The ATO has just released draft Tax Determination TD 2019/D12 in which it confirms that section 951A of the U.S. Internal Revenue Code (IRC) is not a provision of a law of a foreign country that corresponds to sections 456 and 457 of the Income Tax Assessment Act (ITAA) 1936 for the purpose of subsection 832-130(5) of the ITAA 1997.
What this means is that it is the ATO’s view that the U.S. GILTI rules do not correspond with the Australian CFC attribution rules for the purposes of applying the Australian hybrid mismatch rules. As a consequence, certain related party payments may not be deductible in Australia. U.S. shareholders of Australian corporate subsidiaries and other entities in foreign jurisdictions should review the related party transactions of the group in order to determine whether payments made from the Australian company to related parties could be deductible to the Australian company.
The Australian hybrid mismatch rules are examined in detail in our upcoming publication “The Australian hybrid mismatch rules”, but for now, let’s examine these concepts briefly and the practical effect of the draft TD.
Section 951A IRC: The GILTI rules
The 2017 Tax Cuts and Jobs Act (TCJA) added new section 951A into the IRC to address the tax treatment of “global intangible low-taxed income” (GILTI) to tax excessive returns on certain depreciable property. If the GILTI rules apply, a U.S. shareholder (C Corp, S Corp, partnership or individual) holding 10% or more, of a controlled foreign corporation (CFC) must include amount by which its “net CFC tested income” exceeds its “net deemed tangible income” in its U.S. taxable income. These rules require complex calculations to be undertaken. Briefly, “net CFC tested income” includes a CFC’s gross income excluding income “effectively connected” with a U.S. trade or business, Subpart F income (generally passive income such as interest, dividends, annuities, net gains from commodities, foreign currency, and property that does not generate active income, certain rents and royalties, and personal services income which has been subject to low rates of tax in a foreign jurisdiction) and allocable deductions. “Net deemed tangible income” represents the expected return on investments in qualifying business assets (tangle property used to in the CFC’s trade or business). U.S. shareholders may deduct a proportion of any GILTI inclusion, thereby reducing the effective tax rate on GILTI income.
Sections 456 and 457 ITAA 1936
These provisions assess attributable taxpayers (i.e. “significant” Australian resident shareholders of CFCs with an associate-inclusive control interest in the CFC of 10% or more) on tainted foreign income that may otherwise be subject to tax deferral or avoidance. The type of income subject to these provisions is generally passive and not generated by genuine business activities, and the application of these rules are complex and depend on whether the CFC is a resident of a “listed” or “unlisted” country and whether it satisfies the “active income test”.
The Australian hybrid mismatch rules
The Australian hybrid mismatch rules (in Div 832 ITAA 1997) are effective from 1 January 2019 and are mostly an adoption of the proposals in the OECD’s “Neutralizing the Effects of Hybrid Mismatch Arrangements” (2015) and “Neutralizing the Effects of Branch Mismatch Arrangements” (2017) reports.
A hybrid mismatch can arise where differences in the tax treatment of an entity or instrument in two or more jurisdictions enable taxpayers to defer or reduce otherwise applicable taxes – this can happen where:
1. both jurisdictions allow a deduction for a payment; or
2. a payment may be deductible in the payer’s jurisdiction, but not assessable in the recipient’s jurisdiction, or the recipient’s jurisdiction allows a credit, rebate or concession (such as the U.S. dividend received deduction) for that payment that negates its assessability.
This is where consideration of whether a payment is included in assessable income (i.e. by being “subject to foreign income tax”), becomes relevant.
Section 832-130(1) ITAA 1997 states that an amount is “subject to foreign income tax” if foreign income tax is payable in respect of it because it is included in the tax base of a foreign country under that country’s laws. Section 832-130(5) specifically extends this concept to amounts included in assessable income under foreign equivalents to the Australian CFC attribution rules, as it state:
An amount of income or profits of an entity is subject to foreign income tax if the amount is included in working out the tax base of another entity under a provision of a law of a foreign country that corresponds to section 456 or 457 of the Income Tax Assessment Act 1936 (including a tax base that is nil, or a negative amount). [Emphasis added]
Div 832 ITAA 1997 therefore attempts to address the hybrid mismatch by ensuring that income is treated as being assessable in both applicable jurisdictions (“dual inclusion income”) – for example, section 832-680(1) states that an amount of income or profits is dual inclusion income if it is subject to Australian income tax in an income year and subject to foreign income tax in a foreign country in a foreign tax period, or subject to foreign income tax in two foreign countries.
GILTI, CFC attribution and hybrid mismatch rules: what effect does the draft TD have?
If the draft TD is finalized, it would mean that:
1. the U.S. GILTI provisions would not be regarded as being equivalent to the Australian CFC attribution rules for the purposes of determining whether income has been “subject to foreign income tax” and excluded from the reach of the Australian hybrid mismatch rules on the basis of it being “dual inclusion income”; and
2. if an Australian company is owned by a U.S. shareholder that also owns entities in other jurisdictions, it is imperative that the related party transactions of the group are reviewed – even if the U.S. shareholder’s income from a foreign entity is subject to the GILTI rules, this does not mean that for Australian purposes, the relevant amount is income that has been “subject to foreign income tax”.
As the CFC attribution rules generally extend to passive income not generated by genuine business activities, the question arises whether the U.S. Subpart F rules (which deals with passive income as described above) could then be a provision of a law of a foreign country that corresponds to the CFC attribution rules for the purpose of the hybrid mismatch rules. This issue is not addressed in the draft TD and requires clarification.
The closing date for comments on the draft TD is January 17, 2020.
For more information, contact:
Senior Tax Advisor
U.S. Australia Tax Desk