Chapter 4: Definition of foreign managed funds

1.1 Under an exemption style IMR, only foreign managed funds which meet certain qualifying requirements would be eligible for tax exemptions on particular investments.

1.2 To date, the Government’s announcements of elements of a foreign managed funds IMR have proposed that a foreign managed fund would broadly have the following features:

  • it is not an Australian 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.

1.3 This chapter sets out a discussion of the requirements which a foreign managed fund must meet in order to be eligible for an IMR.

1.4 Once funds meet the eligibility criteria, the Board recommends they be exempt only on particular types of transactions or investments they make. A discussion of the types of exempt transactions and investments is set out in Chapter 5.

Legal form of the fund

1.5 The Board considered what types of legal structures for foreign managed funds should be eligible for an IMR.

Views in submissions

1.6 A number of submissions state that there should be a wide definition of ‘;foreign managed fund’ for the purposes of the IMR. Specifically, the definition should cover a wide range of legal structures.

… the eligibility of an IMR should not be affected by the legal structure of foreign managed funds as long as they are of a type which falls broadly as a collective investment vehicle. As foreign funds formed in non-English or American law type jurisdictions (e.g. Japan and countries in mainland Europe) can take other legal forms to the current forms of foreign funds in Australia (i.e., companies, limited liability companies, limited partnerships or a trust) a broad classification is needed.

Financial Services Council

Board’s consideration

1.7 The Board agrees with stakeholders that the foreign managed funds IMR should apply to a broad set of CIV legal structures and arrangements. The Board notes that this is consistent with one of the design principles of the terms of reference with respect to the design of a CIV regime, which states that ‘;the tax treatment of a CIV should be determined by the nature of its investment activities rather than the structure of the entity through which the funds are pooled‘. One of the design principles of an IMR was for the regime to be aligned with broader arrangements for the taxation of CIVs (noted in paragraph 1.4).

1.8 A wide range of structures and arrangements are commonly used as CIVs in foreign jurisdictions.

1.9 For example, the Undertakings for Collective Investments in Transferable Securities (UCITS) regime in the European Union covers a broad range of CIVs and is widely used by fund managers internationally. CIVs under the UCITS regime are not confined to legal entity structures, but also include CIVs which comprise common contractual arrangements among investors and an investment manager. An example is a Common Contractual Fund commonly used in Ireland as a CIV.

1.10 It is important for Australia’s IMR to be compatible with a wide range of international CIV structures and arrangements in order to attract both investments from these funds into Australia and to facilitate the use of Australian financial services intermediaries.

1.11 For these reasons, the Board recommends that the scope of the IMR for foreign managed funds should cover a broad set of CIV structures and arrangements, including common contractual arrangements, and should not be limited to particular types of legal entity.

Recommendation 2:

The Board recommends that the scope of the IMR for foreign managed funds should cover a broad set of CIV structures and arrangements, including common contractual arrangements, and should not be limited to particular types of legal entity.

Residence and permanent establishment considerations

1.12 A requirement for a managed fund not to be Australian resident is an important prerequisite in order for the fund to be eligible for the IMR.

1.13 However, in applying Australia’s tax rules to determine the residence of a managed fund, the Johnson Report found that the residence rules could potentially deem foreign managed funds to be Australian resident entities if their ‘;central management and control’ was based in Australia. The report noted that foreign managed funds were incurring additional transaction costs to ensure that board decisions were made outside Australia and that only a minority constituency of Australian resident board directors were kept in order to avoid the ‘;central management and control’ of the fund being deemed to be located in Australia.

1.14 Furthermore, engaging an investment manager and conducting investment activities in Australia may create further uncertainty as to whether the fund has a permanent establishment in Australia in respect of investments not covered by the IMR.

1.15 As a result, the Johnson Report recommended that an IMR be introduced with the principle that:

The location of central management and control in Australia of entities that are part of the regime will not of itself give rise to Australian tax residency of those entities.

1.16 The Johnson Report further recommended that the IMR be introduced with the following fundamental principle:

For non-resident investors investing in Australian assets through an independent investment adviser, the investors should not be deemed to have … an Australian permanent establishment, merely as a result of using an Australian intermediary.

