1. If you own an overseas company, or have an interest in one, the Controlleld Foreign Company or CFC rules may apply and uou may have to pay Australian tax on income earned by your overseas company—even if it pays you nothing.
2. Australia’s controlled foreign company rules, known as the CFC rules, can apply while the company keeps its profits overseas.
3. Owning an overseas company does not automatically create this tax liability. You need to consider who controls the company, your interest in it and the type of income it earns.

Why do the CFC rules exist?

1. The rules prevent Australian taxpayers from delaying Australian tax on certain income by keeping it in foreign companies they control. They operate under Part X of the Income Tax Assessment Act 1936.
2. Where the rules apply, some of the company’s income may be included in your Australian tax return. This is called attribution. The practical consequence is that you can have a tax bill without receiving a dividend.

When is an overseas company a CFC?

1. A foreign company may be a CFC if it meets one of these three control tests:

6. You do not need to own a majority of the shares for the rules to apply. Indirect interests, voting rights and interests held by associates can affect the result.

Why family ownership matters

1. “Associates” can include relevant family members and connected companies or trusts. For example, if you and your spouse each own 25% of a foreign company, looking only at your own shareholding may overlook the combined interests relevant to the control tests. The precise result depends on the statutory rules and ownership arrangements.

Does every Australian shareholder have attributed income?

1. No. Once the company is identified as a CFC, a separate test determines whether you are an attributable taxpayer.
2. Broadly, this can include an Australian entity whose interest, together with its associates’ interests, is at least 10%. Certain Australians involved in actual control may also be caught. Separate rules then determine the percentage of the company’s attributable income included in your tax return.

What income can be caught?

1. Income requiring examination includes interest, royalties, some rental income and gains on certain investments. Particular sales and services income can also be caught, including transactions involving related parties or Australian connections. Exceptions apply.
2. This means an overseas investment company may present a different tax risk from a company manufacturing goods or selling products to independent customers. However, running a genuine business overseas does not automatically prevent attribution.

Is there an exemption for an active business?

1. The active income test can substantially limit attribution for a company mainly conducting an active business. One key requirement is that its statutory “tainted income ratio” must be less than 5%.
2. “Tainted income” is a legal term covering specified income categories. The ratio is calculated under statutory rules; it is not simply investment income divided by net profit. A ratio of exactly 5% does not satisfy the requirement, and other conditions must also be met. Supporting accounts and records are essential.

Does the company’s location matter?

1. Yes. Different rules apply to companies resident in “listed” and “unlisted” countries. The company’s residence, income and foreign tax treatment all need to be considered.
2. Paying tax overseas does not automatically remove Australian tax exposure. Equally, failing the active income test does not mean every dollar of profit is attributed. The relevant amount must be calculated under modified Australian tax rules.

Example: tax before receiving a dividend

1. Assume you own all of an overseas company, your attribution percentage is 100% and the company has $100,000 of attributable income after the required calculations.
2. You may need to include $100,000 in your Australian assessable income, even if the company retains the money overseas. The $100,000 is the income included in your tax calculation—not the amount of tax payable.

What happens when the profits are paid to you?

1. Section 23AI can prevent qualifying distributions of previously attributed income from being taxed again. You need records establishing the attribution and the relief available.
2. Foreign tax relief must also be checked carefully. Tax paid by the overseas company does not automatically give you an equivalent Australian tax offset.

When should you seek advice?

1. Arrange a CFC review if any of these circumstances apply:

• You or your family hold a substantial interest in an overseas company.
• You influence its decisions despite holding a minority shareholding.
• You hold your interest through another company or trust.
• The company earns investment income or deals with related parties.
• You have assumed no Australian tax arises because no dividend was paid.

1. Provide your adviser with the ownership structure, financial statements, income breakdown, related party transaction details and foreign tax records. These documents help establish whether the rules apply and what you must report.

How Waterhouse Tax Lawyers can help

1. Waterhouse Tax Lawyers can assess whether your overseas company falls within the CFC rules, advise on your Australian tax exposure and assist with ATO enquiries or disputes concerning foreign income.
2. Own a company overseas? Contact Waterhouse Tax Lawyers to understand your Australian tax obligations before an unexpected tax bill arises.

This article provides general information. Obtain advice on your circumstances before making tax or business decisions.