Investment Funds 2019

Last Updated July 15, 2019

Australia

Law and Practice

Authors



Allens brings together a dedicated team of sector specialists who practise in the area of investment funds. The investment funds team comprises five partners and 28 other lawyers, spread across offices in Sydney and Melbourne. Key areas of sector expertise include: advising on all aspects of the design and formation of funds, including retail and wholesale funds and stapled groups, listed and unlisted, across many asset classes and investment strategies; acting for listed and unlisted funds raising capital in the equity and debt capital markets and advising on all aspects of IPOs, capital raisings, private placements, rights issues and hybrid and structured products; assisting fund managers to amend fund constitutions, change responsible entities, document fund financing, undertake PDS rollovers, advise on marketing and advertising restrictions, prepare for members' meetings, and deal with voting exclusions and corporate governance and regulatory issues; and helping funds, financial services providers and issuers of financial products chart their way through a complex regulatory environment, advising clients on Australian financial services regulations. Allens frequently works with its alliance partner, Linklaters, to provide clients with support internationally. The firm's broader team includes members of the following practice areas; tax, banking and finance, M&A, financial services regulation, infrastructure, real estate, projects and disputes.

Australian investment 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.

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.

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. While concessions were introduced in 2002 to, among other things, restore flow-through tax treatment for certain venture capital limited partnerships, 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.

Draft legislation has been released by the Australian Government for public consultation to introduce a new corporate collective investment vehicle, and it is also proposed that a limited partnership vehicle will also 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.

Australian investment funds are generally used for the raising of capital from investors in Australia. Where capital is raised from Australian investors in order to access investments outside Australia, the Australian investment fund may act as a feeder fund that invests in an offshore fund that, in turn, invests in the underlying assets.

It is less common (but not impossible) for Australian investment funds to be used for the raising of capital from investors internationally (outside Australia). Typically, investors outside Australia would invest via their own offshore feeder fund structures into an Australian investment fund that, in turn, invests in the Australian assets.

The process for setting up an investment fund in Australia varies depending on the type of investment fund used and the profile of the investors.

Assuming the investment fund is a unit trust, and capital will be raised exclusively from 'wholesale clients' (generally speaking, being institutional, professional and high net worth investors), the fund will not need to be registered with the Australian Securities and Investments Commission (ASIC), although the trustee of the fund will in most cases be required to hold an Australian Financial Services licence (AFS licence). The core fund document is a trust deed and there is also often a management agreement, unitholders' agreement and subscription agreements. Side letters may also be entered into. The fund is established upon the initial issue of units in the trust.

If capital is to be raised from 'retail investors', the unit trust will generally need to be registered with ASIC as a managed investment scheme (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 MIS registration application and is required to register the MIS within that timeframe unless it appears to ASIC that:

•       the application does not include the required documents;

•       the proposed responsible entity of the MIS does not satisfy the requirements of the Corporations Act 2001 (Cth) (the Corporations Act);

•       the MIS constitution or compliance plan does not satisfy the requirements of the Corporations Act;

•       the compliance plan has not been signed as required by the Corporations Act; or

•       arrangements are not in place that will satisfy the requirements of the Corporations Act in relation to audit of compliance with the compliance plan.

If ASIC registers an MIS, it must give it an Australian Registered Scheme Number (ARSN). 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 the product disclosure statement). It is less common for a unitholders' 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 Australian Securities Exchange (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 the company involves obtaining the consent from each of the proposed directors, secretary and occupier of the registered address (if required), 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 all of 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. Public companies usually take about one hour to be registered, although ASIC is allowed one day. As above, 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.

To qualify for certain concessional tax regimes which broadly entitle non-residents to lower rates of withholding tax on certain types of investment income (eg, rent from non-residential and non-agricultural land), the trustee of an Australian unit trust must be resident in Australia.

The responsible entity (RE) (that is, trustee) of a registered MIS must be a public company registered under the Corporations Act (which may include a foreign company carrying on business and registered in Australia).

There are no regulatory restrictions on the trustee or RE engaging an offshore manager (located outside Australia) to manage an Australian fund. However, if the trust or MIS is intended to qualify for a lower rate of withholding as a withholding managed investment trust (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. This requirement is designed to enhance the competitiveness of the Australian managed funds industry.

From a regulatory perspective, there is no restriction on a company engaging an offshore manager. In relation to limited partnerships, each relevant piece of legislation would need to be considered on a case-by-case basis.

Under Australian law, a trust (including a registered MIS) is not a separate legal entity. Unlike shareholders in Australian companies limited by shares, and limited partners in limited partnerships, beneficiaries of a trust (including unit-holders of a unit trust) do not enjoy statutory limited liability. Instead, the position of beneficiaries of a trust is determined by general law principles and privately negotiated contractual arrangements.

Despite numerous recommendations by law reform bodies in favour of legislation providing for limited liability for unit-holders of public unit trusts (comparable with the protection afforded to shareholders in a limited liability company), there is currently no such protection under the Corporations Act or any other Australian legislation.

Recourse must therefore be had to general trust law, which holds that a beneficiary may be personally and proportionately liable to a trustee for liabilities incurred by the trustee in the proper administration of a trust.

It is settled law, however, that where that liability does exist, it may be excluded or limited by an express provision contained in the relevant trust instrument.

Such exclusion clauses are almost universally included in unit trust deeds in Australia. They are particularly important in the context of widely held public unit trusts, where investment is sought from the public and the investors (including retail investors) do not have an active role in the management of the scheme. As a matter of principle, there is no reason why an exclusion clause of this nature cannot also be effective in a wholly owned or closely held trust.