1.17 The Board therefore considered Australia’s residence rules and permanent establishment rules to see whether changes were appropriate in the context of foreign managed funds accessing the IMR.

Views in submissions

1.18 Broadly, to ensure that foreign managed funds are not treated as Australian residents in circumstances that would not align with the policy objectives of the IMR, some submissions suggested changes to Australia’s residence rules which would link the rules to an entity’s eligibility for the IMR. In particular, submissions suggested that foreign funds should be treated as not being an Australian resident where they otherwise qualify for the IMR and would only be treated as Australian resident by virtue of having central management and control in Australia.

We recommend that changes to ensure that a foreign managed fund is not inappropriately taxed in Australia as a resident where central management and control may be in Australia, should be linked to an entity’s eligibility otherwise for the IMR.

Ernst & Young

1.19 Submissions also said Australia’s current residence rules do not encourage the development of regional head offices in Australia.

… the Board must consider whether the IMR will simply be used to encourage investment management practices in Australia, or whether it will also be used as a consistent tool for encouraging regional offices and headquarters to be established in Australia.

Pitcher Partners Advisors

1.20 Some submissions suggested other targeted modifications to Australia’s residence rules to ensure foreign managed funds would not be taken to be Australian resident where the fund engages an Australian intermediary.

… the IMR rules should contain a provision to the effect that, when determining whether the central management and control of a foreign entity is in Australia for the purpose of determining whether that foreign entity is or is not an Australian resident for all purposes of the Australian tax law, the use of an Australian intermediary (covered by the IMR) is to be disregarded.

Taxation Institute of Australia

Board’s consideration

1.21 The Board recommends that a foreign managed fund must not be an Australian resident in order to be eligible for the IMR.

1.22 The Board agrees with the Johnson Report and comments made by stakeholders that there are a number of difficulties that arise in the application of Australia’s residence tests as they would apply to foreign managed funds seeking to access the IMR.

1.23 Under the current tax law, a company will be taken to be Australian resident if:

  • it is incorporated in Australia; or
  • it carries on business in Australia and either:
    • has its central management and control in Australia; or
    • has its voting power controlled by Australian resident shareholders.

1.24 Also under the current tax law, a limited partnership will be taken to be Australian resident if:

  • the partnership is formed in Australia; or
  • either:
    • the partnership carries on business in Australia; or
    • the partnership’s central management and control is in Australia.

1.25 A trust will generally be taken to be Australian resident if either the trustee of the trust estate was a resident at any time during the income year, or the central management and control of the trust estate was in Australia at any time during the income year10.

1.26 Alternative residence tests apply to unit trusts for capital gains tax (CGT) purposes11 and to unit trusts under the public trading trust rules12. These alternative residence tests require the tracing of beneficial interests in the trust.

1.27 The Board considered a number of options to address the residence related difficulties raised in the Johnson report and raised by stakeholders.

1.28 In developing these options, the Board was of the view that changes should not be introduced broader than what would be necessary to address these difficulties. Consequently, the Board considered that changes should not be made to Australia’s residence rules as they apply generally. These residence rules are long standing principles in Australia’s tax law whose interpretation has been developed over many decades. Instead, for these difficulties to be addressed, the Board considered that a targeted adjustment should be made to the residence rules only for the purposes of applying the IMR rules. The Board considers, however, that a more general change is appropriate for the residence test of limited partnerships (see paragraphs 4.38 to 4.41 below).

Central management and control and the location of board meetings and residence of directors

1.29 The Board considered options for adjustments to be made to Australia’s residence test so that a foreign managed fund would not be taken to be Australian resident only by virtue of it holding board meetings in Australia or having a majority of directors resident in Australia.

1.30 The Board considered the option of adjusting the residence rules such that the holding of board meetings in Australia would not be taken into account in assessing the location of central management and control for a managed fund. However, the Board reached the view that such an adjustment would not be desirable. Determining the location of central management and control requires a weighing together of a number of indicia of which the location of board meetings is one consideration. The Board considered that it was inappropriate to disregard the location of board meetings as this is a relevant factor in assessing the location of central management and control of an entity.

