August 2015 Tax Alert Overview Foreign funds may qualify where: they make direct investments not attributable to an Australian permanent establishment; or if investments are made on the fund s behalf through an eligible independent Australian fund manager in a range of passive assets. Only foreign resident investors or foreign resident funds can benefit from the exemption. Australian investments are restricted to interests of less than 10% and must not be or relate to Australian real property interests. The changes create opportunities for foreign funds and also for Australian asset management intermediaries. Final Element of Investment Manager Regime resolves Australian tax uncertainties for foreign funds The final Element 3 of the Australian Investment Manager Regime (IMR) law (IMR3) will provide long sought after certainty for foreign investors investing into Australia and using the services of Australian financial services providers. We expect the concession will be of significant benefit to the Australian financial services industry. The rules, recently passed by Parliament, are intended to encourage portfolio (passive) investment made into or through Australia by foreign funds that have wide membership or use Australian fund managers, by removing certain impediments arising to certain foreign entities in relation to the operation of Australia s income tax laws. IMR3 completes the Australian IMR for foreign funds and is broader than the interim IMR elements, the IMR1 foreign fund tax amnesty and IMR2 permanent establishment foreign conduit income concessions that were enacted in 2012. The IMR3 concession also expands the IMR2 exemption for investments made through Australia, to apply for all foreign assets (restricted under the IMR2 to portfolio foreign assets). The rules operate prospectively for the 2015-16 and later income years, with optional retrospective application for the 2011-12 to 2014-15 income years, where only the limited IMR2 rules may have previously been available. The reforms arose from the 2009 Johnson Report (the Australia as a Financial Centre review). The reforms have benefited from consultation with EY and other stakeholders and have evolved since the original proposals. They now deliver a workable package of rules, including elements modelled on the long-standing UK investment manager exemption and extend to a broader range of entities investing in a range of passive assets. The new regime is important not just in resolving tax issues that were beginning to be addressed in earlier law changes. More notably, the IMR will allow foreign funds to reassess how they invest in the Australian market and how they use Australian investment advisors to invest in the region.
More details Under the IMR3 concession, certain foreign entities (including individuals, companies, beneficiaries of trusts and partners in partnerships) will be able to disregard the Australian income tax consequences that arise in respect of certain returns from or gains and losses on the disposal of certain investments. To qualify for IMR3 benefits, the IMR entity must be a foreign resident entity and not be carrying on or controlling a trading business in Australia. Foreign residents that might consider taking advantage of the rules include US and Cayman hedge funds, foreign pension funds and other foreign collective investment vehicles. Investing through a feeder fund-master fund structure and/or structuring through certain jurisdictions should no longer be an impediment to accessing the exemption. Broadly, there are two concessions contained in IMR3 in relation to investments (called IMR financial arrangements ): The direct investment concession, applicable where a widely-held foreign entity invests directly into Australia The indirect investment concession, applicable where a foreign entity engages an independent Australian fund manager to invest into, or through, Australia Specified types of foreign entities that are considered genuinely widely-held will automatically qualify as widely-held foreign entities for the purposes of the direct investment concession. Other foreign entities will need to satisfy one of two total participation interest requirements. The concession provides the foreign entity with a tax exemption for, or otherwise disregards, gains and losses that arise in respect of the disposal of an IMR financial arrangement that is not, or does not relate to, a taxable Australian real property interest or an indirect Australian real property interest. The IMR concession may be reduced in an indirect investment scenario where the independent Australian fund manager is entitled to more than 20% of the amounts derived by the fund that would otherwise be exempted by the IMR. Direct investment concession with improved widely held tests The direct investment concession allows the foreign entity to disregard the Australian income tax consequences that arise in respect of the gains and losses on the disposal of certain investments or derived from certain derivative financial arrangements held by an entity where: The entity is an IMR widely held entity for the whole year (or all of the part of the year it exists); The entity and its associates do not directly control 10% or more of an IMR financial arrangement issued by an Australian resident; The returns, gains or losses for the year are not attributable to a permanent establishment in Australia; The investment is a financial arrangement that is not a taxable Australian real property interest or an indirect Australian real property interest or relates to such an interest; and The IMR entity does not, during the year, carry on a trading business in Australia that relates directly or indirectly to the arrangement. A trading business does not include a business comprised exclusively