Foreign investment funds guide

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Chapter 3: Exemptions

To allow the FIF measures to focus on cases that provide the greatest opportunity for deferral of Australian tax, there are a number of exemptions from FIF taxation.

Exemption for attributable taxpayers

The existing foreign source income measures consist of two components - the CFC measures and the transferor trust measures. These measures attribute specified income and gains of foreign companies and trusts to certain Australian residents - known as attributable taxpayers. The FIF measures may overlap with the foreign source income measures. Where this occurs the foreign source income measures apply and, in general, the FIF measures will not apply. However, the FIF measures do apply in working out the income of a CFC, CFT or transferor trust which holds an interest in a FIF. [SECTIONS 493 and 494]

Exemption for active business

The active business exemption exempts you from taxation under the FIF measures for interests you have in foreign companies principally engaged in certain active businesses, known as eligible activities. [SECTION 497]

The active business exemption does not apply to an interest in a non-resident trust. The exemption does apply, however, when working out the net income of a trust estate where the trust invests directly in a foreign company engaged in an active business.

The active business exemption also applies when working out the FIF income of a CFC or a CFT. This is because the income of a CFC or CFT is worked out as though they were a resident taxpayer.

Meaning of eligible activities

To satisfy the exemption, you must establish that the foreign company was principally engaged in one or more eligible activities. [SECTION 496]

All activities that are not named in Schedule 4 of the Act are defined as eligible activities. Mining or agriculture are eligible activities. Schedule 4 does not render them ineligible activities.

See appendix 2 Business activities that are not eligible activities for more information.

There are two methods for establishing whether a foreign company is principally engaged in eligible activities:

• the stock exchange listing method and
• the balance sheet method.

If both of the methods can be applied, you may choose which one to use. [SECTION 498]

Stock exchange listing method

You may use the stock exchange listing method to decide whether a FIF is principally engaged in one or more eligible activities only where the FIF is a company. Your interest in the FIF must be included in a class of interests quoted on a stock market of an approved stock exchange. See appendix 1 Approved stock exchanges for more information. [SECTION 499]

Under this method, your interests in the FIF will be exempt if you can establish that the foreign company FIF is included in a class of companies classified or designated as engaged in an eligible activity on either:

• an approved stock exchange or
• an approved international sectoral classification system. See appendix 3 Approved international sectoral classification systems for more information.

Balance sheet method

The balance sheet method tests whether a foreign company was principally engaged in eligible activities by reference to its balance sheet and, if appropriate, the balance sheets of its subsidiaries. [SUBSECTION 500(1)]

A company is principally engaged in eligible activities if 50 per cent or more of the gross value of the company's assets were for use in eligible activities - the '50 per cent assets test'. [SUBSECTION 500(2)]

This percentage is worked out as follows:

(Gross value of the company's assets used in eligible activities / Gross value of all of the company's assets) * (100 / 1)

The gross value of an asset is its value shown in the company's balance sheet prepared for reporting to the shareholders on an annual basis. The balance sheet test cannot be used if the balance sheet for the company was not prepared in accordance with commercially accepted accounting principles or if it does not give a true and fair view of the financial position of the company. [SUBSECTION 500(9)]

Balance sheet method and lower-tier companies

An offshore holding company may not satisfy the active business exemption in its own right under the balance sheet test if the company does not have any active business of its own. To prevent this result, the exemption allows the first-tier foreign holding company to look through to the underlying assets of certain subsidiaries.

This look-through rule is available where a holding company owns 50 per cent or more of the paid up share capital of another company:

• directly
• indirectly or
• directly and indirectly.

Companies which satisfy this requirement are referred to as subsidiaries of the holding company. [SUBSECTION 500(3)]

The look-through rule allows a holding company to look through to its share of the underlying assets of its subsidiaries. [SUBSECTION 500(3)]

The holding company treats its share of the underlying assets of its subsidiaries as its own in using the balance sheet method to claim the active business exemption. [SUBSECTION 500(3)]

There is no limit to the number of tiers of companies that a holding company may look through, provided the holding company has an interest of 50 per cent or more in each lower-tier company. [SECTION 501]

Whenever the look-through rule applies, any intercompany indebtedness in relation to the holding company and its subsidiaries is not taken into account when working out the percentage of the holding company's assets used in eligible activities. Shares held by the holding company or its subsidiaries in subsidiaries of the holding company are also not taken into account. [SUBSECTION 500(5)]

Exemption for an interest in a foreign bank

The opportunity to invest in a company FIF which is a bank without attracting FIF taxation is provided through a specific exemption.