1.31 For the same reason, the Board considered it inappropriate to adjust the residence rules such that the residence of the directors of a foreign fund would not be taken into account as part of the indicia in assessing the location of the fund’s central management and control.

1.32 The Board considered other options which could replace the central management and control test in the case of foreign managed funds accessing the IMR. These included deeming foreign managed funds not to be Australian resident on the basis of where the fund is ‘;established’, ‘;registered’, ‘;regulated’, or ‘;marketed’. However, the Board considered these options problematic for a number of reasons. The terms ‘;established’, ‘;registered’, ‘;regulated’, or ‘;marketed’ would each give rise to questions as to the scope of those terms. This would create new threshold requirements specific to foreign managed funds accessing the IMR. Furthermore, it may be problematic to assess the location where some funds are ‘;established’ – for example a common contractual arrangement may be entered into by multiple parties resident in different jurisdictions. Funds may also be registered, regulated or marketed in multiple jurisdictions.

1.33 Therefore, the Board was of the view that it was not appropriate to recommend a new residence requirement that would replace the central management and control test for foreign managed funds under an IMR.

Residence and the use of an Australian intermediary

1.34 After considering a number of options, the Board came to the view that any adjustment to the residence rules for the purposes of the IMR should deal with the problem that a foreign managed fund could be taken to be an Australian resident merely by virtue of engaging an Australian intermediary.

1.35 The Board considers that the decision of a foreign managed fund whether or not to engage an Australian investment adviser or other Australian intermediary should not influence the eligibility of the foreign fund for the IMR.

1.36 Accordingly, the Board recommends that the operation of Australia’s residence test be modified, only for the purposes of it applying to a foreign managed fund under the IMR, such that a foreign managed fund will be deemed not to be an Australian resident if the only reason it would be an Australian resident is because it uses an Australian intermediary. This modification should apply to the residence tests for companies, limited partnerships and trusts.

1.37 The Board considers that the meaning of an Australian intermediary should be broad, and should include the case of foreign managed funds using Australian investment managers, brokers, custodians, legal advisers, and dependent agents.

Residence test for limited partnerships

1.38 The Board agrees with stakeholder comments that it is inappropriate for a limited partnership to be treated as an Australian resident merely by virtue of it conducting business in Australia. This would prevent a number of limited partnerships established overseas from accessing the IMR for foreign managed funds where they carry on a business in Australia without having central management and control in Australia – such limited partnerships would be treated as being Australian resident.

1.39 The Board recommends that the residence test for limited partnerships should be amended, only for the purposes of it applying to a foreign managed fund under the IMR, such that a limited partnership will be taken to be Australian resident if:

  • the partnership is formed in Australia; or
  • the partnership carries on business in Australia and has its central management and control in Australia.

1.40 The Board recommends the Government investigate whether the amendment to the residence test for limited partnerships should apply for all limited partnerships in the general tax law, and not only to limited partnerships seeking to access the IMR. This would align the residence test for limited partnerships in the general tax law and under the IMR, and would also more closely align the residence test for limited partnerships to the residence test for companies. In making this investigation, the Board suggests that due consideration be given to the potential implications of such changes.

1.41 The Board also notes that if the Government decides to amend the residence test for limited partnerships in the general tax law, a transitional rule should be implemented to ensure that any limited partnerships which change from being Australian resident to foreign resident as a result of the modification to the limited partnership residence test will not become taxable under CGT Event I1. Transitional rules should also be considered in the case of a limited partnership that is a member of a Australian tax consolidated group changing residence as a result of the modification to the limited partnership residence test.

Residence test for trusts

1.42 The Board recommends that the general residence test for trusts (in subsection 95(2) of Division 6 of Part III of the ITAA 1936) be applicable in testing whether a trust is not a resident of Australia for the purposes of accessing the IMR for foreign managed funds.

1.43 Under this test, a trust will be taken to be Australian resident if either the trustee of the trust estate was a resident at any time during the income year, or the central management and control of the trust estate was in Australia at any time during the income year. This should apply whether or not the trust is a unit trust or a public trading trust.

1.44 The CGT residence test for unit trusts and the residence test for public trading trusts require the tracing of beneficial interests which the Board considers would impose undue compliance and administrative costs for foreign managed funds seeking to access the IMR.

