Australia: Outward Investment

Outward Investment from Australia - The Offshore Perspective
By Jason Gorringe, London

In terms of making or maintaining offshore investments in Australia, whether for immigrating expatriates or Australian residents, the picture isn't an especially pretty one. World-wide taxation for resident entities and a stringent anti-avoidance regime combine to make legal tax minimisation using foreign or offshore vehicles almost an impossibility for individuals, and certainly very difficult (taxing?) for multinational and domestic Australian companies. The government has perhaps come to realise that punitive taxation on foreign investment may eventually be to the detriment of the country's economy, and certain changes have been made, particularly to the Foreign Investment Fund rules.

In 2005, the ATO carried out an investigation into undeclared offshore income which identified more than 700 individuals. Some of the cases were pinpointed using data from Austrac, which monitors money flows entering and leaving Australia. The Australian Crime Commission, which was working with the ATO on offshore cases, said it had raided 85 homes in four states in connection with the offshore tax investigation, issuing 48 warrants in respect of suspected tax evasion.

The Commission also at the time interrogated a number of prominent Australian figures, but was attacked in court as behaving unconstitutionally, and battled more than a dozen Federal Court challenges across four states, including some from individuals who allegedly failed to pay tax on film royalties received from the US via tax haven bank accounts.

Nonetheless, on the eve of the October 31 tax filing deadline that year, ATO Commissioner at the time, Michael Carmody, warned that the crusade against tax avoidance was set to continue, with the authorities training their sights on high profile business people, bosses of "major corporations" and sportspeople.

The ATO also intensified its enforcement effort against members of the legal profession, including barristers, magistrates and judges, who have been the subject of previous "successful" crackdowns on tax avoidance and late filing, according to Carmody.

In November 2005, Bermudian Finance Minister Paula Cox and Australian Treasurer at the time, Peter Costello signed a tax information exchange agreement in Washington DC. The Australian authorities had been keen to initiate a tax information exchange deal with Bermuda after it became apparent that a significant proportion of funds flowing in and out of the country were being transmitted through Bermuda.

According to Mr Costello, the agreement would not only provide for full exchange of information on criminal and civil matters between Australia and Bermuda, but would also boost economic ties between the two.

"These agreements are an essential tool in Australia's efforts to reduce offshore tax evasion," Costello explained in a statement.

In December of that year, it emerged that Canberra had been negotiating similar information sharing agreements with several other offshore jurisdictions in an effort to combat tax evasion and to stem the flow of laundered funds through Australia.

In 2009, Australia’s Assistant Treasurer, Nick Sherry, announced that two anti-tax avoidance campaigns – “Project Wickenby” and the targeting of “phoenix” companies – yielded a total of AUD313m (USD260m) in tax liabilities and penalties in the last fiscal year.

Project Wickenby has, since 2005, targeted a range of tax avoidance and money laundering schemes, including offshore arrangements, and is a cooperative partnership between five key government agencies, including the Australian Taxation Office.

Sherry disclosed that, during the year ended June 30, 2009, Wickenby raised AUD230m in tax liabilities and collected AUD40m in cash. In addition, Wickenby collected AUD159m in tax from people who have been subject to Wickenby action in previous years.

Furthermore, over the period since its initiation, Wickenby has raised AUD406m in tax liabilities and collected AUD117m in cash, and has been responsible for restraining AUD76m of assets under proceeds of crime legislation. The government, Sherry continued, has provided “AUD122m extra funding for Project Wickenby investigations over the next three years."

The targeting of phoenix practices, meanwhile, generated more than AUD83m in tax and penalties. Phoenix companies are those that deliberately go into liquidation to avoid tax and other liabilities, before re-emerging as another corporate entity with largely the same management. Such companies, according to Sherry, "deny vital funds to Australian public services and even cheat employees of wages, superannuation and other entitlements."

In 2008, The Australian Board of Taxation released a position paper which identified ways in which Australia's foreign source income anti-tax-deferral (attribution) rules could be simplified.

The position paper followed on from the Board’s extensive consultation and discussion paper of May 25th 2007, and examines Australia’s attribution rules, the controlled foreign company (CFC) rules, foreign investment fund (FIF) rules, transferor trust rules and the deemed present entitlement rules, which the government admits are notoriously complex, and impose high compliance costs on Australian business.

The Board has examined whether the rules strike an appropriate balance between maintaining the integrity of the tax system and unnecessarily inhibiting Australians from competing in the global economy, and has suggested ways to reduce complexity and compliance costs.

