If you are an attributable taxpayer of a controlled foreign company, then the income you derive may be taxed as it accrues, rather than when it is remitted to you in Australia.
Remember, this legislation is aimed at income, which may be the result of tax avoidance, rather than income arising from genuine business activity.
So if the controlled foreign company is mainly engaged in active business, it will not be affected by the accruals tax system.
How do you work out whether a company is mainly engaged in active business?
The
ACTIVE INCOME TEST - that's how!
What is the ACTIVE INCOME TEST?
If a company derives most of it's income from the sorts of receipts that could be said to be prone to tax minimisation, that might indicate that it is engaged in tax minimisation rather than genuine business.
Such receipts are referred to as
TAINTED INCOME and if they represent more than 5% of the overall level of low taxed income they will trigger the application of the accruals legislation - that's the ACTIVE INCOME TEST.
How does a company satisfy
the ACTIVE INCOME TEST?
There are
5 tests, the fifth of which is the TAINTED INCOME RATIO
Let's look at the first four tests quickly before tackling the fifth.
TEST 1
CONTROLLED FOREIGN COMPANY
must be RESIDENT in a LISTED or UNLISTED COUNTRY
TEST 2
It must
carry on business through a PERMANENT ESTABLISHMENT in it's country of residence for the whole of the statutory accounting period
So what is a PERMANENT ESTABLISHMENT?
You can look up the definition in sec 6 of the 1936 Income Tax Assessment Act if you wish, but if you can't be bothered, just think of it as
a place, at, or through which, the normal business activities are carried on.
Got that?
The section 6 definition excludes some situations which might at first seem to be carrying on business at or through a place. These are...
Dealings through a commission agent or broker do not constitute a permanent establishment.
Carrying on business through a agent who does not exercise a general authority to negotiate or conclude contracts or to fill orders from stock situated in the country is not use of a permanent establishment
Maintaining a place solely for the purchasing of goods or merchandise does not amount to a permanent establishment.
TEST 3
PROPER ACCOUNTS
MUST BE KEPT
Because the TAINTED INCOME TEST (test 5) uses the company's accounts, these must be prepared in accordance with commercially accepted accounting principles.
They must give a true and fair view of the financial position of the controlled foreign company
TEST 4
Controlled foreign company
must be able to SUBSTANTIATE its accounts.
It must be able to produce the accounts which are used to establish the proportion of tainted income - TEST 5.
TEST 5
TAINTED INCOME RATIO less than 5%
GROSS TAINTED TURNOVER
TAINTED INCOME RATIO =
---------------------------------------------
GROSS TURNOVER
So what is GROSS TURNOVER?
GROSS TURNOVER is
the
sum of
the
low taxed net gains from certain transactions
and
other low taxed gross revenue.
Calculating the Gross Turnover in 5 steps...
1. Get total gross revenue
2. Deduct those amounts that have been taxed in Australia/listed countries
3 & 4 Add net capital gains by deducting gross proceeds of sales of assets included in total revenue, then adding back the net gain
5. Add the share of gross turnover of each partnership in which the company is a partner.
THE 5 STEPS REQUIRED IN CALCULATING GROSS TURNOVER -
STEP 1
To calculate the figure, go to the
income statement and add all the amounts which are shown as GROSS REVENUE - that is the incomings before deducting expenses...
STEP 2
Exclude
from the total revenue figure those amounts which have been taxed in Australia or comparably taxed in a listed country
WHICH AMOUNTS HAVE BEEN TAXED IN AUSTRALIA?
Franked dividends (look at the topic on dividends if you don't know what that means)
Amounts which have been included in the controlled foreign company's Australian assessable income. An amount, which has been subjected to dividend or interest withholding tax, has NOT been included in the company's assessable income. Neither are certain amounts that are not fully included such as shipping profits or insurance premiums
Proceeds of DISPOSAL of TAXABLE AUSTRALIAN ASSETS (more on this later)
Amounts which have already be attributed to an Australian taxpayer
So STEP 2 involves deducting
franked dividends,
amounts included in assessable income,
proceeds of disposal of taxable Australian assets and
amounts which have been attributed under this legislation
from the total gross revenue.