Foreign managed funds with no residence

1.45 The Board understands that there may be cases where a foreign managed fund is not strictly resident in any jurisdiction. This may arise, for example, where the foreign managed fund is not a legal entity but comprises a common contractual arrangement among investors and an investment manager. It may also arise where the particular domestic tax residence rules in a jurisdiction do not apply to the type of arrangement used as a managed fund.

1.46 For the avoidance of doubt, the Board considers that where it can be demonstrated a foreign managed fund is not an Australian resident under Australia’s residence rules (that is, the foreign managed fund is a ‘;non-resident’), this should be sufficient for that foreign managed fund to access the IMR. As a general rule, the foreign managed fund should not be required to demonstrate that it is a resident of another jurisdiction under that jurisdiction’s residence rules in order to access the IMR.

1.47 The Board does note that, for integrity purposes, it has recommended in Chapter 6 that a foreign managed fund should be resident in an information exchange country as a prerequisite for accessing the IMR (Recommendation 11). If this recommendation is introduced, a foreign managed fund would technically need to be resident in a particular jurisdiction in order to qualify for the IMR. In this respect, the Board notes there are provisions that will deem residence for entities or other CIV arrangements which are not resident in any jurisdiction (discussed at paragraphs 6.43 to 6.44 below).

Foreign managed funds to be treated as non-resident for all purposes of the tax law

1.48 The Board also acknowledges that once a foreign managed fund is eligible for the IMR under the modified residence test, it would be important that the fund also be treated as non-resident for the purposes of applying all other provisions in the tax law. If this were not the case, a foreign managed fund could be treated as a non-resident for IMR purposes, but be treated as a resident for the purposes of other provisions in the tax law. The Board considers this an undesirable outcome which would create unreasonable complexity.

1.49 Undesired tax distortions could also arise. A foreign managed fund could be treated as a non-resident under the IMR and be exempt on disposals of eligible investments, but be taxable as a resident on receiving dividend income on those investments. The same distortion would arise where a foreign managed fund receives interest income on tradable bonds. In these cases, the appropriate outcome would be for the foreign fund to be treated as a non-resident so that any dividend and interest income would be subject to withholding tax.

1.50 The Board noted that if a foreign managed fund is treated as a non-resident for all purposes in the tax law, this may enable other tax concessions available to non-residents to also be made available to foreign managed funds, including the non-resident CGT rules. This placed an additional emphasis on ensuring that any funds that were appropriately ‘;Australian funds’ were not allowed to be treated as non-resident under a modified IMR residence test – thus, any modifications to the residence rules should not be broader than necessary. The Board considered that its recommended modification to the residence test (set out above) is sufficiently narrow to ensure that funds which are in effect based in Australia are not allowed to access the IMR and other non-resident tax concessions.

1.51 Accordingly, the Board recommends that a foreign managed fund eligible for the IMR under the modified residence test should be taken not to be an Australian resident for the purposes of applying all provisions in the tax law.

Permanent establishment considerations

1.52 There are a number of provisions in the tax law that operate if a non-resident is taken to have a permanent establishment in Australia. For example, the CGT provisions provide Australia with a (prima facie) taxing right in respect of any assets where the non-resident has used the asset at any time in carrying on a business through a permanent establishment.13

1.53 Generally, a non-resident will be taken to have a permanent establishment where the non-resident has a place at or through which the person carries on any business in Australia14. As highlighted in the Johnson Report, the Board considers it inappropriate for a foreign fund to be taken to have a permanent establishment simply by virtue of the fund engaging an investment manager in Australia. Accordingly, the Board recommends that the IMR should also clarify that a foreign fund will not be taken to have a permanent establishment in Australia if the only reason it would have a permanent establishment is because it uses an Australian intermediary.

Goods and Services Tax (GST) considerations

1.54 The Board has primarily focused on the income tax implications of an IMR. Nevertheless, in the course of its review, the Board has been apprised of the fact that any changes made to the meaning of permanent establishment for foreign managed funds under the IMR may have implications for GST purposes.

