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What do you need to do?Review the issues and suggested proposals for reform and consider their impact going forward.
Clint Harding
Senior Associate
Andrew Clements
Partner
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Betsy-Ann Howe
Partner
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Sydney
John Edstein
Betsy-Ann Howe
Michelle Levy
Richard Snowden
In addition to the changes dealing with superannuation, the Federal Budget announcements contained significant changes, which are likely to have a widespread impact on the operation of managed funds in Australia and the global product which may be offered in Australia.
This alert deals with some of the key measures. The entrenched capital gains tax status of certain funds and the changes to the rules dealing with investors investing in global products have the potential to greatly expand the range of investments that managers may effectively offer their clients in Australia.
Managed investment trusts - election to allow capital gains tax to be the primary code for disposals
These changes will allow Australian managed investment trusts (MITs), except those that are taxed as companies, to make an irrevocable election to apply the capital gains tax (CGT) regime as the primary code for taxing certain disposals of assets, with effect from the 2008-09 income year.
This measure implements the interim advice of the Board of Taxation review of taxation of MITs. It will ensure that the taxation treatment of disposals of assets (primarily shares in a company, units in a unit trust and real property investments) by MITs is consistent with the taxation treatment of disposals of similar investments by complying superannuation funds, subject to appropriate integrity rules including that the investments meet the eligible investment business rules in Division 6C of the Income Tax Assessment Act 1936.
The new measures should provide those fund which can take advantage of the new regime with much greater certainty as to their tax status.
MITs that can elect into the regime will be required to make an irrevocable election to apply the CGT regime to all disposals of eligible investments in the first income year that commences on, or after, the 2008-09 income year. The issue of whether gains and losses on disposal of investments by funds should be treated as being on capital or revenue account has been a vexed issue for the industry as a whole.
The proposed changes may not assist all funds - the proposals are limited to MITs. The announcement does not provide guidance on which funds will be regarded as MITs for this purpose. MIT was a new category of fund created by the recently enacted changes to the withholding tax regime for managed funds. If the new measures are limited to MITs under the withholding tax regime, the Government will narrow the application of the new rules. As a result, many other funds may not benefit from the certainty that the elective regime otherwise provides.
The details surrounding the making of the election will also impact upon MITs seeking to rely on the new rules. For example, it is not clear how the election regime will operate. Will it require all eligible MITs to make the election in the current income year or lose the entitlement going forward? If this is the case, there are likely to be issues around distributions to be made by 30 June, particularly in an environment such as we have currently, where losses rather than gains are likely to be the norm. Characterisation of interim distributions will also require some consideration.
Reform of Australia’s attribution regime
Following the Board of Taxation's recent review of Australia’s anti-tax-deferral (attribution) regimes, the Government has announced some sweeping reforms to have effect for income years beginning on or after Royal Assent to the legislation is received.
The objectives of the new measures are:
- to reduce the complexity and compliance costs associated with the anti-tax-deferral regimes including whether the current regimes can be collapsed into a single regime, and
- to examine whether the anti-tax-deferral regimes strike an appropriate balance between effectively countering tax deferral and unnecessarily inhibiting Australians from competing in the global economy.
The Government has announced that it will implement all but one of the Board's recommendations and in doing so will:
- repeal the foreign investment fund (FIF) provisions and replace them with a specific narrowly defined anti-avoidance rule
- modernise the controlled foreign company (CFC) provisions and rewrite them into the Income Tax Assessment Act 1997
- repeal the deemed present entitlement rules, and
- amend the transferor trust rules to enhance their effectiveness and improve their integrity.
Repeal of FIF rules
The Australian foreign investment fund (FIF) provisions previously posed a significant obstacle to managers (Australian or foreign) in offering foreign funds into Australia.
Previously, the FIF rules taxed investors on an accruals basis on their investment in certain foreign resident entities which are offered to global investors. These have included funds resident in the Ireland, Luxembourg or Cayman Islands. Investors that were subject to the FIF regime on their investments in those offshore funds suffered a number of adverse tax consequences as a result of FIF taxation. These included an acceleration in the taxing points, compliance costs in determining under a number of different methods the amount they were assessed under the FIF regime. It also included losing the benefit of capital gains treatment on gains made on the ultimate disposal of their investments. It resulted in many managers “bed and breakfasting” their investments to deal the administrative burden of the FIF regime.
The repeal of the FIF regime should make the offering of foreign funds to Australian investors more attractive by removing these adverse Australian tax consequences for Australian investors in these foreign funds, provided they are not caught by the specific anti-avoidance rule that is to be introduced.
Even for those funds which remain within the scope of the new rules, it may be a significant advantage. In this context, it will be important that the administration associated with the new regime is not so onerous that managers need to continue to bed and breakfast investments to deal with the ongoing administrative burden.
The Treasury has indicated that the repeal of the FIF regime will be subject to a specific, narrowly defined anti-avoidance rule that applies to offshore “accumulation” or “roll up” funds.
Draft legislation is not yet available and very little guidance has been provided to date regarding which “accumulation” or “roll up” funds will be the subject of this anti-avoidance rule, and how this anti-avoidance rule will operate. It is possible that certain foreign funds may be subject to this rule and not obtain the benefit of exclusion from the FIF regime.
The Board of Taxation’s report to the Assistant Treasurer and Minister for Competition Policy and Consumer Affairs, dated September 2008, suggested that an “offshore accumulation fund” may be defined as a non-resident fund that does not materially distribute most of its profits and gains, and where the income and gains of the fund are subject to low levels of risk.
It will be important to monitor any announcements regarding the scope of the proposed specific anti-avoidance rule. It is important that the rule, when introduced, provides investors with the necessary level of certainty regarding the operation of the provisions. This certainty will be critical if the changes are to be effective.
Rewrite of the CFC rules
The rewriting of the CFC rules may have an impact on foreign funds to the extent that Australian resident investors make a significant investment in those foreign funds (e.g. an investment of 10 per cent or more) that is subject to the CFC regime.
Very broadly, the CFC rules taxed on an accruals basis the investment by Australian residents that held a 10 per cent or more interest in certain foreign resident companies (including many foreign funds which are body corporates or limited partnerships) that satisfied one of a number of Australian control tests. In particular, Australian investors subject to the CFC regime would be assessed each year on their share of the income of the relevant foreign resident entity calculated in accordance with Australian tax principles as modified under the CFC regime.
It is not certain the scope, if any, of the substantive changes to the CFC rules that will result in the rewrite of the CFC rules. It is hoped that the rewrite of these rules will limit the scope of the control tests that are the gateway to the application of the CFC rules, and significant simplify the application of the rules which are currently highly complex.
The announcements also indicate that the amendments to the CFC provisions will contain updated definitions of what constitutes active and passive income and the base company income rules will be removed. The existing exemptions within the CFC rules will be retained, including the listed country and Australian financial institution subsidiary exemptions, and additional exemptions introduced for complying superannuation entities. A choice of attribution methods will apply (the branch equivalent calculation, market value, and deemed rate of return methods) where taxpayers are required to include attributable income in their assessable income.
For more information please contact the Mallesons Tax Team.