The Australian experience is that the trust structure is the most common type of entity utilized for an Australian (Onshore) hedge fund, and that fund managers are usually corporate entities. Accordingly, unless otherwise indicated, the following analysis is based on the assumption that the fund is set up as a trust and any fund manager is incorporated.
Any income received in the hands of the fund manager (that is, management and performance fees) is taxed at the corporate income tax rate of 30 percent.
As stated above the effective tax rate should be 30 percent.
There are no concessions, allowances, or exemptions that are specifically available to hedge fund managers.
Broadly, where the fund manager of an offshore fund operates from Australia, the profits of the fund will be subject to Australian income tax liability where:
Both matters are discussed in more detail below.
Under the Australian GST legislation, services will be subject to Australian GST if they are connected with Australia (either the services are performed here or they are made through a business carried on in Australia) and are not GST-free (zero-rated) under the exported services provisions or input taxed (exempt) under the financial supply regime.
Generally, if an Australian fund manager provides services to an Australian resident fund, the services will be taxable supplies subject to GST at the rate of 10 percent.
If an Australian fund manager provides services to an offshore fund, and the offshore fund has no presence in Australia, then the fund manager’s services will be GST-free (zero-rated) and no GST will be payable. To the extent that the fund manager’s services are taxable or GST-free, the fund manager should be entitled to claim the input tax credit in respect of its acquisitions.
While the European model of VAT has an exemption that applies for negotiation or arranging of certain financial supplies, such activities in Australia are subject to GST at the standard rate of 10 percent, if they are not GST-free.
The Australian Government is currently undertaking a wide-ranging review of the Australian tax system. The findings of these review/inquiry activities will influence tax reform and policy for the immediate and longer-term future. Some specific review activities relevant to investment trusts include a review of the tax treatment of Australian managed funds and consideration of initiatives to improve Australia's attractiveness as a regional financial services investment hub. Some key changes that have been introduced recently include:
Further reform initiatives are currently in progress, including:
Developments arising from these reform activities could impact on the taxation of investment trusts in the future (see Section 1.9 for details).
As mentioned above the trust structure (typically a unit trust) is the most common type of entity utilized for an onshore hedge fund. Accordingly, unless otherwise stated, the analysis set out below is based on the assumption that the fund is set up as a trust.
Generally, trusts are flow-through or transparent vehicles which are not viewed as a separate legal entity for Australian income tax purposes. On this basis, except in certain circumstances, the fund should not be subject to taxation in Australia.
It should be noted that where the fund incurs losses of a revenue nature, these losses remain in the fund and cannot be distributed to investors. Broadly, the trust may take them into account in determining its own net (taxable) income in a subsequent year, provided the Australian trust loss provisions are satisfied.
It should also be noted that under certain anti-avoidance rules, some trusts may be treated as corporate unit trusts or public trading trusts. If classified as such, a fund would be subject to tax at the corporate tax rate of 30 percent.
An Offshore hedge fund resident in a country with which Australia has concluded a DTA will generally be entitled to the benefits of the agreement, except to the extent that it maintains a permanent establishment in Australia. If the investment fund maintains a permanent establishment in Australia, the fund’s income attributable to that permanent establishment will generally be subject to tax in the same manner as that of an Australian resident hedge fund. The foreign unitholders of such a fund will generally also be denied the benefit of the relevant agreement as such foreign unitholders will be deemed also to be operating through a permanent establishment in Australia, subject to the comment below regarding deemed source rules. The IMR regime may impact on this treatment for certain offshore hedge funds.
In relation to onshore hedge funds deriving income from a country with which Australia has concluded a DTA, corresponding rules will apply to those described above.
In certain circumstances, it may be possible to "look-through" a non-resident fund to the ultimate foreign investors in the non-resident fund when applying Australia's double tax agreements.
Subject to satisfying certain conditions, where a non-resident unitholder is presently entitled to foreign source income (determined in accordance with Australian domestic tax law) derived from a widely held unit trust from funds management activities carried on through a permanent establishment in Australia, Australian domestic source rules (see below) will apply instead of the deemed source rules included in Australia’s DTAs. Broadly, investments made offshore by the fund can be structured such that the income has a foreign source for Australian income tax purposes. This means that non-resident unitholders would not be subject to Australian income tax in respect of foreign source income attributable to a permanent establishment in Australia. The IMR regime may impact on this treatment for certain offshore hedge funds.
