House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Cessation of the First Home Saver Accounts Scheme

Schedule 1 to this Bill repeals the legislation providing for the First Home Saver Accounts (FHSAs) Scheme, including the related tax concessions.

Date of effect: The repeal of the FHSAs Scheme applies from 1 July 2015 for accounts opened in respect of applications made before 7.30 pm on 13 May 2014. Generally, accounts opened after this date will not be eligible to be first home saver accounts.

The repeal of the tax concessions applies to 2015-16 income year and later income years.

Proposal announced: This measure was announced on 13 May 2014 as part of the 2014-15 Budget.

Financial impact: This measure has the following net financial impact over the forward estimates period:

Human rights implications: This Schedule does not raise any human rights issues. See Statement of Compatibility with Human Rights - Chapter 1, paragraphs 1.50 to 1.62.

Compliance cost impact: This measure results in a small compliance cost saving for business.

Abolishing the dependent spouse tax offset

Schedule 2 to this Bill amends the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997 to:

•

abolish the dependent spouse tax offset (DSTO);

•

expand the dependant (invalid and carer) tax offset (DICTO) by removing the exclusion in relation to spouses previously covered by the dependent spouse tax offset;

•

remove an entitlement to DSTO where it is made available as a component of another tax offset, and replace that component with a component made up of DICTO; and

•

rewrite the notional tax offsets covering children, students and sole parents that are available as components of other tax offsets.

Date of effect: This measure applies to the 2014-15 income year and all later income years.

Proposal announced: The measure was announced in the 2014-15 Budget.

Financial impact: The measure has the following revenue implications:

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 2, paragraphs 2.43 to 2.60.

Compliance cost impact: As the proposals only impact on an individual's ability to claim a tax offset, there is no impact on business or the not-for-profit sector. Total compliance costs of all individuals will be reduced by $0.03 million per year.

Modernising the Offshore Banking Unit Regime

Schedule 3 to this Bill makes a number of reforms to modernise the Offshore Banking Unit regime. The reforms include measures implementing recommendations of the Australia as a Financial Centre - Building on Our Strengths report by the Australian Financial Centre Forum chaired by Mark Johnson. The reforms also include targeted amendments to address a number of integrity concerns with the existing regime.

Date of effect: The amendments apply from 1 July 2015.

Proposal announced: This measure was announced by the Treasurer and Assistant Treasurer in a joint Media Release, titled 'Restoring integrity in the Australian tax system' of 6 November 2013. Further amendments were announced through the publication of an exposure draft on 12 March 2015.

Financial impact: The financial impact of the amendments is as follows:

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 3, paragraphs 3.105 to 3.108.

Compliance cost impact: Low.

Income tax exemption for the Global Infrastructure Hub Ltd

Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 to exempt the Global Infrastructure Hub Ltd from liability to pay income tax on ordinary income and statutory income.

Date of effect: This measure applies from 24 December 2014 to 30 June 2019.

Proposal announced: This measure was announced in the 2015-16 Budget.

Financial impact: This measure has the following financial impact:

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 4, paragraphs 4.14 to 4.18.

Compliance cost impact: Nil.

Deductible gift recipients - extension

Schedule 5 to this Bill amends the Income Tax Assessment Act 1997 to update the list of specifically listed deductible gift recipients (DGRs).

Date of effect: The extension of the listing of the Australian Peacekeeping Memorial Project Incorporated and the extension of the listing of the National Boer War Memorial Association Incorporated applies to gifts made to each organisation before 1 January 2018.

Proposal announced: The extension of the DGR listing of Australian Peacekeeping Memorial Project Incorporated and National Boer War Memorial Association Incorporated was announced in the 2015-16 Budget.

Financial impact: The revenue implications of this measure are as follows ($m):

Human rights implications: This Schedule does not raise any human rights issues. See Statement of Compatibility with Human Rights -paragraphs 5.10 to 5.14. Compliance cost impact: Nil.

Miscellaneous amendments

Schedule 6 to this Bill makes a number of miscellaneous amendments to the taxation, superannuation and other laws. These amendments are part of the Government's commitment to the care and maintenance of the taxation and superannuation systems.

These amendments include style and formatting changes, the repeal of redundant provisions, the correction of anomalous outcomes and corrections to previous amending Acts.

Date of effect: These amendments have various commencement and application dates. Most amendments commence from the day this Bill receives Royal Assent. This explanatory memorandum explains in detail where commencement or application dates differ from Royal Assent. While some of these amendments have retrospective application, taxpayers should not be adversely impacted.

Proposal announced: These amendments have not been previously announced.

Financial impact: These amendments are expected to have a minimal or nil revenue impact.

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 6, paragraphs 6.88 to 6.92.

Compliance cost impact: Negligible.

Investment manager regime

Schedule 7 to this Bill amends the Income Tax Assessment Act 1997 to implement the third and final element of the investment manager regime (IMR) reforms. In addition, these amendments also make some changes to the existing regime. The IMR reforms are designed to attract foreign investment to Australia and promote the use of Australian fund managers by removing tax impediments to investing in Australia. The development and introduction of an IMR was a recommendation of the 2009 report, 'Australia as a Financial Centre: Building on our Strengths - Report by the Australian Financial Centre Forum', commonly known as the 'Johnson Report'.

Date of effect: These amendments apply in relation to the 2015-16 and later income years. In addition, taxpayers may choose to apply some of the amendments to previous income years - the effect of this on taxpayers and other foreign investors is entirely beneficial.

Proposal announced: The Treasurer and the then Assistant Treasurer announced that the Government would proceed with these amendments in a joint Media Release titled, 'Restoring integrity in the Australian tax system' of 6 November 2013.

On 18 December 2014, the then Acting Assistant Treasurer confirmed the Government's commitment to implementing a practical IMR and to releasing updated exposure draft legislation in early 2015 for public consultation.

Financial impact: This measure is estimated to have an unquantifiable cost to revenue over the forward estimates period.

Human rights implications: This Bill does not raise any human rights issues. See Statement of Compatibility with Human Rights -paragraphs 7.93 to 7.99.

Compliance cost impact: The IMR reforms are expected to result in significant compliance cost savings for foreign investors when compared to Australia's existing income tax laws.

Summary of regulation impact statement

Regulation impact on business

Impact: The IMR reforms ensure that specific types of investments made by foreign investors, namely where they engage an independent Australian fund manager to manage their investment or where they are a widely held foreign fund investing directly into Australia, do not trigger Australian income tax consequences.

The IMR reforms are expected to result in significant compliance cost savings for foreign investors when compared to Australia's existing income tax laws.

Main points:

•

The IMR reforms address potential revenue account and capital account treatment as well as source and permanent establishment issues by providing specific tax outcomes. This approach reduces compliance costs for foreign investors and for the funds management industry.

•

The IMR reforms do not apply to Australian resident investors.

Chapter 1 - Cessation of the First Home Saver Accounts Scheme

Outline of chapter

1.1 Schedule 1 to this Bill repeals the legislation providing for the First Home Saver Accounts (FHSAs) Scheme, including the related tax concessions.

Context of amendments

First Home Saver Accounts Scheme

Background

1.2 In 2008, the former Government established FHSAs to assist individuals in saving for their first home. The creation of FHSAs involved a package of legislation - the First Home Saver Accounts Act 2008 (the FHSA Act), the First Home Saver Accounts (Consequential Amendments) Act 2008, the Income Tax (First Home Saver Accounts Misuse Tax) Act 2008, First Home Saver Accounts (Further Provisions) Amendment Act 2008 and the First Home Saver Account Providers Supervisory Levy Imposition Act 2008.

1.3 Under the rules principally set out in the FHSA Act, individuals between 18 and 65 who had not previously owned a home in Australia were entitled to open a FHSA, which could then receive contributions from the individual or others up to a cap (now $90,000) (see sections 27 to 30 of the FHSA Act).

1.4 Amounts can only be withdrawn from a FHSA where specific requirements are satisfied. In most cases, the FHSA holder must:

•

withdraw the amount in order to make a contribution to the purchase of a first home (including making payments towards a mortgage on the home); and

•

have, in at least four financial years, either contributed at least $1,000 to the FHSA or owned a first home.

(See sections 31 to 32 and 32A of the FHSA Act.)

1.5 However, alternative eligibility criteria for withdrawals exist. In particular, a FHSA holder may choose at any time to transfer the balance of a FHSA to superannuation (section 34 of the FHSA Act).

1.6 Commonwealth assistance to saving via a FHSA takes the form of both Government contributions (17 per cent of the first $6,000 contributed in a year) and tax concessions (Part 4 of the FHSA Act and Division 345 of the Income Tax Assessment Act 1997 (ITAA 1997)).

1.7 Take up of FHSAs has been very low, with only around 47,000 in existence as of September 2014.

Tax treatment of First Home Saver Accounts

1.8 FHSAs receive similar tax concessions to superannuation accounts. Broadly:

•

earnings from FHSAs are taxed in the hands of the FHSA provider, not the individual, and at a flat rate of 15 per cent (Division 345 of the ITAA 1997 and sections 23 and 30 of the Income Tax Rates Act 1986);

•

contributions to FHSAs, including Government contributions, are not further taxed (section 345-50 of the ITAA 1997); and

•

withdrawals from FHSAs are generally not taxed (Division 345 of the ITAA 1997).

1.9 If an individual obtains money from a FHSA to purchase a home and the individual:

•

was not eligible to hold the account;

•

does not use the money to purchase or build a first home; or

•

does not meet the occupancy rules in respect of the first home,

then the individual will be liable to a special tax (FHSA misuse tax) to clawback any tax benefits or Government contributions the individual has received in respect of the withdrawn amount (see section 345-100 of the ITAA 1997). FHSA misuse tax does not apply where amounts are contributed to superannuation.

Regulation of First Home Saver Accounts providers

1.10 The FHSA Act also sets out a regulatory regime for providers of FHSAs and FHSA trusts. The rules that apply depend on the class of provider, being intended to be largely consistent with existing prudential obligations for entities of that type.

1.11 FHSA providers and FHSA trusts that are registrable superannuation entity licensees are subject to a prudential framework that is broadly consistent with that which applies to trustees of public offer superannuation funds.

1.12 FHSA providers that are authorised deposit-taking institutions and life insurers are subject to prudential requirements under the Banking Act 1959 or Life Insurance Act 1995.

1.13 Additional investment management requirements apply to FHSA providers that are registrable superannuation entity licensees or life insurance companies and offer FHSAs as investment-linked life insurance policies.

Proposed repeal

1.14 On 13 May 2014, the Government announced as part of the 2014-15 Budget that it intended to close the FHSAs Scheme.

1.15 The savings from the measure will be redirected to repair the budget and fund other policy priorities.

Summary of new law

1.16 Schedule 1 to this Bill will repeal the legislation establishing the FHSAs Scheme and providing for the payment of the Government matching contribution - the First Home Saver Accounts Act 2008, the First Home Saver Account Providers Supervisory Levy Imposition Act 2008 and the Income Tax (First Home Saver Accounts Misuse Tax) Act 2008.

1.17 Schedule 1 will also amend the tax law and the social security law to remove tax and social security concessions available to FHSAs.

Comparison of key features of new law and current law

Detailed explanation of new law

Repeal of the First Home Saver Accounts Acts

1.18 Schedule 1 repeals the FHSA Act. [Schedule 1, item 2, the whole of the First Home Saver Accounts Act 2008]

1.19 The FHSA Act establishes FHSAs, provides rules for their operation, establishes the legislative framework for the payment of matching Government contributions and provides for prudential regulation of FHSA providers, other than FHSA providers that are ADIs and life insurers (which are prudentially regulated under other legislation).

1.20 The repeal of this Act will remove FHSAs and the surrounding regulatory framework from the law. Accounts that are currently FHSAs will cease to be FHSAs. This means that they will no longer be eligible for the benefits this provided, including Government FHSA contributions. However, they will also no longer be subject to the restrictions on contributions and withdrawals, including the taxes and penalties that could apply to individuals and providers where amounts were withdrawn from a FHSA.

Repeal of related Acts

1.21 Schedule 1 also repeals:

•

the First Home Saver Account Providers Supervisory Levy Imposition Act 2008; and

•

the Income Tax (First Home Saver Accounts Misuse Tax) Act 2008.

[Schedule 1, items 1 and 3, the whole of the First Home Saver Account Providers Supervisory Levy Imposition Act 2008 and the Income Tax (First Home Saver Accounts Misuse Tax) Act 2008]

1.22 These two Acts impose taxes related to the operation of the FHSAs Scheme - the First Home Saver Account Providers Supervisory Levy Imposition Act 2008 imposes a tax on FHSA providers to meet the regulatory costs of the Australian Prudential Regulation Authority, while the Income Tax (First Home Saver Accounts Misuse Tax) Act 2008 imposes the penalty tax on individuals that breach the requirements around the use of FHSAs.

1.23 Following the repeal of the FHSA Act, these taxes will become redundant and they will therefore be repealed.

Amendments to the tax law

1.24 Schedule 1 also amends the tax law to remove tax concessions relevant only to FHSAs.

1.25 Prior to these amendments, Division 345 of the ITAA 1997 provided that:

•

individual and Government FHSA contributions were exempt from income tax;

•

individuals were not taxed on the earnings of their FHSAs - instead, the earnings were treated as income of the account provider and taxed at a fixed rate of 15 per cent (see section 30, subsection 23(3A) and paragraphs 23(2)(ba) and 23(3)(aa) of the Income Tax Rates Act 1986); and

•

withdrawals to purchase a first home were not subject to income tax and other withdrawals were also generally not subject to income tax.

1.26 FHSA providers were required to report a range of relevant information to the Commissioner of Taxation (Commissioner), as set out in Division 391 in Schedule 1 to the Taxation Administration Act 1953.

1.27 Following these amendments, there will be no FHSAs. As a result the tax concessions and reporting requirements will become inoperative - there will be no FHSAs to which these concessions can apply. Accounts that were previously FHSAs will be treated in the same way as other deposit or transaction accounts.

1.28 This means that, for example, the holders of former FHSAs, not the providers of the account would be liable for income tax on any interest earned on the account and that this tax would be payable at the individual's marginal rate of income tax rather than a fixed rate of 15 per cent rate.

1.29 As the current tax provisions dealing with FHSAs will become inoperative, they will be repealed. [Schedule 1, items 45 to 117, 151 to 174, 188 to 192, the definition of 'fringe benefit' in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986, subsection 5(2B) of the Income Tax Act 1986, the definitions of 'assessment', 'FHSA', 'FHSA trust' and 'full self-assessment taxpayer' in subsection 6(1), subparagraph 26AH(7)(ba)(i), section 95AA, subparagraph 102MD(a)(ii), paragraphs 124ZM(3)(d), 124ZM(3)(da) and 124ZM(6)(a), the definition of 'complying superannuation/FHSA class of taxable income' in paragraph 124ZM(6)(a), paragraph 202(kb) and the definitions of 'interest-bearing account', 'interest bearing deposit' and 'unit trust' in section 202A of the Income Tax Assessment Act 1936 as well as paragraph 272-100(e) in Schedule 2F to the Income Tax Assessment Act 1936, table item 8A in section 9-1, the table item headed 'reimbursement' in section 10-5, the table item headed 'first home saver accounts' in 11-55, section 15-80, paragraphs 51-120(c) and (d), subparagraphs 115-100(a)(ii), 115-100(b)(iia) and 115-280(a)(ia), paragraphs 115-280(2)(a), 115-280(2)(b), 115-280(5)(a), 115-280(5)(b), 166-245(2)(ba) and 166-245(3)(ba), subsection 205-15(3), paragraphs 205-30(2)(a), 207-15(2)(a), 207-35(1)(c) and 207-45(ca), subsection 210-175(2), the definition of 'complying superannuation/FHSA class of taxable income' in subsection 210-175(2), subparagraph 290-5(c)(iii), paragraphs 290-5(d) and (e), the method statement in subsection 295-10(2), section 295-171, table item 4A in section 296-495, paragraph 295-555(1)(b), the note to subsection 295-555(1), paragraph 295-555(3)(b), subsection 295-555(4), paragraphs 295-615(1)(d) and (e), section 320-1, paragraphs 320-80(2)(b) and 320-85(2)(ba), subsection 320-107(3), the definition of 'complying superannuation/FHSA class rate' in subsection 320-107(3), Division 345, subparagraph 380-15(1)(d)(iv) and subsections 713-545(6) and subsection 995-1(1) of the ITAA 1997, subsection 3(1), paragraphs 23(2)(ba) and (3)(aa), subsection 23(3A), paragraph 23A(b) and section 30 of the Income Tax Rates Act 1986 and table items 4 and 16 in subsection 8AAB(4) and paragraph 15C(8)(c) in the Taxation Administration Act 1953 as well as paragraphs 12-1(3)(b), 45-120(2)(c), 45-120(2)(ca), 45-120(2A)(b), 45-290(2)(c) and 45-290(2)(d), subsection 45-290(3), paragraphs 45-330(2)(c) and 45-330(2)(d), the method statement in subsection 45-330(3), paragraphs 45-370(2)(c) and 45-370(2)(d), the method statement in subsection 45-370(3), table items 24D, 24E and 38C in subsection 250-10(2), subsections 286-75(2B), 286-75(2C), 288-70(1) and 288-70(2), paragraph 288-70(2)(a), table item 6 in subsection 355-65(3), table item 5 in subsection 355-65(4), table item 2 in subsection 355-65(5) and Division 391 in Schedule 1 to the Taxation Administration Act 1953]

Consequential amendments

1.30 There are a number of Commonwealth Acts that contain provisions dealing with FHSAs or refer to FHSAs or concepts related to FHSAs.

1.31 As these provisions and references will become redundant following the repeal of the FHSA Act, they will be repealed as a consequence of these amendments. [Schedule 1, items 4 to 44, 118 to 150, 175 to 187, 193 to 194, the definitions of 'contribution', 'FHSA' and 'FHSA provider' in section 5 and table items 43A and 43B in subsection 6(2) of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006, the definition of 'prudential framework law' in subsection 3(1), paragraphs 3(2)(g) and (h), the note to subsection 3(2) and the definitions of 'protected document' and 'protected information' in subsection 56(1) of the Australian Prudential Regulation Authority Act 1998, paragraphs 12A(1)(h) and 12BAA(7)(ga) of the Australian Securities and Investments Commission Act 2001, subparagraph 11CA(1)(a)(iii), paragraph 11CA(1)(c), subparagraphs 11CA(2)(aa)(ii) and (iii), subsection 18A(5), the definition of 'reviewable decision of APRA' in section 51A, subsection 62A(4), paragraph 69(3)(b) and the note to subsection 69(3) of the Banking Act 1959, the definitions of 'FHSA product' and 'managed investment scheme' in section 9, the definition of 'basic deposit product' and 'FHSA product' in section 761A, table item 2A in subsection 761E(3), paragraphs 761E(3A)(ba), 764A(1)(ha) and 766E(3)(cb), subsection 946AA(1A), paragraph 961F(c), the definition of 'relevant financial product' in subsection 1016A(1) and subparagraphs 1017D(1)(b)(iiia) and 1019A(1)(a)(iiia) of the Corporations Act 2001, the definitions of 'leviable body', 'leviable FHSA entity' and 'levy' in section 7 and subsection 8(7) of the Financial Institutions Supervisory Levies Collection Act 1998, subparagraphs 14(2)(a)(ii) and (iii), 14(4)(b)(ii) and (iii), subsections 74(1), 74(2), 126(1), 126(2) and 216(1), the note to subsection 216(1), subsections 230A(14), 230B(11) and 236(1AA) of the Life Insurance Act 1995, paragraph 8(8)(ba), the definitions of 'financial investment', 'investment' and 'return' in subsection 9(1), paragraph 9(1C)(cb), subsection 9(9B), the definitions of 'trust', 'investment' and 'return' in subsection 23(1) and paragraphs 1118(1)(fa), 1207P(1)(c) and 1207P(1)(d) of the Social Security Act 1991, paragraphs 29G(2)(f) and (v), subsection 108A(3) and the note to subsection 108A(3) of the Superannuation Industry (Supervision) Act 1993, paragraph 5H(8)(ia), the definitions of 'financial investment', 'investment' and 'return' in subsection 5J(1), paragraph 5J(1C)(cb), subsection 5J(6B) and paragraphs 52(1)(faa), 52ZZB(1)(c) and 52ZZB(1)(d) of the Veterans' Entitlements Act 1986 and the heading specifying First Home Saver Accounts Act 2008 in Division 2 of Part 1 and items 4 and 5 in Schedule 8 of the Omnibus Repeal Day (Spring 2014) Act 2015]

Application and transitional provisions

Application and transitional provisions

General rules

1.32 The cessation of the FHSAs Scheme will have effect from 1 July 2015 - from this date FHSAs will cease to be FHSAs. [Schedule 1, items 195 and 197]

1.33 Consistent with this, the repeal of the FHSA Act as well as the various consequential repeals and amendments apply from 1 July 2015. [Schedule 1, items 195 and 197]

1.34 From this date, former FHSA holders will not receive any of the benefits of their accounts being first home savers accounts - for example, the account will now be taken into account in determining their eligibility for social security benefits. Similarly, FHSAs will also cease to be subject to the prior legislative restrictions - for example, a FHSA holder would be able to withdraw all of the money in their account for any purpose, regardless of what contributions they may have made and the current status of their account.

1.35 Consistent with the general rules around repeals of legislation, this repeal does not affect entitlements and obligations that have arisen prior to the day of repeal. The FHSA laws will continue to apply in relation to things done before 1 July 2015 and to things after 1 July 2015 in relation to entitlements and obligations that have arisen prior to the day of repeal. [Schedule 1, subitem 197(2) and items 200, 201 and 202]

1.36 For example, while a FHSA holder would now be able to freely withdraw the money held in their account, if they had withdrawn amounts before the repeal applied they are still potentially subject to FHSA misuse tax and penalties in relation to these withdrawn amounts. Similarly, while a FHSA provider would no longer be required to meet the reporting requirements that applied to FHSAs in respect of a former FHSA or requests to directly transfer the whole amount of a former FHSA into superannuation, they would remain subject to penalties for any breach of these requirements in relation to the period before the day of repeal.