There are some circumstances, however, in which an exclusion clause protecting a beneficiary from personal liability may be held by the courts to be ineffective. In practice, there is a greater likelihood that these circumstances could arise where a trust is wholly owned by one beneficiary, or closely held by a small number of beneficiaries, rather than in the context of a widely held trust.

As the law currently stands, an exclusion clause protecting a beneficiary from personal liability will be held to be ineffective (as against the trustee and the trustee's creditors) in limited circumstances, namely where:

•       the use of such a clause is contrary to public policy;

•       a beneficiary has authorised the trustee to enter into a transaction not within the scope of the trust, or has ratified such a transaction; or

•       the relationship between the trustee and beneficiary (or beneficiaries) has acquired the character of agency – for example, if the beneficiaries have the power to exert, or actually exert, the requisite degree of control over the trustee.

Legal opinions regarding the limited liability of unit-holders in a trust have not traditionally been provided in Australia, because of the absence of statutory protection and because the test depends in part on how the trust is operated in practice. However, it is becoming more common for offshore investors in unit trusts to request a legal opinion of this nature from Australian legal advisers.

On 31 July 2018, a Report prepared by the New South Wales (NSW) Law Reform Commission entitled 'Report 144: Laws relating to beneficiaries of trusts' was tabled in the NSW Parliament. One of the purposes of the report, which was commissioned by the NSW Attorney General, was to review and report on the liability of beneficiaries, as beneficiaries, to indemnify trustees or creditors when trustees fail to satisfy obligations of the trust. One of the recommendations of the Report was that the Trustee Act 1925 (NS) should be amended to provide that, unless the beneficiary has otherwise expressly agreed, the beneficiary is not, as a beneficiary, liable for, or to indemnify, the trustee in respect of any act, default, obligation or liability of the trustee. This recommendation has not yet been implemented.

In Australia, transparent structures for tax purposes typically are 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 that they are tax transparent or 'flow-through'. This means that generally the fund investors (and not the fund or trustee itself) will be taxed on their respective shares of the annual taxable income of the fund.

The managed investment trust (MIT) regime, which was introduced in Australia around a decade ago, provides concessional withholding tax treatment to certain offshore investors who invest in certain types of Australian passive assets through a trust that qualifies as a withholding MIT. A withholding MIT is a MIT that, among other matters, has a significant proportion of its investment management activities in respect of all specified assets of the trust with an Australian nexus carried out in Australia.

Since the introduction of the MIT regime, Australia has become even more popular with offshore investors who seek exposure to real estate, infrastructure, fixed interest and other qualifying assets.

The MIT regime provides concessional tax treatment to investors of 'withholding MITs' who are a resident of a country with which Australia has an effective exchange of information treaty (Australia currently has 114 effective exchange of information treaties). In recent years, the largest inflows into MITs in Australia are from the Asia Pacific region, particularly Japan, New Zealand, China and South Korea. Australian MITs are also popular investment structures for investors from the United States of America, Canada, the Middle East and Europe.

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. 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 PPM), often accompanied by an investor brochure, to Australian wholesale investors to whom interests in an investment fund are offered for subscription.

However, mandatory disclosure is required where interests in an investment fund are offered to retail investors. The form of disclosure document varies depending on whether the interests in the investment fund are 'financial products' or 'securities'. Interests in a registered MIS are financial products, and a regulated disclosure document referred to as a 'product disclosure statement' (PDS) needs to be provided to retail investors before a financial product is offered or issued to them. The content requirements for PDSs are detailed and prescriptive, particularly in relation to the disclosure of fees and costs.

If interests in an investment fund constitute 'securities', such as shares in a company or debentures, the form of disclosure document that must be provided to retail investors is a 'prospectus'. The prospectus content requirements are also set out in the Corporations Act and are more principles-based than the prescriptive requirements that apply to PDSs.

Unit Trusts

As noted earlier, the most common form of investment fund in Australia is the unit trust, largely because trusts are generally treated as flow-through vehicles (unless they are 'public trading trusts') and are flexible from a structuring perspective. Where a unit trust qualifies as a 'managed investment trust' (MIT) for Australian taxation purposes, withholding tax concessions are provided to certain offshore investors, which makes the unit trust an attractive investment vehicle for those investors.

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'. Unregistered schemes are commonly used in Australia to invest in real estate, infrastructure, fixed interest, equities, private equity, credit and other types of investments.

If units are offered to 'retail clients' (whether or not they are also offered to 'wholesale clients'), the unit trust will generally need to be registered with ASIC as a registered MIS. Registered MISs that are not listed on a securities exchange are typically used to invest in equities, fixed interest, mortgages and, to a lesser extent, real estate.

Registered MISs may be listed on a securities exchange such as the Australian Securities Exchange (ASX). Registered MISs listed on the official list of the ASX may invest in a range of assets, including real estate (known as A-REITs), infrastructure and equities (known as Listed Investment Trusts). Registered MISs may also be listed under the AQUA Rules of the ASX as exchange-traded funds (ETFs), managed fund products and structured products. These three product types would be expected to trade generally at a price close to net asset value (NAV) or the price that reflects the underlying instruments that the product seeks to track.

Companies

A company (usually a public company) may also be used as an investment fund, either as part of a 'stapled structure' where units in a trust and shares in a company are traded together as single economic entity (for example, in order to facilitate the streaming of income from passive investments through the trust, and income through a trading business through a company).

Listed Investment Companies (LICs) are investment funds listed on the ASX that provide investors with exposure to a professionally managed portfolio of assets (including shares and fixed income securities) held by the company.

