On 15 January 2010, the Australian Financial Centre Forum released its report (Johnson report) on 'Australia as a financial centre', which contained 19 recommendations, including introduction of an 'investment manager regime' (IMR) for investments by foreign residents managed in Australia and a comprehensive regime for the taxation of 'collective investment vehicles' (CIVs). The Government responded on 11 May 2010 with in-principle support for all recommendations and released a consultation paper.
The Board of Taxation (BoT) was asked to review and report on design of an IMR and to review the tax treatment of CIVs. The BoT released its report on 17 December 2010 and the Assistant Treasurer announced on 19 January 2011 that the Government would introduce an exemption for offshore funds engaging domestic investment advisers (referred to as 'conduit income' measures).
As noted in our article about the tax determinations recently issued by the ATO in relation to certain profits on Australian investments derived by foreign private equity funds, the Australian Government announced that it would introduce measures to deal with uncertainties arising in past years for foreign funds in relation to their Australian tax position due to their disclosure requirements under the US accounting standard known as 'FIN 48' and also announced that it would introduce conduit income measures to encourage the use of Australian fund managers by foreign funds in future years.
Exposure draft (ED) legislation was released in August 2011, containing the following 2 measures:
The proposed measures are the first instalment of the IMR changes and remaining issues raised by the Johnson report are still being considered by the BoT, which is due to release its report to Government (covering both IMR and CIVs) by 31 December 2011. The proposed changes were described by the Assistant Treasurer as 'an important step towards improving Australia's standing as an international financial services centre'.
These measures1 provide an exemption (in the 2010-11 and earlier income years, as noted above) from taxation in relation to 'IMR income' (and for an 'IMR loss', 'IMR capital gain' or 'IMR capital loss' to be disregarded) for:
The exemption applies only if:
The exemption does not apply if the Commissioner is of the opinion that there has been fraud by the IMR foreign fund, beneficiary or partner.
The terms 'IMR foreign fund', 'IMR income', 'IMR loss', 'IMR capital gain' and 'IMR capital loss' are defined in the conduit income provisions (see below).
As noted in our article concerning the 'private equity' tax determinations, the definition of 'IMR income' in the conduit rules does not deal with the issues of Australian source arising from TD 2011/24. It also excludes the type of private equity investments dealt with in the determinations (i.e. non-portfolio investments in Australian companies).
These measures2 will provide that, in working out the taxable income for an income year of certain 'IMR foreign funds', the 'IMR income' of the fund is non-assessable non-exempt income and any 'IMR loss', 'IMR capital gain' or 'IMR capital loss' of the fund is disregarded.
As noted above, the changes are intended to remove a major impediment to the use of Australian investment managers by foreign funds (namely, causing the fund to have a permanent establishment in Australia that it would otherwise not have) and bring Australian closer into line with other major financial services centres. However, there are a number of limitations and uncertainties with the provisions, as noted below.
The proposed provisions will apply (in the 2010-11 and later income years) if:
The EM says that the relief is intended to apply at the fund level (where the entity itself is taxable, e.g. a company or an entity taxed as a company) or at the partner/member level (if the fund is treated as transparent for tax purposes, e.g. a trust) and that it is not intended to apply for an Australian resident partner or member. However, it is not entirely clear that this is achieved in the ED provisions and the EM acknowledges that 'further changes may be necessary to ensure this outcome is achieved'.
The EM says the measures are 'targeted at widely held entities where investors collectively pool their funds to make portfolio investments in foreign sourced assets'.
An entity (regardless of its legal form)3 will be an IMR foreign fund in relation to an income year if:
'Widely held' and 'closely held' are defined as in the definition of a 'managed investment trust' (MIT) for the purpose of the MIT non-resident withholding provisions in Schedule 1 to the Taxation Administration Act 1953 (Cth), subject to necessary modifications (to enable them to apply to non-resident entities of various legal forms).
The 'widely held' test essentially requires that either the fund's interests are listed or the fund has at least 50 members (or certain types of entities have interests totalling more than 25% and no other single entity has an interest of 60% or more). While the definitions allow for tracing through certain types of entities and chains of entities, difficulties and anomalies can arise, for example, where the fund's members are 'feeder funds', which may prevent the fund from being treated as widely held even where, as a matter of substance, it is.
The requirement that the fund is recognised under foreign law as a collective investment vehicle and its members do not have day to day control is similar (but not identical) to a provision in the non-resident withholding rules for MITs allowing for tracing through such a vehicle in determining whether the widely held test is met for those provisions. The scope of the test is not clear and it has been the subject of various private rulings requests and ATO Interpretive Decisions.
'IMR income' is the amount of what would otherwise be the fund's assessable income for the year to the extent that:
Because IMR income is defined by reference to amounts that would otherwise be assessable income, it does not cover amounts that are subject to the withholding tax regime (or would be but for an exemption). The EM says these amounts will continue to be dealt with as they are currently.
A relevant financial arrangement for the purpose of the definition is a 'financial arrangement' within the meaning of the 'TOFA' provisions in Division 230 of the 1997 Act (e.g. debt and equity interests, derivatives, foreign exchange transactions) other than any of the following:
An 'IMR loss' is the amount of the fund's deductions for the year to the extent they are attributable to its IMR income - that is, a net loss, provided that the deductions were incurred with the intention of gaining or producing IMR income.
An 'IMR capital gain'and 'IMR capital loss' is a net capital gain or loss from a CGT asset referred to above that is attributable to a relevant financial arrangement.
The measures in the ED are very limited, dealing only with certain types of income and gains derived by a widely held foreign investment fund where the fund is deemed to have a permanent establishment in Australia solely by reason of using an Australian funds manager.
The measures do not address other issues identified in the Johnson report as 'the main areas of concern regarding the clarity and scope of the Australian tax system as it applies across the financial sector', namely:
Presumably, these matters will be addressed (for later income years) following the BoT's report due by the end of this year.5 However, as noted above, the FIN 48 measures in the ED for previous years do not deal with the uncertainties arising for foreign investment funds in relation to these issues (particularly in light of the Commissioner's tax determinations dealing with foreign private equity funds).
There are a number of issues in the ED measures, including in relation to the definition of 'widely held' and what constitutes and entity that is 'recognised under a foreign law as being used for collective investment'. Specific rules may also be needed to ensure that the benefits of the conduit income exemption flow through to the ultimate investors where the fund is transparent for tax purposes
1 The measures will be contained in proposed new Division 842 of the Income Tax (Transitional Provisions) Act 1997 (Cth).
2 To be contained in proposed new Subdivision 842-I of the 1997 Act.
3 The EM says the provisions are intended to apply to a variety of legal structures, including companies, general and limited partnerships, trusts and certain contractual arrangements.
4 This is in Division 6C of Part III of the 1936 Act, dealing with 'public trading trusts'. 'Trading business' is anything other than 'eligible investment business' as defined in that Division.
5 The Assistant Treasurer said in his Media Release of 19 January 2011 that the BoT 'will continue to progress other aspects of the Johnson IMR recommendations'.
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