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Wednesday, 11 August 2004
Page: 2118


Mr COX (5:54 PM) —The New International Tax Arrangements (Managed Funds and Other Measures) Bill 2004 is the fourth tranche of legislation implementing the government's reforms to international taxation announced in the 2003-04 budget. The reforms to international taxation followed a long process of consultation with industry which at the beginning offered the hope of substantial reform of Australia's international taxation regime to meet the challenges of globalisation and international tax competitiveness. These hopes were never realised. The measures in this bill and its three predecessors represent a bare minimum set of changes intended to reduce compliance costs and remove some completely unnecessary impediments to Australian business.

The more significant international tax reform options—streaming and a tax credit for foreign dividends—were left on the shelf, largely because of the cost, estimated by Treasury at between $520 million and $590 million per year. Streaming and tax credits for foreign dividends would have made it easier for Australian businesses to expand offshore and to attract foreign investment to Australia. Those options would also be easier to integrate with our domestic tax regime than the alternative approach of returning to a classical system of fully taxing dividends in the hands of shareholders but cutting the company tax rate, as has been done in Ireland.

Despite $52 billion in net new spending, the budget was a lost opportunity in many areas. The government did not have the foresight, vision or, because of its pork-barrelling, the money to undertake a major reform of Australian's international taxation regime. Labor will support the measures in this bill, the most important of which remove impediments for the Australian funds management industry to attracting foreign business.

Schedule 1 deals with the capital gains tax treatment of foreign residents. Under current tax law, foreign residents investing in Australian assets directly or through a foreign resident fund are given more favourable taxation treatment than are foreign residents investing through Australian managed funds, or fixed trusts. The tax law effectively impedes foreign residents investing in assets through Australian managed funds, stifling employment growth in the managed fund industry in Australia. The amendments in this bill aim to more closely align the capital gains tax treatment of investments made by foreign residents directly or through foreign managed funds, and investments made through Australian managed funds.

Currently, if a foreign resident disposes of an interest in an Australian managed fund, a capital gains tax event is triggered—and I am really surprised that the minister at the table, the Minister for Small Business and Tourism, did not do something about this when he was Minister for Financial Services and Regulation. This occurs even where the underlying assets of that fund are without the necessary connection to Australia to trigger a capital gains tax event if those assets were held directly.

Foreigners are therefore penalised for investing in those assets through Australian managed funds rather than investing directly in those assets. As a consequence, foreigners have not been able to use Australian managed funds, which otherwise would have a comparative advantage in that they understand investment opportunities in the Asia-Pacific. The changes will result in a capital gains tax event being triggered only if more than 10 per cent of underlying assets of an Australian managed fund have the necessary connection with Australia. This provides closer alignment of the tax treatment of foreigners investing directly and foreigners investing through Australian managed funds.

In addition, capital gains or losses made by foreign residents due to the disposal of assets by an Australian fund will also be disregarded where the gain or loss relates to an asset without the necessary connection to Australia. This change will again ensure that foreign residents are not penalised for holding assets through Australian managed funds. A CGT exemption will also be provided where distributions of foreign source income are made from a fund to a foreign resident. This effectively allows foreign income to flow through an Australian managed fund to a foreign resident. This is appropriate, as foreign residents investing directly in assets generating foreign source income are in general not subject to capital gains tax.

Schedule 2 will ensure that foreign residents are taxed in the same way on foreign source income derived from foreign assets held through Australian managed funds as they are on income from directly held foreign assets. Under Australia's international tax treaties, income derived by a resident of a treaty partner that may be taxed in Australia is deemed to have a source in Australia. Where residents of a treaty partner invest in foreign assets through an Australian managed fund, it is possible to tax income from those foreign assets in Australia; therefore, that income is currently deemed to have an Australian source. If this situation were not corrected, residents of treaty partners would be taxed on income from foreign assets where they invested through Australian managed funds but residents of non-treaty partners would not be taxed. These amendments effectively allow foreign income to flow through an Australian managed fund to a resident of a treaty partner without being subject to Australian tax. These amendments will improve the competitiveness of Australian managed funds in providing services to foreign investors.

Schedule 3 deals with withholding tax provisions. Withholding tax has the effect of increasing the cost of capital to Australian borrowers. The bill makes three changes to the interest withholding tax regime: first, it broadens the range of financial instruments eligible for interest withholding tax exemption by including debt interests; second, it complements the government's decision to treat certain upper tier 2 capital instruments as debt interests for taxation purposes by ensuring that non-capital payments on them are treated as interest for interest withholding tax purposes; and, third, it allows assets and debts to be transferred from Australian subsidiaries of foreign banks to their Australian branches without losing interest withholding tax exemptions.

With an election about to be called, this bill represents the final tranche of the review of international tax arrangement reforms that will be dealt with. The budget estimate of the cost of those international tax measures was $270 million over the budget year 2003-04 and the three forward estimate years. This raised concerns about the budget estimate because the direct cost of the UK double tax agreement was $280 million over four years. The government then introduced the International Tax Arrangements Amendment Bill 2003, which had a further cost of $62.5 million. Subsequently, the government introduced the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004 with a total cost of $105 million over the forward estimates. This bill has a total cost of $20 million over the forward estimates. The total direct cost of the original $270 million RITA budget measures has now reached $467.5 million.

For a long time, the government refused to provide a reconciliation of the budget measure and the total cost of the reforms. Why the government chose not to be transparent on the actual cost of the RITA measures is unclear. I put it down to either total arrogance or not wanting to set any precedent that might involve greater transparency. Eventually, Treasury provided some information that allowed an imperfect reconciliation—in particular, that the cost of the original RITA budget measures also included an offset, which was the result of the government's decision to defer implementation of an earlier decision to provide franking credits for foreign dividend withholding tax. At the time the original decision to provide franking credits for foreign dividend withholding tax was made, in November 1999, the estimates of its cost were $340 million in 2002-03, $190 million in 2003-04 and $200 million in 2004-05. While these numbers do not coincide with the whole of the current budget year and forward estimates period, they do indicate a very substantial offset within that period for 2003-04 and 2004-05 totalling $390 million.

While the likely cost of that measure may have changed, it is safe to conclude on the basis of the information provided by Treasury that the total direct cost of the RITA measures in the 2003 budget will be less than the $270 million estimate contained in that budget. It should also be noted that Treasury provided estimates in the explanatory memorandum for the International Tax Agreements Amendment Bill 2003 of the extra revenue from increased economic activity resulting from the UK double tax agreement of a further $70 million a year. Treasury's modelling shows this activity building up rapidly in the second year of the new UK double tax agreement and continuing at a relatively steady state thereafter. So overall the financial impact of the RITA measures has turned out to be insignificant, indicating a limited cost for limited reforms.