1.55 Under the GST law15, the supply of services to a non-resident is GST-free. Whether or not a foreign entity is regarded as a ‘;non-resident’ for GST purposes depends on a range of factors. However, where a foreign fund engages a fund manager in Australia to provide funds management services, the transaction may not be GST-free. This could be the case where the nature of funds management services involves the fund manager acting as an agent on behalf of the foreign fund – in this case, the fund could be taken to have a permanent establishment in Australia for GST purposes. As the fund is ‘;in Australia’, it will not be a non-resident for the purpose of the GST-free export rules16, and the fund manager would need to charge GST on its services to the fund.

1.56 Where the foreign fund is registered for GST it may be entitled to claim input tax credits for the GST paid. However, to the extent that the funds management services relate to dealings in Australian financial investments, generally no input tax credits will be claimable – rather, a reduced input tax credit may be claimed in particular circumstances.

1.57 There may also be other GST implications which need to be considered prior to implementing the above recommendations regarding modifications to Australia’s residence tests.

1.58 The Board considers that, to support the policy objectives of the IMR for foreign managed funds, it would be desirable that there be consistent permanent establishment and residence tests for income tax and GST purposes. This would reduce complexity for foreign managed funds accessing the IMR. Otherwise, they could be treated as non-resident for income tax purposes, while treated as being ‘;in Australia’ for GST purposes.

1.59 However, the Board is mindful that extending IMR related income tax recommendations to GST law may be inconsistent with existing GST principles, and may result in a potential additional cost to the revenue. Further, any changes to GST law require the agreement of the States and Territories.

1.60 Having regard to these considerations, the Board recommends that the Government consider whether there should be consistent permanent establishment and residence tests for income tax and GST purposes, but only for the purpose of applying to foreign managed funds under the IMR.

Recommendation 3:

The Board recommends that:

  • in order to be eligible for the IMR, a managed fund must not be an Australian resident;
  • the operation of Australia’s residence test be modified, only for the purposes of it applying to a foreign managed fund under the IMR, such that a foreign managed fund will be deemed not to be an Australian resident if the only reason it would be an Australian resident is because it uses an Australian intermediary;
  • the residence test for limited partnerships should be amended, only for the purposes of it applying to a foreign managed fund under the IMR, such that a limited partnership will be taken to be Australian resident if:
    • the partnership is formed in Australia; or
    • the partnership carries on business in Australia and has its central management and control in Australia;
  • the Government investigate whether the amendment to the residence test for limited partnerships should apply for all limited partnerships in the general tax law, and not only to limited partnerships seeking to access the IMR;
  • the general residence test for trusts (in subsection 95(2) of Division 6 of Part III of the ITAA 1936) should be applicable in testing whether a trust is not a resident of Australia for the purposes of accessing the IMR for foreign managed funds;
  • a foreign managed fund eligible for the IMR under the modified residence test should be taken not to be an Australian resident for the purposes of applying all provisions in the tax law;
  • a foreign managed fund should not be taken to have a permanent establishment in Australia if the only reason it would have a permanent establishment is because it uses an Australian intermediary; and
  • the Government consider whether there should be consistent permanent establishment and residence tests for income tax and GST purposes, but only for the purpose of applying to foreign managed funds under the IMR.

Widely held requirement

1.61 The Board’s discussion paper sought comments from stakeholders as to whether it was appropriate to require foreign managed funds to be widely held in order to be eligible for an IMR.

Views in submissions

1.62 Some submissions proposed that the foreign managed funds IMR, whilst confined to the financial services sector, should not be limited to widely held funds. These submissions suggested that the regime should cover a wide spectrum of investment entities, including closely held vehicles.

1.63 However, the majority of submissions appeared to be in favour of having a widely held requirement for foreign managed funds, as long as the widely held test could appropriately take into account not only the direct investors in the fund but also look through those investors in determining widely held ownership.

It is important that the widely held test be structured such that in determining whether a foreign entity that invests in Australia is widely held, the test allows tracing through the Investment Vehicle to the ownership of the Ultimate Fund.

Taxation Institute of Australia

1.64 Some submissions also stated that the widely held requirement would be an appropriate means of helping ensure that the IMR did not provide benefits to Australian residents through round tripping.

