Introduction

 Australia continues to reform its tax and regulatory regime aimed at facilitating investment into Australian private equity, real estate and other funds.

The reforms make Australia a significantly more attractive destination for investor capital. Australia currently has one of the world’s largest pools of investment fund assets. This has been underpinned by Australia’s mandatory retirement income system introduced in 1992. Australia has in excess of A$1.3 trillion in funds under management (FUM), which is equivalent in size to the country’s nominal GDP and represent more than 120 per cent of the domestic equity market capitalisation. Australia’s investor base is sophisticated and outward looking with significant exposures to global markets and alternative asset classes. Aided by ongoing government reforms, Australia’s funds industry is also looking to export services, drawing on its strengths in portfolio construction, risk management, wealth advisory and distribution capabilities and funds administration and custody services. (Source: the Australian Government, Austrade, www.austrade.gov.au/invest).

Foreign investment in Australian funds

Australia has introduced significant tax concessions for funds that are structured as managed investment trusts (MITs). A key requirement to access the MIT regime concession is for the foreign investor to be from an 'exchange of information country' (EOI). The list of EOI countries is broad and growing, and extends to many low tax jurisdictions where offshore funds are domiciled (eg, Cayman Islands has recently been added to this list).

The target fund must qualify as a MIT, and if so, distributions of most gains on sale of underlying assets by the fund to foreign investors in EOI countries may be exempt from Australian tax, or at worst, subject to 7.5 per cent withholding on certain types of distributions from the Australian fund to overseas investors.

Generally, the target trust may qualify as a ‘MIT’ if it satisfies various requirements, including:

  1. the trustee of the trust must be an Australian resident or the central management and control of the trust must be in Australia
  2. the trust is not a trading trust
  3. a substantial proportion of the investment activities, in respect of Australian assets, are carried on in Australia
  4. the trust is a 'managed investment scheme', broadly defined to cover most types of collective investment trusts. This requirement will generally be met if there are two or more investors in the Australian trust
  5. the trust has wholesale membership (generally, institutional or certain high net worth investors). MIT status can also apply to trusts with retail membership
  6. the trust must have at least 25 members. Generous tracing rules allow trusts to satisfy this test by looking through certain qualifying investor entities
  7. the trust must not breach certain concentration limits (broadly, in the case of a wholesale trust, 10 or fewer persons (not counting interests held by certain widely held investors) have a total interest in the trust of 75 per cent or more and no foreign resident individual has an interest in the trust of 10 per cent or more)
  8. the operator or manager of the trust must hold an appropriate Australian financial services licence (or be an authorised representative of a wholesale licence holder).

The recent reforms to legislation helpfully remove ambiguity caused by the original version of the legislation, which potentially covered only investment in registered retail funds. Also, the list of qualifying investors has been broadened to cover additional categories of foreign investor including certain sovereign investors and foreign investment funds.

The reforms have attracted interest from various institutional investors in Europe, the Middle East and Asia.

 Appointment of Australian managers

The Federal government has also pressed forward with their agenda of reforming the local financial services industry by on 19 January 2011 announcing changes to the income tax treatment of investment income of foreign funds aimed making it more likely foreign-based funds will use Australian-based fund managers.

Generally, under the change, income from relevant investments of a foreign fund, that is taken to have a 'permanent establishment' in Australia, will be exempt from income tax (except to the extent it would otherwise be taxable in Australia (for example, if Australian sourced)). The changes mirror the investment manager regime adopted by many other financial hubs such as the UK. Previously, Australia's taxing rules can potentially tax the investment income of the fund even when the foreign investor has no real presence in Australia, putting Australian fund managers at a disadvantage to foreign funds.

The announcement follows on from a proposal in December 2010 to amend the income tax laws to address concerns of foreign funds following the application of US accounting rules, referred to as 'FIN 48'.