The 2009 Federal Budget contained good news with the announcement that the foreign investment fund (FIF) regime would be repealed. However, what would replace this regime has been subject to much speculation. With the release of draft legislation on 28 April 2010, we now have some appreciation of the scope of the new rules that will replace the FIF regime.
The Assistant Treasurer, at the time of last year's Budget stated:
"The FIF rules will be repealed and replaced with a specific narrowly defined anti-avoidance rule that applies to offshore accumulation or roll-up funds. The scope of this rule will be carefully monitored as part of reviewing the effectiveness of the reforms."
Draft legislation to repeal the FIF rules (Tax Laws Amendment (Foreign Source income Deferral) (No.1) Bill 2010) was released by the Assistant Treasurer in December 2009, but that draft did not contain any information as to the anti-avoidance rule that had been previously foreshadowed.
The anti-roll-up rule has now been revealed in the recently released Tax Laws Amendment (Foreign Source Income Deferral)(No.2) Bill 2010.
The anti-roll-up fund provisions are directed at Australian resident investors that have or acquire an interest in a foreign accumulation fund at the end of that investor's income year where:
- that investor obtains a tax deferral benefit for the year, and
- taking into account various specified matters, it is reasonable to conclude that the investor entered into the scheme (whether by their self or with others) for the sole or dominant purpose of that investor (or another entity) obtaining a tax deferral benefit.
Foreign Accumulation Funds Targeted
Central to the operation of the proposed new provisions is the concept of a "foreign accumulation fund". This is defined as an entity that, in an income year:
- was a foreign resident at any time in the year
- was not a controlled foreign corporation (CFC) for the year
- it is reasonably likely that returns on investments of the entity will be subject to a low level of risk. (There is a question as to whether the return on all investments need meet this requirement.), and
- the exception for distributing funds does not apply to the entity for the year (as to which, see below).
The exposure draft contains no guidance on the important issue as to what will be considered a "low level of risk" for these purposes although it is indicated that the explanatory memorandum to the Bill, when it is introduced into Parliament, will explain the effect and intent of this provision.
Distributing Funds Excluded
A fund will not be a foreign accumulation fund if it makes distributions of substantially all of the:
- realised profits and gains of the entity, and
- so much of the realised profits and gains as represents realised profits and gains of other entities in which the fund has a (direct or indirect) interest,
during the period starting at the beginning of the year and ending three months after the end of that year.
Exception for Complying Superannuation Funds
Just as there exists an exception from the FIF rules in respect of investments by complying superannuation funds, so too will such superannuation funds not be subject to the anti-roll-up fund rule.
What is a Tax Deferral Benefit?
This is specified in the exposure draft legislation as, in the income year in which the investor has an interest in the foreign accumulation fund, an amount equal to the difference between:
- the total profits and gains of the fund in the investor's income year reasonably attributable to the investor's interest in the fund, and
- the total of the distributions of profits and gains made to the investor on the interest during that income year.
The following are matters to be taken into account in determining whether the investor entered into the scheme for the sole or dominant purpose of obtaining a tax deferral benefit:
- the distribution pattern of the fund (including a consideration of the fund's stated policy concerning distributions as well as how the fund has previously made income or capital distributions)
- whether the tax that would have been paid by the investor, had the tax deferral benefit been included in the investor's assessable income for the year, is materially different to the amount of tax actually paid by the fund on the amount of the tax deferral benefit
- matters referred to in the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (such as the manner in which the scheme was carried out, the form and substance of the scheme, the change in financial position of the taxpayer as a result of the scheme), and
- any other relevant circumstances.
If the anti-roll-up rules apply, the Commissioner may make a determination that the whole or part of the tax deferral benefit is included in the assessable income of the investor for the income year. In doing so the Commissioner must have regard to:
- the extent to which the profits in the fund are realised
- the number of days in the income year the investor was an Australian resident, and
- any other matters the Commissioner considers relevant.
It will be relevant as to how the Commissioner seeks to identify investors with interests in foreign accumulation funds (or distributing funds) for the purposes of being able to make such determination.
Provision is made so that a taxpayer dissatisfied with a determination made in relation to the entity may object against that determination.
Submissions on the exposure draft legislation close on 26 May 2010. Please contact any of the partners listed on the right hand side should you have any enquiries concerning the exposure draft legislation or require assistance in making a submission concerning it.
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.