UNIVERSITY OF SYDNEY
FACULTY OF LAW

POSTGRADUATE TAX PROGRAM

AUSTRALIAN INTERNATIONAL TAXATION

TWO HOURS

21 june 2000

INSTRUCTIONS:

1. Reading time allowed is 15 minutes.
2. This is an OPEN book examination. Candidates may take any books and materials whatsoever into the examination room.
3. Candidates must answer BOTH questions.
4. The examination is worth 70% of the marks for the course. Both questions are of equal value.
5. In each answer, state any further information (if any) that you may need to fully answer the question. Where necessary, state any assumptions that you have made in answering a question.
This examination consists of 7 pages, including this cover page. Please be sure that your examination paper is complete.

QUESTION ONE

(ANSWER ALL THREE PARTS: PART THREE HAS SOME INTERNAL CHOICE)

Part One (20 marks)

Grommit Pty Ltd, a company incorporated, and managed and controlled in Australia, is a manufacturer of surfboards and skateboards. The shares in Grommit are beneficially owned by Midget Carroll, an Australian surfing star of the 1980s.

On 1 July 1998, Grommit established a manufacturing subsidiary in Malaysia ("Malayco").

Malayco has three directors: Jagdish (chair); Tan and Sekhon. The directors are Malaysian residents. They are partners in an international chartered accounting firm ("CA Int") that also acts for Grommit in Australia.

Directors’ meetings of Malayco are held in Malaysia. The agenda for directors’ meetings is prepared by Jagdish.
A draft agenda is sent to Schwarz, the Australian partner of CA Int that acts for Grommit. Schwarz reviews the draft agenda and, after discussions with Midget, returns the draft to Jagdish with any suggested changes to the agenda. Schwarz also sends Jagdish voting recommendations on the motions to be put to the meeting. All correspondence is through CA Int’s internal e-mail network.

The revised agenda and Schwarz’s voting recommendations are then circulated by Jagdish to the other directors of Malayco. The directors of Malayco invariably follow the recommendations of Schwarz.

However, there was one occasion when Sekhon was concerned that a particular motion, if passed, may breach Malaysian company law. This motion was deferred by the board of Malayco and, on subsequent legal advice, was not proceeded with.

Malayco assembles skateboards from parts provided by Grommit and manufactures surfboards from locally acquired raw materials. Skateboards and surfboards are sold to distributors in Malaysia, SAR Hong Kong, Singapore and Japan.

One-third of all sales are made to Malaysian distributors; one-quarter to Hong Kong distributors; one-quarter to Singapore distributors; and one-sixth to Japanese distributors.

The sales to Malaysian distributors are subject to Malaysian corporate tax at the rate of 28%. The sales to Hong Kong and Japanese distributors are made through an import agent in the relevant country and are subject to tax at the rate of 16% (Hong Kong) and 48% (Japan, including local government income tax).

Sales to Singapore distributors are not subject to tax in Singapore. Sales to foreign distributors are not taxed in Malaysia as the sales proceeds are paid direct into Malayco’s bank account in Hong Kong.

Malayco has a bank account in Malaysia on which it earns interest. The interest is taxable in Malaysia at the corporate rate. No tax is paid in Malaysia or Hong Kong on interest earned on the Hong Kong account.

For the year ended 30 June 1999, Malayco’s profit and loss statement is as follows (in Malaysian currency) –

Income

Sales – skateboards 300,000

surfboards 600,000

Interest – Malaysian account 5,000

Hong Kong account 40,000

945,000

less cost of goods sold 450,000

Gross profit 495,000

Expenses

Selling expenses 75,000

Accountancy fees 40,000

Entertainment 10,000

Bank charges 5,000

Total expenses 130,000

Net profit 365,000

Advise Grommit on the Australian tax implications of the above facts.

AND

Part Two (5 marks)

How would your advice in Part One differ if the operations in Malaysia were established as a branch of Grommit rather than as a subsidiary?

AND

Part Three (Answer one question only; 10 marks)

A. Wealthy is an Australian resident individual. In 1980, Wealthy’s Hong Kong solicitor established a family discretionary trust in Hong Kong. The trustee of the trust is a Hong Kong resident individual. The potential beneficiaries under the trust were Wealthy, his spouse and children. The trustee used the amount settled on trust to establish a company in Hong Kong. The company is incorporated, and managed and controlled in Hong Kong. Shortly after the company was established, Wealthy transferred income-producing properties in Hong Kong to the trust for no consideration. Each year, the company distributes all its after-tax profits to the trust. The trustee has always accumulated the income in the trust. Wealthy died in 1995.

