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Lecture 9

Lecture 9 - International Taxation

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Queensland University of Technology

LECTURE 9 – INTERNATIONAL TAXATION Basic Jurisdiction Rules Residents  The assessable income of an Australian resident includes the ordinary and statutory income derived by the entity from all sources during the year (s 6-5(2) ITAA1997). Non-Residents  An entity that is a foreign resident is only taxed on income that has a source or a deemed source in Australia, i.e. 1. Ordinary income derived directly or indirectly from an Australian source during the year ( s6-5(3)(a)) 2. Statutory income from all Australian sources (s 6-10(5)(a)) 3. Ordinary or statutory income that a provision includes in assessable income on some basis other than having an Australian source (s 6-5(3)(b)) and 6-10(5)(b). An example of this rule is the CGT provisions that bring to account the capital gains or losses realized by a foreign residents as a result of CGT events relating to assets that constitute taxable Australian property (s 855-10(1)). Residence Individuals  An individual will be an Australian resident if he or she is satisfies the test of residence according to ordinary concepts.  If this test is not satisfied, the individual will be a resident if he or she satisfies one of the three statutory tests set out in s 6(1) ITAA 1936: o Domicile test o The 183-day rule o The superannuation test Companies  The definition of “resident’ in s 6(1) provides three alternative tests for the determination of the residence of a company.  A company will be an Australian resident if it satisfies any of these tests: o The company is incorporated in Australia o The company carries on business in Australia and has its central management and control in Australia o The company carries on business in Australia and has its voting power controlled by Australian residents Partnerships  Partnership is not taxed as a separate taxpayer - not necessary to determine its residency.  Instead the test will apply to the partners receiving a share of the partnership income. o The residency of corporate limited partnerships is similar to the test applying to companies (s 94T ITAA 1936). Trusts  The trustee of a trust estate is taxed as a separate entity for income or gains not distributed to beneficiaries.  A trust estate is a “resident trust estate” if: o The trustee was a resident at any time during the income year or o The central management and control of the trust estate was located in Australia at any time during the income year (s 95(2) ITAA 1936) Source of Income Income Source of Income Personal Services Where the services are performed Trading (business income) Where the profits of the business are made Interest Income Place where the loan contract is made or the location of the bank account where the monies are deposited Dividend Income Where the company paying the dividend made its profits Rental income Where the property itself is located Royalties Where the intellectual property is located and registered TAXATION OF FOREIGN SOURCE INCOME OF RESIDENCES  A consequence of the principle that Australian residents are taxed on their worldwide income (“residence principle”) is the possibility that the income derived in a foreign country may be taxed in that country and then taxed again in Australia.  Several methods are available to the residence country to provide unilateral relief from double taxation: a. The exemption method, under which residents are exempted from residence country tax on their foreign source income o Based on the assumption that foreign income has been subject to tax in the foreign country at a rate comparable to tax rates applying in Australia b. The credit method, under which residents are fully taxed on their foreign source income but are allowed a foreign tax credit for the foreign tax paid on that income  More equitable as foreign income is taxed as if it had been derived in Australia.  However, even under that method, it was still possible for Australian residents to avoid paying Australian tax on their foreign source income by interposing a non-resident company between them and the source of income. o This problem was overcome by the legislature by enacting accruals (or attribution) rules which attribute the income derived by the foreign resident company to its Australian owners. c. The deduction method. Under which residents include their foreign source income in their assessable income and are allowed a deduction for the foreign tax paid on that income Foreign Service: Employment Income  The main situation where the exemption method applies is where earnings are derived by Australian residents from foreign service. s 23AG of ITAA 1936  There are three basic conditions that must be realized to qualify for the exemption: a. The foreign earnings are derived by a resident individual b. The resident individual has engaged in foreign service for a continuous period of at least 91 days c. The foreign earnings are not exempt from tax in the foreign country by reason of one of the matters listed in s 23AG(2) (a) to (g)  The exemption in s 23AG will only apply to income earned: o As an aid or charitable