Australian investment funds, including alternative funds, are commonly formed where there is a nexus with Australia, whether that is because investments will be made into Australian assets, or because capital is to be raised from Australian investors. Where there is no such nexus with Australian assets or investors, Australia is not frequently used by advisers and managers for the formation of investment funds.
It is typical for an Australian investment fund to be formed as a vehicle through which investments will be made in Australia, whether by Australian or offshore investors. It is also common for Australian investment funds to be formed where a manager seeks to raise capital from Australian investors. For example, an Australian fund could be established, as a feeder fund, for Australian investors seeking to access investments outside Australia.
A manager or trustee of an alternative fund will typically be incorporated in Australia if the fund itself is formed in Australia.
To qualify for certain concessional tax regimes which broadly entitle certain non-resident investors to lower rates of withholding tax of 15% on certain types of investment income (eg, rent from certain non-residential and non-agricultural land), the trustee of an Australian unit trust must be resident in Australia.
Australia has a very large institutional investor market, comprising predominantly superannuation funds. With the fourth largest private pension market in the world, the size of the superannuation sector in Australia is underpinned by the superannuation guarantee scheme, which currently requires employers to contribute 9.5% of an employee’s income to a superannuation fund.
The types of alternative funds that are commonly established in Australia include real estate funds, infrastructure funds, private equity funds, venture capital funds, hedge funds, debt funds and mortgage funds. In recent years, an emerging asset class for alternative funds is renewable energy investments.
At present, the most common structure for alternative funds in Australia is the unit trust, largely because of its tax flow-through status (unless a trust is a "public trading trust") and its flexibility from a structuring perspective.
If units are offered to "retail clients" (whether or not they are also offered to "wholesale clients") – as those terms are defined in the Corporations Act 2001 (Cth) (the Corporations Act) – the unit trust will generally need to be registered with the Australian Securities and Investments Commission (ASIC) as a registered managed investment scheme (MIS). If units are offered only to wholesale clients, the unit trust does not need to be registered with ASIC, and is sometimes referred to in Australia as an "unregistered scheme". Most alternative funds in Australia are unregistered schemes.
An alternative fund that is a registered MIS may be listed on a securities exchange such as the Australian Securities Exchange (ASX), or it may be unlisted. All unregistered MISs are unlisted.
An alternative fund may be "stapled" to another vehicle, such as another unit trust, a company, a limited partnership or an offshore investment vehicle.
Where a unit trust qualifies as a "managed investment trust" (MIT) for Australian taxation purposes, a lower withholding tax rate of 15% is provided to certain offshore investors on certain income, which makes the unit trust an attractive investment vehicle for those investors.
Companies and Limited Partnerships
To a lesser extent, companies and limited partnerships established under state legislation may also be used. However, those structures may be less attractive as they generally do not provide for flow-through taxation. Under Australian tax law, partnerships are, essentially, treated as flow-through structures for tax purposes. However, in 1992, the tax legislation was amended to treat most limited partnerships as companies for tax purposes. Consequently, during the period that limited partnerships have flourished overseas, limited partnerships have not been seen as attractive vehicles for collective investment in Australia.
That said, companies and limited partnerships established under state legislation are used as structures for alternative funds in some cases where tax concessions have been introduced for particular types of investments. The investors in these funds are typically wholesale clients.
The Australian Government has a range of venture capital programmes designed to attract domestic and foreign investment to help innovate Australian businesses and to commercialise technologies. For example, concessions were introduced in 2002 to, among other things, restore flow-through tax treatment for certain venture capital limited partnerships known as "venture capital limited partnerships" (VCLPs) and "early stage venture capital limited partnerships" (ESVCLPs). However, the eligibility criteria have been so restricted that many limited partnerships cannot qualify. Therefore, as a general proposition, limited partnerships are not currently seen as viable collective investment vehicles outside the venture capital space.
Tax concessions were also more recently introduced, as part of the Australian Government's National Innovation and Science Agenda, for investors in qualifying "early stage innovation companies" (ESICs). To qualify as an ESIC, the company must, among other criteria, be involved in innovation either by satisfying certain tests through self-assessment, or receive a determination from the Australian Taxation Office (ATO).
Draft legislation has been released by the Australian Government to introduce a new corporate collective investment vehicle, and it is also proposed that a limited partnership vehicle will be introduced in the future. It is proposed that these new structures will provide flow-through tax status. These measures are intended to broaden the range of Australian investment vehicles available to Australian and offshore investors. There is currently no clear timeframe in which these measures are expected to be introduced, with the original deadlines having long since passed.
Unit trusts that are not registered MISs are not regulated by any Australian financial services regulatory authority. The trustee of an unregistered MIS may hold an Australian financial services AFSL (AFSL) and, in that capacity, be regulated by ASIC, but the unregistered scheme itself is not regulated.
Registered MISs are subject to extensive regulation that is overseen by ASIC.
Generally speaking, there are no restrictions on the types of investments that may be made by a unit trust, whether or not it is a registered MIS. However, the investments need to be permitted by the constituent document (trust deed) of the unit trust (which typically gives the trustee broad investment powers) and by the AFSL held by the trustee and manager of the fund.
Companies are also regulated by ASIC. Companies have broad investment powers under the Corporations Act, subject to any restrictions imposed by their constituent documents.
VCLPs and ESVCLPs must meet ongoing registration and reporting requirements to maintain their registration. The Department of Industry, Innovation and Science and the ATO jointly administer the VCLP and ESVCLP programmes on behalf of the Australian Government.
VCLPs and ESVLPs are subject to strict investment restrictions, which are difficult to satisfy.
For example, VCLPs can only make investments in an Australian business with total assets of no more than AUD250 million, that is unlisted or will delist within 12 months, has at least 50% of its employees and 50% of its assets in Australia and does not have property development, land ownership, finance, insurance, construction or infrastructure, or make investments to receive interest, rents, dividends, royalties or lease payments as its predominant activity.
