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Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015



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BILLS DIGEST NO. 124, 2014-15 17 JUNE 2015

Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 Anne Holmes, Les Nielson, Kali Sanyal and Tarek Dale Economics Section

Contents

The Bills Digest at a glance ................................................... 4

Purpose of the Bill ............................................................... 5

Structure of the Bill ............................................................. 5

Committee consideration .................................................... 5

Senate Economics Committee ................................................. 5

Senate Standing Committee for the Scrutiny of Bills .............. 5

Parliamentary Joint Committee on Human Rights .................. 5

Schedule 1—First Home Saver Accounts ............................... 5

Background .............................................................................. 5

Policy announcement and design ......................................... 5

Low take-up of First Home Saver Accounts........................... 6

Repeal announcement .......................................................... 7

Other policy options .............................................................. 8

Financial impact ....................................................................... 8

Key issues and provisions ........................................................ 8

Schedule 1, Parts 1-3—repeal and consequential amendments ......................................................................... 9

Schedule 1, Part 4—application and transitional provisions .............................................................................. 9

Schedule 2—Abolishing the dependent spouse tax offset ... 10

Background ............................................................................ 10

Recent reform measures ..................................................... 12

2008-09 Budget ................................................................ 12

2011-12 Budget ................................................................ 12

2011-12 Mid-Year Economic and Fiscal Outlook .............. 12

Date introduced: 27 May 2015

House: House of Representatives

Portfolio: Treasury

Commencement: Schedule 1 commences on 1 July 2015 (except for Part 3, which is dependent on the passage of another Bill which is currently before the Parliament). Schedules 2, 3, 4 and 7 commence on the day the Act receives Royal Assent; and Schedule 5 commences the day after Royal Assent. The miscellaneous amendments in Schedule 6 have various commencement dates.

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website.

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2012-13 Budget ................................................................ 12

Current measure ................................................................. 13

Policy position of non-government parties/independents ... 13

Position of major interest groups .......................................... 13

Financial implications ............................................................ 13

Key issues and provisions ...................................................... 13

Schedule 3—Offshore Banking Units .................................. 14

Structure and Purpose of the Schedule ................................. 14

Background ............................................................................ 15

How did these changes come about? ................................. 17

Additional policy development ........................................... 17

Are these changes part of the Government’s policy on corporate tax avoidance? .................................................... 20

Policy position of non-government parties/independents ... 20

Position of major interest groups ....................................... 20

Financial implications ........................................................ 20

Statement of Compatibility with Human Rights .................. 21

Key issues and provisions................................................... 21

Schedule 3, Part 1: trading activity ........................................ 21

Schedule 3, Part 2: codifying the choice principle .............. 21

Schedule 3, Part 3: allocating expenses .............................. 22

Schedule 3, Part 4: eligible offshore banking activities ....... 23

Schedule 3, Part 5: internal financial dealing and transfer pricing .................................................................... 23

Schedule 3, Part 6: commencement ................................... 24

Concluding comments ....................................................... 24

Schedule 4—Income tax exemption for the Global Infrastructure Hub Ltd ....................................................... 24

Background ............................................................................ 24

Human rights implications ..................................................... 25

Financial implications ............................................................ 25

Key issues and provisions ...................................................... 25

Schedule 5—Deductible gift recipient extensions ............... 25

Background ............................................................................ 25

Financial implications ............................................................ 27

Key issues and provisions ...................................................... 28

Schedule 6—Miscellaneous amendments ........................... 28

Schedule 7—Investment manager regime .......................... 29

Purpose of Schedule 7 ........................................................... 29

Structure of the Schedule ...................................................... 29

Background ............................................................................ 29

What is an Investment Manager Regime? .......................... 29

Why is this worth doing? ..................................................... 29

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The first two phases of the IMR .......................................... 30

Policy Development—Third Phase ...................................... 30

Influence of the UK Model .................................................. 30

The tax position of assets managed under the current IMR ...................................................................................... 31

Policy position of non-government parties/independents ... 31

Position of major interest groups .......................................... 31

Financial implications ............................................................ 31

Statement of Compatibility with Human Rights .................... 31

Key issues and provisions ...................................................... 32

IMR entities ....................................................................... 32

IMR widely held entities .................................................... 32

Independent Australian fund managers ........................... 32

IMR financial arrangements .............................................. 32

The IMR tax concessions ..................................................... 33

Direct investment concession criteria ................................. 33

Indirect investment concession criteria .............................. 33

Operation of the tax concessions ........................................ 33

An interesting problem ....................................................... 34

Comment ............................................................................... 34

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The Bills Digest at a glance Each schedule of the Bill is dealt with on a standalone basis.

Schedule 1 repeals the First Home Saver Accounts Act 2008 (FHSA Act) and related legislation to give effect to the closure of the scheme. Part 1 of Schedule 1 repeals or amends existing legislation thus ensuring that the current concessions under the First Home Saver Account (FHSA) scheme are no longer available. Part 4 contains application and transitional provisions. This includes amendments to ensure that the FHSA is effectively closed from when the Government announced its decision to close the scheme, rather than when the legislation commences.

Schedule 2 abolishes the Dependent spouse tax offset (DSTO), and makes complex adjustments so that:

• spouses who are unable to work through invalidity or caring responsibilities are still covered by the dependant (invalid and carer) tax offset (DICTO)

• taxpayers who receive other offsets that have included a reference to DSTO still receive those offsets and

• calculations that depended on other offsets that are no longer paid are made by other methods.

Schedule 3 amends Division 9A of the Income Tax Assessment Act 1936 (ITAA 1936) which contains rules governing Offshore Banking Units (OBUs). The proposed changes seek to improve the OBU tax integrity, provide increased tax certainty and expand the range of eligible offshore banking (OB) activities.

Though these changes are generally supported by the Industry, it is unlikely that they will be sufficient to increase the amount of business that Australian OBUs undertake, given the level of competition (including tax competition) from other OB hubs in the Asia-Pacific (such as Singapore and Hong Kong). Further, industry is seeking additional changes to the current OBU regime.

Schedule 4 provides an income tax exemption for the Global Infrastructure Hub Ltd, an entity established by the G20 to promote the G20 infrastructure agenda, largely by knowledge sharing and encouraging both public and private investment in infrastructure.

Schedule 5 extends the deductible gift recipient status of the Australian Peacekeeping Memorial Incorporated and the National Boer War Memorial Association Incorporated for three years.

Schedule 6 makes a large number of miscellaneous amendments to tax, superannuation and other laws, including formatting and stylistic changes, repeal of redundant provisions, and correction of errors. It also contains amendments that clarify the constitutional basis of the Product Stewardship (Oil) Act 2000. Amendments to the Taxation Administration Act 1953 are also proposed that will provide new powers to the Tax Commissioner in respect of tax concessions provided to certain entities.

Schedule 7 revises the rules in Subdivision 842-I of the Income Tax Assessment Act 1997 (ITAA 1997), which govern the tax treatment of non-resident passive investment funds invested in, or through, Australia. Its overall aim is to increase the amount of non-resident investment business undertaken by Australian fund managers. It aims to do this by exempting both the income generated and the capital gains realised by non-resident passive investment funds from the Australian tax system. These amendments also aim to create certainty around the tax treatment of widely held foreign funds, as well as extending tax concessions to certain direct investments in Australia (of a portfolio nature).

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Purpose of the Bill The purpose of the Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 (the Bill) is to:

• repeal the First Home Saver Accounts Act 2008 (FHSA Act) and related legislation to give effect to the closure of the scheme

• amend the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) to abolish the dependent spouse tax offset and make complementary changes to protect recipients of other tax offsets

• make changes, primarily to the ITAA 1936, to implement changes to the Offshore Banking Units (OBU) regime to increase the amount of business that Australian OBUs undertake (as well as improving tax integrity)

• amend the ITAA 1997 to make the Global Infrastructure Hub Ltd exempt from income tax

• update the list of deductible gift recipients in the ITAA 1997 to ensure that the two specified entities are able to receive tax deductible gifts for another three years

• make a number of minor amendments to taxation and superannuation legislation, clarify the constitutional basis of the Product Stewardship (Oil) Act 2000 and provide new powers to the Tax Commissioner in respect of tax concessions provided to certain entities and

• amend the ITAA 1997 to make changes to the Investment Manager Regime (IMR) which are aimed at attracting foreign investment by removing tax impediments to investing in widely held foreign funds through Australian investment managers and certain direct investments in Australia (of a portfolio nature).

Structure of the Bill The Bill has seven schedules, which deal respectively with the purposes of the Bill set out above. Each is dealt with in a separate section in this Digest.

Committee consideration Senate Economics Committee The Senate Economics Legislation Committee, in its report on the Bill, noted that some people would be adversely affected by the measures in Schedule 2, but that the improvement in the tax laws was necessary and those who most needed assistance were still supported by other offsets in the taxation system such as the DICTO.1

The Committee recommended that the Bill be passed, but advised that the Government should consider amending the Explanatory Memorandum to the Bill, to clarify concepts relevant to Schedule 7 of the Bill (which deals with the Investment Manager Regime (IMR)).2

Senate Standing Committee for the Scrutiny of Bills At time of writing the Senate Standing Committee for the Scrutiny of Bills had not considered the Bill.

Parliamentary Joint Committee on Human Rights At time of writing the Parliamentary Joint Committee on Human Rights had not considered the Bill.

Schedule 1—First Home Saver Accounts Background

Policy announcement and design First Home Saver Accounts (FHSAs) are a mechanism designed to assist individuals saving for their first home. They were first announced by the Labor opposition in the 2007 election campaign, with a consultation paper released in February 2008 and legislation introduced in May 2008.3

1. Senate Economics Legislation Committee, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 [Provisions], Report, 15 June 2015, accessed 16 June 2015. 2. Ibid., pp. 14-15.

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FHSAs offer a combination of a government contribution and tax concessions, which can be accessed subject to a number of constraints. Under the FHSA Act, FHSA holders benefit from:

• a 17 per cent government co-contribution, up to a deposit threshold ($6,000 in 2013-14)4

• a flat 15 per cent tax rate on the interest from the account, regardless of the account-holder’s marginal tax rate5 and

• FHSA balances and income are exempt from a number of social security asset and income tests.6

However FHSAs are also subject to a number of restrictions. FHSAs are only available to individuals aged 18 to 65, who have not previously opened a home.7 Additionally, to make withdrawals, FHSA holders 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. 8

However other criteria for withdrawal are available, including transferring the balance to a superannuation account.9

Low take-up of First Home Saver Accounts The take-up of FHSAs has been substantially lower than forecast. As discussed in a previous Parliamentary Library publication:

The number of accounts and quantity of savings grew much more slowly than expected. At March 2014 only around 48,000 accounts were open (with a total balance of $537 million), well below the 730,000 forecast for 2012 when the scheme first opened. (The Government expected a total balance of $6.5 billion after four years.) There are a number of factors that may have contributed to the low take-up, including the small number of providers, the four year requirement, and low consumer awareness.

Only a small number of providers ever offered the accounts. When the schemes initially opened in 2008, only two of the four major banks (Commonwealth Bank and ANZ) took part, and by March 2014 none of the major four offered them: the Commonwealth Bank and ANZ kept existing accounts but both stopped offering new accounts. At March 2014, of seventeen FHSA account providers, seven had stopped offering new accounts. A number of initial submissions on the 2008 consultation paper had identified concerns over the cost and regulatory burden, including the National Institute of Accountants and the Australian Bankers’ Association. A submission by the Association of Building Societies and Credit Unions (ABACUS) on the 2011 reforms noted the logistical challenges involved in providing the accounts, including the IT systems and ongoing reporting required.

Industry bodies also frequently noted the four year requirement as lowering demand, although the initial press release announcing the policy stated that ‘it typically takes first homebuyers an average of five years to save an adequate home deposit’. In 2011 ANZ suggested allowing consumers to forgo any tax and co-contribution benefits if they needed to withdraw funds early, and the Australian Bankers’ Association, AMP and ABACUS all argued the four

3. T Plibersek, K Rudd and W Swan, Federal Labor’s low tax First Home Saver Accounts: larger deposits and higher national savings, media release, 4 November 2007; Australian Government, First Home Saver Accounts: outline of proposed arrangements, Canberra, February 2008; Parliament of Australia, ‘First Home Saver Accounts Bill 2008 homepage’, Australian Parliament website, all accessed 1 June 2015.

