Design principles
1.1 Chapter 1 sets out the terms of reference applicable generally to the tax treatment of collective investment vehicles. In designing an IMR for foreign managed funds, the Board considers that the following taxation principles should also be taken into account. These principles (which to some extent overlap with the terms of reference) are commonly used to guide the design of taxation legislation including, in particular, in the modern international context.
Principle 1: Taxation arrangements should reflect the responsiveness of capital to taxation
1.2 Under this principle, mobile capital – for example most portfolio investments, typically the kind of investments made by managed funds – should be lightly taxed or even made exempt. This contrasts with foreign direct investments (or non-portfolio investments), where the more permanent nature of the investment may make it less mobile and less responsive to taxation. In addition, to the extent such investments give rise to location-specific economic rents8, there is scope to impose Australian tax without deterring the investment.
1.3 This principle has become more significant in the context of an increasingly globalised capital market. The erosion of barriers to international capital flows over the past two decades has resulted in capital becoming increasingly mobile. While investment is affected by tax and non-tax factors, a country’s tax settings are important when it comes to attracting and retaining foreign capital due, in large part, to this increasing mobility.
Principle 2: Taxation arrangements should be broadly neutral for economically equivalent investments in order to minimise distortions to investment decisions
1.4 In the context of managed fund investments, neutrality means that:
- investments through a managed fund should be taxed similarly to investments made directly;
- investments using an Australian based intermediary should be taxed similarly to investments using a foreign intermediary (although the arm’s length fee for services provided by the Australian based intermediary would be taxable); and
- tax outcomes should ideally be determined by the nature of the investment activities rather than the legal structure of the entity through which investments are made.
Principle 3: The taxation of active business income and resident investors should be appropriately safeguarded
1.5 Australian active business income should continue to be subject to tax. In the context of an IMR, Australian based intermediaries (including investment advisors, fund managers, custodians and brokers) should be subject to tax on their fee income for providing financial services. Where parties are related, the amount subject to Australian tax should reflect an arm’s length price.
1.6 Safeguarding the taxation of resident investors may necessitate rules to address ‘;round tripping’9 so that Australian residents cannot inappropriately access tax benefits by investing through an IMR foreign managed fund. However, care needs to be taken in designing these rules to avoid unnecessary restrictions or costs.
Principle 4: Tax arrangements should be simple, administrable, enforceable and should conform to international norms and practices
1.7 Ideally, any rules being developed should be:
- simple;
- capable of enforcement and minimise tax administration costs; and
- consistent with international norms and practices and satisfy Australia’s international obligations.
1.8 In developing its recommendations in this report, the Board has had to balance these principles and make an assessment of their appropriate weightings.