Limited partnerships

While most limited partnerships are treated as companies for tax purposes, concessions were introduced in 2002 to provide flow-through tax treatment for certain venture capital limited partnerships. The Australian Government has a range of venture capital programmes designed to attract domestic and foreign investment to help innovate Australian businesses commercialise technologies. The types of venture capital funds that are available to fund managers seeking to raise capital using a flow-through structure that provides tax concessions to investors include Venture Capital Limited Partnerships (VCLPs) and Early Stage Venture Capital Limited Partnerships (ESVCLPs). There are strict eligibility criteria that apply under each of these structures, particularly in relation to the types of investments that may be made through the structure, and many limited partnerships are unable to qualify. Registration as a VCLP or ESVCLP is administered by the Australian Government's 'Innovation and Science Australia' department. The investors in these structures are typically wholesale clients.

Unit trusts that are not registered MISs are not regulated by any Australian financial services regulatory authority. The trustee of an unregistered scheme may hold an AFS licence 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. Companies are also regulated by ASIC.

VCLPs and ESVCLPs must meet ongoing registration and reporting requirements to maintain their registration. The Department of Industry, Innovation and Science and the Australian Taxation Office (ATO) jointly administer the VCLP and ESVCLP programmes on behalf of the Australian Government.

Collective Investment Vehicles

The Australian government has released draft legislation (the most recent iteration of which was released for further public consultation on 17 January 2019) proposing amendments to the Corporations Act 2001 (Cth) to allow the creation of a new corporate collective investment vehicle (CCIV). CCIVs are considered to be more readily recognisable investment structures for foreign investors, rather than trusts. The tax treatment of CCIVs is intended to be the same as the existing regime for attribution-managed investment trusts or 'AMITs'.

The Australian government is also intending to release draft legislation for a new partnership collective investment vehicle, but has not yet announced a date when it will do so.

Asia Region Funds Passport

Over the past nine years, participating economies have been working towards the development of the Asia Region Funds Passport, which came into effect on 1 February 2019. The Passport is intended to allow Australian fund managers to offer interests in qualifying managed funds to retail investors across multiple participating economies in the Asian region with limited additional regulatory requirements. Similarly, fund managers in other participating economies will be able to market their qualifying funds to Australian investors using the more streamlined regulatory process, which should increase competition and choice for Australian investors. At present, the participating economies are Australia, New Zealand, Japan, Thailand and the Republic of Korea.

Stapled Structures

A common investment fund structure in Australia involves 'stapling'. '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 ATO has recently expressed concerns about these structures being used to in effect 'fragment' integrated trading businesses in order to re-characterise trading income, which is ordinarily subject to the corporate tax rate, into more favourably taxed passive income.

Subsequently, in September 2018, the Government proposed extensive reforms to the tax laws applicable to stapled structures. 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, which have not yet been enacted into law, would 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 legislation before Parliament which will deny the concessional 15% withholding tax rate in respect of rent from residential housing (other than commercial residential or student accommodation) and agricultural land. This will also apply to any capital gains distributed to investors that is attributable to the sale of residential housing or agricultural land.

Restrictions on withholding tax exemptions

Under current law, 'superannuation funds for foreign residents' that are exempt from tax in their country of residence are exempt from interest and dividend withholding tax. The Government has introduced (but not yet passed) legislation that seeks to limit the exemption to portfolio-like investments only. Similarly, the legislation would codify the exemption from income and withholding tax for foreign sovereigns, but limit the exemption to portfolio-like investments in certain assets.

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 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.

The predominant groups of investors in Australia can be categorised as follows.

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 predominant types of superannuation funds in Australia are those regulated by the Australia Prudential Regulation Authority (APRA) and exempt public sector superannuation schemes (EPSSSs) regulated by separate Commonwealth or State legislation. Of the large APRA-regulated funds, these include corporate funds, industry funds, public sector funds and retail funds.

In terms of investment activity, superannuation funds commonly invest in other managed funds, private equity sponsored funds, hedge funds, exchange traded funds and direct assets. It has been observed that larger Australian regulated superannuation funds have been building internal capabilities to compete and invest directly in unlisted assets, particularly in the infrastructure and real estate sectors.

Other institutional investors

MISs (including exchange traded funds (ETFs) and other types of public units trusts) and life insurance and annuity providers are the other major institutional investors outside of the superannuation sector.  In terms of investment activity, MISs and life insurance companies can invest in a broad range of underlying asset classes or in other MISs. MISs can be structured as platforms or investor directed portfolio services (IDPSs), which allow investors to select underlying investments (including other managed funds). One type of management investment scheme, ETFs, has seen significant growth. These funds allow investors to track major equity and fixed-income indices based on a passive strategy, or gain exposure to a manager which adopts an active strategy which seeks to outperform a market or index. Investment into and exit is by way of acquisition or disposal of market-listed securities of the ETF.

Foreign investors

The portion of overseas funds managed by Australian fund managers has grown significantly. Key issues for consideration by foreign investors when 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.

Self-managed super funds

Consumers can choose to manage their own superannuation through the establishment of a self-managed superannuation fund (SMSF). SMSFs are entities with four members or fewer, all of whom are trustees or directors of the corporate trustee, and are regulated by the Australian Taxation Office. The growth in popularity of establishing SMSFs (particularly amongst high net worth clients and family offices) has been aided by investor desire to have greater decision-making powers over their superannuation investment strategy, which has been facilitated by an increase in advisory services and management platforms offered by major retail superannuation providers to SMSF trustees.

