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Wednesday, 11 August 2004
Page: 2121


Mr PROSSER (6:04 PM) —I rise to speak in support of the New International Tax Arrangements (Managed Funds and Other Measures) Bill 2004. This bill focuses on making the Australian managed funds industry more attractive to foreign clients. Australia has a significant managed funds industry facilitated by strong economic performance, a highly educated work force, low-cost infrastructure, advanced regulatory systems and a sophisticated financial market. In the 2003-04 budget period, following extensive consultation and a report to the Treasurer by the Board of Taxation, the government announced a package of reforms to international taxation. The measures contained in this bill are a further instalment of those reforms, and the proposed amendments relate to capital gains tax, treaty source rules and interest withholding tax.

Under current capital gains tax arrangements, non-residents investing in assets through an Australian managed fund may be taxed more heavily than if they invested directly in those assets or through a foreign fund. The measures proposed in schedule 1 of this bill will eliminate these distortions. The measures amend the law to provide comparable tax outcomes for foreign residents in Australian managed funds and are designed to reduce taxation impediments to further growth in this area. This will improve the international competitiveness of Australian managed funds, increasing their attractiveness to foreign investors and non-residents investing in Australia and the region.

Schedule 1 of this bill makes a number of changes to the Australian tax treatment of foreign residents that make a capital gain or capital loss in respect of an interest in a fixed trust. Presently, parts of the income tax law make it less attractive for foreign residents to invest in an Australian resident trust holding assets than it is for them to invest directly in those assets. This makes the Australian funds management industry, which commonly uses trusts to pool funds and manage investments, less competitive and efficient than it would otherwise be. It also discourages foreign investment in Australia more generally.

The amendments in schedule 1 of this bill seek to overcome these problems by more closely aligning the tax treatment of foreign residents who invest in fixed trusts with the tax treatment of foreign residents who invest directly in assets in Australia or abroad. This will mean that the tax law will no longer impede foreign residents who seek to invest in assets through Australian resident trusts, including managed funds. The amendments provide a capital gain or capital loss that a foreign resident makes from a capital gains tax event happening to an interest in a fixed trust that is disregarded where the assets underlying the interest in the trust do not have the necessary connection with Australia.

There are nine categories of assets with the necessary connection with Australia listed in the table in section 136-25 of the Income Tax Assessment Act 1997. Assets listed in the table include land in Australia, shares in an Australian resident private company, holdings of at least 10 per cent of the units in a resident unit trust, an interest of any size in any other resident trust, and holdings of at least 10 per cent of the shares in a resident public company.

Schedule 1 to this bill changes the law so that a capital gain or capital loss made by a foreign resident on an interest in a fixed trust, the `first trust', will be disregarded if at least 90 per cent by market value of the trust's assets are without the necessary connection with Australia. A capital gain or capital loss will also be disregarded if at least 90 per cent of assets held by other fixed trusts in which the first trust has an interest, directly or indirectly, through a chain of fixed trusts, are without the necessary connection with Australia.

A capital gain that a foreign resident makes in respect of an interest in a fixed trust is disregarded where the gain relates to an asset without the necessary connection and an exemption to capital gains tax for a distribution of foreign source income by the trustee of a trust to a foreign resident beneficiary. Reflecting the conduit principle of international taxation, foreign source income flowing through an Australian trust to a non-resident is not taxed in Australia. However, under current arrangements when a trust interest is sold, previously distributed foreign source income is, on a delayed basis, subject to Australian capital gains taxation. On the other hand, non-residents investing directly or through an offshore managed fund do not pay Australian capital gains tax in respect of the foreign source income. This amendment will eliminate this distortion. I have also been informed that this will remove an impediment to foreign residents investing in assets through Australian fixed trusts, thereby making the Australian managed funds sector more internationally competitive. This should encourage foreign investors to use Australian funds managers to make investments in Australia and the region.

Schedule 2 of the bill amends the rules for determining the source of income derived by certain residents of treaty partner countries. The interaction of treaty source rules and other treaty rules relating to non-resident beneficiaries of income derived by business trusts operating in Australia has implications for the managed funds industry. This interaction may result in foreign source passive income derived by those foreign beneficiaries through an Australian trust being treated as sourced in Australia and therefore taxed in Australia. For example, an offshore customer invests in an Australian managed fund investing offshore. This interaction inappropriately exposes the offshore beneficiary to Australian tax on conduit income. The amendments ensure the domestic source rules, rather than treaty source rules, apply in this case. The effect of this amendment would be to relieve the conduit income from Australian taxation.

The amendments seek to align the tax treatment of foreign residents who invest in managed funds and derive income from sources outside Australia with the tax treatment that would apply if those foreign residents made such investments directly. Where business profits are attributable to a permanent establishment, generally a branch, operated in Australia by a resident of a treaty partner country, the treaties provide that those profits may be taxed in Australia. In the case of a funds management trust, income from the investment of funds outside Australia may be attributable to activities carried on by the trustee through a permanent establishment in Australia.

