For anyone that has had to plough through the complex provisions
in Part X of the Income Tax Assessment Act 1936, the
reform of the Controlled Foreign Companies
("CFC") rules is likely to be good news.
The new Foreign Accumulation Fund
("FAF") rule seeks to address only the
most abusive cases of deferral that are not caught by the CFC
measures following the repeal of the foreign investment fund
regime. However, there are a few concerns over certain aspects of
the new rules.
A threshold issue for any CFC regime is the meaning of control
of a foreign entity. Under the existing rules, there are three
control tests. Satisfaction of any of the three will potentially
result in passive income derived by the controlled entity being
subject to attribution. The three control tests are:
1. Strict Control Test
If five or fewer Australian entities have an associate-inclusive
control interest of 50% or more, then that entity is a CFC.
2. Objective De Facto Control Test
Where a single Australian entity has an associate-inclusive
control interest of not less than 40% and no other group of
entities control the foreign entity, then that entity is a CFC.
3. Subjective De Facto Control Test
Five or fewer Australian entities together with associates
control the foreign entity.
The new legislation moves away from a quantitative control
interest test towards a qualitative control test as it generally
relies on accounting standards. This is a positive development for
reporting entities because they already use these concepts in their
financial accounts. As a result, it should lead to potential
compliance cost savings.
The main argument against adopting these proposals is that the
relevant accounting standards (AASB 127 and AASB 131) can require a
degree of discretion in determining whether an Australian entity or
group of Australian entities control a foreign entity. This may
lead to uncertainty in some circumstances. Under a quantitative
control test there is a greater level of certainty in determining
whether an entity is controlled by another because it is often
merely a case of determining the amount of equity the Australian
entity has in the overseas entity.
The final issue is that because the accounting standards are
determined by the US based IFRS board, it is unlikely to consider
the Australian tax implications of changes it makes to the
definition of control. This raises issues in relation to Australian
territorial sovereignty and the claimed revenue neutrality of the
Passive Income – New Active Income Carve Out
Under the new rules, income of an active character is not
included in an entity's passive income if:
the income is attributable to a permanent establishment of the
it arises from the entity competing in a market
it arises substantively from the ongoing use of labour by the
At this point in time, there is no guidance on what
"competing in a market" and "substantially from the
ongoing use of labour" mean, so it is difficult to advise with
any certainty until final legislation is released.
One of the major changes provided for in the new rules is the
removal of tainted sales income and tainted services income, which
previously went into the tainted turnover ratio. Under the current
rules, where the tainted income ratio exceeded 5% (ie, gross
"tainted turnover" is greater than 5% of gross turnover)
then income is generally subject to attribution.
The new rules are still based on a 5% passive/active mix
– providing an early exit out of the CFC rules if less
than 5% of a CFC's income, as determined by reference to its
financial accounts, has a passive character. "Prima facie
passive income" includes dividends, rent, royalties and so on,
which are all similar to the old rules. The main difference is that
they are determined by reference to the financial accounts.
The Government claims there will be no leakage as a result of
these changes. However, given that such threshold issues as the
definition of control and passive income will be determined by
reference to accounting rather than tax concepts and by a foreign
board, the possibility of leakage is not remote. Consequently, it
is likely there will be further changes once this legislation
finally comes into effect.
For further information generally please contact your local
Crowe Horwath Head of Tax advisor: Sydney - Steve DiLeo +612 9619
1637 email@example.com; Melbourne – Norman
Elliott +613 9258 6866 firstname.lastname@example.org; Perth -
Peter Fallon +618 9488 1102 email@example.com;
Brisbane – Tony Marks +617 3233 3593
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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