ESVCLPs are eligible to invest in, generally, an Australian business that has total assets of no more than AUD50 million, is unlisted, has at least 50% of its employees and 50% of its assets in Australia and does not have property development, land ownership, finance, insurance, construction or infrastructure, or make investments to receive interest, rents, dividends, royalties or lease payments as its predominant activity.
The ATO administers the ESIC programme. To qualify as an ESIC, the company must either satisfy certain principles-based innovation tests or have the benefit of a ruling from the ATO.
Other than VCLPs and ESVCLPs, which may only make "permitted loans" (and must otherwise typically make equity investments only), funds can originate loans, subject to any restrictions contained in their constituent document or in the AFSL held by the trustee and manager. For VCLPs and ESVCLPs, a permitted loan includes any loan repaid within six months, or loans (broadly speaking) to companies/trusts of which the VCLP/ESVCLP owns at least 10%.
Where a fund originates a loan, its trustee (or the trustee's custodian) will typically be the lender of record and, in that capacity, may be subject to additional regulatory requirements, depending on the nature and extent of the lending activities. These may include:
As noted above, apart from VCLPs, ESVCLPs and ESICs, which must comply with strict rules regarding the eligibility of their investments, unit trusts (whether they are registered or unregistered MISs) are generally free to make any investment, provided this is authorised by their constituent documents and by the AFSL held by their trustee and/or manager.
Therefore, an alternative fund structured as a unit trust could invest in non-traditional assets such as cryptocurrencies, subject to compliance with its trust deed and its trustee/manager having the requisite authorisations under its AFSL.
However, it should be noted that the legal characterisation of crypto-assets, such as cryptocurrencies, tokens and stable coins, is not settled in Australia, and, depending on the structure and features of the particular crypto-asset, under current Australian law it may constitute a security, an interest in a managed investment scheme, a derivative, a debenture, a non-cash payment facility, another type of regulated financial product or no financial product at all. In its most recent statement on the topic (in information sheet INFO 225, issued on 30 May 2019), ASIC made the following remarks:
"Entities and their advisers need to consider all the rights and features of the ICO [Initial Coin Offering] (regardless of how it is named and marketed) in determining whether the crypto-asset is a financial product or involves a financial product. Our experience suggests that ICOs by their nature seek to raise capital from the public to fund a particular project through the issue of crypto-assets such as tokens. If the crypto-asset issued by the ICO is a financial product (such as an interest in a managed investment scheme or a security), the issuer will need to consider the relevant capital raising provisions of the Corporations Act, AFSL requirements and other regulatory requirements. These regulatory requirements are in place to maintain the integrity of Australia’s financial market and ensure consumer protection […] If you do not consider your crypto-asset to be a financial product, can you substantiate your conclusion? Entities should be prepared to justify a conclusion that their ICO does not involve a regulated financial product."
INFO 225 goes on to describe in some detail the features that are likely to mean a cryptocurrency token is a particular type of financial product.
This complexity and uncertainty may make it difficult for an Australian alternative fund to invest in certain crypto-assets without the fund trustee/manager undertaking its own review and assessment as to the legal characterisation of the asset.
For funds that need to be registered with ASIC as a registered MIS, an application to register the MIS must be lodged with ASIC by the proposed trustee of the MIS (referred to as the "responsible entity"). The application must include a copy of the MIS' constitution (being the trust deed) and compliance plan, as well as the relevant ASIC forms and prescribed fee. ASIC has 14 days in which to consider the application and is required to register the MIS within that timeframe unless it appears to ASIC that:
If ASIC registers an MIS, it must give it an Australian Registered Scheme Number. Apart from the constitution and the compliance plan, the fund documents for a registered MIS may include a management agreement and an application form (which would accompany any product disclosure statement issued in respect of the MIS). It is less common for a unit-holders’ agreement or side letters to be put in place for a registered MIS, as registered MISs are generally widely held by passive investors.
A registered MIS that is to be listed on the ASX will also need to apply for admission to the ASX and quotation of units in the MIS.
If a company is to be used as an investment fund in Australia, the company needs to be registered with ASIC. The process to incorporate a company in Australia involves obtaining the consent from each of the proposed directors and company secretaries, and (if required) from the occupier of the registered address, preparing the company’s constitution and having it signed by the members of the company, and applying to ASIC for the company to be registered by completing the prescribed ASIC form and paying the prescribed fee. Once the signed consents and the constitution have been received by ASIC, registration can occur in a matter of minutes for a proprietary company, unless a word in the company’s proposed name is not already on ASIC’s database or in the Macquarie dictionary, in which case it will take about one hour. It usually takes about one hour to register a public company, although ASIC is allowed one day. Other fund documents may include a management agreement, shareholder agreement, side letters and subscription agreements.
Limited partnerships are governed by state and Commonwealth legislation in Australia. Therefore, the process to register a limited partnership varies between jurisdictions, but generally involves an application being made to the relevant statutory authority that regulates the limited partnerships. For limited partnerships that wish to qualify as VCLPs or ESVCLPs, an application must be made to the Department of Industry, Innovation and Science. The application process can take up to two months.
In Australia, there is no requirement to have a local investment manager as a condition for managing a local fund. However, if the MIS is intended to qualify for a lower rate of withholding (ie, 15%) as a withholding MIT for taxation purposes, one of the conditions is that a significant proportion of the investment management activities in respect of all specified assets of the trust with an Australian nexus must be carried out in Australia.
From a regulatory perspective, there is no restriction on a company engaging an offshore manager.
Funds established as Australian unit trusts almost invariably have an Australian corporate trustee. This is a requirement for a registered MIS (whose trustee must be an Australian public company), but is not otherwise a requirement. An Australian proprietary company (including one which is acting as a corporate trustee) must have at least one Australian-resident director. An Australian public company must have at least two Australian-resident directors.
The general partner of a VCLP or ESVCLP must be a resident of Australia or of a country with a double tax agreement with Australia. The requirements above regarding director residence would also apply to a general partner which was a company.
The requirements above regarding director residence would also apply to a corporate fund, such as a listed investment company.
