Investment manager regime – draft legislation released

Publication | September 2011


FIN 48 created a headache both for the offshore funds industry and the Australian Government as it saw many overseas investment funds shy away from Australian investments and the use of Australian investment intermediaries due to uncertainties in the application of Australia’s tax laws.  In December 2010, the Assistant Treasurer announced that amendments to Australia’s tax laws (known as the “Investment Manager Regime”) would be introduced so as to address this issue.  Further announcements regarding this issue and the measures to address it were made in January and May 2011.

On 16 August 2011 the Government released exposure draft legislation to implement the Investment Manager Regime in two parts.  The first part applies to income years up until 30 June 2011 (the “FIN 48” measure) and the second applies from 1 July 2011 (the “conduit income” changes).  Further refinements may be expected following the Board of Taxation’s final report on the Investment Manager Regime, now expected on 30 September 2011.

What is FIN 48?

US Financial Accounting Standards Board Interpretation Number 48 - or FIN 48 - has, since December 2008, required an investment fund adopting US GAAP accounting standards to report “uncertain tax positions” in its financial statements.  A fund’s value must then be reduced in its financial statements in accordance with the extent of the possible tax bill and the probability of the taxes being collected.

Why is FIN 48 a problem for funds investing in Australia?

Foreign funds trying to comply with FIN 48 have realized the uncertainty of Australia's tax rules. The Australian Financial Centre Forum's report on Australia as a Financial Centre (the Johnson Report).
reported that there are several causes of uncertainty:

  • Residency rules.  A foreign investment fund can be considered resident in Australia (and therefore taxable in Australia) if it carries on business in Australia and has its central management and control in Australia.  The location of “central management and control” can be nebulous, particularly in the modern day environment of virtual meetings.
  • Source rules.  This is particularly relevant for funds resident in jurisdictions with no double tax treaty with Australia as these funds will generally only be subject to taxation in Australia on Australian-sourced income and on capital gains attributable to a permanent establishment in Australia.  However, the source rules rely on case law and are difficult to apply with certainty to any given fact scenario.
  • Whether the fund has a permanent establishment in Australia.  If so, then under Australia’s double tax treaties, this would generally entitle Australia to tax all gains attributable to that permanent establishment.  It is a question of degree as to whether the use of an Australian fund manager, adviser or other intermediary means that the foreign investment fund has a permanent establishment in Australia.

Accordingly, to comply with FIN 48, a foreign investment fund may need to conclude in its financial statements that all or some gains are potentially taxable in Australia and it must then measure  the potential taxation liability depending on the likelihood of the taxes being recovered.  This is naturally an undesirable outcome with the potential to deter  foreign investment funds investing in Australia or shy away from appointing an Australian manager.

What is the Australian Government’s solution?

The Australian Government has announced legislative changes to address the uncertainty arising out of the use by foreign funds of Australian intermediaries.  The changes ensure that the use of Australian intermediaries will not of itself give rise to the foreign fund having a permanent establishment in Australia.

The FIN 48 changes

The FIN 48 changes were originally announced to address the uncertainty arising out of the use by foreign funds of Australian intermediaries for taxation years up to and including the 2009-2010 tax year.  In May 2011 it was announced that this temporary fix would extend to the 2010-2011 tax year.  

The basic premise is that, if a foreign fund is using an Australian fund adviser, manager or other intermediary, and therefore a question arises as to whether or not it may have a permanent establishment in Australia, but it has not lodged an income tax return in Australia in respect of income attributable to that permanent establishment for the 2010-2011 income year or an earlier income year, then the Commissioner of Taxation will be precluded from raising an assessment.  In this way, the Australian Government does not address the question of whether or not the fund has a permanent establishment and income of the fund is technically taxable in Australia, it simply uses administrative means to ensure that the foreign fund will not be required to pay tax in Australia on that income.

To give effect to this principle, it is proposed that a new Division 842 will be inserted into the Income Tax (Transitional Provisions) Act 1997.