Currently, there are 44 double tax agreements that have been entered into by Australia.
The government has enacted legislation which is intended to simplify the tax treatment of financial arrangements, predominantly by allowing for a greater linkage with accounting principles/treatment in determining the applicable tax treatment. A significant consequence is that capital gains tax (CGT) treatment is not available to any gains to which TOFA applies. The TOFA rules apply to certain entities from 1 July 2010 onwards (unless a taxpayer elected to early adopt from 1 July 2009).
Generally, managed investment schemes will be subject to the TOFA rules where a scheme holds assets exceeding AUD100 million, or otherwise elect into the TOFA regime. However, the TOFA rules are unlikely to have a significant impact on Australian managed funds that invest in equities or real property (where the default methodologies will apply). Funds that have significant investments in financial securities such as derivatives and hedging instruments will need to consider the impact of the application of the TOFA rules to their investments.
A goods and services tax (GST) has been in operation in Australia since 1 July 2000. The GST is a broad based consumption tax, imposed generally on taxable supplies and taxable importations at the rate of 10 percent.
The Australian GST system shares many common elements with European value-added tax systems. The basic principles under the GST system are that:
Further, under the Australian GST system, trusts (including investment funds) are recognized as entities and therefore may be required to separately register for GST purposes. Consequently, separate supplies can be made between third party suppliers and a trustee of a fund (in its independent capacity) and then subsequently between the trustee and the fund.
Input taxed supplies include financial supplies, which include dealings by a registered entity in certain defined interests such as shares, units in a trust fund, interests under superannuation funds, life insurance and other forms of securities (for example, debentures). Accordingly, supplies made by an investment fund will normally be input taxed financial supplies.
A trust (such as an investment fund) that holds investments in Australian securities will not generally be able to recover the GST charged on purchases that it makes. In addition, the investment fund will generally be required to account for reverse charge GST on services it acquires from outside Australia.
A trust that directly invests in real property will generally be able to recover most if not all of the GST charged on purchases that it makes (except purchases that relate to issuing units in the trust).
A trust may make GST-free, taxable and input taxed supplies. Where an acquisition relates to making both input taxed supplies and GST-free or taxable supplies, the trust may be able to claim GST on purchases to the extent that they relate to GST-free or taxable supplies. The method of apportionment must be fair and reasonable given the circumstances of the enterprise.
Certain financial supplies may qualify for GST-free classification, where they involve, broadly:
If a supply is GST-free no GST is payable on the supply but the fund is entitled to input tax credits for the GST paid on its purchases that relate to the supply. Where a supply is both input taxed and GST-free, the GST-free treatment prevails.
An Australian individual resident unitholder in an Australian hedge fund will be subject to tax in Australia as follows.
Distributions of income and/or net capital gains by the fund (that form part of the taxable income of the hedge fund) will be taxed as ordinary income (subject to the CGT concessions discussed below) of the unitholder at their marginal rate of tax as follows (applicable for year ending 30 June 2013):
|Taxable income (AUD)||Income tax payable (AUD)|
|0 - 18,200||Nil|
|18,200 - 37,000||19% on excess over $18,200|
|37,001 - 80,000||$3,572 plus 32.5% on excess over $37,000|
|80,001 - 180,000||$17,547 plus 37% on excess over $80,000|
|Over 180,000||$54,547 plus 45% on excess over $180,000|
In addition, a Medicare levy of 1.5 percent is currently payable by most residents thus bringing the highest marginal rate (in most circumstances) up to 46.5 percent.
Non-individual resident unitholders will be taxed at their applicable rates of taxation on the distributions of income. Australian corporates are subject to a tax rate of 30 percent. Australian complying superannuation funds are subject to a tax rate of 15 percent. Australian trusts and partnerships are generally flow-through vehicles and the income is taxed in the hands of the beneficiaries/partners.
Gains derived by Australian resident unitholders on the disposal of units in a fund are generally subject to income tax as outlined above (subject to CGT concessions applying from 21 September 1999).