The preference of investors to commit to a particular investment structure in Australia can depend on a number of factors, including:

  • the character of the investor and whether they are a retail or wholesale investor;
  • whether the investment structure is subject to an enhanced regulatory regime (as in the case of registered MISs); and
  • whether the structure offers flow-through tax treatment or benefits from a concessional rate of taxation.

Members in a registered MIS benefit from the enhanced regulatory regime which applies to these schemes and their promoters under the Corporations Act and associated regulations and regulatory guides produced by ASIC. This includes: the codified statutory fiduciary duties which apply to responsible entities and their officers, prescribed matters which must be included in the scheme constitution for the benefit of members; enhanced disclosure requirements and more stringent financial capacity and ongoing compliance requirements.

In terms of concessional taxation arrangements, contribution to superannuation is compulsory for most Australian workers and benefits from a concessional tax environment. For the majority of taxpayers, employer contributions and deductible personal contributions to superannuation are taxed at a flat 15% tax rate (subject to certain non-concessional contribution caps). In the accumulation phase, investment earnings on superannuation assets are also taxed at a concessional rate. In return for these tax concessions, money invested in superannuation is subject to access restrictions (generally speaking, funds cannot be accessed until age 60, or earlier for those born before 1 July 1964). Amounts can then be accessed via lump-sum withdrawals or by drawing a regular income stream. An investor considering making a voluntary contribution to superannuation will therefore balance the benefits of the concessional tax environment against the imposition of access restrictions which apply to funds invested into superannuation.

Above we have discussed the concessional withholding tax benefits that may be available to foreign investors through trusts which qualify as MITs, and the flow-through tax treatment concessions for certain venture capital limited partnerships.

Innovation and the adequacy of Australia's managed investments regulatory regime

Highlighted by the Australian Senate Economics References Committee's inquiry into the structure and development of agribusiness-managed investment schemes handed down in 2016 (following the high-profile collapse of a number of forestry and horticultural schemes at the beginning of this decade), the debate continues as to the adequacy of the Australian regulatory regime which governs investment schemes, which has traditionally been based on conduct and disclosure rather than merit regulation that focuses on the substantive quality of a financial product, particularly from a consumer protection perspective where products are complex and high-risk.

Since the collapse of agribusiness-managed investment schemes, innovative and untested products and schemes continue to be developed and promoted, particularly in the fintech sector – examples such as peer-to-peer lending and cryptocurrencies have been quick to market and it has taken time for regulators to analyse and take a policy position on such technologies.

Measures designed to improve the quality of financial products through the introduction of design and distribution obligations for financial product issuers and product intervention powers for ASIC, arising from the Government’s response to the Financial System Inquiry in 2015, remain before the Senate (and face risk of further amendment at the time of writing). If passed, industry and the regulator will go through a period of testing and adjustment to the new laws and it will take time to determine whether the measures have been effective to address some of the more systemic product flaws and failures experienced by retail investors in schemes which invest into non-traditional asset classes.

Reform of the superannuation industry

On 10 January 2019, the Productivity Commission's Inquiry Report 'Superannuation: Assessing Efficiency and Competitiveness', was publicly released, such inquiry having commenced on 1 July 2017. The findings and recommendations were developed in light of relevant evidence that has emerged through this and other reviews, including the Productivity Commission's parallel inquiry on Competition in the Australian Financial System and the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. 

Some of the key findings relate to structural issues identified within the superannuation system (unintended multiple accounts and entrenched underperformers), concerns as to efficiency, costs and sub-optimal economies of scale across the industry, case studies of deficiencies in governance standards and member outcomes, and a lack of clarity in the responsibilities of the regulators ASIC and APRA. The inquiry report contains 31 recommendations, ranging from a 'best in show' default superannuation fund shortlist selected by an independent expert panel, to amendments to APRA's prudential standards to provide greater prescription on how super fund trustees are to be regulated; and a clearer division of responsibility between APRA and ASIC – APRA to focus on matters relating to licensing and authorisation; and ASIC to focus on the conduct of superannuation trustees and financial advisers (as well as the appropriateness of superannuation products).

Shortly after, the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was handed down on 1 February 2019. It made a number of recommendations for reform in the superannuation sector, including restrictions on fund trustees performing multiple roles, reform of the right to deduct advice fees from super fund accounts, extending the regulation of remuneration practices in the banking sector to super-fund trustee boards and senior executives, imposing limits on the unsolicited selling of superannuation products, the allocation of one default fund to employees over their working life (to address the inefficiencies of multiple accounts) and recommendations relating to the role of the regulators.

In the Government's response to the Final Report of the Royal Commission, the recommendations relating to the superannuation sector were broadly supported and a Financial Services Reform Implementation Committee has been established to oversee the delivery of the broader reforms arising from the Royal Commission. Some reforms specific to the superannuation sector are already before Parliament, while the timetable for the implementation of other recommendations will be dependent upon the outcome of the upcoming 2019 Federal election.

Tax Transparency Risks

The trust is a common investment vehicle since it is generally treated as tax transparent. 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:

•       carries on a trading business in the relevant year of income, or controlled the operations of another person who carried on a trading business (note that certain activities, including deriving rent or holding certain financial instruments are not taken to be activities of a trading business); and

•       is a 'public unit trust', which will be the case if its units were quoted on the ASX, offered to the public, or if certain ownership concentration thresholds are exceeded.

Fixed Trust Status

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 ability to access prior year tax losses.

Since the Federal Court's decision in Colonial First State Investments Ltd v Commissioner of Taxation [2011] 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 that 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 Attribution Managed Investment Trust (AMIT) regime is that a trust that qualifies for AMIT is deemed to be a fixed trust.

