Where an Australian corporate tax entity holds a “participation interest” of 10% or more in a foreign company, any dividend (including an amount that is deemed to be a dividend under Australian tax law) paid by the foreign company will be not assessable and not exempt (NANE) income of the shareholder. On 12 October 2016 the Commissioner released Draft Tax Ruling TR 2016/D2 setting out some practical guidance for taxpayers and advisers on applying the participation test.
In the ordinary course of events, determining whether a shareholder holds a 10% or greater interest will be relatively straightforward. For example, where a parent has a wholly-owned foreign subsidiary throughout the entire income year, the matter is straightforward.
But the point of the Draft Tax Ruling is to provide guidance in those situations where the answer is not so readily apparent.The 10% participation test must be met at the time the distribution is made and so it critical to identify when a dividend, or distribution that is deemed to be a dividend, is made. The Commissioner has decided to focus on the holding at the start of the relevant day for testing purposes.
If this all seems somewhat cryptic, a few examples may demonstrate the point.
Off Market Share Buy-Back
When shares are bought back the percentage interest will often fall as a result of participating in the buy-back.Any deemed dividend portion of the buy-back proceeds is deemed to be a dividend on the day the buy-back occurs.
In the Draft Ruling the Commissioner considers that in this case the “participation test” is to be examined at the commencement of the relevant day. So a holding of say 12% that immediately after the buy-back is reduced to 9% (by the end of that day) would satisfy the requirements for the buy-back deemed dividend to be treated as NANE.
Distribution on cancellation or winding up
Where there is a cancellation or winding up, the payment from the foreign company could include a component that is treated as a deemed dividend.Again the Commissioner points to the position as at the commencement of the day as being the relevant time to perform the “participation test”.The fact that say, on a winding up, the company may no longer exist immediately after making the payment does not defeat the treatment of any deemed dividend as NANE.
Disposal after books close
If a dividend is paid on a later day by reference to shareholdings at an earlier time (the books close date), the “participation test” is to be undertaken at the start of the day on which the dividend is paid.The holding at books close is not relevant.Accordingly, a disposal of shares after books close but before payment date could therefore impact the NANE outcome.
Day shares acquired
Again the focus is on the position at the start of the day. As a result, any shares acquired on the day the dividend is paid would not be counted for the purposes of the “participation test”, despite the fact they are held at the end of that day.