The Government has today released further exposure draft legislation for the long awaited final “third” element in the Investment Manager Regime (IMR) (being, “IMR 3” or the “full” IMR). This follows two prior releases and extensive industry consultation with Treasury.
The “full” IMR was one of the key recommendations from the report by the Australian Financial Centre Forum (the Johnson Report) in 2009 and seeks to provide an exemption for qualifying funds that invest into Australia especially where they use local managers.
Recap of background to IMR 3
The Johnson Report had found that various uncertainties and the scope of Australia’s tax system acted as an impediment to foreign funds investing in Australia. The introduction of an IMR, with clear and comprehensive statutory rules was proposed as the means of addressing the impediments and to encourage use of Australian financial service intermediaries. In this regard, it had been found that, despite having a significant funds management industry in Australia, only a small percentage of funds under management were from foreign investors.
To date legislation dealing with the first element of the IMR (dealing with the so called “FIN 48 issues”) and the second element of the IMR (in essence dealing with local intermediaries managing foreign assets of foreign funds) has been passed. These can be summarised as follows:
- Element 1 (FIN 48) (or “IMR 1”) - addressed the 'FIN48' issue by amending the law to effectively exempt foreign funds (wherever located) from Australian tax on passive investments. They restricted the Commissioner of Taxation's ability to raise assessments in respect of income of a widely held foreign managed fund for the 2010-11 and prior income years;
- Element 2 (Conduit income) (or “IMR 2”) - addressed the tax uncertainty where a widely held foreign managed fund engaged an Australian-based financial services intermediary with respect to foreign investments and Australian assets that were only subject to capital gains tax. The provisions ensured that income from such investments would be exempt from Australian tax if the only reason it was taxable was because the foreign fund engaged the financial services intermediary. The change applied from the 2010-11 income year.
However, neither of the above changes dealt with the issue of foreign funds deriving Australian sourced gains on revenue account for the period post 2011 particularly where such Australian source arose from using local intermediaries. That position seeks to be addressed by IMR 3.
IMR 3 – “Full" IMR
Where a foreign fund meets the definition of an “IMR foreign fund” then in essence Australian sourced capital gains and revenue gains in respect of passive portfolio investments (with the exception of certain real property interests, and interests which allow voting at Board meetings etc) will be exempt from Australian tax. Income from dividends, interest and royalties that is subject to withholding tax is expected to remain unaffected by the changes.
IMR foreign fund
To be an IMR foreign fund a foreign fund must:
- Not be an Australian resident at any time during the income year;
- Be resident in an information exchange country at all times during the income year (although Australia now has a broad list of information exchange countries, there are still some significant exclusions in the context of the global managed funds industry such as Luxembourg and Hong Kong);
- Not undertake a trading business ( a concept drawn from Division 6C trading trust provisions) in Australia at any time during the year (or control such a trading business); and
- Must be an IMR widely held entity, satisfy the IMR widely held test or be prescribed in the regulations (the “IMR widely held conditions”).
In order to obtain the IMR concession, the IMR foreign fund must give an annual information statement to the Commissioner each year.
The rules do not apply in relation to Australian residents.
IMR widely held conditions
In order to satisfy the widely held conditions, the foreign fund must be an IMR widely held entity, satisfy the IMR widely held test or be prescribed in the regulations
The list of IMR widely held entities are broadly consistent with those entities that are recognised as "qualifying investors" for the purposes of the management investment trust ("MIT”) rules. These include, for example, certain listed entities, life insurance companies, pension funds and sovereign wealth funds.
However, in the absence of the foreign fund, itself, being an IMR widely held entity, that fund will need to satisfy the alternative IMR widely held test.
In order to satisfy the widely held test, a foreign fund must have at least 25 members (calculated in the prescribed way).
