On 16 August 2011, the Australian Government released draft law relating to the previously announced Investment Manager Regime (IMR).
The IMR is intended to make the Australian funds management industry more competitive by removing uncertainties in the Australian tax law which may cause foreign funds to be taxed in Australia where they appoint an Australian manager.
The Government has previously made three key announcements on the issue and the exposure draft seeks to cover those announcements (those announcements were made on 17 December 2010, 19 January 2011 and 10 May 2011).
Key features of IMR – conduit income measures (IMRCIM)
The IMRCIM largely follow the previous Government announcements but also provide additional details around the concepts of "total participation interest" and "permanent establishment" which are relevant to the exemption. Specifically, the IMRCIM provide an exemption from Australian income tax, in certain circumstances, where the foreign fund (or a trustee of the foreign fund) does not have a place of business in Australia, but would have a permanent establishment in Australia solely as a result of engaging an Australian based investment manager who habitually exercises a general authority to negotiate and conclude contracts on behalf of the foreign fund. For the IMRCIM to apply, the following key additional criteria must be satisfied:
- the foreign fund must:
- not be an Australian tax resident at any time during the income year;
- be recognised under a foreign law as being used for collective investment - this concept is similar to the concept used in the Management Investment Trust (MIT) rules;
- be one where the members do not have "day to day" control of the operations of the fund;
- not be carrying on a trading business in Australia (this is defined by reference to the public trading trust rules);
- be "widely-held" – this is defined using similar concepts to the MIT rules; and
- not be "closely held" – this is defined using similar concepts to the MIT rules; and
- the income or gain must relate to a financial arrangement (which includes certain debt and equity interests under Australia income tax law); and
- the fund must have a "total participation interest" of less than 10% in the investee entity (ie a portfolio interest) to which the financial arrangement relates; and
- the foreign fund must not be able to vote at a meeting of the Board of Directors of the investee entity, participate in making financial, operating or policy decisions in respect of the operation of the investee entity, or deal with the assets of that investee entity (subject to a limited exception for cases of breach on the part of the investee); and
- in the case of income gains (it is noted that deductions attributable to gaining income gains covered by the IMRCIM are non-deductible), an amount must only be included in assessable income (but for the operation of the IMRCIM) because:
- the income or gains of the foreign fund are treated as taxable in Australia as a result of the "deemed source" rules contained in Australia's tax treaties, ie income which Australia is permitted to tax under the terms of the relevant double tax agreement and to which Australia has extended its tax jurisdiction even where the income would not ordinarily be subject to Australian tax under the terms of Australia's domestic tax law; or
- the Commissioner has made a determination of Australian source pursuant to the domestic transfer pricing provisions; or
- the asset is connected with a "permanent establishment" of the fund in Australia; or
- the asset is an option or a right to acquire an asset connected with a permanent establishment of the fund in Australia; and
- in respect of capital gains or capital losses, the gains must be associated with financial arrangements connected with a "permanent establishment" of the fund in Australia (or options or rights to acquire such assets).
Key features of IMR – FIN 48
In relation to the provisions dealing with the historic risk which may be encountered by some foreign funds and their investors, the proposed measures provide that the ATO may not make an assessment in relation to what will be exempt income or gains (or denied losses) under the IMRCIM where:
- the income year is the 2010-2011 income year or an earlier year and any gains referable to that income year would be ignored under the IMRCIM;
- the foreign fund has previously not lodged an income tax return in Australia in relation to that income year; and
- the Commissioner did not make an assessment in relation to the foreign fund prior to 18 December 2010 except:
- in the case of fraud by the foreign fund; or
- where the ATO had advised the foreign fund, before 18 December 2010, that a tax audit or compliance review would be undertaken.
Some observations on the proposed measures
- To the extent that the relevant income or gain is caught by the current Australian withholding tax rules, the IMRCIM does not prevent such income or gain from being taxed under those rules.
- The exclusion of non-portfolio investments is a deliberate policy decision which will result in many foreign funds not being able to fall within the provisions even where they in fact conduct only passive investment activities in Australia. The difference in tax treatment depending on whether an investor holds a portfolio interest the investee entity appears inequitable and will do little to deal with the concerns of those foreign funds who hold non-portfolio investments as those investors may choose to continue to use foreign investment managers because of the continued Australian tax risk of engaging Australian fund managers. Alternately, an Australian manager will need to have a purely advisory role in connection with the foreign fund and care will need to be taken to ensure that the activities of the Australian manager do not create an Australian source for the foreign fund (or create a permanent establishment where the foreign fund is a treaty resident).
- It is important to note that the concept of a permanent establishment would not ordinarily be relevant in establishing Australia's taxing rights in respect of entities resident in countries with which Australia has not signed a tax treaty (for example Hong Kong or the Cayman Islands etc). In the case of non-treaty country resident entities, the concept of source at general law is relevant. The "permanent establishment in Australia" criterion therefore appears (though not entirely clear) to be a "gateway" test in order to establish a foreign fund's eligibility for the IMRCIM even where the concept would ordinarily be irrelevant for that fund because it resides in a non-treaty country.
- Care will still need to be taken to ensure that the presence of the Australian manager does not create a "place of business" of the foreign fund in Australia. A permanent establishment which arises because there is a place of business is not covered by the IMRCIM.
Submissions open until 30 August 2011
The Government is inviting submissions on the proposed measures until 30 August 2011