For capital gains derived on assets acquired prior to 21 September 1999, individuals, trusts, and complying superannuation funds may elect to be assessed either on the indexation basis (except that indexation is frozen at 21 September 1999) or they may elect to obtain a 50 percent discount on the gain (33 1/3 percent discount for complying superannuation funds), where the relevant asset has been held for at least 12 months.
For assets acquired after 21 September 1999 that have been held for at least 12 months, the abovementioned entities can benefit from the CGT discount to gains derived from the disposal of the assets.
Corporate unitholders are not eligible for the CGT discount.
For the purposes of this document, it is assumed that the non-resident hedge fund is organized as a foreign trust or company.
Where a resident invests in a non-resident trust and the non-resident trust distributes income (including capital gains) to the resident investor, the investor’s share of the taxable income of the non-resident trust (including capital gains) will generally be included in the investor’s taxable income. The foreign sourced income will be grossed up for any foreign tax paid.
A unitholder in a non-resident unit trust will generally be entitled to a foreign tax offset for foreign taxes paid by the trust either on its income and/or gains or on the distribution of net income to the beneficiary.
The foreign tax offset allowed is limited to the lower of the Australian tax otherwise payable on the foreign income or the foreign tax paid (no limitation where the foreign tax credit amount for a year is less than AUD1,000). Any excess credits cannot be carried forward into subsequent income years.
Where a resident invests in a non-resident company and the non-resident company pays a dividend to the resident investor, the dividend will generally be included in the investor’s taxable income. The foreign sourced income will be grossed up for any foreign tax paid.
Where the investor is an Australian company and has a non-portfolio interest (a 10 percent or more voting interest in the foreign company), the dividend will be tax exempt in Australia.
A foreign tax offset is generally available for foreign tax paid on the dividend payment to an Australian non-company investor (that is, withholding tax).
Similarly, a foreign tax offset will generally be available for foreign taxes paid by a foreign fund organized as a company on the dividend payment to an Australian company investor where the Australian company investor has a portfolio interest (less than 10 percent voting interest in the foreign company) (that is, withholding tax). Where the Australian company investor has a non-portfolio interest (a 10 percent or more voting interest in the foreign paying company), no foreign tax offset arises as the dividend will be tax exempt in Australia.
Most of the double taxation agreements which Australia has negotiated provide that relief from double taxation will be available on the above basis also.
The limitations on the amount of foreign tax offsets claimable are the same as outlined above for investments in foreign trusts.
Any gains arising from the disposal of interests in a foreign trust or company are included in the taxable income of Australian resident investors.
Where the interest in the foreign trust/company is held on capital account the CGT concessions outlined above will apply to certain shareholders.
Where a resident investor has a significant/controlling interest in a non-resident hedge fund, the Australian CFC provisions may operate to attribute (on an annual basis) the investor’s share of tainted income derived by the non-resident hedge fund. Tainted income generally includes income from passive sources (for example, interest or dividends), from sales to related parties or from services provided to parties connected with Australia. As part of a review of the tax rules applying to foreign investments, the Government has announced that these rules will undergo changes. Further developments could impact on the tax treatment of significant/controlling interests in offshore hedge funds held by Australian taxpayers (see Section 1.9).
Certain investments in offshore funds may also qualify to be treated as a foreign hybrid. Foreign hybrids are typically entities that would ordinarily be treated as companies for Australian tax purposes but are treated as partnerships for foreign tax purposes (that is, the members of the entity are taxed instead of the entity itself). Foreign hybrids can include foreign limited partnerships, foreign limited liability partnerships, U.S. limited liability companies, and other similar entities. The operation of the foreign hybrid rules means that these entities will be treated as flow through partnerships (instead of companies) for Australian tax purposes.
To the extent to which a resident hedge fund’s income is sourced in Australia, corresponding distributions to non-resident unitholders will generally be subject to tax. The rate of tax and method of payment will depend upon the type of income concerned.
Assuming that the non-resident investor holds their interest on capital account, the categories of assets to which non-residents are liable to CGT is restricted to Australian real property held directly or indirectly through an interposed entity and the disposal of business assets used in an Australian branch/permanent establishment.
Broadly, non-resident investors will only be subject to Australian CGT on disposal of interests in an Australian investment entity if they (and their associates) own 10 percent or more of the entity (at the disposal time or in any continuous 12-month period in the two years leading up to the disposal) and the underlying assets of the entity which are attributable to Australian real property comprise more than 50 percent of the total assets of the fund (by market value).
