Commonwealth Numbered Regulations - Explanatory Statements

[Index] [Search] [Download] [Related Items] [Help]

INCOME TAX AMENDMENT REGULATIONS 2004 (NO. 3) 2004 NO. 115

Section 266 of the Income Tax Assessment Act 1936 (the Act) provides that the Governor-General may make regulations not inconsistent with the Act or the Income Tax Assessment Act 1997 (ITAA 1997), prescribing all matters which by the Act or the ITAA 1997 are required or permitted to be prescribed, or which are necessary or convenient to be prescribed for giving effect to the Act or the ITAA 1997.

The purpose of the amending regulations is to improve the international competitiveness of Australian companies with operations in seven countries which have comparable tax systems to Australia's, and are prescribed in Part 1 of Schedule 10 to the Income Tax Regulations 1936 (the Principal Regulations). These countries are Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States. For companies operating in these countries, the amending regulations will reduce compliance costs, and increase commercial flexibility.

These benefits are achieved by the regulations more precisely identifying highly mobile income and profits that are concession ally taxed in those countries. In general only these identified amounts are subject to Australian tax on an annual basis (whereas for other countries a wider range of income is taxable). This approach replaces the broad-brush method adopted in the previous regulations.

Concession ally taxed income in the seven countries is referred to in the Act as 'designated concession income' (DCI). DCI is relevant for the controlled foreign companies rules in Part X, rules relating to offshore permanent establishments in section 23AH, and the transferor trust rules in Division 6AAA of Part III of the Act. These provisions ensure that highly mobile income earned by Australian residents through such entities located in another country does not avoid tax.

DCI is defined in section 317 of the Act as income or profits of a kind specified in the regulations, where no foreign tax is payable or (reduced) tax is payable because of a feature of the tax law of the foreign country specified in the regulations. Part 8A, Foreign Income, of the Principal Regulations specifies those amounts of income or profits that are DCI.

Under the previous arrangements, taxpayers had to identify all income or profits from operations in the seven countries that fell within two general classes and one specific class of DCI. Such income or profits had then to be re-examined to determine whether it met tests of 'subject to a reduction in tax' or 'exempt from tax'. This was a compliance intensive process, and inhibited commercial flexibility.

These amendments remove the two general classes of DCI. The specific aspects of the seven countries' tax systems that are identified as integrity risks are individually listed. Nearly all information a taxpayer requires to determine the DCI of its operation in one of the countries is contained within a Schedule to the regulations. This will allow taxpayers to more readily and directly identify any DCI.

The amendments also simplify the current regulations and remove some anomalies.

Details of the specific amendments are in the Attachment.

Details on the compliance impacts of the measure are available in the Board of Taxation's International Taxation - A Report to the Treasurer available at www.taxboard.gov.au. These amendments substantially implement Recommendation 3(a) of the Board.

The changes to the regulations have an estimated cost to the revenue of $10 million per annum from 2005-2006 onwards.

The Regulations commence on 1 July 2004, and apply to statutory accounting periods, accounting periods and years of income beginning on or after 1 July 2004.

ATTACHMENT

Details of the Income Tax Amendment Regulations 2004 (No. 3)

Regulation 1

Regulation 1 sets out the name of the regulations as the Income Tax Amendment Regulations 2004 (No. 3).

Regulation 2

Regulation 2 provides that the regulations commence on 1 July 2004.

Regulation 3

Regulation 3 provides that the Income Tax Regulations 1936 are amended by Schedule 1. Schedule 2 amends those regulations as modified by Schedule 1.

Regulation 4

Regulation 4 provides that the Schedule 1 and 2 amendments apply to accounting periods, statutory accounting periods and years of income commencing on or after 1 July 2004.

Statutory accounting periods relate to controlled foreign companies (CFCs), and are the applicable period in the majority of cases where the amendments apply. The inclusion of accounting periods and years of income relate to other cases where the amendments can apply; in particular, permanent establishments and trusts.

Schedule 1 - Amendments

Item 1

Item 1 inserts a new Division heading 'Division 1 General'.

