On 19 January 2011 the Australian Government announced a change to the income tax treatment of investment income of foreign funds, to apply to the 2010-11 and later income years. The change is intended to make it more attractive for foreign-based funds to use Australian-based fund managers. T
he change addresses the situation where a foreign fund may be taken to have a “permanent establishment” in Australia because of an Australian intermediary who is a dependent agent, branch or subsidiary of the foreign fund. In this situation, potentially all or a part of the investment income (including capital gains) of the foreign fund may become attributable to the permanent establishment and be subject to Australian tax. On the other hand, if the foreign fund had engaged a foreign fund manager, no Australian tax would have applied to the investment income of the fund, except to the extent that income was otherwise taxable (for example, because it was sourced in Australia). This inequality of treatment has tended to disadvantage Australian investment managers.
Australian income tax law will be amended to provide that to the extent the relevant investment income of a non-resident is taxed only because a foreign fund is taken to have a “permanent establishment” in Australia, that income will be exempt from Australian income tax. In future, Australia will only tax the arm's-length fee for services provided by the Australian intermediary.
The amendments will align Australia's tax law with international practice, such as the United Kingdom's Investment Manager Exemption.
The amendments are also part of the Government’s response to the “FIN 48” issue – that is, US-based fund managers investing in Australia may be adversely affected by the application of certain US accounting rules to managed funds, these being widely referred to as “FIN 48”. Under these rules, funds are required to make disclosures in their financial accounts in relation to uncertain tax positions, including for prior income years. While those rules do not directly affect Australian tax outcomes, dealing with the requirements has underlined to foreign investors the uncertainty of Australian tax law.
While the Government has yet to develop a definition of “foreign managed fund” in consultation with industry, the Government has noted that a foreign managed fund generally has the following features:
- it is not an Australian tax resident
- it is widely held (and not closely held)
- it undertakes passive investment, and
- it does not carry on or control a trading business in Australia.
The amendments will cover the income, gains and losses arising from the following investments by foreign managed funds:
- portfolio interests in companies (including companies listed on the Australian Securities Exchange), portfolio interests in other entities (including units in a unit trust) and bonds, except to the extent the amount gives rise to a withholding tax liability, and
- financial arrangements (for example, derivatives) and foreign exchange transactions, except to the extent they are in respect of an underlying interest that is otherwise taxable (such as taxable Australian property).
This latest announcement follows:
- the release of the Australian Financial Centre Forum’s Report Australia as a Financial Centre: Building on our Strength (the “Johnson Report”, dated 17 November 2009) the release on 11 May 2010 of the Government’s Consultation Paper Developing an Investment Manager Regime: Improving conduit income arrangements for managed funds
- the Government’s announcement on 17 December 2010 (as another part of its response to the “FIN 48” issue referred to above) of amendments to the income tax laws so that where a foreign managed fund has not lodged a tax return for the 2009-10 or prior income years in respect of certain investment income of the fund, the Australian Taxation Office will not be permitted to raise an assessment in respect of that income, except where the fund lodges a tax return disclosing such income, and
- the release on 17 December 2010 of the Board of Taxation’s Discussion Paper Review of Tax Arrangements Applying to Collective Investment Vehicles