House of Representatives

Tax Laws Amendment (Investment Manager Regime) Bill 2012

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 2

Investment manager regime - 2010-11 and earlier income years - FIN 48

Outline of chapter

2.1 Schedule 2 to this Bill inserts new Subdivision 840-I into the Income Tax ( Transitional Provisions ) Act 1997 (ITTPA 1997). The Subdivision prescribes the treatment of returns, gains, losses and deductions on certain investments of widely held foreign funds, for the 2010-11 and earlier income years. The amendments will apply where the returns or gains would otherwise be assessable income of the fund and where the fund or a foreign resident partner or beneficiary of the fund has not lodged an income tax return and the Commissioner of Taxation (Commissioner) has not made an assessment or notified the fund of an audit or review. Where the Subdivision applies, the relevant returns or gains will be treated as non-assessable non-exempt (NANE) income or will be disregarded and the deductions, losses, capital gains and capital losses will also be disregarded.

2.2 This Subdivision together with new Subdivision 842-I of the Income Tax Assessment Act 1997 (ITAA 1997) (see Chapter 1) will form the first two elements of the investment manager regime (IMR).

2.3 As the amendments made by Schedule 2 and explained in this Chapter are designed to address the consequences of the United States Financial Accounting Standards Board Interpretation Number 48 Accounting for Uncertainty in Income Taxes - the amendments are often referred to as the 'FIN 48' measures.

2.4 All legislative references are to the ITAA 1997 unless otherwise stated.

Context of amendments

2.5 In 2006, the US Financial Accounting Standards Board issued United States Financial Accounting Standards Board Interpretation Number 48 Accounting for Uncertainty in Income Taxes (FIN 48) - subsequently codified into the United States accounting standard ASC 740-10, to increase the relevance and consistency of income tax reporting.

2.6 The standard initially applied only to public companies subject to US Generally Accepted Accounting Principles (US GAAP), however since 31 December 2009 the standard also applies to private entities that prepare US GAAP accounts (including managed funds).

2.7 The standard does not affect the income tax treatment of entities as it does not prescribe whether or not a particular amount is included in assessable income or allowed as a deduction. Rather, the standard sets out rules on how to report in financial statements, in particular reporting the income tax benefits received from taking uncertain tax positions in any tax return for any jurisdiction.

2.8 FIN 48 has had a particular impact on foreign funds with US reporting requirements which have a presence in Australia, or derive income that could be considered to have an Australian source, as the tax treatment of the income of these foreign funds is uncertain.

2.9 These issues were raised with the Australian Financial Centre Forum. The Forum's final report - Australia as a Financial Centre: Building on our Strengths - stated that tax uncertainties and the scope of the tax system acted as significant constraints on cross border activities. It also noted the impact of FIN 48 on the managed funds industry.

2.10 The Forum recommended the introduction of an IMR to improve the certainty and scope of the current taxation arrangements of managed funds.

2.11 The Government announced on 17 December 2010 that the tax law would be amended to deal with the uncertainty surrounding the impact of FIN 48. This measure was to apply to the 2009-10 and earlier income years but was later extended to also apply to the 2010-11 income year.

2.12 Schedule 2 to this Bill introduces amendments to the tax law to give effect to the 17 December 2010 announcement - the 'FIN 48' measure. Schedule 1 to this Bill gives effect to the announcement made in January 2011 - the 'conduit income' measure. Details of this measure are in Chapter 1.

Summary of new law

2.13 The proposed amendments are designed to clarify the taxation treatment of certain income for the 2010-11 and earlier income years of foreign funds which have not lodged a tax return or have had an assessment made of their income tax liability. Australian resident investors will not gain any tax benefit from this measure and will remain taxable on any income received from foreign funds.

2.14 Where the conditions of the provisions are met, certain types of investment income and gains will be exempt from Australian tax. In addition, losses or outgoings in respect of certain investments will be disregarded.

2.15 These amendments will apply to the 2010-11 and earlier income years.

Comparison of key features of new law and current law New law Current law For 2010-11 and earlier income years where a foreign fund or a foreign resident partner or beneficiary of a foreign fund has not lodged an income tax return and the Commissioner has not made an assessment or notified the fund of an audit or review, certain income will be disregarded or treated as NANE income. In addition, certain deductions and capital losses will be disregarded. Where a foreign fund invests in Australian financial arrangements or in foreign financial arrangement and engages the services of an Australian intermediary, any income or gains from that financial arrangement may be taxable in Australia.

Detailed explanation of new law

IMR foreign fund

2.16 The Subdivision applies to an IMR foreign fund that is a corporate tax entity, a trust or a partnership. 'IMR foreign fund' is defined in section 842-230 which is introduced by Schedule 1 of the Bill and is discussed at paragraphs 1.17 to 1.18. [ Schedule 1, item 1, subsections 842-210(2), 842-215(2 ) and 842-220(2), item 1, section 842-230 and item 7, subsection 995-1(1 )]

Requirements for amounts to be disregarded

2.17 For income, deductions, gains or losses of a foreign fund to be disregarded under this Subdivision, relevant entities must satisfy the requirements of not having lodged a tax return, or having an assessment made or having received a notification of an audit or compliance review.