4. First Home Saver Account Act 2008 (Cth) (FHSA Act), section 38; Australian Taxation Office (ATO), ‘First home saver account: caps and thresholds’, ATO website, 3 July 2014, both accessed 1 June 2015. 5. Income Tax Assessment Act 1997 (Cth) (ITAA 1997), division 345; Income Tax Rates Act 1986 (Cth), sections 23 and 30; ATO, ‘First home saver accounts: benefits’, ATO website, 3 July 2014, accessed 1 June 2015. 6. Social Security Act 1991 (Cth), subsections (8)(8)(ba) and (9)(1); ATO, ‘First home saver accounts: benefits’, op. cit. 7. FHSA Act, subsection 15(1); Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, p. 9,

accessed 10 June 2015. 8. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., pp. 9-10. 9. FHSA Act, section 34.

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year requirement was too restrictive. In a small survey by mortgage broker Loan Market, a number of respondents saw the time and withdrawal requirements as restrictive. However a shorter time requirement might have simply provided additional benefits to those who had already decided to buy a first home, without encouraging behaviour changes or improving first home buyer access.

A final factor is that consumers may simply not have been aware of the accounts. Forty-six per cent of respondents to the Loan Market survey had not heard of the accounts, suggesting that poor awareness may have contributed to low take-up. 10

The chart below shows the number of FHSAs and average account balance.

Figure 1 FHSAs and average account balance

Source: Parliamentary Library estimates based on Australian Prudential Regulation Authority (APRA), ‘First Home Saver Accounts’, APRA website, accessed 1 June 2015, and supplied.

Repeal announcement The Coalition Government announced that it would repeal the FHSA scheme in the 2014-15 Budget. The Treasurer’s press release stated that:

The scheme is being abolished as it has had limited effectiveness in improving housing affordability due to the low take-up of accounts since their introduction by the former government in 2008. 11

There was a gap of over a year between the announcement date (13 May 2014) and the subsequent introduction of the Bill (27 May 2015) and this has caused some uncertainty for account-holders.12 This section sets out relevant dates between the announcement and introduction of legislation:

10. T Dale, ‘First Home Saver Accounts scheme closure’, FlagPost weblog, 18 June 2014, accessed 1 June 2015. 11. J Hockey (Treasurer), Abolishing the First Home Saver Accounts Scheme, media release, 13 May 2014, accessed 10 June 2015. 12. J Hockey (Treasurer), Abolishing the First Home Saver Accounts Scheme, op. cit.; Australian Parliament, ‘Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015 homepage’, Australian Parliament website, accessed 3 June 2015.

0

20

40

60

Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2013

Number of FHSA's ('000)

Average FHSA balance ($ '000)

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• 13 May 2014: the Government announces the closure of the FHSA scheme. The Government’s intent is that ‘new accounts opened from Budget night will not be entitled to the existing government co-contribution or any tax or social security concessions’13

• 15 May 2014: the Government makes regulations to ensure that individuals opening new accounts are informed of the Government’s proposed changes14

• 30 June 2014: end of the 2013-14 financial year. The Government’s announcement states that ‘existing account holders will continue to receive the government co-contribution and all tax and social security concessions associated with these accounts for the 2013-14 income year’.15 The Government proposes that the co-contribution will not apply from the 2014-15 financial year, however because the co-contribution is based on deposits during the 2014-15 financial year, this does not have an administrative impact until the end of the 2014-15 financial year

• 27 May 2015: the Government introduces the Bill to terminate the FHSA scheme and

• 1 July 2015: the Government stated that FHSA ‘tax and social security concessions … will be withdrawn from 1 July 2015’, and, in addition, FHSA ‘holders will be able to withdraw their account balances without restriction’.16

Other policy options The Government has not announced an intention to replace FHSAs, on the grounds that they ‘have not helped address rising housing costs in Australia.’ The Government argues that any problems in the housing market are problems of supply, and in particular of regulatory barriers to supply.17

While the Treasurer has previously discussed the possibility of allowing superannuation accounts to be used to fund deposits on a first-home (a policy approach which shares key features with the current FHSA regime),18 this measure was not adopted as a formal policy position by the Government, and the Prime Minister has been reported as stating ‘at this stage we don’t have any plans to introduce it‘.19

Financial impact The Explanatory Memorandum states that the cessation of the FHSA scheme will result in a revenue increase of $113.3 million over the forward estimates, as set out in Table 1 below.

Table 1 Financial impact of terminating the FHSA scheme, $m

2013-14 2014-15 2015-16 2016-17 2017-18

- 1 35.1 38.1 39.1

Source: Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, p. 3, accessed 3 June 2015.

Key issues and provisions Part 1 of Schedule 1 repeals the FHSA Act and related legislation to cease the current concessions under the FHSA. Part 4 contains application and transitional provisions that ensure that the FHSA is effectively closed from when the Government’s announced its decision to close the scheme, rather than when the legislation commences.

13. J Hockey (Treasurer), Abolishing the First Home Saver Accounts Scheme, op. cit. 14. First Home Saver Accounts Amendment (Notice of Changes) Regulation 2014; First Home Saver Accounts Regulations 2008, regulations 13AA and 13AB, accessed 10 June 2015. 15. J Hockey (Treasurer), Abolishing the First Home Saver Accounts Scheme, op. cit. 16. Ibid.

17. J Frydenberg, ‘Second reading speech: Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015’, House of Representatives, Debates, 27 May 2015, p. 17, accessed 14 June 2015. 18. J Hockey (Treasurer), Interview with David Koch, Sunrise, transcript, 6 March 2015; for a more detailed discussion of superannuation for housing see T Dale and K Swoboda, ‘Superannuation for housing deposits and the “deposit gap"’, FlagPost weblog, 9 April 2015, both

accessed 3 June 2015. 19. J Kelly, ‘Labor won’t support pension changes says Chris Bowen’, The Australian, (online edition), 9 March 2015, accessed 14 June 2015.

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Schedule 1, Parts 1-3—repeal and consequential amendments Part 1 of Schedule 1 of the Bill repeals the First Home Saver Account Providers Supervisory Levy Imposition Act 2008 (Cth), the FHSA Act and the Income Tax (First Home Saver Accounts Misuse Tax) Act 2008.

Part 2 makes consequential amendments to a large number of Acts to reflect the closure of the FHSA scheme.

Part 3 amends the Omnibus Repeal Day (Spring 2014) Act 2015, which is an Act that does not yet exist. The Omnibus Repeal Day (Spring 2014) Bill 2014 has not yet received Parliamentary approval.20

Schedule 1, Part 4—application and transitional provisions Part 4 of Schedule 1 of the Bill relates to the application and transitional provisions, which are particularly important given the date of the Government’s announcement and the date of the subsequent introduction of legislation (see ‘Repeal announcement’, above). In particular, proposed subsection 196(1) specifies that any FHSA opened after 7:30 pm 13 May 2014 ‘is not, and never was, an FHSA’. However, proposed subsection 196(2) provides an exception where an application was lodged prior to that deadline, and the account was then opened after the deadline but before 1 July 2015.

Proposed section 197 specifies that the FHSA regime ends on 1 July 2015, with some minor administrative exceptions (see proposed sections 201(2) and 203-205 below).

Proposed sections 198-202 have the effect, broadly speaking, of allowing elements of the FHSA legislative regime to be relied on even where the relevant section has been amended or repealed. The broad intent here is that the legislative framework can be relied on in relation to matters arising from before the repeal date. The Explanatory Memorandum notes:

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.

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.

21

However, there are some exceptions:

• proposed subsection 201(2) specifies that the repeals of provisions of the Social Security Act 1991 (Cth) and the Veterans’ Entitlements Act 1991 (Cth) are not disregarded. This has the effect that the provisions which currently exclude FHSAs from asset tests, and FHSA income from income tests, cannot be relied on in the future after they are repealed by the Bill22

• proposed section 203 ensures that a number of requirements to take action do not apply after particular dates. The FHSA Act requires FHSA holders, the Tax Commissioner and FHSA providers to take particular steps in response to certain circumstances (for example, if an account-holder is no longer eligible). Proposed section 203 ensures that requirements for:

- FHSA holders do not apply from 1 July 2015 ‘in respect of circumstances that arose on or after 1 June 2015’ - the Tax Commissioner do not apply from 1 July 2015, ‘even in relation to circumstances that arose before 1 July 2015’ - FHSA providers do not apply from 1 July 2015 ‘in relation to trigger days that occur on or after 17 June

2015’.

20. Parliament of Australia, ‘Omnibus Repeal Day (Spring 2014) Bill 2014 homepage’, Australian Parliament website, accessed 3 June 2015. 21. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 16. 22. Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, Schedule 1, items 129 to 144 and 175 to 187.

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Under proposed section 204, the government co-contribution ‘is not payable for the 2014-15 financial year or a later financial year’. This matches the Government’s budget announcement. Where a government co-contribution is owed for the ‘2013-14 financial year or an earlier financial year’, the Tax Commissioner must still make the payment for any applications lodged ‘on or before 30 June 2017’.23

Proposed section 205 ensures that where individuals have provided a tax-file number in relation to a FHSA, they are not required to provide it again once the FHSA ceases to be a FHSA.

Schedule 2—Abolishing the dependent spouse tax offset Schedule 2 of the Bill amends the ITAA 1936 and the ITAA 1997. The purpose of Schedule 2 is to:

• bring an end to the dependent spouse tax offset (DSTO)

• expand the range of spouses that the dependant (invalid and carer) tax offset (DICTO) applies to

• withdraw 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

• rephrase the notional tax offsets covering children, students and sole parents that are available as components of other tax offsets.24

Importantly, item 38 in Part 4 of Schedule 2 provides that the proposed amendments will have retrospective effect, having been deemed to apply from 1 July 2014.

Human rights implications

According to the Explanatory Memorandum, this Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights—Chapter 2, paragraphs 2.43 to 2.60 of the Explanatory Memorandum (EM).25

However, it is worth noting that the previous amendments to the ITAA 1936 through the Tax and Superannuation Laws Amendment (2013 Measures No. 2) Bill 2013 regarding consolidation of dependants’ offsets drew some criticism from the Parliamentary Joint Committee on Human Rights. At the time, the Committee made the following remarks:

The amendments, however, appear to reduce the amount of tax offsets available to assist individuals with dependents and it is unclear what effect this reduction might have on the right to social security and the right to an adequate standard of living under articles 9 and 11 of the ICESCR [International Covenant on Economic, Social and Cultural Rights] respectively, as well as family and children’s rights more generally. … It is also unclear why taxpayers eligible for the zone, overseas forces and overseas civilian tax offsets will be quarantined from these changes.

The statement of compatibility does not explain the potential impact of the changes on families and children; nor does it provide any justification for the amendments… 26

The Committee was satisfied with the Minister’s response and had no further comment on that aspect of the Bill.27

Background

Dependent spouse tax offset (DSTO)

Under sections 159J and 159H of the ITAA 1936 taxpayers who maintain certain classes of dependants can claim tax offsets.28 With certain qualifications, the dependants are generally spouses, invalid spouses, spouses who care for an invalid, housekeepers, child-housekeepers, invalid relatives and parents/parents-in-law.29

23. See proposed subsection 204(3). 24. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 21 (para 2.1). 25. Ibid., p. 30. 26. Parliamentary Joint Committee on Human Rights, Sixth report of 2013, The Senate, Canberra, 15 May 2013, p. 81, accessed 16 June 2015. 27. Parliamentary Joint Committee on Human Rights, Tenth report of 2013, The Senate, Canberra, 27 June 2013, p. 109, accessed 16 June 2015.

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The DSTO is a tax offset available to taxpayers who maintain a dependent spouse. The maximum DSTO available to taxpayers was $2,535 (indexed) in 2014-15.30 Where the spouse derives adjusted taxable income, the offset otherwise allowable is reduced by $1 for every complete $4 by which the spouse’s adjusted taxable income exceeds $282.31 In general, eligibility for the DSTO is currently limited to taxpayers who have a spouse born before 1 July 1952.

