1.1 Foreign managed funds which meet the qualifying conditions become eligible for the IMR. The next question is whether all investments made by these qualifying funds should be granted exemptions under the IMR, or whether exemptions should be restricted only to certain types of investments.
Portfolio investment and eligible investment business requirements
1.2 The Board’s discussion paper suggested that the exemptions offered under a foreign managed funds IMR should only extend to the disposal of investments that are of a portfolio nature and are consistent with the eligible investment business rules in Division 6C of Part III of the ITAA 1936.
1.3 The Board sought stakeholder comments on this suggestion.
Views in submissions
1.4 The majority of submissions supported the focus of an IMR on portfolio investments.
1.5 Submissions also broadly agreed that it would be appropriate to define investments with reference to the eligible investment business rules in Division 6C of Part III of the ITAA 1936, subject to certain modifications.
… the range of investments listed in the definition of “eligible investment business” in section 102M of Part III of the ITAA 1936 would be an appropriate starting point to define the range of investments that should be covered by an IMR. However, we recommend that one key modification should be made for use in an IMR. This includes the removal of the reference to investing in land.
Taxation Institute of Australia
1.6 In defining the specific types of investments which should be exempted, some submissions referred to the investments exempted under tax rules in other jurisdictions comparable to an IMR and sought a wide list of eligible investments similar to the United Kingdom (UK) and Singapore regimes.
Australia should consider establishing a similar wide ranging IMR to those of Singapore and the United Kingdom (UK), which include the full range of investment products. Otherwise the Australian initiative will not be competitive in attracting foreign investment management activities.
Ernst & Young
1.7 Furthermore, some submissions stated the list of eligible investments should be adaptable to the development of financial services and investments over time.
… it is hoped that the range of eligible investments will be as broad as possible and or cover both direct investments in Australian collective investment vehicles (…) Trying to restrict the IMR regime to a closely defined group of assets (e.g. marketable securities only) may hinder innovation in this industry and leave Australia at a competitive disadvantage …
Henry Davis York
1.8 Submissions suggested the ring fencing of ineligible activities carried out in Australia by eligible non-residents. Measures to deal with ring fencing exempt income so that it is not tainted by non-qualifying investments would include:
- de minimis thresholds which if not satisfied would result in the application of the ordinary Australian taxation rules to the investments not covered by the IMR, if not to all of the non-resident’s investments in Australia; or
- allowing the benefits of the IMR to be applied on a proportional basis (as in the UK).
- To have an effective IMR, other activities of non-residents coupled with the complexity of fund groups, should not influence their access to an IMR.
Deloitte Touche Tohmatsu
Board’s consideration
Portfolio investment requirement
1.9 The Board considers that IMR exemptions should only be granted for the disposal of portfolio investments made by foreign managed funds.
1.10 The Board notes that portfolio investments are typically more liquid in nature compared with non-portfolio investments, and therefore are more likely to be mobile and responsive to source taxation. For this reason countries such as the United Kingdom, Singapore and Hong Kong do not tax, or only lightly tax, portfolio investments. To the extent that Australia imposes taxation on mobile capital it will likely discourage investment in Australian financial assets.
1.11 The exemption of portfolio investments also flows on from findings made in the Asprey Report of 1975 which found that difficulties in collecting tax from stock-exchange transactions could only effectively be overcome through exempting such transactions. While it did not directly support such an exemption, Asprey recognised its potential as a way of attracting to Australia financial operations by non-residents.
1.12 The Board notes that the exemption of portfolio investments is also consistent with elements of the non-resident capital gains tax exemption rules18 introduced in December 2006. Under these rules, non-residents are generally exempted from capital gains tax on the sale of assets apart from Australian real property. However, non-residents remain taxable on capital gains from investments in an entity whose predominant value is in Australian real property (that is, a land-rich entity), but would generally be exempt if their investment in such an entity is only of a portfolio nature. These portfolio investments were exempted partly due to the mobility of such investments and the difficulty for foreign investors in obtaining information on whether their investments were land-rich.
1.13 The Board considers that in assessing whether a foreign managed fund has a portfolio investment, the foreign managed fund must have a less than 10 per cent interest in that investment.
1.14 The Board also considered whether a portfolio investment should take into account not only the interests held in an investment directly by a foreign managed fund, but also interests held in that investment by ‘;associates’ of the foreign fund. This would stop related foreign managed funds making portfolio investments in the same entity such that their aggregate holding was of a non-portfolio nature.
1.15 However, if this requirement is imposed, and considering beneficiaries are associates of trustees and partners are associates of partnerships, a foreign managed fund established as a trust or partnership would need to ask its investors to disclose all of their investments in any of the entities that the fund invested in. The Board considers this would be practically unworkable for foreign managed funds given investors could refuse to disclose such information.