2.18 There is no requirement that for an amount to be treated as a pre-2012 IMR income it must otherwise be assessable income only because the fund has a permanent establishment in Australia that arises solely as a result of engaging an Australian resident entity to habitually exercise a general authority to negotiate and conclude contracts on its behalf. This requirement only applies to the conduit income measure in Division 842-I. No lodgement of a tax return, issue of an assessment, or notification of an audit

2.19 In the case of a corporate tax entity which is an IMR foreign fund, for an amount to be disregarded the entity must:

not have lodged an income tax return in relation to the 2010-11 or any earlier income year before the commencement of the Subdivision [ Schedule 2, item 1, paragraph 842-210(2 )( c ) to the ITTPA 1997 ];
not have had, before 18 December 2010, an assessment made of tax payable for any income year [ Schedule 2, item 1, paragraph 842-210(2 )( d ) to the ITTPA 1997 ]; and
not have been notified before 18 December 2010 of an audit or compliance review [ Schedule 2, item 1, subsection 842-210(5 ) to the ITTPA 1997 ].

2.20 Where the IMR foreign fund is a flow through vehicle, for an amount to be disregarded in the calculation of the foreign beneficiary's or non-resident partner's share of the net income or partnership loss:

the trust and beneficiary or the partnership and partner must not have lodged an income tax return in relation to the 2010-11 or any earlier income year before the commencement of the Subdivision [ Schedule 2, item 1, paragraphs 842-215(2 )( c ) and 842-220(2 )( c ) to the ITTPA 1997 ];
the beneficiary or partner must not have had, before 18 December 2010, an assessment made of tax payable for any income year [ Schedule 2, item 1, paragraphs 842-215(2 )( d ) and 842-220(2 )( d ) to the ITTPA 1997 ]; and
the trust or partnership must not have been notified before 18 December 2010 of an audit or compliance review [ Schedule 2, item 1, subsections 842-215(6 ) and 842-220(5 ) to the ITTPA 1997 ].

2.21 Broadly, the above requirements apply to the entity which would otherwise be subject to tax on the IMR income:

in the case of a fund which is a corporate tax entity, the requirements apply to the IMR fund, and
in the case of a flow through IMR fund, the requirements apply to the beneficiary or partner.

2.22 However, in the case of a flow through entity, the requirement that there has been no tax return lodged applies both to the foreign fund and the relevant beneficiary or partner. Fraud

2.23 In addition to the above requirements, if the Commissioner is of the opinion that there has been fraud by the corporate tax entity, trust or partnership of a foreign fund, any amounts which may have been otherwise disregarded will not be disregarded in the calculation of the entity's taxable income, net income or partnership loss. [ Schedule 2, item 1, subsections 842-210(4), 842-215(5 ) and 842-220(4 ) to the ITTPA 1997 ]

Amounts to be disregarded Pre-2012 IMR amounts

2.24 Amounts to be disregarded include income from certain financial arrangements (which in the case of a corporate tax entity will be NANE income), deductions relating to that income, capital gains and capital losses arising from certain financial arrangements.

2.25 While the disregarded amounts are similar to amounts disregarded for the purposes of the conduit income provisions - Division 842-I (see Chapter 1) - the requirements of the two Subdivisions are not the same. Amounts disregarded for the purposes of the conduit income measures are referred to as IMR income, IMR deductions, IMR capital gains and IMR capital losses, while amounts disregarded under this Subdivision - the FIN 48 measures - are referred to as:

pre-2012 IMR income;
pre-2012 IMR deductions;
pre-2012 IMR capital gains; and
pre-2012 capital losses.

Pre-2012 IMR income

2.26 The pre-2012 IMR income of a foreign fund which is a corporate tax entity is treated as NANE income. [ Schedule 2, item 1, paragraph 842-210(3 )( a ) to the ITTPA 1997 ]

2.27 The pre-2012 IMR income of a foreign fund which is a flow through vehicle is taken into account in determining the fund's pre-2012 non-IMR net income, pre-2012 non-IMR partnership net income or pre-2012 non-IMR partnership loss. In effect the pre-2012 IMR income of a flow through vehicle is disregarded in calculating the distribution to a non-resident beneficiary or partner of the fund.

