New decree specifies application
The Federal Minister of Finance published a decree on the passive income of corporations subject to low taxation on 25 January 2019.
What are the implications of the controlled foreign company legislation and change in method?
Foreign passive income will be taken into account from two points of view in Austria from 2019 onwards:
|CONTROLLED FOREIGN COMPANY LEGISLATION||CHANGE IN METHOD|
What does the new decree stipulate?
The decree specifies the application of the new controlled foreign company legislation and the new change in method with regard to the distribution of profits by passive subsidiaries subject to low taxation and the disposal of such international participations.
Among other things, the decree contains “technical” details relating to the following points:
1. Determination of low taxation level of foreign subsidiary
The average tax burden for the subsidiary concerned has to be determined separately for each financial year.
Foreign taxes should be taken into account insofar as the assessment basis is comparable with the one applying to corporation tax. Subsequent corporation tax refunds should be taken into account even with retroactive effect. If the corporation tax is only applied at the time of the distribution or if a loss was made during the year, the low tax rate assessment should be based on the nominal tax rate.
A low taxation level is not applied if a low average tax burden only stemmed from special foreign write-off systems, the formation of provisions or the application of losses from previous years.
2. Passive income: Determination of the one-third threshold under the controlled foreign company legislation
The one-third threshold for passive income compared with total income is to be applied for every financial year.
The previous two financial years are also taken into account for the determination of the one-third threshold if the level is exceeded by no more than 25% during the year or if active income is negative.
3. Evidence of substance
The controlled foreign company legislation does not apply if evidence of substance is provided (evidence of material economic activity).
According to the decree, it is assumed that a material economic activity exists when at least on third of staff, equipment, assets and premises are used for “active” economic activities AND at least one third of the income is generated by these “active” economic activities.
Doubts arise, however, concerning the concept of a material economic activity according to the decree if the subsidiary’s activity only involves holding or transferring interests, passing on assets or holding intangible assets whose development has not even been paid for by the company.
4. Details concerning the change in method (above 5% interest)
- In principle, the 50% threshold for passive income is to be determined for each year.
- The previous two financial years may also be taken into account for the assessment of the 50% threshold if the latter is exceeded by up to 25% or if losses are recorded.
- In exceptional circumstances, evidence of substance may be applied in order to avoid a change in method, e.g. in the case of start-up losses in any operational subsidiary with negligible interest income.
- In the event of the distribution of profits from several years, the applicable years are the ones during which the profit was generated; in case of doubt the FIFO principle applies.
5. Sale of a basically tax-free international cross-shareholding
In the event of the disposal of an international cross-shareholding (over 10% and longer than 1 year), an assessment is carried out to determine whether the subsidiary generated more than 50% passive income overall during the previous seven financial years. If the passive income is preponderant, the total capital gains are taxable; if the active income is preponderant the total capital gains are tax free.
Note: If losses are recorded during certain years, the passive income can quickly become preponderant.
However, capital gains remain completely tax free, in spite of passive income being preponderant, if the Austrian parent company can prove that the capital gains from shareholdings (hidden reserves) stemmed mainly from the active division of the company.
The corresponding documents should ideally be prepared prior to the sale as unlimited access to data may no longer be possible after the sale.
In order to avoid unwanted surprises when completing the tax return for 2019, we recommend for international holding, management or group structures to be checked accordingly. The real estate sector could also be affected by the new rules.