1.16 In view of the above, the Board recommends that, in implementing the portfolio investment requirement, further consideration be given to any integrity issues that would need to be addressed. In particular, it may be desirable to ensure that foreign managed funds do not act in concert with other entities to acquire interests of greater than 10 per cent while still accessing the exemption.
Prescribed list of eligible investments
1.17 The Board recommends that the IMR exemptions should only extend to a prescribed list of eligible investments made by a foreign managed fund. The Board notes that the prescribed list of eligible investments will comprise investments which must be portfolio in nature (including investments in shares of a company or units of a trust), and certain other financial investments (including investments in bonds and securities). Foreign managed funds would be permitted to make investments apart from those contained in the prescribed list, but these investments would not qualify for exemption.
1.18 The Board agrees with comments made by stakeholders that, in developing a prescribed list of eligible investments, the list of investments covered by the eligible investment business rules in Division 6C of Part III of the ITAA 1936 is an appropriate starting point. The Board also notes that other jurisdictions generally exclude investments in land and land-rich entities from qualifying for exemption.
1.19 For example, under the United Kingdom’s Investment Manager Exemption rules, transactions relating to land, including transactions of any nature which result in either the acquisition of land or cash flows from such assets (that is, contracts in land or contracts relating to land), are not within the definition of investment transactions which are given exemption.
1.20 Futures and option contracts relating to land are specifically excluded from the definition of investment transactions subject to the exemption in the United Kingdom Investment Manager Exemption rules. However, certain futures and options contracts involving indices of land can qualify for exemption depending on the characteristics of the particular index used.
1.21 The Board recommends that, similar to other jurisdictions, transactions in land, including transactions of any nature which result in the acquisition of land, should be excluded from the prescribed list of eligible investments which qualify for IMR exemption. At the same time, the Board also recommends that the Government consider allowing certain land related futures and options contracts to be part of the prescribed list of eligible investments where they relate to a publicly quoted index.
1.22 The Board also considered whether IMR exemptions should apply to investments in Australian land-rich entities.
1.23 The Board noted in Chapter 2 that one of the generally accepted principles for the design of international taxation is that taxation arrangements should reflect the responsiveness of capital to taxation (Principle 1). In this context, land-rich entities can derive location-specific economic rents, and therefore there is scope to impose Australian tax without deterring investment in these entities.
1.24 However, as noted in paragraph 5.12, the Board acknowledges that Australia’s non-resident CGT rules provide an exemption from capital gains tax to non-residents who dispose of investments in Australian land-rich entities, as long as those investments are portfolio in nature. One reason for this exemption from capital gains tax on portfolio investment in land-rich entities was the practical difficulty for foreign residents in determining whether the entities in which they invest are land-rich.
1.25 The same difficulty would arise if foreign managed funds are required to investigate whether their portfolio investments in Australian entities are land-rich before they can access the IMR exemption for those investments. This difficulty may be particularly relevant where a foreign managed fund makes portfolio investments in Australian entities listed on an Australian stock exchange, which the Board understands would comprise the majority of Australian equity investments made by foreign managed funds.
1.26 The Board considers that investments in entities listed on an Australian stock exchange are typically more liquid than investments in unlisted entities. Investors wanting to invest in a listed entity can obtain information on the share price from the stock exchange, and normally can readily execute a purchase or sale using the stock exchange. In contrast, investors wanting to invest in an unlisted entity could typically be expected to undertake some level of investigation before committing to an investment, including obtaining pricing information and potentially a greater level of information on the nature of the investee’s assets and activities. This is particular so since there are likely to be greater transaction costs in disposing of the investment.
1.27 The Board therefore considers that it would be overly cumbersome to require a foreign managed fund to ascertain whether an investment in an Australian listed entity was not land-rich before the investment could qualify for IMR exemption. Including such a requirement could create substantial compliance costs and may serve to undermine the objectives of the IMR for foreign managed funds. However, the Board considers it would not be unreasonable to require a foreign managed fund to ascertain as part of its purchase investigations whether an investment in an Australian unlisted entities was not land-rich.
1.28 The Board considers that this outcome would provide a practical approach which balances the desirability of maintaining taxation over Australian land interests and minimises compliance costs for foreign managed funds. The Board also notes that this approach would be broadly consistent with tax rules in the United States and Canada which also require land-rich testing for portfolio investments in unlisted entities, but no such testing for portfolio investments in listed entities.19
1.29 Therefore, the Board recommends that portfolio investments in Australian entities which are listed on an Australian stock exchange should be included in the prescribed list of eligible investments which qualify for IMR exemption, regardless of whether or not those entities are land-rich. However, the Board recommends that portfolio investments in Australian entities which are not listed on an Australian stock exchange should only be included in the prescribed list of eligible investments where those entities are not land-rich.
