In a positive development for the Australian funds management industry, the legislation for the first two elements of the IMR was passed by the Senate late last week and is now awaiting Royal Assent.
According to the Minister for Financial Services and Superannuation, Bill Shorten:
Moore Stephens has followed the progress of the IMR since it was the key recommendation of the November 2009 report by the Australian Financial Centre Forum (commonly known as the 'Johnson report'). We welcome this legislation as it finally provides clarity and certainty for foreign managed funds and their investors on the Australian income tax implications of certain foreign fund income (both retrospectively and into the future) while also providing opportunities for Australian fund managers to increase their funds under management.
This measure is, in the words of Mr Shorten, "in line with the government's objective to secure Australia's position as a thriving and robust financial services centre". We encourage the Federal Government to continue taking steps towards achieving this objective because it is an objective that has been called into question in recent times with the doubling of the withholding tax rate on Managed Investment Trusts (MIT's) and the abolition of the 50% Capital Gains Tax (CGT) concession for non-residents.
The 'conduit Income' measure or 'Element 2' of the IMR
Under the 'conduit foreign income' rules introduced in 2005, certain foreign income of a company paid directly, or through one or more other Australian entities, to foreign owners does not attract any additional Australian tax. Though these rules provide relief from Australian income taxation on conduit income received through an Australian company, they did not address the Australian income tax treatment of conduit income received through a managed fund.
Applying from 1 July 2010 onwards, this measure excludes from Australian income tax certain types of investment income and gains of 'widely held' foreign funds that would be subject to Australian income tax because the fund is treated as having a 'permanent establishment' (PE) in Australia solely from the use of an Australian based agent, manager or service provider. Previously, the engagement by a foreign fund of the services of an Australian intermediary to exercise a general authority to negotiate and conclude contracts on its behalf arguably meant that it had a PE in Australia. Accordingly, the fund could be subject to Australian income tax on any income and gains attributable to that PE (as it would have an Australian source). This had the potential to subject income and gains (that would be otherwise exempt) to Australian income tax.
An 'IMR foreign fund' can be a corporate tax entity, a trust or a partnership but must satisfy the following criteria:
- Not a resident of Australia at any time during the income year;
- Not a resident trust estate at any time during the income year;
- Does not carry on a trading business in Australia at any time during the income year;
- 'Widely held' at all times during the income year; and
- Does not breach the 'concentration test' at any time during the income year
The 'Fin 48' measure or 'Element 1' of the IMR
As noted in the Moore Tax News article published on 12 March 2012 (when the second exposure draft legislation for the IMR was released for public consultation):
The certainty provided for prior years was that where a foreign managed fund had not lodged an income tax return for the 2009-10 or prior income years in relation to certain investment income of the fund, the Australian Taxation Office (ATO) would not be permitted to raise an assessment in respect of that income, except where the fund lodges an income tax return disclosing such income. The Government announced in the 2011-12 Federal Budget that this measure would be extended to the 2011 income year.
To access this measure, an 'IMR foreign fund' that is a corporate tax entity must:
- Not have lodged an income tax return in relation to the 2010-2011 or any earlier income year;
- Not have had, before 18 December 2010, an assessment made of tax payable for any income year; and
- Not have been notified before 18 Dec 2010 of an audit or compliance review
For IMR foreign funds that are flow through vehicles (such as a trust or a partnership), the following conditions must be met:
- The trust and beneficiary or the partnership and partner must not have lodged an income tax return in relation to the 2010-2011 or any earlier income year;
- The beneficiary or partner must not have had, before 18 December 2010, an assessment made of tax payable for any income year; and
- The trust or partnership must not have been notified before 18 December 2010 of an audit or compliance review
'Element 3' of the IMR (not included in this legislation)
Foreign funds will be exempt from Australian income tax on all Australian sourced income, gains or losses from portfolio investments (i.e. investments where less than 10% is held) and certain financial arrangements.
As noted in the Moore Tax News article published on 21 December 2011 (when the Government released their response to this element in the Board of Taxation's report):
- Gains on disposal of portfolio interests in listed equities and certain financial arrangements; and
- Gains on disposal of portfolio interests in unlisted equities where the investee entity in question is not land-rich.
Returns from portfolio investments will remain subject to dividend, interest, royalty withholding taxes (at a rate of 10-15%) and managed investment trust withholding tax (at 7.5% at the date of that article, now proposed to increase to 15%). Furthermore, gains on disposal of portfolio investments in unlisted land-rich entities will remain subject to tax if the investment is held on revenue account. It is noted that such disposals would not be taxed if the investment is held on capital account.
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