“The government is keen to advance reforms to Australia’s tax laws to improve the competitiveness of Australian business, cut red tape and to help make Australia an Asian financial hub,” stated Assistant Treasurer Chris Bowen, commenting on the Board's paper.

“The government therefore welcomes the release of the Board’s position paper and will closely examine the Board’s final recommendations when they are released later in the year," he added.

In June, 2010, the Australian government announced the passage through parliament of a number of tax reforms dealing with foreign source income, thin capitalization rules, goods and services tax (GST) administration and managed investment trust (MIT) definition, together with simplifications of corporate reporting requirements.

The passage of the relevant bill through the Senate enacts significant reforms to Australia's foreign source income anti-tax-deferral (attribution) rules by repealing the foreign investment fund (FIF) and deemed present entitlement rules in the income tax laws.

These measures, when combined with the government's wider package of foreign source income attribution reforms, are estimated to reduce compliance costs for Australian taxpayers and businesses by between AUD40m (USD35m) and AUD80m a year, and should contribute to the government's objective of promoting Australia as a financial hub.

Once Royal Assent is received, the repeal of the FIF and deemed present entitlement rules will apply to the 2010-11 and later income years. The other reforms, to be introduced to parliament shortly, are the modernization of the controlled foreign company rules, improvements to the transferor trust rules and the introduction of the anti-roll-up fund rule, which will apply from the time the FIF rules are repealed.

Reforms to Australia's thin capitalization tax laws, as they apply to authorized deposit taking institutions, have also been passed. The reforms clarify the treatment of treasury shares, the business insurance asset known as 'excess market value over net assets' and capitalized software costs under the thin capitalization rules.

The reforms to the thin capitalization rules were made necessary following changes to Australian accounting standards and were originally announced in the 2009-10 budget. The amendments took effect from January 1, 2009.

In addition, parliament passed legislation that streamlines the administration of the goods and services tax (GST), and reduces compliance costs for taxpayers. Compliance costs are reduced for taxpayers for cross border transport supplies; the GST treatment of global roaming in Australia is ensured to be consistent with Australia's treaty obligations; and the appropriate treatment for GST groups under the recent amendments concerning third party payments is also assured.

The amendment to the GST treatment of global roaming applied from July 1, 2000. The other reforms applied from July 1, 2010.

Furthermore, an amended definition of a MIT now applies for the purposes of the withholding tax concessions and more closely aligns the definition used across different parts of the tax law. It now allows widely held wholesale unregistered managed investment schemes and government owned managed investment schemes to be recognized as MITs for withholding tax and capital account election purposes.

The government professes that these amendments better reflect general industry practices and ensure that, while continuing to attract and retain foreign capital, the Australian funds management industry continues to be supported and enhanced.

The main provisions of the legislation came into effect for the financial year ending June 30, 2010.

Controlled Foreign Company Rules

Probably the best way to deal with the various anti-avoidance provisions currently in force in Australia is one at a time, so we will start with arguably the most vicious. CFC provisions in Australia (as everywhere that they exist) are designed to prevent Australian resident entities from sheltering their income, gains or profits from Australian taxation by locating them in a low tax country where they would be taxed lightly, if at all. To counter this, the CFC provisions impose tax on the resident shareholders of the foreign company on the accrued profits made by such companies, whether that profit is distributed in Australia or not. This is known as the attribution process.

Proposals put forward by the Board of Taxation in 2003, which received Royal Assent in December 2005 sought to amend the tax regime for CFCs in certain countries.

According to the Treasury, the CFC reforms in question were designed to streamline the application of the CFC rules, reducing the informational requirements and compliance costs of those rules, and improving the flexibility of Australian companies with operations offshore, without significantly increasing risks to integrity. The changes were also designed to help improve the efficiency and competitiveness of outwardly oriented Australian business, and to make Australia a more attractive place for regional headquarter operations.

They included the introduction of exemption for CFCs in Broad Exemption Listed Countries (BELCs)

BELCs are countries with similar tax regimes to Australia. There are currently seven BELC countries: Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States.

The Board proposed exempting from attribution, the income of a CFC sourced in a BELC, or otherwise included in the tax base of a BELC. To limit the compliance burden of dealing with more than one CFC regime, the Board also proposed an exemption from Australia's CFC rules for non-BELC subsidiaries of BELC CFCs, where the BELC's own CFC rules are broadly comparable to Australia's CFC rules.

These recommendations were addressed in two stages. The first stage addresses the income attribution of CFCs resident in BELCs, with the second stage addressing the Board's proposal in relation to non-BELC subsidiaries of BELC CFCs.

