Background
1.1 On 11 May 2010, the then Assistant Treasurer and the then Minister for Financial Services, Superannuation and Corporate Law announced1 the Government’s response to the Report of the Australian Financial Centre Forum Australia as a financial centre: Building on our strengths (the Johnson Report). As part of its response, the Government indicated it had provided in-principle or direct support for nearly all of the 19 recommendations made in the Johnson report. It stated that the recommendations were important reforms that would enhance Australia’s status as a financial services centre and help expand exports and imports of financial services.
1.2 These reforms would build on Australia’s growing status as a leading regional financial centre and support growth and jobs in the Australian managed funds industry. Australia’s managed funds stood at around $1.8 trillion at the end of 2010, equal to around 133 per cent of nominal GDP. With one of the largest pools of funds under management in the world, Australia would be well placed to build up its position as a leading regional financial centre.
1.3 On 11 May 2010, the then Assistant Treasurer and the then Minister for Financial Services, Superannuation and Corporate Law made a separate announcement2 that indicated it had given in principle support to the Johnson report’s recommendation for the introduction of an Investment Manager Regime (IMR) of wide application. The announcement stated that the Government would start consultation on the design of an IMR that will reform and expand Australia’s managed funds industry by removing impediments to international investment.
1.4 The Government noted that there is considerable merit in developing a regime that provides a set of comprehensive and clear cross-border taxation rules for a range of entities in the financial sector. It also noted that there are a number of design issues relating to an IMR that will need to be considered, including:
- the scope of the regime;
- aligning the IMR with broader arrangements for taxing collective investment vehicles (CIVs); and
- balancing the objectives of providing certainty and enhancing the competitiveness of our financial sector with maintaining the integrity of the tax system.
1.5 The Government announced a two–stage process to develop the key features of an IMR. As the first stage, the Government released a consultation paper focussed on the taxation of the conduit income of foreign managed funds. As the second stage, the Government noted that other design issues relating to an IMR, including the taxation of non-resident investments in domestic assets, would be referred to the Board as part of a broader CIV review, whose detailed terms of reference were to be announced.
1.6 With respect to the first stage, the Government noted that an important element of the IMR would be to ensure that non-residents investing in foreign assets would not face further Australian tax on their investments when using Australian fund managers (referred to as conduit relief). In this respect, it noted that important reforms could be made to the treatment of conduit income of managed funds in advance of the comprehensive CIV review.
1.7 On 12 July 2010 the then Assistant Treasurer and the then Minister for Financial Services, Superannuation and Corporate Law announced3 the next stage in the development of an IMR by requesting that the Board consider the design of an IMR as part of its review of CIVs, for which the corresponding terms of reference were announced in a separate press release4.
1.8 The Government noted that the Board will report on the design of a comprehensive IMR, which will provide a set of clear and comprehensive rules on the taxation of certain non-resident investments into Australian and offshore assets. It also noted that Treasury was engaged in consultations with stakeholders and that it had been asked to consider and report by 31 October 2010, in consultation with the Board, on the scope for early delivery of an IMR.
1.9 The terms of reference for the CIV review, which include the IMR component, are reproduced in the next section.
Terms of reference
1.10 The Board of Taxation was asked to examine and report on the tax treatment of CIVs, having regard to the Managed Investment Trust (MIT) tax framework and including whether a broader range of tax flow-through CIVs (such as corporate CIVs) should be permitted.
1.11 The review should have regard to the following broad principles:
- CIVs in this context are widely held investment vehicles (with typically long term portfolio investors) that undertake primarily passive investment activities, consistent with the eligible investment rules in Division 6C of the ITAA 1936.
- The tax treatment of a CIV should be determined by the nature of its investment activities rather than the structure of the entity through which the funds are pooled.
- The tax outcomes for investors in a CIV should be broadly consistent with the tax outcomes of direct investment, other than flow through of losses (subject to limited special rules for their utilisation).
1.12 As part of the review, the Board was asked to examine the effectiveness of the special tax treatment accorded under the Venture Capital Limited Partnership regime in a way that recognises its policy objectives.
1.13 In making its recommendations, the Board should consider:
- the nature and extent of, and the reasons for, any impediments to investment into Australia by foreign investors through CIVs;
- the benefits of extending tax flow-through treatment for CIVs, including the degree to which a non-trust CIV would enhance industry’s ability to attract foreign funds under management in Australia;
- whether there are critical design features that would improve certainty and simplicity and enable better harmonisation, consistency and coherence across the various CIV regimes, including by rationalisation of the regimes where possible.
1.14 The Board was also asked to examine and report on the design of an IMR for investments by foreign residents managed in Australia. The Government had asked the Treasury to consult on issues relating to the taxation of conduit income of managed funds as recommended in Australia’s Future Tax System review (Assistant Treasurer’s Media Release No 92 of 11 May 2010). Having regard to the likely overlap between certain issues in the Treasury consultations and the IMR, the Treasury was requested to regularly inform the Board of the progress and outcomes of its consultations.