1.37 However, certain reporting and other obligations under the FHSA Act will cease to apply from 1 July 2015 even where they arose in relation to matters before 1 July 2015 where the nature of the obligations would make them redundant following the repeal. [Schedule 1, item 203]

1.38 For the purposes of the tax law, as accounts will cease to be FHSA from 1 July 2015, the tax concessions relevant to FHSAs will have no application after this date and former FHSAs will be treated for tax purposes in the same way as any other savings or deposit account. For example, any interest payments made after 1 July 2015 will generally be income of the account holder and not that of the account provider.

1.39 The consequential repeal of the now inoperative provisions of the tax law dealing with FHSAs will also have effect from 1 July 2015. The saving and transitional provisions ensure that this repeal will not affect the tax treatment of FHSAs during the period prior to the repeal. [Schedule 1, subitem 197(2) and items 198 to 202]

1.40 The Commissioner, the Australian Securities and Investments Commission and the Australia Prudential Regulation Authority will retain the power to undertake compliance action with respect to the application of the laws relating to FHSAs before the day of repeal, and where necessary, undertake appropriate action, including recovery of past payments and enforcement against past breaches of the FHSA Act or tax law. [Schedule 1, items 198 to 202]

Government contributions

1.41 While the repeal of the FHSAs Scheme generally only applies from 1 July 2015, entitlement to a Government contribution will cease to arise from 1 July 2014. As a result, these amendments specify that no entitlement to a Government contribution will arise for the 2014-15 financial year or any later income year. [Schedule 1, subitem 204(1)]

1.42 However, this does not affect any existing entitlements of an individual to Government FHSA contributions that have already arisen prior to the repeal. [Schedule 1, subitem 204(2)]

1.43 Such existing entitlements will be rare - most taxpayers will have received any contribution to which they are entitled for the 2013-14 year prior to 1 July 2015 as all that they need do to claim their entitlement is to lodge a tax return for the income year.

1.44 However, if a taxpayer does not lodge a tax return and does not separately notify the Commissioner of their entitlement to a Government FHSA contribution, the period in which taxpayers could seek to claim an entitlement to a Government FHSA contribution is indefinite. However, in the context of the cessation of the FHSAs Scheme, maintaining the administrative framework necessary to process such claims indefinitely would impose an unreasonable burden on the Australian Taxation Office.

1.45 Instead, this Schedule will prevent the Commissioner from paying a Government FHSA contribution where the individual lodges the relevant tax return or gives the relevant notice after 30 June 2017. [Schedule 1, subitem 204(3)]

First Home Saver Accounts opened after Budget night

1.46 In its announcement of the cessation of the FHSAs Scheme, the Government made clear that FHSAs opened in respect of applications made after the announcement would not receive any of the benefits from the Scheme.

1.47 To give effect to this, the amendments will provide that such accounts have never been eligible to be FHSAs, with effect from Budget night. As a consequence, they will have never been entitled to matching Government contributions nor to any of the tax and social security concessions provided to FHSAs. [Schedule 1, item 196]

Tax file numbers

1.48 Following the repeal of the FHSA Act, individuals that quoted a tax file number to their FHSA provider for the purposes of the FHSA Act, will be taken to have quoted the tax file number to the entity that was their FHSA provider, in respect of the account that was a FHSA, for the purposes of the tax file number rules in Part VA of the ITAA 1936. [Schedule 1, item 205]

1.49 This ensures that individuals who have already quoted their tax file number need not quote it again simply because their account ceases to be a FHSA. Individuals that do not wish for their tax file number to be recorded in relation to an investment may contact the investment provider to request this at any time.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

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

Cessation of the First Home Saver Accounts Scheme

1.50 This Schedule 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

1.51 Schedule 1 to this Bill will repeal the legislation establishing the FHSAs Scheme and providing for the payment of the Government matching contribution - the First Home Saver Accounts Act 2008, the First Home Saver Account Providers Supervisory Levy Imposition Act 2008 and the Income Tax (First Home Saver Accounts Misuse Tax) Act 2008.

1.52 Schedule 1 will also amend the tax law and the social security law to remove tax and social security concessions available to first home saver accounts (FHSAs).

Human rights implications

1.53 This Schedule does not engage any of the applicable rights or freedoms.

1.54 Broadly, measures relating to the affordability of housing can engage the right to an adequate standard of living. This right, broadly, encompasses the right to have affordable and secure access to a habitable and accessible dwelling with that is provided essential services.

1.55 What this right does not encompass is a right to own a dwelling.

1.56 Obviously, a scheme that places individuals or groups that otherwise faced challenges in accessing adequate housing to purchase a home would be engage with the right to adequate housing.

1.57 However, the FHSAs Scheme is not such a scheme. The FHSAs Scheme provides concessions and Commonwealth support for individuals who are already in a position to save towards the purchase of their first home. Access to the Scheme is not linked to wealth or income and, the benefits it provides are both linked to how much an individual is able to save.

1.58 It is improbable that individuals would be in a position where they can afford to save the significant amounts to purchase a home, even with the assistance provided by the FHSAs Scheme, but are unable to obtain adequate housing on the rental market.

1.59 In addition, even if the FHSAs Scheme were engaged with the right, its removal would be a reasonable and proportionate measure.

1.60 Take up of the Scheme has been very limited, with only 47,000 FHSAs in existence as of September 2014 and there has been no evidence it has been effective in addressing concerns about housing affordability.

1.61 Maintaining a poorly subscribed scheme where there is little basis on which to conclude, it has achieved its intention or assisted in the access to adequate housing, is a reasonable step to address the legitimate objective of efficient use of government resources.

Conclusion

1.62 This Schedule is compatible with human rights as it does not raise any human rights issues.

Chapter 2 - Abolishing the dependent spouse tax offset

Outline of chapter

2.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) to:

•

abolish the dependent spouse tax offset (DSTO);

•

expand the dependant (invalid and carer) tax offset (DICTO) by removing the exclusion in relation to spouses previously covered by the dependent spouse tax offset;

•

remove an entitlement to DSTO where it is made available as a component of another tax offset, and replace that component with a component made up of DICTO; and

•

rewrite the notional tax offsets covering children, students and sole parents that are available as components of other tax offsets.

Context of amendments

Operation of the existing law

Dependency tax offsets

2.2 The dependency tax offsets are contained in the ITAA 1936 and were available for taxpayers who maintain certain classes of dependants, which are: spouses, invalid spouses, spouses who care for an invalid, housekeepers, housekeepers (with child), child-housekeepers, child housekeepers (with child), invalid relatives and parents/parents-in-law.

2.3 The dependency tax offsets have been subject to significant amendment over the years in which the offsets have been progressively phased-out or limited. The dependency tax offsets themselves now only apply to limited situations, however, the eligibility rules for those offsets that have been phased-out or limited continue to be used throughout the tax law for other purposes, resulting in significant complexity. This is because inoperative elements of the provision have to be retained and cross references updated to ensure any new limitations and phase-outs are ignored for the purposes of the relevant sections.

Dependent spouse tax offset

2.4 The DSTO is a tax offset that is intended to deliver a concession to taxpayers who maintain a dependent spouse. The DSTO is worth up to $2,471 (indexed) in 2013-14. Generally, eligibility for the DSTO is currently limited to taxpayers who have a spouse born before 1 July 1952.

2.5 The DSTO is contained in section 159J of the ITAA 1936 along with a number of other dependant tax offsets.

2.6 Taxpayers eligible to receive an amount of the zone tax offset (ZTO), overseas civilians tax offset (OCTO) or overseas forces tax offset (OFTO) are effectively exempt from the phase-out of DSTO. These taxpayers may claim an additional amount equal to the DSTO for a dependent spouse born after 1 July 1952 as part of their entitlement to ZTO, OCTO or OFTO. In addition, they may also receive 50 per cent or 20 per cent of the DSTO ($1,236 or $494 (as indexed for 2013-14)) as a further component of their ZTO, OCTO or OFTO.

2.7 The DSTO is income tested, based on the taxpayer's and the spouse's adjusted taxable income. In addition, a taxpayer cannot claim the DSTO in respect of any part of a year for which the taxpayer or their spouse is eligible for Family Tax Benefit Part B (FTB Part B). However, this condition does not apply to the equivalent amount made available under the ZTO, OCTO or OFTO.

Dependant (invalid and carer) tax offset

2.8 A taxpayer may be entitled to the DICTO for an income year if, during that year, they contributed to the maintenance of an eligible dependant. (Subdivision 61-A of the ITAA 1997.)

2.9 The circumstances whereby a taxpayer may be found to contribute to the maintenance of an eligible dependant are not limited. However, where the taxpayer and the dependant reside together, the taxpayer would generally be considered to have contributed to the maintenance of that dependant.

2.10 An eligible dependant may be:

•

a taxpayer's spouse, parent, child (aged 16 years or over), brother or sister (aged 16 years or over) who is genuinely unable to work due to invalidity;

•

the taxpayer's spouse's parent, brother or sister (aged 16 years or over), who is genuinely unable to work due to invalidity; or

•

a taxpayer's spouse or parent/parent-in-law, who is genuinely unable to work due to carer obligations.

2.11 A dependant is considered to be genuinely unable to work due to invalidity where that person receives: a disability support pension or a special needs disability support pension under the Social Security Act 1991; or an invalidity service pension under the Veterans' Entitlements Act 1986.

2.12 A dependant is considered to be genuinely unable to work due to carer obligations if they are:

•

receiving a carer payment or carer allowance under the Social Security Act 1991; or

•

wholly engaged in providing care to a relative who receives a disability support pension or a special needs disability support pension under the Social Security Act 1991 or an invalidity service pension under the Veterans' Entitlements Act 1986.

Background

2.13 The dependency tax offsets originate from a time when the single income family was the norm, and the welfare system was in its infancy. In recent years, former Parliaments enacted amendments to limit the number of people who could receive a tax concession in respect of their dependant.

2.14 In their 2008-09 Budget, the former Government announced the introduction of an income test for the dependency offsets, linking the income limit to that for FTB Part B. This was estimated to raise $125 million over the forward estimates at the time.

2.15 The DSTO is already being phased-out for most taxpayers. The former Government implemented several measures phasing out the DSTO and consolidating the other dependency offsets.

2.16 In their 2011-12 Budget, it was announced that DSTO would be restricted to taxpayers with a spouse born before 1 July 1971, with an estimated revenue gain at the time of $755 million over the forward estimates.

2.17 In their 2011-12 Mid-year Economic and Fiscal Outlook, it was announced that eligibility for DSTO would be further restricted to taxpayers with a spouse born before 1 July 1952, with an estimated revenue gain at the time of $370 million over the forward estimates.

2.18 In their 2012-13 Budget, it was announced that the eight other dependency tax offsets would be consolidated into a single offset that could be claimed by taxpayers maintaining certain dependants who were genuinely unable to work due to invalidity or carer obligations. At the time, this was estimated to generate revenue of $70 million over the forward estimates.

2.19 Taxpayers eligible to receive ZTO, OCTO or OFTO were not affected by these measures.

2.20 In addition, the proposal to have the consolidation of the dependency offsets begin to apply to taxpayers eligible for the ZTO, OCTO or OFTO means that these taxpayers: would no longer be able to receive a concession for a parent or parent-in-law who is able to work, or for a housekeeper or a child housekeeper; but may be able to receive a higher amount of offset for an invalid relative, or for a parent or parent-in-law who is genuinely unable to work.

Summary of new law

2.21 Schedule 2 to this Bill amends the ITAA 1936 and the ITAA 1997 to:

•

repeal the provisions providing an entitlement to the DSTO, and associated cross references to the DSTO contained in other provisions in the tax law;

•

expand the DICTO by repealing the provision excluding spouses covered by the dependent spouse tax offset from being covered by DICTO;

•

remove the DSTO and instead allow the DICTO to be claimed as a component of the ZTO, OCTO, OFTO; and

•

rewrite the notional tax offsets contained in the ITAA 1936 covering children, students and sole parents into the ITAA 1997 (which are used for calculating components of ZTO, OCTO and OFTO) and update cross references to reflect the rewrite.

Comparison of key features of new law and current law

Detailed explanation of new law

Repealing the dependent spouse tax offset

2.22 Schedule 2 to this Bill repeals sections 159J and 159JA of the ITAA 1936. The effect of the repeal is to abolish the DSTO for all taxpayers. [Schedule 2, item 16]

2.23 Schedule 2 to this Bill also repeals cross references to the DSTO included in sections 23AB (about OCTO), 79A (about ZTO) and 79B (about OFTO) of the ITAA 1936. The effect of removing these cross- references is to abolish a secondary form of access to the DSTO for taxpayers receiving a ZTO, OCTO or OFTO. [Schedule 2, items 1, 3, 4, 6, 7, 9, 11 and 13 to 15, subsections 23AB(7), 23AB(7A), 79A(2), 79A(4), 79B(2), 79B(4), 79B(4A) and 79B(6) of the ITAA 1936]

Expanding eligibility for the dependant (invalid and carer) tax offset

2.24 Schedule 2 repeals paragraphs 61-10(1)(d) and (e) of the ITAA 1997. The effect of the repeal is to broaden eligibility for the DICTO to cover those spouses who genuinely are unable to work due to invalidity or carer obligations that were previously covered by the DSTO. [Schedule 2, item 28, subsection 61-10(1) of the ITAA 1997]

2.25 Schedule 2 also incorporates the DICTO into the ZTO, OFTO and OCTO as a 'concessional/relevant rebate amount' so that an additional 20 per cent or 50 per cent of a taxpayer's DICTO entitlement can be claimed as a component of those offsets. This replaces the 20 per cent or 50 per cent of a taxpayer's DSTO entitlement (ignoring eligibility conditions) that could previously be claimed as part of the ZTO, OFTO and OCTO. [Schedule 2, items 3, 7 and 14, subsections 23AB(7A), 79A(4) (definition of 'relevant rebate amount'), and 79B(6) (definition of 'concessional rebate amount') of the ITAA 1936]

Rewrite of the notional tax offsets

2.26 While the dependency tax offsets provisions contained in sections 159J, 159JA, 159K, 159L, 159LA and 159M of the ITAA 1936 no longer apply in respect of any income year, certain elements of those offsets do operate as notional tax offsets for purposes of other taxation laws.

2.27 The dependent child/dependent student tax offset (section 159J) and the sole parent tax offset (section 159K) do not provide any taxpayer with a tax offset and have not provided a tax offset to any taxpayer for a number of years. However, those two offsets are used to calculate the amount of a taxpayer's ZTO and OFTO, and the dependent child/dependent student tax offset is used to calculate the amount of taxpayer's OCTO. This is because those offsets incorporate, as a component of a larger entitlement, a portion of other offsets a taxpayer may be entitled to, even if that entitlement is notional.

2.28 Dependants for whom a taxpayer may be entitled to a notional offset can also be dependants for the purposes of the net medical expenses tax offset and the Medicare levy family income threshold.

2.29 As the dependency tax offsets have been the subject of numerous amendments over the last 50 years, the provisions are now extremely complex and difficult to understand and apply. For this reason, this Bill also rewrites parts of the dependency tax offsets that are still required into the ITAA 1997.

2.30 The notional dependant (non-student child under 21 or student) tax offset contained in section 159J of the ITAA 1936 has been rewritten into the ITAA 1997. [Schedule 2, item 17, Subdivision 961-A of the ITAA 1997]

2.31 The effect of section 159J has been replicated into the rewritten provision. There are no changes to the operation of that notional offset.

2.32 The notional sole parent tax offset in section 159K of the ITAA 1936 has also been rewritten into the ITAA 1997. There are no changes to the operation of that notional offset. [Schedule 2, item 17, Subdivision 961-B of the ITAA 1997]

Consequential amendments

Cross references to the notional tax offsets

2.33 The amendments replace cross references to the old notional tax offsets to the new notional tax offsets. [Schedule 2, items 21 to 23 and 30 to 32]

2.34 The amendments to the definition of 'dependant' for the purposes of the net medical expenses tax offset has been updated to remove all references to dependants for which a rebate under section 159J may be available and instead refer only to dependents who are the taxpayer's spouse, child (under 21) or who are covered by the notional tax offsets or DICTO. [Schedule 2, items 21 and 22]

Repeal of redundant provisions

2.35 Provisions that are redundant as a result of the repeal of the dependent spouse tax offset are repealed. [Schedule 2, items 18 to 20, 24 to 26 and 33]

Technical amendments

2.36 A number of technical amendments are made to the DICTO to ensure it operates as intended. The intended operation of DICTO is set out in the explanatory memorandum to the Tax and Superannuation Laws Amendment (2013 Measures No. 2) Bill 2013.

2.37 These technical amendments are beneficial to taxpayers.

Application and transitional provisions

2.38 The amendments generally apply to the 2014-15 income year and to all later income years. [Schedule 2, item 38]

2.39 The technical amendments apply to the 2012-13 income year and to all later income years which align with the introduction of the DICTO. The amendments are all beneficial to taxpayers. [Schedule 2, item 39]

Finding tables

2.40 This Chapter includes finding tables to help you locate which provision in this Bill corresponds to a provision in the current law that has been rewritten, and vice versa.

2.41 References to old law in the finding tables are to these provisions in the ITAA 1936.

2.42 References to the new law are to provisions of the ITAA 1997, unless otherwise indicated. Also, in the finding tables:

•

No equivalent means that this is a new provision that has no equivalent in the current law. Typically, these would be guide material.

•

Omitted means that the provision of the current law has not been rewritten in the new law.

Finding table 1 - old law to new law

Finding table 2 - new law to old law

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

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

Abolishing the dependent spouse tax offset

2.43 This Schedule 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

2.44 Schedule 2 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) to:

•

abolish the dependent spouse tax offset (DSTO);

•

expand the dependant (invalid and carer) tax offset (DICTO) by removing the exclusion in relation to spouses previous covered by the dependent spouse tax offset; and

•

rewrite the notional tax offsets covering children, students and sole parents.

Human rights implications

2.45 The Committee has previously sought further information in respect of the consolidation of the dependency tax offsets and a number of human rights.^[1] The then Assistant Treasurer's response was published in a subsequent report of the Committee.^[2]

2.46 The measure contained in Schedule 2 does not engage any of the applicable rights or freedoms. However, given the Committee's previous view in relation to the consolidation of the dependency tax offsets, the following is noted in relation to the right to social security and the right to an adequate standard of living, family and children's rights.

2.47 The measure contained in Schedule 2 does not alter an individual's entitlement to direct assistance through the social security system.

2.48 The dependency tax offsets originate from a time when the single income family was the norm, and the welfare system was in its infancy. Over time, the means by which Parliaments have provided assistance to families has changed to reflect changing Australian society.

2.49 Whilst at times it is appropriate to use the tax system to provide assistance, the dependency tax offsets have been subject to significant amendment over the years in which the offsets have been progressively phased-out or limited and replaced with more appropriate forms of direct assistance.

2.50 The dependency tax offsets themselves now only apply to limited situations, however, the eligibility rules continue to be used throughout the tax law for other purposes which have resulted in significant complexity. This is because inoperative elements of the provision have to be retained and cross references updated to ensure any new limitations and phase-outs are ignored for the purposes of the relevant sections.

2.51 The objective of the measure contained in Schedule 2 is to further simplify the system of tax offsets in line with the previous amendments to consolidate the dependency offsets and Government budget priorities.

2.52 The effect of the measure is to remove the remaining limited eligibility to the dependent spouse tax offset for taxpayers with dependent spouses born before 1 July 1952 and those taxpayers eligible to receive an equivalent amount as part of their zone tax offset (ZTO), overseas civilians tax offset (OCTO), or overseas forces tax offset (OFTO). The amendments generally apply to the 2014-15 income year and to all later income years.

2.53 However, a taxpayer may be entitled to the DICTO (the consolidated offset) for an income year if, during that year, they contributed to the maintenance of an eligible dependant. (Subdivision 61-A of the ITAA 1997.)

2.54 The circumstances whereby a taxpayer may be found to contribute to the maintenance of an eligible dependant are not limited. However, where the taxpayer and the dependant reside together, the taxpayer would generally be considered to have contributed to the maintenance of that dependant.

2.55 An eligible dependant may be:

•

a taxpayer's spouse, parent, child (aged 16 years or over), brother or sister (aged 16 years or over) who is genuinely unable to work due to invalidity;

•

the taxpayer's spouse's parent, brother or sister (aged 16 years or over), who is genuinely unable to work due to invalidity; or

•

a taxpayer's spouse or parent/parent-in-law, who is genuinely unable to work due to carer obligations.

2.56 A dependant is considered to be genuinely unable to work due to invalidity where that person receives a disability support pension or a special needs disability support pension under the Social Security Act 1991, or an invalidity service pension under the Veterans' Entitlements Act 1986.

2.57 A dependant is considered to be genuinely unable to work due to carer obligations if they are:

•

receiving a carer payment or carer allowance under the Social Security Act 1991; or

•

wholly engaged in providing care to a relative who receives a disability support pension or a special needs disability support pension under the Social Security Act 1991 or an invalidity service pension under the Veterans' Entitlements Act 1986.

2.58 It is estimated that around 85,000 to 90,000 taxpayers will claim DSTO with respect to the 2012-13 income year, and that around three quarters of these taxpayers utilised this offset to reduce their income tax liability. Around 6,000 taxpayers are estimated to be able to claim the DICTO, instead of DSTO, for a dependent spouse who is invalid or cares for an invalid and would not be worse off under the proposal.

2.59 In addition, the proposal to have the consolidation of the dependency offsets begin to apply to taxpayers eligible for the ZTO, OCTO or OFTO means that these taxpayers would no longer be able to receive a concession for a parent or parent-in-law who is able to work, or for a housekeeper or a child housekeeper; but would be able to receive a higher amount of offset for an invalid relative, or for a parent or parent-in-law who is genuinely unable to work.