Under section 159J of the ITAA 1936, a resident individual taxpayer is entitled to the DSTO if the following conditions are satisfied, as set out in the Australian Tax Handbook 2015:

 the taxpayer contributes to the maintenance of her or his spouse: subsection 159J(1)

 the spouse is a resident of Australia… [a proportionate offset is allowed if the dependant is a resident for part of the income year only]: subsection 159J(1)

 the taxpayer’s adjusted taxable income for rebates (ATI) does not exceed $150,000 (the income test): subsections 159J(1AB) and (1AC)… 32

 the taxpayer is not a member of a family tax benefit (FTB) Part B family with shared care: subsections 159J (1AB) and 159JA(1) 33 … and

 the spouse was born before 1 July 1952: subsection 159J(1C). 34

For purposes of other dependency offsets, an eligible dependant may be:

• a taxpayer‘s spouse, parent, child (aged 16 years or over), or 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.35

Persons receiving 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, are considered to be genuinely unable to work due to invalidity.36 A dependant is also 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. 37

28. CCH, Australian Master Tax Guide 2013, 52nd edn, [15-020], p. 811. Income Tax Assessment Act 1936, accessed 16 June 2015. 29. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 21 (para 2.2). 30. R Deutsch, M Friezer, I Fullerton, P Hanley and T Snape, Australian Tax Handbook 2015, Thomson Reuters, [100 110], pp. 2074; Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 25.

31. Income Tax Assessment Act 1997 (ITAA 1997), section 61-45; ITAA 1936, subsection 159J(4); R Deutsch, M Friezer, I Fullerton, P Hanley and T Snape, Australian Tax Handbook 2015, Thomson Reuters, p. 729. 32. Adjustable taxable income (ATI) includes taxable income, total net investment loss, adjusted fringe benefits, income from certain tax fee pensions and benefits, and foreign sourced income that is tax exempt (see CCH, Australian Master Tax Guide 2015, 56th edn, [15-060],

p. 817).

33. ITAA 1997 section 61-20; Australian Tax Handbook 2015, Thomson Reuters, op. cit. [19 160], p. 729. 34. Australian Tax Handbook 2015, Thomson Reuters, op. cit. [19 160], pp. 734-5. 35. ITAA 1997, section 61-10. 36. ITAA 1936, subsection 159J(6). 37. Explanatory Memorandum, op. cit., p. 23.

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Paragraphs 61-10 (1)(d) and (e) of the ITAA 1997 preclude a taxpayer from receiving an offset due to invalidity or caring responsibilities for a spouse when he or she is receiving a rebate of tax in relation to that spouse as a dependant under the ITAA 1936.38

Recent reform measures For a long period of time, the dependency tax offsets have been available to Australian resident tax payers. The initial idea was mainly to help single income families in the absence of a mature welfare system.39 In recent times, however, with a view to containing the over-claiming of tax offsets, reducing overlapping provisions and encouraging workforce participation, there have been a number of legislative amendments to limit the number of people who could receive a tax concession in respect of their dependants, as outlined below.

2008-09 Budget In the 2008-09 Budget, the previous Labor 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.40

2011-12 Budget In the 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. The reform measure was to address a barrier to workforce participation by progressively removing the tax concession for taxpayers with a non-working spouse and no children. Taxpayers with an invalid or permanently disabled spouse, supporting a carer, or people who were eligible for the zone, overseas forces and overseas civilian tax offsets would not be affected by the measure.41

2011-12 Mid-Year Economic and Fiscal Outlook In the 2011-12 Mid-Year Economic and Fiscal Outlook (MYEFO), the Government 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. At the time, the Government announced the measure with a view to persuading non-working spouses to work (on the premise that people without children should not receive a tax benefit for choosing to stay at home).42

2012-13 Budget In the 2012-13 Budget, the Government undertook a measure to consolidate eight dependency tax offsets into a single, streamlined and non-refundable offset, now called the dependant (invalid and carer) tax offset or DICTO, that was only available to taxpayers who maintained a dependant who was genuinely unable to work due to carer obligation or disability. The offsets to be consolidated were the invalid spouse, carer spouse, housekeeper, housekeeper (with child), child-housekeeper, child-housekeeper (with child), invalid relative and parent/parent-in-law tax offsets. The new consolidated offset was to be based on the highest rate of the existing offsets it replaced, resulting in an increased entitlement for many of those eligible for this measure. At the time, taxpayers who were eligible to claim more than one offset amount in respect of multiple dependants would still have been able to do so. The measure was estimated to generate a revenue gain of $70 million over the forward estimates. However, despite this consolidation, these eight other dependency tax offsets still remained available to taxpayers eligible to receive zone tax offset (ZTO), overseas civilians tax offset (OCTO) or overseas forces tax offset (OFTO).43 These taxpayers were also eligible for the DSTO, regardless of the age of their spouse.44

38. ITAA 1997, paragraph 61-10(1)(d). 39. Explanatory Memorandum, op. cit., p. 23 (para 2.13). 40. Ibid., p. 23 (para 2.14); Australian Government, Budget measures: budget paper no. 2: 2008-09, p. 34, accessed 9 June 2015. 41. Explanatory Memorandum, op. cit., p. 24 (para 2.16); Australian Government, Budget measures: budget paper no. 2: 2011-12, p. 14, accessed

9 June 2015. 42. Explanatory Memorandum, op. cit., p. 24 (para 2.17); Australian Government, Mid-year economic and fiscal outlook: 2011-12, p. 169, accessed 9 June 2015. 43. Explanatory Memorandum, op. cit., p. 24 (para 2.18); Australian Government, Budget measures: budget paper no. 2: 2012-13, p. 35, accessed

9 June 2015. 44. Australian Government, Budget measures: budget paper no. 2: 2014-15, p. 13, accessed 9 June 2015.

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Current measure In the 2014-15 Budget, the Government announced that the DSTO for all taxpayers would be removed from 1 July 2014. This means that an offset can be claimed only for a dependant (including a spouse) who is genuinely unable to work because of a disability or caring responsibilities.45

For taxpayers who were eligible to receive the ZTO, OCTO or OFTO, the offsets would be consolidated into the DICTO as they had already been for other taxpayers.46 As now, taxpayers eligible for these offsets could still receive a further entitlement of 50 per cent or 20 per cent of their DICTO entitlement as a component of ZTO, OCTO or OFTO, depending on where they reside.47

Although the measure was announced in last year’s budget, the legislation to amend the provisions has been introduced only recently.

Policy position of non-government parties/independents Given that the proposed reforms are similar to the measures proposed by the former Government, or a continuation of those, the Labor party has agreed to support the proposed changes in Schedule 2 of this Bill.48

As at the date of writing, no independents have taken a position on the proposed measures in Schedule 2 of the Bill.

Position of major interest groups There was no reaction to Schedule 2.

Financial implications The Explanatory Memorandum states that the proposed measures are expected to have a positive impact on the Commonwealth Budget, as follows:

Table 2: Financial impact of DSTO reforms, $m

Year 2015-16 2016-17 2017-18

Amount $130

$100 $90

Source: Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, p. 4.

Key issues and provisions Section 23AB of the ITAA 1936 deals with overseas civilian tax offset (OCTO); section 79A deals with the zone tax offset (ZTO); and section 79B deals with the overseas forces tax offset (OFTO). Items 1, 3, 4, 6, 7, 9, 11, 13, 14 and 15 remove references to the DSTO from those sections, thus abolishing a ‘secondary form of access to the DSTO’ currently available to recipients of a ZTO, OCTO or OFTO.49 Items 3, 7 and 14 incorporate the dependant (invalid and carer) tax offset (DICTO) into those sections so that the additional 20 or 50 per cent of the DSTO that used to be available is now available as an addition to the DICTO.50

Item 16 abolishes the DSTO by repealing sections 159J and 159JA of the ITAA 1936. It also repeals sections 159K, 159L, 159LA and 159M. These sections refer to other offsets which have not been paid for many years: they were ‘notional tax offsets’ which have been used only to calculate entitlements under other tax provisions.

Item 17 inserts proposed Division 961 into the ITAA 1997. This rewrites the notional dependant (non-student child under 21 or student) tax offset contained in section 159J, and the notional sole parent tax offset in section 159K, of the ITAA 1936 into the ITAA 1997 without any changes to the operation of those notional offsets.51

45. Ibid.

46. Explanatory Memorandum, op. cit., p. 24. 47. Ibid., p. 25. 48. P Coorey, ‘Spouses and doctors lose tax break’, The Australian Financial Review, 9 June 2015, p. 1, accessed 10 June 2015. 49. Explanatory Memorandum, op. cit., p. 26 (para 2.23). 50. Ibid., (para 2.25). 51. Ibid., p. 27 (para 2.32).

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Consequential amendments

Items 18 to 20, items 24 to 26 and item 33 repeal provisions that are redundant as a result of the repeal of the dependent spouse tax offset.52

Items 21 to 23 and items 30 to 32 replace cross references to the old notional tax offsets with references to the new notional tax offsets.53 The definition of ‘dependant‘ for the purposes of the net medical expenses tax offset54 has been updated to remove all references to dependants for which a rebate under section 159J may be available and instead refers only to dependants who are the taxpayer‘s spouse or child (under 21) or who are covered by the notional tax offsets or DICTO.55

Technical amendments

A number of technical amendments are made to the DICTO to ensure it operates as intended. Details of the intended operation of DICTO are set out at pages 63 to 69 of the Explanatory Memorandum to the Tax and Superannuation Laws Amendment (2013 Measures No. 2) Bill 2013.56 The Government states that the technical amendments ‘are beneficial to taxpayers’.57

Application and transitional provisions

Item 38 proposes the amendments generally to apply to the 2014-15 income year and to all later income years.58 Item 39 proposes that the technical amendments to be applicable starting from 2012-13 income year and to all later income years which align with the introduction of the DICTO.59 The Government states that ‘the amendments are all beneficial to taxpayers’.60

Finding tables

The Explanatory Memorandum includes two tables to locate which provisions in this Bill correspond to provisions in the current law that has been rewritten, and vice versa.61 The ‘old law’ provisions refer to sections of the ITAA 1936 whilst the ‘new law’ provisions refer to sections of the ITAA 1997.

Schedule 3—Offshore Banking Units Structure and Purpose of the Schedule Schedule 3 of the Bill is divided into six parts. Parts 1 to 5 contain amendments to the ITAA 1936 in respect of Offshore Banking Units (OBUs). A summary of the purpose of these parts of Schedule 3 is as follows:

• Part 1 makes amendments that limit the use of certain tax concessions62

52. Ibid., p. 28. 53. Ibid., p. 27 (para 2.33). 54. A net medical expense rebate is available to a taxpayer whose net medical expenses in the year of income exceed certain thresholds. Single taxpayers with adjustable taxable income (ATI) of $88,000 or less and families with ATI below $176,000 will be able to claim 20% of net

medical expenses over the Level 1 threshold of $2,218 for 2014-15. Single taxpayers with ATI above $88,000 and families with ATI above $176,000 will be able to claim 10% of net medical expenses over the Level 2 threshold of $5,233 for 2014-15.(see CCH, Australian Master Tax Guide 2015, 56th edn, p. 841). The adjustable taxable income includes taxable income, reportable superannuation contributions, total net investment loss, adjusted fringe benefits, income from certain tax free pensions and benefits from Department of Human Services or Veterans Affairs, target foreign income minus any child support payment the taxpayers pays. (see CCH Australian Master Tax Guide 2015, 56th edn, p. 31.) 55. Explanatory Memorandum, op. cit., p. 27 (para 2.34). 56. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2013 Measures No. 2) Bill 2013, accessed 10 June 2015. 57. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, p. 28 (para 2.37). 58. Ibid., para 2.38. 59. Ibid., para 2.39. 60. Ibid.

61. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 29. 62. Ibid., p. 39 (para 3.27).

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• Part 2 inserts the so called ‘choice principle’ governing the operation of certain tax concessions into the ITAA 1936 (previously it had been governed by a taxation determination)63

• Part 3 creates a new framework governing the methods by which expenses can be allocated between a Domestic Banking Unit (DBU) and a related OBU64

• Part 4 expands the list of eligible Offshore Banking (OB) activities and

• Part 5 aims to ensure that the internal financial dealings of an OBU and its domestic parent are carried out on an ‘arm’s length basis’.65

Parts one, three and five are tax integrity measures. Parts two and four improve the operation of OBUs, and seek to make them more competitive with similar entities in other countries, especially those in the Asia-Pacific region. Part six sets out when the amendments start to apply.

Background

What are OBUs and DBUs?