Item 2

Item 2 substitutes a definition of 'CGT asset' for 'asset'. 'Asset' and 'CGT asset' have the same meaning, but 'CGT asset' is the term used for the current capital gains tax provisions in the Income Tax Assessment Act 1997.

Item 3

Item 3 substitutes the term 'CGT asset' for the first use of 'asset' within the definition of 'compulsory acquisition'.

Item 4

Item 4 removes from sub regulation 152A(2) a number of definitions not used in the amended regulations. These definitions are no longer required given the removal of the general classes of designated concession income (DCI).

Item 5

Item 5 removes further definitions from subregulation 152A(2) that are no longer required given the removal of the general classes of DCI.

The most significant of these is the term 'relevant period'. This was previously used to encompass three different time periods used in relation to DCI in the Act. However, as the Act specifies the relevant period wherever it refers to DCI, it is unnecessary to also do so in the regulations. The amended regulations generally specify that an item is DCI, and leave determination of the relevant time period to the relevant section of the Act.

Item 5 also inserts a definition of 'wholly-owned group'. This replaces the 'group company' definition in the previous subregulation 152G(3), that referred to subsections in the Act that had previously been repealed (see item 8).

Item 6

Item 6 removes subregulations 152A(3) and (4). These subregulations are unnecessary as the definitions they relate to have been repealed.

Item 6 substitutes new subregulations 152A(3) and (4) that relate to terms previously located elsewhere in the regulations.

Subregulation 152A(3) defines 'capital gains', a term used in the new subregulation 152A(4) and Schedule 9.

Although capital gains are no longer a general category of DCI (as under previous paragraph 152D(1)(a)), the definition of 'capital gains' is still necessary for several specific items of income now listed as DCI.

The amended definition is based on the definition of 'capital gains' in the previous regulation 152B. That definition has been modified to clarify that it refers only to capital gains according to ordinary concepts, rather than to capital gains that would be determined by, for example, Part 3-1 of the Income Tax Assessment Act 1997. This is not intended to be a change in meaning from the previous regulations. Rather it is included to remove any doubt that may have arisen from certain Federal Court decisions (see final appeal decision, Dismin Investments Pty Ltd v Federal Commissioner of Taxation [2001] FCT 690).

As in the previous regulations, this ordinary concept of capital gains has no application beyond identifying an amount as DCI.  After that is done, the capital gains tax provisions (as modified by Part X of the Act if relevant) will operate to determine whether any part of the identified DCI that is also adjusted tainted income gives rise to (notional) assessable income.

Subregulation 152A(4) modifies the term 'passive income' for the purposes of Schedule 9. 'Passive income' is defined in section 446 of the Act. However, paragraph 446(1)(k) refers to 'net gains', a concept defined in section 445 of the Act. This definition is substantially different to the 'capital gains' definition in subregulation 152A(3). Subregulation 152A(4) therefore substitutes the Subregulation 152A(3) definition of 'capital gains' into the definition of 'passive income'.

Subregulation 152A(4) also ensures that the timing and entity references in the 'passive income' definition in section 446 (and related provisions) relate to all parts of the Act where the DCI definition is relevant. Section 446 refers to 'company' and 'statutory accounting period', the terms relevant for CFCs. Subregulation 152A(4) ensures that the section (and related provisions) can be meaningfully applied to determine DCI in respect of transferor trusts under Division 6AAA, and permanent establishments under section 23AH of the Act. These provisions use the term eligible designated concession income, a subset of DCI.

Item 7

Item 7 inserts a new Division heading 'Division 2 Controlled foreign companies'. All regulations primarily relating to CFCs are placed within this Division.

Item 8

Item 8 substitutes previous regulations 152B to 152H with new regulations 152B to E. The new regulations replace, or partially replace, previous regulations 152D, 152F, 152G and 152J.

Previous regulation 152B was the definition of 'capital gains', now primarily incorporated in new subregulation 152A(3), and in part in new subregulation 152B(2).

Previous regulations 152C and E have no equivalent in the amended regulations. These regulations contained concessional tax tests that were in effect substantially similar to tests in Part X of the Act. Where it is necessary to use such a concessional tax test in Schedule 9, the Part X tests are used as appropriate.