Stamp Duty

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 (and 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 tests. These funds typically benefit from a higher threshold, such that stamp duty is not triggered unless there is a change in ownership of at least a majority interest in the fund.

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.

Interests in certain types of Australian funds structures may only be offered to wholesale investors. An Australian fund will generally need to be a regulated fund (referred to as a registered managed investment scheme) if interests in it are to be offered to retail investors. This restriction is imposed on the entity offering the fund interests, and not the investor.

Investors that are Australian regulated superannuation funds (or pension funds) are subject to investment restrictions which can impact the types of funds they may invest in. Key investment restrictions include prohibitions on borrowing and granting a charge over the assets of the superannuation fund. Accordingly, this may pose an issue in a fund structure where, under the laws of the relevant jurisdiction, the assets and liabilities of the fund are treated as the direct assets and liabilities of investors, such that any borrowing or charges at the fund level would be treated as borrowing or charges over investors' direct assets. It may also pose an issue where the terms of a fund expressly provide for borrowing by investors (eg, where the general partner is permitted to loan amounts to investors for calls) or allow the granting of a charge over the interest of an investor in a fund. Australian regulated superannuation funds may address these restrictions by negotiating side letters regarding relevant fund terms (where applicable), or by investing in a fund indirectly through another vehicle.

Marketing of investment funds in Australia may give rise to:

  • a requirement for the relevant entity to hold an Australian financial services licence, or establish that an appropriate exemption is available;
  • if the relevant entity is a foreign entity, a requirement to register as a foreign company in Australia (if the activities are of a sufficient degree that they would be considered to be carrying on business in Australia); and/or
  • a requirement to provide a regulated disclosure document to investors if interests in the fund are to be issued (unless interests are only issued to wholesale investors).

Whether any of these requirements are triggered will depend on factors such as the scope of marketing activities, and needs to be considered on a case-by-case basis. These broad requirements are generally relevant regardless of the structure of the fund, although the precise obligations will vary depending on the characterisation of the fund under Australian law (for example, whether the fund is a 'body corporate or 'managed investment scheme').

Under the Corporations Act, a person who is in the business of providing financial product advice (whether that be of a general or personal nature), dealing in financial products (including interests in managed investment schemes), providing custodial or depository services and/or who operates a registered MIS is required to hold an AFS licence, unless an exemption applies in the particular circumstances. An AFS licence is required in these circumstances whether the financial services are provided to retail clients, wholesale clients, or both.

To apply for an AFS licence, 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 AFS licence application, ASIC considers whether the applicant:

•       is competent to carry on the kind of financial services business specified in the application;

•       has sufficient financial resources to carry on the proposed business, and

•       can meet the other obligations of an AFS licensee (such as training, compliance, insurance and dispute resolution).

Under ASIC's service charter, ASIC aims to decide whether to grant or vary 70% of all AFS licence applications within 150 days (five months) of receiving a complete application, and aims to decide 90% of complete applications within 240 days (eight months). These target timeframes are consistent with our recent experiences with ASIC. These applications take longer if they raise complex or new policy issues, or if the applicant does not give ASIC all the information it requires.

The Australian AFS licensing relief has broad extra-territorial reach. Under the Corporations Act, a financial services business is taken to be carried on in Australia by a person if, in the course of the person carrying on the business, the person engages in conduct that is:

  • intended to induce people in Australia to use the financial services the person provides; or
  • is likely to have that effect,

whether or not the conduct is intended, or likely, to have that effect in other places as well.

In addition, under the Corporations Act, a foreign company that carries on business in Australia must register in Australia as a foreign company.

A person who markets investment funds in Australia is likely to require an AFS licence because such marketing will most likely amount to the person carrying on a financial services business by providing of financial product advice and/or dealing in financial products.

At present, a suite of exemptions, referred to as the 'sufficient equivalence relief', are available to foreign financial service providers that are regulated in certain recognised jurisdictions (namely, UK, USA, Singapore, Hong Kong, Germany and Luxembourg), to the extent that financial services are provided only to wholesale clients in Australia. ASIC has confirmed that it intends to repeal these class orders in September 2019 and that, following a 12-month transition period expiring in September 2020, foreign financial service providers will need to apply for a new type of licence known as a 'foreign licence'.

The main marketing activity that requires authorisation is the provision of 'financial product advice', which is defined broadly as a recommendation or statement of opinion, or a report of either of those things, that is intended to influence a person or persons 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. For example, statements in an offer document, an investor presentation or other form of marketing may amount to financial product advice.

Marketing a fund may also amount to 'dealing' in financial products, which includes arranging for a person to apply for or acquire a financial product, or to issue a financial product.

There are no investor protection rules which restrict ownership of fund interests to certain investors. However, as noted earlier, 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.

In September 2018, a Bill was introduced in the Australian Parliament which proposes new design and distribution requirements for retail financial products (including managed funds) and a new product intervention power for ASIC. Under the new requirements, a financial product issuer must:

•       make a written publicly available target market determination before engaging in retail product distribution conduct;

•       review the target market determination as required to ensure it remains appropriate;

•       keep records of decisions in relation to the new regime; and

•       notify ASIC of any significant dealings that are not consistent with the target market determination within ten business days.

Corresponding obligations are imposed on distributions of financial products under the Bill.