There is no requirement that an Australian fund (whether established as a unit trust, limited partnership or company) maintain Australian premises or have Australian employees, but it would be unusual for this not to be the case in practice.
The responsible entity of a fund which is a registered MIS must comply with certain requirements regarding the appointment and supervision of custodians of the fund's assets. These requirements include that the custodian must (among other things):
Corresponding requirements apply to providers of custodial services in Australia, whether or not they provide those services to registered or unregistered MISs. In addition, subject to limited exceptions, providers of custodial services must hold an AFSL.
There is no requirement that custodians and other service providers such as administrators, money-laundering reporting officers and compliance officers be located in Australia.
To the extent that non-local service providers (including administrators, custodians, director services providers) provide financial services in Australia, they may be carrying on a financial services business in Australia, which brings with it regulation.
Financial services include dealing in financial products or arranging for others to deal in financial products (eg, buying or selling or amending financial products), holding financial products on behalf of someone (eg, providing custodial services), and providing financial product advice. If the activities are of a sufficient degree that they would be considered to be carrying on business in Australia, then the relevant service provider would be required to hold an AFSL authorising the relevant service.
Managed investment schemes (whether retail or wholesale, registered or unregistered) are the most common fund structures used in Australia. For tax purposes, managed investment schemes may be managed so that they are taxed under a concessional regime as either a managed investment trust (MIT) or an attribution-managed investment trust (AMIT).
There are a variety of other fund structures which might also be used that are subject to different tax regimes. These include unit trusts (that are not MITs or AMITs), companies, limited partnerships, VCLPs and ESVCLPs.
MITs and AMITs
MITs are tax-transparent or flow-through entities in that taxation is generally imposed on the unit-holders. The trustee may be liable to pay withholding tax in certain circumstances, including on behalf of foreign resident unit-holders – where the MIT is a "withholding MIT", the trustee may pay a final withholding tax at potentially concessional rates (see below) or, where the MIT is not a withholding MIT, the trustee is generally liable to pay a non-final withholding tax on account of Australian-sourced income or gains. Losses of trusts, including MITs and AMITs, do not flow through to investors.
The main advantages of MITs include:
An AMIT is a particular type of MIT and is tax-transparent or a flow-through entity – one of the key conditions which must be satisfied for a MIT to be an AMIT is that the rights to income and capital are clearly defined at all times.
Other Australian Trusts
There are other kinds of Australian trusts, including unit trusts, which do not qualify for the MIT or AMIT regimes, but which might also be used as investment fund structures. These trusts generally also benefit from tax transparency, but do not benefit from the concessions discussed above such as deemed capital account treatment or the lower MIT withholding rates.
One key tax risk which Australian funds must manage is that certain trusts which are "public trading trusts" do not benefit from tax transparent treatment and are instead taxed in the same way as a company at the corporate tax rate. Generally, a trust will be taxed in this manner if it:
Another tax-related issue which Australian funds must consider is whether the fund satisfies the definition of a "fixed trust". A fixed trust has the benefit of certain tax outcomes which investors might ordinarily expect, such as in respect of the distribution of franking credits and the potential ability to access prior year tax losses.
Since the Federal Court’s decision in Colonial First State Investments Ltd v Commissioner of Taxation  FCA 16 and the ATO’s views published in respect of that decision, there has been some uncertainty regarding what would constitute a fixed trust. The narrow interpretation of fixed trust accepted by the Federal Court has been widely interpreted to mean there are very few trusts which qualify as a fixed trust in the absence of a favourable exercise of the Commissioner’s discretion.
One advantage of falling within the concessional AMIT regime is that a trust that qualifies for AMIT is deemed to be a fixed trust.
Australian companies do not benefit from tax transparency and will be subject to the corporate tax rate on worldwide income. The corporate tax rate is generally 30%, although some companies may be eligible for a lower 27.5% rate if, broadly, they have annual aggregate turnover less than AUD50 million and derive 80% or less of their assessable income from passive investments.
An ESIC is a company that meets certain qualifying criteria (see above). It will be taxed as a company for Australian tax purposes.
Australian Limited Partnerships
Limited partnerships – except venture capital limited partnerships and early stage venture capital limited partnerships (see below) – are generally taxed as companies and do not benefit from tax transparency or flow-through treatment (and are referred to as "corporate limited partnerships").
VCLPs and ESVCLPs
VCLPs and ESVCLPs are statutory regimes designed to attract venture capital investment. Unlike corporate limited partnerships, these funds are taxed on a flow-through basis as partnerships. In contrast to trusts, losses of partnerships may flow through to partners (subject to integrity restrictions). In addition, these structures benefit from generous tax concessions, described below, but are subject to stringent investment criteria, including registration with Innovation and Science Australia (see 2.3 Regulatory Regime, above).
Foreign Unit Trusts
A foreign unit trust is similarly taxed as a flow-through entity for Australian tax purposes.
Foreign Resident Limited Partnerships
Foreign resident corporate limited partnerships are, subject to the foreign hybrid rules discussed below, generally taxed as companies for tax purposes.
Where the foreign hybrid rules apply, the corporate limited partnership will not be treated as a company but will remain a partnership for Australian tax purposes. The partnership will be treated as a transparent entity for Australian tax purposes. Various tests must be satisfied in order for a limited partnership to qualify as a foreign hybrid, including that the limited partnership is not a resident for the purposes of the tax law of any other foreign country.
Stamp duty is a tax imposed by the states and territories of Australia on certain transactions, particularly where they might involve direct or indirect changes in ownership of Australian land; some jurisdictions also impose stamp duty on certain business transactions.
This can potentially affect the activities and transactions entered into by the investment fund, but also can affect investors acquiring interests in (or disposing of interests in) the fund, including minority interests in the fund or indirect interests in the fund (particularly, as discussed above, where the fund owns interests in land). Each state and territory’s stamp duty regime, however, contains various concessions, including relevantly for funds that satisfy certain widely held or wholesale tests. These funds typically benefit from a higher threshold, such that stamp duty is not triggered unless there is a change in ownership of a "significant interest" in the fund (as defined in the relevant stamp duty legislation of each state and territory).