Conclusion

2.60 This Schedule is compatible with human rights as it does not raise any human rights issues.

Chapter 3 - Modernising the Offshore Banking Unit regime

Outline of chapter

3.1 Schedule 3 to this Bill makes a number of reforms to modernise the Offshore Banking Unit (OBU) regime. The reforms include measures implementing recommendations of the Australia as a Financial Centre - Building on Our Strengths report by the Australian Financial Centre Forum chaired by Mark Johnson. The reforms also include targeted amendments to address a number of integrity concerns with the existing regime.

Context of amendments

3.2 The amendments in Schedule 3 are made to the OBU regime contained in Division 9A of the Income Tax Assessment Act 1936 (ITAA 1936). All legislative references in this Chapter are to the ITAA 1936 unless otherwise specified.

3.3 The regime is designed to provide tax incentives to attract and maintain highly mobile financial sector activities within Australia. These activities broadly include:

•

financial intermediation between offshore lenders and offshore borrowers; and

•

providing other financial services to offshore investors investing outside Australia.

3.4 Assessable income from eligible offshore banking (OB) activities is effectively subject to a tax rate of 10 per cent, rather than the corporate tax rate of 30 per cent. This is achieved by bringing to account only an 'eligible fraction' of income from OB activities and associated expenses (section 121EG).

3.5 In addition, under Division 11A, interest payments made by OBUs when borrowing from offshore are not subject to interest withholding tax when the borrowed funds are used to carry on eligible OB activities (sections 128GB and 128NB).

Operation of the existing law

3.6 An OBU is a notional division or business unit of an Australian entity that conducts OB activities. To be considered an OBU, an entity must be declared by the Treasurer as an OBU.

3.7 An OBU receives concessional tax treatment in respect of eligible OB activities, provided additional criteria are met. The list of eligible OB activities is provided at paragraph 3.21.

Trading activity

3.8 One kind of eligible OB activity is trading activities (subsection 121D(4)). Amongst other things, trading activities include trading with an offshore person in shares and other membership interests of non-resident entities. As a result, trading in the shares of an offshore subsidiary may constitute an eligible OB activity.

3.9 This has the effect of allowing the conversion of ineligible non-OB activities to eligible OB activities. That is, the offshore subsidiary may undertake ineligible activities and the OBU may claim the same economic benefit as assessable OB income by trading in the shares it owns in the subsidiary.

The choice principle

3.10 A taxpayer that is an OBU may engage in activities that are not eligible OB activities. These activities are said to be undertaken by the taxpayer's domestic banking unit (DBU) - another notional division of the entity. The taxpayer must keep separate accounting records for their OBU and DBU activities (subsection 262A(1A)).

3.11 The Commissioner of Taxation (Commissioner) has expressed the view that a taxpayer is entitled to make the choice, at the time of entering into an eligible OB activity transaction, to treat the activity as if it were ineligible. This treatment can be achieved by the taxpayer recording the transaction in its non-OBU accounting records ( TD 93/135 ). A consequence of this choice is that any income from the transaction is not entitled to concessional taxation as assessable OB income. Similarly, expenses or losses on the transaction are entitled to deductions at the full corporate tax rate.

3.12 As the transaction is treated as not being an OB activity, the associated income does not risk the taxpayer failing the purity test in section 121EH if the activity was financed through non-OB money.

3.13 Furthermore, by choosing to attribute offshore borrowing to its DBU, the taxpayer can avoid a recoupment of exempted withholding tax by not claiming the exemption under section 128GB (see section 128NB of the ITAA 1936, and the Income Tax (Offshore Banking Units) (Withholding Tax Recoupment) Act 1988). This choice is necessary where, for example, the taxpayer intends to apply offshore borrowings to its domestic lending activities.

3.14 In 2007, the Commissioner released a discussion paper that considered the withdrawal of TD 93/135, although the determination has not been withdrawn. The availability of the choice referred to in TD 93/135 enables taxpayers to avoid inadvertent breaches of the purity test and the imposition of withholding tax recoupment penalties. The status of the choice principle as an administrative interpretation creates some uncertainty for participants in the regime.

Allocation of expenses

3.15 The expenses of a taxpayer with an OBU must be allocated between the taxpayer's DBU and OBU. Deductions for expenses allocated to each unit are deductible at a 30 per cent and 10 per cent tax rate respectively.

3.16 Section 121EF uses a number of concepts to categorise deductions:

•

Allowable OB deductions, which include:

•

exclusive OB deductions, which relate only to deriving assessable OB income;

•

some general OB deductions; or

•

some apportionable OB deductions.

•

Loss deductions (per Division 36 of the Income Tax Assessment Act 1997 (ITAA 1997)).

•

Exclusive non-OB deductions, which relate only to non-OB assessable income.

3.17 General deductions, which do not relate exclusively to assessable OB or assessable non-OB income (and are not loss or apportionable deductions) are allocated to the OBU on the basis of a statutory formula. The formula allocates these deductions according to the proportion of the taxpayer's adjusted assessable income (assessable income less exclusive interest deductions) that consists of adjusted OB income.

3.18 The use of adjusted assessable income is intended to prevent distortions arising from low-margin OB activities (see the explanatory memorandum to the Taxation Laws Amendment Bill (No. 4) 1992, paragraphs 32-33).

3.19 Apportionable deductions, as defined in subsection 6(1), relate to neither assessable OB income nor assessable non-OB income and are allocated according to a separate statutory formula in subsection 121EF(5).

3.20 Section 121EF does not expressly refer to deductions allowable for expenses incurred in deriving non-assessable non-exempt (NANE) income, for example, deductions for interest costs under section 25-90 of the ITAA 1997. As such, the current law treats these deductions as deductions to be allocated according to the existing statutory formula for determining general OB deductions.

The list of eligible OB activities

3.21 The list of eligible activities is contained in section 121D of the ITAA 1936. The current list includes:

•

borrowing and lending activities;

•

guarantee-type activities;

•

trading activities;

•

eligible contract activities;

•

investment activities;

•

advisory activities;

•

hedging activities; and

•

activities prescribed in the regulations.

3.22 Certain requirements apply before a listed activity is eligible to produce concessional OB income for the OBU. Section 121EA ensures that the OBU undertakes the OB activities within Australia. Furthermore, many of the activities are only eligible when undertaken with counterparties that meet the definition of 'offshore person' in section 121E.

3.23 The list of eligible activities has remained constant since 1998. Furthermore, no regulations have been made prescribing additional activities relevant to modern commercial practice.

Internal financial dealings

3.24 Section 121EB treats the different permanent establishments of an OBU as separate persons in working out if there are eligible OB activities under sections 121D to 121EA. This enables an OBU to deal with its offshore permanent establishment and satisfy the requirement for dealing with an offshore person.

3.25 As a result, the existing law contemplates that an OBU may source funding internally from its own offshore branch operations for the purposes of applying the OB money funding requirements.

3.26 The existing law does not stipulate that the internal dealings are to be priced on an arm's length basis. The transfer pricing rules in Division 815 of the ITAA 1997 may apply to a number of potential transactions involving OBUs. However, the internal dealings within a single entity are not subject to the application of an arm's length requirement under the existing transfer pricing rules.

Summary of new law

3.27 Schedule 3 implements a number of reforms to the OBU regime. These include:

•

limiting the availability of the OBU concession in certain circumstances where it could otherwise be used to convert an ineligible activity into an eligible OB activity;

•

codifying the choice principle to remove uncertainty for taxpayers;

•

introducing a new method of allocating certain expenses between the operations of a taxpayer's DBU and OBU;

•

modernising the list of eligible OB activities; and

•

treating internal financial dealings (for example, between an entity's DBU and OBU) as if they were on an arm's length basis.

Comparison of key features of new law and current law

Detailed explanation of new law

Part 1: Trading activity

3.28 Part 1 of Schedule 3 limits the eligible trading activity in certain situations.

3.29 Under the existing law, an OBU may trade with an offshore person in the shares and other membership interests it has in an offshore subsidiary (paragraphs 121D(4)(a) and (b)). This trading activity may constitute an eligible OB activity, even if the subsidiary is undertaking ineligible non-OB activities.

3.30 This makes it possible to convert ineligible non-OB activities to eligible OB activities, by allowing the OBU to undertake ineligible activities through an offshore subsidiary, and trading in the interests of the subsidiary.

Total participation interest of 10 per cent or more

3.31 To address this integrity concern, the amendments limit the scope of the eligible trading activity category. Trading in things, such as shares, that affect the total participation interest in another entity will no longer be an eligible OB activity if the total participation interest is 10 per cent or more just before the trading activity occurred. [Schedule 3, items 1 and 2, paragraph 121D(1)(c), paragraph 121D(4A)(a) and subparagraph 121D(4A)(b)(i) of the ITAA 1936]

3.32 'Total participation interest' is an existing concept used in section 960-180 of the ITAA 1997. It includes both direct and indirect participation interests. However, for the purposes of the new law, any rights that the OBU may have, directly or indirectly, on the winding-up of the entity are disregarded in determining the total participation interest. The rights on winding-up may vary considerably from other interests and can therefore distort the total participation test. [Schedule 3, item 2, subsection 121D(4B) of the ITAA 1936]

3.33 This amendment will ensure that trading in subsidiaries, or other entities where the OBU holds an interest of at least 10 per cent, no longer attracts concessional tax treatment.

Example 3.1: Change in participation interest

On 1 July 2015, AusOBU holds a total participation interest in an offshore company, Forco, of 20 per cent.

On 3 July 2015, AusOBU buys more shares in Forco, taking its total participation interest to 25 per cent. Under the new law, the purchase of the shares will not be an eligible OB trading activity, because AusOBU holds a participation interest of at least 10 per cent.

On 6 July 2015, AusOBU sells some of its shares in Forco, taking its total participation interest to 7 per cent. Under the new law, the sale of the shares will not be an eligible OB trading activity because AusOBU's total participation interest just before the sale was more than 10 per cent.

Example 3.2: No net change in participation interest

On 1 July 2015, AusOBU holds a total participation interest in an offshore company, SJP Ltd, of 20 per cent.

On 3 July 2015, AusOBU buys more shares in SJP Ltd, taking its total participation interest to 25 per cent. Later that day, AusOBU decides to sell some shares in SJP Ltd, so that its total participation interest returns to 20 per cent.

Under the amendments, neither the purchase nor sale of the shares is an eligible OB trading activity. Even though there is no net change in the total participation interest, the new law considers whether the thing (in this case, the shares) affected the total participation interest, rather than whether the trade of the thing affected the total participation interest.

Participation interests not held for trading

3.34 Trading in a thing that affects the total participation interest will not be an eligible OB activity if, just before the trading activity, any of the traded interest the OBU held was not recorded in the OBU's accounting records as held for trading in accordance with the accounting standards. [Schedule 3, item 2, subparagraph 121D(4A)(b)(ii) of the ITAA 1936]

3.35 This rule applies even if the total participation interest is less than 10 per cent just before the trading activity.

3.36 This rule is intended to clarify that the 'trading activity' limb applies to genuine trading activity, as evidenced by the OBU's accounting records.

3.37 This is determined by reference to the accounting standards issued by the Australian Accounting Standards Board. Currently, accounting standard AASB 9 Financial Instruments defines held for trading as a financial asset or financial liability that:

•

is acquired or incurred principally for the purpose of selling or repurchasing it in the near term;

•

on initial recognition is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking; or

•

is a derivative (except for a derivative that is a financial guarantee contract or a designated and effective hedging instrument).

Example 3.3: Interests not held for trading

AusOBU holds an investment in a Singaporean company, MP Ltd. This investment is not recorded as being 'held for trading' in AusOBU's accounting records. AusOBU's acquired this investment as part of its long-term strategy to increase its exposure to the Singaporean market, rather than for the principal purpose of selling or repurchasing it for short term gains.

Any trading of AusOBU's investment will not be an eligible OB trading activity.

3.38 The amendments in Part 1 only limit the scope of the eligible trading activity. In some circumstances, an activity ineligible for concessional treatment as a trading activity may be eligible as a contract activity, for example.

Part 2: The choice principle

3.39 Part 2 of Schedule 3 codifies the choice principle articulated in TD 93/135.

3.40 A taxpayer may choose to treat a transaction that is an eligible OB activity as if it was ineligible. The choice must be made when the transaction is entered into. Once made, the choice is irrevocable and effective for all purposes. [Schedule 3, item 6, subsection 121EAA(1) of the ITAA 1936]

3.41 A taxpayer may evidence this choice by entering the transaction in their non-OB accounting records rather than the OB accounting records maintained under subsection 262A(1A). [Schedule 3, items 4 and 6, section 121C and subsections 121EAA(2) and (3) of the ITAA 1936]

3.42 In relation to certain eligible OB activities, the OBU may not 'use money' in the sense required for the transaction to be eligible for entry into the entity's OB accounting records (see subsection 262A(1A) and TD 93/214 ). Where the entity has no choice but to record the transaction in its non-OB accounting records, recording the transaction in this way will not be evidence of a choice. If a choice is made in these circumstances to treat an activity as if it were ineligible, the choice should be recorded in some other way to satisfy paragraph 262A(2)(b).

Example 3.4: Evidencing a choice where no money is used

An OBU undertakes eligible portfolio management activities for a non-resident. The OBU does not 'use money' for the purposes of subsection 262A(1A) when managing the portfolio.

The OBU necessarily records its fee income earned from the activity in its non-OB accounting records. This will not be taken as evidence of a choice by the OBU to treat the activity as an ineligible activity.

The OBU will remain eligible for the concessional treatment of the fee income.

If the OBU wished to exercise the choice, it would need to make a specific record of that choice (paragraph 262A(2)(b)).

3.43 Regardless of how the choice is recorded, the record should be made as soon as practicable after the taxpayer enters into the transaction. This is consistent with the existing interpretation of the obligation to maintain records generally (section 262A and TR 96/7 , paragraphs 49 and 50).

3.44 Once made, the choice is irrevocable. However, the recording of a choice (including a choice to treat the activity as an eligible activity) may be corrected if the record was made by mistake. That is, the record may be altered only where the recording was inadvertent and did not give effect to the actual intent of the taxpayer at the time the transaction was entered into.

3.45 The choice principle is not applicable to ineligible activities. An OBU must record a transaction that is not an eligible OB activity in its non-OB accounts.

Grouping of transactions

3.46 Making the choice in relation to one transaction will have an impact on the treatment of other transactions if the transactions are part of the same scheme. If a taxpayer choses to treat a particular transaction that is an eligible OB activity as if it were ineligible, all other transactions within the same scheme are treated as if they are ineligible. [Schedule 3, item 6, subsection 121EAA(4) of the ITAA 1936]

3.47 Transactions will be considered to form a single scheme where it is reasonable to do so. This is a question of fact and degree. The question can be determined by having regard to a number of factors. These factors draw on the factors used to group rights and obligations into arrangements under section 230-55 of the ITAA 1997. [Schedule 3, item 6, subsections 121EAA(4) to (6) of the ITAA 1936]

3.48 To determine whether a number of transactions arise under one or more schemes, regard is to be given to the:

•

nature of those transactions, when considered separately and in combination (including having regard to the substance and character of the rights obligations created);

•

terms and conditions of the transactions, including having regard to the legal terms of the rights and obligations created in their economic context, including those relating to the amount and timing of the consideration to be paid or received, and the pricing of those rights and obligations relative to what would otherwise be expected of such rights and obligations, when considered separately and together;

•

circumstances surrounding the entering into of the transaction and the proposed exercise or performance of rights and obligations created, (including what can reasonably be seen as the purposes of one or more of the parties involved), when the rights and obligations are considered separately and when considered in combination;

•

whether the rights and obligations created can be dealt with separately or whether they must be dealt with together (for example, the separate interests that comprise a stapled security cannot be dealt with separately);

•

normal commercial understandings and practices in relation to the transactions when considered separately and when considered in combination, including whether commercially they are regarded as separate things or as a group or a series that forms a whole; and

•

objects of the OBU regime.

Example 3.5: Asymmetric swap scheme

A taxpayer enters into an asymmetric swap scheme with an offshore counterparty. The scheme comprises of two swaps that take opposite positions on an underlying commodity.

Under the new law, the taxpayer must make the same choice in respect of both swaps. That is, the taxpayer cannot choose to treat one swap as an eligible OB activity, and the other swap as an ineligible activity.

Example 3.6: Loan facilities

A taxpayer operates an OBU and a DBU. The taxpayer secures a loan facility from a third-party lender. The taxpayer draws down funds on behalf of its OBU and DBU under the facility.

The taxpayer chooses to treat the drawdown of funds for the DBU as though it was not an eligible OB activity. The creation of the facility, the drawdown of funds for the DBU and the drawdown of funds for the OBU are each separate schemes.

The choice made with respect to the DBU funding does not prevent the borrowing for the OBU being an eligible OB activity.

Example 3.7: Umbrella trading arrangements and hedging

A taxpayer enters into an umbrella trading arrangement with an offshore person. The arrangement covers a broad range of transactions.

The taxpayer hedges a number of eligible OB trading activities. The hedging is not an eligible OB activity. Consequently, the taxpayer chooses to treat the hedged trading activities as ineligible activities.

The umbrella arrangement also covers a number of eligible OB trading activities that are not hedged through ineligible transactions. The grouping rules do not apply to treat these transactions as ineligible activities. It is not a normal commercial practice to understand the two trading activities, one hedged by ineligible activities and the other not, as comprising a single scheme.

3.49 Further examples, relevant to the interpretation of section 230-55 of the ITAA 1997, on which these amendments draw, are contained in the explanatory memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008. Regard may be had to these examples when interpreting the present amendments. It is important to note, however, that the objects of the Taxation of Financial Arrangements rules are different to the object of the OBU regime and the relevant provisions assess different things (for example, transactions rather than rights and obligations).

3.50 The grouping rules do not apply merely because one or more transactions, being eligible OB activities, are associated with one or more ineligible transactions. No choice can be made in relation to ineligible transactions.

Example 3.8: Ineligible activities

An OBU creates a loan facility for a corporate group. The parent company of the group is an offshore person but the group contains an Australian subsidiary. Under the facility, all members of the group can drawdown funds from the taxpayer.

Lending to the Australian subsidiary is an ineligible activity. No choice can be made under subsection 121EAA(1). The grouping rules in subsections 121EAA(4) to (6) are not engaged. The lending to the offshore persons within the group remains an eligible OB activity.

Part 3: Allocation of expenses

3.51 Part 3 of Schedule 3 sets out a new framework for allocating deductions that relate to both OB and non-OB income, such as rent on a building used for both OBU and DBU activities, between the taxpayer's OBU and DBU.

3.52 Under the current law, certain deductions must be apportioned using a statutory formula, which is based on adjusted income allocated to the taxpayer's OBU and DBU.

3.53 The effect of the amendments is to replace the statutory formula with a rule that the unallocated deduction is allocated to the taxpayer's OBU to the extent that it relates to OB income. This is achieved by amending the definition of a general OB deduction. The new rule draws on the apportionment principles applicable to the general deduction provision in section 8-1 of the ITAA 1997. [Schedule 3, item 15, subsection 121EF(4) of the ITAA 1936]

3.54 The definition of a general OB deduction under the new law requires that the deduction relate to OB income, rather than 'assessable' OB income. This is intended to cater for deductions that relate to expenses incurred in deriving NANE income, as well as assessable income.

3.55 For example, deductions claimed under section 25-90 of the ITAA 1997 could be apportioned using this new rule. Section 25-90 deductions relate to interest and other similar expenses incurred in deriving dividends that are NANE income under section 768-5 of the ITAA 1997.

3.56 To support the new definition of a general OB deduction, the new law inserts a definition of 'OB income' and modifies the current definition of 'assessable OB income'. [Schedule 3, items 13 and 14, section 121EDA and subsection 121EE(2) of the ITAA 1936]

3.57 The definition of 'OB income' is based on the existing definition of 'assessable OB income', with appropriate modifications. The definition of 'assessable OB income' has been modified to be so much of OB income as is assessable.

Part 4: Eligible activities

3.58 Part 4 of Schedule 3 modernises the existing list of eligible OB activities in section 121D of the ITAA 1936. This ensures that the OBU regime operates as intended by attracting mobile financial sector activity.

Creation of lending facilities

3.59 The list of eligible activities includes lending money to an offshore person. To this, the amendments add the activity of making a commitment to lend money, even where the commitment is not funded. [Schedule 3, items 18 and 22, section 121C and paragraph 121D(2)(b) of the ITAA 1936]

3.60 A commitment to lend money is where an OBU makes funds available to an offshore person but the funds are not drawn down, or are yet to be drawn down. Income in the form of fees for making the credit facility available is mobile income and will be treated accordingly as assessable OB income.

3.61 The new element of the activity will be subject to the existing currency restrictions in paragraph 121D(2)(b).

Syndicated lending activities

3.62 A syndicated lending arrangement involves a number of financial institutions lending to a borrower. Syndicated arrangements are common in large capital raisings. In addition to committing to lend their own capital, an OBU may be involved in arranging contributions from a syndicate of other lenders. The OBU may also be involved in underwriting some of the credit risk. The OBU will earn a fee for these services.

3.63 The position of arranger within a syndicate is highly mobile. An amendment is made to include undertaking the services of an arranger in the list of eligible OB activities. This amendment ensures that any such service is an eligible OB activity regardless of whether it also falls within the scope of paragraph 121D(3)(c). [Schedule 3, item 23, paragraph 121D(2)(e) of the ITAA 1936]

Guarantee activities and connections with Australia

3.64 Subsection 121D(3) lists four guarantee activities as eligible OB activities. Three of the activities are restricted to (relevantly) activities that are conducted wholly outside Australia, property located outside Australia and events that can only happen outside Australia.