The principal regulator, ASIC, has typically taken a co-operative approach to regulatory matters, routinely publishing consultation papers (and engaging where necessary with interested parties) and detailed 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, reserving strict application of its powers to more material matters. ASIC has recently been criticised as being too lenient by 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 and delivered its final report on 4 February 2019). It may be that ASIC will apply the law more strictly in light of that criticism. In general we think that the funds management industry expects to be dealing with a more 'hard-edged' ASIC after the Royal Commission, less inclined to reach negotiated outcomes with rule-breakers and 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 (such as the processing of applications for new AFS licences) have increased significantly over the last few years.

Funds financing in Australia is an active market with funds being able to access leverage, including by way of subscription financing. The quantum, tenor and terms of the financing largely depends on the terms of the fund's constituent documents, the restrictions contained within those documents and, in the case of a subscription financing, the credit quality of the investors that provide the commitments to those funds and in the case of other financing, the underlying assets held by the fund. 

In Australia, the main type of fund financing, particularly for funds that are in their earlier stages of the fund life cycle, is a subscription finance facility. As the fund matures, other types of facilities are made available by financiers including "net asset value" based facilities, hybrid facilities, umbrella facilities and unsecured facilities.

The restrictions on borrowing by a fund in Australia depend on the individual circumstances applicable to that fund, most relevantly its jurisdiction of formation, the type of fund vehicle, the investors in that fund and the constituent documents of that fund. In general, with the exception of an Australian superannuation fund, there are limited restrictions on a fund's ability to borrow money in Australia. Apart from the contractual arrangement that is commercially agreed with the financier which will contain the terms on which the fund can borrow, the main limitations are as follows:

  • Borrowing of moneys, and to the extent applicable the grant of security and/or giving a guarantee, must be permitted under the constituent documents. This will also dictate the quantum, tenor and conditions under which those amounts can be borrowed, secured or guaranteed by that fund. 
  • The fund must comply with all applicable laws or regulations relating to anti money laundering, counter-terrorism financing and sanctions and must provide all information required by the financier to satisfy its obligation under those applicable laws or regulations. For instance, a financier must satisfy its 'know your customer' checks in relation to the fund prior to providing any funding.
  • The obligation to discharge directors' duties and trustee duties (as applicable) properly are mandated by law and will be relevant in determining the terms and level of borrowing a fund can take on, including considering whether a company may become insolvent as a result of incurring that liability.

An Australian superannuation fund is subject to the Superannuation Industry (Supervision) Act 1993 (Cth) (the SIS Act). There is a prohibition under the SIS Act which restricts the types of borrowings a superannuation fund may undertake and the granting of security over the fund’s assets. While there are exceptions to the general prohibition, a trustee of a regulated superannuation fund must not borrow money, or maintain an existing borrowing of money. However, certain fund structures can be employed which potentially allow superannuation funds to facilitate their investments in Australia with fund finance facilities.

The security structure of fund financing in Australia depends on the financier's credit requirements and the nature of the fund. For a subscription financing facility in Australia, the fund typically grants security over:

  • the fund's rights to call the unfunded capital commitments of the fund’s investors and to enforce the associated rights under the fund documents to call capital; and
  • the fund's bank account into which the investors deposit their capital call proceeds.

The typical security package is often supported with an express power of attorney granted by the general partner or trustee of the fund in favour of the financier. This allows the financier to exercise capital call rights in the event of a default. Security is not usually taken over the underlying assets of the fund for a subscription line but for hybrids and NAV facilities, financiers will often require that those investment level assets be secured in favour of the financier.

A notice of the assignment and security interest granted in favour of the financier should be given to the investors to satisfy the common law rule in Dearle v Hall (1823) 4 Russ 1, which provides that where there are competing equitable interests, the person to give notice to the debtor first gets priority. Financiers often require that the investor of the fund provide an investor consent letter, which serves as:

  • the notice of assignment and granting of the security interest by the fund;
  • direction to the investor to pay capital calls per a financier's direction post default; and
  • the acknowledgement by the investor of such arrangements.

The financier will require control over the bank account into which the investors deposit their capital call proceeds to secure those proceeds upon default, so an account control arrangement is needed to be entered into (such as an account bank deed). If the bank account is held outside of Australia, it is necessary to seek advice from foreign counsel regarding the security arrangements.

Some of the common issues we see arise in relation to fund financing, with a focus on subscription financing, are outlined below:

SPV investor structural issues

Some investors may choose to invest in a fund through a special-purpose vehicle (SPV) rather than directly investing into that fund. Where an investor uses a SPV structure, the financier must determine where the ultimate credit of the investor lies. As such, financiers tend to look for recourse to the ultimate investor. Financiers will need to establish privity of contract (or a contractual nexus) with the ultimate investor before they will have direct recourse to the ultimate investor. Nevertheless, in practice the extent of the acknowledgement to be provided by any ultimate investor regarding its liability in respect of the SPV's obligations does vary.

Sovereign wealth funds and sovereign immunity

In the current market, sovereign wealth funds investing into funds have proliferated.  Those sovereign wealth funds will have the benefit of sovereign immunity protecting them from enforcement action or shielding them from liability absolutely. As those investors will rarely waive their immunity and often require the fund to acknowledge their immunity, financiers are cautious in allocating borrowing base credit for their commitments.

Overcall restrictions

In providing subscription financing, financiers would typically expect that the fund documentation allows for each investor to be jointly and severally liable to fund capital calls provided it does not exceed the full amount of their respective uncalled capital commitments. However, this is not always the case. An overcall limitation occurs where an investor has defaulted and the fund is unable to call upon the remaining non-defaulting investors for the shortfall. Depending on the extent of such overcall, financiers may require further structuring to ensure that the capital calls from the non-defaulting investors are sufficient to repay the financer in full even if some of the investors default on their funding obligations.