The risks for round tripping are limited substantially by limiting the application of IMR to widely held foreign funds as it restricts the extent to which funds can be established as accumulation vehicles to defer taxation through deferring distribution of income.

Financial Services Council

Board’s consideration

1.65 The Board considers that it would be appropriate to include a widely held requirement for an IMR for foreign managed funds.

1.66 The basic character of a CIV as a widely held vehicle is emphasised in the Board’s terms of reference for its CIV review, and was a principle behind the design of the MIT regime. The Board was also specifically asked by the Government to consider the alignment of the design of an IMR with broader arrangements for taxing CIVs. The Organisation for Economic Co-operation and Development (OECD) Report on CIVs also included a widely held requirement in defining a CIV.17

1.67 A widely held requirement also broadly aligns with the commercial nature of most foreign managed funds which operate as collective investment vehicles. These entities will generally pool the funds of many investors who do not have responsibility for the management of the fund. Instead, fund managers are responsible for managing the funds of investors in these CIVs.

1.68 In addition, the Board agrees with the views by certain stakeholders that the widely held requirement can assist in safeguarding the misuse of the IMR by Australian residents for tax deferral purposes through round tripping.

1.69 Round tripping in the IMR context refers to the potential for Australian investors to use non-resident interposed entities to inappropriately access the benefits of the IMR exemption. There is the potential for the Australian investor to defer taxation on investments in Australian assets through the IMR which would not have arisen if the investment had been made directly. Imposing a widely held requirement, together with potential other integrity measures, would operate to reduce the ability of Australian investors to influence the decision of a foreign fund to accumulate income so as to defer Australian taxation. The Board acknowledges, however, that round tripping could still occur despite Australian investors not having the ability to influence the decisions of a foreign fund if those Australian investors chose to invest into a fund which accumulates and reinvests profits as part of its investment policy.

1.70 Further details on the risks of round tripping and other integrity issues relevant to the design of an IMR for foreign managed funds are set out in Chapter 6.

1.71 In implementing a widely held requirement, the Board agrees with stakeholders that the test should capture not only direct investors in a foreign managed fund but should also be able to look through those investors to assess whether the fund is widely held. The Board also considers that the look through or tracing rules should be as simple as possible to create certainty and to not impose undue compliance burdens on foreign managed funds.

1.72 In designing these tracing rules, an appropriate starting point may be the widely held requirements in the definition of an Australian MIT. However, the MIT tracing rules would need to be modified to ensure that the widely held test can trace through entities with different legal structures which may invest into the foreign managed fund. The Board understands that the current MIT tracing rules may not allow tracing through entities apart from trusts.

1.73 Apart from the principles recommended above, the Board acknowledges there are also many detailed issues which would need to be considered in the design of a widely held test appropriate for foreign managed funds accessing the IMR. The Board considers that the Government should consult on the detailed design on the widely held test prior to the introduction of the IMR.

1.74 The Board notes that issues concerning the scope of an IMR for entities which are not managed funds are not covered in this report.

Recommendation 4:

The Board recommends that:

  • a widely held requirement be included as part of the eligibility criteria for a foreign managed fund to access the IMR;
  • the widely held test should be able to look through direct investors in the foreign managed fund to assess whether the fund is widely held; and
  • the look through rules for the widely held test should be as simple as possible to create certainty and to not impose undue compliance burdens on foreign managed funds.

Requirement not to carry on or control a trading business in Australia

1.75 In its discussion paper, the Board suggested that the definition of a foreign managed fund should also include a requirement that the fund not carry on or control a trading business in Australia (except to the extent that its dealings in securities may amount to trading). This requirement would be broadly consistent with rules in Division 6C of Part III of the ITAA 1936.

1.76 The Board sought stakeholder comments on the appropriateness of this requirement.

Views in submissions

1.77 Submissions generally supported the requirement that a foreign managed fund not carry on or control a trading business in Australia.