Generally, an OBU is ‘a notional division or business unit of an Australian entity that conducts offshore banking activities. To be considered an OBU an entity must be declared by the Treasurer to be an OBU’.66 For taxation purposes, technically an OBU is, under subsection 128AE(2) of the ITAA 1936, a company declared to be such by the Treasurer, provided that it is either:

(i) a body corporate that is an ADI (authorised deposit-taking institution) for the purposes of the Banking Act 1959 (ii) a public authority constituted by a law of a State, being a public authority that carries on the business of state banking (iii) a company in which all of the equity interests are beneficially owned by an offshore banking unit (other

than one that is covered by (iv), below) (iv) a person who the Minister is satisfied is appropriately authorised to carry on business as a dealer in foreign exchange (v) a life insurance company registered under section 21 of the Life Insurance Act 1995 (vi) a company incorporated under the Corporations Act 2001 that provides funds management services on a

commercial basis (other than solely to related persons) or (vii) a company that the Minister determines, in writing, to be an OBU.67

Given the precision of the examples of OB activity given in section 121D and 121DA (which deals with types of ‘investment activity’) of the ITAA 1936, it would appear that, at the very least an OBU is an entity that:

• borrows or lends money to an offshore person that is not Australian currency68

• underwrites a risk for an offshore person in respect of property outside Australia or an event that can only happen outside Australia69

• syndicating a loan for an offshore person70

• issuing a performance bond to an offshore person in relation to activities that are, or will be, conducted wholly outside Australia71

63. Ibid., p. 43, paras 3.39 and 3.40. 64. Ibid., p. 47, para 3.51-3.53. 65. Ibid., p. 53, paras 3.97-3.100. 66. Ibid., p. 36. 67. Section 995-1, Income Tax Assessment Act 1997 notes that the term ‘Offshore Banking Unit ‘has the meaning given by section 128AE of the

Income Tax Assessment Act 1936’. The above definition is taken from section 128AE ITAA 1936, as this is the only place where the Treasurer is empowered to declare certain organisations to be OBUs. 68. ITAA 1936, subsection 121D(2) and paragraph 121E(b). 69. Ibid., subsection 121D(3). 70. Ibid.

71. Ibid.

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• trading with an offshore person in:

- securities issued by non-residents - eligible contracts under which any amounts payable are payable by non-residents - shares in non-resident companies - units in non-resident trusts or - currency, or options or rights in respect of currency72 • certain types of investment activity (as defined in subsection 121D(6) and section 121DA)

• portfolio investment activities made by non-residents73 and

• certain advisory or hedging activities provided to offshore persons.74

Hence the range of entities that can be considered an OBU are potentially very diverse.

What a domestic banking unit may be is not further defined in tax legislation. Rather, the Explanatory Memorandum states that such a unit is ‘another notional division of the entity’.75 That is, it is another division of the entity that contains an OBU, but is itself not an OBU. Other sources of the precise meaning of this term are even less helpful than the above.

Why are these provisions included in the ITAA 1936?

Between 1981 and 1986 a series of reports had considered the establishment of an OBU regime in Australia.76 In 1986 various tax concessions were established, but they proved insufficient to attract offshore banking business to Australia. In his ‘One Nation’ statement of 26 February 1992 the then Prime Minister, Paul Keating, foreshadowed significant changes to the OBU rules to attract business to Australia.77

Schedule 3 of this Bill amends Division 9A of the ITAA 1936. This Division was inserted by section 15 of the Taxation Laws Amendment (No. 4) Act 1992.78 The second reading speech to the Bill for that Act, in relation to OBUs, noted that:

The Government is confident that this measure will promote the development of a viable offshore banking centre in Australia at a time when such activities are likely to be shifted from Hong Kong to elsewhere in the Asia-Pacific region. Development of offshore banking in Australia will also help to integrate Australia more closely with the Asian-Pacific growth economies by becoming an expanded financial centre of the region.

79

Are these units worth promoting?

Promoting the growth of Australia as regional financial centre could potentially generate significant benefits. Increasing the use of Australian OBUs is part of that process.80 A recent paper enumerated the economic and financial advantages of OBUs:

72. Ibid., subsection 121D(4). 73. Ibid., subsections 121D(6A) and (6B). 74. Ibid., subsections 121D(7) and (8). 75. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 36. 76. A full chronology on the development of OBU policy in Australia is given in T Frost, U Mac Donald and C Marston, ‘Offshore banking units’,

appendix A, paper presented to presented to the Tax Institute 2014 Financial Services Taxation Conference, Gold Coast, 19-21 February 2014, accessed 14 June 2015. 77. K Sadiq, ‘Bringing OBUs onshore: assessing the concessions’, Journal of Australian Taxation, 1(2), September/October 1998, pp. 123-126, accessed 1 June 2015. This paper gives additional details of the development of the OBU regime in Australia to 1998. A full chronology on the

development of OBU policy in Australia is given in T Frost, U Mac Donald and C Marston, ‘Offshore banking units’, appendix A, paper presented to presented to the Tax Institute 2014 Financial Services Taxation Conference, Gold Coast, 19-21 February 2014, both papers accessed 1 June 2015. 78. Taxation Laws Amendment (No. 4) Act 1992, accessed 14 June 2015. 79. P Baldwin, ‘Second reading speech: Taxation Laws Amendment Bill (No. 4) 1992’, House of Representatives, Debates, 25 June 1992, p. 3999, accessed 1 June 2015. 80. M Johnson et al, Australia as a financial centre - building on our strengths, report by the Australian Financial Centre Forum, November 2009, p. 5, accessed 10 June 2015.

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The foundation of the OBU not only brings profits to the domestic economy but also improves the integration of the capital market, increases capital circulation, and promotes the operating performances of related industries. As the OBU diminishes the limits of overseas capital borrowers, the capital circulation is more convenient and attracts a large number of overseas borrowers, bringing positive effects to the domestic economy. All of these advantages will increase government tax income.

81 (emphasis added, citations omitted)

How did these changes come about? The most recent set of changes were initiated by the report of the Australian Financial Centre Forum entitled ‘Australian as a Financial Centre - Building on our Strengths’ (Johnson Report).82 This report observed that:

Australia’s financial sector ranks highly in international surveys on many of the key requirements for a successful financial centre. These include a highly skilled workforce and a first class regulatory framework that has served us well through the global financial crisis. Yet our exports and imports of financial services are low by international standards. Our funds management sector, one of the largest and most sophisticated in the world, manages only a small volume of funds sourced from offshore.

83

Clearly, the original policy intent prompting the insertion of Division 9A into the ITAA 1936 has not been realised, given that the Johnson Report recommendations were aimed at promoting ‘Australia as a regional financial services hub’ - a goal also articulated in 1992. In relation to OBUs the Johnson Report recommended that:

• in its response to the report the Government state its support for, and commitment to, the OBU regime

• the tax uncertainty about the choice of activities (whether they be an OBU activity or not) be addressed by legislation (see discussion below)

• the list of eligible OBU activities in Division 9A of the ITAA 1936 be regularly reviewed and updated and

• a streamlined process for vetting new OBU applications be put in place.84

Additional policy development The then Government welcomed the report and its recommendations.85 Since that time additional policy development has taken place:

• the previous Government’s 2013-14 Budget announced changes to the OBU regime that were aimed at improving the tax integrity of that regime (as much as increasing the use of these entities), specifically:

- treating dealings with related parties, including the transfer of transactions between an OBU and a related domestic bank, as ineligible for OBU treatment86 - treat transactions between OBUs, including between unrelated OBUs, as ineligible for OBU treatment - ensure that other provisions of the income tax law interact appropriately with the OBU provisions and - tighten the current list of eligible OBU activity87

81. Chen Jo-Huia et al, ‘The influence of macroeconomic factors and banking fragility on Offshore Banking Unit (OBU)’, Asia Pacific Management Review, 18(4) (2013), p. 409. 82. M Johnson et al, Australia as a financial centre - building on our strengths, op. cit. 83. Ibid., p. 1. 84. Ibid., pp. 61-62. 85. C Bowen (Minister for Financial Services, Superannuation and Corporate Law) and N Sherry (Assistant Treasurer), Government welcomes

Johnson Report on Australia as a financial services centre, joint media release, 15 January 2010, accessed 1 June 2015. This report was initiated by the former Government, see C Bowen (Assistant Treasurer), Appointment of chair and panel of experts to lead Government’s initiative to position Australia as a leading financial services centre in the Asia-Pacific region, media release, 26 September 2008, accessed 16 June 2015. 86. There is some suggestion that this particular focus was prompted by the Commissioner of Taxation changing his view on the operation of the

relevant provisions in Division 9A ITAA 1936, as the result of intensive audits of Macquarie Bank between 2006 and 2008, and the resulting tax dispute with that Bank. See N Khadem, ‘Macquarie Group hit by tax office “U-turn”’, The Sydney Morning Herald, (online edition), 18 November 2014 and R Gluyas, ‘Macquarie brawl prompted change’, The Australian, 17 May 2013, p. 17, both accessed 2 June 2015. This particular matter ended up in the Federal Court, see Macquarie Bank Limited v Commissioner of Taxation [2013] FCA 887. This case, and the subsequent appeal, was decided in favour of the Commissioner of Taxation. 87. Australian Government, Budget measures: budget paper no. 2: 2013-14, pp. 34-35, accessed 1 June 2015. D Bradbury (Assistant Treasurer),

Protecting the corporate tax base from erosion and loopholes - measures and consultation arrangements, media release, 14 May 2013, attachment C, accessed 11 June 2015.

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• on 28 June 2013 the previous Government released a consultation paper on reforms to the Offshore Banking Unit regime. All of the changes proposed by the Bill were discussed in this paper88

• while deferring the start date, the current Government announced that it would be proceeding with some of the previously announced changes89 and

• on 12 March 2015 Treasury released draft legislation and explanatory material for comment. Submissions closed on 8 April 2015.90

The proposed changes go beyond those recommended by the Johnson Report, and have been developed by both the current and previous governments. For example, tax integrity concerns have prompted several of the proposed changes in this Bill, an issue not touched on by the Johnson Report’s recommendations.

How many Australian OBUs are there and how active are they?

The following table shows the number of offshore banking unit adjustments for entities completing a company tax return:

Table 3: Number of OBU tax return adjustments

Year 2009-10 2010-11 2011-12 2012-13

Number 45 55 50 40

Source: Australian Taxation Office (ATO), ‘Taxation statistics 2012-13, companies: selected items, for income years 1979-80 to 2012-13’, ATO website, accessed 1 June 2015.

A recent paper noted that fewer than half the currently registered OBUs actually appeared to be active (as evidenced by a reference in a company tax return). This paper’s latest figure was 146 OBUs currently registered with the Australian Tax Office. The above figures appear to confirm this activity pattern.91

Under tax law, an OBU unit’s income is then separately taxed (discussed below under the heading ‘Current tax treatment of OBUs’).92 An indication of OBU activity can therefore be gauged by the overall amount of income deducted from company tax returns in respect of OBU activity. The following table shows some recent overall amounts deducted from company tax returns arising from OBUs:

Table 4: Amounts deducted from company assessable income arising from OBU activity, $m

Year 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13

Amount 1,071.8 1,009.6 894.7 374.0 386.4 617.0 630.6

Source: Australian Taxation Office (ATO), ‘Taxation statistics 2012-13, companies: selected items, for income years 1979-80 to 2012-13’, ATO website, accessed 1 June 2015.

While some of the apparent decline in activity since 2006-07 (a high point in terms of OBU income deducted from company assessable income) may be due to the effects of the global financial crisis, a real decline in overall OBU activity can be observed.

This is not to suggest that the apparent low level of OBU activity in Australia is terminal. Indeed, one commentator notes that a great deal of use is being made of Australian OBUs.93 Rather, the activity is not as extensive as it could be.

88. D Bradbury (Assistant Treasurer), Government continues consultation on Offshore Banking Unit reforms, media release, 28 June 2013; Treasury, Improving the Offshore Banking Unit regime, Discussion paper, Treasury website, 28 June 2013, both accessed 1 June 2015. 89. A Sinodinos (Assistant Treasurer), Offshore banking unit: deferral of start date, media release, 29 September 2013 and J Hocky (Treasurer) and A Sinodinos (Assistant Treasurer), Restoring integrity in the Australian tax system, joint media release, 6 November 2013, both accessed

11 June 2015. 90. Treasury, ‘Reforms to offshore banking units’, Draft legislation, Treasury website, 12 March 2015, accessed 1 June 2015. 91. T Frost et al., ‘Offshore Banking Units’, op. cit., pp. 20-21. 92. See ITAA 1939, Division 9A, Subdivision C generally. 93. T Frost et al, ‘Offshore Banking Units’, op. cit., pp. 24-25.