Where stamp duty is imposed, it is generally assessed at maximum rates of between 4.5% and 5.75% (depending on the jurisdiction) on the dutiable value of the transaction (being the greater of the consideration paid or market value). Higher rates can apply to foreign investors in residential land.
Goods and Services Tax
Goods and Services Tax (GST) is a form of value-added tax imposed on "taxable supplies". Certain activities and transactions undertaken by investment funds could be subject to GST, including, for example, leasing office space or selling certain types of land. GST does not generally apply to the acquisition or disposal of units in a unit trust.
Australia has entered into tax treaties with over 40 other states around the world, including the USA, the UK, India, China and Singapore. A notable exception is Hong Kong.
Generally speaking, foreign investors from treaty countries are entitled to reduced withholding tax rates on distributions of dividends, interest and royalties. Withholding taxes on the distributions of dividends are generally reduced from 30% to between 0% and 15%; on interest they can be reduced from 10% to 0%; and on royalties they are generally reduced from 30% to between 5% and 10%.
The majority of Australia’s tax treaties are based upon the OECD Model. Australia has also signed and ratified the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), which entered into force for Australia on 1 January 2019. The MLI may modify the impact of double tax agreements (DTAs) that Australia has entered into. Australia has nominated 42 of its 43 DTAs (with the exception of its more recent DTA with Germany) as covered tax agreements under the MLI.
As a result, depending upon the elections of the other states, the DTA between Australia and those states may be modified. Australia has provisionally adopted, for example, Article 3 of the MLI which ensures income derived by or through a fiscally transparent entity is considered to be income of a resident for treaty purposes to the extent that the jurisdiction of residence treats the income as income of one of its residents under domestic law. Where the MLI affects a DTA, Article 3 may improve a limited partner’s ability to claim the benefits of the DTA (where the DTA does not otherwise have a comprehensive equivalent article). For example, where it applies, income derived by or through a fiscally transparent entity is considered to be income of a resident for treaty purposes to the extent the jurisdiction of residence treats the income as income of one of its residents under domestic law.
In addition, Australia has concluded DTAs that contain specific provisions that address interposed fiscally transparent entities (eg with Japan) may have the effect of enabling limited partners to claim the benefit of double tax agreements.
It is not uncommon for Australian alternative funds to use one or more subsidiaries. For funds structured as units trusts, a subsidiary will typically take the form of a wholly-owned sub-trust. The principal reason for using sub-trusts is segregation of liability, given there are no Australian fund vehicles which comprise segregated or protected cells (eg, as a way of limiting the recourse of lenders in respect of a particular fund asset to the assets of the sub-trust which holds it, rather than to all of the assets of the fund).
Funds may also incorporate bodies corporate downstream (eg, to act as a bid vehicle in the context of a consortium bid for an asset).
The majority of promoters/sponsors of alternative funds in Australia are Australian, the jurisdiction having a well-established and large funds management practice (in part driven by the existence of large pools of superannuation capital seeking a home). However, a number of well-established, international promoters/sponsors have established and manage Australian alternative funds (typically involving the establishment of an Australian office and one or more Australian subsidiaries).
As noted above, Australian investment funds are commonly formed where there is a nexus with Australia, including because capital is to be raised from Australian investors. On that basis, alternative funds established in Australia typically have Australian investors.
However, it is common for Australian alternative investment funds to have a mixture of local and offshore investors. While investors hail from a broad range of offshore jurisdictions, investors from Canada (in particular, Canadian pension funds), Europe (typically, Dutch, German, Swiss and UK pension funds and insurance companies), China (including Hong Kong and, in particular, sovereign wealth funds and other institutional investors), Japan (a range of pension funds, insurance companies and other institutional investors), South Korea (pension funds), Malaysia and Singapore are particularly prevalent.
Other than in the context of funds-of-one, it is less common (but not impossible) for Australian investment funds to be used exclusively for the raising of capital from investors internationally (outside Australia) – in that context, investors outside Australia typically invest via their own offshore feeder fund structures into an Australian investment fund that, in turn, invests in Australian assets.
The portion of overseas funds managed by Australian fund managers has grown significantly. A key issue for consideration by foreign investors considering an investment in Australia is whether approval is required under Australia's foreign investment regime, which regulates certain types of acquisitions by foreign persons of equity securities in Australian companies and trusts, and of Australian businesses and real property assets. Another issue relevant to foreign investors in Australia is whether the investment vehicle qualifies for a concessional rate of withholding tax.
As noted above, Australian investment funds are commonly formed where there is a nexus with Australia, including because the fund will be acquiring Australian assets. It is not uncommon for Australian funds also to acquire assets in New Zealand but, typically, where capital is raised in Australia in order to access investments outside Australia, the Australian investment fund acts as a feeder fund that invests in an offshore fund that, in turn, invests in the underlying assets.
In keeping with global trends, there is increasing regulatory scrutiny of financial services in Australia. Although the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry – also known as the Banking Royal Commission or the Hayne Royal Commission, which was established on 14 December 2017 by the Australian government (the Banking Royal Commission) – was not aimed at alternative fund managers, ASIC was criticised as being too lenient.
It may be that ASIC will apply the law more strictly in light of that criticism. In general, we think the funds management industry expects to be dealing with a more hard-edged ASIC after the Banking Royal Commission, less inclined to reach negotiated outcomes with rule-breakers and more willing to take legal action to set precedent and deter others. In addition to stricter enforcement of the existing regime, it is likely there will be a proliferation of regulation; by way of example, alternative fund managers operating in Australia typically require an AFSL, and there has been discussion of extending a watered-down version of the Banking Executive Accountability Regime, which applies to authorised deposit-taking institutions (ADIs) and establishes, among other things, deferred remuneration, key personnel and notification obligations for ADIs, to all AFSL holders.