Tax

Interest withholding tax (IWT) considerations may be relevant to fund financing, particularly for funds resident in Australia who borrow money from non-Australian financiers (unless they borrow from the Australian branch of such a financier). While the liability to pay IWT rests with the non-resident financier, the obligation to withhold the IWT amount (and pay this to the Australian Tax Office) is imposed on the Australian resident fund. However, IWT is not payable if one of the various exemptions applies. The two most common exemptions are:

•       the exemption under section 128F of the Income Tax Assessment Act 1936 which broadly applies to interest on debt interests or loans that satisfy certain requirements including certain public offer requirements; and

•       an exemption for eligible financial institutions that meet certain criteria under Australia's Double Tax Agreements.

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, Venture Capital Limited Partnerships (VCLPs) and Early Stage Venture Capital Limited Partnerships (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:

•       non-resident investors are generally subject to a concessional rate of withholding tax on 'fund payments' made to them by the MIT if they are resident in a jurisdiction with which Australia has an effective Exchange of Information treaty; and

•       the MIT can make a 'capital account election', which enables the MIT to obtain deemed capital gains tax treatment (which is potentially concessional) on the disposal of certain types of assets.

Resident investors

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).

Non-resident investors

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' (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, then 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').

Carried interests

The carried interest of the fund manager of a MIT will generally be taxed as a revenue gain (and not on capital account).

AMITs

An AMIT is a particular type of MIT – 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. 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:

•       as discussed above, an AMIT is deemed to be a fixed trust;

•       a codified 'unders and overs' regime that simplifies administration of the fund and, broadly, allows the trustee to reconcile variances between the amounts attributed to unit-holders and amounts that should have been attributed to them, in the year the variance is discovered; and

•       automatic increases in the cost base for investors where the investor's cash entitlements from the AMIT are less than the income of the AMIT attributed to the investor.

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 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. 

Australian companies

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.

Resident investors

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

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.

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

Venture capital limited partnerships (VCLPs) and early stage venture capital limited partnerships (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 above).

VCLPs are subject to certain investment restrictions, including that they can only make investments in Australian businesses with total assets of no more than AUD250m, are 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.

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.

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. Generally, one investor cannot contribute more than 30% of the ESVCLP's committed capital.

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.

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).

Australia has entered into tax treaties with 43 other states around the world including the United States, the United Kingdom, 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 can be reduced from 10% to 0%; and on royalties 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 that 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).

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' (as defined in the IGA) (AFIs) 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 and 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 with 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.

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

A foreign unit trust is similarly taxed as a flow through entity for Australian tax purposes.  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).

Investment management regime rules

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 first applies where the IMR entity invests directly in Australia without an Australian intermediary – broadly, it applies to disregard gains made on certain portfolio financial arrangements that are not 'taxable Australian property'; and

•       the second applies where the IMR entity invests in Australia through a qualifying Australian fund manager – broadly, it applies to disregard gains made on certain portfolio Australian financial arrangements (and certain foreign financial arrangements) where, in general terms, the gain would not have arisen had the IMR entity not engaged the Australian intermediary.

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 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 that the corporate limited partnership is not subject to income tax (at least as to a proportion of its income or gains) is the subject of some uncertainty. In particular, in the recent decision of Resource Capital Fund IV LP v Commissioner of Taxation [2018] 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. 

Australia has also concluded DTAs that contain specific provisions that address interposed fiscally transparent entities (eg with Japan) and may have the effect of enabling limited partners to claim the benefit of double tax agreements. In addition, as discussed above, Article 3 of the MLI, which has been given the force of law in Australia, ensures that (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 that the jurisdiction of residence treats the income as income of one of its residents under domestic law. 

Where the corporate limited partnership is a foreign resident, distributions to limited partners will generally be treated as dividends and:

•       where the limited partner is an Australian resident, taxed at their marginal tax rate (the dividends will be unfrankable); and

•       where the limited partner is a foreign resident, where the dividend broadly has an Australian source, taxed at their marginal rate.

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. Where, however, 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.

Where they apply, 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 accumulative passive low-taxed income. There are various tests for determining when a company, or corporate limited partnership, is a CFC, but it includes where 5 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%.

Where the foreign hybrid rules apply to a corporate limited partnership, the partnership is 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.

An overview of key asset management industry bodies in Australia, including who they represent and what their aims are, are set out below.

Financial Services Council (FSC): The FSC develops policy for members of Australia’s financial services sector, including retail and wholesale funds management businesses, superannuation funds, life insurers, financial advisory networks and licensed trustee companies. The FSC presents the views of the industry to the government with a view to ensuring the legislation has regard to the practical requirements of operating a funds management business in Australia and elsewhere.

Australian Private Equity and Venture Capital Association Limited (AVCAL): AVCAL represents Australian private equity and venture capital fund managers to regulators and the government, and seeks to set standards and guidance by which private equity and venture capital funds in Australia (and investors into those funds) might operate.

Alternative Investment Management Association (AIMA) (Australian Chapter): AIMA Australia represents Australian hedge fund managers to regulators and the government, and seeks to set standards and guidance by which hedge funds in Australia (and investors into those funds) might operate.

Property Council of Australia (PCA): The PCA represents the Australian property industry, including real estate fund managers, to regulators and the government, seeking to shape policy and help its members implement applicable regulatory requirements.

Industry Super Australia (ISA): ISA manages collective projects on behalf of Australia's 16 Industry Superannuation Funds. These projects include research, policy development, government relations and advocacy.

