Taxation of Foreign Source Income

Australia has complex accruals taxation regimes that attribute certain types of income earned by foreign entities to Australian resident taxpayers where the Australian entity has a certain degree of control over the foreign entity. This is intended to prevent the deferral of tax through the sheltering of income in foreign tax havens. There are three accruals regimes:

the controlled foreign company (“CFC”) regime – which attributes income earned by an Australian-controlled foreign company, where the income has not been assessed comparably to the Australian tax regime;
the transferor trust regime – which attributes income earned by offshore trusts, particularly where an Australian resident taxpayer has transferred property to the offshore trust; and
the foreign investment fund (“FIF”) regime – which affects other foreign entities not covered by the CFC and transferor trust regimes.

Distributions from foreign companies in which an Australian taxpayer holds a 10% or greater (“non-portfolio”) interest are usually not subject to tax in Australia. Similarly, income and capital gains derived by active business activities of a foreign branch of an Australian company are generally not subject to tax in Australia. Previously-attributed income that is subsequently received by an Australian taxpayer is also not subject to tax in Australia.

Under the conduit foreign income rules, an Australian company that receives foreign income that is not subject to Australian tax (for example, as a result of a foreign income exemption or foreign tax credit or offset) can distribute such income to foreign shareholders free of dividend withholding tax even if it is repatriated as an unfranked dividend.

New foreign income tax offset rules

Australia’s foreign tax credit (“FTC”) system will be replaced by a new foreign income tax offset system, applicable for income years, statutory accounting periods and notional accounting periods (for CFCs, FIFs and transferor trusts) starting on or after 1 July 2008.

Broadly, the new foreign income tax offset rules allow Australian resident taxpayers to receive a non-refundable tax offset for foreign income tax paid on an amount that is included in their assessable income. The new system is better aligned to Australia’s broader taxation of foreign income and simplifies the process for claiming relief from double taxation.

Some key differences from the FTC system are as follows:

A resident taxpayer that receives non-taxable distributions from a CFC or FIF that was paid out of previously-attributed income will only be entitled to an offset for foreign direct (withholding) taxes paid on the distribution, not foreign underlying taxes.
The offset is also not available for foreign tax paid on any other non-taxable foreign income amounts (so-called “non-assessable, non-exempt income” such as foreign non-portfolio dividends and active foreign branch income). This is consistent with Australia’s unilateral exemption of such income.

Current treatment of excess foreign tax credits

Currently, excess FTCs can be carried forward on a class basis for a maximum of 5 years and are utilised on a first-in, first out basis. This gives FTCs an effective life of 6 years (that is, the year in which it arose, and 5 subsequent years). Excess FTCs cannot be transferred to group companies outside the consolidation regime.

Disclaimer
The material contained in this publication is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser.
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This document is current as at 1 May 2008.