Evolving Role of Promoters/sponsors
As Australian superannuation funds continue to grow and become more sophisticated investors, they are increasingly moving away from a model focussed on investments into third-party managed funds. The larger Australian superannuation funds now have significant presence overseas and have made a plethora of large direct investments, both in Australia and offshore (including, increasingly, as part of consortia involving more traditional direct investors). While superannuation funds continue to serve as the major source of capital for Australian alternative funds, they are looking for more from their managers, including through access to co-investment, training and secondment opportunities.
Again mirroring trends overseas, there is significant "dry powder" (ie, cash which has been raised from investors but not yet deployed) chasing investments in Australia, following a flurry of high-profile and large alternative fund raises in Australia in the past few years, particularly in private equity, infrastructure and, to a lesser extent, real estate.
The disclosure regime in Australia varies depending on whether the investors in the fund will be retail or wholesale clients, as well as the type of investment fund in question.
Mandatory disclosure to investors is required only where interests in an investment fund and offered or issued to retail clients; a retail client is an investor that is not a wholesale client – which, broadly speaking, includes institutional, sophisticated and high net worth investors.
In the context of alternative funds, a regulated disclosure document does not need to be provided to wholesale clients and it is not necessary to provide any form of disclosure to such investors. However, it is customary in Australia to provide an information memorandum or other type of offer document (known in other jurisdictions as a "private placement memorandum"), often accompanied by an investor brochure or presentation, to Australian wholesale investors to whom interests in an investment fund are offered for subscription.
CCIVs and LPCIVs
Draft legislation has been released by the Government for public consultation to introduce a new corporate collective investment vehicle (CCIV), and it is also proposed that a limited partnership vehicle (LPCIV) will be introduced in the future. It is proposed that these new structures will provide flow-through tax status. The introduction of the CCIV and the LPCIV is intended to broaden the range of Australian investment vehicles available to Australian and offshore investors and encourage further offshore investment into Australian funds, by extending flow-through tax status to investment vehicles with which overseas investors are more familiar. While it is anticipated that, if and when introduced, the CCIV will be more commonly used for retail funds, given the limited partnership's status as the vehicle of choice for private equity and other alternative funds internationally, the expectation is that the proposed LPCIV will appeal to managers of, and investors in, alternative funds.
ASIC currently offers certain relief from the need to obtain an AFSL to certain foreign financial service providers (FFSPs) who provide financial services in Australia only to wholesale clients. Subject to the satisfaction of any relevant conditions:
However, ASIC is proposing to repeal both forms of relief, replacing the limited connection relief with a much more narrowly construed relief with more onerous conditions, and requiring all other FFSP who operate a financial services business to obtain an AFSL, albeit subject to fewer obligations than those applying to Australian entities who hold an AFSL. ASIC continues to consult on the proposed changes but the expectation is that, save for marginal tweaks, it will implement its current proposal, which includes transition periods for FFSPs relying on either of the existing reliefs.
Recent Tax Changes
The Government has recently introduced extensive reforms to the tax laws applicable to "stapled structures". Stapled structures are essentially arrangements where two or more entities that are commonly owned are bound together such that they cannot be bought or sold separately. Typically, at least one of these entities is a trust seeking to benefit from flow-through taxation in respect of certain qualifying passive investments (an "asset entity"), while another entity would carry on a trading business and be taxed as a company at the corporate tax rate (an "operating entity").
The reforms are intended to address concerns about non-residents accessing the concessional managed investment trust withholding tax rate of 15% in respect of, in essence, active trading income through the use of stapled arrangements. The reforms address these concerns by imposing a final withholding tax at the corporate rate of 30% to distributions derived from trading income that has been converted into passive income using a MIT, excluding rent received from third parties.
Higher MIT withholding tax rate for agricultural and residential land
The Government has also introduced measures which deny the concessional 15% withholding tax rate in respect of rent from residential housing (other than commercial residential or certain student accommodation) and agricultural land. This also applies to any capital gains distributed to investors that is attributable to the sale of residential housing or agricultural land.
Restrictions on withholding tax exemptions
Previously, superannuation funds for foreign residents that are exempt from tax in their country of residence were exempt from interest and dividend withholding tax. The Government has introduced measures to limit the exemption to portfolio-like investments only. Similarly, the exemption from income and withholding tax for foreign sovereigns are now also limited to portfolio-like investments in certain assets.
Proposed Tax Measure – CGT Discount
The Government has also announced a change to the application of the 50% capital gains tax discount for MITs and AMITs. Currently, the capital gains tax discount applies to MITs and AMITs at the trust level. The proposed measure is intended to prevent beneficiaries that are not entitled to the CGT discount in their own right from getting a benefit from the CGT discount being applied at the trust level.
Alternative fund managers in Australia are typically established as proprietary companies, with two exceptions:
Under the Corporations Act, a person who is in the business of providing financial product advice, dealing in financial products (including interests in an MIS and shares in a company) or arranging for dealing in financial products, providing custodial or depository services and/or who operates a registered MIS is required to hold an AFSL, unless an exemption applies. An AFSL is required in these circumstances, irrespective of whether the financial services are provided to retail clients, wholesale clients, or both.
To apply for an AFSL, an application in the prescribed form must be made to ASIC, accompanied by a series of supporting "proofs" and the prescribed fee. The supporting proofs identify the "responsible managers" nominated by the applicant to demonstrate its organisational competence, and address an extensive range of other matters, including the applicant’s compliance arrangements, adequacy of resources and risk management systems.
In assessing an AFSL application, ASIC considers whether the applicant:
Under ASIC’s service charter, ASIC aims to decide whether to grant or vary 70% of all AFSL applications within 150 days (five months) of receiving a complete application, and aims to decide 90% of complete applications within 240 days (eight months).
Marketing a Fund
A person who markets investment funds in Australia is likely to require an AFSL because such marketing will most likely amount to the person providing financial product advice or dealing in financial products.
At present, a suite of exemptions, referred to as the "sufficient equivalence relief", are available to certain FFSPs. However, as noted at 2.19 Anticipated Changes, above, ASIC is proposing to repeal those reliefs, albeit with a transition period.