This exemption is available for your interest in a foreign bank where the following requirements are satisfied.

• Approved stock exchange

You must hold shares in the bank of a class listed on a stock exchange approved in regulation 152N, Schedule 12 of the Income Tax Regulations (the Regulations). See appendix 1 Approved stock exchanges for more information. Unlisted shares issued by some banks as a substitute for deposits with the bank would not satisfy this criterion.

• Trading requirement

The class of shares you hold in the bank must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange during the period for which you are seeking the exemption.

• Authorised to carry on banking business

The bank must be authorised under the law of its place of residence to carry on banking business.

• Principally engaged in the banking business

The bank must be principally engaged in the active carrying on of banking business. [SECTION 503]

Exemption for an interest in a foreign holding company of a foreign bank

It is not uncommon for a banking business to be structured so that shares in the licensed bank are held by a holding company. Members of the public invest in the bank by acquiring publicly listed shares in the holding company. To allow for this, the exemption for certain shares in a publicly listed foreign bank is extended to an interest that an Australian resident holds in a holding company with a wholly owned subsidiary that is a foreign bank. [SECTION 504]

A company will qualify for the exemption from the FIF measures as a holding company of a bank if the following requirements are satisfied.

• Approved stock exchange

You hold shares in the holding company of a class listed on any stock market of a stock exchange approved in regulation 152N, Schedule 12 of the Regulations. See appendix 1 Approved stock exchanges for more information.

• Designated a bank

The holding company is included in a class of companies designated as a bank or engaged in banking on either:

• an approved stock exchange or
• an approved international sectoral classification system.

See appendix 3 Approved international sectoral classification systems for more information.

• Trading requirement
  • The class of shares you have in the holding company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange during the period in which the exemption applies.
  • If the holding company has only one subsidiary, that subsidiary must be wholly owned and have been principally engaged in the active carrying on of a banking business.
  • If the holding company has more than one subsidiary, the principal activities of the wholly owned subsidiaries in the group, taken together as an economic unit, must be the active carrying on of a banking business.

In each case, the subsidiary or, where there is more than one subsidiary, at least one of the wholly owned subsidiaries must be authorised under the law of its place of residence to carry on banking business.

Exemption for an interest in a foreign life insurance company

The opportunity to invest in a foreign life insurance company without attracting FIF taxation is provided through a specific exemption. [SECTION 506]

A foreign company is considered to be engaged in life insurance business as defined in the Life Insurance Act 1995 only if:

• the company is authorised in its country of residence to carry on life insurance business and
• the balance sheet of the company shows that at least 50 per cent of the gross value of the company's assets were for use in carrying on life insurance business. [SECTION 507]

Look-through rule

The foreign life insurance company may have an interest in a subsidiary company. Accordingly, the measures provide a look-through rule to a 50 per cent owned subsidiary. The subsidiary's assets are looked at to decide whether the foreign life insurance company passes the 50 per cent assets test. [SUBSECTIONS 507(3) to (11)]

Exemption for an interest in a foreign holding company of a foreign life insurance company

A company will qualify for the exemption from the FIF measures as a holding company of a life insurance company if the following requirements are satisfied.

• Approved stock exchange

You must hold shares in the holding company of a class listed on any stock market of a stock exchange approved in regulation 152N, Schedule 12 of the Regulations. See appendix 1 Approved stock exchanges for more information.

• Designated a life insurance company

The holding company is included in a class of companies designated as engaged in life insurance on either:

• an approved stock exchange or
• an approved international sectoral classification system. See appendix 3 Approved international sectoral classification systems for more information.

• Trading requirement
  • The class of shares you have in the holding company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange during the period in which the exemption applies.
  • If the holding company has only one subsidiary, that subsidiary must be wholly owned and have been principally engaged in the active carrying on of life insurance business.
  • If the holding company has more than one subsidiary, each must be wholly owned and the principal activities of the subsidiaries in the group, taken together as an economic unit, must be the active carrying on of life insurance business.

