Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)

Chapter 3 Superannuation funds for foreign residents withholding tax exemption

Outline of chapter

3.1 Schedule 3 to this Bill amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

3.2 All references in this Chapter are to the ITAA 1936 unless otherwise stated.

Context of amendments

3.3 A foreign resident that derives dividends or interest paid by an Australian resident generally has a liability to withholding tax in respect of the payment (section 128B). However, a withholding tax liability does not arise if the foreign resident is a superannuation fund for foreign residents which is exempt from income tax in the country in which it resides (paragraph 128B(3)(jb)). Generally, the dividends or interest are also NANE income of the superannuation fund (section 128D).

3.4 The exemption from dividend and interest withholding tax makes it very attractive for these superannuation funds to gear their Australian equity investments using investor debt to lower their overall Australian tax on the investments. Combined with a stapled structure, this exemption can result in these superannuation funds paying little Australian tax on Australian business activities.

3.5 In addition, the broad exemption from dividend and interest withholding tax puts these superannuation funds in a better financial position than other investors. For example:

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foreign corporate entities typically pay 10 per cent interest withholding tax on interest income; and

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Australian investors pay tax on interest income at their marginal tax rates.

3.6 To address these concerns, the Government has decided to limit the withholding tax exemption for superannuation funds for foreign residents to portfolio-like investments only. As a result, interest and dividend income derived by superannuation funds for foreign residents from non-portfolio like investments will be taxed.

Summary of new law

3.7 Schedule 3 to this Bill amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

3.8 Therefore, a superannuation fund for foreign residents will not be liable to withholding tax on amounts of interest, dividends or non-share dividends it receives from an Australian entity only if:

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the income derived by the superannuation fund is exempt from income tax in the country in which it resides;

•

the superannuation fund has a portfolio like interest in the entity that pays the dividends, non-share dividends or interest to it; and

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the superannuation fund does not have influence (either directly or indirectly) over decisions that comprise the control and direction of the operations of the entity that pays the dividends, non-share dividends or interest to it.

Comparison of key features of new law and current law

Detailed explanation of new law

3.9 Schedule 3 to this Bill amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

3.10 A superannuation fund for foreign residents (as defined in section 118-520 of the ITAA 1997) is, broadly, a fund that:

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is a provident, benefit, superannuation or retirement fund that is indefinitely continuing;

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was established in a foreign country;

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was established and is maintained for foreign residents; and

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has its central management and control carried on outside Australia by entities that are foreign residents.

3.11 The withholding tax exemption for superannuation funds for foreign residents will be limited to interest, dividend and non-share dividend income derived from an entity in which a superannuation fund has a portfolio-like interest - that is, where the superannuation fund does not have a non-portfolio holding of 10 per cent or more and does not have influence of the kind described in subsection 128B(3CD) in relation to the entity.

3.12 Consequently, a superannuation fund for foreign residents will be exempt from withholding tax under paragraph 128B(3)(jb) only if:

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the superannuation fund satisfies the portfolio interest test in subsection 128B(3CC) in relation to the test entity:

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at the time the income was derived; and

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throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time;

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the superannuation fund does not, at the time the income was derived, have influence of the kind described in subsection 128B(3CD) in relation to the test entity; and

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the income is not NANE income of the superannuation fund because the superannuation fund is a covered sovereign entity.

[Schedule 3, items 1 and 2, subsection 128B(3CA)]

3.13 The test entity is generally the entity that paid the interest, dividends or non-share dividends (as mentioned in subparagraph 128B(3)(jb)(ii)). However, if the superannuation fund for foreign residents derives the income because it is a beneficiary of an Australian resident trust (that is, if subsection 128A(3) applies), the test entity is the Australian resident trust. [Schedule 3, item 2, subsection 128B(3CB)]

The portfolio interest test

3.14 A superannuation fund satisfies the portfolio interest test in subsection 128B(3CC) in relation to the test entity if the sum of the total participation interests (as defined in section 960-180 of the ITAA 1997) the superannuation fund holds in the test entity:

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is less than 10 per cent; and

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if the test entity has any non-share equity interests, would be less than 10 per cent if, in working out the direct participation interest (under section 960-190 of the ITAA 1997) that any entity holds in a company, both:

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an equity holder were treated as a shareholder; and

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the total amount contributed to the company in respect of non-share equity interests were included in the total paid-up share capital of the company.

[Schedule 3, item 2, subsection 128B(3CC)]

3.15 A superannuation fund for foreign residents must apply the portfolio interest test in respect of the interest it holds in the test entity.

The influence test

3.16 A superannuation fund for foreign residents has influence of the kind described in subsection 128B(3CD) in relation to the test entity if:

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the superannuation fund, acting alone or in concert with others, is directly or indirectly able to determine the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity's operations; or

•

at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the superannuation fund (whether those directions, instructions or wishes are expressed directly or indirectly, or through the superannuation fund acting in concert with others).