Authorisation of Marketing Activities
The main marketing activity that requires authorisation is the provision of "financial product advice", which is defined as a recommendation or statement of opinion, or a report of either of those things, that is intended to influence a person in making a decision in relation to a particular financial product or class of financial products, or could reasonably be regarded as being intended to have such an influence. Statements in an offer document, an investor presentation or other form of marketing may amount to financial product advice.
The Corporations Act distinguishes between retail clients and wholesale clients, and, to the extent that retail investors invest in a unit trust, the trust will generally need to be registered as an MIS. Australia also has design and distribution requirements for retail financial products (including managed funds) and ASIC has a product intervention power.
Approach of the Regulator
ASIC has typically taken a co-operative approach to regulatory matters, routinely publishing consultation papers and regulatory guidance. ASIC does not generally discuss regulatory questions with individual fund managers or advisers in an ad hoc manner, typically reserving engagement for more formal consultation processes.
ASIC has generally also taken a co-operative approach to processing and dealing with breaches by fund managers. However, as noted at 2.19 Anticipated Changes, following the Banking Royal Commission, ASIC is likely to apply the law more strictly, be less inclined to reach negotiated outcomes with rule-breakers, and be more willing to take legal action to set precedent and deter others.
ASIC tends to be punctual in dealing with matters within expected timeframes, although the expected timeframes for some regulatory processes (eg the processing of applications for new AFSLs) have increased over the last few years.
In Australia, transparent structures for tax purposes are typically the most common. At present, the most common investment vehicle in Australia is the unit trust, largely because of its tax flow-through status and its flexibility from a structuring perspective. In certain circumstances, trusts may be taxed as companies, but generally when trusts are designed for use as investment funds they are managed to ensure they are tax transparent or flow-through. This means that generally the fund investors (and not the fund, manager or trustee) will be taxed on their respective shares of the annual taxable income of the fund.
Generally, if the fund manager is a company, it will be subject to tax as a company in the same way described above. There are certain tax concessions offered in respect of "carried interest", which are discussed in 3.5 Taxation of Carried Interest.
Australia has an investment management regime (IMR) that applies to certain non-resident entities that satisfy a widely held test.
The IMR provides two tax concessions:
The "carried interest" of the fund manager of a MIT will generally be taxed as a revenue gain (and not on capital account).
Further, the carried interest of the general partner of either a VCLP or an ESVCLP (excluding any management fee or any distribution attributable to an equity investment by the partner) will generally have deemed capital account treatment. This capital gain can also be subject to the capital gains discount (where eligibility requirements are satisfied).
Managers may outsource their investment functions. If the manager is a responsible entity, then it remains responsible under statute for the conduct of any person to whom it outsources any functions.
Managers which are required to hold an AFSL will need to meet certain financial requirements. These depend on what kinds of financial services the manager provides, whether the MIS is registered or not, and so forth. All AFSL holders must meet solvency and net assets requirements, a cash-needs requirement and an audit requirement. Some licensees will also need to meet a surplus liquid funds requirement or an adjusted surplus liquid funds requirement.
An offshore manager is not required to have local employees.
Offshore managers who carry on a financial services business in Australia are subject to the same regulatory regime as local managers (see 3.2 Regulatory Regime, above), subject to the following:
The key investor base in Australia is the quickly developing pool of Australian superannuation fund assets, with many superannuation investors having a sizeable portion of their assets allocated to private market assets. It is expected that allocations to private market assets generally, but to private equity and other alternative assets in particular, are likely to grow strongly in the coming years.
Complementing the superannuation client base for alternative funds in Australia is a suite of other major institutional investors, including several government/sovereign wealth investors, a handful of major institutional investment managers (often aggregating superannuation investor money) and an increasing number of family office and high net worth individual investors.
Leaving aside Australian real estate and infrastructure funds, retail client exposure to alternative fund product remains relatively limited.
The categories of investors able to be targeted for investment into alternative funds in Australia will differ depending on the fund structure and regulatory status of the fund in question.
In general terms, retail clients are typically only able to access an Australian domiciled fund product that meets various regulatory requirements, including requirements relating to the registration of the fund as an MIS and regulation of the fund operator/manager. In addition, retail funds may only be marketed in Australia by (or via) an entity holding an AFSL. Funds that meet these onerous regulatory requirements are able to be marketed to all potential investors (whether retail or otherwise).
Alternative fund products that cannot (or do not) meet those retail requirements are prohibited from being marketed to any retail client. Those products can only be marketed and sold to non-retail client investors in Australia (ie, wholesale clients). While a wholesale fund product of this type does not need to meet fund registration/MIS requirements (that is, the fund itself is not directly regulated), the fund operator/manager of a wholesale product established in Australia will typically still be required to hold an AFSL.
Further, even wholesale funds may generally only be marketed in Australia by (or via) an entity holding an Australian financial services licence, although limited exemptions apply for non-Australian funds that are marketed by non-Australian managers (see 3.8 Local Regulatory Requirements for Non-local Managers).
See 4.2 Marketing of Alternative Funds.
Subject to the above, there are no restrictions on local Australian investors investing into alternative funds established in Australia.
The extent to which regulatory filings are required to be made prior to the marketing of an alternative fund product in Australia depends on the nature of the fund. As noted above:
The disclosure requirements applying to alternative fund products marketed in Australia will depend on the nature of the fund.
If the fund is a retail fund, all retail clients must be provided with a product disclosure statement (if structured as a MIS) or prospectus (if structured as a company) prior to be issued with an interest in the fund. Detailed content requirements apply to each of those formal offering documents. Ongoing disclosure to investors is also required in relation to material events or developments during the life of the fund. Special additional rules apply to product disclosure statements prepared for hedge fund products.
In contrast, if the fund is a wholesale fund, no formal disclosure regime applies, although in this context it is customary in Australia to provide an information memorandum or other type of offer document (known in other jurisdictions as a "private placement memorandum"), often accompanied by an investor brochure or presentation.
