them increasingly competing in the world economy. While integrity continues to be a feature of these rules, the Board wishes to ensure that the integrity objective is better balanced with other objectives such as efficiency, equity, simplicity and low compliance costs. These objectives are fundamental to ensuring that Australian businesses remain competitive.
The Board heard during consultations and from submissions that, while the concept of a single harmonised regime had some appeal, the merits of designing reforms around an existing framework in the controlled foreign company (CFC) rules carried far more appeal.
This report puts forward the Board’s final recommendations to the Government for consideration. These recommendations represent the Board’s considered views on the design of the foreign source income anti-tax-deferral rules going forward and have been developed through consultations with and submissions from industry and tax practitioners.
The Board’s key findings are:
- The CFC provisions are retained as the primary set of rules designed to counter tax deferral arrangements.
- The CFC provisions are 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 are retained, including the listed country and Australian financial institution subsidiary exemptions, and additional exemptions are introduced in certain circumstances for Australian listed public companies and 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.
- The CFC provisions are rewritten in the Income Tax Assessment Act 1997 (ITAA 1997).
- The foreign investment fund (FIF) provisions are 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.
- The transferor trust rules are retained with amendments to enhance their effectiveness and improve their integrity.
The Board’s specific recommendations are:
Recommendation 1
Retain the CFC provisions as the primary set of rules designed to counter tax deferral arrangements.
- Rewrite the rules into the Income Tax Assessment Act 1997.
- Apply the rewritten CFC rules to closely held fixed trusts.
- Amend the rules to ensure that non-common law entities that confer ownership rights cannot avoid the operation of the CFC rules.
Repeal the FIF and deemed present entitlement regimes.
Recommendation 2
Exempt Australian listed public companies from the rewritten CFC rules provided they satisfy at least one of the following eligibility criteria:
- A comparable worldwide effective tax rate rule.
- A sufficient distributions rule.
- A maximum worldwide passive income rule.
Recommendation 3
Retain and modernise the existing legal-based definitions of passive income by addressing the constraints of the eligibility criteria as set out in paragraphs 3.37 to 3.38.
Facilitate a group approach to determine eligibility for the CFC active income exemption.
Recommendation 4
Remove the base company income rules.
Develop express integrity rules only where they are clearly needed and justified.
Recommendation 5
Exempt complying superannuation funds from the CFC rules.
Recommendation 6
Allow taxpayers to choose from the branch-equivalent calculation, market value or deemed rate of return attribution methods.
Recommendation 7
Retain the tax laws approach for the CFC branch-equivalent calculations.
Recommendation 8
Repeal section 404 of the Income Tax Assessment Act 1936 and its attendant list.
Amend the non-portfolio dividend exemption in section 23AJ of the Income Tax Assessment Act 1936 by:
- allowing other equity-like features to be taken into account to demonstrate ownership (including rights to dividends, capital and returns upon winding-up); and
- precluding all debt-like interests.
Recommendation 9
Replace the current FIF rules with a specific anti-roll-up fund measure, with the broad design features of the measure being modelled on the principles set out in paragraph 3.90.
Recommendation 10
Remove the control requirement for pre-commencement and pre-resident transferor trusts.
For foreign entities with multiple resident transferors, base the amount of income attributed to each transferor on the respective value of the property or services they transfer to the foreign entity and that, where it is not possible to determine this value, the transferor is deemed to hold a 100 per cent interest in the foreign entity.
Consider further technical issues with the transferor trust rules as part of consultation on any draft legislation.
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