As part of the Australian Government’s review of the taxation treatment of collective investment vehicles, the Board of Taxation has issued a comprehensive discussion paper for comment on how to enhance the competitiveness of the tax regime for Australian investment funds.
In the review of Australia as a Financial Services Centre by the Australian Financial Centre Forum chaired by Mark Johnson the existing regime for managed funds was identified as one of the main reasons global funds managers do not use Australia as a regional funds management base.
The discussion paper notes that this was due primarily to the complexity and lack of certainty of the existing tax regime.
Collective investment vehicles
The discussion paper defines collective investment vehicles as entities which are widely held and undertake passive investment activities. One of the policy objectives for redesigning the tax regime is to develop a regime which is based on “flow through” taxation. That is, investors in Australian managed funds should be subject to the same taxation outcomes that would apply if they held the underlying investments directly. Therefore the income and gains of managed funds would flow through to managed funds and be subject to taxation in the hands of investors.
The predominant form of collective investment vehicle in Australia is a unit trust. This type of vehicle has some limitations such as not permitting the flow through of certain tax attributes. The paper raises the possibility of expanding the range of collective investment vehicles that would be subject to “flow through” taxation to include limited partnerships and corporate entities. Limited partnerships, in particular, are commonly used internationally for collective investment funds.
Flow through taxation treatment should permit the flow through of tax losses to investors. The paper, however, appears not to favour this design option. Flow through taxation should also permit the flow through of the tax character of income and gains, foreign tax offsets and franking credits.
Investment manager tax regime
The paper also raises the option of introducing a comprehensive investment manager tax regime. As an interim measure, the Australian Government recently announced that it will amend the tax law as it applies to foreign managed funds which are taken to have an Australian permanent establishment because they use an Australian based investment manager. Under the proposal, the income of the fund that would otherwise be subject to Australian tax will be exempt. The proposal will only apply to widely held funds which have passive/portfolio investments and so it is not expected to apply to private equity or venture funds. The proposal does not address the risk of Australian taxation because of residency or source issues. It will include integrity measures to ensure that Australian investors are not able to use the exemption by establishing and investing in foreign funds.
The paper canvasses the option of proposing an exemption model for a comprehensive investment manager tax regime. Under this model, the income of a foreign managed fund which uses an Australian intermediary to invest in foreign and domestic assets would be exempt from Australian tax, other than final withholding tax on dividends, interest and royalties. The exemption would apply to passive investments.
There are likely to be several issues which will need to be addressed in the design of such a comprehensive regime. These include:
• how to define foreign managed funds
• what other entities should be able to qualify
• the types of investments that should be included e.g. should taxable Australian property may be excluded and
• appropriate integrity measures e.g. how to address “round tripping” where Australian investors seek to avoid Australian tax by investing through qualifying foreign managed funds.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Asian Banking & Finance. The author was not remunerated for this article.
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Emanuel Hiou is a Partner on Financial Services Taxation at Deloitte Australia.