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Why is Australian OBU activity so low?

Some reasons for the lack of Australian OBU activity have been advanced, specifically:

• a lack of a clearly defined ownership of the OBU within an organisation

• a lack of properly structured remuneration arrangements to reward deal originators for using OBUs

• the additional and complex internal controls and systems to aid compliance with the myriad of rules relating to the operations of an OBU

• accounting systems that do not distinguish between offshore and domestic transactions

• complexity of the OBU rules

• the lack of certainty surrounding the choice principle (see discussion below under the heading ‘Schedule 3, Part 2: codifying the choice principle’)

• a lack of awareness amongst many financial market participants of the potential benefits of the OBU regime

• language in the legislation that is now out of date with the modern banking and financial services industry and

• many organisations, especially foreign owned ones, appear to have concluded that the Singaporean Financial Services Incentive Scheme (see below), is considerably more attractive and user-friendly than Australia’s OBU regime.94

It is important to note that not all these issues can be addressed by the Government. Many items on the above list are matters for potential users, and operators, of Australian OBUs.

Current tax treatment of OBUs

Briefly, Australian OBUs enjoy the following tax concessions:

• income (other than capital gains) derived by an OBU from eligible offshore banking activities is taxed at an effective rate of ten per cent, whilst other income and capital gains flowing to the OBU are taxed at normal company tax rate (30 per cent)95

• interest paid by an OBU on qualifying offshore borrowings and gold fees on certain offshore gold borrowings are exempt from withholding tax96income and capital gains from an overseas investment trust, that only benefits non-residents or foreign charities, is tax exempt97

• investment income and capital gains derived by an overseas charitable institution, managed by an OBU or that is an outgoing from an OBU, is also tax exempt98 and

• capital gains produced by a trust that is managed or controlled by an OBU, where the only beneficiaries are non-residents, and where the average Australian asset percentage of the portfolio is 10 per cent or less, are disregarded for tax purposes.99

OBU income is concessionally taxed if it arises from OBU activities listed in sections 121D to 121EF of the ITAA 1936. This specified list does not prevent OBUs from undertaking other financial activity, but income arising from non-OBU activities is not concessionally taxed.

Regional competition to Australian OBUs

94. Ibid., pp. 21-22. 95. ITAA 1939, sections 121EE, 121EF and 121EG. For an overview of these provisions see: R Deutsch, M Friezer, I Fullerton, P Hanley and T Snape, Australian Tax Handbook 2015, Thomson Reuters, [100 110], p. 1341. 96. CCH, Australian Master Tax Guide 2015, 56th edn, p. 1155. See section 128NB ITAA 1936. 97. Subsection 121ELB(2), ITAA 1936. 98. Section 121ELA, ITAA 1936. 99. Section 121 ELB, ITAA 1936.

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Australia is not alone in implementing an offshore banking regime. In the Asia-Pacific region Taiwan, Hong Kong, Singapore, Thailand, Malaysia, and Japan all have established OBUs.100 Briefly, some advantages enjoyed by Singapore’s OBUs, in comparison to the Australian regime, are:

• income taxed at 5, 10 or 12 per cent, depending on the circumstances

• a broader range of qualifying OBU activities

• the relevant OBU rules are regularly updated

• less onerous rules for separation of OBU and non-OBU monies and

• no dividend withholding tax.101

Are these changes part of the Government’s policy on corporate tax avoidance? In the 2015-16 Budget the Government announced a number of measures aimed at dealing with corporate tax avoidance and released exposure draft tax legislation.102 The Government’s announcements on corporate tax avoidance are mainly implementing actions arising from the Organisation for Economic Cooperation and Development (OECD)’s Base Erosion and Profit Shifting Project (BEPS). This project formally commenced in July 2013,103 while the policy development process for the tax integrity measures contained in the Bill has been in train since the release of the Johnson Report in 2009. That said, the focus on tax system integrity of the proposed OBU measures in the Bill is consistent with the Government’s corporate tax avoidance announcements.

Policy position of non-government parties/independents As at the date of writing, neither the non-government parties, nor the independents, have taken a position on the proposed measures in Schedule 3 of the Bill.

The Shadow Assistant Treasurer, Dr Andrew Leigh, had criticised the Government for backing away from the previous Government’s proposed changes to OBU rules.104 Given that the proposed reforms are similar to those proposed by the former Government, it may be the case that the Labor Party will support the proposed changes in Schedule 3 of this Bill.

Position of major interest groups The Australian Financial Markets Association (AFMA) supports the measures in Schedule 3, but believes that additional reforms are needed:

AFMA maintains that further reform is necessary to place the OBU regime on a competitive footing with comparable regimes in other jurisdictions. In particular, we have continued to advocate for a more principles-based regime that can respond nimbly to financial market developments and the adoption of a holistic approach to eligibility that ensures that all aspects of a transaction lifecycle can be offered from Australia ...

Today’s initiatives are a solid foundation for future improvement of the regime and we encourage the government to continue the dialogue with industry to optimise the regime in a manner that both protects revenue integrity and supports the growth of our financial services exports. 105

Financial implications The Explanatory Memorandum states that the proposed measures are expected to have a positive impact on the Commonwealth Budget, as follows:

100. Chen Jo-Huia et al., ‘The influence of macroeconomic factors and banking fragility on Offshore Banking Unit (OBU)’, op. cit., p. 408. 101. T Frost, et al, ‘Offshore Banking Units’, op. cit., p. 30 and following. 102. L Nielson, ‘Tightening anti-avoidance provisions for multinational companies’, Budget review 2015-16, Parliamentary Library, Canberra, accessed 2 June 2015.

103. OECD, ‘About BEPS’, OECD website, accessed 2 June 2015. 104. A Leigh, (Shadow Assistant Treasurer), Transcript of radio interview, ABC Radio National Drive, media release, 6 November 2014, accessed 2 June 2015. 105. R Christie, ‘Offshore banking reforms to boost financial services exports’, INFINANCE News, 29 May 2015, accessed 2 June 2015.

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Table 5: Financial impact of OBU reforms, $m

Year 2016-17 2017-18 2018-19

Amount 12.4 13.6 15.8

Source: Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, p. 5.

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Schedule’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that this Schedule is compatible.106

Key issues and provisions Schedule 3, Part 1: trading activity Part 1 of Schedule 3 deals with the trading activity of an OBU.

Item 2 inserts proposed subsection 121D(4A) into the ITAA 1936. The effect is to slightly narrow the range of permissible OBU activities, by placing restrictions on trading in subsidiaries. Increasing or reducing an OBUs’ participation interest in another offshore entity, above or below ten per cent (as the case may be), will not give rise to concessionally taxed OBU income. Of course the OBU may undertake this activity, but any resulting income will be taxed at the normal company tax rate.

This is an integrity measure. The mischief targeted is the use of an offshore subsidiary of an OBU to undertake ineligible activities, which is an activity that gives rise to income that does not qualify for concessional tax treatment. These profits are generated by the purchase of shares in the subsidiary undertaking the non OBU activity, and later reselling these shares when that non-OBU activity has concluded.

However, this measure also catches profits earned by a subsidiary that also undertakes approved OBU activities, so it could be seen as a restriction on how an OBU chooses to undertake its business (assuming that there is a good reason for the OBU not to undertake the OBU activity in question itself). Further, this measure does not apply to buying or selling shares in an offshore subsidiary where the OBU’s interest remains below ten per cent. This may provide a significant way around the intent of this proposed amendment.107

Schedule 3, Part 2: codifying the choice principle Part 2 of Schedule 3 deals with the ‘choice principle’. Briefly, this principle states that an OBU may choose to classify an action as a non-OBU activity. Division 9A of the ITAA 1936 contains no provisions in respect of the ‘choice principle’. The Johnson Report recommended that certainty be provided by legislating this principle (currently contained in a Tax Determination (TD)).108 This recommendation is understandable, since whilst a Tax Office discussion paper in 2007 foreshadowed the withdrawal of this TD, it remains in force, thus creating a level of uncertainty as to the future application or availability of this principle to OB activities.109

The choice principle is important to the operation of OBUs, as a recent paper has observed:

[Section] 121EH [of the] ITAA 1936 contains the so called ‘purity test’ which, briefly stated, is triggered when more than 10% of an OBU’s assessable income for an income year is attributable to activities that used non-OB money. The DBU [domestic banking unit] of an OBU taxpayer is likely (often, and indeed generally, on an inadvertent basis)

106. The Statement of Compatibility with Human Rights can be found at page 54 of the, Explanatory Memorandum to the Bill. 107. For example, there is nothing to stop an OBU buying and selling interests in an off-shore subsidiary on multiple occasions provided that at no time does its total interest in that subsidiary exceed ten per cent. In this way profits from non-OBU activities undertaken by an offshore subsidiary could be turned into concessionally taxed OBU income.

108. M Johnson et al, Australia as a financial centre - building on our strengths, report by the Australian Financial Centre Forum, November 2009, p. 61, accessed 10 June 2015; Australian Taxation Office (ATO), ‘Income tax: Offshore Banking Units - what is the effect of a transaction which falls within the definition of offshore banking activity, which is entered into by the part of an OBU which handles the domestic (as opposed to offshore) activities of the bank and which is accounted for in the domestic books?’, Tax Determination 93/135, ATO website, 8 July 1993, accessed 3 June 2015.

109. Treasury, Improving the Offshore Banking Unit regime, Discussion paper, June 2013, p. 9, accessed 3 June 2015; Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, p. 37 (para 3.14).

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to undertake a variety of activities that would constitute eligible OB activities. Absent being able to choose to book a transaction to its DBU, an OBU taxpayer is likely to inadvertently fail the purity test.

[Section] 128GB [of the] ITAA 1936 provides an exemption from interest withholding tax that would otherwise be imposed under s.128B on “offshore borrowings”. However, this exemption is effectively clawed back with penalties where the funds are used in the OBU taxpayer’s DBU (i.e. the funds are not used for eligible OB activities). Accordingly, being able to choose not to claim the s.128GB exemption is critical where an OBU taxpayer raises funds overseas for its DBU operations.

110

Item 6 of Part 2 inserts proposed section 121EAA into the ITAA 1936, and legislates the choice principle. The proposed amendment will increase the level of certainty on the operation of tax law. For example, proposed subsections 121EAA(4) to (6) clarify how making the ‘choice’ in relation to one transaction will impact on the treatment of ‘grouped’ transactions that are part of the same scheme. In short, as noted in the Explanatory Memorandum:

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. 111

However, some uncertainties remain as the Tax Commissioner may change his or her opinion on how exactly the law operates.112

Schedule 3, Part 3: allocating expenses Part 3 of Schedule 3 seeks to address problems in the allocation of expenses (deductions) between OBUs and DBUs. Subsection 121EF(2) of the ITAA 1936 classifies allowable OB deductions into three types:

• an exclusive offshore banking (OB) deduction

• a general OB deduction and

• an apportionable OB deduction.

The June 2013 ‘Improving the Offshore Banking Unit regime’ Treasury Discussion noted that ‘exclusive deductions are allocated exclusively to OB or non-OB income based upon the relevant facts. General and apportionable deductions are allocated according to the relevant legislative formulae. Concerns have not been raised regarding the treatment of exclusive deductions.113 However, industry has argued that the general OB deductions rule is complex and cumbersome and delivers distorted and arbitrary expense allocations.’114

The Bill’s proposed approach (in item 15) is to repeal the existing general OB deduction subsection (121EF(4)) and replace it with proposed subsection 121EF(4), which defines a general OB deduction as:

A deduction that:

(a) is none of the following:

(i) a loss deduction;

110. T Frost et al., ‘Offshore Banking Units’, op. cit., p. 64. 111. Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 44 (para 3.46). 112. The Inspector General of Taxation has published a table of instances where the Commissioner for Taxation has been considered to have changed his view of how tax law applies. See: Inspector General of Taxation, Follow-up Review into Delayed or Changed Australian Taxation

Office Views on Significant Issues, ‘Appendix 1: stakeholder examples of potential “U Turns"’, Inspector General of Taxation website, July 2014, accessed 3 July 2015. This is not to argue that the Commissioner should never change his or her view, far from it. Rather, there are limits on the provision of certainty in the application of tax law by way of legislative action. 113. Treasury, Improving the Offshore Banking Unit regime, op. cit., p. 10; This was no doubt true in 2013 when this paper was written, but T Frost et al have expressed serious concerns about the exclusive deductions sections of the ITAA 1936 OBU provisions. See T Frost et al., ‘Offshore Banking Units’, op. cit., p.70 and following. 114. Treasury, ‘Improving the Offshore Banking Unit regime’, op. cit., p. 10. Concerns have also been raised about the apportionable deductions formula. However, changes to this particular provision are not part of this Bill’s amendments.

