Jurisdiction - Australia
Reports and Analysis
Australia – Another Step Towards Australian Tax Certainty For Foreign Funds.

20 May, 2013

 

 

WHAT YOU NEED TO KNOW

 

  • The Government has released exposure draft legislation to implement the third and final element of the investment manager regime (IMR3).
  • Foreign funds that satisfy the strict conditions set out in the proposed IMR3 rules will generally be exempt from Australian tax in relation to:

 

– Australian-sourced gains from Australian portfolio (ie, interests of <10%) investments; and

– gains from foreign investments (whether portfolio or non-portfolio (ie, interests of ≥10%)) which may otherwise have been within the Australian tax net, solely because an Australian intermediary was used in connection with making the foreign investment.


Notwithstanding the proposed IMR3 rules, foreign fund managers and their auditors will still need to deliberate on whether an ASC 740-10 (formerly known as FIN48) provision needs to be raised for the 2012 calendar year given the IMR3 rules have yet to be legislated and review their historical positions, given the intended retrospectivity of the proposed IMR3 rules.


WHAT YOU NEED TO DO

 

  • Foreign fund managers planning to make investments in Australia should consider the potential benefits of being taxed under the proposed IMR3 rules rather than Australia's ordinary income tax rules.

 

Background


The creation of a taxing regime for foreign funds had its genesis from recommendations set out in the Johnson Report. The Johnson Report found that the uncertain application of Australia’s tax rules were dissuading foreign funds from issuing mandates to Australian investment advisors and Australian fund managers to invest in Australia.


An investment manager regime to tax certain funds was introduced in three stages, with the proposed IMR3 rules being the final stage (and it will effectively be the taxing regime for foreign funds from the 2011/2012 income year). The FIN48 rules (Stage 1) and the Interim IMR rules (Stage 2) became law in the 2012 calendar year were limited in application, but did resolve some Australian tax uncertainties for eligible foreign funds.


The FIN48 rules resolved the uncertainty around the ASC 740-10 (formerly known as FIN48) disclosure by exempting certain foreign funds resident in any country from Australian tax on passive portfolio investments for the 2010/2011 income year and prior income years, subject to a number of restrictive conditions (eg, the foreign fund must never have lodged an Australian income tax return).

 

The Interim IMR rules resolved the Australian tax uncertainty where a widely held foreign fund engaged an Australian investment advisor or Australian fund manager and made gains from certain foreign investments and Australian assets. The Interim IMR rules ensured that income from such investments would be exempt from Australian tax if the only reason it was taxable was because the foreign fund used the Australian investment advisor or Australian fund manager. The change applied from the 2010/2011 income year and later income years.

 

The proposed IMR3 rules introduce a number of additional conditions for foreign funds to satisfy in order to be taxed under the investment manager regime. The exposure draft legislation states that the proposed IMR3 rules will be effective from the 2011/2012 income year.


Conditions for the proposed IMR3 rules to apply


The proposed IMR3 rules will cover a broad range of collective investment vehicle structures and arrangements, but will only apply to foreign funds which meet all of the following conditions:

 

  • resident of an exchange of information (EOI) country throughout the income year;
  • must not be an Australian resident throughout the income year;
  • does not carry on a trading business in Australia;
  • does not directly or indirectly control a trading business in Australia;
  • satisfies the "widely held" test at all times during income year;
  • does not breach the "closely held" test; and
  • provides an annual information statement to the Commissioner and investors within 3 months of the end of the foreign fund's income year.


The conditions included in the proposed IMR3 rules are currently drafted to apply to the current IMR rules. Foreign fund managers and their advisors may be required to revisit prior year positions to confirm that the foreign funds satisfy the requisite conditions. Foreign funds that do not satisfy the conditions will be taxed under general Australian income tax rules.


Proposed changes


The proposed IMR3 rules introduce a number of changes to the investment manager regime. Some of the more pertinent changes in the proposed IMR3 rules are set out below.