1.78 In its submission, the Australian Private Equity & Venture Capital Association Limited (AVCAL) submitted that the requirement for a foreign managed fund not to carry on or control a trading business in Australia was not appropriate. It submitted that although a private equity or venture capital fund may have control over an Australian trading business, generally no particular investor into the fund would have control. For this reason, AVCAL submitted that each investor into a private equity or venture capital fund would be passive in nature, and that this should entitle the fund in which they invest to access the IMR.

Board’s consideration

1.79 The Board considers that it is appropriate as a qualifying condition for access to the IMR that foreign managed funds not carry on or control a trading business in Australia (as defined in Division 6C of Part III of the ITAA 1936). This is consistent with the principles covering the taxation arrangements applying to CIVs provided in the terms of reference for the Board’s CIV review, the requirements of the MIT regime, and the requirements of a foreign managed fund for the purposes of the Government’s announcements of elements of an IMR for foreign managed funds (referred to in paragraphs 1.20 to 1.24).

1.80 The Board also notes that it has been requested to consider as a design principle that the IMR be aligned with broader arrangements for the taxation of CIVs (noted in paragraph 1.4). In particular, the CIV terms of reference refer to CIVs undertaking primarily passive investment activities. In contrast, it is common for a private equity fund to directly or indirectly actively manage a business. This is made possible by having control of the relevant business. Exempting the income arising from that active involvement in the relevant business would be inconsistent with the international tax principles set out in Chapter 2.

1.81 Whether or not an individual investor in a private equity fund itself has control, it shares in the benefits of control held by the fund which, as indicated above, can come from the ability of the fund to have an active role in the relevant business. Consistent with the CIV terms of reference (at paragraph 1.11), it is the nature of the fund’s activities that should determine its tax treatment, not the nature of the investor’s investment in the fund.

1.82 The Board also notes that stakeholders indicated during targeted consultations that managed funds generally do not carry on a trading business (as defined in Division 6C of Part III of the ITAA 1936), and do not acquire interests in investments large enough to confer control.

1.83 The Board therefore recommends that in order to qualify for the IMR, foreign managed funds should not carry on or control a trading business in Australia (as defined in Division 6C of Part III of the ITAA 1936).

Recommendation 5:

The Board recommends that to be eligible for the IMR, a foreign managed fund should not carry on or control a trading business in Australia (as defined in Division 6C of Part III of the ITAA 1936).

Managed in Australia requirement

1.84 In addition to the above design features, the Board also sought comments on the appropriateness of a ‘;managed in Australia’ requirement, such as that in the MIT regime.

Views in submissions

1.85 Most stakeholders were not in favour of ‘;managed in Australia’ or minimum spend requirements. They found such requirements could curtail the regime’s potential for success and increase complexity and compliance activities. Furthermore, the submissions suggested that a ‘;managed in Australia’ requirement would limit investors’ flexibility in managing assets and discourage utilisation of the IMR.

We submit that there should not be a “managed in Australia” requirement in the IMR. Such a requirement would restrict the way in which foreign funds choose to manage assets and generally distort decision-making. Furthermore … to the extent that such tests include general, undefined terms such as “investment management”, uncertainty is created which deters investment.

The Institute of Chartered Accountants in Australia

Board’s consideration

1.86 The Board agrees with stakeholders that a ‘;managed in Australia’ requirement should not be incorporated into the IMR for foreign managed funds.

1.87 The Board considers that one key objective of the IMR for foreign managed funds is to provide certainty for the tax treatment of portfolio investments made by these funds in or through Australia. Specifically, the Board is proposing that such investments be exempted under an IMR. This is regardless of whether these foreign managed funds engage an Australian fund manager or not. Therefore, it is unnecessary and would be inappropriate to impose a managed in Australia requirement for the IMR.

1.88 The Board also agrees with stakeholders that a ‘;managed in Australia’ requirement would limit investors’ flexibility in managing assets and potentially discourage utilisation of the IMR.

1.89 Furthermore, the Board acknowledges that there are benefits in attracting mobile portfolio investment into Australia by providing exemptions under an IMR, even where an Australian intermediary is not engaged. Direct investments from foreign managed funds into Australia would provide business to other financial service providers, and would assist in deepening Australian capital markets.

Recommendation 6:

The Board recommends that a ‘;managed in Australia’ requirement not be incorporated into the IMR for foreign managed funds.