[Schedule 3, item 2, subsection 128B(3CD)]

3.17 For the purposes of determining whether a superannuation fund for foreign residents has the requisite level of influence, any breach of terms of a debt interest by any entity is disregarded. [Schedule 3, item 2, subsection 128B(3CE)]

3.18 A superannuation fund for foreign residents must apply the influence test in respect of the influence it has in relation to the test entity.

3.19 A superannuation fund will indirectly have influence of the kind described in the influence test where, for example, the influence or ability to influence the test entity is held by an Australian resident entity that is controlled by the superannuation fund.

Example 3.1 : Dividend withholding tax exemption applies

SFFR is a superannuation fund for foreign residents. SFFR holds 8 per cent of the ordinary share capital of Aus Co.

The rights attached to the ordinary shares acquired by SFFR are identical to the rights of all other ordinary shareholders in Aus Co. SFFR has no capacity to influence (either directly or indirectly) Aus Co in any way outside of its basic rights as a minority holder of ordinary shares.

There are no other factors present which indicate SFFR can influence Aus Co in any way.

SFFR holds a total participation interest in Aus Co of less than 10 per cent and does not have influence in relation to Aus Co of the kind described in the influence test.

Therefore, any dividends paid by Aus Co to SFFR will be exempt from dividend withholding tax under paragraph 128B(3)(jb).

Example 3.2 : Dividend subject to withholding tax

SFFR is a superannuation fund for foreign residents. SFFR holds 15 per cent of the ordinary share capital of Aus Co.

SFFR holds a total participation interest in Aus Co of more than 10 per cent.

Therefore, any dividends paid by Aus Co to SFFR will not be exempt from dividend withholding tax under paragraph 128B(3)(jb).

Example 3.3 : Dividend and interest withholding tax exemption applies

FSF is a superannuation fund for foreign residents. FSF holds 8 per cent of the issued units of Aus Trust.

The rights attached to the units acquired by FSF are identical to the rights of all other unitholders in Aus Trust. FSF has no capacity to influence (either directly or indirectly) Aus Trust in any way outside of its basic rights as a minority holder of units.

Aus Trust is an Australian resident managed fund which holds two investments:

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15 per cent of the ordinary shares in Portfolio Investment Co; and

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a bond.

There are no other factors present which indicate FSF can influence Aus Trust in any way.

FSF holds a total participation interest in Aus Trust of less than 10 per cent and does not have influence in relation to Aus Trust of the kind described in the influence test.

Therefore, any dividends (on the shares held in Portfolio Investment Co) or interest (on the bond) that flows to FSF through Aus Trust will be exempt from dividend and interest withholding tax under paragraph 128B(3)(jb).

Example 3.4 : Dividend subject to withholding tax

SFFR is a superannuation fund for foreign residents. SFFR holds 8 per cent of the ordinary share capital of Aus Co.

Under Aus Co's constitution, any investor with an equity interest of 8 per cent or more is entitled to appoint an individual to an Advisory Board of Aus Co. The Board of Directors of Aus Co cannot make certain decisions in relation to the control and direction of Aus Co's operations without the Advisory Board's approval.

In these circumstances, SFFR has influence in relation to Aus Co of the kind described in the influence test.

Therefore, any dividends paid by Aus Co to SFFR will not be entitled to a dividend withholding tax exemption under paragraph 128B(3)(jb).

Application and transitional provisions

3.20 The amendments to limit the withholding tax exemption for superannuation funds for foreign residents apply to income that is derived by a superannuation fund on or after 1 July 2019. [Schedule 3, subitem 3(1)]

3.21 A seven year transitional rule applies to assets acquired by a superannuation fund for foreign residents on or before 27 March 2018. In these circumstances, the amendments apply to income derived by a superannuation fund in respect of such an asset on or after 1 July 2026.

3.22 Under the transitional rule, the amendments apply to an income that is derived by a superannuation fund on or after 1 July 2026 if:

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the income was derived by the superannuation fund in respect of an asset;

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the superannuation fund did not derive the income because it was presently entitled to the income as a beneficiary of a trust - that is, subsection 128A(3) does not apply to the income; and

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the superannuation fund acquired the asset on or before 27 March 2018.

[Schedule 3, subitem 3(2)]

3.23 In addition, under the transitional rule, the amendments apply to income that is derived by a superannuation fund on or after 1 July 2026 if:

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the superannuation fund derived the income because it was presently entitled to the income as a beneficiary of a trust because it holds an interest in the trust - that is, because of the operation of subsection 128A(3);

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the superannuation fund started to hold the interest in the trust on or before 27 March 2018;

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the dividend, non-share dividend or interest that was included in the income of the trust as mentioned in subsection 128A(3) was so included in respect of an asset; and

•

the trustee of the trust acquired the asset on or before 27 March 2018.

[Schedule 3, subitem 3(3)]

3.24 The transitional rules ensure that there is no immediate adverse impact on superannuation funds for foreign residents for investments held at the time the changes were announced.