3.65 These strict restrictions limit the application of the concession and are inappropriate where the connection between Australia and the relevant activities is not significant. Accordingly, an amendment is made to require only that the activity not relate, to a material extent, to a place within Australia. [Schedule 3, items 18, 24 and 25, section 121C and subsection 121D(3) of the ITAA 1936]

3.66 The materiality threshold requires a comparison between, for example, the activities undertaken in Australia and those conducted elsewhere. In relation to property, the comparison is between the intended use of the property, either in Australia or elsewhere. Similarly, in the case of events, it is necessary to consider the likelihood of the event occurring in Australia.

3.67 This materiality threshold means that activities occurring predominantly outside Australia but with a slight or theoretical connection to Australia can be treated in the same way as activities conducted wholly outside Australia.

Example 3.9 : Material connections to Australia

An OBU underwrites a risk for an offshore person in relation to the insurance of an aeroplane. The aeroplane spends the majority of its time flying international routes. This includes international flights to and from Australia. The aeroplane does not fly any domestic routes within Australia. The aeroplane's connection to Australia is not material.

The insurance covers property that is used within Australia and elsewhere and includes coverage for risks that could occur in either Australia or elsewhere. However, the likelihood of an insured event occurring within Australia is not material in the context of the scope of the policy, nor is the use of the property within Australia material. The underwriting is an eligible OB activity.

Trading in commodities and entering into commodity derivative contracts

3.68 Subsection 121D(4) provides that certain trading activities are eligible OB activities. Trading activities include trading with offshore persons in a number of precious metals, or in options or rights in respect of those metals.

3.69 An amendment is made to provide that trading in any commodity with an offshore person is an eligible OB activity where it is incidental to an eligible contract activity. The activity includes trading in rights or options in the commodity. [Schedule 3, item 27, paragraph 121D(4)(i) of the ITAA 1936]

3.70 The purpose of this amendment is to allow certain commodity trading activities to be eligible OB activities where they are undertaken to hedge positions in commodity derivatives.

3.71 Commodity trading can be undertaken through commodity exchanges or over-the-counter facilities.

Securities lending and repurchase agreements

3.72 Amendments are made to the definition of eligible contract activity to include entering into securities lending and repurchase agreements in the list of eligible OB activities. [Schedule 3, items 17, 18, 19 and 32, sections 121C and 121DB, and paragraph 121D(1)(d) of the ITAA 1936]

3.73 Repurchase arrangements involve the sale and repurchase of securities. In most cases, the repurchase price will be higher than the sale price or forward value of the securities. The increase reflects the cost (repo rate) of the original purchaser providing credit to the original owner. Securities lending arrangements, in contrast, are often motivated by the borrower wishing to use the securities in another arrangement, for example short-selling, in return for a fee to the lender.

3.74 Repurchase arrangements share many of the commercial features of a secured loan, where the securities sold act as collateral. Similarly, securities lending has many of the commercial features of lending and trading in securities. This amendment will provide certainty for these arrangements.

3.75 The terms 'securities lending agreement' and 'repurchase agreement' are intended to have their ordinary commercial meaning.

Non-deliverable forward foreign currency contracts

3.76 Paragraph 121D(4)(e) includes trading in non-Australian currencies, or related options and rights, with any person (including Australian residents) as an eligible trading activity. This facilitates trading in forward foreign currency contracts, including as a hedging mechanism.

3.77 A non-deliverable forward foreign currency contract is an instrument that may be used to hedge foreign exchange exposures. The contract works in a similar way to a standard forward foreign currency contract, except the obligations are settled in another currency (settlement being the difference between an agreed notional exchange rate and the forward exchange rate). This is necessary where the relevant currency is not widely traded.

3.78 Under the contract, no rights are created with respect to the foreign currency, which means that the activity is outside the scope of the existing currency trading activity ( ID 2011/27 ). A non-deliverable forward foreign currency contract, therefore, is currently only an eligible OB activity where it is entered into with an offshore person (subsection 121D(5)).

3.79 An amendment is made to allow trading in these contracts with any person to be an eligible OB activity. This will align the tax treatment of non-deliverable forward foreign currency contracts with equivalent foreign exchange contracts. [Schedule 3, item 26, paragraph 121D(4)(aa) of the ITAA 1936]

3.80 A further amendment is made to allow OBUs to treat entering into such a contract with any person as an eligible OB activity. [Schedule 3, items 17, 28 and 32, sections 121C and 121DB, and subsection 121D(5) of the ITAA 1936]

Portfolio investment and funds management activities

3.81 Subsection 121D(6A) includes managing a portfolio investment in the list of eligible OB activities. That is, an OBU that manages a fund on behalf of a non-resident may be entitled to concessional tax treatment of management fees received.

3.82 A fund may invest in both Australian things (for example shares in Australian resident companies) and things that are not Australian things. Under the existing law, the entire fund management activity may be an eligible OB activity (subject to some requirements).

3.83 Only that portion of the assessable OB income that relates to investments in things that are not Australian things is eligible to receive the concessional tax treatment. This treatment is achieved through subsection 121EE(3A), which reduces the amount of assessable income treated as OB assessable income by the average Australian asset percentage of the fund. The percentage is worked out by reference to the value of Australian things as a proportion of a fund's total value (section 121DA).

3.84 Paragraph 121D(6A)(f) restricts the capacity of OBUs to manage funds that contain investments in Australian things where the average Australian asset percentage for the fund exceeds 10 per cent.

3.85 Unlike the reduction achieved through subsection 121EE(3A), this requirement operates to render the entire fund ineligible for concessional tax treatment if the 10 per cent threshold is exceeded.

3.86 The requirement limits the accessibility of the activity and the concession, preventing some OBUs from marketing suitable funds to offshore counterparties. Movements in the value of a fund's assets may inadvertently tip the fund above the 10 per cent threshold, making the entire fund ineligible as an OB activity.

3.87 The limitation is unnecessary to achieve the object of limiting the availability of the OBU concession to offshore investments. This objective can be achieved through reliance on the apportionment of income achieved through subsection 121EE(3A).

3.88 Amendments are made to remove the requirement in paragraph 121D(6A)(f). [Schedule 3, items 29 and 30, paragraphs 121D(6A)(e) and (f) of the ITAA 1936]

Advice on disposal of investments

3.89 Subsection 121D(7) makes the giving of investment or financial advice an eligible activity. A limitation applies in the case of advice relating to the making of an investment. In those circumstances, the advice must relate to an investment that is outside Australia. Other advice is not limited in this way. However, there has been uncertainty in the interpretation of this provision with respect to advice provided in relation to the disposal of investments.

3.90 An amendment is made to clarify that advisory activities includes the provision of advice in relation to the disposal of an investment, regardless of its location. [Schedule 3, items 18, 20, 31 and 32, sections 121C and 121DC, paragraph 121D(1)(f), and subsection 121D(7) of the ITAA 1936]

Leasing activities

3.91 Amendments are made to add leasing activities involving offshore persons to the list of eligible OB activities. [Schedule 3, items 18, 21 and 32, section 121C, paragraph 121D(1)(ga) and section 121DD of the ITAA 1936]

3.92 The addition of leasing activities is intended to give greater flexibility to OBUs in recognition of the fact that many leasing arrangements have similar commercial features to existing OB activities such as lending.

3.93 An OBU may enter into a leasing activity as either a lessor or a lessee (or a sublessor or a sublessee). The activity covers both operating leases and finance leases.

3.94 Using the concept of lease from section 51AD of the ITAA 1936, a lease is any arrangement that includes the owner of property granting another person a right to use the property. A lease also includes a sublease where a lessee subleases the property to a sublessee.

3.95 The activity will not apply to hire-purchase arrangements that are recharacterised under division 240 of the ITAA 1997 as notional sale and loan arrangements. Notional loan arrangements may nevertheless be eligible OB activities under subsection 121D(2).

3.96 The leased property must not be used to a material extent within Australia. The materiality condition is intended to align with that discussed in paragraph 3.66 and Example 3.9.

Example 3.10 Leasing Offshore Property

A second OBU leases and subleases the aeroplane referred to in Example 3.9. The leasing activity is an eligible OB activity.

Part 5: Internal financial dealings

3.97 Part 5 of Schedule 3 treats the internal financial dealings of an OBU as being on an arm's length basis.

3.98 Under the existing law, an OBU may source funding internally from another branch of the same entity (section 121EB). Because of the scope of this rule, there are gaps in the application of Australia's transfer pricing rules (Division 815 of the ITAA 1997) to an OBU's internal dealings.

3.99 To address this, the new law provides that the OBU's OB income or allowable OB deductions are treated as being those amounts that would be included or allowed, were the internal parties dealing with each other at arm's length. [Schedule 3, item 33, subsection 121EB(4) of the ITAA 1936]

3.100 In determining the arm's length conditions, taxpayers should have reference to the guidance materials available under Australia's transfer pricing rules in Division 815. [Schedule 3, item 33, subsection 121EB(5) of the ITAA 1936]

Consequential amendments

3.101 Amendments are made to references to 'OB activity' that are consequential to the codification of the choice principle in Part 2. [Schedule 3, items 3, 5 and 7, paragraph 121B(2)(a), subsection 121D(1) and subsection121EB(1) of the ITAA 1936]

3.102 Amendments are made that are consequential to the allocation of expenses in Part 3. [Schedule 3, items 8, 9, 10, 11, 12 and 16, subsection 6(1), paragraphs 121B(2)(b) and 121EH(a), and sections 121C and 121E of the ITAA 1936]

Application provision

3.103 The amendments made by Schedule 3 generally apply in relation to income years starting on or after 1 July 2015. [Schedule 3, subitem 34(1)]

3.104 However, the codification of the choice principle in Part 2 of the Schedule applies to activities entered into on or after 1 July 2015. [Schedule 3, subitem 34(2)]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

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

Modernising the Offshore Banking Unit Regime

3.105 This Schedule 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

3.106 Schedule 3 makes a number of reforms to modernise the Offshore Banking Unit regime. The reforms include measures implementing recommendations of the Australia as a Financial Centre - Building on Our Strengths report by the Australian Financial Centre Forum chaired by Mark Johnson. The reforms also include targeted amendments to address a number of integrity concerns with the existing regime.

Human rights implications

3.107 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

3.108 This Schedule is compatible with human rights as it does not raise any human rights issues.

Chapter 4 - Income tax exemption for the Global Infrastructure Hub Ltd.

Outline of chapter

4.1 Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide an exemption from the liability to pay income tax on the ordinary and statutory income of the Global Infrastructure Hub Ltd. (Hub).

Context of amendments

Policy background

4.2 The Hub was established following a joint statement from the Prime Minister and the Treasurer at the G20 Leaders' Summit in November 2014.

4.3 The Hub will work internationally to lift the quality of public and private investment in infrastructure through information development, knowledge sharing, training and the implementation of leading practices.

4.4 The Australian government will contribute $30 million for the establishment and ongoing operation of the Hub until 2018. It is expected that financial contributions will be provided to the Hub by various other governments and the private sector.

Summary of new law

4.5 Listing the Hub in the ITAA 1997 as an income tax exempt entity provides the Hub with certainty on the tax treatment of contributions made to it; these contributions will be income tax free.

4.6 As the mandate for the Hub will cease in 2018, the exemption from income tax will apply to amounts that would be included in assessable income from 24 December 2014 to 30 June 2019.

Comparison of key features of new law and current law

Detailed explanation of new law

4.7 Schedule 4 to this Bill makes amendments to Division 50 of the ITAA 1997 to provide the Hub an exemption from income taxation for a defined period. [Schedule 4, item 1]

4.8 The Hub will be listed as an income tax exempt entity meaning that all payments made to it, by the Australia and other governments, non-government organisations and other contributors, will not be subject to income tax. This will enable the Hub to utilise the full amount of contributions toward its purposes.

4.9 The Hub will operate in its current form until the end of 2018. The exemption from income tax applies from 24 December 2014 to 30 June 2019 with all contributions and other income of the Hub being exempt from tax for that period. [Schedule 4, item 1]

4.10 Payments to the Hub will be exempt from income tax until 30 June 2019 to ensure that payments made in the 2018-2019 income year are exempt from income tax. [Schedule 4, item 1]

4.11 As the mandate for the Hub ends at the end of 2018, its exemption from income tax will expire on 1 July 2019. [Schedule 4, item 1]

Application and transitional provisions

4.12 The amendments apply from 24 December 2014 until 30 June 2019. [Schedule 4, item 1]

4.13 On 1 July 2021, the provision will self-repeal. [Schedule 4, item 2]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

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

Income tax exemption for Global Infrastructure Hub Ltd

4.14 This Schedule 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

4.15 Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 to provide the Global Infrastructure Hub Ltd exemption from income tax liability.

4.16 These changes will ensure that payments made to the Global Infrastructure Hub Ltd, including from the Australian and foreign governments, are not subject to income taxation.

Human rights implications

4.17 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

4.18 This Schedule is compatible with human rights as it does not raise any human rights issues.

Chapter 5 - Deductible gift recipients - extension

Outline of chapter

5.1 Schedule 5 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to update the list of specifically listed deductible gift recipients (DGRs).

Context of amendments

5.2 The income tax law allows income tax deductions for taxpayers who make gifts of two dollars or more to DGRs. To be a DGR, an entity must fall within one of the general categories set out in Division 30 of the ITAA 1997 or be specifically listed be name in that Division.

5.3 DGR status helps eligible entities attract public financial support for their activities.

Summary of new law

5.4 The amendments extend the listing of the Australian Peacekeeping Memorial Project Incorporated and the National Boer War Memorial Association Incorporated by three years.

Detailed explanation of new law

Australian Peacekeeping Memorial Project Incorporated (ABN 56 102 846 791)

5.5 Taxpayers may claim a tax deduction for gifts made to the Australian Peacekeeping Memorial Project Incorporated after 31 December 2012 and before 1 January 2018. [Schedule 5, item 1, table item 5.2.32 in subsection 30-50(2) of the ITAA 1997]

5.6 The Australian Peacekeeping Memorial Project Incorporated is seeking donations to build a memorial on Anzac Parade in Canberra, ACT to recognise the services of Australians who have served in peacekeeping missions.

National Boer War Memorial Association Incorporated (ABN 29 293 433 202)

5.7 Tax payers may claim a tax deduction for gifts made to the National Boer War Memorial Association Incorporated after 31 December 2012 and before 1 January 2018. [Schedule 5, item 1, table item 5.2.32 in subsection 30-50(2) of the ITAA 1997]

5.8 The National Boer War Memorial Association Incorporated is seeking donations to commemorate Australian service in the Boer War (1899 to 1902) by constructing a memorial on Anzac Parade in Canberra, ACT.

Consequential amendments

5.9 The provisions that automatically repeal the DGR listings after they cease to have effect have also been extended to account for the extension period of the listings. The DGR listings will automatically be repealed on 1 July 2022, which aligns with the general amendment periods for most taxpayers. [Schedule 5, items 2 and 3, table item 8 in subsection 2(1) and heading in Division 1 of Part 2 of Schedule 4 of the Tax and Superannuation Laws Amendment (2013 Measures No. 2) Act 2013]

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

Schedule 5 - Deductible gift recipients - extension

5.10 This Schedule 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

5.11 The income tax law allows income tax deductions for taxpayers who make gifts of two dollars or more to DGRs. To be a DGR, an entity must fall within one of the general categories set out in Division 30 of the ITAA 1997 or be specifically listed by name in that Division.

5.12 This Schedule extends the listing of the Australian Peacekeeping Memorial Project Incorporated and the National Boer War Memorial Association Incorporated by three years. This measure allows taxpayers to claim a tax deduction for gifts made to these organisations after 31 December 2012 and before 1 January 2018.

Human rights implications

5.13 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

5.14 This Schedule is compatible with human rights as it does not raise any human rights issues.

Chapter 6 - Miscellaneous amendments

Outline of chapter

6.1 Schedule 6 to this Bill makes a number of miscellaneous amendments to the taxation, superannuation and other laws. These amendments are part of the Government's commitment to the care and maintenance of the taxation and superannuation systems.

6.2 These amendments include style and formatting changes, the repeal of redundant provisions, the correction of anomalous outcomes and corrections to previous amending Acts.

Context of amendments

6.3 Miscellaneous amendments to the taxation and superannuation laws such as those contained in Schedule 6 are periodically made to remove anomalies and correct unintended outcomes. Progressing such amendments gives priority to the care and maintenance of the tax system, a process supported by a 2008 recommendation from the Tax Design Review Panel.

6.4 Industry input is collected through the Tax Issues Entry System (TIES). Part 1 of Schedule 6 addresses three TIES issues:

•

Ensuring that life insurance companies are not inappropriately liable for franking deficit tax (TIES issue 0011/2013);

•

Correcting inconsistent wording in a provision of the Fringe Benefits Tax Assessment Act 1986 that defines in-house residual fringe benefits (TIES issue 0004/2013); and

•

Correcting a diagram intended to provide guidance on when an entity is required to, or may, register for goods and services tax (GST) (TIES issue 0010/2013).

Summary of new law

6.5 These miscellaneous amendments address technical deficiencies and legislative uncertainties within various taxation, superannuation and other provisions.

6.6 Schedule 6 contains the following Parts:

•

Part 1: General amendments

•

Part 2: Consequential amendments relating to the Public Governance, Performance and Accountability Act 2013.

Detailed explanation of new law

Part 1: General amendments

Updating section references in the A New Tax System (Goods and Services Tax) Act 1999

6.7 Section 23-1 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) includes a diagram showing entities when they:

•

are required to be registered for GST; and

•

may be registered for GST.

6.8 Before the amendments made by this Schedule, that diagram referred to Division 147 of the GST Act. Division 147 was repealed by the Tax Laws Amendment (2009) Measures No. 5) Act 2009 and replaced with Division 58, but the diagram was not updated to reflect that change. Accordingly, this amendment replaces the reference to Division 147 in the diagram with a reference to Division 58. This addresses TIES issue 0010/2013. [Schedule 6, item 1, section 23-1 of the A New Tax System (Goods and Services Tax) Act 1999]

6.9 Section 134-10 of the GST Act sets out rules to recover an amount of an input tax credit that an entity received in respect of an acquisition where the entity receives a subsequent payment in respect of the acquisition from a third party (for example, a rebate paid by the manufacturer of a product to the final purchaser). Before the amendments, paragraph 134-10(1)(e) provides that no such adjustment is required where the payment is considered to be for a separate supply from you.

6.10 The terminology in paragraph 134-10(1)(e) was inconsistent with that used elsewhere in the GST Act, where supplies are not described as being 'from you'; rather, they are described as being supplies 'you make'. This Schedule standardises the terminology in paragraph 134-10(1)(e) so it refers to a supply 'you make' instead of a supply 'from you'. [Schedule 6, item 2, paragraph 134-10(1)(e) of GST Act]

Misdescribed amendments to the Income Tax Assessment Act 1997

6.11 The Charities Act 2013 extended charitable status to ancillary funds where they contributed to an entity that would be charitable if it were not a government entity. This enables such entities to retain their charitable status and therefore removed the need for a specific income tax exemption for public and private ancillary funds.

6.12 The Charities (Consequential Amendments and Transitional Provisions) Act 2013 made consequential amendments to the Income Tax Assessment Act 1997 (ITAA 1997) to remove this specific tax exemption. One of those consequential amendments was intended to change the words 'charitable institutions and trust funds for charitable purposes' to 'charities' in section 50-100 of the ITAA 1997. A spelling error in the Charities (Consequential Amendments and Transitional Provisions) Act 2013 meant that the amendment was misdescribed, i.e. the text it sought to replace was not identical to the text it was actually replacing. This Schedule corrects the spelling error. [Schedule 6, item 3, item 31 of Schedule 1 to the Charities (Consequential Amendments and Transitional Provisions) Act 2013]

6.13 To ensure the effectiveness of this amendment, it commences immediately following the commencement of the relevant provisions in the Charities (Consequential Amendments and Transitional Provisions) Act 2013.

6.14 The Minerals Resource Rent Tax (Consequential Amendments) and Transitional Provisions Act 2012 made consequential amendments following the introduction of the Minerals Resource Rent Tax. The Minerals Resource Rent Tax has since been repealed by the Minerals Resource Rent Tax Repeal and Other Measures Act 2014, but not all of the minor consequential changes were reversed.

6.15 One of the consequential amendments sought to change the words '*mining operations' in subparagraph 40-80(1)(c)(i) of the ITAA 1997 to 'mining and quarrying operations'. However, that amendment was misdescribed because that subparagraph of the ITAA1997 did not include an asterisk before the words 'mining operations.

6.16 The amendment was therefore not reversed when the Minerals Resource Rent Tax was repealed.

6.17 This Schedule removes the asterisk in the amending Act. [Schedule 6, item 41, item 16 of Schedule 3 to the Minerals Resource Rent Tax (Consequential Amendments and Transitional Provisions) Act 2012]

6.18 To ensure the effectiveness of this amendment, it commences immediately following the commencement of the relevant provisions in the Minerals Resource Rent Tax (Consequential Amendments) and Transitional Provisions Act 2012.

Inconsistent wording in the Fringe Benefits Tax Assessment Act 1986

6.19 The Fringe Benefits Tax Assessment Act 1986 (FBTAA) provides for the taxation of various fringe benefits. Different rules apply to different types of fringe benefit. One type of benefit is in-house residual fringe benefits.

6.20 A residual fringe benefit is a fringe benefit that is not one of the types of fringe benefit with its own specific rules (e.g. car fringe benefits) (sections 45 and 136(1) FBTAA). A residual fringe benefit can be an in-house residual fringe benefit in two cases (subsection 136(1) FBTAA, definition of in-house residual fringe benefit).

6.21 The first case is where the benefit is provided by the employer or an associate of the employer, and the provider carried on a business providing the same or similar benefits to outsiders.

6.22 The second case is where the benefit is provided by someone other than the employer or an associate of the employer, but the provider purchased the benefit from the employer or an associate of the employer (the seller), and both the provider and the seller carried on a business providing the same or similar property to outsiders. This provision prevents employers setting up artificial arrangements to avoid falling within the first case.

