Investment Manager Regime, Fin 48 Reforms and an update on outstanding tax reforms
The Australian Government has released exposure draft legislation to implement the following tax reforms (which have been previously announced):
- amendments to prevent the Australian Taxation Office from raising assessments for certain investment income of foreign managed funds for the 2010-11 and previous income years. This announcement was made to address a key area of investment uncertainty for US-based fund managers investing in Australia arising from the application of US accounting standard 'FIN 48' (the FIN 48 reforms) – as previously announced by the Assistant Treasurer on December 17 2010 and extended by the 2011-12 Budget. Importantly, the Government is still to announce its position for foreign funds for the 2011-2012 financial year and subsequent years (see further details below).
- changes to the tax treatment of certain investment income of foreign funds where those funds are taken to have a permanent establishment in Australia by virtue of the fact they have engaged an Australian based intermediary. These changes are referred to as the 'Conduit Income' reforms. Under these reforms, income from relevant investments of a foreign fund, that is taken to have a permanent establishment in Australia, will be exempt from income tax – as previously announced by the Assistant Treasurer on January 19 2011.
Although these reforms provide much needed certainty around complex Australian tax, source and permanent establishment issues, the Exposure Draft released confirms that these concessions apply only in limited and specific circumstances. Accordingly it is advisable for foreign funds and managers to confirm that their circumstances will qualify and be eligible for these concessions.
Minter Ellison's national team of tax experts can assist you with these important reforms. Please contact us to discuss these and other opportunities.
Which foreign funds are eligible?
An entity is an eligible foreign fund where it satisfies the following at all times during the income year:
The foreign fund is:
||not a resident of Australia
||This applies whether or not the foreign fund is a taxable or a transparent entity.|
||recognised under a foreign law as a collective investment vehicle
This will include foreign funds which take a variety of forms, including a company, trust, limited partnership or common contractual fund and which are designed to pool funds of a number of investors, where;
- there is a common purpose of investing;
- members do not have day to day control of the operations of foreign fund
||not carrying on a 'trading business' in Australia
A trading business for this purpose is defined in the Tax Act and will not include the following 'passive' activities in Australia;
- investing in land for the purpose or primarily for the purpose of deriving rent;
- investing or trading in:
- secured or unsecured loans;
- bonds, debentures, stock or other securities;
- shares in a company, including shares in a foreign hybrid company;
- units in a unit trust;
- futures contracts;
- forward contracts;
- interest rate swap contracts;
- currency swap contracts;
- forward exchange rate contracts;
- forward interest rate contracts;
- life assurance policies;
- a right or option in respect of such a loan, security, share, unit, contract or policy; and
- any similar financial instruments.
The foreign fund can still carry on non passive activities outside Australia.
The foreign fund is widely held if:
- it is listed for quotation on the official list of an approved stock exchange, or
- has at least 50 members.
Special tracing rules apply to determine the number of members in the foreign fund. Importantly:
- any foreign funds will be 'look through' entities for the purpose of identifying 50 or more underlying investors.
- interests held by associates' will be aggregated;
- where the investor is a specified widely held entity, it is deemed to represent a notional member with a membership interest equal to '50 multiplied by the membership interest percentage held by the entity'.
Specified widely held entities include the following:
- a life insurance company;
- a complying superannuation fund, a complying approved deposit fund or a foreign superannuation fund, being a fund that has at least 50 members;
- a pooled superannuation trust that has at least one member that is a complying superannuation fund with at least 50 members;
- a managed investment trust in relation to the income year;
- an entity that is recognised under a foreign law as being used for collective investment by means of pooling the contributions of at least 50 members of the entity as consideration to acquire rights to benefits produced by the entity, if the members of the entity do not have day-to-day control over the operation of the entity;
- an entity, the principal purpose of which is to fund pensions (including disability and similar benefits) for the citizens or other contributors of a foreign country;
- certain qualifying investment entities which are wholly owned by one or more foreign government agencies;
- certain qualifying entities which are established and wholly-owned by an Australian government agency;
- another eligible foreign fund.
||not closely held
||A foreign fund is closely held where either 20 or fewer persons have 75% or more of the participation interests (as defined) in the foreign fund or one foreign resident individual (together with their associates) holds an interest of 10% or more. |
Participation interests held by specified widely held entities are ignored for the purpose of applying this test.
What Income, Gains and Losses are covered?
Income, gains and losses made on financial arrangements are covered except as follows:
- non-portfolio (10% or more) debt and equity interests;
- derivative financial arrangements that relate to non portfolio debt or equity interests;
- a derivative financial arrangement that relates to a capital gains tax (CGT) asset that is Taxable Australian Real Property (eg Australian real property or mining rights) or an indirect Australian real property interest;
- a financial arrangement the terms of which allow the foreign fund to do any of the following:
- vote at a meeting of the Board of Directors (or other governing body) of the issuer of the financial arrangement; or
- participate in making financial, operating or policy decisions in respect of the operation of the issuer of the financial arrangement; or
- deal with the assets of the issuer of the financial arrangement
(unless the only situation is where the issuer breaches the terms of the financial arrangement)
Financial arrangement for these purposes generally follows the existing TOFA (Taxation of Financial Arrangements) definition under Division 230 of the Tax Act – that is a 'cash settlable' legal or equitable right or obligation to receive a financial benefit. This includes an equity interest. A 'financial benefit' is defined to mean:
- anything of economic value;
- includes property and services;
- includes anything that the regulations provide is a financial benefit; and
- even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.
