The Assistant Treasurer, the Hon Bill Shorten MP, has today released the much anticipated exposure draft legislation which is intended to clarify the following:
- how certain income and gains of foreign funds are taxed for the 2010-11 and prior income years (which principally deals with the investment uncertainty arising from the application of US accounting standard 'FIN 48'); and
- the treatment of certain investments of foreign funds, where the returns or gains are treated as being attributable to a permanent establishment in Australia (which deals with the tax treatment of certain investment income of foreign funds where those funds are taken to have a permanent establishment in Australia by virtue of the fact they have engaged an Australian based intermediary).
The Government has indicated that the legislation is intended to achieve the following:
- provide certainty for foreign funds which invest through Australian intermediaries;
- promote Australia's fund managers and financial expertise to overseas investors, which is a further step to position Australia as a leading financial services centre; and
- bring Australia's investment manager regime more closely in line with other financial services centres like the UK, Hong Kong and Singapore.
The exposure draft legislation is a very welcome development and should provide certainty of tax treatment for funds that have invested in Australia, as well for those funds that engage an Australian based intermediaries (such as a local broker) going forward. The current announcement confirms the prior announcements in December 2010 (stating the exemption), January 2011 (covering funds that appoint local managers to in essence manage foreign assets) and May 2011 (extending the exemption to the 2011 income year) and is a major plank in establishing Australia as a financial centre. In this regard the Government is to be congratulated in responding to the concerns by foreign funds that could have otherwise put substantial investments into Australia at risk.
The Government has also requested the Board of Taxation to report on the full IMR as it relates to foreign managed funds by the end of the third quarter 2011.
Taxation of foreign funds for the 2010-11 and prior income years - FIN 48 exemption
The proposed amendments will provide certainty of tax treatment for funds that have invested in Australia. Where a foreign fund has not lodged a tax return for the 2010-11 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.
In order to benefit from the announced exemption, a IMR foreign fund must generally have the following features:
- it is not an Australian resident;
- it is recognised under a foreign law as being used for collective investment;
- the members do not have day-to-day control over the operation of the entity;
- it typically does not carry on or control a trading business in Australia (via a full a branch business);
- it is widely held (tracing is possible similar to the current MIT rules - so widely spread investors such as pension funds will assist the fund); and
- it is not closely held (in essence controlled by a few non-qualifying investors).
The definition of IMR foreign fund is intended to cover a variety of legal structures, including (but not limited to) companies, partnerships (general and limited), trusts and certain contractual arrangement.
An exemption is also provided for beneficiaries and partners of IMR funds, who are not Australian residents.
The amendments cover IMR income or an IMR loss, and is expected to cover income, gains and losses (of both a revenue and capital nature) attributable to, or arising from, the following financial assets or financial arrangements:
- 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.
- 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), or to the extent the financial arrangement gives rise to a right to vote on the Board of Directors or an ability to participate in the management of the entity.
These changes are intended to apply to the 2010-2011 income year and prior years.
Taxation of investments of foreign funds, where the returns or gains are treated as being attributable to a permanent establishment in Australia - Interim IMR
The proposed amendments are designed to ensure that a foreign fund is not discouraged from engaging the services of an Australian based intermediary and to ensure that non-residents are not subject to Australian tax on what would otherwise be foreign source income. This may occur where some or all of the investment income of a foreign fund is attributed to a ‘permanent establishment’(“PE”) in Australia, and is therefore subject to Australian tax. Australian resident investors should not gain any tax benefit from this measure.
Under the proposed measure, income from relevant investments of a foreign fund, that is taken to have a PE in Australia, will be exempt from income tax.
In order to benefit from the announced exemption, the foreign fund must be an IMR foreign fund (which must generally have the same features as those set out above in relation to the Fin 48 exemption). However, the amendments will only cover IMR income, IMR capital gain, an IMR loss or IMR capital loss which arise because of a presence of a PE in Australia by reason of the trade (eg because of the use of a broker) - they are not meant to cover a full trading operation of the fund in Australia (unless this is to only manage foreign assets). The broader exemption that will allow appointment of managers to trade in Australia is expected as part of the “full” IMR that the Board of Taxation is considering.
These changes are intended apply from the 2011-2012 income year.
The due date for submission in relation to the exposure draft legislation is 30 August 2011. Mallesons will be putting in a submission and comments on the exposure draft are welcome.
The exposure draft legislation can be accessed here.