Following extensive consultation between government and industry, the final Investment Manager Regime (IMR) rules have now been legislated. The rules took effect from 1 July 2015, with an elective retrospective application date of 1 July 2011. These rules replace the existing IMR provisions contained in subdivision 842-I of the Income Tax Assessment Act 1997.
Australia has enacted the IMR to remove tax impediments that might prevent foreign investment funds investing in domestic markets or engaging Australian fund managers to manage funds on their behalf.
These measures are designed to improve liquidity in the Australian market and make foreign capital more readily available to Australian businesses. The rules are also aimed at ensuring that Australian fund managers can provide management services to foreign funds without creating Australian tax exposure for the ultimate investors.
The Australian IMR tax rules, modelled on the UK Investment Manager Exemption, apply to qualifying foreign funds that are investing either in, or through, Australia.
Access to tax concessions
The concessions apply to “direct” and “indirect” investments by an “IMR entity” in relation an “IMR financial arrangement”.
An entity is an IMR entity for an income year if it is not an Australian resident or trust at all times during the income year.
An IMR financial arrangement is a financial arrangement (such as shares, debts and derivative financial arrangements) unless it is, or relates to, Australian real property or an indirect Australian real property interest (such as units in a property trust).
Where the conditions of either category of investment is satisfied, the same tax concessions will apply.
In order to access the direct investment concession, the IMR entity must satisfy the following conditions:
- the IMR entity must be an “IMR widely held entity” during the whole of the year;
- the interest in the issuer of, or counterparty to, the IMR financial arrangement must be a portfolio interest (i.e. less than 10%) during the whole of the year;
- none of the returns, gains or losses for the year from the arrangement are attributable to a permanent establishment of the foreign entity; and
- the IMR entity does not, during the year, carry on a trading business in Australia.
An IMR entity is “widely held” if no member of the entity has a “total participation interest” in the entity of 20% or more or there are not five or fewer members who have a combined participation interest in the entity of at least 50%. Note, these tests are applied in the alternatives and only one needs to be passed.
Certain entities, such as foreign life insurance companies and pension funds are deemed to be widely held. Where such entities hold a majority interest in a foreign fund, the fund would qualify as an IMR widely held entity.
In determining total participation interest, reference is made to both direct and indirect participation. As such, it is possible to trace through investors and entities (such as feeder funds) to determine whether an IMR entity meets the tests.
A foreign fund will also be able to access the concession where it appoints an “independent Australian fund manager”.
An entity is an “independent Australian fund manager” where no more than 70% of the managing entity’s income for the income year is received from the IMR entity (or associates). There is a concession available for new managing entities unable to meet the 70% test for the first 18 months. Further, the remuneration of the managing entity must be determined on an arm’s length basis.
Alternatively, the manager will be deemed to be independent if the foreign fund satisfies the test for an “IMR widely held entity”.
What are the tax concessions?
Where either the direct or indirect investment conditions are satisfied, then the following concessions are available in relation to qualifying financial arrangements:
- Excluding gains and losses from specific financial arrangements from Australian tax. For example, returns on derivative financial arrangements would not be taxable. However, the concession does not apply to returns that are subject to withholding tax, such as a dividend, interest and royalty amounts.
- Disregarding capital gains and capital losses arising from financial arrangements.
- Note that a financial arrangement that relates to a CGT asset that is taxable Australian real property, or an indirect Australian real property interest, will not be covered.
The IMR concession is reduced where the independent Australian fund manager as well as its connected entities have a right to receive, either directly or indirectly, more than 20% of the IMR entity’s profits for that year.
Temporary breaches of the total participation interest tests due to a reason beyond its control should not result in the IMR entity being denied the benefit of the IMR concessions.
The concessions may not apply to all foreign funds, and, to the extent that a foreign fund does not qualify, it will be subject to the general tax laws and may incur some tax exposure where the fund invests into Australia.
Entities starting up or winding down
There are specific rules that apply to an IMR entity that is starting up or winding down. If an IMR entity has never satisfied the total participation interests test, then it is still taken to be an IMR widely held entity, provided that it is being actively marketed with the intention of satisfying the total participation tests.
It will be a question of fact as to whether an IMR is being actively marketed, and this requires evidence of ongoing genuine attempts to obtain third-party investment to meet the total participation interests test.
The rules also cover an IMR entity whose activities and investments are being wound down. The IMR entity in this case will continue to be considered to be widely held, even if it no longer satisfies the total participation interests test.
Where to from here?
The IMR is regarded as a positive development for the funds management industry for a number of reasons. Currently, many foreign funds are using swaps to gain exposure to Australian investments. It is anticipated that going forward under the IMR, eligible foreign funds will be able to invest in Australian investments more directly.
In addition, fund principals now have the opportunity to relocate to Australia. Currently, many Australians wanting to return have been deterred by the tax uncertainty for their foreign investors if they were to manage money from Australia.
Likewise, the IMR is likely to encourage more Australian fund managers to actively market their investment management services globally and for offshore funds to establish trading operations in Australia.