worker employed by an approved developing country relief fund, a public disaster relief fund or a prescribed charitable institution that is exempt from Australian income tax; o As a government aid worker; o As a government employee deployed as a member of a disciplined force. Foreign Earnings  Foreign earnings = income consisting of earnings, salary, wages, commissions, bonuses and allowances s 23AG(7)  The following amounts are specifically excluded from the definition of “foreign earnings”: o Assessable pensions, o Annuities, o Superannuation payments and o Employment termination payments Foreign Service  Foreign service = “service in a foreign country as the holder of an office or in the capacity of an employee”. s 23AG (7)  In determining the period of continuous foreign service, intervals when the taxpayer is temporarily absent in accordance with the terms and conditions of the service, such as recreation leave and sick leave are included (s 23AG(6)). Short business trips to Australia or to another foreign country directly related to the Foreign Service and compassionate breaks also form part of the continuous period. o However, long service leave, leave without pay, or period between jobs are not treated as part of the continuous period. o The period of continuous service may span two income years (IT2441).  The one-sixth rule provides that a period of absence that is less than one sixth of the total period of foreign service will not break the period of foreign service. Calculation of tax on non-exempt income  Foreign earnings of an Australian resident that are made exempt from Australian tax under S 23AG are taken into account in the calculation of the Australian tax on any other income derived by the individual.  This rule prevents the relevant exemption from reducing the Australian tax that relates to income other than the foreign exempt income (“exemption with progression”). o This is achieved by calculating a notional average rate of tax payable of the total of exempt and non- exempt income and then by applying this notional tax rate to the non-exempt income (s 23AG(3)).  Where a taxpayer does not qualify for the exemption, for example the work may have been performed in a foreign bank, the foreign employment income will need to be included in the individual tax return as assessable income and the taxpayer may be entitled to a foreign income tax offset for amounts of foreign tax paid. Foreign Income Tax Offset System (FITO)  A FITO is a non-refundable tax offset. A FITO entitlement arises in the year that the foreign income on which the foreign tax has been paid is included in the assessable income. (s 770-10) o It is not necessary for the taxpayer to pay the foreign tax in the same year that the foreign income is included in the assessable income. Determination of FITO entitlement  “Foreign Income tax” is a tax imposed by a foreign tax law on profits or gains whether of an income or capital nature or a tax which is similar to the Australian withholding tax. (s 770-15(1) (b))  There is a FITO limit is the greater of $1,000 and the difference between the tax payable and the tax that would be payable for the income year after excluding the following: a. Any tax offsets b. Amounts in respect of which foreign income tax was paid and any other amount of foreign source income; and c. Any debt deduction attributable to overseas permanent establishment or other deductions reasonably attributable to excluded income under para (b) s 770-75  Where the total foreign income tax paid by the taxpayer is less than $1,000, the taxpayer is not required to calculate the FITO limit; i.e. the taxpayer’s FITO will be equal to the amount of foreign income tax paid on amounts included in the assessable income. No carry-forward of excess FITO  The FITO system does not allow the carry forward of excess foreign tax credit - all available FITOs will need to be utilized in the year in which they arise.  A transitional measure will allow the carry forward of excess foreign tax credit which arose from the previous system. o The so called “pre-commencement excess foreign tax” can be used to increase FITO entitlement until the 2013-14 income year (s 770-220 TPA). Foreign losses: situation before 1 July 2008  The general principle was that foreign losses could only be offset against assessable foreign income (s79D of ITAA 1936).  In addition they could only be offset against foreign income of the same class (s 160AFD ITAA1936). Foreign losses: situation post 1 July 2008  Excessforeignincome deductionscannowbe deductedfrom domesticassessableincomeorfrom foreignincome ofadifferentclass.  Similarlyresidenttaxpayersareno longer requiredtomake anelectionto offsetdomesticlossesagainstforeign incomeaswasthecase before1 July 2008 Convertible Foreign Loss  Transitional measures have been put in place in Div 770TPA providing the conversion of foreign losses that had not beenutilisedby 1 July 2008 underformers160AFD. o Theselossesare referredtoas“convertibleforeignlosses”.  Under these rules, a taxpayer has a convertible foreign loss if there is an un-recouped foreign loss with respest to a particular class of foreign income and the overall foreign loss was made in any of the ten income years before 1 July2008.  