In each case, the subsidiary or, where there is more than one subsidiary, at least one of the wholly owned subsidiaries must be authorised under the law of its place of residence to carry on life insurance business.

Whether the subsidiary or subsidiaries were principally engaged in the active carrying on of life insurance business is decided by a balance sheet test. This test requires that at least 50 per cent of the gross value of the company's assets were for use in carrying on life insurance business as defined in section 11 of the Life Insurance Act 1995. [SECTION 507A].

Exemption for an interest in a foreign general insurance company

An exemption is provided to an Australian resident for shares in a publicly listed general insurance company where the following requirements are satisfied.

• Approved stock exchange

Shares you hold in the company must be of a class listed on any stock market of a stock exchange approved in Schedule 3 of the Act. See appendix 1 Approved stock exchanges for more information.

• Trading requirement

The class of shares you hold in the company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange during the period in which the exemption applies.

• Authorised to carry on general insurance business

The general insurance company must be authorised under the law of its place of residence to carry on general insurance business. This requirement ensures that the company meets regulatory requirements for general insurance businesses in its country of residence.

• Principally engaged in general insurance business

An additional requirement is that the general insurance company is principally engaged in the active carrying on of general insurance business during the period in which the exemption applies. [SECTION 509]

Exemption for an interest in a foreign holding company of a foreign general insurance company

A company will qualify for the exemption from the FIF measures as a holding company of a general insurance company if the following requirements are satisfied.

• Approved stock exchange

The shares you have in the holding company must be of a class listed on any stock market of a stock exchange approved in Schedule 3 of the Act. See appendix 1 Approved stock exchanges for more information.

• Designated a general insurance company

The holding company is included in a class of companies designated as engaged in general insurance on either:

• an approved stock exchange or
• an approved international sectoral classification system. See appendix 3 Approved international sectoral classification systems for more information.

• Trading requirement
  • The class of shares you have in the holding company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange.
  • If the holding company has only one subsidiary, that subsidiary must be wholly owned and be principally engaged in the active carrying on of general insurance business.
  • If the holding company has more than one subsidiary, each subsidiary must be wholly owned and the principal activities of the wholly owned subsidiaries in the group, taken together as an economic unit, must be the active carrying on of general insurance business.
  • The subsidiary or, where there is a group of subsidiaries, at least one of the wholly owned subsidiaries must be authorised under the law of its place of residence to carry on general insurance business. [SECTION 509A]

Exemption for an interest in a foreign company engaged in certain activities connected with real property

A specific exemption is provided for an interest consisting of shares in a publicly listed company whose activities are connected with commercial real property where the following requirements are satisfied.

• Approved stock exchange

You hold shares in the company of a class listed on any stock market of a stock exchange approved in regulation 152N, Schedule 12 of the Regulations. See appendix 1 Approved stock exchanges for more information.

• Trading requirement

The class of shares you hold in the foreign company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange during the period in which the exemption applies. [SECTION 511]

Foreign company principally engaged in real property activities

The company must be principally engaged in the active carrying on of one or more activities connected with real property. This requires that the foreign company be principally engaged in one or more of the specified activities, which are:

• construction
• development of real property through capital improvement
• receipt of rental income from commercial real property owned by the foreign company where the management, maintenance and security services for the commercial property are principally provided by directors or employees of the foreign company or by a wholly owned subsidiary that is principally engaged in providing those services through its directors and employees
• provision of management services through directors or employees of the foreign company
• acting as agent for the sale or purchase of commercial real property. [SUBPARAGRAPH 511(b)(ii)]

Exemption for an interest in a foreign holding company of a foreign real property company

A company will qualify for the exemption from the FIF measures as a holding company of a real property company if the following requirements are satisfied.

• Approved stock exchange

You hold shares in the holding company of a class listed on any stock market of a stock exchange approved in regulation 152N, Schedule 12 of the Regulations. See appendix 1 Approved stock exchanges for more information.

