When our clients incorporate companies in foreign jurisdictions, we need to consider how the Controlled Foreign Company (CFC) rules might apply to them.
Under which control tests can a company be classified as a CFC?
- Strict control test;
- Assumed controller test; and,
- De facto control test.
You can find detailed explanations of these tests in the ATO’s foreign income return form guide.
The CFC rules exist to ensure Australian shareholders are taxed on their share of a CFC’s “tainted income” as it is earned (i.e., it is attributed to the Australian shareholder), not just when it is transferred to the Australian shareholder, unless:
- the income is comparably taxed in the CFC’s country of residence (i.e., this is determined by looking to see if the country where it is earnt is a listed country as set out below), or
- its income is almost exclusively derived from active business activities (by passing the “active income test” summarised below”).
If you satisfy one of these tests, then the income is not taxed in Australia until the income is remitted back to Australia.
Listed Countries
The comparably taxed countries are “listed” countries. There are only 7 listed countries:
- Canada
- France
- Germany
- Japan
- New Zealand
- UK
- US
Active Income Test
If a CFC passes the “active income test”, income attribution generally doesn’t apply. The active income test requires that less than 5% of the gross turnover of the CFC is “tainted income”.
Tainted income includes passive income, tainted sales income, and tainted services income.
Passive income includes dividends, interest, rent and royalties.
Tainted sales income is, broadly, income from the sale of goods to an Australian associate, or income from the sale of goods originally purchased from an Australian associate (including a foreign resident with an Australian PE).
Tainted services income is broadly income from the provision of services to an Australian associate (including a foreign resident with an Australian PE).
Attribution for Listed Countries
Where a CFC is resident in a listed country and they fail the active income test, generally only “eligible designated concession income” (EDCI) is attributable. EDCI is basically income that isn’t taxed in a listed country. A full list of items of designated concession income for each listed country can be found in the appendices to the ATO’s foreign income return form guide.
Attribution for Unlisted Countries
Where a CFC is resident in an unlisted country and they fail the active income test, the income that is attributed to the Australian shareholder (ie taxable to the Australian shareholder in the year it is earned) is broadly the amount that would have been its taxable income if the CFC was Australian resident, and its only income was tainted income.
Summary
The CFC rules are quite complex to navigate, but generally don’t create major Australian tax liabilities unless they are located in unlisted countries and derive significant passive income, or
- Make sales of goods to an Australian associate, or
- Make sales of goods purchased from an Australian associate, or
- Provides services to an Australian associate.
If you have clients that have cross border ownership with Australian entities, you should be aware of these rules to ensure the proper planning is put in place.
Feel free to contact Darren O’Malley of this office to discuss this issue.
Author – Darren O’Malley
*Correct as of 12 October 2022
*Disclaimer – this article has been produced by Kreston Stanley Williamson as a service to its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this article, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under professional standards legislation.