Previous regulation 152H has also been omitted. This regulation has no relevance in the amended regulations as the general class of DCI it related to has been removed.

Regulation 152B       Income or profits as designated concession income

New regulation 152B replaces previous regulation 152D to the extent that it provides the link between the definition of DCI in section 317 of the Act and the list of DCI items in Schedule 9.

The remainder of previous regulation 152D concerned general classes of profits identified as DCI. These classes will no longer be used to identify DCI and are not replicated in the amended regulations.

Subregulation 152B(1) identifies as DCI the items set out in new Part 2 of Schedule 9 (see item 11), with the table identifying for each individual item of DCI:

•       the particular listed country (in column 2);

•       the type of entity in respect of that country (column 3);

•       the kind of income or profits of the specified entity (in column 4); and

•       the feature of the country's tax system applying to those income or profits (in column 5).

Subregulation 152B(2) ensures that, where relevant, DCI includes income or profits from an entity's interest in a partnership, or beneficial interest in a trust estate. It is particularly relevant to paragraphs 385(2)(c) and (d) of the Act.

Regulation 152C       Broad-exemption listed countries and limited-exemption listed countries

Regulation 152C is equivalent to previous regulation 152J. Subregulations 152C(1) and (2) link the definition of 'broad-exemption listed country' and 'limited-exemption listed country' in subsection 320(1) of the Act to the actual lists of countries in Part 1 and Part 2 of Schedule 10.

Regulation 152D       Capital gains regarded as subject to tax

Regulation 152D is equivalent to previous regulation 152F and operates in substantially the same manner. Pursuant to subsection 324(2) of the Act, it extends the subject to tax test in section 324 to include certain roll-over relief situations.

A capital gain will be taken to be subject to tax for the purposes of section 324 where the gain would have been subject to tax but for the tax law of the relevant country deferring a tax liability in circumstances of the kind specified in new regulation 152E. As for the previous regulation 152F, it is not necessary that the roll-over relief results in the same future tax liability, or that the same entity be liable to pay the future tax.

The previous regulation 152F also contained a separate definition of capital gains, and this has been maintained in subregulation 152D(1).

Regulation 152E       Circumstances specified for the definition of roll-over relief in Regulation 152D

Regulation 152E is equivalent to previous regulation 152G and operates in the same manner. It has been slightly rewritten and terms have been updated. For example 'CGT asset' replaces 'asset', and 'wholly-owned group' replaces 'group company' (see items 2 and 5).

As for the previous regulations, the circumstances outlined in regulation 152E relate generally to the type of roll-over provisions available for capital gains tax purposes under Australian tax law.  A country's tax law may contain a particular roll-over relief provision that is similar, but more extensive than its Australian equivalent. 

In this case,  a particular roll-over event will still fall within regulation 152D if the circumstances are as described in regulation 152E.  If the circumstances in respect of which the roll-over in the relevant country is allowed are different to those described in regulation 152E, then the roll-over will not be regarded as being 'subject to tax'.  

Example A:  A relevant country's tax law contains a provision allowing roll-over relief for transfers between companies with 75 per cent common ownership. If a company group has 100 per cent common ownership, and obtains roll-over relief under the provision, it will fall within the circumstances outlined in paragraph 152E(b).  However, if a group with 80 per cent common ownership obtains roll-over relief under the provision, it will not fall within paragraph 152E(b).

Item 9

Item 9 omits regulations 152I and 152J.

Previous regulation 152I is not necessary as new subregulation 152B(1) and new Part 2 of Schedule 9 fulfil its function in the amended regulations.

Previous regulation 152J linked the definition of 'broad-exemption listed countries' and 'limited-exemption listed countries' in subsection 320(1) of the Act to the actual lists of countries in Part 1 and Part 2 of Schedule 10. These provisions have been replicated in new regulation 152C (see item 8).

Item 10

Item 10 inserts a new Division heading 'Division 3 Foreign investment funds'. All regulations primarily relating to foreign investment funds are placed within this Division.

Item 11

Item 11 inserts a new Schedule 9.