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(ii) an apportionable deduction;

(iii) an exclusive OB deduction;

(iv) an exclusive non-OB deduction; and

(b) is allowable from the OBU’s assessable income of the year of income;

is a general OB deduction to the extent that:

(c) it is incurred in gaining or producing the OB income of the OBU; or

(d) it is necessarily incurred in carrying on a business for the purpose of gaining or producing the OB income of the OB

Item 15 will repeal the formula in existing subsection 121EF(4). The new approach is consistent with the general approach to determining tax deductions in subsection 8-1 of the ITAA 1997.

It is arguable that the treatment of issues in dealing with the allocation of expenses between DBUs and OBUs is incomplete, as concerns have also been raised about the workability of both the exclusive and apportionable OB deductions provisions.115 Indeed, the formula for the latter deduction appears to be more complex than the existing formula for the general OB deduction.116

Schedule 3, Part 4: eligible offshore banking activities As noted above, the Johnson Report recommended that the list of eligible OB activities be regularly reviewed and updated.117 Part 4 of Schedule 3 expands the range of activities that an OBU may undertake to generate concessionally taxed OB income. A wider range of activities means that OBUs can offer a wider range of services to non-resident clients and thus potentially expand the demand for their services. The proposed amendments aim to ‘modernise’ the list of eligible OB activities by, for example, encompassing:

• the creation of lending facilities (that is, making commitments to lend money such as a credit facility that is not fully drawn on)118

• trading in commodities and commodity derivative contracts119

• guarantee activities and connections with Australia120

• portfolio investment and funds management activities121 and

• leasing activities.122

Schedule 3, Part 5: internal financial dealing and transfer pricing The proposed amendments in Part 5 of Schedule 3 seek to ensure that financing of an OBU’s activities by a related party (including fees and interest rates charged) is priced on an arm’s length basis. The Explanatory Memorandum notes that this will address the ‘gaps in the application of Australia‘s transfer pricing rules (Division 815 of the ITAA 1997) to an OBU‘s internal dealings’.123 Proposed subsection 121EB(4) provides that an OBU‘s OB income or allowable OB deductions are to be treated as the amounts that would be included or allowed, were the internal parties dealing with each other ‘at arm’s length’.124 Further, proposed

115. See T Frost, et al, ‘Offshore Banking Units’, op. cit., p. 71 and following and Treasury, ‘Improving the Offshore Banking Unit regime’, op. cit., p. 10. 116. See subsection 121EF(5), ITAA 1936. 117. M Johnson et al, Australia as a financial centre - building on our strengths, op. cit., p. 61. 118. Proposed section 121C and paragraph 121D(2)(b). 119. Proposed paragraph 121D(4)(i). 120. Proposed section 121C and subsection 121D(3). 121. Proposed paragraphs 121D(6A)(e). 122. Proposed sections 121C, 121DD and paragraph 121D(1)(ga). 123. Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 53 (para 3.98). 124. Ibid., para 3.99.

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subsection 121EB(5) provides that in determining the ‘arm’s length’ conditions, reference must be made to the guidance materials related to the transfer pricing rules found in Division 815 of the ITAA 1997.

The amendments appear to be aimed at the ‘mischief’ of using transfer pricing mechanisms to transfer an undue amount of profits away from the Australian company tax system.125

Schedule 3, Part 6: commencement Item 34 provides that the amendments made by Schedule 3 (other than Part 2) apply in relation to all income years after 1 July 2015. The amendments made by Part 2 will apply to a thing done by an OBU from 1 July 2015.

Concluding comments The finance industry has suggested that a wide range of additional amendments to the OBU rules should be pursued.126 While many of the changes that have been proposed may be worthwhile, it is not clear that, of themselves, they would increase the use of Australian OBUs, given the other reasons noted above for the low level of activity in this area. However, the proposed amendments nonetheless would appear to go some way towards making Australia more competitive in this area.

Schedule 4—Income tax exemption for the Global Infrastructure Hub Ltd Schedule 4 to this Bill amends the ITAA 1997 to provide the Global Infrastructure Hub Ltd (the Hub) exemption from income tax liability. The proposed changes are designed to ensure that payments made to the Hub, including from the Australian and foreign governments, are not subject to income taxation.127

Background In November 2014, as part of Australia’s initiative to implement the G20’s infrastructure agenda, Australia secured the agreement of all G20 members to establish the Hub in Sydney.128

In April 2015, China, Mexico, New Zealand, Republic of Korea, Saudi Arabia, Singapore and the United Kingdom committed to offer financial contributions to the Global Infrastructure Hub. The other G20 member countries are expected to support the Hub through specific commitments over coming months.129 The objectives of the project are to:

• address data gaps

• lower barriers to investment

• increase the availability of investment-ready projects

• help match potential investors with projects and

• improve policy delivery.130

The current financial contributions of $50 million, including a $30 million contribution from Australia, will be used for the establishment and ongoing operation of the Hub until 2018. More financial contributions are expected from various other G20 members and the private sector. The World Bank and the Organisation for Economic Co-operation and Development (OECD) will collaborate with the Hub.131

The Hub has been registered as a company under Australian law. Directors on the Board will consist of members from Australia, China, the Republic of Korea, Turkey and the United Kingdom to represent the G20. The inaugural meeting of the Hub’s permanent Board was held in Washington on 15 April 2015, with Treasury Secretary John Fraser in the Chair.132

125. For a very brief overview of transfer pricing see: J Murphy and D Cockeril’, 'Senate inquiry into corporate tax avoidance’, Flag Post weblog, 19 December 2014, accessed 14 June 2015. 126. See T Frost, et al, ‘Offshore Banking Units’, op. cit., pp. 40-46 and R Christie, ‘Offshore banking reforms to boost financial services exports’, op. cit. 127. Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 55. 128. Ibid. 129. J Hockey (Treasurer), Support builds for the Global Infrastructure Hub, media release, 17 April 2015, accessed 5 June 2015. 130. Global Infrastructure Hub, Fact sheet, Global Infrastructure Hub website, accessed 16 June 2015. 131. J Hockey (Treasurer), Support builds for the Global Infrastructure Hub, media release, op, cit. 132. Ibid.

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This measure applies from 24 December 2014 to 30 June 2019.133

Human rights implications According to the Explanatory Memorandum, this Schedule does not raise any human rights issues.134

Financial implications According to the Explanatory Memorandum, there will be no financial impact nor any compliance cost.135

Key issues and provisions Item 1 of Part 1 amends the table in section 11-5 of the ITAA 1997, listing the Hub as an income tax exempt entity, meaning that all payments made to it, by the Australian and other governments, non-government organisations and other contributors, will not be subject to income tax.

Item 2 of Part 1 amends section 50-40 of the ITAA 1997 to provide that the Hub’s exemption from income tax applies from 24 December 2014 to 30 June 2019, so that for operations to 2018 when the Hub’s mandate expires (including any in the financial year 2018-19) all contributions and other income of the Hub will be exempt.

Items 3 and 4 of Part 2 provide that the exemptions discussed above will sunset (that is, self-repeal) on 1 July 2021.

Schedule 5—Deductible gift recipient extensions Schedule 5 to this Bill amends the ITAA 1997 to update the list of specifically listed deductible gift recipients (DGRs). It extends the listing of two entities to the list of deductible gift recipients (DGRs), thereby allowing for donations of $2 or more to these entities to be tax deductible for the donor until 31 December 2017.

Background A DGR is an organisation that is entitled to receive income tax deductible gifts and deductible contributions. There are two methods of gaining DGR status:

• by applying to the Commissioner for Taxation for endorsement as a DGR or

• by having the organisation listed by name in Division 30 of the ITAA 1997 or in the Income Tax Regulations 1997.136

Under Division 30 of the ITAA 1997 (sections 30-1 to 30-320), taxpayers who make gifts of $2 or more to an organisation which is a DGR are able to deduct those amounts from their taxable income.137 Treasury estimates the annual cost to the budget of tax deductibility for gifts to DGRs at around $1.09 billion in 2013-14, and $1.10 billion in 2014-15.138

As at 31 October 2014, there were in total 28,100 entities listed as deductible gift recipients, including 190 entities specifically named in the ITAA 1997, and 10,827 DGR funds.139 In 2012-13 income year individual claims for deductions were made in respect of a total of 4.6 million gifts valued at just under $2.3 billion.140

Recent reforms to DGR status

In 2012, the former Government announced the formation of the Not-For-Profit Tax Concession Working Group to ‘consider ideas for better delivering the support … provided through tax concessions to the not-for-profit

133. Schedule 4, Part 1, item 2; Explanatory Memorandum, Tax Laws and Superannuation Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 56 (para 4.9). 134. Explanatory Memorandum, op. cit., p. 57. 135. Ibid., p. 5. 136. Sections 30-17 and 30-120, Income Tax Assessment Act 1997, accessed 4 June 2015. 137. CCH, Australian Master Tax Guide 2015, 56th edn, p. 992. 138. Treasury, Tax expenditure statement 2014, ‘chapter 2: tax expenditures’, Canberra, January 2015, p. 28, accessed 4 June 2015. 139. ATO, ‘Deductible gift recipients’, ATO website, and Taxation statistics 2012-13, Table 3: Deductible Gift Recipients, Number of Deductible Gift

Recipients as at 31 October 2014, accessed 4 June 2015. 140. ATO, ‘Taxation statistics 2012-13 income year: charities-Table 5’, data,gov.au, accessed 4 June 2015.

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(NFP) sector’.141 The terms of reference stated that the ‘Working Group will identify whether there are fairer, simpler and more effective ways of delivering the current envelope of support provided through tax concessions to the NFP sector’.142 The Working Group released a consultation paper in November 2012, which included a history of DGR concessions as well as discussion of the DGR framework. It also discussed options for reform, including extending DGR status to all charities, changes in the threshold, and a number of other options.143

The Working Group’s final report was made public by the Treasury in response to a request for access under the Freedom of Information Act 1982144 on 21 February 2014.145 The report is dated May 2013, but had not been previously released. The Working Group recommended that:

 DGR status should be extended to all charities, but restricted to activities that are not for the advancement of religion, charitable child care and primary and secondary education, except where this is sufficiently related to another charitable purpose.

 Except in the most exceptional circumstances, DGR status should be limited to charities and charitable-like government entities. …

 The current minimum of $2 for deductible gifts is an anachronism and could be removed with few consequences. 146

The Working Group also rejected other options to modify the DGR system such as a replacing deductibility with a tax offset for donations.147

Proposed changes to the list of deductible gift recipients

In the 2015-16 Budget, the Government announced that the following organisations, which are currently listed as DGRs, would have their listings extended, to expire on 31 December 2017:

• the Australian Peacekeeping Memorial Project and

• the National Boer War Memorial Association.148

Information about the activities of each of the entities is set out in the Explanatory Memorandum.149 This material is summarised in Table 6, with links to each of the entities’ website.

Briefly, the Australian Peacekeeping Memorial Project Incorporated is seeking donations to build a memorial on Anzac Parade in Canberra, ACT. 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.150

Taxpayers will be entitled to claim back an income tax deduction for gifts of money or property to these DGRs before 1 January 2018.151

141. M Butler (Minister for Social Inclusion) and M Arbib (Assistant Treasurer), Not-for-profit sector tax concession working group, media release, 12 February 2012, accessed 4 June 2015. 142. Ibid. 143. Not-For-Profit Sector Tax Concession Working Group (NFPSTCWG), Fairer, simpler and more effective tax concessions for the not-for-profit

sector, NFPSTCWG, Discussion paper, November 2012, pp. 18-34, accessed 4 June 2015. 144. Freedom of Information Act 1982, accessed 4 June 2015. 145. Treasury, ‘FOI disclosure log’, Treasury website, accessed 4 June 2015. 146. Not-For-Profit Sector Tax Concession Working Group, Fairer, simpler and more effective: tax concessions for the not-for-profit sector: final

report, NFPSTCWG, May 2013, p. 5, accessed 4 June 2015. The only rationale advanced for removing DGR status to activities associated for the advancement of religion was that ‘DGR status for gifts is an additional concession, over and above the basic tax exemption that recognises the public benefit provided by charities. In the case of charities for the advancement of religion, it is the view of the Working Group that given the pluralist nature of our society, additional support through deductible donations is not warranted’, p. 24. 147. Ibid., p. 5. 148. Australian Government, Budget measures: budget paper no. 2: 2015-16 , p. 28, accessed 4 June 2015. 149. Explanatory Memorandum, op. cit., pp. 59-60. 150. Ibid., p. 60. 151. Australian Government, Budget measures: budget paper no. 2: 2015-16 , p. 28, accessed 4 June 2015.

