Australia: Two New Fund Vehicles

On 3 May 2016, Treasurer Scott Morrison announced the Australian federal budget. Among the tax measures announced was the announcement that two new types of fund vehicle are to be created – a corporate collective investment vehicle (CIV) and a limited partnership CIV. These new legal forms are intended to increase the international competitiveness of the Australian asset management industry. But is it enough?

Background

The announcement of the new CIVs in the Australian budget can be indirectly traced back to the Johnson Report which was published in November 2009 1  and provided the foundation for three subsequent reports on the taxation aspects of the Australian asset management industry and included an entire report dedicated to the taxation of collective investment vehicles and specifically addressed the need for legislative change in this regard. 2

The Johnson Report acknowledged that a fund vehicle needs to be a conduit for tax purposes with limited investor liability otherwise it simply doesn't work as a vehicle for collective investments. 3  Unit trusts are the only vehicles which can be established in Australia matching these requirements. General and tax law partnerships are conduits but carry unlimited liability for investors. Limited partnerships are generally taxed as companies in Australia and the specific concession applying to Venture Capital Limited Partnerships (VCLPs), which are tax transparent, remains tightly controlled under the legislation,4 leaving the unit trust as the only option where an Australian collective vehicle is required.

The Johnson Report noted that unit trusts are not a commonly used vehicle for international investing, particularly given the understandable lack of familiarity with a 'trust' by investors from civil law jurisdictions. Unit trusts are very common – and work very well – for funds offered to Australian investors. These plug into the existing structures of superannuation and insurance company investors, and for property funds there is often no better suited structure.

Subsequent to the Johnson Report, the Board of Taxation concluded that, in order to increase its international competitiveness as an asset management hub, Australia needed a new type of CIV which offering tax transparency and investor protection.5  The Board of Taxation report refers to the corporate CIV and the partnership CIV separately although functionally they are clearly intended to meet the same requirements.

The VCLP regime

It is worth noting that Australia has tried to introduce unique conduit vehicles before. The VCLP regime was introduced in 2002 and was designed to offer the very taxation conduit function that the partnership CIV and the corporate CIV will provide. The introduction of this regime required both Federal legislation amendments to the Australian Income Tax acts and amendments to State and Territory partnership law in order to realise this unique entity.6

The adoption rate for the VCLP regime, and the genus of limited partnerships which this encompasses, has been disappointing. This may be partially due to the strict approval criteria and the ongoing regulatory requirements which must be met to comply with the regime.7  Perhaps, more fundamentally, it could be argued that this regime was designed around a problem facing the Australian funds industry that was more theoretical than real. It is still not clear in what way a VCLP based structure is a superior vehicle for Australian venture capital investing than the combination of an offshore limited partnership and corporate subfunds in tax treaty jurisdictions. Given that non-residents are only subject to Australian CGT on gains made in relation to taxable Australian real property, it may not even be necessary to structure transactions through a treaty jurisdiction.8

Funds management hub vs funds domicile

It is important to be specific when describing the desire for a jurisdiction to become a hub for the asset management industry. Is the objective to increase fund formations in that jurisdiction using its local law or is the intention to attract the funds management function? The economic spin offs are quite different. The asset management function is typically seen as the higher value added function, with the greater potential to utilise other parts of the domestic financial services sector. This is compared to the fund administration and ongoing compliance functions which are more typically undertaken in a domiciled fund jurisdiction.

Clearly the two don't need to go together. For many years now, the Cayman Islands exempted limited partnerships have been a commonly used venture capital or private equity fund vehicle. These are almost a default choice for US managers, and are often distributed to US based investors by managers who do not have any operational presence in the Cayman Islands. Similarly Irish and Luxembourg funds are very common structures for both traditional and alternative funds. These can easily be managed by a UK fund manager without a presence in continental Europe.

The analysis of the Australian funds regime needs to specifically identify what Australia is seeking to attract. If, indeed, it is the fund management function, then arguably the greater emphasis of the legislature should be upon the Australian taxation of offshore funds and the regulatory and tax considerations of managers wishing to establish an Australian presence.

Personal taxation matters

A very important part of attracting fund managers to a particular jurisdiction is the personal taxation of the investment professionals themselves. If Australia has any aspiration of becoming a funds management hub, this should be a key consideration.

The UK has been hugely successful in attracting highly remunerated foreign investment professionals with features of their tax system such as the remittance basis of taxation for so-called 'resident non-doms'. This, combined with a settled position on the treatment of carried interest, meant that there were tried and tested ways to tax efficiently structure the remuneration and returns of an investment professional based in the UK. Although the possible structuring options have recently been reduced in the wake of changes announced during 2015. Despite this legislative incursion, carried interest will still only be taxable at the CGT rate of 28%, and not at the higher marginal tax rates which apply to employment income in the UK.