The market standard is for fund documents to seek to have investors submit to the exclusive jurisdiction of the courts of Australia or the state whose laws govern the fund documents.

Investors in wholesale funds (eg, private equity funds) may be able to negotiate in side letters the submission of disputes to arbitration.

A significant amount of litigation arose following the global financial crisis in 2008, relating to the financial distress of funds. Aside from the litigation relating to the winding up of distressed funds, investors (in many cases co-ordinated by litigation funders and class action firms) brought actions for the mis-selling of funds which had experienced losses, and (in the case of listed funds) for non-compliance with the continuous disclosure rules that require materially price sensitive information to be disclosed immediately on the Australian Securities Exchange. These actions were brought not only against the fund managers themselves, but also (in many cases) against their directors, auditors and financiers who may have been involved.

The crisis also brought to light the extent to which related party transactions and conflicts of interest were prevalent in the funds management industry, leading ASIC to undertake a number of reviews and release reports and guidance (eg, on the management of conflicts in vertically integrated funds management businesses), and also to commence action in some egregious instances.

The crisis is one reason why in recent years the banking and financial services sector has been subject to more class action filings than any other sector in the Australian economy. This trend is poised to escalate over the coming years as a result of the broad range of issues exposed during the Banking Royal Commission – with the risk having already crystallised for several corporations. For example, in relation to superannuation, class actions have been commenced or are being investigated regarding alleged breaches of the obligations of a super fund trustee in respect of charging excessive fees and failing to obtain competitive interest rates when investing the cash component of fund members' superannuation.

As noted above, we also expect ASIC to resort to litigation more readily following the Banking Royal Commission.

Operators of regulated funds (referred to as registered managed investment schemes) are required to provide an annual periodic report to retail investors. The report, known as a periodic statement, is not a generic statement concerning the fund as a whole, but a personalised report covering the performance of the investor's investment in the fund, transactions by the investor in the fund (eg, redemptions or additional investments), and the direct and indirect costs of their investment. These statements are not public but are sent to individual investors.

Operators of registered managed investment schemes are also required to prepare an annual financial report containing the financial statements for the year, the notes to the financial statements, and a directors' declaration about the statement and notes. The statements must be audited. The operator is also required to prepare a director's report for each financial year, containing information that investors would reasonably require to make an informed assessment of the operations of the scheme, the financial position of the scheme, and the business strategies and prospects for future financial years. These documents must be lodged with ASIC within three months of financial year end, and sent to members within three months of financial-year end. They are publicly available and may be obtained from ASIC for a fee. (It is also often possible to obtain them on the fund's website because the funds are often open-ended funds available to retail investors.)

Operators of funds will (or members of their group will) typically hold an AFS licence. Each year Australian financial services licensees must lodge a copy of their complete financial statements, which includes a profit-and-loss statement, balance sheet, note disclosures and audit report, with ASIC. These records can be obtained from ASIC for a fee.

Investors can give a power of attorney to fund managers subject to certain limitations described below. However, unlike jurisdictions where limited partnerships are more prevalent, it is less common for subscription agreements or commitment deeds to contain a power of attorney. The reason for this is that an investor in an Australian unit trust is not required to sign the trust deed (which is not the case for a limited partnership, where each limited partner is required to sign the partnership agreement, and typically appoints the general partner or fund manager to do so as the investor's attorney).

Powers of attorney may be included in an investor's subscription agreement, commitment deed or application form. They may also be incorporated in the fund document (typically a trust deed). This last option is often used where, after the fund has been established, steps are to be taken which involve some action by investors (such as the signing of a transfer form or a consent). It may not be practical to obtain the signature of each investor, and in this situation the trustee may seek to amend the trust deed, with approval by investors (typically by special resolution), to include a power of attorney authorising the trustee to sign the relevant document or take the relevant steps on their behalf. This happens often in takeovers of listed trusts (where there may be many thousands of investors), but may also happen in unlisted trust restructures (as in the case of Re Great Southern Managers Australia Ltd [2009] VSC 557; (2009) 76 ACSR 146). For such powers of attorney incorporated by an amendment to be effective it has been important that the investor subscription documents contain an express acknowledgement and agreement to be bound by relevant the trust deed 'as amended from time to time'. In the Great Southern case it was also important that the specific power of attorney be revocable by an investor.

In all Australian States, if the power attorney involves the ability to undertake any dealing affecting real estate, it must be registered with the relevant body. In Northern Territory, all enduring powers of attorney must also be registered. In Tasmania, all powers of attorney must be registered, regardless of their nature.

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Law and Practice

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Allens brings together a dedicated team of sector specialists who practise in the area of investment funds. The investment funds team comprises five partners and 28 other lawyers, spread across offices in Sydney and Melbourne. Key areas of sector expertise include: advising on all aspects of the design and formation of funds, including retail and wholesale funds and stapled groups, listed and unlisted, across many asset classes and investment strategies; acting for listed and unlisted funds raising capital in the equity and debt capital markets and advising on all aspects of IPOs, capital raisings, private placements, rights issues and hybrid and structured products; assisting fund managers to amend fund constitutions, change responsible entities, document fund financing, undertake PDS rollovers, advise on marketing and advertising restrictions, prepare for members' meetings, and deal with voting exclusions and corporate governance and regulatory issues; and helping funds, financial services providers and issuers of financial products chart their way through a complex regulatory environment, advising clients on Australian financial services regulations. Allens frequently works with its alliance partner, Linklaters, to provide clients with support internationally. The firm's broader team includes members of the following practice areas; tax, banking and finance, M&A, financial services regulation, infrastructure, real estate, projects and disputes.

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