1.1 The Johnson Report noted difficulties were faced by foreign funds with Australia’s ‘;permanent establishment’ rules. Under these rules, a foreign fund could be taken to have a taxable presence in Australia if it used an Australian investment advisor or fund manager and could result in the fund paying Australian income tax or losing the benefit of the non-resident capital gains tax exemption.
1.2 The Government’s announcement25 on 19 January 2011 of the conduit income element of the IMR for foreign managed funds proposed income tax amendments to exempt income from relevant investments of a foreign managed fund where such income would be taxable only due to the fund being taken to have a permanent establishment in Australia. The exemption was designed to ensure that no tax is imposed on investment income of a fund by virtue of it engaging domestic investment advisers or other Australian based intermediaries when the fund has no real presence in Australia.
1.3 The announcement noted that the proposed changes would not affect the taxation in Australia of the arm’s length fee for the management function performed by Australian based intermediaries used by foreign managed funds.
1.4 The Board’s discussion paper sought comments on the option of ensuring Australian intermediaries were only taxed on their arm’s length fees for providing services to foreign managed funds. Specifically, it asked what types of intermediaries such an option should apply to and whether ring-fencing issues should be considered.
Views in submissions
1.5 Submissions generally called for a broad notion of eligible intermediaries.
We consider that the IMR should be potentially applicable to all investment intermediaries in Australia whether they execute contracts for non-residents as part of the investment advisory and management function or whether they simply provide advice in one of many possible forms. The basic conditions of the UK IMR in this regards should be sufficient.
Greenwoods & Freehills
1.6 Stakeholders broadly concurred that Australia’s transfer pricing rules would be sufficient to determine the arm’s length fee which is appropriate for the services rendered.
1.7 If the IMR were to include provisions dealing with the taxation of the payments for an intermediary’s services, some submissions suggested that a special bright line test for independence would be appropriate. This test would deem an intermediary to be dealing with the foreign managed fund at arm’s length for the purpose of dispensing with any further substantiation requirements to prove that they were indeed dealing at arm’s length. If the relationship could, by virtue of the bright line test, be characterised as independent then there would be no need to include such explicit rules dealing with payment for services in the regime.
The UK threshold of 80 per cent of the business of the adviser being constituted by work for the non-resident provides a sensible bright line test for independence (…) though the manager should be able to demonstrate independence as a factual matter if outside this test.”
Greenwoods & Freehills
1.8 However, those submissions were generally opposed to unnecessarily onerous requirements to substantiate that the intermediary is acting independently.
In relation to the requirement to charge an arm’s length fee for investment management services, we do not believe that onerous substantiation requirements should be in place if the investment manager is “independent” of the foreign investor. If the two parties are truly independent, then it is expected that the investment manager would charge a fee that is not less than customary.
Pitcher Partners Advisors
Board’s consideration
1.9 The Board is of the view that the recommendations it has made above in relation to introducing an exemption style IMR for foreign managed funds are adequate to ensure that foreign managed funds are not inappropriately taxed by virtue of the use of an Australian intermediary.
1.10 The exemption proposed for the IMR would apply to portfolio investments made by qualifying foreign managed funds. Since the exemption would apply to such investments made by the foreign managed fund, the fund would be exempt whether it made the investments directly or whether it made the investments using an Australian intermediary which gave rise to it having an Australian permanent establishment.
1.11 The exemption would cover the case of a foreign managed fund using any type of Australian intermediary for its investments, including investment advisers, fund managers, brokers, financial institutions, dependent agents and custodians. It would also cover the case of a foreign managed fund being taxable on its investment income only by virtue of it using the Australian stock exchange as an intermediary.
1.12 The Board also agrees with the majority of stakeholders that Australia’s existing transfer pricing rules would be sufficient to ensure an Australian related party intermediary’s arm’s length management fee is appropriately taxed.
1.13 The Board notes that, during targeted consultations, concerns were raised that there may be a problem in the operation of the arm’s length test where the test may apply to assess what would be appropriate remuneration based on the actual performance of an Australian fund manager rather than being based on what would be considered appropriate remuneration at the time the management contract was entered into. Accordingly, the Board recommends that the Government investigate whether there is a problem in the operation of the arm’s length test within the transfer pricing rules in this context, and if so, that any appropriate amendments be made.
1.14 During targeted consultations, stakeholders also raised the point that fund managers seeking tax certainty and wanting to avoid possible problems in the operation of the arm’s length test may require advanced confirmation of arm’s length fees with the ATO. These stakeholders acknowledged that fund managers could enter advanced pricing arrangements (APAs) with the ATO to provide this certainty, but to achieve this outcome the process to obtain APAs would need to be timely.
1.15 It is expected that once an IMR is introduced, there would be considerable demand for APAs to be obtained from the ATO from Australian financial intermediaries which act for related foreign managed funds. If APAs could not be provided in a timely manner, it would deter the use of Australian financial intermediaries even after introduction of the IMR.
1.16 The Board therefore recommends that the ATO take into account a potential increase in APA applications following the introduction of an IMR, and that it accords appropriate priority to this area in its allocation of resources.
Recommendation 12:
The Board recommends that:
- no further measures should be incorporated into an IMR for foreign managed funds to ensure the appropriate taxation of Australian intermediaries; and
- Australia’s transfer pricing rules should continue to operate where appropriate to tax Australian intermediaries on their arm’s length fees for services provided to foreign managed funds;
- the Government investigate whether there is a problem in the operation of the arm’s length test within the transfer pricing rules, and if so, that any appropriate amendments be made; and
- the ATO take into account a potential increase in APA applications following the introduction of an IMR, and that it accords appropriate priority to this area in its allocation of resources.