FIN 48 reforms – Additional requirements
The Fin 48 exemption applies to foreign funds, foreign trustees, foreign resident beneficiary or partner in an eligible foreign fund.
The following additional requirements must be satisfied for the exemption to apply:
- The foreign fund, foreign trustee, foreign resident beneficiary or partner has not lodged an Australian income tax return in relation to the 2010-2011 and prior income years.
- Before 18 December 2010, the Commissioner did not make an assessment of the taxable income of the foreign fund, foreign trustee, foreign resident beneficiary or partner (exceptions apply if there has been fraud and/or the Commissioner notified the foreign fund, foreign trustee, foreign resident beneficiary or partner that an audit or compliance review would be undertaken).
Conduit Income Reforms - Additional Requirements
A foreign fund must also meet the following additional requirements to be eligible for the conduit income concessions:
- The foreign fund does not have a place of business in Australia but may have a permanent establishment (PE) in Australia solely as a result of engaging an Australian investment manager or other Australian intermediary who habitually negotiates and concludes contracts in Australia (an 'agency PE').
- The income or gain must have been taxable in Australia only because of rules that deem an item to have an Australian source because of the presence of a PE in Australia. That is, the amounts must have been included in the entity’s assessable income only because of one of the following provisions:
- the ‘source’ provisions in the International Tax Agreements Act 1953; or
- transfer pricing PE attribution rules (section 136AE of the ITAA 1936); or
- a CGT asset that has been used at any time in carrying on a business through a permanent establishment in Australia or an option or right to acquire such assets. This provision is designed to deal with revenue gains on CGT assets (or options or rights over such assets) that are used in carrying on a business through a PE.
Update on outstanding tax reforms
The Australian financial services industry is undergoing important and significant tax reform to reduce uncertainty, complexity and compliance and which should therefore encourage the development of the industry. Tax uncertainty has been identified as a material impediment to economic expansion and development as a financial services hub in the Asia-Pacific region. The reforms noted above should materially reduce uncertainty for foreign investors and fund managers alike. Additional reforms are still in progress and a brief update on these ongoing reforms is included as follows:
Fin 48 for 2012 and later years
The Government has not announced a final position for gains made by foreign funds in respect of the 2011-2012 financial year and later years. Accordingly over-the-counter (OTC) transactions entered into and executed outside of Australia continue to be the best way of managing the tax risk and Fin 48 disclosure risks in relation to Australian securities as an interim measure. The IMR concessions noted above may provide further relief in relation to these OTCs. The Board of Taxation has been asked to report to Government by 30 September 2011 on the broader IMR issues.
Codifying Sovereign immunity exemption
Sovereign investors (including Sovereign Funds) should be aware of potential changes to Australian taxation arrangement for sovereign investments:
- Australia is currently in the process of codifying the sovereign immunity exemption available under international law – which exempts dividend and interest income derived by a foreign government;
eligible sovereign entities holding portfolio equity interests (directly or indirectly through wholly owned subsidiaries) may be automatically be eligible for exemption; and
sovereign entities investing through foreign collective investment vehicles may no longer be eligible for exemption.
Review of collective investment vehicles
- The Board of Tax is to report to the Australian Government before 31 December 2011 on the review of Collective Investment Vehicles (CIVs) including whether flow through status of trusts should be extended to other vehicles such as limited partnerships or companies.
A new tax system for Australian MITs
- A new tax regime will be introduced for MITs effective from 1 July 2012. This should provide greater certainty to foreign fund managers regarding the character of distributions they receive from MITs.
- The new tax regime will allow the trustee of an MIT to choose an attribution method of taxation (that is, in lieu of the current present entitlement rules), where the unit holders of the MIT have clearly defined rights or entitlements:
- the trustee of the MIT must attribute the tax income of the trust to the unit holders of the MIT on a fair and reasonable basis consistent with their rights and entitlements under the MITs constituent documents and the duties of the trustee;
- unit holders will be assessed on the amount that is attributed to them by the trustee, as a consequence of the trustee properly exercising a power conferred upon it under the trust instrument; and
amounts attributed by the trustee to the unit holder will generally retain their character in the hands of the unit holder consistent with the character that applied at the trustee level.
The Government is in the process of developing the FAF rule and CFC reforms and is engaged in ongoing public consultation
The FIF rules have been repealed (so that Bed & Breakfast arrangements are no longer necessary) and Exposure draft legislation has been released for comment (consultations closed on 18 March 2011). The Government announced on 29 June 2011 that the foreign accumulation fund (FAF) integrity rule will not apply for the 2010-11 income year.
A wider range of foreign investment products may be attractive to Australian investors where Australia's anti-deferral rules are to be relaxed.
- The replacement foreign accumulation fund rules will only apply where:
- the market value of debt interests held by the foreign fund comprises 80% or more of the market value of all assets held by the foreign fund; and
- the foreign fund does not distribute more than 80% of the realised profits and gains derived by it or its controlled entities within three months after the end of its accounting period.
- Australian investors such as complying superannuation funds, life insurance companies, trusts with a superannuation fund or life insurance company as the sole member, or partnerships with a superannuation fund or life insurance company as a member are exempted from applying these rules.
- Superannuation funds will be exempted from applying the controlled foreign company (CFC) rules.
- CFC testing will only apply to a taxpayer and its associates rather than ALL Australian investors;
- Australia's controlled foreign company rules will be amended so that foreign companies involved in the leasing of real property or otherwise involved in significant business activities should no longer attract anti-deferral taxation.