Under this new Division the Commissioner is precluded from raising an assessment in respect of IMR income or an IMR loss of an IMR foreign fund in respect of the 2010-11 or earlier income year where:

  • such fund had not lodged an income tax return in relation to that year; and
  • the Commissioner has not, prior to 18 December 2010, made an assessment of the taxable income of the fund (or the trustee, where the fund is a trust).

An “IMR foreign fund” is an entity:

(a) that is a non-resident of Australia at any time during the income year;
(b) recognised under a foreign law as a collective investment vehicle;
(c) where members of the entity do not have day-to-day control of its operations;
(d) which does not carry on a trading business in Australia;
(e) which is widely held (as determined according to the “managed investment trust” definition in the Taxation Administration Act 1953); and
(f) not closely held (again, determined by reference to the “managed investment trust” definition).

“IMR Income” is assessable income attributable to a return or gain from a financial arrangement (as defined) which is treated as having a source in Australia by reason of being attributable to an Australian permanent establishment of the fund.  An “IMR Loss” is the amount of the fund’s deductions for the income year to the extent to which they are attributable to gaining the fund’s IMR income.

The relief provided will not apply however if:

(a) the Commissioner is of the opinion that there has been fraud by the fund; or
(b) before 18 December 2010 the Commissioner notified the fund that an audit or compliance review would be undertaken.

For a foreign fund resident in a jurisdiction which has no double tax treaty with Australia, for example the Cayman Islands, the liability to taxation in Australia on revenue gains depends on the question of the source of the income, rather than the question of whether or not the fund has a permanent establishment in Australia.  However, the exposure to Australian capital gains tax for such a fund is dependent on whether or not the fund has a permanent establishment in Australia. Therefore, this amendment may only provide limited certainty for funds in jurisdictions with which Australia does not have a double tax treaty. It is hoped that this position will be rectified when the proposed legislation is finalised.

The Conduit Income Changes

In January 2011 the Assistant Treasurer announced the “conduit income” changes to apply from 1 July 2011 where IMR foreign funds using Australian fund managers would not be subject to adverse tax consequences (see our legal update: New tax exemption for foreign funds using Australian investment managers).

The principle behind the conduit income changes is that a foreign fund’s liability to taxation in Australia should not depend on whether or not it uses an Australian intermediary or a foreign intermediary.  An IMR foreign fund will therefore be exempt from Australian taxation on relevant investment income where it is taken to have a 'permanent establishment' in Australia only because it engages an Australian based investment manager.  Australia will only tax the fee for services provided by the Australian intermediary.

The amendments will cover the income, gains and losses arising from the following foreign investments by IMR foreign funds:

  • Portfolio interests in companies (including companies listed on the Australian Securities Exchange), portfolio interests in other entities (including units in a unit trust) and bonds;
  • Financial arrangements (for example, derivatives) and foreign exchange transactions, except to the extent they are in respect of an underlying interest that is otherwise taxable (such as taxable Australian property).A new Subdivision 842-I is intended to be inserted into the Income Tax Assessment Act 1997.  

Without the proposed relief being provided, the activities of the Australian investment manager could result in the fund being treated as having a permanent establishment in Australia so as to result in profits from investments managed by the Australian investment manager being subject to Australian tax.

If the foreign fund had a permanent establishment, apart from the activities of the Australian investment manager (eg. if it maintained a branch in Australia), it will continue to be subject to Australian tax on profits attributable to that branch. In addition, amounts subject to Australian withholding tax will not be eligible for exemption.

Although it is intended that the relief from Australian tax provided applies at either the fund level or at the beneficiary/partner/member level (where the fund is treated as transparent for tax purposes), it would not provide relief to an Australian resident taxpayer who is a beneficiary/partner/member of that fund.  Such resident beneficiaries/partners/members will remain taxable on their share of net income from the fund.


As identified above, there are a number of uncertainties in the application of Australia’s taxation laws to foreign funds, and the Investment Manager Regime addresses some, but not all of them.  One of the challenges in applying the proposed new rules is qualifying the foreign fund under the widely held tests, in particular where a foreign manager uses multiple feeder funds.  Notwithstanding the challenges, the changes bring Australia closer in line with other key financial services centres and should remove a major hurdle preventing foreign funds from appointing Australian advisors.  

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