Australia Tax Alert - 12 March 2012
Second exposure draft of Investment Manager Regime released
By Peter Madden, Vik Khanna, Mark Hadassin, Alyson Rodi and David Watkins
On 7 March 2012, the Australian government released the second exposure draft of the Investment Manager Regime (IMR) legislation containing the “FIN 48 exemption” and the conduit income measure (no explanatory material was released). The IMR is expected to remove tax-related impediments to international investment into Australia by foreign-managed funds and impediments to the use of Australian intermediaries by such funds.
The FIN 48 exemption was first announced by the Assistant Treasurer in December 2010 as being applicable to the 2009/10 and prior income years. In the 2011/12 budget, it was announced that this measure would be extended to the 2010/11 income year. Under this measure, where an “IMR foreign fund” has not submitted a tax return for the 2010/2011 or prior income year and the Australian Taxation Office (ATO) has not issued an assessment, the ATO will not be permitted to issue an assessment in respect of “IMR income.” Subject to those same conditions relating to tax returns and assessments, the ATO also will not be able to assess nonresident beneficiaries and partners on their share of certain income derived through fiscally transparent IMR foreign funds.
The conduit income measure was first announced by the Assistant Treasurer in January 2011. Under this measure, qualifying income and capital gains of an IMR foreign fund that has a permanent establishment (PE) in Australia solely because it engages the services of an Australian-resident investment manager will be exempt from tax as from the 2010/11 income year.
On 16 December 2011, the government announced that it would implement the final stage of a comprehensive IMR into Australia retroactively as from 1 July 2011. Key elements of this announcement accorded with recommendations made by the Board of Taxation, including that the IMR be restricted to foreign-managed funds resident in countries that are recognized by Australia as engaging in effective exchange of information and that income or gains from an interest in an Australian “land-rich entity” will not be an eligible investment unless it is a portfolio interest in an Australian publicly listed company. Legislation on these measures has not yet been released.
The FIN 48 and conduit income measures were previously included in exposure draft legislation which was released on 16 August 2011.
The main differences between the August 2011 and March 2012 exposure drafts are outlined below.
IMR foreign fund
In response to submissions, the definition of IMR foreign fund is broader than it was in the first draft. The following table summarizes the differences in the definition of IMR foreign fund in the two exposure drafts.
|August 2011 draft||March 2012 draft|
The December 2011 announcement proposed that a foreign-managed fund only be able to access the post-1 July 2011 IMR if sufficiently resident in a country recognized by Australia as engaging in effective exchange of information.
In respect of the widely held requirement (see table), the general conditions include:
- The fund is listed on an “approved stock exchange” (an extensive list of global exchanges); or
- The fund has at least 25 members; or
- Certain “foreign widely held entities” have a direct or indirect interest in the fund of at least 25%. These entities include “foreign superannuation funds” with at least 50 members and certain foreign government pension funds; or
- The fund is wholly owned directly or indirectly by one or more of the entities at (1), (2) or (3) above.
In addition, foreign widely held entities can themselves be treated as IMR foreign funds.
The fund cannot be tightly held, referred to as the “concentration test.” A fund will be excluded under the concentration test if 10 or fewer entities have a direct or indirect interest in the fund of 50% or more. In applying this test, the interests of certain entities are disregarded (i.e. disregard the interests held by various entities, including another IMR foreign fund or “foreign widely held entities”).
While the revised widely held test and the concentration test are much improved as compared to the August 2011 draft, many funds likely will still have difficulties in meeting these tests. This especially will be the case where a master fund has a number of feeder funds, which do not themselves qualify as IMR foreign funds. This was a key area of focus of the Board of Taxation in its IMR report, where the board noted that the widely held test “should capture not only direct investors in a foreign managed fund but should also be able to look through those investors.” We agree with the Board’s comments and consider that the recently released draft rules do not fully meet those objectives.
