In keeping with its goal of encouraging more foreign investment into Australia, the Federal Government will change existing laws to ensure foreign pension and sovereign wealth funds can access the Managed Investment Trust (MIT) withholding tax regime.
In summary, the regime allows a MIT to make payments to non-residents at concessional withholding tax rates, offering an attractive Australian investment option for foreign funds where they and their members are ultimately based overseas.
Popularity of MITs in Australia
The use of MITs in Australia is growing rapidly. In the superannuation industry alone, the value of savings under management has exploded from $183 billion in 1993 to $1.5 trillion today.
As at 1 January 2010, 17.6% of all inflows to Australian MITs came from foreign pension and sovereign wealth funds. By 31 December 2011, this figure had grown to 26%.
The withholding tax regime
In the 2007/08 Federal Budget, the Government introduced a concessional withholding tax rate with a view to developing Australia as a regional financial services hub. It initially set the withholding tax rate at 30%. In the 2008/09 Budget, the Treasurer announced the rate would be reduced to 7.5%. The goal in reducing the rate was to promote foreign investment into MITs in Australia.
As part of the 2012/2013 Federal Budget, the Government revised the withholding tax rate for MITs and increased it to 15% for payments from 1 July 2012.
Where a foreign trust (such as a foreign pension or sovereign wealth fund) can satisfy the relevant requirements under the tax laws for MITs, it can qualify for the concessional tax treatment.
However, since its inception in 2008, the major hurdle for these offshore funds looking to invest in Australian has been the law itself. The law has prevented offshore funds from obtaining the concessional rate because of a technicality and gap in the drafting of the law.
The gap arises because of the way the MIT tax laws are expressed to exclude beneficiaries acting in their capacity as trustees of another trust (as most foreign pension and sovereign wealth funds are taken to be when they invest as institutional investors in an Australian MIT). This was confirmed by an ATO Interpretative Decision in August 2012.
The ATO Interpretative Decision
The ATO set out the situation for a typical foreign pension fund. The fund is usually formed for the purpose of providing a benefit to non-residents (the members of the fund being overseas) and these foreign funds usually pool their assets together to form an investment trust. When the foreign fund invests in a MIT, it does so as a trustee of the foreign fund and it is characterised as a beneficiary of the MIT.
In such cases, the ATO confirmed that the tax laws act to exclude those funds that are beneficiaries acting in their capacity as a trustee of another trust. As a result, the ATO decision resolved that all foreign pension funds and sovereign wealth funds were required to pay the full withholding tax rate of 45%.
A realignment to the original intent of the regime
The ATO’s decision was met with intense criticism and was considered to be at odds with Government policy that sought to encourage foreign investment in Australia and the flow of capital across the globe.
As a result, on 13 February 2013 the Assistant Treasurer announced that the Government will amend the income tax laws to ensure foreign pension funds can access the withholding tax regime for MITs.
The amendments are intended to apply retrospectively, back to when the regime began on 1 July 2008.
Although the particulars of the amending legislation are yet to be determined, the Government is confident the amendment will overcome the concerns raised by industry and help stimulate what the original regime intended – the flow of capital from foreign pension and sovereign wealth funds into investment trusts in Australia.
The property sector has already welcomed the Government’s response to the ATO decision with the Property Council of Australia issuing a press release to coincide with Government’s announcement on 13 February 2013.
Assuming the legislation is amended, it will remedy this anomaly for foreign trusts, meaning the concessional tax rate (currently 15%) will generally be available to foreign pension funds and sovereign wealth funds looking to invest in Australian MITs.