TAX AND SUPERANNUATION LAWS AMENDMENT (2015 MEASURES NO. 1) BILL 2015 Explanatory Memorandum

Commonwealth of Australia Explanatory Memoranda

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TAX AND SUPERANNUATION LAWS AMENDMENT (2015 MEASURES NO. 1) BILL 2015

2013-2014-2015 THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA HOUSE OF REPRESENTATIVES TAX AND SUPERANNUATION LAWS AMENDMENT (2015 MEASURES No. 1) BILL 2015 SUPPLEMENTARY EXPLANATORY MEMORANDUM Amendments to be moved on behalf of the Government (Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Table of contents Glossary .................................................................................................. 5 General outline and financial impact ....................................................... 7 Amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 ............................... 9

Glossary The following abbreviations and acronyms are used throughout this explanatory memorandum. Abbreviation Definition IMR Investment Manager Regime PE permanent establishment 5

General outline and financial impact Amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 The amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 make some minor changes to give full effect to the Investment Manager Regime (IMR) reforms. Specifically, these amendments provide clarity to foreign investors and Australian fund managers about the operation of the IMR concession in promoting Australia as a regional financial centre. 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: These amendments have not previously been announced. Financial impact: Nil. The amendments do not alter the financial impact as outlined in the explanatory memorandum to the Bill (unquantifiable). Human rights implications: None. The amendments do not raise any human rights issues. Compliance cost impact: Nil. The amendments do not alter the estimated annual compliance cost savings as outlined in the explanatory memorandum. 7

Amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 Outline of chapter 1.1 The amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 make some minor changes to give full effect to the Investment Manager Regime (IMR) reforms. Specifically, these amendments provide clarity to foreign investors and Australian fund managers about the operation of the IMR concession in promoting Australia as a regional financial centre. Detailed explanation of the new law Amendments - Sub-underwriting arrangements 1.2 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. 1.3 These amendments ensure that the engagement of the independent Australian fund manager does not create an impediment to investing in Australia. 1.4 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 made their share of the fund's investments directly. Sub-underwriting fees are 9

Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 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. Amendments - Permanent establishments and residents of foreign countries 1.5 In addition to disregarding certain income tax consequences that arise from the disposal of an IMR financial arrangement, there is a second limb of the IMR concession that 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 permanent establishment (PE) in Australia. This means, for example, that amounts paid to an IMR entity as compensation for a loss suffered directly as a result of act done, or an omission, by the independent Australian fund manager would be income that relates to an IMR financial arrangement. 1.6 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. 1.7 These amendments make it clear when this limb of the IMR concession applies. Specifically, 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) of the Income Tax Assessment Act 1997. Amendments - Total participation interests of independent fund managers 1.8 In certain circumstances, only genuinely widely held entities may qualify for the IMR concession and, depending on the IMR entity, this requires satisfying specific total participation interest tests. An independent fund manager of an IMR entity may have additional rights or 10

Amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 interests in the IMR entity that are necessary for it to carry out its fund management role. 1.9 These amendments ensure, in applying the total participation interest tests to determine whether an entity is an 'IMR widely held entity', that entitlements to remuneration of an independent fund manager (rather than an 'independent Australian fund manager') are disregarded to the extent that the remuneration is brought to tax (in Australia or under a foreign law) in the current income year. These entitlements to remuneration can include direct or indirect entitlements and contingent entitlements of the independent fund manager and any of its connected entities. It is not only such entitlements of independent Australian fund managers that are disregarded under this rule, but rather 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 IMR concession. In this case, 'independent fund manager' takes its ordinary meaning. Amendments - Technical corrections and withholding tax 1.10 In addition, these amendments clarify several potential legislative ambiguities and correct minor drafting errors. Amendments - Application 1.11 Schedule 7 provides foreign entities with the choice of applying alternative tests (based on the concept of an IMR entity) to determine whether they are an 'IMR foreign fund' for the purposes of the IMR concession for the 2010-11 and earlier income years. 1.12 These amendments ensure that 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. 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. 11

Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 Amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 1.13 The amendments to Schedule 7 are 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 1.14 The amendments to Schedule 7 of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 make some minor changes to give full effect to the IMR reforms. Specifically, these amendments provide clarity to foreign investors and Australian fund managers about the operation of the IMR concession in promoting Australia as a regional financial centre. 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. Human rights implications 1.15 The amendments to Schedule 7 do not engage any of the applicable rights or freedoms. Conclusion 1.16 The amendments to Schedule 7 are compatible with human rights as it does not raise any human rights issues. 12

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