Widely held test


To qualify for the proposed IMR3 rules, the foreign fund must satisfy the "widely held" test. The "widely held" test as currently drafted in the exposure draft legislation may now allow common structures such as feeder funds, co-investment funds, direct investor funds and general partner funds to satisfy the "widely held" test. Currently, there is a strong risk that many of these funds were not satisfying the requirements (despite the fact that the policy intent of the FIN48 rules and the Interim rules was to enable a number of these structures to meet this definition, provided the other conditions in the law were satisfied).


The exposure draft legislation allows tracing through interposed entities to the ultimate individual investors with direct or indirect interests in the foreign fund. Special concessionary tracing rules will apply to interests held by foreign life insurance companies, foreign superannuation funds and foreign government pension funds, making it easier for those entities to satisfy the requirements (as an example, where one of these entities has a 50% interest in the foreign fund, the foreign fund will satisfy the "widely held" test).


However, the "widely held" test will not be satisfied if a foreign fund fails the "closely held" test. The foreign fund will not be considered to be "widely held" where 10% or more of the economic interests are ultimately held by one entity or if 10 or fewer entities hold 50% or more of the foreign fund. Foreign fund managers will need to carefully monitor the "closely held" test, particularly in general partner funds where general partner interests can be significant.


There are a number of issues with the tracing requirements in applying the "widely held" test and "closely held" test to fund structures. For example, the "closely held" test appears to require the foreign fund to trace its interests to confirm the "closely held" test has been satisfied. It will likely be difficult for many foreign funds to satisfy these tracing requirements. Further amendments to the exposure draft legislation may be necessary to allow the rules to operate in the manner intended.


Portfolio interests in Australian assets


The proposed IMR3 rules will apply to exempt certain portfolio (<10%) Australian-sourced returns and gains from Australian tax, irrespective of whether the foreign fund has used an Australian intermediary.


This change provides tax certainty to foreign funds in that the tax outcome for foreign funds is not affected by whether the asset is held on revenue or capital account and aligns the investment manager regime with the existing capital gains tax exemptions for foreign residents.

 

Portfolio interests in foreign assets


The proposed IMR3 rules will apply to exempt gains from foreign investments (whether portfolio (<10%) or non-portfolio (≥10%)) which may otherwise have been within the Australian tax net, solely because an Australian intermediary (eg, broker) was used in connection with making the foreign investment (subject to certain exceptions).


Annual information statement


Under the proposed IMR3 rules, an annual information statement is to be provided to the ATO within 3 months of the end of the income year and contain the:

 

  • name and address of the foreign fund;
  • tax residency of the foreign fund;
  • foreign fund's status within the IMR (this information will be used in the written notification that is to be provided to the partners); and
  • application of the IMR to the foreign fund.


The form of the annual information statement has yet to be finalised and will be a key issue for foreign funds to consider. For example, it is unclear what disclosure will be necessary regarding the underlying investors in the foreign fund.


Also, foreign fund managers will be required to provide written notification (or publication on a website for generally up to 4 years) to investors within 3 months of the end of the income year containing information that the foreign fund satisfies the conditions of being an "IMR foreign fund".


Conclusion


A number of issues have been rectified in the proposed IMR3 rules, however there remains some key issues which need to be addressed further, particularly around the eligibility of limited partnerships, the tracing requirements imposed on foreign funds and the compliance requirements that need to be satisfied by the foreign funds.


It also remains to be seen whether the eligibility requirements are too prescriptive to be of practical use to many foreign funds and whether further amendments to the "widely held" test and the "closely held" test should be made.


Foreign funds and their advisors will need to closely monitor any further changes to the exposure draft legislation to determine the impact on historical positions and the impact it may have on future investments.

 

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For further information, please contact:

 

Ian Kellock, Partner, Ashurst
ian.kellock@ashurst.com


Tim Loh, Ashurst
tim.loh@ashurst.com

 

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