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Chapter 32: Foreign source income of residents

The challenge for taxation policy

Under the proposed entity taxation arrangements, the taxation of foreign source income derived through trusts would largely be aligned with the treatment of companies. The loss of foreign tax credit flow-through for investments via trusts could have a negative impact on collective investment vehicles.

The current anti-tax-deferral rules applying to investments through foreign entities provide the scope for tax avoidance and can cause problems for taxpayers.

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A strategy for reform
  • To address the foreign tax credit impact of entity taxation.
  • To improve the anti-tax-deferral rules.
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Key policy issues

Impact of entity taxation

Problems with the anti-tax-deferral rules

What are the consequences of entity taxation for income derived through trusts? How should relief from international double taxation available for companies be extended to trusts? Should foreign tax credits flow through entities to resident taxpayers? How could problems with the active business exemption in the foreign investment fund measures be addressed? How could the
anti-tax-deferral rules for foreign trusts be improved?
How could the transferor trust measures be improved?
Options
Trust distributions would be treated as dividends.

Foreign tax credit flow-through would cease to be available.

Rules may be required to treat loans from foreign trusts as dividends.

Options
Entities could be allowed a credit for 'underlying tax' for amounts derived from a foreign trust.

The exemption for dividends paid from comparably taxed profits could be provided to resident trusts.

The branch profit exemption could be available for offshore branches of resident trusts.

Option 1
Collective investment vehicles could be excluded from the proposed entity taxation arrangements.

Option 2
Imputation credits could be provided for foreign dividend withholding tax.

Option 1
The active business exemption could be removed.

Option 2
The active business exemption could be replaced with an active income test for non-portfolio investments and a jurisdictional exemption for portfolio investments.

An exemption for certain foreign trusts could be considered.

Options
The deemed present entitlement rules could be removed.

Widely-held fixed trusts could be treated in the same way as companies.

Overlap could be reduced in the anti-tax-deferral rules for trusts.

Options
Some exemptions could be removed.

The time allowed for making adjustments could be extended.

Rules could be developed for dealing with hidden trusts.