Final Element of Investment Manager Regime Released

Industry are continuing to lobby for an investment manager regime more aligned to other jurisdictions after the narrow scope and compliance requirements of the proposed investment manager regime were highlighted in the latest exposure draft legislation.

The Government released exposure draft legislation on 4 April 2013 implementing the third (and final) element of the Investment Manager Regime (IMR) tax rules which are designed to encourage foreign funds to invest into Australia1. Following the introduction of the first and second elements of the IMR in 2012 and, once passed, the new rules will provide certainty to qualifying foreign funds that have invested in Australia.

The proposed  rules are intended to operate so that a foreign fund which qualifies as an ‘IMR foreign fund’ will be exempt from Australian tax on Australian sourced revenue and capital gains derived from passive portfolio investments. This exemption does not extend to Australian real property. Income in the form of dividends, interest and royalties will remain subject to withholding tax.

Foreign funds that do not satisfy the IMR requirements will be taxed under general Australian income tax rules.

Qualifying as an IMR Foreign Fund

A foreign fund will qualify as an ‘IMR foreign fund’ where:

  • the fund is not an Australian resident at any time during the income year
  • the fund does not carry on or control a trading business in Australia
  • the fund is a resident in an information exchange country. Australia has been actively negotiating information exchange treaties with a number of countries and these jurisdictions usefully include the Cayman Islands. However, there are a number of notable exceptions from this list including Hong Kong and Luxembourg. Funds resident in these excluded jurisdictions will not be able to benefit from the IMR concessions
  • the foreign fund must be ‘widely held’ and not ‘closely held’.

What is ‘widely held’?

A foreign fund will be ‘widely held’ if the shares or units in the fund are listed on an approved stock exchange or the fund has 25 or more notional members.

In determining whether a fund is widely held, new rules have been introduced which allow tracing through interposed entities making it easier for a foreign fund to meet this requirement.

When will a foreign fund be ‘closely held’?

A foreign fund will be closely held, and therefore not eligible to take advantage of the IMR concessions if:

  • an individual holds total participation interests in the fund of 10% or more
  • 10 or fewer members hold 50% or more.

For the purposes of applying both the ‘widely held’ and ‘closely held’ tests, special deeming rules apply in relation to certain types of investors (eg pension funds)

An interesting inclusion in the rules is a requirement that the foreign fund must give an annual information statement to the ATO in relation to its Australian activities. Notification must also be given to members. This requirement will add to the compliance burden for foreign funds looking to take advantage of the IMR regime.

Start ups

Depending on when a foreign fund is established, the foreign fund may have up to 18 months to satisfy the ‘widely held’ and ‘closely held’ tests. For example, a fund that was established in January 2013 will be treated as being an ‘IMR foreign fund’ for the year ended 30 June 2013 and 30 June 2014. This effectively gives the fund 18 months to satisfy the ‘widely held’ and ‘closely held’ tests. To the extent that the fund does not qualify as an ‘IMR foreign’ fund at all times during the income year in the year ending 30 June 2015, the prior concession will be retrospectively denied such that the fund will not be regarded as being an IMR foreign fund for the start-up phase.

In contrast, a fund that is established in the first half of the income year, for example, in November 2013, will be treated as an IMR foreign fund for the year ended 30 June 2013, effectively giving it 7 months to satisfy the widely held and closely held tests.

Some observations

The tests that must be satisfied in order to qualify as an ‘IMR foreign’ fund can be commercially difficult to satisfy. Our experience has been that only a small number of foreign funds are ultimately able to access the IMR tax concessions. In particular we note that given the investment manager participation rates in investment funds, it is not unusual for foreign funds to breach the ‘closely held’ test as a consequence of 10 (or fewer) investors holding more than a 40- 50% interest in the fund.

Submissions have been made to Treasury noting the uncommercial nature of the tests and have sought to increase the closely held limit to an amount which would be more reflective of industry practices and would allow more foreign funds to satisfy the ‘closely held’ test.

In order to ensure that foreign funds are able to access and benefit from the IMR regime, it will be necessary for the government to reassess and revise the eligibility criteria. Whether a revised exposure draft is issued by government or whether a Bill including the changes recommended in submissions is introduced into Parliament is uncertain.

1  At the time of press, it is not expected that the legislation will be passed before the government goes into caretaker mode. Industry associations are hopeful this will provide an opportunity to revisit some of the concerning aspects.

Greg Reinhardt

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Greg Reinhardt Partner

Greg is the Head of our Tax practice and is a recognised specialist in taxation law, advising clients across a range of industries in relation to income tax, GST, stamp duty and other state taxes.

Greg has particular expertise advising clients in the financial services sector, including managed investment funds, derivative markets, insolvency and restructuring.

He advises public and private companies, investment funds, foreign corporations and banks in respect of the tax implications of mergers and acquisitions, disposals, corporate restructures, property and infrastructure projects, financing and leasing arrangements, international taxation, financing transactions, property and infrastructure projects, managed investment schemes and other collective investment vehicles (CIVs) and tax due diligence as well as the establishment of new businesses in Australia.

Greg has published a number of articles on taxation law issues, particularly on the topic of making Australia a financial services hub, and is a regular speaker at conferences.

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Seema Mishra

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Seema Mishra Special Counsel

Seema specialises in taxation law and provides income tax, GST and stamp duty advice to clients in a range of industries.

Seema is a Special Counsel in our Taxation practice.

She advises clients in the financial services, including funds management, industry, along with large domestic and multi-national corporations in relation to a range of issues, including the tax implications of mergers and acquisitions, disposals, restructures, international taxation, as well as banking, restructuring and insolvency matters and the establishment of new business in Australia.

Seema also advises clients in the not-for-profit sector on structuring issues, including the establishment of charitable funds.

Seema's experience has included both domestic and international secondments. She has authored a number of articles and publications, and is a contributor to the Australian Tax Handbook (published by Thomson Reuters).

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