1.30 The Board notes that, under the non-resident CGT rules (in the case of non-portfolio investments)20, an entity is land-rich if over 50 per cent of its market value is attributable to interests in Australian real property. This test requires a consideration of not only Australian real property interests directly held by that entity, but any Australian real property that may be held by the entity’s subsidiaries. The Board considers that in the context of testing whether a portfolio investment in an Australian unlisted entity is land-rich under an IMR for foreign managed funds, the same test should broadly apply.
1.31 However, the Board suggests that the Government consider whether a modification should be made in testing whether a portfolio investment in an Australian unlisted entity is land-rich or not. Under this modification, Australian unlisted vehicles (such as Australian equity funds) whose value is predominantly attributable to investments in Australian listed entities would be taken not to be land-rich. This is consistent with the above recommendation that foreign managed funds be exempt on portfolio investments in Australian listed entities irrespective of whether they are land-rich or not.
1.32 The Board considers that withholding tax should continue to apply to payments of interest, dividends, royalties and MIT fund payments paid to foreign managed funds on their Australian investments. One of the policy drivers behind the IMR is to ensure that foreign funds receive the same after tax outcome whether or not they use an Australian intermediary. In addition, if withholding tax that currently applies to payments made to foreign managed funds was to be eliminated by the IMR, a tax bias toward qualifying IMR foreign funds would be created over other Australian assets that would otherwise have been subject to withholding taxes.
Recommendation 7:
The Board recommends that:
- the tax exemption provided under an IMR should be restricted to the disposal of investments that are of a portfolio nature;
- a foreign managed fund will have a portfolio investment if it has a less than 10 per cent interest in that investment;
- in implementing the portfolio investment requirement, further consideration be given to any integrity issues that would need to be addressed;
- the IMR exemptions should only extend to a prescribed list of eligible investments made by the foreign managed fund;
- transactions in land, including transactions of any nature which result in the acquisition of land, should be excluded from the prescribed list of eligible investments which qualify for IMR exemption;
- however, the Government should consider allowing certain land related futures and options contracts to be part of the prescribed list of eligible investments where they relate to a publicly quoted index;
- portfolio investments in Australian entities which are listed on an Australian stock exchange should be included in the prescribed list of eligible investments, regardless of whether or not those entities are land-rich;
- portfolio investments in Australian entities which are not listed on an Australian stock exchange should only be included in the prescribed list of eligible investments where those entities are not land-rich; and
- withholding taxes should continue to apply to payments of interest, dividends, royalties and MIT fund payments paid to foreign managed funds on their Australian investments.
Non-portfolio investments in non-Australian assets
1.33 The Board’s discussion paper also sought specific comments from stakeholders as to the appropriateness of providing IMR exemptions for the disposal of non-portfolio investments made by foreign managed funds in non-Australian assets.
Views in submissions
1.34 Some submissions commented on whether an IMR should exempt foreign managed funds on non-portfolio investments made in non-Australian assets. These submissions stated that such investments should be treated as exempt.
The IMR should also cover all non-Australian assets (whether represented by portfolio or non-portfolio interests). This is consistent with the principle that all conduit income should be exempt from Australian tax.
Taxation Institute of Australia
Board’s consideration
1.35 The Board agrees with the views raised in submissions that foreign managed funds should be exempt on gains made on non-portfolio investments in non-Australian assets. The Board considers that the purpose of this would be to ensure that conduit income is not subject to Australian tax.
1.36 Foreign managed funds accessing the proposed IMR would generally have a diversified suite of investments, which may include both portfolio investments and non-portfolio investments in Australia or offshore. Whilst Recommendation 7 would treat gains made on the fund’s Australian and offshore portfolio investments as exempt, gains made on any offshore non-portfolio investments (conduit income) could still be subject to Australian tax.
1.37 For example, under current tax rules, a foreign managed fund making a non-portfolio investment in a United States company listed on the New York Stock Exchange would generally not be subject to Australian tax. However, the foreign managed fund could be made subject to Australian tax if it used an Australian investment advisor to make this investment. Specifically, if the Australian investment advisor makes the buying and selling decisions with respect to the investment, any gains on disposal of the investment could be taken to be sourced in Australia and thus be potentially subject to Australian tax.
1.38 The Board considers that there will be a disincentive for a foreign managed fund to engage an Australian intermediary to manage its suite of investments if this creates the risk that non-portfolio offshore investments could be made taxable in Australia on the basis of being Australian-sourced. This could act to undermine the IMR for foreign managed funds. On this basis, the Board recommends that a gain made by a foreign managed fund from the disposal of non-portfolio investments in non-Australian assets (that is, conduit income) should not be subject to Australian tax if the only reason it is subject to Australian tax is because it uses an Australian intermediary.
Recommendation 8:
The Board recommends that a gain made by a foreign managed fund from the disposal of non-portfolio investments in non-Australian assets (that is, conduit income) should not be subject to Australian tax if the only reason it is subject to Australian tax is because it uses an Australian intermediary.