6.23 The use of the word 'property' instead of 'benefits' in the second case was an error, and created inconsistency between the two cases. This amendment corrects the error by replacing 'property' with 'benefits'. This addresses TIES issue 0004/2013. [Schedule 6, item 4, subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986]

Consequential amendments relating to the standardisation of the definition of Australia across the tax law

6.24 Schedule 4 to the Treasury Legislation Amendment (Repeal Day) Act 2015 made various amendments to the tax law as part of rewriting and standardising the definition of 'Australia' for income tax purposes.

6.25 GST and other indirect taxes only operate in a subset of what is included in the standardised definition of 'Australia'. Therefore, the definition of 'Australia' for GST and other indirect taxes was relabelled as the 'indirect tax zone'. This change did not entail any change in scope for indirect tax purposes.

6.26 This Schedule makes consequential amendments to the Fuel Tax Act 2006 to replace 'Australia' with 'indirect tax zone' where appropriate. [Schedule 6, items 5 to 11, sections 3-5, 41-5, 41-10, 42-5, 43-7 and 110-5 of the Fuel Tax Act 2006]

6.27 To ensure alignment with the application of the new standardised definition of Australia in other areas of tax law, these amendments to the Fuel Tax Act 2006 apply to taxable fuel acquired, manufactured or imported on or after 1 July 2015. [Schedule 6, item 12]

Style changes to the ITAA 1997

6.28 Section 13-1 of the ITAA 1997 sets out a list of tax offsets, and directs readers to the provision that allows each offset. The formatting of two of the items in the list, relating to farm household allowance, is inconsistent with other items in the list. This Schedule corrects the formatting. [Schedule 6, items 13 and 14, section 13-1 of the Income Tax Assessment Act 1997]

6.29 The ITAA 1997 uses asterisks to indicate the use of a defined term (section 2-10 ITAA 1997). Where a definition only applies in certain contexts, an asterisk is generally only used where the defined term is being used in the context in which the definition applies.

6.30 Carrying on is defined in subsection 995-1(1). That definition applies when an entity is carrying on an enterprise.

6.31 The ITAA 1997 frequently uses the words 'carrying on' in the phrase 'carrying on a business'. Although there is considerable overlap between an enterprise and a business, they do not have the same meaning under the ITAA 1997. Therefore, many instances of this phrase do not have an asterisk before the words 'carrying on'.

6.32 However, an asterisk does precede the term 'carrying on' when it is used in the phrase 'carrying on a business' in some instances. This creates inconsistencies in drafting practice within the ITAA 1997.

6.33 The same issue arises with the phrases 'carry on', 'carries on' and 'carried on'.

6.34 This Schedule amends various provisions of the ITAA 1997 to standardise the use of asterisks for the term 'carrying on' and its derivatives. [Schedule 6, items 15 to 26, 32 to 34 and 36, sections 25-110, 26-47, 30-242, 35-5, 35-10, 40-880, 41-20, 316-65, 415-15, 415-20 and 995-1 of the ITAA 1997]

6.35 Defined terms are also not asterisked in non-operative or guide material (subsection 2-15(2) ITAA 1997).

6.36 Section 104-5 of the ITAA 1997 includes a table summarising CGT events. CGT events are events for which you can make a capital gain or loss. This table includes a summary of CGT event K1 that uses the terms Kyoto unit and Australian carbon credit unit, which are defined in subsection 995-1(1) of the ITAA 1997. These terms are marked with an asterisk in the table. This is inconsistent with normal drafting practice, and other defined terms used in the table are not asterisked.

6.37 The same issue arose in table item 18A of the table included in section 112-97, which included the term 'Kyoto unit' with an asterisk. That table sets out cost base modifications outside Parts 3-1 and 3-3 of the ITAA 1997.

6.38 This Schedule removes these asterisks to provide consistency of drafting. [Schedule 6, items 29 and 30, sections 104-5 and 112-97 of the ITAA 1997]

6.39 Subsection 995-1(1) of the ITAA 1997 provides that "available frankable profits has the meaning given by section 215-20 and affected by subsection 215-5(1)". This Schedule amends that definition to remove the grammatical error by replacing 'give' with 'given'. [Schedule 6, item 35, subsection 995-1(1) of the ITAA 1997]

Clarification of the objects of the taxation of employee share schemes

6.40 The rules for the taxation of employee share schemes are contained in Division 83A of the ITAA 1997. Where employees or their associates receive discounts on shares or rights to acquire beneficial interests in shares under an employee share scheme (ESS interests), those discounts are generally included in their assessable income, and so are liable to income tax.

6.41 In some cases, the inclusion of the discounts in assessable income is deferred, and so is the liability to pay tax.

6.42 Division 83A is intended to provide that these deferrals are not unduly brought to an end just because a company is going through a takeover or restructure, including a demerger. The objects clause in subsection 83A-130(1) sets out where it is intended that the employee share scheme will continue to apply where a takeover or restructure occurs.

6.43 This objects clause does not correctly describe restructures which are demergers, because the CGT demerger rules require no change in the ownership of the old company (section 125-70(2) of the ITAA97 - referred to as the 'head entity'). In demergers, the change in ownership instead occurs in the demerger subsidiary.

6.44 This Schedule amends subparagraph 83A-130(1)(a)(ii) of the ITAA 1997 to provide that the object of section 83A-130 is to allow Division 83A to continue to apply when the whole or partial replacement of ESS interests is a result of a change (the restructure) in the ownership (including the structure of the ownership) of either the old company or a demerger subsidiary of the old company. [Schedule 6, item 27, subparagraph 83A-130(1)(a)(ii) of the ITAA 1997]

6.45 To ensure subsection 83A-130(1) operates as intended, this amendment applies in relation to ESS interests acquired on or after 1 July 2009, the initial application date of Division 83A. [Schedule 6, item 28]

Incorrect references relating to franking debits and life insurance companies

6.46 Subsection 205-30(1) of the ITAA 1997 includes a table (the general table) setting out circumstances when a debit arises in the franking account of an entity, and the amount of debit that will arise.

6.47 Subsection 219-30(1) of the ITAA 1997 provides that the general table also applies to life insurance companies, except items 2 and 3. Subsection 219-30(2) provides a different table (the life insurance table) setting out circumstances where franking debits arise for life insurance companies, and the amount of debit that will arise.

6.48 Items 2 and 3 of the general table were excluded from applying to life insurance companies because the circumstances in which they applied were supposed to be identical to the circumstances in item 2 and 3 of the life insurance table, and the life insurance table was to take priority in those circumstances. However, it is instead items 2 and 2A of the general table which are identical to items 2 and 3 of the life insurance table. This means that item 3 of the general table has incorrectly been stopped from applying to life insurance companies, and item 2A of the general table has been incorrectly applying instead.

6.49 This Schedule amends subsection 219-30(1) to correct this error and provide that the table in section 205-30 (except items 2 and 2A) applies to a life insurance company in the same way as it applies to any other company. This addresses TIES issue 0011/2013. [Schedule 6, item 31, subsections 205-30(1) and 219-30(1) of the ITAA 1997]

6.50 To ensure the effectiveness of this amendment, it commences immediately following the commencement of the provision that inserted the error.

Standardising the definition of taxable dealing in relation to wine across the tax law

6.51 Subsection 995-1(1) of the ITAA 1997 provides that wine taxable dealing means a taxable dealing (within the meaning of section 33-1 of the A New Tax System (Wine Equalisation Tax) Act 1999).

6.52 Section 33-1 of the A New Tax System (Wine Equalisation Tax) Act 1999 provides that taxable dealing means an assessable dealing that happens on or after 1 July 2000 for which no exemption is available under Division 7.

6.53 The existence of two different terms in the tax law creates unnecessary complexity. Therefore, this Schedule amends the ITAA 1997 to change the defined term from 'wine taxable dealing' to 'taxable dealing'. The term taxable dealing will only refer to a taxable dealing within the meaning of section 33-1 of the A New Tax System (Wine Equalisation Tax) Act 1999) when it is used in relation to wine.

6.54 As the defined terms in subsection 995-1(1) also apply to Schedule 1 to the TAA 1953, this Schedule also replaces the term 'wine taxable dealing' with 'taxable dealing in relation to wine' where it appears in Schedule 1 to the TAA 1953. [Schedule 6, items 37 to 38, 55 and 56, section 995-1 of the ITAA 1997 and sections 111-60 and 382-5 of Schedule 1 to the TAA 1953]

Renumbering the Income Tax Rates Act 1986

6.55 The Income Tax Rates Amendment (Research and Development) Act 2011 and the Income Tax Rates Amendment (Temporary Flood and Cyclone Reconstruction Levy) Act 2011 separately inserted a new section 12B into the Income Tax Rates Act 1986. As a result, there are 2 sections numbered 12B in the Income Tax Rates Act 1986. One specifies to the rate of income tax payable for recoupments of research and development activities and the other specifies the rate of the temporary flood and cyclone reconstruction levy.

6.56 The Income Tax Rates Amendment (Temporary Flood and Cyclone Reconstruction Levy) Act 2011 provides for section 12B to be repealed on 1 July 2016. However, given there are two sections 12B, this will not be effective because it is not clear which section 12B the legislation should repeal.

6.57 To ensure the correct section is repealed on 1 July 2016, and to remove the confusion created by having two identical section numbers, this Schedule renumbers the section specifying the rate of the temporary flood and cyclone reconstruction levy to section 12C and amends the Income Tax Rates Amendment (Temporary Flood and Cyclone Reconstruction Levy) Act 2011 to provide that section 12C will be repealed on 1 July 2016. [Schedule 6, items 39 and 40, section 12B of the Income Tax Rates Act 1986]

Removing doubt as to the constitutional basis of the Product Stewardship (Oil) Act 2000

6.58 The Product Stewardship (Oil) Act 2000 (PSO Act) was enacted on the basis that it is supported by the Commonwealth's legislative and executive powers under the Constitution. Nevertheless, this Schedule inserts specific saving rules into the PSO Act to safeguard its provisions in the event of an adverse constitutional challenge.

6.59 The savings rules rely on the Commonwealth's external affairs power in paragraph 51(xxix) of the Constitution and the taxation power in paragraph 51(ii) of the Constitution. This is done by providing that:

•

the PSO Act also has the effect it would have if its operation in relation to product stewardship (oil) benefits were expressly confined to an operation limited to product stewardship (oil) benefits in relation to external affairs; and

•

the PSO Act also has the effect it would have if its operation in relation to product stewardship (oil) benefits were expressly confined to an operation limited to product stewardship (oil) benefits in relation to taxation. [Schedule 6, item 42, section 4A of the Product Stewardship (Oil) Act 2000]

Updating terminology in the Superannuation (Government Co-contribution for Low Income Earners) Act 2003

6.60 The Superannuation (Government Co-contribution for Low Income Earners) Act 2003 provides for a government co-contribution to be paid into a person's superannuation fund or retirement savings account where certain criteria are met. Sections 16 and 20 of that Act require trustees of complying superannuation funds and providers of retirement savings accounts to repay government co-contributions paid to them where the trustee or the provider has not credited the co-contribution to the person's account by the end of the 28th day after the day on which the co-contribution was paid to the trustee or provider. Paragraphs 16(1)(d) and 20(1)(d) require those trustees or providers to give the Commissioner a statement in the approved form in relation to the co-contribution.

6.61 The requirement to provide a statement in the approved form was inserted by the Treasury Legislation Amendment (Repeal Day) Act 2015. Previously, the requirement was to provide prescribed information.

6.62 However, the Treasury Legislation Amendment (Repeal Day) Act 2015 did not update the terminology used in subsections 16(3) and 20(3) of the Superannuation (Government Co-contribution for Low Income Earners) Act 2003, which set out penalties where a taxpayer does not provide prescribed information under the respective sections.

6.63 To ensure consistency, this Schedule replaces the references to prescribed information in subsections 16(3) and 20(3) with references to statements in the approved form. It also inserts commas into paragraphs 16(1)(d) and 20(1)(d) for ease of reading. [Schedule 6, items 43 to 46, sections 16 and 20 of the Superannuation (Government Co-contribution for Low Income Earners) Act 2003]

Grammatical errors in the Tax Agents Services Act 2009

6.64 Section 20-5 of the Tax Agent Services Act 2009 provides for the conditions that a partnership needs to meet to be eligible for registration as a registered tax agent, BAS agent or tax (financial) adviser.

6.65 The requirements relating to tax (financial) advisers were added into the Act by the Tax Laws Amendment (2013 Measures No. 3) Act 2013. The amendments adding those requirements for tax (financial) advice services contained an error, which means that the end of subparagraphs 20-5(2)(c)(ii) and 20-5(3)(d)(ii) read "; and; or" instead of "; or", and subparagraphs 20-5(2)(c)(iii) and 20-5(2)(d)(iii) end in a full stop instead of "; and". This Schedule fixes those errors. [Schedule 6, items 47 to 50, section 20-5 of the Tax Agent Services Act 2009]

6.66 To ensure the effectiveness of these amendments, they commence immediately following the commencement of the provision that inserted the error.

Grammatical error in Schedule 1 to the TAA 1953

6.67 Subsection 12-390(4) of Schedule 1 to the TAA 1953 requires certain entities to withhold an amount from certain payments it receives on behalf of a foreign resident (the recipient) if the payment, or part of it, was covered by a notice or information under section 12-395. A note under this subsection informs the reader that if the recipient [is] not a foreign resident, the entity must provide a notice or information about the payment under section 12-395. This note is missing the word 'is'.

6.68 This Schedule inserts the missing word. [Schedule 6, item 51, section 12-390 of Schedule 1 to the TAA 1953]

Repealing redundant address for service provision

6.69 Section 105-140 in Schedule 1 to the TAA 1953 provides address for service rules for the purposes of all indirect tax laws. However, Part 2A of the Taxation Administration Regulations 1976, supported by section 388-50 in Schedule 1 to the TAA 1953 (which allows the Commissioner to require an entity to provide such an address when providing an approved form), will provide preferred address for service rules for all taxation laws, including indirect tax laws, from

1 July 2015. This is because of recent amendments made by the Treasury Laws Amendment (2015 Measures No. 1) Regulations 2015. This Schedule repeals section 105-140 because it will be redundant from

1 July 2015. [Schedule 6, items 52 and 53, sections 105-1 and 105-140 of Schedule 1 to the TAA 1953]

6.70 To align with the application of the changes to the general address for service rules made by the Treasury Laws Amendment (2015 Measures No. 1) Regulations 2015, these amendments apply on or after 1 July 2015. [Schedule 6, item 54]

Revoking endorsements for tax concessions

6.71 This Schedule amends section 426-55 of Schedule 1 to the TAA 1953 to ensure that the Commissioner can revoke endorsement for access to certain tax concessions in relation to past periods of non-compliance regardless of whether such non-compliance is present at the time a decision to revoke endorsement happens. [Schedule 6, items 57 and 58, section 426-55 of Schedule 1 to the TAA 1953]

6.72 Section 426-55 of Schedule 1 to the TAA 1953 gives the Commissioner the power to revoke the endorsement of an entity to access a tax concession (e.g. a charity endorsed to access an income tax exemption) if certain circumstances are present. The primary circumstance is where the entity is not entitled to be endorsed because of non-complying behaviour. The revocation of endorsement happens from the day specified by the Commissioner. The objective of the endorsement regime is to ensure that before an entity accesses certain tax concessions, there is an assessment of the entity's entitlement by the Commissioner. The regime is then structured in a manner consistent with the self-assessment regime in that an entity has an obligation to advise the Commissioner if they are no longer entitled to endorsement so that the Commissioner can take necessary action to revoke endorsement. Similarly, the Commissioner may by way of audit, identify an entity was not entitled to endorsement in relation to a prior period, and can revoke endorsement retrospectively.

6.73 In the case of Cancer and Bowel Research Association Inc v Commissioner of Taxation, the Federal Court of Australia identified a defect in the revocation provisions in that the Commissioner would not be able to revoke endorsement in a situation in which he or she has identified (through audit) that the entity is no longer entitled to be endorsed but at the time the Commissioner makes a decision to revoke endorsement, the entity changes its behaviour to be entitled to endorsement on that day.

6.74 The consequence of this defect is that a non-complying entity can frustrate the Commissioner's actions to revoke endorsement (because of non-complying behaviour over an extended period), by changing its behaviour when it gets notice of an audit or compliance action.

6.75 The amendments correct the defect and ensure the Commissioner can take appropriate action in relation to past periods of non-compliance, identified by way of audit, by revoking endorsement in relation to those periods of non-compliance where such action is appropriate given the circumstances of the taxpayer concerned.

6.76 The amendments made by Part 2 apply to decisions to revoke endorsements where the decision is made on or after the day this Bill receives Royal Assent (regardless of when the endorsement took effect). [Schedule 6, item 59]

Repeal redundant provisions in the Taxation (Deficit Reduction) Act (No. 3) 1993

6.77 Division 4 of Part 2 of the Taxation (Deficit Reduction) Act (No. 3) 1993 provided for a change in income tax rates. This Division was to commence in accordance with regulations made for that purpose (subsection 2(3) of the Taxation (Deficit Reduction) Act (No. 3) 1993). No such regulations have been made, and none are intended. This Schedule repeals subsection 2(3) and Division 4 of Part 2 of the Taxation (Deficit Reduction) Act (No. 3) 1993 because they are redundant. [Schedule 6, items 60 to 61, sections 2 and 7 of the Taxation (Deficit Reduction) Act (No. 3) 1993]

Updating a section reference regarding general interest charge

6.78 Section 12A of the Taxation (Interest on Overpayments and Early Payments) Act 1983 provides that the Commissioner of Taxation may have to pay interest where the Commissioner remits or refunds certain amounts paid by a person more than 30 days after the day on which the person requested the remission or refund.

6.79 This includes where the Commissioner remits the whole or part of an amount paid as general interest charge under section 163AA and subsection 204(3) of the Income Tax Assessment Act 1936. Section 163AA imposes general interest charge on an unpaid late lodgement penalty. Subsection 204(3) imposed general interest charge on an unpaid amount of tax or shortfall interest charge.

6.80 Subsection 204(3) was repealed by the Tax Laws Amendment (Transfer of Provisions) Act 2010, and rewritten as section 5-15 of the ITAA 1997.

6.81 This Schedule replaces the reference to subsection 204(3) of the Income Tax Assessment Act 1936 with a reference to section 5-15 of the ITAA 1997. [Schedule 6, item 62, section 12A of the Taxation (Interest on Overpayments and Early Payments) Act 1983]

6.82 To align with the repeal of subsection 204(3) of the Income Tax Assessment Act 1936, this amendment applies from 1 July 2010. [Schedule 6, item 63]

Clarifying the application date of previous amendments to the tax law

6.83 Part 2 of Schedule 2 to the Treasury Legislation Amendment (Repeal Day) Act 2015 inserted Division 393 into Schedule 1 to the TAA 1953. This Division provides for investment bodies to report investment information to the Commissioner of Taxation. Item 73 contains an application provision intended to provide that the amendments made by Part 2 (i.e. the new Division 393) apply in relation to quarters or financial years beginning on or after 1 July 2015. However, due to an error, it implies that all of the amendments made by Schedule 2 may apply from that date. This application provision was not intended to apply to the amendments made by the other Parts of Schedule 2 (Parts 1, 3 and 4).

6.84 This Schedule clarifies that the application provision in

item 73 of Part 2 of Schedule 2 to the Treasury Legislation Amendment (Repeal Day) Act 2015 has only operated and will only operate with respect to that Part. [Schedule 6, item 64, item 73 of Schedule 2 to the Treasury Legislation Amendment (Repeal Day) Act 2015]

Part 2: Consequential amendments relating to the Public Governance, Performance and Accountability Act 2013

6.85 The Public Governance, Performance and Accountability Act 2013 replaced the Financial Management and Accountability Act 1997 (FMA Act) and the Commonwealth Authorities and Companies Act 1997 (CAC Act) as the primary financial legislation of the Commonwealth from 1 July 2014.

6.86 As a result, consequential amendments are required to update legislative references to either the FMA Act or the CAC Act. This Schedule amends the Australian Charities and Not-for-profits Commission Act 2012 to replace references to the FMA and CAC Acts with the equivalent provisions in the Public Governance, Performance and Accountability Act 2013. [Schedule 6, items 65 to 81, sections 110-15, 115-30, 115-50, 125-5, 125-10, 125-15, 135-15, 140-20, 145-5, 175-70 and 300-5 of the Australian Charities and Not-for-profits Commission Act 2012]

6.87 To ensure the effectiveness of these amendments, they commence immediately following the commencement of section 6 of the Public Governance, Performance and Accountability Act 2013.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

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

Schedule 6: Miscellaneous Amendments

6.88 This Schedule 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

6.89 Schedule 6 to this Bill makes a number of miscellaneous amendments to the taxation, superannuation and other laws. These amendments are part of the Government's commitment to the care and maintenance of the taxation and superannuation systems.

6.90 These amendments include style and formatting changes, the repeal of redundant provisions, the correction of anomalous outcomes and corrections to previous amending Acts.

Human rights implications

6.91 These amendments make a number of minor and machinery changes to the taxation and superannuation provisions to ensure the provisions are consistent with their original policy intent. As such, this Schedule does not engage any of the applicable rights or freedoms.

Conclusion

6.92 This Schedule is compatible with human rights as it does not raise any human rights issues.

Chapter 7 - Investment manager regime

Outline of chapter

7.1 Schedule 7 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to implement the third and final element of the investment manager regime (IMR) reforms. In addition, these amendments also make some changes to the existing regime. The IMR reforms are designed to attract foreign investment to Australia and promote the use of Australian fund managers by removing tax impediments to investing in Australia. The development and introduction of an IMR was a recommendation of the 2009 report, 'Australia as a Financial Centre: Building on our Strengths - Report by the Australian Financial Centre Forum', commonly known as the 'Johnson Report'.