• Designated a real property company

The holding company is included in a class of companies designated as engaged in one or more of the activities mentioned above on either:

• an approved stock exchange or
• an approved international sectoral classification system. See appendix 3 Approved international sectoral classification systems for more information.

• Trading requirement
  • The class of shares you have in the holding company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange.
  • If the holding company has only one subsidiary, that subsidiary must be wholly owned and be principally engaged in the active carrying on of one or more of the activities mentioned above that are connected with real property.
  • If the holding company has more than one subsidiary, each subsidiary must be wholly owned and the principal activities of the wholly owned subsidiaries in the group, taken together as an economic unit, must be the active carrying on of one or more of the activities mentioned above. [ SECTION 511A ]

Exemption for an interest in foreign trusts

Recent reforms in emerging markets have liberalised investment rules. Australians can now directly invest on the stock market of countries that previously restricted their investment. Therefore the exemption for interest in foreign trusts or funds previously listed in appendix 4 or regulation 152M, Schedule 11 of the Regulations, is no longer required and ceased on 31 December 1996. Investments previously exempt under the foreign trust exemption must now comply with either the active business or another exemption to obtain relief from taxation under the FIF measures. The foreign trusts previously exempt are listed in appendix 4 on page 47. [SECTION 513]

Exemption for an interest of $A50,000 or less

A small investor exemption is provided for both direct and indirect interests in FIFs. The exemption is only available if you are a natural person and your interest, together with those of your associates, in FIFs, FLPs and resident public unit trusts is $A50,000 or less at the end of the financial year. [SECTIONS 96A and 515]

Associates

An associate includes:

• your spouse, but does not include your spouse who, although legally married to you, has been living separately and apart from you for at least 12 months
• your child, whether or not the child lives with you
• your stepchild who lives with you
• your partner in a partnership and a spouse or child of the partner
• a trustee of a trust, other than a public unit trust or an eligible Part IX entity - broadly, a superannuation fund, an approved deposit fund or a pooled superannuation trust - if you or an associate benefit under the trust and
• a company in which you and your associates have a majority voting interest or which is sufficiently influenced by your and your associates.

If you are under 18 years of age, your associates include, in addition to the above:

• your parents and
• your brother or sister. [SECTION 491]

Example

Exemption for an interest of $A50 000 or less

Direct interests of the taxpayer and associates in FIFs and FLPs	Direct interests of the taxpayer and associates in resident public unit trusts	Total of interests in FIFs, FLPs and resident public unit trusts	Application of the small investor exemption to the taxpayer's direct interests in FIFs and FLPs	Application of the small investor exemption to the taxpayer's interests in resident public unit trusts
$30 000	$15 000	$45 000	Exemption applies - taxpayer's direct interests in FIFs and FLPs are exempt from the FIF measures.	Exemption applies - taxpayer's share of the resident public unit trust's net income does not include those amounts which relate to FIF income of the trust.
$26 000	$25 000	$51 000	Exemption applies - taxpayer's direct interests in FIFs and FLPs are exempt from the FIF measures.	Exemption does not apply - taxpayer's share of the net income of the resident public unit trust includes those amounts which relate to FIF income of the trust.
$50 000	$1000	$51 000	Exemption applies - taxpayer's direct interests in FIFs and FLPs are exempt from the FIF measures.	Exemption does not apply - taxpayer's share of the net income of the resident public unit trust includes those amounts which relate to FIF income of the trust.
nil	$60 000	$60 000	Exemption applies - taxpayer's direct interests in FIFs and FLPs are exempt from the FIF measures.	Exemption does not apply - taxpayer's share of the net income of the resident public unit trust includes those amounts which relate to FIF income of the trust.

Direct interests in FIFs and FLPs

Where the direct interests in FIFs and FLPs of you and your associates are $A50 000 or less, the FIF taxation provisions do not apply. [SUBSECTION 515(1)]

Direct interests in resident public unit trusts

This test measures the interests in Australian resident public unit trusts, FIFs and FLPs of you and your associates. Where the total of these interests is $A50 000 or less, your share of the net income of the resident public unit trust will not include any amount included in the net income of the trust under the FIF measures because of the FIF interests held by the trust. If the interests are more than $50 000 under both tests, then the exemption is not available. The example on page 9 sets out how the exemption applies. [SUB SECTION 96A(2) ]

Exemption for visitors to Australia

The FIF measures do not apply to you if you are a natural person who is a resident of Australia for an income year if you satisfy all of the following conditions.