of trading in financial instruments. The IMR3 substantially improves the current widely held tests used to determine if an entity is an IMR widely held entity, including the previous concentration test. After concerns raised that the original proposed IMR3 rules were overly restrictive and difficult to apply, the final tests incorporate a number of improvements. To be widely held the foreign entity must be: A foreign life insurance company or a specified white list entity as used in the managed investment trust (MIT) concession rule (for example, superannuation funds with at least 50 members and exempt foreign government pension funds); or An entity of a kind specified in regulations (none have issued yet); or Not closely held. The not closely held requirement is met where: No member has total participation interests in the entity of 20% or more; or There are not 5 or fewer members whose total participation interests in the entity are 50% or more. Total participation interests include both direct and indirect interests. The participation tests allow tracing interests through interposed entities to Tax Alert: Final Element of Investment Manager Regime resolves Australian tax uncertainties for foreign funds EY August 2015 Page 2
other entities (not just to individuals as originally drafted). Voting interests are disregarded. Direct or indirect entitlements to remuneration of an independent fund manager (and any entity connected with it), that is both subject to tax in Australia or under a foreign law and subject to tax in the year the entitlement is granted, are disregarded when determining the participation interests in the IMR entity. Start-up and wind down concessions deem the fund to be widely held where certain conditions are met. The IMR widely held entity status may continue where temporary circumstances outside the fund s control have caused a breach and it is fair and reasonable to treat the entity as widely held having regard to various matters, including for example whether timely action was taken to rectify those circumstances. Example 2 IMR3 Direct investment concession In this example, a widely-held Cayman Master Fund that is not an Australian resident for Australian tax purposes is managed outside Australia and has no presence in Australia. The Fund invests in Australian listed equities and non- Australian equities. The investments in Australian listed equities are portfolio (less than 10%) interests. The Cayman Master Fund can rely on the IMR concession to disregard the Australian income tax consequences which would otherwise arise in relation to the gains and losses on the disposal of the Australian equities if they are Australian sourced gains. Example 1 - An entity is a widely-held foreign entity In this illustrative example, assume a Feeder Fund owns all the interests in a Cayman Master Fund which invests in Australian equities. The Feeder Fund has 6 investors with equal interests (i.e. each investor has a 16.67% interest in the Feeder Fund and is not affiliated with one another). In order to determine whether the Cayman Master Fund is widely-held for the purposes of the direct investment concession it is necessary to trace through the Feeder Fund to determine the underlying investors. The Cayman Master Fund will be widely held as no entity (i.e. investor) has an interest of 20% or more in the Fund. This will be the case, notwithstanding that there are 5 investors whose total interests in the Fund exceed 50%. Indirect investment concession An alternative indirect investment concession applies, with some similarity to the UK investment manager exemption. This concession will exempt gains and losses from certain IMR financial arrangements where a foreign entity uses an independent Australian fund manager to make investments in Australian or foreign assets on its behalf. The activities of the Australian fund manager may or may not give rise to a permanent establishment of the foreign entity in Australia for Australian tax purposes. However, in either case, the IMR concession may be available if the IMR financial arrangement is Tax Alert: Final Element of Investment Manager Regime resolves Australian tax uncertainties for foreign funds EY August 2015 Page 3
made on the IMR entity s behalf by an independent Australian fund manager which is an Australian resident that carries out investment management activities for the IMR entity in the ordinary course of its business and whose remuneration for those activities is at arm s length. The manager must satisfy any one of three independence conditions to be eligible for the concession: The IMR entity (the fund) is an IMR widely held entity ; or 70% or less of the managing entity s income for the income year is from the IMR entity or an entity connected with the IMR entity; or Under a startup rule where it has been carrying out investment management activities for 18 months or less, the managing entity takes all reasonable steps to ensure that the proportion of its income for the income year will be reduced to 70% or less. Therefore for the purposes of the indirect investment concession, it is not necessary for the IMR entity to be widely-held, unlike for the direct investment concession, provided 70% or less of the managing entity s income for the income year is received from the foreign entity (or entities connected with it) or it is taking reasonable steps to achieve this. For Australian investments only, the entity and its associates must not directly control 10% or more of the IMR financial arrangement issued by an Australian resident. The IMR entity must not, during the year, carry on a trading business in Australia that relates directly or indirectly to the arrangement. A trading business does not include a business comprised exclusively of trading in financial