2.28 For an amount to be treated as pre-2012 IMR income, the amount must be attributable to a return or gain from a financial arrangement covered by section 842-245 [ Schedule 1, item 1, paragraph 842-270 and item 15, subsection 995 1(1 )]. Financial arrangements covered by section 842-245 are discussed in Chapter 1 (see paragraphs 1.37 to 1.40). Pre-2012 IMR deductions

2.29 Pre-2012 IMR deductions are amounts that (ignoring subsection 842-210(3) and paragraphs 842-240(1)(b) and 842-245(a)) would be deductible, but only to the extent that they are attributable to pre-2012 IMR income. [ Schedule 2, item 1, section 842-230 to the ITTPA 1997 ]

2.30 Pre-2012 IMR deductions are disregarded in working out:

the taxable income or tax loss of a IMR fund which is a corporate tax entity [ Schedule 2, item 1, paragraph 842-210(3 )( b ) to the ITTPA 1997 ]; and
the pre-2012 non-IMR net income, or the pre-2012 non-IMR partnership net income or the pre-2012 non-IMR partnership loss of a IMR fund which is a flow through vehicle [ Schedule 2, item 1, paragraphs 842-230(2 )( b), and 842-230(2 )( c ) to the ITTPA 1997 ].

2.31 In effect pre-2012 non-IMR deductions are not taken into account in determining a foreign resident beneficiary's or foreign resident partner's share of the net income or partnership loss or an IMR fund which is a flow through entity. Pre-2012 IMR capital gains

2.32 The pre-2012 IMR capital gain is the sum of the fund's capital gains made in the relevant income year in respect of capital gains tax (CGT) assets that are financial arrangements covered by section 842-245. [ Schedule 1, item 1, subsection 842-270(3 ) and item 14, subsection 995-1(1 )] Pre-2012 capital losses

2.33 The pre-2012 IMR capital loss is the sum of the fund's capital losses made in the relevant income year that are attributable to a CGT asset that is a financial arrangement covered by section 842-245. [ Schedule 2, item 1, section 842-235 to the ITTPA 1997 ]

Taxable entities and flow through entities

2.34 As is the case for the conduit income measures - that is new Subdivision 842-I (see Chapter 1) - Subdivision 842-I of the ITTPA 1997 applies to foreign funds that are either 'taxable entities' (such as companies and corporate limited partnerships) or 'transparent' or 'flow-through entities' (such as partnerships and trusts). The structure of the foreign fund will dictate the level at which the exemption applies.

2.35 Where a fund is a taxable entity, the exemption of certain amounts will apply at the fund level.

2.36 Where a fund is a transparent entity, the exemption of certain amounts will apply either at the trustee level or at the foreign resident beneficiary level, and in the case of a partnership, at the foreign resident partner level. This approach is designed to ensure that an Australia member of a flow through entity, cannot access the exemption which may be available to foreign resident members of the entity.

IMR foreign funds that are taxable entities

2.37 Where the IMR foreign fund is a corporate tax entity, certain amounts (pre-2012 IMR amounts) are disregarded in calculating the entity's taxable income, tax loss or net capital loss. [ Schedule 2, item 1, subsection 842-210(3 ) to the ITTPA 1997 ]

2.38 The calculation of the corporate entity's taxable income, tax loss or net capital loss for the for the 2010-11 and earlier income years, is the same as that described in paragraphs 1.59 to 1.61, except the amounts to be disregarded are pre-2012 IMR amounts.

2.39 As the Subdivision does not apply to any distributions (including capital distributions) received from a company or a corporate limited partnership, the tax treatment of such distributions remains unchanged.

IMR foreign funds that are flow though entities

2.40 Where the IMR foreign fund is a flow though entity, for example a partnership or a trust, certain amounts (pre-2012 IMR amounts) are in effect disregarded in calculating a foreign resident partner's or foreign resident beneficiary's taxable income, tax loss or net capital loss. [ Schedule 2, item 1, subsections 842-215(3), 842-215 ( 4 ) and 842-220(3 )]

2.41 The Income Tax Assessment Act 1936 , in particular Divisions 6 and 115, apply to the trustee of an IMR foreign fund, subject to the modifications of this Subdivision. The effect of the modifications is that where a trustee is assessed and liable to pay tax that liability will only be in respect of non-IMR net income rather than in respect of all the net income of the IMR foreign fund.

2.42 The calculation of the flow-through entity's net income, partnership loss, tax loss or net capital loss for the 2010-11 or earlier income years is the same as described in paragraphs 1.62 to 1.73, except the amounts to be disregarded are pre-2012 IMR amounts.

Application and transitional provisions

2.43 The Subdivision will commence on the date that the Bill receives Royal Assent and applies to the 2010-11 and prior income years. [ Section 2 of the Tax Laws Amendment ( Investment Manager Regime ) Bill 2012, item 8 of the table ].

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights ( Parliamentary Scrutiny ) Act 2011

Tax Laws Amendment ( Investment Manager Regime ) Bill 2012

2.44 This Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights ( Parliamentary Scrutiny ) Act 2011 .

Overview

2.45 This Bill clarifies the treatment of returns and gains, as well as losses and deductions, on certain investments of foreign funds.

2.46 The Bill also clarifies the taxation treatment of certain income for the 2010-11 and earlier income years of foreign funds which have not lodged a tax return of have had an assessment made of their income tax liability.

Human rights implications

2.47 This Bill does not engage any of the applicable rights or freedoms.

Conclusion

2.48 This Bill is compatible with human rights as it does not raise any human rights issues.

Minister for Financial Services and Superannuation, the Hon Bill Shorten


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