Corporate - Income determinationLast reviewed - 09 December 2022
Inventory generally may be valued at cost (full absorption cost), market selling value, or replacement price. Where, because of obsolescence or other special circumstances, inventory should be valued at a lower amount, the lower valuation generally may be chosen, provided it is a reasonable valuation. Special rules apply, however, regarding the valuation of trading stock for certain companies joining a consolidated group. Last in first out (LIFO) is not an acceptable basis of determining cost, nor is direct costing in respect of manufactured goods and work-in-progress.
Conformity is not required between book and tax reporting. For tax purposes, inventory may be valued at cost, market selling value, or replacement price, regardless of how inventory is valued for book purposes. Those who choose to come within the small-medium business entity measures (broadly defined as taxpayers who carry on business and who, together with certain 'connected' entities, have an aggregated turnover of less than AUD 50 million may ignore the difference between the opening and closing value of inventory if, on a reasonable estimate, this is not more than AUD 5,000.
A capital gains tax (CGT) applies to assets acquired on or after 20 September 1985. Capital gains realised on the disposal of such assets are included in assessable income and are subject to tax at the corporate tax rate. In order to determine the quantum of any gain for any assets acquired before 21 September 1999, the cost base is indexed according to price movements since acquisition, as measured by the official CPI until 30 September 1999. There is no indexation of the cost base for price movements from 1 October 1999. Disposals of plant and equipment are subject to general rules rather than the CGT rules. Capital losses are allowable as deductions only against capital gains and cannot be offset against other income. In calculating capital losses, there is no indexation of the cost base.
Companies that are tax residents in Australia generally are liable for the tax on gains on the disposal of assets wherever situated, subject to relief from double taxation if the gain is derived and taxed in another country. However, the capital gain or capital loss incurred by a company from a CGT event in relation to shares in a foreign company is reduced by a percentage reflecting the degree to which the foreign company's assets are used in an active business if the company holds a direct voting percentage of 10% or more in the foreign company for a certain period before the CGT event. Attributable income from CGT events happening to shares owned by a controlled foreign company (CFC) are reduced in the same way. Capital gains and capital losses made by a resident company in respect of CGT events happening in respect of 'non-tainted' assets used to produce foreign income in carrying on business through a PE in a foreign country are disregarded in certain circumstances.
Non-resident companies are subject to Australian CGT only where the assets are taxable Australian property (i.e. Australian real property, or the business assets of Australian branches of a non-resident). Australian CGT also applies to indirect Australian real property interests, being non-portfolio interests in interposed entities (including foreign interposed entities), where the value of such an interest is wholly or principally attributable to Australian real property. 'Real property' for these purposes is consistent with Australian treaty practice, extending to other Australian assets with a physical connection with Australia, such as mining rights and other interests related to Australian real property. A 'non-portfolio interest' is an interest held alone or with associates of 10% or more in the interposed entity.
Proceeds from the sale of certain taxable Australian property by a non-resident are subject to a non-final WHT of 12.5% of the proceeds.
A 'gross-up and credit' mechanism applies to franked dividends (dividends paid out of profits that have been subject to Australian tax) received by Australian companies. The corporate shareholder grosses up the dividend received for tax paid by the paying company (i.e. franking credits attaching to the dividend) and is then entitled to a tax offset (i.e. a reduction of tax) equal to the gross-up amount. A company with an excess tax offset entitlement converts the excess into a carryforward tax loss using a special formula.
Dividends paid to another resident company that are unfranked (because they are paid out of profits not subject to Australian tax) are taxable, unless they are paid within a group that has chosen to be consolidated for tax purposes. Dividends paid between companies within a tax consolidated group are ignored for the purposes of determining the taxable income of the group.
Franked dividends paid to non-residents are exempt from dividend WHT.
An exemption from WHT is also available for dividends received by non-resident shareholders (or unitholders) in an Australian corporate tax entity (CTE) to the extent that they are ‘unfranked’ and are declared to be conduit foreign income (CFI). These rules may also treat the CFI component of an unfranked dividend received by an Australian CTE from another Australian CTE as not taxable to the recipient, provided it is on-paid within a specified timeframe. Broadly, income will qualify as CFI if it is foreign income, including certain dividends, or foreign gains, which are not assessable for Australian income tax purposes or for which a foreign income tax offset has been claimed in Australia.
Non-portfolio dividends repatriated to an Australian resident company from a company resident in a foreign country will be non-assessable, non-exempt income, but only if it is a distribution paid on an equity interest as determined under Australian tax law.
Income of a non-resident entity in which Australian residents hold interests is not assessable when repatriated to Australia where the income has been previously attributed to those residents and taxed in Australia (see Controlled foreign companies [CFCs] in the Group taxation section for more information).
Stock dividends, or the issue of bonus shares, as they are known under Australian law, are, in general, not taxed as a dividend, and the tax treatment is the spreading of the cost base of the original shares across the original shares and the bonus shares. However, if a company credits its share capital account with profits when issuing bonus shares, this will taint the share capital account (if it is not already a tainted share capital account), causing the bonus share issue to be a dividend. Certain other rules may apply to bonus share issues, depending on the facts.