7.2 All legislative references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

7.3 In 2008, the then Assistant Treasurer and Minister for Competition Policy and Consumer Affairs established the Australian Financial Centre Forum (AFCF) as a Government and industry partnership to examine ways to position Australia as a leading regional financial services centre. In November 2009, the AFCF provided its report to the then Minister for Financial Services, Superannuation and Corporate Law. A copy of the report is available on the AFCF's website (www.afcf.treasury.gov.au).

7.4 The Johnson Report noted that features of Australia's tax system could act as an impediment to certain cross-border activities - including certain investments made by foreign investors into or through Australia. The introduction of an IMR to provide specific exemptions from Australian income tax for particular investments of foreign investors was proposed as a means of removing such impediments.

7.5 In August 2011, the Board of Taxation (BOT) made a number of recommendations in respect of the design of an IMR in its report, 'Review of an Investment Manager Regime as it relates to foreign managed funds: a report to the Assistant Treasurer'. The BOT recommended that an exemption style IMR be introduced that would apply to portfolio level investments made into Australia, as well as to certain investments made through Australia that were subject to Australian tax because of the use of Australian based intermediaries or fund managers. A key recommendation of the BOT was that the IMR should only apply to the investments of foreign funds that are genuinely widely held. A copy of this report is available on the BOT's website (www.taxboard.gov.au).

7.6 Following the release of the BOT's report, the then Minister for Financial Services and Superannuation announced on 16 December 2011 that the Government would address the uncertainty faced by foreign investors with respect to aspects of Australia's income tax laws when making passive investments into Australian assets and foreign assets.

7.7 There are three elements to the IMR reforms:

•

Element 1 was enacted by the Tax Laws Amendment (Investment Manager Regime) Act 2012 (previous IMR Act). Element 1 was designed to mitigate the consequences of United States of America (US) accounting standard Financial Interpretation Number 48 to ensure that Australia's income tax regime did not cause any uncertain tax positions to arise in relation to past transactions of foreign funds. The relevant provisions are contained in the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997).

•

Element 2 was also enacted by the previous IMR Act. Element 2 created a new Subdivision 842-I to provide concessional income tax treatment to foreign investors on their share of certain returns or gains from investments of a portfolio nature (membership interests of less than 10 per cent of the total) in assets through Australia by widely held foreign funds.

•

This Bill implements Element 3 of the IMR reforms by extending the concession to cover direct investments in Australian assets that are of a portfolio nature. These amendments also remove the portfolio restriction in respect of investments in foreign assets that are made through Australia. The amendments also make significant changes to the criteria that determine when a foreign fund is widely held and simplify the legislative mechanism for providing the IMR concession.

7.8 The IMR regime provides two concessions. The first is designed to place individual foreign investors that invest into Australia through a foreign fund in the same income tax position in relation to disposal gains and disposal losses as they would typically have been had they made their share of the fund's investments directly (rather than through the fund). The second is designed to ensure that a foreign investor that invests through an independent Australian fund manager will be in the same position, in relation to disposal gains and losses, as if they had invested directly.

7.9 These changes are expected to encourage greater foreign investment to Australia and allow Australian fund managers to actively market their financial services globally, thereby promoting Australia as a regional financial services centre.

Summary of new law

7.10 These amendments replace the existing Subdivision 842-I with a new regime that allows foreign entities to qualify for the IMR concession either by investing directly in Australia (direct investment concession) or investing via an Australian fund manager (indirect investment concession). An entity may independently qualify for the direct investment concession or the indirect investment concession. Whilst the tax consequences of either concession are the same, the indirect investment concession applies to a broader range of transactions.

7.11 As noted in paragraph 7.7, these amendments broaden the scope of the IMR regime. As part of this, the amendments remove a number of existing concepts and definitions used in Subdivision 842-I.

7.12 In addition, these amendments also make several technical changes to the operation of Subdivision 842-1 of the IT(TP)A 1997 to ensure some entities are not inadvertently excluded or disadvantaged in relation to Element 1 of the IMR reforms.

Comparison of key features of new law and current law

Detailed explanation of new law

7.13 The IMR concession is designed to encourage investment made into, or through, Australia by foreign entities by removing two impediments arising from the operation of Australia's income tax laws.

7.14 The first impediment arises for direct investments made by foreign entities into Australian assets that do not relate, directly or indirectly, to Australian real property or an Australian trading business. Disposal gains on such investments are either taxed on revenue account (as assessable income) or disregarded as a capital gain (because they are not taxable Australian property).

•

In general, whether an investment is held on revenue or capital account is determined by having regard to the purpose and activities of the entity making the investment. For example, a foreign individual who disposes of a passive investment in an asset typically realises gains of a capital nature rather than revenue and therefore would not be subject to Australian income tax.

•

By contrast, where such gains are made from pooling the investments of a wide base of investors into a fund, having regard to the purpose and activities of such a fund, equivalent disposal gains are more likely to be revenue and therefore subject to Australian income tax.

7.15 The second impediment arises for foreign entities investing through an independent Australian fund manager. To the extent use of such a manager constitutes an Australian permanent establishment (PE) certain returns or gains from these investments would have an 'Australian source' and so, in the absence of these amendments, would typically be taxable in Australia.

What is the IMR concession?

7.16 The IMR concession disregards specific Australian income tax consequences arising from specific investments made by foreign entities, including individuals, companies, beneficiaries of non-resident trusts and partners in partnerships. [Schedule 7, item 1, subsection 842-210(1)]

7.17 Consistent with Australia's existing arrangements for the taxation of trusts and partnerships, specific rules apply to non-resident trusts and partnerships to ensure the IMR concession flows through to foreign beneficiaries and partners. For example, a foreign beneficiary of a non-resident trust would apply the IMR concession to the extent necessary to work out their assessable income in Australia. These rules are necessary because of the flow-through nature of trusts and partnerships and the existing income tax provisions in Division 5 (partnerships) and Division 6 (trusts) of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). [Schedule 7, item 1, subsection 842-210(2)]

What entities qualify for the concession?

7.18 The concept of an IMR entity forms a key building block in determining whether a foreign entity receives the IMR concession. Only income derived by an IMR entity may qualify for the concession. However, as noted above, should foreign investors invest through an IMR entity that is a non-resident trust or partnership then those consequences flow through to the foreign beneficiaries or foreign partners.

7.19 Given the objectives of the IMR reforms, an entity will only be an IMR entity in relation to an income year if it is not an 'Australian resident' and not a 'resident trust for CGT purposes' at all times during the year. This means that the IMR concession does not affect the tax treatment of Australian residents that have interests in the IMR entity. Australian residents continue to be subject to Australian income tax on such investments. [Schedule 7, item 1, section 842-220]

7.20 'Australian resident' and 'resident trust for CGT purposes' are existing Australian income tax law concepts that are defined in subsection 995-1(1). The use of these concepts ensures that look-through vehicles that do not have a residency status for Australian income tax purposes can still qualify for the IMR concession.

7.21 As Australia's income tax system operates on an income year basis (the standard income year being 1 July to 30 June), these rules similarly operate on an equivalent income year basis. This means that an entity which initially qualifies as an IMR entity will need to assess on an ongoing basis that it continues to meet these requirements.

Example 7.1

Walkers Worldwide, a non-resident trust, is an IMR entity and has net income of $100. Rick and Carlie are beneficiaries of Walkers Worldwide and are each entitled to 1 per cent of its income

Rick is an Australian resident. Because of his residency status and Walkers Worldwide's status as a trust, the IMR concession has no application in working out Rick's assessable income. As such, for the purposes of determining Rick's share of the net income of the trust, Walkers Worldwide has a net income of $100. Rick's assessable income includes his share ($1) of the net income of Walkers Worldwide.

Carlie is not a resident of Australia for Australia's income tax purposes. Because of her residency status and Walkers Worldwide's status as a trust, the IMR concession notionally applies to the trust for the purposes of working out Carlie's assessable income (which includes her share of the net income of Walkers Worldwide).

What are the tax consequences of the concession?

7.22 The IMR concession operates by:

•

treating certain amounts of income that would otherwise be 'assessable income' as 'non-assessable non-exempt income';

•

denying certain 'deductions'; and

•

disregarding certain 'capital gains' and 'capital losses'.

'Assessable income', 'non-assessable non-exempt income', 'deductions', 'capital gains' and 'capital losses' are all core Australian income tax concepts and are defined in subsection 995-1(1). [Schedule 7, item 1, paragraphs 842-215(1)(a), (b) and (c) and 842-215(2)(a), (b) and (c)]

Example 7.2

Further to Example 7.1.

Assume that all of Walkers Worldwide's income qualifies for the IMR concession such that Walkers Worldwide's income of $100 is non-assessable non-exempt income, resulting in it having no net income.

The benefit of the IMR concession flows through to Carlie as she would consequently have no assessable trust distribution and (as a result of Walkers Worldwide's income being made non-assessable non-exempt) no capital gain in respect of her trust interest.

Similarly, if Carlie's entitlement to the $1 of income flows from Walkers Worldwide to another non-resident trust before being distributed to Carlie, then the benefit of the IMR concession will pass through the non-resident trust to Carlie. This is because the income has already been made non-assessable non-exempt income in the hands of Walkers Worldwide for the purposes of working out Carlie's assessable income.

7.23 There are two limbs to the IMR concession.

•

The first limb applies in relation to financial arrangements and is relevant for both the direct investment concession and the indirect investment concession.

•

The second limb applies in relation to specific tax consequences that arise or relate to an IMR financial arrangement as a result of an independent Australian fund manager constituting a PE of the IMR entity. As such, the second limb is relevant for just the indirect investment concession.

The IMR concession applying to IMR financial arrangements

7.24 The first limb of the IMR concession applies to disposal gains and losses arising from financial arrangements and to gains and losses arising from derivative financial arrangements. The concepts of a 'financial arrangement' and a 'derivative financial arrangement' are set out in sections 230-45 to 230-55 and subsection 230-350(1) respectively. Both concepts constitute an IMR financial arrangement for the purposes of the IMR concession. [Schedule 7, item 1, subsection 842-215(1)]

7.25 However, consistent with the design principle that the IMR concession does not provide foreign investors with a more advantageous outcome in relation to income that would otherwise be taxable capital gains, particular financial arrangements are excluded. Specifically, a financial arrangement will be an IMR financial arrangement unless it is, or relates to, a 'CGT asset' that is 'taxable Australian real property' or an 'indirect Australian real property interest'. 'CGT assets' are defined in section 108-5 and the concepts of 'taxable Australian real property' and 'indirect Australian real property interest' are set out in sections 855-20 and 855-25 respectively. [Schedule 7, item 1, paragraphs 842-225(1)(a) and (b)]

7.26 This means, for example, that gains arising from the disposal of portfolio equity interests in companies and in other entities (such as units in a unit trust), gains arising from the disposal of bonds and foreign exchange gains made under forward contracts qualify for the IMR concession. However, regular returns on IMR financial arrangements do not.

7.27 In addition, the IMR financial arrangement must not relate, either directly or indirectly, to the IMR entity carrying on a 'trading business' in Australia. The requirement that the financial arrangement not relate to such a business ensures that the IMR concession applies to passive, rather than active, types of income. The concept of a 'trading business' is set out in section 102M of the ITAA 1936. [Schedule 7, item 1, paragraphs 842-215(3)(d) and (5)(c)]

7.28 Extending the IMR concession to derivative financial arrangements recognises that entities frequently enter into such arrangements to minimise the risks associated with the underlying investment. Limiting the IMR concession to the underlying investment activity of an IMR entity and not arrangements associated with that activity would significantly undermine the effectiveness of the regime.

Sub-underwriting arrangements

7.29 Sub-underwriting arrangements are typically used to share the risk assumed by an underwriter. Where an entity seeks to raise finance, an underwriter guarantees, for a fee, that those funds will be raised by agreeing to take up any unsubscribed interests. An independent Australian fund manager, on behalf of an IMR entity, may sub-underwrite some or all of the underwriter's risk. Where those subscribed interests are themselves IMR financial arrangements, the sub-underwriting fee earned by the IMR entity may qualify for the IMR concession. If the IMR entity does not ultimately take up any interests because, for example, the offer is fully subscribed, the sub-underwriting fee can still qualify for the IMR concession. [Schedule 7, item 1, subsection 842-215(2)]

7.30 These rules for sub-underwriting arrangements apply only in respect of the indirect investment concession and not the direct investment concession. This is because the direct investment concession is designed to place individual foreign investors that invest into Australia through a foreign fund in the same income tax position in relation to disposal gains and disposal losses as they would typically have been had they invested directly rather than collectively through a foreign fund. Sub-underwriting fees are typically on revenue account (rather than capital account) regardless of whether an investor invests collectively or directly. Therefore, it is not appropriate to extend the sub-underwriting rules to the direct investment concession. [Schedule 7, item 1, paragraph 842-215(3)(e)]

The IMR concession applying in relation to permanent establishments

7.31 In addition the second limb of the IMR concession applies to disregard any additional income tax consequences that relate to or arise under an IMR financial arrangement as a result of the IMR entity having a PE in Australia on account of engaging an independent Australian fund manager. This means, for example, that amounts paid to an IMR entity as compensation for a loss suffered directly as a result of an act done, or an omission, by the independent Australian fund manager in relation to an IMR financial arrangement would be income that relates to that arrangement. [Schedule 7, item 1, subsection 842-215(2)]

7.32 Similarly, a foreign exchange gain from normal expense accruals of the fund (such as from related management fees) that would otherwise be assessable, could be considered to indirectly relate to each of the IMR financial arrangements of the fund. This means that these fees, provided they do not relate to anything other than one or more IMR financial arrangements of the IMR entity, would qualify for the IMR concession.

7.33 The question of whether a foreign entity has a PE in Australia depends on whether that entity is a resident of a country with an international tax agreement with Australia (based on the entity's residency as defined under the relevant international tax agreement). Consequently, to the extent that an IMR entity's income is not treated as having a source in Australia as a result of being attributable to a PE under a relevant international tax agreement, then this limb of the IMR concession still applies to the extent that the income is treated as having a source in Australia because of subsection 815-230(1). [Schedule 7, item 1, subsection 842-215(7)]

7.34 Amounts of income that would otherwise be subject to withholding tax, such as dividends, interest and royalty payments, do not qualify for the IMR concession. [Schedule 7, item 1, subsection 842-215(6)]

Qualifying for the direct investment concession

7.35 An IMR entity may qualify for the direct investment concession in relation to an income year if:

•

it is an IMR widely held entity during the whole of the year (or all of the part of the year that it exists);

•

the interest of the entity in the issuer of, or counterparty to, the IMR financial arrangement does not pass the 'non-portfolio interest test' during the whole of the year; and

•

none of the returns, gains or losses from the arrangement are attributable to a 'permanent establishment' in Australia.

[Schedule 7, item 1, subsections 842-215(3) and (4)]

7.36 Consistent with the BOT's recommendations, the concept of an IMR widely held entity ensures the IMR concession applies to only those entities that are genuinely widely held. Paragraphs 7.41 to 7.65 provide further information about what entities qualify.

7.37 The 'non-portfolio interest test' is set out in section 960-195. Not passing the non-portfolio interest test requires the holding entity and its associates to hold a direct participation interest of less than 10 per cent in the issuer of, or counterparty to, the IMR financial arrangement. Consistent with the requirement that the IMR financial arrangement not relate to a trading business in Australia, this rule ensures that the IMR concession applies only in respect of passive, rather than active, business income.

7.38 Using the concept of a counterparty to an IMR financial arrangement ensures that it is the interest of the IMR entity in the other party to the derivative that is tested (rather than the entity to which the derivative relates).

7.39 The definition of a 'permanent establishment' is set out in either the applicable international tax agreement (based on the residency of the IMR entity) or, if no such agreement applies in relation to the IMR entity, subsection 6(1) of the ITAA 1936. [Schedule 7, item 1, paragraph 842-215(3)(c) and subsection 842-215(7)]

7.40 It is important to note that the direct investment concession does not apply to disposal gains or losses that are attributable to an Australian PE.

•

Instead, the IMR entity may qualify for the indirect investment concession if the Australian PE is an independent Australian fund manager and the relevant gains or losses have arisen as a result of that engagement.

•

Paragraphs 7.66 to 7.79 provide further information about the indirect investment concession.

Example 7.3:

Bonjour Investments Ltd is a foreign investment entity based outside of Australia but it also has an Australian office that constitutes an Australian PE.

Should Bonjour Investments Ltd makes portfolio investments directly into Australia (that is, not through its office) then any gains or losses made on disposal of those investments will not be attributable to its PE in Australia.

The fact that Bonjour Investments has an Australian PE does not disqualify it from accessing the direct investment concession.

What is an IMR widely held entity?

7.41 To provide flexibility, an entity may qualify as an IMR widely held entity in one of two ways. Specific types of entities that are genuinely widely held automatically qualify whereas other entities need to satisfy one of two total participation interest requirements. This approach provides a balance between minimising compliance costs for foreign investors and ensuring that only genuinely widely held entities qualify for the IMR concession.

•

However, to help alleviate the cliff-edge nature of the total participation interest requirements, there is a temporary exception to these requirements.

•

This rule is discussed in paragraphs 7.63 to 7.65.

Specific types of widely held entities

7.42 A 'foreign life insurance company' as defined in subsection 995-1(1) as well as an entity listed in subsection 12-402(3) of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) (with the exception of those entities listed in paragraph 12-402(3)(e)) automatically qualifies as an IMR widely held entity.

•

The entities listed in subsection 12-402(3) of Schedule 1 to the TAA 1953 are entities that are taken to be widely held under the rules relating to managed investment trusts.

•

Alternative rules apply to entities listed in paragraph 12-402(3)(e) of Schedule 1 to the TAA 1953 - these rules are explained in paragraph 7.54.

[Schedule 7, item 1, paragraphs 842-230(1)(a) and (b)]

7.43 To provide ongoing flexibility, the regulations may prescribe additional types of entities. [Schedule 7, item 1, paragraph 842-230(1)(c)]

Widely held entities based on total participation interests

7.44 Alternatively, an entity may qualify as an IMR widely held entity if it satisfies either of the following tests (the total participation interest tests):

•

no entity has a 'total participation interest' of 20 per cent or more in the IMR entity; or

•

there are no five or fewer entities with a combined 'total participation interest' of at least 50 per cent in the IMR entity.

[Schedule 7, item 1, paragraph 842-230(2)(a)]

7.45 These percentages are based on the requirements in the United Kingdom's (UK) Investment Manager Exemption (IME) and like the UK's IME, either of the above tests, not both, need to be satisfied in order for the IMR entity to be an IMR widely held entity. This means, for example, that if a fund (that is an IMR entity) has six unaffiliated investors with equal interests in the fund, then despite the fund having five investors who hold the majority of interests in the fund, it will nonetheless be an IMR widely held entity because each investor has a total participation interest of less than 20 per cent.

7.46 The concept of a 'total participation interest' is set out in section 960-180 and incorporates the concepts of a 'direct participation interest' as defined in section 960-190 and an 'indirect participation interest' as defined in section 960-185.

7.47 Using these existing concepts ensures that it is possible to trace through a range of entities that may invest in an IMR entity to determine each entity's total participation interest in the IMR entity. Where an entity has an indirect participation interest through one or more interposed entities, then the interposed entity is treated as having a total participation interest of nil in the IMR widely held entity. Nonetheless, reference is still required to be made to an entity's direct and indirect participation interests in an interposed entity to calculate that entity's total participation interest. [Schedule 7, item 1, subsections 842-235(1) and (2)]

7.48 In practice, it may not be necessary for the IMR entity to continue tracing through a chain of entities once it identifies an entity in the chain with a total participation interest of less than 20 per cent. However, it may be necessary for the IMR entity to test all entities that have a direct participation interest in the IMR entity (and potentially all entities with an indirect participation interest if the entities with direct participation interests have a combined total participation interest of at least 50 per cent) to ensure that no five or fewer entities have a combined total participation interest of at least 50 per cent. Ultimately it will be a matter for the IMR entity to assure itself that it does not breach the total participation interest tests.

7.49 In testing an entity's total participation interest, the IMR entity needs to treat that entity and each of its 'affiliates' as together being one entity. The concept of an entity's affiliate is set out in section 328-130. This rule ensures an entity is not able to artificially dilute its total participation interest. [Schedule 7, item 1, subsections 842-235(1) and (4)]

7.50 Similarly, the IMR entity should not treat an entity that is a nominee of another entity as having rights in the test entity. Instead, the IMR entity should treat the other entity as having those rights. [Schedule 7, item 1, subsections 842-235(1) and (5)]

7.51 In addition, the IMR entity should not treat an object of a trust as having a direct participation interest or an indirect participation interest in the IMR entity. This is because the IMR widely held test focuses on the economic benefits that investors receive from a foreign entity. Once an object of a trust receives or becomes entitled to a share of the income of a trust, then it will also become a beneficiary of the trust. A total participation interest calculated on the basis of being a beneficiary (rather than an object) of the trust better reflects the economic benefits accruing to that entity. [Schedule 7, item 1, subsections 842-235(1) and (3)]

7.52 For the same reason, it is not necessary to test who controls the voting power of the IMR entity (which sometimes may be the fund manager). As the widely held test is designed to ensure that the IMR entity is widely held the criteria in paragraph 350(1)(b) of the ITAA 1936 can be ignored in determining whether an entity has a total participation interest in another entity. [Schedule 7, item 1, subsections 842-235(1) and (8)]

7.53 Furthermore, an independent fund manager may have additional rights or interests in the IMR entity that reflect its fund management role rather than an entitlement to economic benefits. As such, an IMR entity may disregard any direct or indirect entitlement (including contingent entitlements) of an independent fund manager or any entity connected with the fund manager that is subject to tax in the year it is received in calculating the total participation interest of the fund manager (and any entity connected with the fund manager). For example, a fund manager's entitlements from the IMR entity may consist of seed capital, flat fees, profit incentives and returns payable on seed capital and profit incentive interests - some of which may be taxable in the year received whereas other entitlements may have deferred tax consequences. It is not only such entitlements of independent Australian fund managers that are disregarded under this rule, but also such entitlements of any independent fund manager. This could include, for example, circumstances where the IMR entity has engaged a foreign fund manager and is accessing the direct investment concession. In this case, 'independent fund manager' takes its ordinary meaning. The concept of an entity 'connected with' another entity is set out in section 328-125. [Schedule 7, item 1, subsections 842-235(1) and (9)]

7.54 As the purpose of the total participation interest tests is to determine if an entity is an IMR widely held entity, it is not necessary to apply these rules to an entity that is specifically listed as an IMR widely held entity or an entity listed in paragraph 12-402(3)(e) of Schedule 1 to the TAA 1953. Instead, such an entity is deemed to have a total participation interest of nil. This means, for example, if an IMR widely held entity invests in another IMR entity (the second IMR entity), then it would have a total participation interest of nil should the second IMR entity choose to test whether the total participation interests of each of its investors exceeds 20 per cent. [Schedule 7, item 1, subsections 842-235(1) and (6)]

7.55 When testing whether there are five or fewer entities with a combined total participation interest of at least 50 per cent, by deeming the participation interest of such an entity to be nil, it will not affect the counting of the total participation interests but it is still counted as an entity in the calculation of the number of entities. [Schedule 7, item 1, subsections 842-235(1) and (7)]

Example 7.4

Doone Funds is a feeder fund that wholly invests in Clem Investments, an IMR entity. To determine whether Clem Investments is an IMR widely held entity, it is necessary to test Doone Funds total participation interest.

