In February 2011 the Assistant Treasurer released a further exposure draft of the foreign accumulation fund (FAF) rules. These rules are intended as specific narrowly defined anti-avoidance rules that will replace the foreign investment fund (FIF) regime.
The position at present is somewhat unusual having regard to the way Australian tax legislation is typically repealed and introduced. The Tax Laws Amendment (Foreign Source Income Deferral) Act (No. 1) 2010 took effect on 14 July 2010 and repealed the FIF rules. However, as at that date, legislation dealing with the anti-avoidance rules which were to replace the FIF rules was still at the initial exposure draft stage (and that draft was commented upon in our legal update of 5 May 2010, New Anti-roll-up Fund Rules to Replace Foreign Investment Fund Regime).
While the repeal of the FIF regime was a positive development, there has been some justifiable concern as to what the final form of the anti-avoidance rules, intended to fill the gap left by the repeal of the FIF regime, will look like. Further exposure draft FAF legislation has now been released that provides some further insight as to the intended scope of the proposed regime.
Compared to the voluminous provisions that comprised that former FIF regime, the exposure draft FAF legislation is a very slender document at only 6 pages in length - although some of the provisions in that draft legislation have yet to be finalised.
Under the exposure draft legislation the FAF regime is directed at Australian residents, Australian trusts and Australian partnerships that hold interests in a FAF and that FAF is not a controlled foreign corporation (CFC) for which the resident is an attributable taxpayer. Taxpayers holding such interests will be required to include FAF attributable income in their assessable income for the relevant income year.
Entities proposed to be treated as FAFs
Critical to the operation of the proposed provisions is what type of entity will be treated as a FAF. A FAF is proposed to be defined as:
- non-resident company or non-resident fixed trust
- that meets the “investments requirement”, and
- that meets the “accumulation requirement”.
An entity will not be a FAF if it lacks any of the above features.
The investments requirement will be satisfied if the market value of all debt interests held by the entity comprises 80 per cent or more of the market value of all assets held by the entity. Notes released by the Government that accompanied the Exposure Draft legislation indicate that this requirement is designed to “target entities investing to receive low-risk, interest-like returns”. This is an important requirement and is expected to significantly limit the types of entities that will be treated as FAF’s. An offshore fund that predominantly undertakes equity investments would therefore not be treated as a FAF.
This requirement will be satisfied unless 80 per cent or more of the profits or gains of the entity are distributed within the distribution period. Entities seeking to avoid satisfying the accumulation requirement must, in the case of companies (or entities taxed as companies) ensure that 80 per cent or more of its profits and gains are distributed in the distribution period which starts at the commencement of the entity’s “FAF statutory accounting period” (which is the 12 month period for which accounts are prepared for the entity in compliance with the tax laws of a country) and ends 3 months after the end of that period.
A trust will not be caught if an amount of 80 per cent or more of its profits and gains is distributed in the distribution period or otherwise constitutes net income of the trust that is included in the assessable income of 1 or more beneficiaries of the trust.
FAFs may be prescribed by regulation
Regulations may also prescribe kinds of entity that are to be treated as FAFs if they meet the investments requirement and any other requirements set by those regulations.
FAF attributable income
The Exposure Draft does not provide any elaboration as to calculating a FAF’s attributable income other than noting the proposal to include a calculation method to work out the FAF attributable income and that “the calculation will be based on the change in the market value of an interest in the FAF over the FAF statutory accounting period, plus distributions from the FAF”. The reference to “a change in market value of an interest” is puzzling having regard to what may generally be understood as a reference to the “calculation method” in the context of the former FIF regime.
Lightly taxed entity exemption
No detail is provided in the Exposure Draft as to this exemption. The accompanying notes to the Exposure Draft indicate that complying superannuation entities and other entities through which they invest, that are similarly lightly taxed, will be excluded from the proposed FAF rules. This is on the basis that, as those entities are already concessionally taxed, “they are unlikely to ever be motivated to invest in a FAF in order to achieve a deferral outcome”.