Part 1 of the Schedule makes it clear that, unless the contrary intention appears, words and phrases in the Schedule have the same meaning as they have in Part X of the Act or Part 8A of the regulations.

In particular, it is noted that the meaning of the expression 'subject to tax' is to be found in section 324 of the Act, whereas section 325 explains when an amount is taxed in a particular country at the normal company tax rate of that country (for example, Canada in item 202 of Part 2 to the Schedule).

(Note that in new Schedule 9 the tests in section 324 and 325 are employed in a negative manner. So, for example, in item 201 of Part 2 of the Schedule, the reference is to "Not subject to tax in Canada in a tax accounting period". If the relevant kind of income or profit is subject to tax, as explained by section 324, in any tax accounting period, then the required feature is not present and the item is not DCI.)

Part 2 of the Schedule itemises DCI. The table below provides a brief explanation for the inclusion of each item.

Item	Summary of the concessional tax treatment that has resulted in an item being identified as DCI
201	Canada: international banking centres (IBCs) IBCs were listed in the previous Schedule 9 as specific DCI. Interest income derived in respect of an IBC from loans to non-residents is exempt from tax in certain circumstances.
202	Canada: investment corporations and mutual fund corporations Investment corporations can deduct from their tax otherwise payable 20 per cent of the amount by which their taxable income exceeds their taxed capital gains. Mutual fund corporations (which may also qualify as an investment corporation) receive a refund of tax for dividends paid out of realised capital gains.
203	France: société d'investissement à capital variable (SICAVs) SICAVs were listed in the previous Schedule 9 as specific DCI. SICAVs are exempt from tax on their portfolio income.
204	France: tonnage taxed income Tonnage tax is a tax based upon shipping tonnage, rather than income or profits related to the shipping. Tonnage tax rates are generally set to provide a significantly concessional tax outcome.
205	Germany: passive income of a permanent establishment Several of Germany's tax treaties provide an exemption from German tax for the income, including in some cases passive income, of German companies from their permanent establishments outside of Germany.
206	Germany: capital gains on shares Germany generally exempts from tax capital gains on the disposal of shares by a company, but with five per cent of the gain added to the tax base as a non-deductible business expense.
207	Germany: tonnage taxed income Tonnage tax is a tax based upon shipping tonnage, rather than income or profits related to the shipping. Tonnage tax rates are generally set to provide a significantly concessional tax outcome.
208	Japan: governmental bonds Interest on Japanese government bonds received by qualified non-residents (including in respect of such a non-resident carrying on a business in Japan through a permanent establishment) is tax exempt.
209	New Zealand: capital gains New Zealand has no general capital gains tax.
210	United Kingdom: substantial shareholding exemption Companies resident in the United Kingdom are exempt from United Kingdom capital gains tax on the disposal of a non-portfolio interest in another company where certain conditions are satisfied. This item only applies in certain conditions to capital gains that benefit from the exemption. These conditions are discussed in more detail below.
211	United Kingdom: tonnage taxed income Tonnage tax is a tax based upon shipping tonnage, rather than income or profits related to the shipping. Tonnage tax rates are generally set to provide a significantly concessional tax outcome.
212	United Kingdom: open-ended investment companies (OEICs) OEICs are exempt from tax on capital gains, and taxed at 20 per cent on other income. In addition, OEICs that hold mostly debt securities can distribute this taxable income as deductible distributions, meaning that they are effectively exempt from tax in the United Kingdom. Such distributed amounts may not be subject to Australian tax (for example, because of the availability of an exemption under section 23AJ of the Act).
213	United States of America: tax-exempt governmental bonds Interest paid by a state or municipality of the United States of America is generally tax exempt.
214	United States of America: regulated investment companies (RICs) RICs receive a tax deduction for dividends paid, and accordingly do not usually pay tax themselves. Such distributed amounts may not be subject to Australian tax (for example, because of the availability of an exemption under section 23AJ of the Act).

Items 206, 208, 209 and 213

Items 206, 208, 209 and 213 identify as a relevant entity in column 3 an entity (or company) in carrying on a business in a country at or through a permanent establishment of the entity in that country.