Resident investors in MITs will generally be taxed on a proportion of the taxable income of the MIT – that proportion is the proportion of the trust law income of the MIT to which they are made presently entitled (as generally determined in accordance with the MIT’s constitution).
Australia’s tax system does not necessarily produce an alignment between the net taxable income to be included in the investor’s tax return and the accounting income of the trust - that is, there may be a separation between the economic and tax outcomes for unit-holders. As a result, it is possible for the resident investor to receive payments in excess of the amounts included in their taxable income (or vice versa). The amount of any excess distribution is called the "tax-deferred distribution" and reduces the investor’s cost base in their units of the trust. Unless the cost base of the units has been reduced to zero, the tax on this income is deferred until the investor disposes of the units.
Resident investors will also generally be taxed on any gains made on the disposal of their interest in the MIT. Investors that are individuals, trusts or superannuation funds and hold their interest on capital account may be entitled to a tax concession that reduces the amount of the capital gain on which they are assessed by up to 50% (depending on the type of investor).
Payments of dividends, interest or royalties to a non-resident by a MIT will generally be subject to Australian withholding tax. The rate of withholding is 30% for unfranked dividends, 10% for interest and 30% for royalties under domestic law, but those rates may be lowered under an applicable Double Tax Agreement (see below).
Payments of other forms of income will also generally be subject to withholding. As discussed above, non-resident investors in MITs will generally benefit from a concessional rate of withholding on fund payments from the MIT of 15% where the payment is made to a resident of a country with an exchange of information agreement with Australia (EOI Country) and 30% to a resident of a non-EOI country.
Non-resident investors are generally not subject to any tax on distributions of capital gains (provided the MIT is a fixed trust), unless the gain relates to the disposal of "taxable Australian property" (this being, in broad terms, direct or indirect interests in Australian land), in which case such investors may be eligible for the reduced 15% withholding.
Similarly, if the non-resident holds their units in the MIT on capital account, they will not generally be subject to capital gains tax on disposal of their units unless their units in the MIT are taxable Australian property. If their interest is taxable Australian property, then the sale of their interest may be subject to a non-final withholding tax of 12.5% of the sale price ("foreign resident CGT withholding").
Under the AMIT regime, unit-holders are generally taxed on an attribution basis, that is, on the amount attributed to the unit-holder on a fair and reasonable basis in accordance with the trust constituent documents, rather than based on their proportionate present entitlement to trust income.
The AMIT regime also provides a number of other concessions, including relevantly:
Although Australian companies are subject to tax, Australia has a comprehensive dividend imputation regime intended to prevent the double taxation of dividends paid to Australian resident investors out of profits which have already been taxed in the company.
If the distribution has been "franked" (ie, paid out of taxed profits), the resident shareholder will be subject to tax on the grossed-up (pre-tax) amount of the dividend entitled to a tax offset of an equivalent amount to that of the franking credit attached to the distribution.
Where the distribution is unfranked, the resident investor will be taxed at their marginal tax rate on the distribution without any corresponding gross-up or tax offset.
Companies are not entitled to the capital gains tax discount that may be available to Australian resident individuals and trusts (50%) or complying superannuation entity (33.33%). Australian resident investors in LICs who receive a dividend attributable to a capital gain may be entitled to a deduction that reflects the CGT discount the shareholder could have claimed if they had made the capital gain directly. In addition, foreign income tax offsets are not available for Australian resident shareholders in respect of foreign tax paid by an Australian company.
Non-resident investors do not benefit in the same way from Australia’s dividend imputation regime, although dividends that are fully franked (ie, paid out of profits which have been taxed) are not subject to any further tax. Otherwise, dividends paid by Australian companies to non-resident investors will generally be subject to a final withholding tax at 30% (subject to the availability of any protections under a Double Tax Agreement – see above).
An investor that is a governmental entity or a tax-exempt "superannuation fund for foreign residents" may be exempt from Australian dividend withholding tax under Australia’s sovereign immunity regime (although, as noted above, the Australian Government has introduced legislation narrowing the scope of this exemption).
Australia also has "conduit foreign income" rules under which, where certain criteria are met, foreign-sourced income of a company that, broadly, is not subject to Australian tax in the hands of the company can be distributed to foreign investors without being subject to Australian dividend withholding tax.
VCLPs and ESVCLPs
A foreign qualifying investor in a VCLP is generally not subject to tax on its share of any gain (whether on revenue or capital account) arising on the disposal of an eligible venture capital investment by the VCLP, provided (among other conditions) the VCLP holds the asset at risk and for at least 12 months. This concession is not available to Australian investors.
An investor (whether resident or foreign) in an ESVCLP is entitled to tax exemptions for both income and capital gains on its share of any gains arising on the disposal of eligible venture capital investments by the ESVCLP, as well as a non-refundable carry-forward tax offset of up to 10% of their eligible contributions.
Certain investors acquiring shares in a qualifying ESIC may be entitled to certain tax concessions in relation to their investment (in the form of non-refundable tax offsets). In addition, investors may be able to disregard certain capital gains realised on shares in qualifying ESICs that have been held for certain holding periods.
Tax Structuring Preferences of Investors
The Australian income tax implications of investing through a particular type of fund depend upon the individual circumstances of the investor (including its residency) as well as the nature and type of investment.
As a general matter, the ability of MITs and AMITs to elect to treat qualifying assets as being on capital account is attractive to many investors (both Australian and foreign). This is because deemed capital account treatment avoids the vexed question whether the gains made by MITs/AMITs are on revenue or capital account, and because foreign residents are not subject to tax on capital gains made from disposals of assets that are not taxable Australian property. In addition, MITs/AMITs that are withholding MITs offer concessional (15%) rate of tax on certain types of income for investors in information-exchange countries.
Certain eligible categories of foreign investors may also be attracted to investments in VCLPs since, as described above, qualifying gains on disposals of VCLP assets are generally exempt from Australian tax. Similarly, both Australian and foreign resident limited partners may be attracted to investments in EVCLPs since qualifying gains on disposals of EVCLP assets are similarly exempt from Australian tax. In addition, carried interest is generally taxable as a capital gain. Given the stringent conditions that apply to the VCLP and ESVCLP regimes (see above), the favourable tax concessions are generally harder to access.