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Table 6 Deductible Gift Recipients (DGRs) in Schedule 5 of the Bill

DGR type

DGR name

Conditions

Summary of activities as outlined in the Explanatory Memorandum

Link to website

Other recipients

Australian Peacekeeping Memorial Project Incorporated

The extension of the listing of the Australian Peacekeeping Memorial Project Incorporated applies to gifts made to this organisation before 1 January 2018.

The Australian Peacekeeping Memorial Project Incorporated is a charitable entity to erect a memorial in Canberra by the Peacekeepers Day on the 14th September 2017 that appropriately recognises the sacrifice and continuing contribution of Australians to international peacekeeping.

Australian Peacekeeping Memorial Project Incorporated

Other recipients

National Boer War Memorial Association Incorporated

The extension of the listing of the National Boer War Memorial Association Incorporated applies to gifts made to this organisation before 1 January 2018.

The National Boer War Memorial Association (NBWMA) is a charitable entity that has secured the support of the Canberra National Memorials Committee and the National Capital Authority to construct a memorial on the site along the ANZAC Parade in honour of those who lost their lives in the Boer War in South Africa during 1899-1902.

National Boer War Memorial Association Incorporated

Source: Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, pp. 59- 60.

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.

Financial implications The revenue implication of this measure is an estimated tax expenditure of $1.4 million over the forward estimates period.

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Table 7: Financial impact of extending DGR status, $m

Organisation 2015-16 2016-17 2017-18 2018-19 2019-20

Australian Peacekeeping Memorial Project Incorporated - $0.1 - $0.2 - $0.2 - $0.1 -

National Boer War Memorial Association Incorporated - $0.1 - $0.3 - $0.3 - $0.1 -

Total - $0.2 - $0.5 - $0.5 - $0.2 -

Source: Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, p. 6.

Key issues and provisions Division 30 of the ITAA 1997 sets out the rules for working out deductions for certain gifts or contributions. In particular, Subdivision 30-B contains tables of recipients of deductible gifts, divided into a number of categories.

Item 1 of Schedule 5 amends the entry in the table in subsection 30-50(2) of the ITAA 1997, which relates to the claim of a tax deduction for gifts made to the Australian Peacekeeping Memorial Project Incorporated after 31 December 2012 and before 1 January 2018,152 and the claim of a tax deduction for gifts made to the National Boer War Memorial Association Incorporated after 31 December 2012 and before 1 January 2018.153

Items 2 and 3 of Schedule 5 provide that the DGR listings discussed above will sunset (that is, will be automatically repealed) on 1 July 2022.154

Human rights implications

According to the Statement of Compatibility with Human Rights—paragraphs 5.10 to 5.14 of the Explanatory Memorandum to the Bill—this Schedule does not raise any human rights issues.

Schedule 6—Miscellaneous amendments Schedule 6 makes a number of minor amendments to tax, superannuation and other laws. They appear all to be routine updates and corrections.

However, in an apparent reaction to recent High Court decisions in Williams v Commonwealth (Williams No. 1)155 and Williams v Commonwealth of Australia [2014] HCA 23 (Williams No. 2),156 Schedule 6 also contains amendments that clarify the constitutional basis of the Product Stewardship (Oil) Act 2000.157

Further, in response to the Federal Court decision in Commissioner of Taxation v Cancer and Bowel Research Association Inc,158 amendments to the Taxation Administration Act 1953 are also proposed that will provide new powers to the Tax Commissioner to revoke various tax concessions in situations in which he or she identifies (through an audit) that the entity is no longer entitled to be endorsed.159

152. Explanatory Memorandum, op. cit., p. 59. 153. Ibid., p. 60. 154. Ibid. 155. Williams v Commonwealth of Australia [2012] HCA 23, accessed 17 June 2015. 156. Williams v Commonwealth of Australia [2014] HCA 23, accessed 17 June 2015. 157. Product Stewardship (Oil) Act 2000, accessed 17 June 2015. 158. Commissioner of Taxation v Cancer and Bowel Research Association Inc (includes Corrigenda dated 10 and 13 December 2013) [2013] FCAFC

140, accessed 17 June 2015. 159. Schedule 6, items 57 to 59; Explanatory Memorandum, op. cit., pp. 73-74, paras 6.71-6.76; Taxation Administration Act 1953, accessed 17 June 2015.

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Schedule 7—Investment manager regime Purpose of Schedule 7 Schedule 7 of the Bill amends the ITAA 1997 by repealing existing Subdivision 842-I of that Act and replacing it with new text. This subdivision deals with the Investment Manager Regime (IMR) and contains tax rules applying to certain foreign investment funds investing either in, or through, Australia.

The amendments implement the third phase of the IMR reforms. The first two phases were implemented by the Tax Laws Amendment (Investment Manager Regime) Act 2012.160 The purpose of the third phase reforms is to ‘attract foreign investment to Australia and promote the use of Australian fund managers’161 by:

• extending the concession to cover direct investments in Australian assets that are of a portfolio nature

• remove restrictions on portfolio investments in foreign assets made through Australia

• significantly change the criteria that determine when a foreign fund is ‘widely held’ and

• simplify the legislative mechanisms that provide the IMR concession.162

In summary, the above changes are aimed at removing tax impediments to investing in or through Australia, and thus making such investments more competitive internationally.163

Structure of the Schedule Schedule 7 is divided into two parts, both of which amend the ITAA 1997:

• Part 1 contains the main amendments and

• Part 2 contains other amendments.

Background

What is an Investment Manager Regime? There is no one definition of an IMR. Rather, the Johnson Report, which dealt with developing Australia as a financial centre, stated that most IMRs implemented in other countries were designed to allow for greater ‘internationalisation’ of the domestic funds management business. This is to be achieved by providing clarity and certainty regarding the tax treatment of the funds management sector with respect to assets sourced offshore. A common feature of all IMRs is that they provide concessional tax treatment of profits generated for the non-resident investor from these funds.164

Why is this worth doing? As noted in the commentary on Offshore Banking Units above (Schedule 3 of the Bill), promoting the growth of Australia as regional financial centre has the potential to generate significant benefits.165 Australia’s funds management sector is much larger and more diverse than its offshore banking industry and is in a better position to increase the total funds under management (and hence taxable income) through managing foreign sourced assets. When the potential of the Asian investment market is taken into account, the opportunities for increasing Australian based funds management activity are potentially quite large.166

160. B Pulle, Tax Laws Amendment (Investment Manager Regime) Bill 2012, Bills digest, 12, 2012-13, Parliamentary Library, Canberra, 2012; Parliament of Australia, ‘Tax Laws Amendment (Investment Manager Regime) Bill 2012 homepage’, Australian Parliament website, both accessed 4 June 2015.

161. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 78 (para 7.1). 162. Ibid., p. 79 (para 7.7). 163. Ibid., p. 80 (para 7.9). 164. M Johnson (Chair), et al., Australia as a financial centre - building on our strengths, op. cit., p. 7. 165. Ibid., p. 5. 166. Ibid., p. 6 on growth potential of the Asian region.

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The first two phases of the IMR To date, legislation dealing with the first phase of the IMR (the so called ‘FIN 48 issues’) and the second phase of the IMR (the conduit income concession) have been legislated.167 Briefly:

• phase one addressed the 'FIN 48' issue by amending the law to effectively restrict the Commissioner of Taxation's ability to raise assessments in respect of income of a widely held foreign managed fund for the 2010-11 and prior income years and

• phase two (conduit income) addressed the tax uncertainty where a widely held foreign managed fund engaged an Australian-based financial services intermediary with respect to foreign investments and Australian assets that were only subject to capital gains tax.

Policy Development—Third Phase The Explanatory Memorandum provides a comprehensive summary of the policy development of the IMR regime.168 Four separate versions of draft legislation for phase three amendments have been issued since 2010.169 The amendments in the first three versions were generally considered ‘unworkable’ by the financial industry.170

In comparison with previous drafts of Phase three IMR amendments the latest draft:

… adopts a UK style ‘bright-line simplified test’ to determine whether an entity is widely held and abandons the reporting requirements as a condition of application of the IMR. It also liberalises some aspects of Phase 2, for example, the limitation to portfolio investment only applies to investments into Australia, and not to investment elsewhere. Finally it removes the requirement that the foreign investor be a resident of an exchange-of-information (EOI) country which it had inherited from the [Managed Investment Trusts] MIT withholding tax.

171

These appear to be significant changes in comparison with earlier drafts of these proposed amendments.

The Government announced that it was proceeding with phase three amendments on 6 November 2013.172

Influence of the UK Model More than one commentator has noted that the proposed amendments are heavily influenced by the United Kingdom’s Investor Manager Exemption.173 There are five conditions, all of which must be met before the UK investment manager exemption can apply, as follows:

• the investment manager must be carrying on the business of providing investment management services

• the transaction must be carried out by the investment manager in the ordinary course of the investment management business

167. The FIN 48 issue arose out of the US accounting standard Financial Interpretation no. 48 (FIN 48). Amongst other things FIN 48 required investment funds to report uncertain tax positions going back some years from the end of 2010. This was dealt with by an amendment in the transitional provisions legislation preventing the issue of assessments after 17 December 2010 relating to IMR income for the 2010-2011 and earlier income years.

168. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., pp. 106-111. A history of the IMR concept back to the Asprey Report of 1975 (Taxation Review Committee, Full Report, 31 January 1975) can be found in P L Dowd, ‘The investment manager regime . . . so far’, The Tax Specialist, 16(3), February 2013, pp. 104-123, accessed 11 June 2015.

169. B Shorten (Minister for Financial Services and Superannuation), Government announces final element of Investment Manager Regime, media release, 16 December 2011; B Shorten (Minister for Financial Services and Superannuation), Government confirms legislative timetable for Element 3 of the Investment Manager Regime, media release, 21 December 2012; C Bowen (Treasurer), Investment Manager Regime legislation out for consultation, media release 31 July 2013; M Cormann (Minister for Finance), Government committed to implementing the Investment Manager Regime, media release, 18 December 2014; Treasury, ‘Implementing Element 3 of the Investment Manager Regime’, Draft legislation, Treasury website, 12 March 2015, all accessed 4 June 2015. Other versions of the draft legislation are available on the Treasury consultations and submissions website.

170. R Vann et al, ‘IMR - fourth time lucky’, Tax Brief, Greenwoods Herbert Smith Freehills (an accountancy firm), 9 April 2015, accessed 11 June 2015. 171. Ibid. 172. J Hockey (Treasurer), A Sinodinos (Assistant Treasurer), Restoring integrity in the Australian tax system, joint media release, 6 November

2013, accessed 11 June 2015. 173. J McCormack and A Maharaj, ‘Investment Manager Regime - draft Legislation to implement Element 3 finally released’, DLA Piper Tax Alert, March 2015, p. 2, accessed 5 June 2015; R Vann, C Colley, T Eggleston, A Hirst, ‘IMR - fourth time lucky’, op. cit; Explanatory Memorandum,

Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 88 (para 7.42).