A major difference between the August 2011 draft and March 2012 draft is that the FIN 48 and conduit income measures will no longer rely on the same definition of IMR income. However, a common feature for both the FIN 48 and conduit income measures will be that the underlying transaction relates to a “financial arrangement” other than:
- Certain financial arrangements, including derivative financial arrangements in respect of an entity where the IMR foreign fund has a total participation interest of 10% or more;
- Derivative financial arrangements that relate to Australian real property or (broadly) an interest of 10% or more in shares in companies that are Australian land-rich; and
- A financial arrangement that allows the IMR fund a right to vote at a meeting of the board of directors, an ability to participate in the management decisions of the entity or deal with the assets of the entity (unless such rights arise as a result of a breach of the terms of the financial arrangement).
As mentioned above, based on the December 2011 announcement it appears that income or gains from an interest in an Australian land-rich entity will be excluded unless arising from a portfolio interest in an Australian publicly listed company.
FIN 48 exemption
The FIN 48 exemption provides that an IMR foreign fund that is a corporate taxpayer (broadly, companies and corporate limited partnerships) will treat IMR income as non-assessable and non-exempt income (NANE). As a result, assessable income attributable to a return or gain from a financial arrangement, other than one of the three excluded financial arrangements should be NANE. The FIN 48 exemption has been extended to IMR capital gains and losses (the first draft only included IMR income and losses).
A provision also has been included to prevent an IMR fund from utilizing a tax loss or net capital loss in a future income year where such loss is attributable to IMR income, an IMR capital gain, an IMR deduction or an IMR capital loss.
In respect of IMR foreign funds that are trusts or partnerships, the FIN 48 exemption is to operate so that, in computing the net income attributable to a nonresident beneficiary or partner, the trust or partnership disregards IMR income, IMR capital gains, IMR deductions and IMR capital losses. Australian resident beneficiaries or partners will continue to be assessed under the trust or partnership provisions in the normal way.
As noted, the conduit income measure is intended to exempt income and gains of an IMR foreign fund that has a permanent establishment (PE) in Australia solely because it engages the services of an Australian-resident investment manager. The conduit income measure will apply to IMR income as described above, which also meets the tests set out below.
|August 2011 draft||March 2012 draft|
The IMR income for the conduit income measure seeks to capture income attributable to a return or gain from a non-excluded “financial arrangement” which, on general principles, does not have an Australian source, but which is treated as being Australian sourced by virtue of the connection with a PE in Australia as a result of engaging an Australian-resident intermediary.
As amounts subject to withholding tax (e.g. interest) are excluded from assessable income, such amounts are intended to be excluded from IMR income, such that the withholding tax provisions continue to apply in the normal manner.
The provisions in the second draft, although an improvement on the first draft, still appear to be incomplete. It is uncertain, for example, as how to the IMR rules will apply in the case of a fund that initially has a total participation interest of 10% or more in an entity, but through a process of staggered sell downs ends up with a total participation interest of less than 10% in the entity.
Further, the draft legislation does not contain any measures to address integrity concerns. For example, consider the situation of multiple parallel funds which have the same investors and qualify as IMR foreign funds with IMR income (e.g. less than 10% interests), but collectively have a greater than 10% interest in Australian listed mining companies. At present, the provisions do not appear to address such a situation.
A further issue arises in relation to foreign funds that are corporate limited partnerships (CLPs). Under current Australian tax law, a CLP is an Australian resident if it carries on business in Australia. For a CLP that uses the services of an Australian intermediary and the services provided by the Australian intermediary would result in the CLP having a PE in Australia, arguably the CLP would be considered to be carrying on business in Australia. Such CLPs would then be Australian resident companies for Australian tax purposes and would then fail the residence test.
Funds with concerns as to whether they would qualify as an IMR foreign fund in prior income years for the purpose of the FIN 48 exemption should contact a specialist. Even for funds that qualify as IMR foreign funds, it should be noted that they may have derived in the past non-portfolio Australian-source income and gains not eligible for the FIN 48 exemption.
Submissions on the second exposure draft close on 4 April 2012. The relevant legislation is expected to be introduced into Parliament in the May/June sittings.