For these purposes, there are special membership counting and tracing rules in determining whether a fund is widely held. These rules enable tracing up a chain of interposed entities until you reach individual interest holders or IMR widely held entities and certain foreign collective investment vehicles. Further, the IMR widely held entities and eligible foreign collective investment vehicles are allocated 50 notional ‘individual’ members meaning that if a single IMR widely held entity holds a total participation interest of 50 per cent or more in a fund, the fund will pass the widely held test (as it will be treated as having at least 25 members). This change will overcome a major uncertainty with IMR 1 & 2.
However, a foreign fund will automatically fail the widely held test if:
- Any one of the fund’s members holds a total participation interest in it of 10 per cent or more (determined in accordance with the above membership counting and tracing rules noted above); or
- The sum of any 10 or fewer of the fund’s members’ total participation interests in it is 50 per cent or more (also determined in accordance with the above membership counting rules).
The rules also retain the relief for inadvertent breaches of short duration. Under this rule, a fund that breaches the widely held test can retain its status as an IMR foreign fund for an income year, provided that it is not in breach for more than 30 days in the income year, and the fund (or an entity responsible for the fund) and its associates were unable to prevent the breach from occurring. This was to address a key concern of industry that the former iteration of the IMR regime was a "cliff edge" regime (which meant that if one of the requirements was not satisfied on any particular day (even if inadvertent) then the fund was not eligible for the IMR concessions for the whole income year).
Further, there continues to be start-up and wind down rules that allow funds to qualify when commencing (or closing) and the number of members are below the threshold because the fund is building (or reducing) its capital.
The rules also continue to allow voting interests to be ignored when applying the IMR widely held test. This caters for the situation where say a General Partner of a LP may have a larger voting interest than their rights to participate in income. This addresses another key concern which arose under the rules relating to IMR 1 & 2.
Further issues for consultation
A number of issues will still need to be discussed and resolved in connection with the upcoming consultation with Treasury.
- Whether the tracing rule should recognise “entities” rather than simply “individuals”. This would enable tracing up a chain of interposed entities to the point where further tracing is not possible. It is not always possible to identify ultimate individuals. Under the current tracing rules, if a fund cannot identify ultimate individuals, then there is a risk that the benefit of tracing is not available (even if the fund knows that interests are widely held by a range of interposed entities).
- Whether the prescribed list of IMR widely held entities should be expanded. For example, endowment funds (e.g. charitable funds) should be included etc. It is not generally possible to trace through these entities (as no “individuals” hold identifiable “interests”, and objects are ignored etc). However, it is noted that there is a regulation to allow additional entities to be added.
- Whether the conditions for the automatic failure of the widely held test are too restrictive. This has previously been of concern for many foreign funds. Some funds have significant interests held by endowment funds etc, which would not get the benefit of the tracing rule (noted above). Therefore, where an endowment fund holds a greater than a 10% interest, the widely held test would arguably be failed. Further, many managers hold income rights (rather than just voting rights) in the fund, which means the 10% test could also be failed on account of holding those rights.
- Whether the start-up and wind-down phases are too short. Many foreign funds have significant start-up periods. It can often take years to achieve a wide investor base. It has been suggested that factors such as the continued active marketing of the fund should be taken into account, rather than a drop dead date.
- Whether the annual reporting requirement should be removed.
However, on the whole, it is anticipated that the "full" IMR will provide greater flexibility and tax certainty to managers of foreign funds. This is on the basis that the "full" IMR will allow managers to engage Australian intermediaries (such as brokers or other service providers) without subjecting the relevant foreign fund to Australian tax.
Managers of foreign funds should, however, review the terms of this third exposure draft closely. In particular, the "full" IMR still imposes certain limitations on the foreign funds that they are able to obtain the benefit of the exemption.
The "full" IMR exemption applies from the 2011-12 income year. These changes will also apply to the previously enacted element 2 (dealing with conduit income) or "IMR 2".
Consultation with Treasury closes 14 February 2014.
A copy of the press release is available here.