Australia Consults On CFC Rules

by Mary Swire, Tax-News.com, Hong Kong

19 July 2010

Australia’s Assistant Treasurer, Nick Sherry, has released for public comment a discussion paper that represents a further step towards reforming controlled foreign company (CFC) rules.

The modernization of the CFC rules is part of wider reforms to Australia's foreign source income anti-tax-deferral (attribution) rules. The reforms include the measures recently passed by the Parliament to repeal the foreign investment fund and deemed present entitlement rules, as well as exposure draft legislation setting out the detail of the proposed anti-roll-up fund rule. Details surrounding the transferor trust changes are still to be developed.

The policy objective of the CFC rules is to ensure that passive investment decisions of Australian resident taxpayers are not distorted by tax considerations, thereby protecting Australian tax revenue. Foreign passive investment will continue to be treated the same as capital that is invested in Australia.

However, there are, the Treasury says, legitimate commercial reasons why residents invest capital in foreign active businesses, which should be taxed at the same competitive level as other investments in that jurisdiction. The centrepiece for these reforms is, therefore, a proposed active business income exemption, which is designed to ensure only passive income is attributed to Australian resident controllers.

As presently drafted in the proposed legislation, prima facie passive income is accepted as active income, and is excluded from attribution, where it “‘arises in the ordinary course of the active conduct of a trade or business by the entity”. This test would be applied to each item of passive income, and it would not be sufficient to show that the CFC is engaged in the active conduct of a trade or business to render all of its income active.

The active conduct of a trade or business by an entity is then defined as “the competitive participation by the entity in industrial, commercial or financial undertakings, evidenced by human activity.” Importantly, the human activity does not have to be performed by a director or employee of the CFC. The activity may be out-sourced to a contractor, subcontractor, or an agent.

There are also a number of other important reforms that feature in the proposed CFC rules. These include a de minimis passive income test, grouping relief, the removal of double taxation and deductibility rules.

"Reforms to the CFC rules, while still maintaining the integrity of Australia's tax base, will improve the competitiveness of Australian businesses by reducing red tape and compliance costs for affected businesses," the Assistant Treasurer said. "The discussion paper takes account of submissions received in response to the CFC consultation paper released earlier this year."

"Given the scale, complexity and importance of these rules it is desirable that a further round of consultation occur in respect of the development of the enabling legislation before it is introduced into Parliament," he added. Submissions to the Treasury close on August 31, 2010.

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