The first stepstn the procedure is to identify the taxpayer’s convertible foreign losses” incurred in each of the 10 yearspriorto 1 July 2008.  The convertible foreign loss for an income year is calculated as the foreign loss relating to any foreign income class forthatyearreducedasfollows: a. If acompanytaxpayer hasforeignlosses inthe“otherincome” class,these lossesaredisregardedto the extentthatthey wereincurredwhilegaining incomethat is nowclassifiedasnon-assessable non-exempt income. b. Thelosses incurredinthethreemostdistant incomeyears(n-8 to n-10)mustbereducedby 50% for all taxpayers  Thecalculation producesaconvertibleforeignlossforeachrelevantyear.  Forthepurposeofthetransitional rules,theamountofconverted foreign lossesistreated asifitwasataxlossfor thatyear(i.e.itisaddedto the domestic loss).  However some restrictions apply: o The overall total of foreign losses of the 10 preceding years can be carried forward in each of the first four years on or after 1 July 2008 is limited. o No more than 20% can be carried forward in the first year ( 2008/09), o No more than 40% in the first two years (2008/09 & 2009/10) and o No more than 60% in the first 3 years (2008/09 to 2010/11). o No more than 80% in the first four years. o There are no restrictions thereafter.  These special restrictions do not apply if the starting “parcel” does not exceed $10,000 or if the taxpayer chooses to reduce their total convertible foreign loss to $10,000.  In either of these cases, the taxpayer can be carried forward for deduction in 2008/09.  The excess over $10,000 never becomes deductible. ACCRUALS TAXATION SYSTEM – ONLY ASSESSABLE VIA MC  The effect of the accruals rules (or attribution rules) is to bring into the assessable income of Australian residents on an “accruals basis” a share of the income and gains earned by foreign entities in which they have a controlling interest, even though the income or gains have not been distributed. Controlled Foreign Company (CFC)  The CFC rules are contained in Part X of ITAA 1936 (S 316 to 468).  The main operative provision for the CFC rules is S 456. S 456 provides that where a CFC has attributable income for a statutory accounting period in respect of an attributable taxpayer, the attribution percentage of the attributable income is included in the taxpayer’s assessable income for the year of income in which the CFC’s accounting period ends. What is a CFC?  A CFC is broadly defined by the Act as a foreign company which is controlled by Australian residents.  Under s 340, a foreign company is a CFC if any of the following situations applies: a. Fiveor fewer Australianresidentswithaninterestofat least1% intheCFC(1%Australianentities) havean aggregateassociate-inclusivecontrol interestintheforeign company ofat least50%(strictcontrol) b. A singleAustralianentity has anassociate-inclusivecontrolinterestofatleast40%in theforeigncompany,and theforeigncompanyis notcontrolledby unrelatedentities(defactocontrol) c. A groupoffiveorfewerAustralianentitieseitheraloneortogetherwith associatescontroltheforeign company (subjective defactocontrol)  Australian entity is defined in s336 as a partnership, a trust or any other resident entity (i.e. an individual or a company).  The associate-inclusive control interest is defined as the sum of that entity’s direct and indirect control interests and the direct and indirect control interests of its associates traced through the chain of ownership (s 349). Listed countries  There are now seven listed countries: Canada, France, Germany, Japan, New Zealand, the UK and the US  All other countries are unlisted countries.  These are countries that are considered to have tax systems closely comparable to Australia Attributable Taxpayer  An attributable taxpayer is defined by s 361(1)(a) as a Australian entity with an associate-inclusive control interest of at least 10% in the CFC.  Where a company is determined to be CFC under the subjective de facto control test, an Australian entity with at least 1% associate-inclusive control interest will be an attributable taxpayer (s 361(1)(b)). Attributable Income  The attributable income of a CFC is basically the taxable income of the CFC calculated as if it were a resident taxpayer (s 382). The calculation of attributable income is a purely notional calculation based on the rules listed in Div 7 Part X ITAA 1936 (s381 to 431B).  The determination of the attributable income of a CFC depends on whether or not the CFC is based in a listed country, and whether or not the CFC passes the active income test. o The rules regarding the active asset test are found in s 432. The active income test is passed if the CFC satisfies a number of basic conditions: a. TheCFC isinexistenceattheendoftheaccountingperiodandhasbeenaresidentofalistedor unlistedcountry atalltimesduringtheaccountingperiod b. TheCFC hasatalltimescarriedoutbusinessthroughapermanent establishmentinitscountry of residence c. TheCFCmaintainsaccountsare prepared in accordancewithaccountingstandards d. TheCFC haslessthan5%ofitsgrossturnoverasstatedin itsaccounts intheformof taintedincome.  “Tainted income” covers “passive income” (s446)
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