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Australia's Investment Manager Regime: End in sight?

By Ken Woo, Tax Partner, Grahame Roach, Tax Director, and Darren Mack, Tax Director

PwC Australia

Q2 2013

Global competition to attract “mobile capital” has driven tax concessions to lower taxes for foreign investors. These concessions, known as investment manager exemptions or regimes, are already offered by countries such as the US, UK, Hong Kong and Singapore. Australia is in the process of finalising its own investment manager regime with the aim to reduce tax uncertainty, and disincentives for certain widely held funds seeking to invest in Australia and use Australian intermediaries. Foreign funds that are unable to rely on a tax treaty with Australia have been potentially exposed to Australian tax on gains on Australian investments, and on foreign investments where the use of an Australian intermediary gave rise to a permanent establishment. This article focuses on the intended scope of the final element of the IMR.

Where are we at?
The IMR has been introduced in 3 tranches through a series of announcements, consultations, draft legislation and enacted law.  The final tranche (or Element 3) of the IMR was released as an exposure draft legislation on 4 April 2013. Broadly, these new rules will operate retrospectively from the 2012 income year. The legislation provides an exemption from Australian income tax available for certain widely held foreign funds on portfolio (and in certain cases some non-portfolio) investments, and limits the exemption to foreign funds resident in countries with which Australia has an effective exchange of information agreement.

Foreign funds covered - “IMR Foreign Fund”
Broadly, an entity will be an IMR Foreign Fund provided that at all times during an income year:

  • It is not an Australian resident;
  • It is not a resident trust estate;
  • It is a resident of an information exchange country;
  • The entity does not carry on or is not able to control a trading business in Australia;
  • It satisfies the widely held test;
  • It does not breach the closely held test; and
  • The entity gives the Commissioner of Taxation a statement within 3 months of the end of the income year.

Widely held test
An entity will be widely held if:

  • It is listed; or
  • It has at least 25 members; or
  • It is specified in the regulations (which have not been drafted to date).

Closely held test 
The closely held test is breached where 10 or fewer members have a participation interest in the entity of 50% or more in the fund, and introduces an additional requirement that a total participation interest of 10 % or more cannot be held by a single member (including those interests held by the single members' relatives).

Tracing through to the ultimate investors
In applying the widely held and closely held tests, funds are required to:

  • Trace through interposed entities to underlying individual investors and treat the individual as a member but not interposed entities.
  • Count an individual and his/her relatives as a single member.
  • Calculate the notional members of “Foreign widely held” entities (foreign superannuation funds, foreign life insurance companies, or an entity established by an exempt government agency for the purposes of funding pensions) by multiplying their participation interest in the relevant fund by 50.
  • Disregard a nominee but include the other entity which it holds the investment on behalf of.

Voting interests are no longer considered
It is not uncommon for a significant proportion of the voting rights in a fund to be retained by a small number of entities that are responsible for the management of the fund. Accordingly, direct participation interests that are voting interests are not counted to the extent that the widely held and closely held tests require the identification or calculation of a direct participation interest of one entity in another entity. 

Funds in the start up phase have concessional treatment 
The draft legislation includes a ‘start-up’ rule to complement the existing ‘wind-down’ rule.  Consistent with the existing ‘wind-down’ rule, the widely held and closely held tests will be deemed to be satisfied when a fund is in a defined start-up phase. Integrity rules are proposed to ensure that this start-up phase rule will only apply in respect of entities that ultimately become IMR foreign funds, and to ensure that the start-up and wind-down phase rules cannot be used consecutively.

Basis of taxation
Broadly, gains and returns granted exemption by the IMR are those arising from:

  • Portfolio interests (i.e., less than 10%) in qualifying investments.
  • Non-portfolio (i.e., 10% or more) interests in non-Australian investments where the return or gain is attributable to an Australian permanent establishment of the fund which arises only because the fund engaged an Australian intermediary.

The following are not qualifying investments under the draft legislation:

  • investments in “taxable Australian real property” (i.e. Australian real property or certain mining rights over Australian land) or “indirect Australian real property interests” (broadly, an interest of 10% or more in a land rich entity); or
  • generally, those that give the foreign fund the right to vote at a meeting of the Board of Directors or participate in making financial, operating or policy decisions in respect of the operation of the issuer of the investment

In determining whether the foreign fund has a portfolio or non-portfolio interest in another entity, the direct participation interests of the foreign fund and its associates are now considered.

Where to from here?
The IMR should draw the appropriate balance between encouraging foreign investment and preventing potential abuse. Accordingly, there are certain aspects of the rules which may warrant further consultation - for example:

  • The widely held and closely held tests. Does the 10% rule inappropriately disqualify funds with significant carried interest arrangements or profit allocations? Should there be relief for inadvertent breaches?
  • Exchange of information (EOI) requirement. Is the EOI requirement globally competitive? Should funds resident in Luxembourg and Hong Kong be excluded?
  • Foreign widely held entities.  Should this category be broadened? Entities such as endowments, foundations, charities and sovereign wealth funds have significant capital to invest.
  • Start up concession.  Will funds be in a position to access the start up concession? Should there be relief for funds which genuinely attempt to satisfy the tests, but due to commercial or market factors are unable to do so?

Foreign funds should reconfirm that they would still qualify as an IMR Foreign Fund and which investments would be protected. As the IMR has evolved through announcements, there has been a tendency to quickly conclude that funds and investments qualify for the concession. However, now that the rules are clearer, considerable care and diligence is needed to confirm this. The consequences of a surprise outcome make this critical.

ken.woo@au.pwc.com
grahame.roach@au.pwc.com
darren.mack@au.pwc.com
www.pwc.com.au
 

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