House of Representatives

Income Tax Assessment Amendment (Foreign Investment) Bill 1992

Second Reading Speech

by the Minister assisting the Treasurer the Hon. Peter Baldwin MP

I move that the Bill be now read a second time.

This Bill is the Government's third major piece of legislation in its program to reform the taxation of foreign source income. This revised Bill contains the necessary new provisions for inclusion in the Income Tax Assessment Act 1936 to give effect to the Government's approach in relation to the taxation of Foreign Investment Funds. The Foreign Investment Fund measures contained in this Bill will take effect on and from 1 January 1993.

The development of this body of tax reform law, with its many rounds of consultation with affected taxpayers and their advisers, demonstrates this Government's commitment to tackle the hard issue of tax minimisation and deferral opportunities available to Australians through some types of offshore investment while recognising some taxpayers' legitimate need to invest offshore to achieve portfolio diversification.

The precise targeting of the Foreign Investment Fund measures as contained in this Bill is the result of extensive consultation over the last 12 months. Numerous responses to the release of the broad design features of the Foreign Investment Fund measures contained in a Budget press release of August last year, a detailed Information Paper of April this year and the initial Bill introduced into this House on 25 June 1992 have contributed to the Bill before you today.

In addition, an independent assessment of the initial Bill that was commissioned by the Treasurer has provided significant input to the final Bill.

I would now like to briefly discuss the nature of the consultancy and the major findings of this assessment contained in the Arnold Report and adopted by the Government as outlined in the Government's response. Both these papers were publicly released by the Treasurer last month.

The brief for the consultancy, announced by the Treasurer on 25 June 1992, involved the consultant in discussions with affected taxpayers and their advisers in relation to the implementation of the Government's approach to the taxation of Foreign Investment Funds. It was required that the report make recommendations on implementation issues as well as how to further minimise tax avoidance opportunities in this area of offshore investment. The consultant appointed was Professor Brian Arnold of the University of Western Ontario, Canada. Professor Arnold is a well known and respected expert in the area of international tax law.

The Arnold Report acknowledged the need for the Foreign Investment Fund measures proposed by this Government and endorsed the basic approach taken to implement these necessary measures. The adoption of the bulk of Professor Arnold's recommendations reflected in this Bill is a demonstration of this Government's commitment to further refine the scope of the Foreign Investment Fund measures to target areas of tax minimisation and deferral and where possible reduce compliance and administration costs.

Before providing a brief background and outline of the Foreign Investment Fund measures contained in this Bill I would like to draw attention to a new exemption from these measures. In cases where only 5 per cent or less of a taxpayer's aggregate interests in Foreign Investment Funds will give rise to taxation under these measures, because the other 95 per cent or more of the taxpayer's interests are exempt under another of the exemptions, then the entire interests in foreign investment funds will not be subject to these measures.

This exemption recognises the need for balanced investment portfolios. Taxpayers with minimal investment in 'black list activity' offshore companies and in offshore trusts do not put the revenue at risk and are rightly excluded.

The inclusion of an exemption for those taxpayers with balanced investment portfolios in foreign investment funds, coupled with the change to a 'black list activity' approach to provide an exemption for active business companies as recommended by the Arnold Report,has closely targeted the Foreign Investment Fund measures at offshore investment that provides tax minimisation and deferral.

The need for the Foreign Investment Fund measures, as well as the Foreign Tax Credit System introduced in 1987 and the Foreign Source Income measures introduced in 1991, arose from a tax system that was heavily biased in favour of investments in low-tax countries. The system also encouraged Australians to artificially source profits in offshore tax havens and, in cases where Australians could control the distribution policy of a foreign entity, to defer remittance of profits.

The Foreign Tax Credit System which has operated since the 1987-88 income year replaced the system that gave a general exemption from Australian tax to income that was earned offshore that had been subject to foreign tax, regardless of the amount of tax paid. The Foreign Tax Credit System provides generally for foreign income to be subject to Australian tax with a credit being allowed for any foreign tax paid.

The Foreign Source Income measures which took effect from the 1990-91 income year introduced an accruals system of taxing foreign source income. The accruals taxation element of this legislation is directed at passive income and other forms of tainted income that is derived in low tax countries by Australian controlled foreign companies and accumulated offshore, avoiding Australian tax. It also applies to certain non-resident trusts to which Australians have transferred property or services for less than full value.