Please refer to Section 1.9 for details of the Investment Manager Regime which may apply to certain foreign funds that invest in Australia.
The Australian Government has recently undertaken a wide-ranging review of the Australian tax system. Some specific review activities relevant to investment trusts include a review of the tax treatment of Australian managed funds and consideration of initiatives to improve Australia's attractiveness as a regional financial services investment hub (See Investment Manager Regime, below). These recommendations are currently undergoing a process of consultation, and developments arising from this consultation could impact on the taxation of hedge funds in the future.
The tax arrangements governing the MIT regime are still under review, with the expected start date of any changes being pushed back to 2014. The Government has proposed to alter the rules applying to MITs, most significantly by codifying the industry practice of rolling forward "under" and "over" distributions within a threshold of 5 percent, with anything above the 5 percent threshold subject to additional statutory rules. Also proposed is the provision of an elective "attribution" system of taxation for qualifying MITs to replace the current present entitlement to income concept.
The FIF provisions have been repealed, effective from 1 July 2010, so funds may now be able to hold non-controlling interests in foreign entities without being required to accrue amounts under the FIF rules. These anti-deferral rules will be replaced by the proposed FAF integrity rules (see below).
The Australian Government proposes to introduce the FAF provisions, which is an integrity rule that will apply to certain offshore investments. The proposed rules are narrower in scope as compared to the FIF regime that was repealed, as the FAF rules are intended to apply to foreign funds that accumulate (or roll up) interest-like returns which it receives.
The government has proposed changes to the CFC regime in order to reduce complexity and compliance costs for certain taxpayers. While the government has released exposure draft legislation for consultation, there is currently no set time for the implementation of any changes.
On September 13, 2012, the Tax Laws Amendment (Investment Manager Regime) Bill 2012 was enacted into law in Australia, becoming Act No. 126 of 2012. The Bill amends the Income Tax Assessment Act 1997 to prescribe the treatment of returns, gains, losses and deductions on certain investments of widely held foreign funds.
The legislation prevents the ATO from raising assessments for certain investment income of foreign managed funds for the 2010-2011 income year and previous income years. This aims to address the concerns raised by foreign funds in relation to the US accounting rules widely referred to as FIN48. Furthermore, the legislation ensures that foreign funds that use Australian intermediaries are not subject to Australian tax on certain income that, in the absence of an Australian intermediary, would otherwise be foreign source income. Australian resident investors will not benefit from the new tax concessions.
In order to qualify as an “IMR Foreign Fund” and thus, benefit from the new legislation, the fund should meet the following conditions:
On 4 April 2013 the Government released the third and final tranche of draft legislation for consultation. This element is expected to provide a broader exemption going forward for IMR foreign funds in relation to Australian sourced investment income arising from Australian assets that are held on revenue account.
On 24 October 2012, the Government released Taxation of Trust Income –options for Reform, proposing to reform in Division 6 of the Income Tax Assessment Act 1936.
This paper follows an initial consultation paper, Modernising the Taxation of trust income- options for reforms (released 21 November 2011) which outlined three possible models for taxing trust income. Taxation of Trust Income – Options for Reform paper expands on two of the suggested models in the previous paper.
The two models articulated in this policy options paper are:
The paper also canvasses two issues that will affect the scope of new arrangements for taxing trust income:
The proposed start date for the reform of trust taxation has been deferred one year from 1 July 2013 and is now due to commence on 1 July 2014.
Given that most hedge funds are structured in the form of a trust, any changes to the taxation of trust income will be relevant for hedge funds in Australia (to the extent that they are not MITs).
The Government released draft legislation on 8 March 2013 proposing to remove eligibility of the 50% discount on capital gains earned after 8 May 2012 by non-residents on Taxable Australian Property. Non-residents will still be entitled to a discount on capital gains accrued prior to 8 May 2012 (after offsetting any capital losses), provided they choose to value the asset as at that time.
1A recognized trust scheme has been defined as a managed investment scheme within the meaning of section 9 of the Corporations Act 2001, or an approved deposit fund, a pooled superannuation trust, a public sector superannuation scheme or a regulated superannuation fund (other than a self managed superannuation fund) within the meaning of the Superannuation Industry (Supervision) Act 1993.
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