Like the UK, the US has for a long time had a settled position on the treatment of carried interest as long term capital gains which significantly reduces the effective rate of taxation on this slice of an investment professional's compensation. For how much longer this lasts is anyone's guess. The most recent attempt to address this 'loophole' are the proposals announced by President Obama in February of this year. For other jurisdictions, it is not the special treatment of carried interest but the fundamentals of the tax system which have inherent appeal. The rate of income tax payable in Hong Kong is 15% while the maximum rate of tax in Singapore for an individual is 22%. Neither of these jurisdictions have clarified the taxation of carried interest and there is currently a range of approaches which are adopted. This includes the use of traditional offshore structures at one end of the spectrum and the payment of performance bonuses which pass through as employment income at the other.

The position of Australian tax resident investment professionals is comparatively grim. The carried interest entitlement of an investment manager in a VCLP is treated as a capital gain and thus eligible for the CGT discount of 50%. Given the way that the VCLP rules have been shaped, and the limited number of VCLPs which have actually been formed, this outcome is not commonplace. Offshore carry structures can be used but once a distribution is made back to Australia, full rates of individual taxation applies. Decanting the funds arising from an offshore carry structure into a separate controlled offshore vehicle gives rise to a host of attribution consequences with the result that it is generally not a viable option.

Advantages of the corporate CIV and the partnership CIV

If we are to have two new entity types dotting the Australian funds landscape, then hopefully these will offer the best-in-class features as compared to other jurisdictions. Many traditional domiciled fund jurisdictions enable the creation of companies with segregated cells, in which assets can be internally separated within a single fund entity. This structure, in theory, avoids the need for separate fund SPVs for each investment which is particularly common in Private Equity funds. The UK has the open-ended investment company and there are equivalent vehicles available in Mauritius and Luxembourg. A similar vehicle is under consideration for Singapore and Hong Kong.

Perhaps a trickier ask for any corporate CIV is that is it able to benefit from Australia's network of double tax treaties. The ability of CIVs to obtain treaty benefits is now part of the BEPs debate on limitation of benefits, and it remains to be seen how sustainable it is for some jurisdictions to continue to offer treaty benefits for resident corporate funds which are themselves not subject to tax. The ability of a corporate CIV to claim treaty benefits was mentioned in passing by the Board of Taxation in their report9 but it is now potentially more contentious.

While treaty benefits would be a nice to have for a corporate CIV, this is more aligned with the aspiration for Australian domiciled funds to be used as a regional platform than the reality of Australia as an investee jurisdiction. At the moment, investors simply don't pool into Australian funds and it would seem bold to assert that a new fund vehicle is going to change that. Even for countries such as Singapore, which has been successful in attracting managers to manage offshore funds and certain resident funds, the adoption rate for master pooling vehicles established in Singapore (such as the Singapore limited partnership) is comparatively low. Investor familiarity is a key consideration as this avoids fund raising being more complicated than it has to be. A manager needs to demonstrate a very compelling reason to depart from tried and tested structures. This is particularly so for vehicles established in jurisdictions where the applicable law has not been subjected to the scrutiny of the legislature.

Arguably the most useful application of a corporate CIV which is able to access Australia's tax treaty network is to act as a subfund sitting underneath a more traditional master pooling vehicle. It is highly desirable for the implementing legislation to recognise this, rather than automatically assuming that investor funds will pool directly into a corporate CIV or partnership CIV.

Conclusion

The pending introduction of a corporate CIV and partnership CIV in Australia is worth noting, though there is reason to approach this with guarded optimism at best. A real game changer for the Australian funds offering would be a clearly articulated concession for the taxation of carried interest or something else to entice investment managers to use Australia as a hub. With the Government coffers dwindling and the zeitgeist of the big end of town paying more tax, this is unfortunately far from a likely outcome.

Footnotes

1. Report of the Australian Financial Centre Forum, Australia as a financial centre: Building on our strengths, 17 November 2009.

2. The Board of Taxation, Review of Tax Arrangements Applying to Collective Investment Vehicles, December 2011.

3. Above n1, at page 62.

4. Refer Subdivision 118-F of the ITAA97. For simplicity, reference is made in this article to only VCLPs and not to the related vehicles: VCMPs, ESVCLPs, and AFOFs.

5. Above n2 at page 42.

6. Changes to State and Territory partnership law were required to give the VCLP legal personality, which is not a feature of limited partnerships.

7. These have been relaxed somewhat by amendments contained in the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016.

8. The risk of this approach is however that gains may be taxable as Australian sourced ordinary income per TD 2010/21

9. Above n2 at page 41.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.