The Bill before you will introduce legislation to counter avoidance opportunities that remain after the introduction of the Foreign Source Income measures. These are the cases where a foreign company or trust, although not generally controlled by Australians, is nevertheless an attractive investment vehicle because it allows for the accumulation of income offshore, especially in low-tax countries, allowing the investor to minimise and defer Australian tax.

Australian residents who have invested in offshore life bonds or other foreign life policies with an investment component will also be subject to the Foreign Investment Fund measures.

This new approach to the taxation of foreign source income will ensure that Australians investing offshore pay their fair share of tax.

This Bill will also amend the existing trust provisions in their application to non-resident trust income. These amendments will supplement the Foreign Source Income provisions in areas where the Foreign Investment Fund measures will not apply.

A minor technical amendment to the Controlled Foreign Company measures is also included in this Bill.

I will now turn to the more detailed aspects of the Bill.

The Foreign Investment Fund Measures

Foreign companies and foreign trusts

The Foreign Investment Fund measures will apply to Australian taxpayers who have an interest in a foreign company or a foreign trust. For a foreign company, these will generally be taxpayers who hold shares in the company. Similarly, for a foreign trust the measures will apply to taxpayers who have an interest in the corpus or income of the trust, most commonly units in a unit trust.

In designing the Foreign Investment Fund measures, the Government has carefully targeted those non-controlling interests in foreign entities that provide the greatest scope for tax avoidance. The particular focus of the measures is on long-term interests in multi-tiered, offshore investments that enable the deferral of Australian tax through the accumulation of low taxed income offshore. That income is usually converted into concessionally-taxed capital gains on the disposal of the interests. The measures include a range of exemptions to ensure that they are properly targeted.

Interests held for less than 12 months will in general not be subject to Foreign Investment Fund taxation. In addition, Foreign Investment Fund taxation will not apply in the year of disposal of a taxpayer's entire Foreign Investment Fund interest regardless of how long that interest has been held. An exception is made in the case of a foreign life policy (which will be taxed up until the point of disposal).

A small investor exemption applies where an individual taxpayer has offshore investments not exceeding $50,000.

The active business exemption will ensure that there is no tax hindrance to portfolio diversification or joint venture participation by Australians who wish to invest directly into a foreign company that is principally engaged in active business. These active businesses provide no or little scope for tax minimisation and deferral.

The 'black list' of activities not eligible for the exemption currently includes banking, general and life insurance, real estate, financial services, certain investment business and management of funds. However, banking, insurance or real estate conducted in a company that is publicly listed and whose shares are widely held will be exempted.

A further exemption will ensure that Australian investors have access to markets where a country prohibits direct investment on its stock exchanges. This is provided by excluding from the measures investments made direct in certain approved country funds in those countries.

These measures will not apply to short term visitors whose stay in Australia doesn't exceed 4 years and who have not applied for or been granted permanent residency.

Foreign life assurance policies

The Foreign Investment Fund measures will also apply to taxpayers who have a life assurance policy where that policy is issued by a non-resident. However, policies that provide life cover only are excluded from the measures. Policies issued before 1 July 1992 which cannot be cancelled, surrendered or redeemed are also excluded if they are not materially altered after that date.

Non-resident trusts

At the time of introduction of the Foreign Source Income measures, it was recognised by the Government that avenues still remained for the deferral of Australian tax on trust income of foreign trusts. The Foreign Investment Fund measures will address those cases in which trust income is accumulating for the benefit of a resident even though the trust may not be controlled by Australian residents.

The Bill will also introduce changes to the method of calculating the beneficiary's share of the income of a non-resident trust for those foreign trusts not taxed under the Foreign Investment Fund methods of taxation. These changes will align the taxation treatment of those beneficiaries with the taxation treatment for non-resident trusts that will operate under the Foreign Investment Fund measures.

The Bill will make changes to the way the interest charge currently applies to distributions to Australian beneficiaries of accumulated income of non-resident trust estates. The principal change will be to exclude from the interest charge distributions made by non-resident public unit trusts.

Financial impact

The revenue gains of the Foreign Investment Fund measures will generally be realised after the end of the 1992-93 financial year.

It is estimated that these measures will yield a revenue of about $90 million in the 1993-94 financial year and $200 million in the1994-5 financial year.

These estimated revenue figures have been revised to take into account the new commencement date of 1 January 1993 and the recent release of relevant statistics that show an increase in portfolio offshore investment that can be expected to continue in the medium term.

I present the Explanatory Memorandum for this Bill.

I commend the Bill to the House.