Australia's treaties also provide that where business is carried on by a trustee through a permanent establishment in Australia, a non-resident beneficiary who is presently entitled to the income of the trust will be deemed to carry on that business through that permanent establishment. These provisions were introduced to ensure that non-resident beneficiaries of business trusts operating in Australia would be taxed in accordance with the principles of the business profits article in our tax treaties. The interaction of the deemed source rules and the permanent establishment rules for beneficiaries of business trusts can have the effect that income derived by non-resident beneficiaries from funds management activities of the trust is deemed to have an Australian source even though the income arises from funds invested offshore. The amendments proposed in this bill will ensure that, where such income has a source outside Australia under the ordinary rules for determining source of income for domestic law purposes, the income will continue to have a foreign source.

Under the current law, the business profits articles of Australia's treaties provide for the taxation in Australia of income attributable to a permanent establishment of an enterprise of the treaty partner country in Australia. Attributable income can include income that might normally be considered to be sourced outside Australia. The source rules applicable to Australia's treaties provide that where Australia has a taxing right over that income of a resident of the treaty partner country under the treaty, that income is deemed to have an Australian source. Where the trustee of a managed fund has a permanent establishment in Australia under the treaty—regardless of whether the trustee is an Australian resident or not—and, in the course of carrying on a business of funds management through that permanent establishment, it invests funds offshore, the income from such investments will be attributable to that permanent establishment. This income is currently deemed to be sourced in Australia and will be subject to tax in Australia.

The deemed permanent establishment rules for non-resident beneficiaries mean that this result also applies to the beneficiaries. By exempting from Australian tax, foreign-source income derived by Australia's fixed trusts, to which foreign-resident beneficiaries are presently entitled, will remove tax barriers to foreign residents investing in assets through Australian fixed trusts, such as managed funds. In turn, this should improve the international competitiveness of Australia's managed funds industry, enabling the industry to attract more offshore funds for investment in Australian and foreign assets.

Ensuring that such foreign-source income is no longer subject to Australian tax will reduce compliance costs for resident investors in Australia's managed funds, and trustees of fund managers will no longer be required to withhold tax in respect of foreign-source income. In removing Australian tax in these cases, the amendments will improve Australia's international competitiveness in providing funds management services to foreign investors.

Schedule 3 to this bill amends the taxation law relating to interest withholding tax arrangements and impediments. There are three distinct amendments that relate to the imposition of income tax withholding. They seek to ensure that IWT provisions operate as intended and are consistent with recent developments in tax law. These changes will allow Australian businesses generally to take advantage of global opportunities to lower their cost of debt and facilitate efficient business structures.

The first amendment broadens the range of financial instruments eligible for IWT exemption by adding `debt interest' as a debt for tax purposes. It arises as a consequence of the introduction of the debt-equity rules in 2001. While the concept of `interest' in the IWT provisions was partially aligned with the new debt-equity rules in 2001, the concepts of `debenture' and `offshore borrowing' need to be similarly updated to make the IWT provisions work as intended. This current measure will ensure that payments on financial instruments now treated as debt for tax purposes, including certain redeemable preference shares, will also be exempt from IWT, provided that certain conditions are met, if those payments qualify as `interest'.

The second amendment treats payments of a non-capital nature made on certain upper tier 2 hybrid capital instruments as interest for IWT purposes. This amendment complements the government's decision, announced in March 2003, to introduce regulations to treat as debt for taxation purposes certain upper tier 2 capital instruments issued by authorised deposit-taking institutions that are banks. This amendment ensures that non-capital payments on such instruments are interest for IWT purposes. This change, together with the first set of amendments, will ensure that these payments are exempt from withholding tax in the appropriate circumstances.

The final amendment allows additional assets and debts to be transferred from Australian subsidiaries of foreign banks to their Australian branches without losing IWT exemptions. In 2001, changes were made to the IWT legislation to allow non-resident companies, including foreign banks, carrying on business through permanent establishments in Australia to issue debentures that qualify for exemption from IWT. However, the legislation allowing debentures issued after 18 June 1993 to be transferred from Australian subsidiaries of foreign banks to their branches without the loss of IWT exemption was not amended. Therefore, the banks' subsidiaries could not transfer debentures issued after that date to their branches and then wind-up their subsidiaries without the loss of the exemption. The final amendment ensures that the IWT exemption is not lost if IWT-exempt instruments are transferred from an Australian subsidiary of a foreign bank to a branch. This will facilitate the transfer of all business from foreign banks' Australian subsidiaries to their Australian branches, if they wish. The amendments are expected to reduce compliance costs for the taxpayers affected.

The size of Australia's funds management pool, and its prospects for continued growth, is drawing global firms to establish operations in Australia. The resultant clustering of activity and the concentration of expertise has created a robust domestic industry. This infrastructure provides the framework for Australia to become a funds management hub for the Asia-Pacific region and these reforms will remove the impediments to achieving that goal.

The measures in this bill are a further instalment of the reforms to implement the government's response to the review of international taxation arrangements. The measures are consistent with the government's policy objectives of enhancing the competitiveness of Australian based managed funds and removing barriers to Australia's development as a global financial services centre. There has been strong business support for the bills, and the business community has played a valuable and constructive role in helping to develop the proposed legislation. This bill again demonstrates that the government has listened and been responsive to industry calls for specific tax reforms to remove the distortions from the tax system and allow Australian businesses to grow and prosper. The future of the Australian economy is fundamentally linked to global prosperity and to Australians being a part of that prosperity. This bill is an important part of modernising Australia's international tax system to make the most of Australia's potential to market financial products to foreign investors. I commend the bill to the House.