The kind of income or profit identified in column 4 of those items is only that kind of income or profit that relates to the carrying on of a business in the country at or through a permanent establishment in the country. The entity may have income or profit of the relevant kind but not related to the permanent establishment, and hence not DCI unless elsewhere specified.

Item 210, United Kingdom: substantial shareholding exemption

Item 210 identifies as DCI the capital gains of United Kingdom resident companies in respect of shares in companies, where those gains benefit from the United Kingdom substantial shareholding exemption, and subject to certain conditions. Those conditions limit the scope of the item to an area of specific integrity concern.

In general, the exemption of gains under the United Kingdom's substantial shareholding exemption does not raise significant integrity concerns as there is considerable overlap with the capital gains tax (CGT) concession on the disposal of active foreign companies contained in the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004.

However, the Australian CGT concession will generally not apply to the extent that the foreign company whose shares are disposed of has CGT assets, or underlying CGT assets, that have (subject to certain modifications) the necessary connection with Australia. The United Kingdom substantial shareholding exemption is not limited in this way.

The conditions in item 210 therefore focus on whether the company whose shares are being disposed of has CGT assets with the necessary connection with Australia (in the way described in section 136-25 of the Income Tax Assessment Act 1997 - see subsection 6(1) of the Act), or underlying CGT assets with such a connection held through one or more entities. (The meaning of entity is explained in section 317 of the Act, and associate in section 318.)

Examples of where an underlying CGT asset may be held through another entity include when an entity holds shares in the other entity, or is a partner, or has a beneficial interest in a trust estate of which the other entity is the trustee. An entity could also hold an underlying interest in a CGT asset through a chain of entities that are associates. However, the mere fact that another entity is an associate does not necessarily mean that an underlying CGT asset is held through it.

Example B: Company A, a resident of the United Kingdom wholly-owns Company B, a resident of the United Kingdom, that wholly-owns Company C, an Australian resident company. The disposal of Company A may give rise to DCI. While Company A does not have CGT assets with the necessary connection with Australia, it does hold an underlying interest in such assets through Company B, which is an associate.

Example C: If Company A did not own any part of Company B, but they were still associates (for example, as would be the case if Company B owned Company A (as well as Company C)), then on the sale of Company A DCI would not arise under this item.

Item 12

Item 12 renames Schedule 10 as 'Broad-exemption listed countries and limited-exemption listed countries for the purposes of Part X of the Act', and updates the regulation reference.

Schedule 2

Item 1 of Schedule 2 amends the numbering of the regulations. The table below provides a guide to the amended numbering and a comparison against the previous regulations.

Previous regulation	New regulation
Part 8A, Foreign Income	Part 8A, Foreign Income Division 1 General
152A Interpretation	152A Interpretation
	Division 2 Controlled foreign companies
152B What are capital gains?	Definition in 152A(3)
152C When are income or profits subject to a reduction of tax?	No equivalent
152D Income or profits as designated concession income	Equivalent 152B, operation altered
152E When are capital gains exempt from tax?	No equivalent
152F Certain capital gains regarded as subject to tax	Equivalent 152D, operation unaltered, wording altered
152G Circumstances specified for purposes of Regulations 152E and 152F	Equivalent 152E, operation unaltered, wording altered
152H Tax sparing	No equivalent
152HA Accruals tax laws	Renumbered as 152F, unaltered
152I Features relating to taxation in broad-exemption listed countries	No equivalent
152J What are broad-exemption listed countries and limited-exemption listed countries	Equivalent 152C
152K State foreign taxes that are treated as federal foreign taxes	Renumbered 152G, unaltered
	Division 3 Foreign investment funds
152L Amortisation of expenditure in acquiring property	Renumbered 152H
152N Approved stock exchanges	Renumbered 152I
152P International sectoral classification systems	Renumbered 152J

Item 2

Item 2 updates the regulation reference in the heading of Schedule 12 'Approved stock exchanges for the purposes of Part XI of the Act'.

Item 3

Item 3 updates the regulation reference in the heading of Schedule 13 'Approved international sectoral classification systems for the purposes of Part XI of the Act'.