CFCs in BELCs

The first stage applies to income that may be attributable to Australian taxpayers because of their interest in a CFC resident in a BELC.

Previously, two classes of income were attributed in respect of BELC CFCs. The first was `eligible designated concession income' (EDCI) - subject to an `active income test'. The second class of income (for example, transferor trust and foreign investment fund (FIF) income) was always attributable irrespective of the active income test.

To implement the Board's recommendation, the Government announced that it would pare back the classes of tainted income treated as EDCI. The Board recognised that in limited cases, income subject to specific features of a BELC's tax system should remain subject to attribution. Only items which pose significant integrity risks would remain subject to attribution. This more targeted approach was expected to largely eliminate the attribution of a BELC CFC's income.

This measure was designed to reduce the informational requirements and compliance costs business face in applying the CFC rules where BELC CFCs are involved, without a significant impact on integrity or the revenue. Instead of business having to self-assess whether items of tainted income derived by BELC CFCs are attributable, these items would be expressly listed.

Initially, FIF and transferor trust (and other trust) income of a BELC CFC were to remain attributable. However, if after further assessment, a BELC's FIF or transferor trust regime raises no integrity risks then this income may also become expressly excluded from attribution.

CFCs in Non-BELCs controlled by BELC CFCs

The second stage applied to the income that may be attributable to Australian resident taxpayers because of their interest in a BELC CFC, which in turn, has a controlling interest in a non-BELC CFC (ie where indirect control of a non-BELC CFC through a BELC CFC exists).

Previously, the income of a non-BELC CFC controlled through a BELC CFC could be attributable under the CFC regimes of both the BELC and Australia. While the law currently made allowance for the attribution by other CFC regimes, this attribution `duplication' could be compliance-intensive and, where the BELC CFC regime is closely comparable to Australia's, may have resulted in little or no Australian tax being paid.

By removing the Australian CFC regime from applying to the extent that a closely comparable BELC CFC regime also applies (attributing the income of a non-BELC CFC), this measure aimed to remove unnecessary compliance effort without a significant impact on integrity or the revenue. In effect it `pushed down' responsibility to the closely comparable BELC CFC regime to ensure income is appropriately attributed and tax is not deferred.

To ensure sufficient integrity, a BELC CFC regime needs to be considered closely comparable in certain key respects, including:

• Mechanisms used to determine what countries receive jurisdictional exemptions from attribution;
• The control test, which determines what companies are regarded as CFCs;
• The parameters of any active income test used; and
• The income items that are subject to attribution.

The impact of a BELC's conduit arrangements on attribution will also need to be considered.

In July, 2010, ustralia’s Assistant Treasurer, Nick Sherry, released for public comment a discussion paper that represented a further step towards reforming controlled foreign company (CFC) rules.

The modernization of the CFC rules is part of wider reforms to Australia's foreign source income anti-tax-deferral (attribution) rules. The reforms include the measures recently passed by the Parliament to repeal the foreign investment fund and deemed present entitlement rules, as well as exposure draft legislation setting out the detail of the proposed anti-roll-up fund rule. Details surrounding the transferor trust changes are still to be developed.

The policy objective of the CFC rules is to ensure that passive investment decisions of Australian resident taxpayers are not distorted by tax considerations, thereby protecting Australian tax revenue. Foreign passive investment will continue to be treated the same as capital that is invested in Australia.

However, there are, the Treasury says, legitimate commercial reasons why residents invest capital in foreign active businesses, which should be taxed at the same competitive level as other investments in that jurisdiction. The centrepiece for these reforms is, therefore, a proposed active business income exemption, which is designed to ensure only passive income is attributed to Australian resident controllers.

As presently drafted in the proposed legislation, prima facie passive income is accepted as active income, and is excluded from attribution, where it “‘arises in the ordinary course of the active conduct of a trade or business by the entity”. This test would be applied to each item of passive income, and it would not be sufficient to show that the CFC is engaged in the active conduct of a trade or business to render all of its income active.

The active conduct of a trade or business by an entity is then defined as “the competitive participation by the entity in industrial, commercial or financial undertakings, evidenced by human activity.” Importantly, the human activity does not have to be performed by a director or employee of the CFC. The activity may be out-sourced to a contractor, subcontractor, or an agent.

There are also a number of other important reforms that feature in the proposed CFC rules. These include a de minimis passive income test, grouping relief, the removal of double taxation and deductibility rules.

"Reforms to the CFC rules, while still maintaining the integrity of Australia's tax base, will improve the competitiveness of Australian businesses by reducing red tape and compliance costs for affected businesses," the Assistant Treasurer said. "The discussion paper takes account of submissions received in response to the CFC consultation paper released earlier this year."