So much for amounts which have been taxed in Australia,
What about amounts which have been comparably taxed in a listed country?
AMOUNTS WHICH HAVE BEEN TAXED COMPARABLY IN A LISTED COUNTRY are…
1. Amounts derived through a branch in a listed country IF they have been taxed in that country (There is a exception to this rule for DESIGNATED CONCESSION INCOME, but we will talk more about that later)
2. NON PORTFOLIO DIVIDEND (once again we will explain what that is later) from a company resident in a listed country
3. That part of a NON PORTFOLIO DIVIDEND (yes, we haven't yet talked about what this means) from a company resident in a non listed company, which is PAID FROM UNDERLYING PROFITS...WHICH HAVE BEEN TAXED IN A LISTED COUNTRY
So now we have calculated the amounts of gross revenue which have been taxed in Australia and listed countries. Now we look at capital gains.
In STEP 3 we will get rid of the proceeds of disposals from such gains, and then in STEP 4 we will add back the net profits on such gains.
STEP 3
DEDUCT PROCEEDS OF DISPOSALS FROM GROSS REVENUE
Amounts which are included in the revenue parts of the accounts as proceeds from sale of assets are excluded from GROSS REVENUE.
So to are exchange rate fluctuations and commodity investments
However, sales of trading stock NOT deducted - they are revenue items.
STEP 4
INCLUDE 'NET' GAINS
Now we can 'bring back' just the profit element of the gains we have excluded in STEP 4
To determine NET GAIN the sum of the individual gains is reduced by the sum of the losses. An overall net loss on disposals can not reduce gross turnover - the loss will just be ignored.
The gain for each item disposed of must be calculated individually, and market values must be used for consideration received.
STEP 5
INCLUDE PARTNERSHIP TURNOVER
The share of gross turnover of each partnership in which the company is a partner is included in the gross turnover amount for the company.
Let's recapitulate.... Gross Turnover =
Total Revenue
-
Revenue taxed in Australia or listed countries
+
Gross Proceeds Disposals
+
Net Proceeds Disposals
+
Share P'shp Turn over
So now we know the meaning of GROSS TURNOVER, but what is
GROSS TAINTED TURNOVER?
Gross Tainted Turnover consists of the types of revenue that are prone to tax minimisation - the sorts of receipts that keep cropping up in tax avoidance schemes.
Remember, if these make up more than 5% of gross turnover, the controlled foreign company FAILS the ACTIVE INCOME TEST
GROSS TAINTED TURNOVER consists of
...
PASSIVE INCOME
TAINTED SALES
TAINTED SERVICES INCOME
Let's start with PASSIVE INCOME. It includes
dividends
tainted interest income
annuity income
tainted rental income
amounts derived as consideration for the assignment... of copyright, patent, design, trade mark or other like property or right
net gains on disposal of tainted assets
income derived from carrying on a business of trading in tainted assets
net tainted commodity gains
net tainted currency exchange gains
So now we know what
PASSIVE INCOME is - but what is tainted sales and tainted services income?
The short answer is that
tainted sales and tainted services incomeis income from certain transactions
with,
or originating from,
associates or Australian residents.
Let's not lose the forest for the trees - our aim is to work out if the tainted income ratio is less than 5%
GROSS TAINTED TURNOVER
TAINTED INCOME RATIO =
---------------------------------------------
GROSS TURNOVER
We have worked out
GROSS TURNOVER, and this will make the next step, which is working out GROSS TAINTED TURNOVER, less complicated.
Why?
Because
GROSS TAINTED TURNOVER is merely the parts of GROSS TURNOVER which represent....
PASSIVE INCOME
TAINTED SERVICES INCOME
TAINTED SALES INCOME
(We have just looked at those concepts so they shouldn't present a problem)
plus NET TAINTED GAINS
These are sum of the parts of the NET GAINS from
disposal of commodities
currency exchange rate fluctuations
disposal of assets
THAT IS TAINTED.
plus the company's share of GROSS TAINTED TURNOVER of each partnership in which it is a partner.
PASSING the ACTIVE INCOME TEST in an UNLISTED COUNTRY=NO attribution
Dealings through a commission agent or broker do not constitute a permanent establishment.