•

Flimbin Fund, an endowment fund, holds a 15 per cent interest in Doone Funds.

•

Wiggins Ltd, has an 85 per cent interest in Doone Funds. Wiggins Ltd has six shareholders (who are not affiliates) Casey, Rebecca, Ross, Michelle, Alex and Essam each with a 16.67 per cent shareholding.

As Casey, Rebecca, Ross, Michelle, Alex and Essam each have a total participation interest in Clem Investments of 14.17 per cent (calculated as 16.6 per cent × 85 per cent × 100 per cent), Wiggins Ltd's total participation interest of 85 per cent in Clem Investments and Doone Fund's total participation interest of 100 per cent in Clem Investments are ignored.

As no entity has a total participation interest of more than 20 per cent, Clem Investments qualifies as an IMR widely held entity.

Example 7.5

Gorch Investments invests in Anny Funds Management, an IMR entity. To determine whether Anny Funds Management is an IMR widely held entity, it is necessary to test Gorch Investments' total participation interest.

•

The Kuttner Hunger Fund, a charity, has a 30 per cent interest in Gorch Investments and Rubashov Ltd has a 70 per cent interest in Gorch Investments.

•

Rubashov Ltd has twenty shareholders (who are not affiliates) with each having an equal 5 per cent shareholding.

As each of Rubashov Ltd's shareholders has a total participation percentage of 3.5 per cent in Anny Funds Management (calculated as 5 per cent × 70 per cent × 100 per cent), Rubashov Ltd's total participation percentage of 70 per cent is ignored.

As no five entities (the Kuttner Hunger Fund plus four shareholders in Rubashov Ltd) have a combined total participation interest of 50 per cent or more, Anny Funds Management is an IMR widely held entity.

Example 7.6

Wexler Worldwide has a 100 per cent interest in Lahiri Funds Management, which is an IMR entity.

Bevers Insurance Ltd, a foreign life insurance company, has a 10 per cent interest in Wexler Worldwide but is taken to have a total participation interest of nil in Lahiri Funds Management.

Lincoln Perpetual, an endowment fund, has a 20 per cent interest in Wexler Worldwide and so has a total participation interest of 20 per cent in Lahiri Funds Management (unless another entity is identified as having a direct participation interest in Lincoln Perpetual).

Grailman Ltd has a 70 per cent interest in Wexler Worldwide but it has four shareholders; Phil, Winchin, Ly and Kamala, each with a 25 per cent shareholding. As Phil, Winchin, Ly and Kamala are not affiliates, each shareholder has a 17.5 per cent total participation interest in Lahiri Funds Management (calculated as 25 per cent × 70 per cent × 100 per cent).

Lahiri Funds Management is not a widely held IMR entity.

•

Lincoln Perpetual has a 20 per cent total participation interest in Lahiri Funds Management.

•

There are five entities with total participation interests in Lahiri Funds Management that have a combined total participation interest of 50 per cent or more - Bevers Insurance Ltd plus Lincoln Perpetual plus Phil plus Winchin plus Ly have a combined total participation percentage of 72.5 per cent.

Example 7.7

Maraj Investments is a feeder fund for Codrea Capital, a master fund and IMR entity.

Adichie Ltd, a life insurance company, holds a 30 per cent interest in Maraj Investments but is taken to have a total participation percentage of nil in Codra Capital (as it is an entity covered by paragraph 12-402(3)(a) of Schedule 1 to the TAA 1953).

Chillson Endowments, an endowment fund, has a 10 per cent interest in Maraj Investments, and therefore has a total participation interest of 10 per cent in Codrea Capital (unless another entity is identified as having a direct participation interest in Chillson Endowments).

Quellman Ltd has a 60 per cent interest in Maraj Investments but it has five shareholders, Lucas, Michael, Evelyn, Ivy and Vinson, each with a 20 per cent shareholding. Each shareholder has a total participation interest of 12 per cent in Codrea Capital (calculated as 20 per cent × 60 per cent × 100 per cent).

Notwithstanding five entities (Lucas, Michael, Evelyn, Ivy and Vinson) having a combined total participation interest of 60 per cent, Codrea Capital is an IMR widely held entity as no entity has a total participation interest of 20 per cent or more.

Special rules for starting up, winding down and temporary circumstances outside an IMR entity's control

7.56 In addition, specific rules apply when the IMR entity is starting up or winding down. These rules recognise that in some circumstances an IMR entity may take some time to grow an investment base that satisfies the total participation interest tests. Similarly, an IMR entity is unlikely to satisfy the total participation interest tests once it starts winding down its investment activities.

7.57 As noted in paragraph 7.41, a temporary circumstances exemption also applies to alleviate the cliff-edge nature of the total participation interest tests.

Starting up

7.58 If an IMR entity has never satisfied the total participation interests test, then it is still taken to be an IMR widely held entity provided it is being actively marketed with the intention of satisfying the total participation interest tests. It will be a question of fact whether an IMR entity is being actively marketed and this requires evidence of ongoing genuine attempts to obtain third party investment to meet the total participation interests test. [Schedule 7, item 1, paragraph 842-230(2)(b)]

7.59 Although there is no express time limit on how long an IMR entity can be actively marketed with such an intention before it is taken to fail this test, an IMR entity that has not satisfied the total participation interest tests within a reasonable period of time (such as 18 months) of receiving its first investor may need to provide compelling evidence about its genuine attempts to obtain third party investment to rebut any presumption that it is not being actively marketed with such an intention.

7.60 Depending on the circumstances, there may be other forms of evidence indicating that an IMR entity is not being actively marketed with the intention of satisfying the total participation interest tests.

Winding down

7.61 If an IMR entity's activities and investments are being wound down, then it will be taken to continue to be widely held even if it no longer satisfies the total participation interests test. This accommodates situations where investors withdraw their funds from the IMR entity once they have been notified that the fund is being wound down. [Schedule 7, item 1, paragraph 842-230(2)(c)]

7.62 It will be a question of fact whether an IMR entity is being wound down. However, once an IMR entity has sent notices to its investors notifying them that it is being wound, then prima facie it would be taken to be wound down.

Temporary circumstances outside of an IMR entity's control

7.63 In some cases, an IMR entity may temporarily breach the total participation interest tests due to a reason beyond its control. For example, it is common for foreign investment entities to have substantial keystone investors, such as a life insurance company, a complying superannuation fund or another type of IMR widely held entity. The sudden and unexpected exit of such a keystone investor may result in an IMR entity failing the widely held test.

7.64 In these circumstances, having regard to the actions of the IMR entity to resolve these issues (and the speed with which they are taken), the IMR entity may continue to be treated as being widely held if it is fair and reasonable to do so. There are no limits on what actions the IMR entity could take and, depending on the circumstances, this may include winding down the entity. However, it is important to note that this rule applies only in relation to temporary circumstances. Accordingly, 'temporary' takes its ordinary meaning. [Schedule 7, item 1, section 842-240]

7.65 This rule provides an opportunity for the IMR entity to rectify the breach of the total participation interests test without losing the benefit of the IMR concession.

Qualifying for the indirect investment concession

7.66 As noted in paragraph 7.10, an entity may qualify for either the direct investment concession or the indirect investment concession. In determining whether an IMR entity qualifies for the indirect investment concession, it does not matter whether or not it also qualifies for the direct IMR investment concession. However, it is important to note that the second limb of the IMR concession (relating to PEs) only applies in relation to the indirect investment concession.

7.67 An IMR entity may qualify for the indirect investment concession in relation to an income year if:

•

the IMR financial arrangement is made on the IMR entity's behalf by an independent Australian fund manager; and

•

if the issuer, or counterparty to, the IMR financial arrangement is an Australian resident or a resident trust for CGT purposes - then the interest in the entity does not pass the 'non-portfolio interest test'.

Importantly, the requirement to not pass the non-portfolio interest test only applies in relation to interests in financial arrangements that are issued by Australian residents. There is no equivalent requirement in relation to financial arrangements issued by foreign residents. This is because investments into foreign assets by foreign residents without going through Australia would typically be outside the Australian tax net and therefore whether the foreign returns and gains are passive or active income is not important. The requirement that the non-portfolio interest test applies in respect of Australian investments is consistent with the trading business restriction applying to IMR financial arrangements. Paragraphs 7.24 to 7.28 provide further information about IMR financial arrangements and paragraph 7.37 provides further information about the non-portfolio interest test. [Schedule 7, item 1, subsection 842-215(5)]

What is an independent Australian fund manager?

7.68 To qualify as an independent Australian fund manager, the managing entity must be an Australian resident and carry out investment management activities for the IMR entity in the ordinary course of its business. This means, for example, that Australian brokers that buy and sell securities on the Australian Securities Exchange for foreign investors as part of their ordinary stock broking function would be considered as providing such services and therefore could be independent Australian fund managers. [Schedule 7, item 1, paragraphs 842-245(1)(a) and (b)]

7.69 In addition, the managing entity must, having regard to the Organisation for Economic Co-operation and Development (OECD) transfer pricing guidelines, receive an amount equivalent to arm's length level of remuneration for its services. [Schedule 7, item 1, paragraph 842 245(1)(c) and subsection 842-245(2)]

7.70 To ensure the relationship between the IMR entity and the managing entity is genuinely independent, either:

•

the IMR entity must be an IMR widely held entity; or

•

no more than 70 per cent of the managing entity's income for the income year is received from the IMR entity or an entity 'connected with' the IMR entity ('the 70 per cent or less test').

Paragraphs 7.41 to 7.65 provide further information about the requirements for an IMR entity to be an IMR widely held entity. [Schedule 7, item 1, subparagraphs 842-245(1)(d)(i) and (ii)]

7.71 There are also consequences if the independent Australian fund manager has an entitlement to more than 20 per cent of the value of the IMR concession to the IMR entity - see paragraphs 7.73 to 7.79.

Example 7.8

Three foreign investors, Lee, Ivar and Tanya, form a partnership to invest in Australian shares. Lee, Ivar and Tanya engage a fund manager, Tayler, on a commercial basis to acquire and sell shares on their behalf. Tayler is based in Australia and buys and sells shares for a wide range of Australian and international clients.

In one income year, Tayler makes a total of 100 transactions, of which 20 are made on behalf of Lee, Ivar and Tanya.

Assuming that Tayler receives equivalent amounts of income for each transaction, then only 20 per cent of Tayler's income for that income year is received from Lee, Ivar and Tanya and so Tayler qualifies as an independent Australian fund manager.

7.72 Recognising that newly formed managing entities may not be able to satisfy the 70 per cent or less test, an entity that has been carrying out investment management activities for 18 months or less need only take all reasonable steps to ensure that its proportion of income from the IMR entity (and entities connected with the IMR entity) is reduced to 70 per cent or less in the income year to qualify as an independent Australian fund manager. This will be a question of fact. [Schedule 7, item 1, subparagraph 842-245(1)(d)(iii)]

Example 7.9

Further to Example 7.8.

Lee, Ivar and Tanya subsequently engage another Australian fund manager Philomena to make various investments on their behalf. Philomena has only recently become a fund manager and so has no other clients. Accordingly, 100 per cent of Philomena's income is received from Lee, Ivar and Tanya.

However, provided Philomena is taking reasonable steps to bring her income from Lee, Ivar and Tanya below the 70 per cent threshold, such as actively seeking out new clients, then she qualifies as an independent Australian fund manager.

Consequences if an independent Australian fund manager is entitled to a share of at least 20 per cent of the IMR entity's profits

7.73 As noted in paragraph 7.71, if an independent Australian fund manager has a right to receive part of the profits of the IMR entity in an income year and the value of that entitlement exceeds 20 per cent of the net value of the IMR concession for that year (the 20 per cent profit test), then the IMR concession is reduced by the full amount of the fund manager's entitlement. This rule helps to ensure that the fund manager is genuinely independent and that the benefit of the concession is targeted to foreign resident investors. A fund manager's entitlement may take the form of a contingent entitlement or a direct or indirect right to part of the profits of the IMR entity and includes any entitlements of other entities connected with the fund manager. This ensures that carried interests of the fund manager are subject to the test, unless brought to tax in that income year. There are no consequences if the independent Australian fund manager's total entitlement is 20 per cent or less.

•

However, recognising that an independent Australian fund manager may have entitlements in the IMR entity that reflect its management role (rather than as an investor), some entitlements are excluded for the purposes of the 20 per cent profit test.

•

Furthermore, there may be some circumstances when an independent Australian fund manager's entitlements can temporarily exceed the 20 per cent profit test. The consequences of these circumstances are mitigated through the fund manager being able to test its entitlement across a qualifying period (rather than a single income year) or being able to demonstrate that the circumstances for breaching the test arose outside the control of the IMR entity, or the fund manager and entities connected with the fund manager, and that steps are being taken to address these circumstances.

The 20 per cent profits test has been designed so that an IMR entity applies the test in relation to each income year to determine if it needs to reduce the value of the IMR concession in that year. This avoids any complexity arising from an IMR entity having to lodge subsequent income tax returns for previous income years or seek amended assessments should any anticipated entitlements not eventuate. [Schedule 7, item 1, subsection 842-250(1)]

7.74 Similar to the exclusion of some of the independent Australian fund manager's entitlements to profits from being counted towards the total participation interest test in the IMR entity (as set out in paragraph 7.53), equivalent entitlements are excluded from counting towards the 20 per cent test. Specifically, an entitlement (including a contingent entitlement) that is taxable in the year it is received does not count towards the 20 per cent test. [Schedule 7, item 1, paragraph 842-250(1)(b) and subsection 842-250(8)]

7.75 The concept of the net value of the IMR concession is the unadjusted concessional amount. The unadjusted concessional amount is calculated by adding up all amounts made non-assessable non-exempt under the IMR concession plus all capital gains disregarded under the concession and subtracting all deductions and capital losses disregarded under the concession (including deductions that are disallowed because they relate to amounts non-assessable non-exempt income as a result of the IMR concession.

•

Should the independent Australian fund manager have an entitlement that exceeds the 20 per cent profit test in an income year, then the IMR entity would need to reduce the value of the IMR concession. This requires subtracting the amount of the fund manager's entitlement from the amount made non-assessable non-exempt under the IMR concession and, if necessary, reducing any disregarded capital gains by a proportional amount.

•

For example, if an IMR entity receives $100 non-assessable non-exempt income in an income year under the first limb of the IMR concession and its independent Australian fund manager has a total entitlement to $30 in the same income year, then the IMR entity would need reduce the amount of non-assessable non-exempt income it receives under the IMR concession to $70 (and, as a result, may have $30 brought to tax in Australia).

[Schedule 7, item 1, subsections 842-250(3), (4) and (5)]

7.76 However, as noted in paragraph 7.73, an IMR entity may not have to reduce the value of the IMR concession in a particular income year even if its independent Australian fund manager has an entitlement that exceeds the 20 per cent profits test. If the fund manager's entitlement does not, on average, exceed the 20 per cent profits test over a qualifying period (of up to five years) or the circumstances for the breach are outside the control of the IMR entity or the fund manager and the fund manager is taking steps to address these circumstances, then the IMR entity need not reduce the amount of the IMR concession.

7.77 For the purposes of the 20 per cent test, the qualifying period includes the relevant income year (the current year) as well as up to four consecutive preceding income years. The IMR entity (or the independent Australian fund manager) has complete choice each year over whichever combination of preceding income years to include in the qualifying period - this can include previous income years where the fund manager's entitlement is below the 20 per cent profit test. For example, the IMR entity could choose to include:

•

the percentage of the fund manager's entitlement in the current income year and the percentage of the fund manager's entitlement in the preceding income year;

•

the percentage of the fund manager's entitlement in the current income year and the percentage of the fund manager's entitlement in each of the preceding two income years;

•

the percentage of the fund manager's entitlement in the current income year and the percentage of the fund manager's entitlement in each of the preceding three income years; or

•

the percentage of the fund manager's entitlement in the current income year and the percentage of the fund manager's entitlement in each of the preceding four income years.

[Schedule 7, item 1, subsections 842-250(6) and (7)]

7.78 Alternatively, if the circumstances for the breach are outside of the control of the fund manager, or the IMR entity, then the IMR entity need not reduce the amount of the concession as long as the fund manager (or an entity connected with the fund manager) is taking steps to address these circumstances, with the intention that it satisfies the 20 per cent test. Of the two tests, this test is likely to be more important in relation to newly formed IMR entities that are being actively marketed where the fund manager needs to provide seed capital before seeking third party investors. This test may also accommodate situations when a keystone investor unexpectantly exits and the fund manager's entitlement correspondingly increases.

•

Although there is no express time limit on how long an independent Australian fund manager can continue to take steps to address the relevant circumstances before it fails this test, a fund manager that does not address the circumstances in a reasonable time may need to provide compelling evidence about the circumstances giving rise to the breach of the 20 per cent test to rebut any presumption that such circumstances are not outside the control of the fund manager or the IMR entity.

•

For example, if a fund manager's entitlement remains consistently about 20 per cent test or increases over time, then it would be hard to argue that the relevant circumstances arose out of its control and that it is taking steps to address those circumstances.

[Schedule 7, item 1, subsection 842-250(2)]

7.79 Although these two tests are mutually exclusive, there is nothing to stop an IMR entity from applying either test depending on its particular circumstances. For example, an IMR entity could choose to test its fund manager's entitlement over all of qualifying period combinations and, even if it exceeds the 20 per cent profit test, may still be able to show that the circumstances for the breach arose out of its control and that it is taking steps to address these circumstances.

Example 7.10

Rosifund is an independent Australian fund manager of an IMR entity. Starting in year 1, Rosifund and entities connected with Rosifund, are entitled to receive a share of the profits of the IMR entity in each year.

In year 1, Rosifund is entitled to $200 representing 40 per cent of the net value of the IMR concession. As this exceeds the 20 per cent test, Rosifund may test its entitlement over a qualifying period or show that the circumstances arose out of its control (or the control of the IMR entity) and that it is taking steps to address these circumstances.

•

As Rosifund and the IMR entity have only just come into existence, it is not possible to test Rosifund's entitlement over a qualifying period.

•

However, because of this, and the fact that it takes some time to build up the IMR entity to be widely-held, the circumstances of the breach are out of Rosifund's control and as long as the IMR entity is being actively marketed the value of the IMR concession need not be reduced.

In year 2, Rosifund's entitlement is 20 per cent and so the value of the IMR concession need not be reduced. There is no need to test Rosifund's entitlement over a qualifying period (or show that Rosifund is taking steps to reduce any circumstances outside of its control). In this year, the 20 per cent threshold is not exceeded and therefore the IMR entity remains entitled to the full IMR concession.

Similarly, Rosifund's entitlement is 20 per cent in years 3 and 4.

In year 5, Rosifund is entitled to a 30 per cent share of the profits.

•

Rosifund may test its entitlement over any qualifying period but as its entitlement in year 5 exceeds 20 per cent, and its entitlement in each of the four preceding years is not below 20 per cent, Rosifund's entitlement over the qualifying period exceeds 20 per cent.

•

However, if the circumstances for the breach arose outside of Rosifund or the IMR entity's control, such as the exit of a keystone investor, and Rosifund is taking steps to bring down its entitlement so that it does not exceed 20 per cent then the IMR entity is not required to reduce the value of the IMR concession by $150.

•

It would be unlikely that Rosifund could claim that the breach of the 20 per cent threshold because it is still in a start-up phase, particularly as Rosifund's entitlement has not exceeded 20 per cent in years 2 and 3. However, this would be a question of fact that depends on the specific circumstances.

In year 6, Rosifund's entitlement is 20 per cent. There is no need to test Rosifund's entitlement over a qualifying period (or show that Rosifund is taking steps to reduce any circumstances outside of its control, including those relating to year 5).

In years 7 and 8, Rosifund's entitlement is 15 per cent in each year.

In years 9 and 10, Rosifund's entitlement is 10 per cent in each year.