"Given the scale, complexity and importance of these rules it is desirable that a further round of consultation occur in respect of the development of the enabling legislation before it is introduced into Parliament," he added. Submissions to the Treasury close on August 31, 2010.

Transferor Trust Rules

These rules exist to prevent Australian resident entities from sheltering assets from Australian taxation by diverting them to non-resident trusts, for example in low or no tax jurisdictions. Where these rules apply, the non-resident trust estate is deemed to be Australian for taxation purposes, and is included in the assessable income of a resident transferor. The categorisation of countries is similar to the CFC rules.

In broad-exemption countries, there is no attribution of trust income derived from that country except where the trust has taken advantage of certain tax concessions, and in limited-exemption countries, the net income of the trust (less any amounts already being assessed in the hands of resident beneficiaries) is counted as attributable income and taxed accordingly.

There are, however, amnesty provisions for the winding up of trusts established prior to commencement of Australian residence (where they would otherwise be subject to Transferor Trust rules). Under these provisions, trust distributions to Australian residents are taxed at 10% (at the time of writing), and an indemnity is offered to ensure that trust distributions made under the amnesty do not get the taxpayer in trouble with the ATO! However, such an amnesty is only offered once the taxpayer has satisfied the authorities that:

• The foreign trust has been wound up;
  
• A full distribution of all the property held in the trust has been made;
  
• That property includes the balance remaining:
  
• of all amounts transferred to the trust prior to the transferor becoming a resident (or prior the commencement of transferor trust measures)
  
• of all income derived by the trust from those transferred amounts, or from the reinvestment of such income
  
• If full distribution was not made to Australian residents, no Australian resident has any direct or indirect interest in that part of the property that was distributed to non-Australian residents.

Easy, isn't it…ahem.

Foreign Investment Fund and Foreign Life Assurance Policy Rules

Australia's Foreign Investment Fund (FIF) rules apply Australian income tax to the increase in value of non-controlling holdings in overseas trusts and companies if their income is mainly passive, which neatly scoops offshore and foreign mutual funds and other similar types of investment into the tax net. An equivalent rule applies to Foreign Life Assurance Policies (FLP).

However, in June 1999, the government had a partial change of heart, perhaps recognising the tension between trying to ensure that revenue was not leaking overseas, whilst trying to ensure that Australia remained competitive in an increasingly globalised investment world. As a result of this recognition, they decided to exempt interests held in certain US funds from the existing FIF provisions, reasoning that this move would: 'Encourage Australian fund managers to make their operations internationally competitive by exposing them to competition from US funds, and facilitating portfolio allocations to such funds.'

The underlying message here seems to be that the government realised that Australian resident investors were being unduly restricted in their ability to diversify their portfolios by the Foreign Investment Fund rules, and that they were not necessarily investing in home grown funds because they performed any better, but because they were afraid of the heavy tax compliance burden and harsh taxation pertaining to an overseas investment.

There are several other exemptions from FIF and FLP taxation, including one for residents holding a temporary work permit (i.e. planning to be resident for less than 4 years). Investments totalling under AU$50,000 (at the time of writing)are usually also exempted.

More complete information on the Foreign Investment Fund regime can be found on the Australian Taxation Office website.

What if I already have offshore investments?

As we've seen, the Australian taxation system has most of the bases covered. While you may be benefiting from higher returns as a result of offshore investments while you are resident in Australia, the reasonably high level of income taxation on nearly everything will certainly take a bite out of your returns.

Therefore, if you are planning to immigrate to Australia and already have offshore investments or vehicles in place, the sensible option is to take professional advice before departure, as there may be some way in which you can bring forward or postpone distribution, or redistribute your assets amongst family members. (Although be aware of the punitive taxation rates which can be levied on the unearned income of minors that we talked about previously, if you decide to take this route).

International tax planning once resident in Australia is possible, but the emphasis should be on asset protection and transparency, as opposed to just tax minimisation. Fiscal transparency (for example using structures like Limited Partnerships and Limited Liability Companies, which are available in many offshore jurisdictions, and are usually untaxed there) is important because it may mean that gains from higher yielding international and offshore investments can be taxed in the Australian resident's hands on the same basis as domestic investments.

To conclude, then, it would seem that although it is now very difficult for individuals, whether resident expats or Australian citizens, to legally achieve tax minimisation by investing or sheltering assets offshore, there are still opportunities on a corporate level, although the balance does seem to be in favour of foreign multinationals with Australian subsidiaries or branches, rather than Australian companies with foreign interests.