1.15 The recommendations should seek to enhance Australia’s status as a leading regional financial centre and support growth and employment in the Australian managed funds industry while maintaining the integrity of the tax system and revenue neutral or near revenue neutral outcomes.
1.16 The Board was asked to report to the Assistant Treasurer by 31 December 2011.
Recent developments
1.17 As part of Treasury’s consultations on the scope for early delivery of an IMR, stakeholders advised that the managed funds industry was experiencing considerable difficulties due to Financial Accounting Standards Board Interpretation Number 48 Accounting for Uncertainty in Income Taxes (FIN 48). This is now codified into the United States accounting standard ASC 740-10.
1.18 Entities subject to FIN 48 are required to identify any uncertain tax positions and make an assessment as to whether, on the balance of probabilities, that position is sustainable having regard to its technical merits. If the technical merits of the position indicate that it is more likely than not that tax is payable, entities are required to make provision for that tax liability. Therefore, entities required to prepare consolidated financial statements in the United States would need to raise tax provisions for uncertain tax positions taken by them or their subsidiaries in both the United States and any other country. FIN 48 initially applied only to public companies. However, since 31 December 2009, the accounting standard has also applied to private entities including managed funds.
1.19 As a result of the FIN 48 provisioning requirements, and given the perceived uncertainty in the Australian tax treatment of gains made by foreign funds disposing of Australian investments, stakeholders advised that some foreign funds active in the Australian market had started making provisions for uncertain Australian tax positions. Furthermore, these provisions were affecting the fund’s net asset value and unit redemption price (where the fund was not exchange traded).
The Government’s announcements of elements of an IMR for foreign managed funds
The FIN 48 measure
1.20 On 17 December 2010 the Government announced5 that it would introduce income tax amendments to restrict the ability of the Commissioner of Taxation to raise assessments against certain foreign managed funds in respect of relevant investment income (broadly, portfolio investment income and certain derivatives) for the 2009-10 and prior income years.
1.21 This announcement was intended to help address industry concerns in relation to FIN 48. Specifically, by restricting the ability of the Commissioner to raise assessments on foreign managed funds for gains made on certain portfolio investments and derivatives in Australia in prior income years, foreign managed funds covered by the announcement would not need to raise tax provisions under FIN 48 for uncertain tax positions taken in these income years in relation to these gains.
Investment manager regime – the conduit income measure
1.22 On 19 January 2011 the Government announced6 that it would introduce amendments to exempt income from relevant investments of a foreign managed fund where the income would be taxable only due to the fund being taken to have a ‘permanent establishment’ in Australia. This exemption is designed to ensure that no tax is imposed on certain gains of a fund by virtue of it engaging domestic investment advisers when the fund has no real presence in Australia. In particular, any gains made by a foreign fund investing in foreign assets through the use of an Australian investment adviser (conduit income) would not be subject to Australian tax.
1.23 The Government noted that the change will align Australia’s taxing rules with international practice, such as the United Kingdom’s Investment Manager Exemption, and that the Board will continue to progress other aspects of the Johnson IMR recommendation.
Investment Manager Regime – interim arrangements
1.24 On 10 May 2011, the Government announced7 that it would extend its FIN 48 measure to apply to the 2010-11 income year. In addition, the Assistant Treasurer announced that to address the ongoing treatment of these investments, he had requested that the Board bring forward its report on an IMR as it relates to foreign managed funds to the end of the third quarter of 2011.
The Board’s review of the design of an IMR for foreign managed funds
1.25 In view of the Government’s announcements of certain elements of an IMR, the Board’s current review of an IMR for foreign managed funds is particularly centred on the appropriate ongoing tax treatment of investments by foreign managed funds (that is, for the 2011-12 and future income years). This includes:
- defining foreign managed funds;
- defining the type of investments made by foreign managed funds that should be covered by an IMR; and
- considering the potential integrity measures that might be needed to balance the objectives of providing certainty and enhancing the competitiveness of our financial sector with maintaining the integrity of the tax system.
1.26 Issues concerning the scope of an IMR for entities which are not managed funds are not covered in this report.
1.27 The Board notes that in the international context, the term IMR (or other similar terms) is often used to refer to a system of rules which cover the tax treatment of domestic investment managers who act on behalf of foreign investors. However, for the purposes of this report, the term IMR encompasses the tax treatment of investments made by foreign managed funds in the case where they engage an Australian investment manager (or other Australian intermediary) as well as the case where the foreign managed funds make investments directly without using an Australian investment manager. This accords with the scope of the Board’s current review of an IMR for foreign managed funds.
Review processes
1.28 In developing the recommendations in this report, the Board undertook wide consultation, including:
- preliminary consultations with a range of stakeholders;
- release of a discussion paper on the broader CIV review issues in December 2010 to invite and facilitate submissions; and
- targeted consultation meetings with a number of key stakeholders.
Submissions
1.29 The Board received 35 written submissions in response to its discussion paper, 16 of which provided input in relation to the IMR component of the review.
Board’s report
1.30 The Board has considered the issues raised by stakeholders in their submissions and at the consultation meetings, and the views of the above named members of the expert panel. However, the Board’s recommendations reflect its independent judgment.