Consequential and other amendments

7.80 These amendments include guide material and an objects clause for Subdivision 842-I. [Schedule 7, item 1, sections 842-200 and 842-205]

7.81 These amendments add a reference to the IMR concession to the list of non-assessable non-exempt provisions in section 11-55. [Schedule 7, item 5]

7.82 These amendments remove redundant definitions in the dictionary in subsection 995-1(1) arising from the repeal of the previous Subdivision 842-I and replace them with references to new IMR-related definitions. [Schedule 7, items 6, 7, 8, 9 and 10]

7.83 These amendments also exclude business carried on by a partnership that solely relates to IMR financial arrangements from being used to determine if the partnership carries on business in Australia for the purposes of section 94T of the ITAA 1936 and therefore if the partnership is a resident for tax purposes. Importantly, these amendments do not exclude business carried on by the partnership (or the fund manager) for the purposes of the central management and control test in relation to the limited partnership definition in subparagraph 94T(1)(f)(ii) of the ITAA 1936. [Schedule 7, items 2 and 3]

'IMR foreign fund' technical corrections

7.84 These amendments also correct several technical deficiencies with the original definition of an 'IMR foreign fund' in Subdivision 842-I. Whilst the new Subdivision 842-I no longer relies on the concept of an 'IMR foreign fund' (instead relying on the concept of an 'IMR entity'), the definition of an IMR foreign fund continues to have ongoing application in relation to Element 1 of the IMR regime. Accordingly, these amendments provide foreign entities with the choice of applying alternative tests to determine whether they are an IMR foreign fund for the purposes of the earlier amendments. [Schedule 7, item 12, subsection 842-208(1) of the IT(TP)A 1997]

7.85 These tests incorporate the definition of 'IMR entity' but with some modifications to better match the earlier requirements to be an IMR foreign fund - this includes ensuring the entity meets the requirements to be a widely held IMR entity based on the total participation interests in the entity. [Schedule 7, item 12, subsections 842-208(2) and (3) of the IT(TP)A 1997]

7.86 A foreign entity that makes this choice also has the benefit of the amendments to section 94T of the Income Tax Assessment Act 1936 that would otherwise apply only from the 2011 12 income year. [Schedule 7, item 12, section 842-209]

7.87 This is necessary as the amendments to section 94T exclude business carried on by a partnership that solely relates to an IMR financial arrangement from being used to determine if the partnership carries on business in Australia.

Application and transitional provisions

7.88 These amendments commence on Royal Assent.

7.89 These amendments apply in relation to the 2015-16 income year and later income years. [Schedule 7, item 11 and item 12, paragraph 842-207(1)(a) of the IT(TP)A 1997]

7.90 In addition, a taxpayer may choose to apply the new Subdivision 842-I in relation to the 2011-12, 2012-13, 2013-14 and 2014-15 income years. [Schedule 7, item 11 and item 12, paragraph 842-207(1)(b) and subsection 842-207(2) of the IT(TP)A 1997]

7.91 The IMR foreign fund technical corrections, in effect, apply on an optional basis to the 2010-11 and earlier income years. [Schedule 7, item 12, section 842-208 of the IT(TP)A 1997]

7.92 Taxpayers that choose to apply these transitional arrangements need not notify the Commissioner of Taxation about this choice. Instead, the taxpayer's business records can provide sufficient evidence of this choice.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

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

Investment manager regime

7.93 This Schedule 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

7.94 This Schedule amends the Income Tax Assessment Act 1997 and the Income Tax (Transitional Provisions) Act 1997 to implement the third and final element of the investment manager regime (IMR) reforms.

7.95 The IMR ensures that foreign investors are not subject to Australian income tax on their investments when they invest through an independent Australian fund manager or when the foreign investor is a widely held foreign entity investing in specific types of Australian assets.

7.96 These reforms extend the IMR to cover a broader range of investments as well as make changes to the eligibility criteria for foreign investors.

7.97 Although the amendments introduced by this Schedule have some retrospective application, the optional nature of this application means the effect of this on taxpayers and other foreign investors is entirely beneficial.

Human rights implications

7.98 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

7.99 This Schedule is compatible with human rights as it does not raise any human rights issues.

REGULATION IMPACT STATEMENT

Introduction

7.100 This regulation impact statement (RIS) was prepared by the Department of the Treasury at the original decision making stage and was assessed as adequate for inclusion in this explanatory memorandum by the Office of Best Practice Regulation. It was publicly released on

8 February 2012 and is publicly available on the Department of the Prime Minister and Cabinet's website.^[3]

7.101 A RIS is a document prepared by departments and, as such, this RIS reflects the Department of the Treasury's assessment of the costs and benefits of each option at the decision making stage. Accordingly, this RIS does not reflect changes arising from further consultation during the legislative development of these amendments.

Assessing the problem

Introduction

7.102 Following the report by the Australian Financial Centre Forum (AFCF) headed by Mark Johnson ('The Johnson report')^[4] the Government agreed in principle to an IMR which would provide a set of clear and comprehensive rules on the taxation of certain non-resident investments into Australian and offshore assets. The AFCF proposed that the IMR would apply broadly, extending beyond funds management to cover a range of other activities in the financial sector.

7.103 Subsequently, the Government announced two amendments to the income tax law:

•

On 17 December 2010, the Government announced that it would provide certainty of tax treatment for funds that have invested in Australia. Where a foreign managed fund has not lodged a tax return for the 2009-10 or prior income years in respect of certain investment income of the fund, the Australian Taxation Office (ATO) will not be permitted to raise an assessment in respect of that income, except where the fund lodges a tax return disclosing such income.

•

On 19 January 2011, the Government announced that income from relevant investments of a foreign fund, that is taken to have a 'permanent establishment' in Australia solely due to the use of an Australian financial intermediary, will be exempt from income tax.

7.104 This RIS relates to the third, and final, element of the IMR which will address providing certainty in the prospective tax treatment of foreign managed funds investing in portfolio, passive, Australian securities. While this RIS is intended to be a stand-alone document, further background and context of the measures is contained in the RIS on the first two elements of the IMR published on 16 September 2011.^[5] That RIS contains details of the AFCF recommendations for an IMR and details of consultation which had occurred. Exposure drafts of legislation relating to these announcements were released on 16 August 2011 for public comment.^[6]

The Johnson Report

7.105 Australia's taxing arrangements for non-resident investment in domestic and offshore assets was most recently examined as part of the Johnson Report into developing Australia as a Financial Centre.

7.106 The Johnson Report, released in January 2010, found that Australia has arguably the most efficient and competitive 'full service' financial sector in the Asia Pacific region. However, it also found the percentage of funds under management sourced from offshore investors was low.

7.107 While the Johnson Report acknowledged that there were a number of reasons for the low level of offshore funds under management, it found that a critical reason was uncertainty regarding the tax treatment of funds managed out of Australia but sourced from offshore.

7.108 The Johnson Report found that this uncertainty stemmed from the fact that many of the taxation concepts central to the taxation of non-resident investment - such as 'source', 'permanent establishment', 'central management and control' and the revenue/capital distinction - were generally not codified in statute but rather relied on the application of common law principles, developed through cases that were not always easily adapted to the operation of modern financial markets, with taxation outcomes depending on a consideration of the facts and circumstances of each company and/or transaction.

7.109 The Report also noted that, in contrast, a number of overseas financial centres, including Hong Kong, Singapore, New York, Tokyo and London have statutory rules designed to provide clarity and certainty regarding the taxation treatment of the income of non-resident investors, including where they used domestic fund managers.

7.110 According to the Johnson Report, some of the consequences of the current taxation arrangements are that:

•

potential foreign investors being unwilling to invest via Australian based vehicles or use Australian based investment advisers;

•

financial transactions or decisions that could have occurred through an Australian based broker, exchange or other intermediary being undertaken offshore, or not at all; and

•

some Australian fund managers resisting opportunities to expand their funds under management from offshore clients or, alternatively, setting up offshore vehicles that were managed offshore.

7.111 In summary, the Johnson Report found that the combined effects of the current taxing arrangements were that Australia was unable to take advantage of some potential financial transactions, investment flows and new business opportunities.

Johnson Report Recommendation 3.1 - an investment manager regime

7.112 To resolve this uncertainty on a prospective basis, the Johnson Report recommended introducing an IMR to provide clear and comprehensive statutory rules for taxing non-residents investing in Australian and offshore assets.

7.113 The Report argued that an IMR should:

•

ensure non-resident investors investing in Australia or overseas through an Australian intermediary did not attract additional Australian tax on investments merely by use of that intermediary;

•

remove impediments to Australian investment managers (or fund managers) managing offshore sourced funds, and also encourage financial services companies to establish or maintain their regional headquarters in Australia; and

•

remove disincentives to attracting financial services business to Australia.

7.114 While the focus of much of the discussion in the Johnson Report identifies problems in the tax law that affect the managed funds industry, the report recommended an IMR with wide application, extending beyond funds management to other financial services activities (such as banking and insurance). This RIS addresses funds management aspect of the IMR only.

Why is Government action required to correct the problem?

7.115 Uncertainty regarding their potential tax liability for investment in Australia is likely to have an adverse impact on the investment decisions of foreign managed funds, and act as an impediment to the development of Australia as a regional financial centre. There is also anecdotal evidence that some foreign funds managers are not investing in Australia as a result. That said, the overall level of investment in Australia is currently at historically high levels, and projected to grow further in coming years.

What are the objectives of government action?

7.116 The objective of Government action is to remove impediments to Australia's continued development as a regional financial centre from uncertain taxation treatment of foreign managed funds, consistent with maintaining the integrity of the income tax base and achieving the Government's medium term fiscal strategy.

7.117 In order to achieve this, it is important that Australia's taxing arrangements in this area be amended so that they:

•

are clear and certain;

•

maintain the integrity of the taxation system (by safeguarding the taxation of the corporate tax base and the taxation of resident investors);

•

do not discourage the use of Australian based financial intermediaries; and

•

have only a limited impact of government revenue, consistent with the Government's commitment to return the budget to surplus in the 2012-13 financial year.

Board of Taxation review of IMR in relation to foreign managed funds

7.118 The Board of Taxation was asked to examine and report on the design of an IMR for foreign managed funds as part of its review of the taxation treatment of collective investment vehicles. In response to a request by the Assistant Treasurer on 10 May 2011, the Board of Taxation brought forward its consideration of an IMR as it applies for foreign managed funds to 30 August 2011.

7.119 The Board of Taxation made 12 recommendations in relation to the implementation of the IMR. The Board recommended that:

•

An IMR for foreign managed funds should be implemented using an exemption style approach (Recommendation 1).

•

Foreign managed funds covered by the IMR should:

•

comprise a broad set of collective investment vehicle structures and arrangements, and should not be limited to particular types of legal entity (Recommendation 2);

•

not be an Australian resident (Recommendation 3) - (in this context, the Board also recommended that certain modifications be made to Australia's residence and permanent establishment tests for foreign managed funds accessing the IMR);

•

be widely held (Recommendation 4);

•

not carry on or control a trading business in Australia (Recommendation 5); and

•

not be subject to a 'managed in Australia' requirement (Recommendation 6).

•

For foreign managed funds covered by the IMR, gains from the disposal of portfolio investments (those in which the foreign managed fund has less than a 10 per cent interest) in a prescribed list of eligible investments should be exempt from tax (Recommendation 7).

•

A gain made by a foreign managed fund from the disposal of a non-portfolio investment in non-Australian assets (that is, conduit income) should not be subject to Australian tax if the only reason it is subject to Australian tax is because it uses an Australian intermediary (Recommendation 8).

•

In order to protect the Australian tax base:

•

income derived by Australian investors from a foreign managed fund is not made exempt merely by virtue of the income being treated as exempt for the foreign managed fund under the IMR (Recommendation 9);

•

integrity rules should not be introduced into the IMR for foreign managed funds to address deferral of taxation that would operate in addition to Australia's foreign source income attribution rules, and that a review be undertaken of these rules after enactment to ensure that inappropriate outcomes are not arising through the IMR rules (Recommendation 10); and

•

foreign managed funds should be required to be resident of an information exchange country and to lodge annual information returns with the ATO (Recommendation 11).

•

Australia's transfer pricing rules should continue to operate where appropriate to tax Australian intermediaries on their arm's length fees for services provided to foreign managed funds (Recommendation 12).

Options for Consideration

Option 1: No change to the law

7.120 Option 1 would maintain the current legislative arrangements. Where there is uncertainty in the law, this would be resolved through the existing administrative processes, with interpretative guidance to be sought from the ATO or the judicial process (that is, the courts).

Option 2: Change the income tax law to define and fully tax Australian income of foreign managed funds

7.121 Option 2 would seek to resolve uncertainty in relation to current income taxation treatment of foreign managed funds by bringing these investments more clearly within the Australian income tax net. That is, the legislation would be amended to state that income, gains and losses from such investments would be on revenue account and fully subject to income tax in Australia.

Option 3: Change the income tax law to restrict the taxation of Australian income of portfolio investments of foreign managed funds (IMR)

7.122 Option 3 would seek to resolve uncertainty in relation to current income taxation treatment of foreign managed funds by restricting the application of Australian income tax law, subject to appropriate safeguards to protect the integrity of measures, consistent with the recommendations of the Board of Taxation report.

7.123 Foreign managed funds would generally be exempt from Australian tax on income, gains and losses on portfolio investments, with Australia's tax received on these investments limited to income on which withholding tax currently applies (dividends, interest, royalties and certain distributions from management investment trusts),^[7] and gains and losses on the sale of interests in land.

7.124 A foreign managed fund would be defined as an entity with the following features:

•

it is not an Australian resident;

•

it is widely held;^[8]

•

it undertakes passive, typically portfolio investment (this refers to the kinds of investments typically undertaken by managed funds);^[9]

•

it does not carry on or control a trading business in Australia; and

•

it is domiciled in a country which is recognised by Australia as engaging in effective exchange of information.

7.125 Apart from the final dot point (the domicile/exchange of information requirement), which was recommended by the Board of Taxation as an integrity measure, this definition is consistent with draft legislation which relates to Element 1 and 2 of the IMR released on 16 August 2011.^[10]

7.126 In addition, to the extent a tax liability arises only because of the use of an Australian intermediary, the investment income would not be taxed. However, the Australian intermediary would be taxed on their arm's-length fees for services. This would be similar to the approach adopted in the United Kingdom (UK) IMR, which taxes income derived by a UK investment manager from providing management services and requires that the manager must receive remuneration at a rate not less than what is 'customary' for the services provided.

7.127 To ensure resident taxpayers remain taxable on income received by resident investors from investing via foreign managed funds, integrity rules to prevent such 'round-tripping' may be needed. In developing such rules, compliance design would need to be proportionate to revenue at risk. Option 3, consistent with the Board's Recommendations, would be implemented with the following integrity measures to ensure the integrity of the resident tax base:

•

income derived by Australian investors from a foreign managed fund is not made exempt merely by virtue of the income being treated as exempt for the foreign managed fund under the IMR;

•

foreign managed funds will be required to be resident of an information exchange country and to lodge annual information returns with the ATO (Recommendation 11); and

•

foreign managed funds will be required to be widely held.

Impact Analysis

Impact groups

7.128 The main groups to be impacted by this proposal are:

•

non-resident investors, including foreign managed funds, that are currently investing, or considering investing, in or via Australia;

•

the domestic funds management industry - that is, Australian based intermediaries, such as Australian investment advisers, fund managers, brokers and other financial service providers, that provide services to managed funds;

•

Australian managed funds; and

•

the Australian Government, including the ATO.

Option 1: No change to current law

7.129 Option 1 maintains the current legislative arrangements and deals with tax uncertainty through guidance from the ATO and litigation. Under this option, certainty could be marginally improved through the use of private rulings and access to other interpretative guidance.

Complexity/Uncertainty

7.130 Under Option 1, it is conceivable that over time tax law uncertainty could be addressed through increased interpretative guidance through the ATO or judicial processes, this option would:

•

be time consuming and only resolve issues as they arise; and

•

increase administration and compliance costs for the ATO.

7.131 However, relying on tax administrators and the judicial process to resolve uncertainty in the tax law would clearly be inferior to legislating to provide 'upfront' certainty (for example, through introducing clear statutory inclusions or exemptions or specific legislative schemes such as IMRs).

Revenue impact

7.132 While there would be no direct costs to revenue from Option 1 (as current tax settings would be left unchanged), there could be an indirect (negative) impact should it result in lower economic growth by impeding the development of Australia as a regional financial centre.

Option 2: Change the income tax law to define and fully tax Australian income of foreign managed funds

7.133 Option 2 would seek to subject to Australian income tax the Australian income of foreign managed funds.

Compliance Costs/Enforcement

7.134 This option would pose very significant enforcement difficulties for the ATO. While it would improve certainty of treatment compared with the current law, there could also be significant compliance costs for non-resident taxpayers, particularly where international taxation treaty issues arise.

Revenue impact

7.135 While in theory this approach might be expected to raise additional revenue, in practice the significant practical difficulties involved in enforcing this legislation would mean that the revenue impact may not be very different to under the current law. In addition, as with Option 1, there could be an indirect (negative) impact should it result in lower economic growth by impeding the development of Australia as a regional financial centre.

Option 3: Change the income tax law to restrict the taxation of Australian income of portfolio investments of foreign managed funds (IMR)

7.136 Option 3 would seek to resolve uncertainty in relation to current income taxation treatment of foreign managed funds by restricting the application of Australian income tax law, subject to appropriate safeguards to protect the integrity of measures, consistent with the recommendations of the Board of Taxation report.

Improved certainty/reduced compliance costs

7.137 This option, by exempting a range of portfolio type investments, improves certainty with respect to tax treatment of investment management services within. In particular the exemption regime would address current revenue/capital, source and permanent establishment issues affecting foreign managed funds through providing specific tax outcomes over these issues. This approach should reduce compliance costs by removing the need for investors to work through a series of sophisticated provisions in the law.

Impact on resident savers and investors

7.138 The measures are not expected to have a significant impact on Australia resident savers and investors.

7.139 As an exemption style regime would provide a different tax treatment to foreign investors than is provided to resident savers and investors, in the absence of other measures, it would provide an incentive Australian residents to structure their affairs in such a way as to take advantage of the more favourable tax treatment. In order to reduce the risk to the resident tax base, the IMR will include a number of integrity measures designed to minimise the potential such structuring. These measures include:

•

A widely held requirement would mean that, in order to gain access to the IMR, foreign managed funds would need 25 or more members. This limits the opportunity for Australian investors to engage in 'clubbing' arrangements which involve a small number of people with similar tax profiles banding together to access the benefits of the regime by structuring through an off-shore entity.

•

Requiring a fund to be widely held will reduce the likelihood that a small number of people with similar tax profiles will be able control the investments of a foreign managed fund and hence benefit inappropriately from the IMR.

•

the requirement that foreign managed funds be domiciled in countries which are recognised by Australia as engaging is effective exchange of tax information. This will enable the Commissioner of Taxation to request information on foreign managed funds operating in Australia, including details about their Australian investors (if any).

7.140 The integrity rules designed to protect the revenue base from the incentive for resident investors to restructure affairs to take advantage of the preferential treatment of foreign managed funds are disclosure based, and should not impose significant compliance costs on resident taxpayers or funds.

Australian funds management sector

7.141 The Johnson Report noted that the Australian funds management industry currently manages only a small volume of funds from offshore.^[11] This option would reduce compliance costs of the industry by providing certain treatment in relation to the management of foreign funds by Australian domiciled fund managers. In the longer term, as this option removes an impediment to the development of the Australian funds management industry it could be expected to assist in the development of Australia as a regional financial centre.

Consultation

7.142 Extensive consultation was undertaken with industry, stakeholders, the ATO and the Board of Taxation throughout this process. See RIS published on 16 September 2011.^[12]

Consultation with the Financial Centre Task Force (formerly AFCF)

7.143 Treasury has met with the Financial Centre Task Force in order to review the benchmarks which had proposed when designing a framework for the IMR suggested in the Johnson Report.

Consultation with the Board of Taxation on the IMR to address funds management issues

7.144 Treasury has consulted closely with the Board of Taxation and its Panel of practitioner advisers on the development of the IMR.

7.145 In the period August to October 2010, Treasury attended several meetings of the Board of Tax Working Group on the Collective Investment Vehicle review, during which the Working Group was provided with opportunities to comment on a draft Interim IMR. Feedback from consultation was incorporated into the design of the early version IMR, specifically in relation to the design principles underpinning the early version IMR.

7.146 Later the Assistant Treasurer requested that the Board of Taxation bring forward its consideration of an IMR as it applies for foreign managed funds to 1 September 2011. As noted above, the Board of Taxation has since delivered that report and the recommended option is consistent with that report.

Consultation with the Australian Taxation Office

7.147 Treasury has also had ongoing consultation with the ATO in developing these proposals, including formal processes through the Board of Taxation and the Working Group established to oversee the review of the taxation of collective investment vehicles.

Revenue impact

7.148 Option 3 of the IMR has been assessed as having an unquantifiable but small cost to revenue over the forward estimates.

7.149 Prior to the introduction of the IMR, income tax payable by foreign managed funds was estimated to be $50 million per annum over the forward estimate period. The portion of this revenue impact that is attributable to a prospective exemption (option 3) is unquantifiable but small.

Conclusion

Recommended Option

7.150 The recommended option is Option 3 which would seek to resolve uncertainty in relation to current income taxation treatment of foreign managed funds by restricting the application of Australian income tax law, subject to appropriate safeguards to protect the integrity of measures, consistent with the recommendations of the Board of Taxation report.

Implementation and review

7.151 The IMR would be implemented by amending the Income Tax Assessment Act 1997.

7.152 As discussed, implementing Option 3, an IMR which addresses funds management issues for foreign managed funds, is anticipated to reduce their compliance costs and transaction costs. This initiative is also expected to reduce administrative costs for the ATO. As the purpose of Option 3 is to address deficiencies in the tax treatment of foreign managed funds and reduce the complexity of those arrangements, transitional arrangements would not be required.

7.153 Treasury and the ATO will monitor this taxation arrangement, as part of the whole taxation system, on an ongoing basis in order to identify and manage any unanticipated issues arising from implementing the IMR. It is intended that there will be a review of the IMR two years after its implementation.

APPENDIX A

Proposed treatment of investments of foreign managed funds

Table 7.1 : Investments of foreign managed funds

Index

Schedule 1: First Home Saver Accounts

Schedule 2: Dependent spouse tax offset

Schedule 3: Offshore banking units

Schedule 4: Exemption for Global Infrastructure Hub Ltd

Schedule 5: Deductible gift recipient extensions

Schedule 6: Miscellaneous amendments

Schedule 7: Investment manager regime