• You have a temporary entry visa granted under the Migration Act 1958.
• The period of time from the issue date of the first entry visa which is current until its expiry date is 4 years or less. Where the current visa was issued as an extension of an earlier visa, the period of time from the issue date of the earliest visa until the expiry date of the current visa is 4 years or less.
• You are not awaiting the outcome of an application for permanent residency under the Migration Act 1958.

A new entry visa or permit issued under the Migration Act 1958 as an extension of the original entry visa or permit is considered to be an extension of the original visa or permit.

New Zealand citizens

You are also excluded from the FIF measures under this exemption if you:

• are a New Zealand citizen
• have not lived in Australia for more than 4 years
• do not intend to reside in Australia permanently. [SECTION 517]

Exemption for employer-sponsored foreign superannuation

This exemption is available to you if you are a natural person with an interest in a FIF that is an employer-sponsored superannuation fund. The FIF must be a superannuation fund maintained by your employer, or an associate of your employer, for the benefit of their employees. Also, you must be an employee or former employee of the employer. [SECTION 519]

Exemption for an interest in a FIF that is trading stock

Where an interest in a FIF forms part of your trading stock and you elect, under the trading stock provisions of the Act or section 70 of the Income Tax (Transitional Provisions) Act 1997, to bring those interests to account at market value, you are not subject to FIF taxation on income accruing from that interest. [SECTION 521]

If you bring an interest in a FIF to account as trading stock but do not avail yourself of the election, a change to the valuation methods available in the trading stock provisions will apply. The change will prevent movement between the methods of valuation and will require closing stock for the 1991-92 and subsequent income years to be valued consistently at cost. One exception to this treatment is where you used market value or replacement value for the opening value of an article of trading stock that is a FIF interest at the start of 1991-92. In this case, you use that value for that FIF interest.

This exemption is not available to a CFC that has an interest in a FIF as part of its trading stock. This is because a CFC cannot elect to value its trading stock at anything but cost when working out its attributable income under Part X of the Act. For further information, refer to Taxation Determination TD96/39. [SUBSECTION 31(7)]

Exemption for an interest in a multi-industry foreign company

Your interest in a multi-industry foreign company is exempt from FIF taxation if the foreign company is principally engaged in two or more of the following activities:

• construction
• development of real property through capital improvement
• receipt of rental income from commercial real property owned by the company where the management, maintenance and security services for the property are principally provided by the directors or employees of the company or by a wholly owned subsidiary that is principally engaged in providing those services through the directors and employees of that subsidiary
• provision of management services for real property by the directors or employees of the company
• acting as agent in connection with the sale or purchase of commercial real property
• general insurance business of a kind that the company was authorised to carry on under the law of its place of residence
• life insurance business of a kind that the company was authorised to carry on under the law of its place of residence
• activities that allow an exemption under the active business exemption, discussed on pages 4, 5 and 6. [SUBPARAGRAPH 523(b)(ii)]

In addition to being involved in certain activities, the foreign company must be listed on a stock market of any approved stock exchange. The class of shares you hold in the foreign company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange during the period in which the exemption applies to you. A list of approved stock exchanges is contained at Schedule 12 of the Regulations. See appendix 1 Approved stock exchanges. [SECTION 523]

Exemption for an interest in a foreign holding company of a foreign mixed activity company

Your FIF interest will qualify for the exemption from the FIF measures as a holding company if the following requirements are satisfied. [ SECTION 523A ]

• Approved stock exchange

Your shares in the holding company are of a class listed on any stock market of a stock exchange approved in Schedule 12 of the Regulations. See appendix 1 Approved stock exchanges.

• Trading requirement
  • The class of shares you have in the holding company must be widely held and actively traded on a regular basis on a stock market of an approved stock exchange.
  • If the holding company has only one subsidiary, that subsidiary must be wholly owned and have been principally engaged in actively carrying on two or more of the activities mentioned above or in subparagraph 523(b)(ii).
  • If the holding company has more than one subsidiary, the principal activities of the wholly owned subsidiaries in the group, taken together as an economic unit, must be the active carrying on of two or more of the activities mentioned above or in subparagraph 523(b)(ii).

