House of Representatives

New International Tax Arrangements (Managed Funds and Other Measures) Bill 2004

Second Reading Speech

Mr Ross Cameron (Parliamentary Secretary to the Treasurer)

I move:

That this bill be now read a second time.

The bill I am introducing today further modernises Australia's international tax regime as part of the government's ongoing review of international tax arrangements. It builds on legislation directed at the superannuation and funds management industries, which passed parliament last week. It also follows legislation for a participation exemption and important reforms to Australia's tax treaty policies reflected in the new tax treaty with the United Kingdom, signed in August 2003.

This bill focuses on making the Australian managed funds industry more attractive to foreign clients. Australia has a significant managed funds industry facilitated by strong economic performance, a highly educated work force, low-cost infrastructure, advanced regulatory systems and sophisticated financial markets.

Schedules 1 and 2 make changes designed to reduce taxation impediments to further growth in this area. These changes will allow Australian managed funds to become more internationally competitive, increasing their attractiveness to non-residents.

Under current capital gains tax arrangements, non-residents investing in assets through an Australian managed fund may be taxed more heavily than if they invested directly in those assets or through a foreign fund. Measures in schedule 1 will eliminate these distortions. Complementing this, measures in both schedules 1 and 2 will reduce taxation of foreign source conduit income earned by non-residents via interposed Australian managed funds.

Schedule 1 makes three key changes to the income tax law.

It amends the law to disregard a capital gain or capital loss made by a foreign resident from disposing of its interest in an Australian fixed trust if the underlying assets of the trust are not Australian assets. A second amendment will disregard a capital gain made by a foreign resident in respect of the taxpayer's interest in a fixed trust, if the gain ultimately relates to an asset of the trust which is not an Australian asset. In both cases, had the underlying asset been directly held by the foreign investor, Australian capital gains tax would not apply.

Reflecting the conduit principle of international taxation, foreign source income flowing through an Australian trust to non-residents is not taxed in Australia. However, under current arrangements when a trust interest is sold, previously distributed foreign source income is, on a delayed basis, subject to Australian capital gains taxation. On the other hand, non-residents investing directly or through an offshore managed fund do not pay Australian capital gains tax in respect of the foreign source income. A third amendment will eliminate this distortion.

Schedule 2 amends the rules for determining the source of income derived by certain residents of treaty partner countries. The interaction of treaty source rules and other treaty rules relating to non-resident beneficiaries of income derived by business trusts operating in Australia has implications for the managed funds industry. This interaction may result in foreign source passive income derived by those foreign beneficiaries through an Australian trust being treated as sourced in Australia and therefore taxed in Australia.

For example, if a New Zealand resident invests in an Australian managed fund investing offshore, this interaction inappropriately exposes the New Zealand beneficiary to Australian tax on conduit income. The amendments ensure the domestic source rules rather than treaty source rules (which have a wider potential reach) apply in this case. The effect of this amendment would be to relieve the conduit income from Australian taxation.

The amendments will align the tax treatment of foreign residents investing through managed funds that derive income from sources outside Australia with the tax treatment that would apply if those foreign residents made such investments directly.

Schedule 3 implements three measures finetuning interest withholding tax arrangements, consistently with other recent developments in the tax law. These changes will allow Australian businesses generally to take advantage of global opportunities to lower their cost of debt and to facilitate efficient business structures.

The first measure broadens the range of financial instruments eligible for interest withholding tax exemption by adding `debt interests'. The second treats payments of a non-capital nature, made on certain Upper Tier 2 hybrid capital instruments issued by banks, as interest for interest withholding tax purposes. Finally, the bill facilitates the transfer of additional assets and debts from Australian subsidiaries of foreign banks to their Australian branches without losing interest withholding tax exemptions.

The size of Australia's funds management pool and its prospects for continued growth, are drawing global firms to establish operations in Australia. The resultant clustering of activity and the concentration of expertise has created a robust domestic industry. This infrastructure provides a framework for Australia to become the funds management hub for the Asia-Pacific region and these reforms will remove impediments to achieving that goal.

I note the strong business support for the bill. The business community has played a valuable and constructive role in helping develop the proposed legislation. This bill again demonstrates that the government has listened and been responsive to industry calls for specific tax reforms to remove distortions from the tax system and allow Australian businesses to grow.

The future of the Australian economy is fundamentally linked to global prosperity and to Australians being a part of that prosperity. This bill is an important part of modernising Australia's international tax system, to make the most of Australia's potential to market financial products to foreign investors.

Full details of the measures in this bill are contained in the explanatory memorandum.

I commend this bill and present the explanatory memorandum.

Debate (on motion by Mr McClelland) adjourned.