Indirect income interests of 10% or more in Australian companies

2012 legislation covers indirect income interests of 10% or more in Australian companies and how the exemption is applied to companies held through a FIF or CFC.

Section EX 35 of the Income Tax Act 2007

A person who has an income interest of 10% or more in a company that is resident and subject to tax in Australia (and that meets certain other conditions specified in section EX 35) does not attribute any income or loss from that Australian company.

An amendment has been made to clarify how this exemption should be applied to Australian companies that are held indirectly through another foreign investment fund (FIF) or a controlled foreign company (CFC).

Key features

An amendment has been made to section EX 35(a) so that the reference to "direct income interest" (which is defined under section EX 30) has been replaced with a reference to "income interest calculated under section EX 50(4)".

Under section EX 50(4) a person works out their income interest in a FIF as though that FIF were a CFC.

Under the CFC rules (and the attributable FIF income method) a person's income interest is calculated by adding their direct income interests and any indirect income interests. Direct income interests are measured under section EX 9. They include interests such as shares that the person holds themselves.

Indirect income interests are calculated under section EX 10 by multiplying a person's direct income interest in a CFC by that CFC's direct income interest in a second CFC. For example, if a person owns 50% of CFC 1 and CFC 1 owns 40% of CFC 2, the person's indirect income interest in CFC 2 would be 20% (50% of 40%).

Under section EX 50(4), the same approach also applies to foreign companies that are not CFCs. That is, if a person has a direct income interest in one foreign company and that foreign company has a direct income interest in another company, the person's indirect interest in the second foreign company is calculated by applying the rules in sections EX 8 to EX 11, EX 13, EX 16 and EX 17 and EX 26 as though both companies were CFCs.

This ensures that a person can still meet the requirement in section EX 35(a) of having at least a 10% income interest in an Australian company when their interest is an indirect interest held through another foreign company.

Examples

A person has a 50% direct income interest in a foreign company which has a 50% direct income interest in an Australian company. The person's indirect income interest in the Australian company is 25%. The person will satisfy the requirement in section EX 35(a).

A person has a 50% direct income interest in a foreign company which has a 10% direct income interest in an Australian company. The person's indirect income interest in the Australian company is 5%. The person will not satisfy the requirement in section EX 35(a), unless they have some other income interests (direct or indirect) in the Australian company which cause their total income interest to add up to 10% or more.

Note that if a person's interest in an Australian company satisfies the exemption in section EX 35, and that foreign company is not a CFC, the person is not required to apply the FIF rules to any indirect interests in FIFs held by that Australian company. In contrast, if a person has a CFC interest in an Australian company they would be required to look-through and apply FIF rules to any indirect interests in other foreign companies due to section EX 22(3).

Example

A person has a 10% direct income interest in an Australian company which has a 50% direct income interest in another foreign company.

If the Australian company is a CFC or a FIF for which the person uses the attributable FIF income method, the person would have a 5% indirect income interest in the other foreign company.

If the Australian company is not a CFC, and the Australian company qualifies for an exemption from the FIF rules (such as the section EX 35 exemption), or the person uses the fair dividend rate, cost, comparative value or deemed rate of return method for the Australian company, the person would not usually be regarded as holding an indirect income interest in the second foreign company.

Further explanation and examples on how to apply the section EX 35 exemption can be found in the Tax Information Bulletin, Vol 24, No 6, July 2012.

Application date

The amendment to section EX 35 applies from income years beginning on or after 1 July 2011. This is consistent with the application dates of the international tax reforms in the Taxation (International Investment and Remedial Matters) Act 2012.