instruments. Under the indirect investment concession, there may be consequences if the independent Australian fund manager and other connected entities have direct or indirect entitlements to receive more than 20% of the amounts derived by the fund that would otherwise be protected by the IMR: The concession is reduced by the full amount of the fund manager s entitlement. However a fund manager s entitlement to remuneration or performance fee arrangements are excluded from counting towards the 20% profits test if the entitlements are subject to tax in the year the right to the profits is received. There will also not be a reduction, despite breach of the 20% profits test, if: The fund manager s entitlement does not, on average, exceed the 20% profits test over a qualifying period (of up to 5 years); or Circumstances for the breach are outside the control of The IMR entity; or The independent Australian fund manager or a connected entity of the same; and the independent Australian fund manager is taking steps to address those circumstances. Example 3 - Australian fund manager In this example, a US LP engages an independent Australian fund manager to buy and sell Australian and foreign equities on its behalf. The independent Australian fund manager has no entitlement to the US LP s profits. The US LP may be able to rely on the IMR investment concession to disregard the Australian income tax consequences which may otherwise arise in relation to the gains and losses on the disposal of the Australian (portfolio) and foreign (portfolio or non portfolio) equities. Optional retrospective application An entity has the option to apply the IMR3 rules retrospectively for the 2011-12 to 2014-15 income years (otherwise only the previous limited IMR2 conduit foreign income exemption rules are available in these years). The retrospective application now applies for both the direct investment concession and indirect investment concession. Tax Alert: Final Element of Investment Manager Regime resolves Australian tax uncertainties for foreign funds EY August 2015 Page 4
An IMR entity can also choose to apply the new widely held tests to the 2010-11 and earlier income years, encompassing the first year of the IMR2 conduit foreign income exemption and the IMR1 foreign fund amnesty. The Australian Taxation Office does not need to be notified of either choice, however the entity will need to have appropriate business records that reflect the use of the new rules. The law does not provide any extensions to the time limits which apply for amending prior year assessments. Next steps Foreign funds wanting an exposure to Australian investments or broader Australian activities to manage global investments can now move forward with projects to upgrade their Australian activities using these sensible and workable rules. Considerations will include: Whether to apply the provisions to previous years to resolve any queries concerning prior year eligible investment activities Exploring the opportunities to refine how to invest in the region by making greater use of Australian managers and advisors. Entities not covered by the new definition of IMR widely held entity, for example some endowment funds, should plan their actions including whether to seek to be listed by regulation. Australian fund managers and other investment advisors can now consider how to market their services more actively to foreign fund managers (the services including managing investments in Australia, throughout the Asia-Pacific and globally). How EY can help EY has extensive experience in advising on the IMR rules and other managed fund tax matters and can assist you to: Understand the operation of the rules, obligations, and impact on your fund and its investors Confirm and document the application of the rules Assist with process, tax policy and governance documentation Confirm continued eligibility each year Tax Alert: Final Element of Investment Manager Regime resolves Australian tax uncertainties for foreign funds EY August 2015 Page 5
Contacts Sydney Antoinette Elias (Financial Services) Tel: +61 2 8295 6251 antoinette.elias@au.ey.com Michael Anderson (International) Tel: +61 2 8295 6991 michael.anderson@au.ey.com Australian Tax Desk, New York Andrew Nelson Tel: +1 212 773 5280 andrew.nelson@ey.com Melbourne Peter Janetzki (International) Tel: +61 3 8650 7525 peter.janetzki@au.ey.com Dale Judd (Financial Services) Tel: +61 3 9655 2769 dale.judd@au.ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY s Tax services Your business will prosper as you build it on a strong foundation and grow it in a sustainable way. At EY, we believe that managing your tax obligations responsibly and proactively can make a critical difference. Our global teams of talented people bring you technical knowledge, business experience and consistency, all built on our unwavering commitment to quality service wherever you are and whatever tax services you need. We create highly networked teams that can advise on planning, compliance and reporting and help you maintain constructive tax authority relationships wherever you operate. Our technical networks across the globe can work with you to reduce inefficiencies, mitigate risk and improve opportunity. Our 38,000 tax professionals, in more than 140 countries, are committed to giving you the quality, consistency and customization you need to support your tax function. For more information, please visit www.ey.com/au. 2015 Ernst & Young, Australia. All Rights Reserved. SCORE NO: AU00002347 This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk. Liability limited by a scheme approved under Professional Standards Legislation. Tax Alert: Final Element of Investment Manager Regime resolves Australian tax uncertainties for foreign funds EY August 2015 Page 6