The tax treatment of investors in domestic funds is generally discussed above. The following contains a brief discussion regarding foreign funds operating in Australia.
Foreign Unit Trusts
An Australian resident unit-holder in a foreign unit trust will generally be taxed in a similar way to an investment in an Australian unit trust. One difference relates to capital gains made from the disposal of assets by a foreign resident trustee of a "foreign trust for CGT purposes" that are not taxable Australian property. In such a case, the Commissioner of Taxation has taken the view that the capital gain will not be included in any unit-holder’s assessable income, whether the unit-holder is an Australian resident or foreign resident. The unit-holder would generally, however, be subject to tax on receipt of a payment attributable to such a capital gain. In addition, the Commissioner has recently taken the view that such an amount is not eligible for the capital gains discount.
Australia has also enacted transferor trust rules that, where they apply, attribute the profits of a foreign trust to the transferor of property or services to the foreign trust. The rules, however, largely apply to discretionary trusts.
Foreign resident unit-holders are generally only subject to tax on Australian-sourced income; where the foreign resident unit-holder is presently entitled to a share of trust income that is Australian-sourced, the trustee must withhold tax on behalf of the non-resident at the non-resident’s marginal rate and such withheld tax is creditable against the foreign resident’s end-of-year tax liability (see above).
Foreign Resident Limited Partnerships
Where the limited partner is a resident of a country with which Australia has concluded a double tax agreement (DTA), the limited partner’s ability to claim the benefits of the double tax agreement to ensure the corporate limited partnership is not subject to income tax (at least as to a proportion of its income or gains) has been the subject of some recent dispute.
In particular, in the recent decision of Resource Capital Fund IV LP v Commissioner of Taxation  FCA 41, the Federal Court determined that US-resident limited partners in a Cayman Islands limited partnership were entitled to claim the benefits of the business profits article in the Australia-United States DTA to dispute the assessment relating to the gains made by that limited partnership. However, the Full Federal Court in Federal Commissioner of Taxation v Resource Capital Fund IV LP  FCAFC 51 overturned the decision of the Federal Court at first instance. In doing so, it ruled that each limited partnership was a "taxable entity" under Australian tax law rather than, as was held at first instance, the limited partners. This meant the limited partnerships, rather than limited partners, were required to establish any rights to benefits under the Australia-United States DTA.
Where the corporate limited partnership is a foreign resident, distributions to limited partners will generally be treated as dividends and:
Controlled Foreign Company and Foreign Hybrid Rules
Since a corporate limited partnership is generally treated as a company (subject to the foreign hybrid rules), the controlled foreign company (CFC) rules are potentially applicable.
As noted above, where the foreign hybrid rules apply, the corporate limited partnership will not be treated as a company but will remain a partnership for Australian tax purposes. The CFC rules operate to include certain "attributable income" in Australian taxpayers’ assessable income on an attribution basis – that is, as and when the CFC derives the income, rather than when the income, or an amount attributable to such income, is paid to the Australian taxpayers. The rules are designed to counteract the practice of establishing foreign companies that accumulate passive low-taxed income. There are various tests for determining when a company, or corporate limited partnership, is a CFC, but it includes where five or fewer Australian entities, whose direct and indirect interests – together with the direct and indirect interests of their associates – in the company or corporate limited partnership total not less than 50%.
Broadly, FATCA requires non-US financial institutions to perform due diligence on its account holders and to provide information on US account holders to the US Internal Revenue Service (IRS). Australia has entered into an intergovernmental agreement with the US (IGA), which allows Australian financial institutions to provide information and make reports to the ATO rather than the IRS, and for the ATO to pass that information on to the IRS. In broad terms, the IGA means that "Australian Financial Institutions" (AFIs) – as defined in the IGA – will not be exposed to 30% FATCA withholdings on payments of US source income that are made to them (except in the case of significant non-compliance by an AFI with its FATCA obligations). Nor are they required to deduct 30% FATCA withholdings on payments made by them except in limited circumstances. The obligations under the IGA have been implemented into Australian law; penalties apply for failure to meet them.
In summary, the obligations of an AFI include conducting certain due diligence procedures on its account holders and reporting specified information to the ATO on an annual basis in relation to financial accounts held with it by US citizens, US tax residents and certain other US entities. It must also register with the IRS.
An entity will be an AFI if it is any of the following types of financial institution: a custodial institution, a depository institution, an investment entity or a specified insurance company (each of which is separately defined under the IGA), and it is resident in Australia or is an Australian branch of a non-Australian financial institution. The definition of "financial institution" covers more than what would commonly be thought of as a financial institution, and would include most investment funds in the investment entity category, although the position should be verified in each case.
AFIs cannot opt out of their FATCA obligations. However, the IGA exempts certain "non-reporting Australian financial institutions" from having to comply with the due diligence and information-reporting requirements, including Government entities or agencies, superannuation entities and public sector superannuation schemes, certain entities that have an almost exclusively local client base and do not solicit customers outside Australia, and certain investment advisors and investment managers.
Australia has also enacted legislation to give effect to the Common Reporting Standard (CRS), which came into effect from 1 July 2017. Similarly to FATCA, the CRS regime requires financial institutions to conduct certain due diligence procedures and report specified information to the ATO on an annual basis in relation to any accounts held with them by a foreign resident or by an entity controlled by a foreign resident.
The financial institutions that are required to perform due diligence and report under the CRS in Australia are broadly similar to those under FATCA, although there are some differences in the definitions of the categories of financial institution, and there are fewer exemptions under the CRS regime. The due diligence requirements under the CRS are also similar to those under FATCA, although the CRS requires due diligence to be performed on a wider set of accounts than under FATCA, as certain de minimis account balance thresholds under FATCA for due diligence purposes do not apply under the CRS.
Penalties apply for non-compliance with the regime.