Special rules apply to the taxation of financial arrangements (TOFA). 'Financial arrangement' is widely defined to cover arrangements that involve a cash settlable legal or equitable right to receive, or obligation to provide, something of economic value in the future.
These measures provide six tax-timing methods for determining gains or losses in respect of financial arrangements, along with revenue account treatment of the resulting gains or losses to the extent that the gain or loss is made in earning assessable income or carrying on a business for that purpose. The default methods are the accruals method and the realisation method, one or other of which will apply depending on the relevant facts and circumstances of a particular financial arrangement. In broad terms, the accruals method will apply to spread an overall gain or loss over the life of the financial arrangement (or a particular gain or loss over the period to which it relates) where there is sufficient certainty that the expected gain or loss will actually occur. A gain or loss that is not sufficiently certain is dealt with under the realisation method.
Alternatively, a taxpayer may irrevocably choose one or more of four elective methods (i.e. fair value, retranslation, financial reports, and hedging) to determine the tax treatment of financial arrangements covered by the election. Qualification criteria must be met before the elective methods may be used. Generally, these criteria require that the taxpayer prepare a financial report in accordance with Australian (or comparable) accounting standards and that it be audited in accordance with Australian (or comparable) auditing standards.
Exemptions from this regime may be available having regard to the duration of the arrangement or the nature of the relevant taxpayer and the annual turnover or value of assets of that taxpayer. Certain types of financial arrangements are excluded from these rules, including leasing and hire purchase arrangements. Foreign residents are taxable on gains from financial arrangements under these measures to the extent that the gains have an Australian source.
Royalties are generally subject to taxation as ordinary income.
However, royalties paid to a non-resident (other than where it is received in respect of a PE in Australia of a resident of a treaty country) are subject to a final WHT applied to the gross amount of the royalty. Royalties for WHT purposes covers payments that fall within the ordinary meaning of the term as well as certain specified payments (e.g. payments for the use of, or the right to use, copyright, patent, design or model, plan, secret formula or process, trademark, or any industrial, commercial, or scientific equipment; the supply of scientific, technical, industrial, or commercial knowledge or information; the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of any of the aforementioned rights, equipment, or information; and the use of, or the right to use, visual images and/or sounds in connection with television or radio broadcasting that are transmitted by satellite, cable, optic fibre, or similar technology), subject to the application of any DTA. Generally, payments for services will not constitute the payment of a royalty. See the Withholding taxes section for further information.
Foreign exchange gains and losses
Foreign currency gains and losses are recognised when realised, regardless of whether there is a conversion into Australian dollars, and are included in or deducted from assessable income, subject to limited exceptions.
For foreign exchange gains and losses associated with financial arrangements subject to the TOFA measures (as discussed above), the compliance impact of the foreign exchange rules will be reduced for those taxpayers who are eligible to and elect the TOFA retranslation or financial reports tax-timing methods which will broadly have the effect of recognising for tax purposes the same foreign exchange gains or losses reported for accounting purposes.
To reduce compliance costs for foreign currency denominated bank accounts that are not subject to the TOFA rules, some taxpayers may elect to disregard gains or losses on certain low balance transaction accounts that satisfy a de minimis exemption or may elect for retranslation by annually restating the balance of the account by reference to deposits, withdrawals, and the exchange rates at the beginning and end of each year (or by reference to amounts reported in accordance with applicable accounting standards).
There are also exceptions to the timing and/or characterisation aspects of the realisation approach where the foreign currency gain or loss is closely linked to a capital asset or where the particular financial arrangement is subject to the hedging elections under the TOFA rules.
Entities or parts of entities, satisfying certain requirements, are able to choose to account for their activities in a currency other than Australian dollars for income tax purposes as an intermediate step to translating the result into Australian dollars (known as the 'functional currency' choice).
The current basis upon which the foreign income of corporations resident in Australia is taxed is set out below.
- Foreign dividends or distributions paid on equity interests as defined for Australian income tax purposes (i.e. the exemption does not apply to dividends paid on legal form shares that are treated as debt interests) are exempt from tax when received by a resident corporate tax entity that holds at least a 10% participation interest in the foreign company. The exemption also applies to distributions received indirectly (e.g. via a trust) by resident companies. However, hybrid mismatch rules may operate to limit the exemption (see the Group taxation section for more information).
- Active foreign branch profits of a resident company from carrying on business through a PE in a foreign country and capital gains made by a resident company from the disposal of non-tainted assets used in deriving foreign branch income (except income and capital gains from the operation of ships or aircraft in international traffic) are not assessable for tax.
- Other foreign income of Australian resident corporations is subject to tax; however, in most cases, an offset for foreign income tax paid is allowed to the extent of Australian tax payable on such income.
- Generally, limited partnerships are treated as companies for Australian tax purposes. In certain circumstances, foreign limited partnerships, foreign limited liability partnerships, United States (US) limited liability companies, and United Kingdom (UK) limited liability partnerships are treated as partnerships (i.e. as a flow-through entity) rather than as a company for the purposes of Australia's income tax laws.
- Australia also has a comprehensive CFC regime. See Controlled foreign companies (CFCs) in the Group taxation section for more information.