Exemption for underwriting members of Lloyd's

If you are an underwriting member of Lloyd's and have an interest in assets that form part of a Lloyd's Premiums Trust Fund, you are exempt from taxation for FIF income from that interest. Funds which qualify as Premiums Trust Funds are referred to in section 83 of the Insurance Companies Act 1982 of the United Kingdom. [SECTION 527]

Exemption for a balanced investment portfolio in FIFs

If you invest in a wide spread of shares in foreign companies, you may find that your investments in non-exempt FIF activities may typically be less than 5 per cent of your investment portfolio. Because these cases of portfolio diversification involve minimal scope for deferral, an exemption is provided for investments in non-exempt FIF activities if their aggregate value is not more than 5 per cent of the value of your total investments in FIFs.

For the purposes of this exemption, your total investments do not include your interests which, at the end of a notional accounting period, are excluded from the FIF measures because of exemptions for:

• the attributable taxpayer
• interest in an employer-sponsored superannuation fund.

You value your FIF interests at the end of the income year at cost or market value, whichever is the greater. [SECTION 525]

There are no restrictions on the types of FIFs that are eligible for this balanced portfolio exemption. The FIFs may include non-exempt activities such as financial services. They may or may not be listed on any stock exchange, approved or otherwise. They may also include trusts.

In the example below, Marika's interests in FIFs are excluded from the FIF measures because her interests in non-exempt FIFs - the foreign funds management company and the Swedish Foreign Trust - are not more than 5 per cent of her total FIF interests.

The United Kingdom superannuation fund is not included when working out total FIF interests, as it is an employer-sponsored superannuation fund.

EXAMPLE

Investments in FIFs

Marika's FIF interest	Amount invested in FIFs	Exempt FIFs: percentage of total investments	Non-exempt FIFs: percentage of total investments
Company X - exempt shares listed on Athens stock exchange	$25 000	($25 000/$171 000) x (100/1)=14.6%
Foreign funds management company - non-exempt	$3000		($3000/$171 000) x (100/1)= 1.8%
Company Y - satisfies active business exemption	$75 000	($75 000/$171 000) x 100/1=43.9%
United Kingdom employer superannuation fund	$150 000	This is a Division 11 amount and is not included in the total of FIF investments
Bank of United States - satisfies bank exemption		($63 000/$171 000) x (100/1)=36.8%
Swedish Foreign Trust - non-exempt	$5000		($5000/$171 000) x (100/1)=2.9%
Total	$171 000	95.3%	4.7%

Update 1999-2000

Exemption for interests in certain FIFs resident in the United States

An exemption is available for your FIF interests in:

• an entity that is treated as a corporation and is subject to trust on his worldwide income and
• a company or trust that is treated as a regulated investment company or real estate investment trust

for the purposes of the United States internal revenue code 1986.

Subject to the conditions outlined below, an exemption is available for your FIF interests in:

• a limited partnership or a limited liability company formed under a United States law or United States State law and
• a common trust fund recognised under the United States internal revenue code 1986.

'Entity' in the following text refers to limited partnerships, limited liability companies and common trust funds.

Your FIF interests in the entity are exempt if:

• your interest in the entity is held for the sole purpose of investing in:
  • a business conducted in the United States of America (USA) or
  • real property located in the USA, and
• the entity does not:
  • have an interest in income or gains from non-USA sources
  • hold an interest in a FIF not resident in the USA or
  • hold real property outside the USA.

Your FIF interests in the entity are also exempt where:

• the above interests and property do not exceed 5 per cent of the value of the entity's total interests and
• property and the value of assets held by the entity that:
  • produce income from sources outside the USA or
  • if disposed of would give rise to a gain from a source outside the USA,

do not exceed 5 per cent of the value of assets held by the entity.

The exemption is also available when determining FIF income under the calculation method. The amendments to the calculation method apply to assessments for income years ending on and after 2 July 1998.

ATO references:
NO NAT 2130