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• the investment manager must act in relation to the transaction on behalf of the non-resident in an independent capacity. This is called the ‘independence test’ and is considered by reference to the legal, financial and commercial characteristics of the investment manager’s relationship with the non-resident

• the investment manager, together with any persons connected with the investment manager must not be beneficially entitled to more than 20 per cent of the taxable profits of the non-resident from transactions carried out through the investment manager. This is called the ‘20% rule’ and

• the remuneration that the investment manager receives in respect of the transaction is not less than the customary amount for that class of business.174

The effect of these conditions is to exempt only those investment managers who are acting in the ordinary course of their business on arm's length terms and are independent of the non[UK]-resident.175

The tax position of assets managed under the current IMR Where the conditions in current Subdivision 842-I of the ITAA 1997 are satisfied:

• returns or gains relating to financial arrangements (known as IMR income) are non-assessable non-exempt income (that is, not assessed for tax purposes) or disregarded

• deductions and losses relating to financial arrangements (known as IMR deductions) are disregarded

• capital gains relating to financial arrangements (known as IMR capital gains) are disregarded and

• capital losses relating to financial arrangements (known as IMR capital losses) are disregarded.

These amounts are also disregarded if a foreign resident beneficiary of a trust, or a foreign resident partner in a partnership, receives them (or amounts attributable to them) through one or more interposed trusts or partnerships.176 The proposed changes do not alter this overall tax position.

Policy position of non-government parties/independents To date neither the non-government parties nor independents have expressed a view on the amendments proposed by Schedule 7. Given that the proposed amendments are quite different to the exposure drafts circulated by the previous Government, it would appear that Labor’s support for this schedule of the Bill cannot be assumed.

Position of major interest groups Generally, Industry has welcomed the proposed amendments in Schedule 7.177 One commentator noted that:

… initial reaction to the proposed new provisions has been positive. Indeed, it is very likely that the provisions will be widely used—which surely must be a good thing. 178

Financial implications The Explanatory Memorandum states that this measure is estimated to have an unquantifiable cost to revenue over the forward estimates period.179

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Schedule’s compatibility with the human rights and freedoms recognised or declared in the

174. HM Revenue and Customs (HMRC), ‘INTM269060 - non-residents trading in the UK: through UK investment managers, brokers or Lloyd’s agents: investment manager exemption: conditions’, Guidance note, HMRC website, accessed 5 June 2015. 175. HMRC, ‘INTM269060 - non-residents trading in the UK: through UK investment managers, brokers or Lloyd’s agents: investment manager exemption: conditions’, op. cit. Further information on the UK Investment Manager Exemption can be found at HM Revenue and Customs,

‘INTM269000 - non-residents trading in the UK: through UK investment managers, brokers or Lloyd’s agents - contents, Index, HMRC website, accessed 5 June 2015. 176. Section 842-200, ITAA 1997. 177. Financial Services Council, Investment Manager Regime legislation is significant for financial services trade, media release, 12 March 2015, accessed 4 June 2015; Alternative Investment Management Association (AIMA), AIMA welcomes proposed IMR legislation, media release, 12 March 2015, accessed 4 June 2015; R Vann et al, ‘IMR - fourth time lucky’, op. cit. 178. R Vann et al, ‘IMR - fourth time lucky’ op. cit. 179. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., p. 7.

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international instruments listed in section 3 of that Act. The Government considers that this Schedule is compatible.180

Key issues and provisions Item 1 of Part 1 of Schedule 7 repeals current Subdivision 842-I of the ITAA 1997 and replaces it with new text. The following outlines some key features of the proposed Subdivision 842-I.

Definition of an investment manager entity

The tax concession provided by the proposed amendments can (depending on a number of factors discussed below) only be accessed by foreign resident IMR entities, IMR widely held entities and independent Australian fund managers in relation to IMR financial arrangements.181 How these concepts are defined is discussed below.

IMR entities Proposed section 842-220 defines an IMR entity as one that is not an Australian resident and is not a resident trust for capital gains tax purposes, for all of the income year.

IMR widely held entities Proposed section 842-230 defines an IMR widely held entity as:

• an entity specified in regulations

• a foreign life insurance company or

• a wide range of superannuation, insurance, pension or foreign government controlled entities.182

Further, a widely held IMR entity can be one where no other entity has a total participation interest in the IMR entity of 20 per cent or more; or there are not five or fewer members who have combined participation interest of at least 50 per cent or more.183 Proposed sections 842-235 and 842-240 contain rules for determining total participation interests in a widely held IMR entity and for dealing with temporary circumstances that result in a widely held IMR entity failing to meet the relevant criteria. The operation of these provisions is explained in detail on pages 88 to 96 of the Explanatory Memorandum.

Independent Australian fund managers Proposed section 842-245 defines an Independent Australian Fund Manager as one that is an Australian resident for tax purposes, carries out investment management activities for the IMR entity during the ordinary course of its business and receives remuneration for undertaking the relevant investment activities that is what the remuneration would be between the parties dealing at arm’s length. Further, one of the following must also apply:

• the IMR entity is a widely held entity (see above)

• 70 per cent or less of the Australian managing entity’s income comes from the IMR entity in question or

• if the Australian managing entity has been in operation less than 18 months it takes all reasonable steps to ensure that its IMR entity income will be less than 70 per cent of its total income by the end of that 18 month period.

IMR financial arrangements The definition of an IMR financial arrangement proposed by the Bill is linked to the existing (and expansive) definition of a ‘financial arrangement’ and ‘derivative financial arrangement’ in the ITAA 1997.184 Proposed

180. The Statement of Compatibility with Human Rights can be found at page 105 of the Explanatory Memorandum to the Bill. 181. Proposed subsection 842-210(1). 182. A list of such entities is in paragraphs 12-403(3)(a), (b), (c), (d), (f), (g) or (h) in Schedule 1 to the Taxation Administration Act 1953. 183. Proposed subsection 842-230(2). 184. See: ITAA 1997, sections 230-45 to 230-55 and subsection 230-350(1); Explanatory Memorandum, Tax and Superannuation Laws Amendment

(2015 Measures No. 1) Bill 2015, op. cit., p. 84 (para 7.24).

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section 842-225 defines an IMR financial arrangement as a financial arrangement other than one that relates to taxable Australian real property or an indirect Australian real property interest.185

As a result, the definition of IMR financial arrangement precludes an IMR entity undertaking concessionally taxed financial arrangements in relation to (for example) real estate or mining interests. This is also a feature of the current legislation and the IMR entity may undertake Australian property related transactions, and have them assessed under domestic tax law.186

The IMR tax concessions The proposed amendments will create two types of tax concession: the direct investment concession and the indirect investment concession.187

Direct investment concession criteria An IMR widely held entity qualifies for the direct investment concession if it satisfies the conditions in proposed subsection 842-215(3). First, the IMR entity must be an IMR widely held entity for the whole of the year. Second, during the whole year the interest of the entity in the issuer of (or counter party to) the IMR financial arrangement fails the non-portfolio test contained in section 960-195 of the ITAA 1997. (The non-portfolio test means that the other entity (and its associates) does not have a combined direct participation interest greater than ten per cent in the IMR entity.)

Third, none of the returns, gains or losses for the year from the financial arrangement are attributable to a permanent establishment in Australia. Finally, the IMR entity did not, during the year, engage in trading business within the meaning of section 102M of the ITAA 1936 that relates (either directly or indirectly) to the financial arrangement in question.188

Indirect investment concession criteria An IMR widely held entity qualifies for the indirect investment concession if it satisfies the conditions in proposed subsection 842-215(5). First, the IMR financial arrangement was made on the IMR entity’s behalf, by an independent Australian Fund Manager. Second, if the issuer of, or the counterparty to, the IMR financial arrangement is an Australian resident or a resident trust for CGT purposes, the interest of the entity in that issuer or counterparty does not pass the non-portfolio test (see above). Finally, the IMR entity does not carry on a trading business that relates (directly or indirectly) to the IMR financial arrangement (see above).

The reference to the ‘entity’ who may or may not have an interest in the issuer of, or the counterparty to, the IMR financial arrangement in proposed paragraph 842-215(5)(b) must be read in the context of sections 2-15 and 960-100 of the ITAA 1997. In simple terms, ‘entity’ is defined as including an individual, body corporate, body politic, partnership, unincorporated association or body of persons, a trust, superannuation fund or an approved deposit fund.

As a result, the indirect investment concession will be a flexible concession that will be widely available to a range of different types of corporate and non-corporate entities as well as individuals.

Operation of the tax concessions Both the direct and indirect investment concessions operate by:

• treating certain amounts of income that would otherwise be ‘assessable income‘ as ‘non-assessable non-exempt income (and therefore not assessable for tax purposes)‘

• denying certain ‘deductions‘ (losses and outgoings arising are not deductible for tax purposes) and

185. Property interests are defined in sections 855-20 and 855-25 ITAA 1997. 186. Readers would be aware that in the current political environment foreign purchase and control of Australian real property is a sensitive issue. See also: ITAA 1997, subsection 842-245(3), which currently also excludes derivative financial arrangements dealing with CGT assets that are Australian real property or an indirect Australian real property interest.

187. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit., pp. 80, 86 and 96 (paras 7.10, 7.32 and 7.63). 188. Briefly, in section 102M of the ITAA 1936, a trading business means a business that does not consist wholly of ‘eligible investment business’. In turn an ‘eligible investment business’ is defined as one that is ‘investing or trading in any’ of a wide range of types of loans, securities and

investment contracts listed in that definition.

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• disregarding certain ‘capital gains‘ and ‘capital losses‘.189

Under proposed section 842-250 the above IMR concessions are reduced if an independent Australian fund manager is entitled to a share of an IMR entity’s income exceeding 20 per cent of that income. Certain exemptions are provided in selected circumstances.190 Importantly however, because the concessions are restricted to foreign entities:

… 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. 191

An interesting problem One commentator has observed that:

The revised exposure draft does not require the entity to be resident in an ‘Information Exchange Country.’ The absence of this requirement suggests that foreign funds resident in jurisdictions that are not Information Exchange Countries, such as Luxembourg and Hong Kong, now may be able to use the IMR concession. 192

Recently the tax practices of Luxembourg in particular have been the subject of considerable adverse comment.193

Comment Given that the overall tax outcomes of the current and proposed IMR provisions are similar a reader might ask what are the differences between the two and are they important?

The first and most obvious difference is that the proposed amendments split the tax concession into two types, direct and indirect. The use of Australian fund managers for IMR concessionally taxed direct investment is explicitly recognised in the proposed changes, and is a significant difference between the proposed and current regimes. This clarifies the current arrangements and makes the tax free status of most of the IMR regime more certain.

Another particular difference is that the proposed definition of IMR financial arrangement is deliberately broader than the current one, potentially including all possible financial transactions (save those involving Australian real property). Currently, section 842-245 of the ITAA 1997 places some restrictions on the types of financial transactions that can be undertaken by current IMR participants. So, the proposed regime is deliberately broader in its scope of investment activities, so as to attract more investment.194

The Explanatory Memorandum states that the tax free status of IMR transactions and investment under the current legislation is not assured.195 The amendments undertaken by Schedule 7, Part 1 appear to put this matter beyond doubt: provided the qualifying conditions are met IMR financial arrangements will not be subject to Australian tax. That said, one industry commentator has observed:

While investing in eligible Australian financial arrangements through the use of an independent Australian broker/agent should expect to qualify for the Direct Concession, where the Australian broker/agent does not give rise to a PE [permanent establishment] for the foreign fund, it is not clear whether investing in qualifying IMR financial arrangements using the services of a resident broker would fall within the ordinary meaning of ‘investment management activities’ of an independent Australian fund manager for the purposes of the Indirect Concession.

189. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit. p. 83, para 7.22; proposed section 842-215. 190. Proposed subsection 842-250(2). 191. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit. p. 82 (para 7.19); proposed

subsection 842-210(1), proposed section 842-220. 192. PricewaterhouseCoopers (PwC), ‘Investment Manager Regime revised exposure draft exempts foreign funds from Australian tax’, Tax Insights form International Tax Services, PwC website, 19 March 2015, p. 3, accessed 5 June 2015. 193. For an example of recent public comment see N Chenoweth, ‘How Disney’s tax bill was McDucked’, The Australian Financial Review,

10 December 2014, p. 1, accessed 11 June 2015. 194. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit. p. 78 (para 7.1). 195. See summary table in Explanatory Memorandum, Tax and Superannuation Laws Amendment (2015 Measures No. 1) Bill 2015, op. cit.,

pp. 80-81.

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Further guidance on this point is required to confirm eligibility of independent Australian brokerage arrangements for the Indirect Concession. 196

It is still possible that non-resident investors will find these qualifying conditions too onerous, although they do not appear to be so.

196. PwC, ‘Investment Manager Regime revised exposure draft exempts foreign funds from Australian tax’, op. cit.

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