The Australian Taxation Office has just become aware of the existence of the trust and is threatening to assess the potential beneficiaries of the trust to tax on the income accumulated in the trust since 1 July 1990. Advise the potential beneficiaries.

B. The eleven members of a Sydney tax discussion group have decided to establish a company in the Cayman Islands to invest in equity and debt instruments issued by companies listed on stock exchanges in the United States, Singapore and South Africa. Two members are cousins, two are engaged to be married and two work for the same law firm (one as a partner and the other as an employee). The members of the group are otherwise unrelated.

Advise the group of the Australian tax consequences of establishing the Cayman Islands company.

QUESTION TWO (ANSWER THREE PARTS ONLY: EACH PART IS OF EQUAL VALUE)

Part One

Rory, a resident of Brazil, beneficially owns all the issued shares in Holders Pty Ltd, a company incorporated, and managed and controlled in Brazil. The only asset of Holders is shares in Property Pty. Ltd., a company incorporated in Brazil with its central management and control in Australia. Holders holds all the issued shares in Property. The only asset of Property is unimproved real estate property in Australia. The land was acquired by Property in 1986 and has substantially increased in value. Rory originally acquired the land in the hope of one day migrating to Australia and building a house on the land. This is now not an option and Rory decides to realise the land. Rory seeks your advice on the following proposals -

(a) Property sells the land and distributes the profit on sale to Holders as a dividend.

(b) Holders arranges for the liquidation of Property. The liquidator sells the property and distributes the profit (net of liquidation expenses) to Holders.

(d) Rory arranges for the appointment of a new board of directors of Property all of whom will be residents of Brazil. In future, all director’s meetings will be held in Brazil. After this change has been made, Holders will dispose of its shares in Property.

(e) Rory disposes of his shares in Holders for a profit that reflects the increase in value in the land owned by Property.

Part Two

Media (HK) Ltd is the holder of various literary, film and video copyrights. Aussie Pty Ltd is a subsidiary of Media and wishes to use the copyrights in Australia.

It has been suggested in relation to each copyright that an agreement should be entered into whereby in exchange for a ten year transfer of the copyright with respect to Australia (but not the rest of the world) Aussie should pay Media a lump sum of A$1m. This amount will remain outstanding as an interest free loan to be paid off as revenues of Aussie permit. Where at the end of a ten year period the revenues from the use of the copyright are not sufficient to pay the $1m, the balance of the debt is to be forgiven. Where the revenues from a copyright exceed $1m, the cost of the next copyright licence is to be increased by 90% of the excess, and the amount in excess of $1m is to be paid immediately.

Advise on the tax effects of these arrangements for the parties.

Part Three

Manufactures Ltd. (a resident of Australia) wishes to raise $10 million. An arrangement is made with its bank (a resident of Australia) whereby Manufactures draws bills on the bank for $12 million such bills being in favour of Manufactures and payable at monthly intervals over twelve months commencing twelve months from the date of the bills.
Manufactures then sells the bills on the money market to a non-resident at the prevailing discount rate and receives $10 million. On maturity the bills are duly presented to the bank by the non-resident discounter and paid in full by the bank. The amount paid by the bank in respect of each bill is debited to Manufactures account with the bank which is put in funds by Manufactures by further similar arrangements.

What are the Australian taxation implications of this procedure?

Would it make any difference if the bank were a non-resident?
Would your advice differ if instead of Manufactures selling the bills on the market the bank itself had discounted the bills (the bank being in this case a non-resident)?
What if the non-resident holder sold to an Australian resident shortly before maturity of the bills?
What if the non-resident sold shortly before maturity to another non-resident who held to maturity?

Part Four

Manufacturers Ltd, a Hong Kong company, has a branch in Sydney which sells its products to the Australian market. In its most recent tax return in Australia for the 1998-1999 income year, Manufacturers has claimed the following deductions:

(a) 10% interest on a "loan" from head office to the branch;

(b) a foreign exchange loss on profits of the branch repatriated to head office;

(c) a contribution of $100,000 as its share of administrative, accounting and management services worth $1 million performed in head office; and

(d) $10 per item as cost of goods sold (the cost of manufacture on an absorption cost basis in Hong Kong being $7.50).

The ATO has is proposing to disallow the first and second deductions as not being relevant under Australian law, disallow the third deduction on the basis that it is included in the cost of manufacture and reduce the fourth deduction to $7.50.

Advise Manufacturers which also wishes to know whether it is able to amend its return to be assessed under ss 38-43 of the Income Tax Assessment Act 1936 and what would be the result if it did.

UNIVERSITY OF SYDNEY FACULTY OF LAW