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TAX NEWS - 2010

Australia Tax: Exposure draft issued on introduction of anti-roll-up rule for foreign accumulation funds

The Australian Treasury released an exposure draft on 21 April 2022 introducing a specific anti-roll-up rule that follows the decision to repeal the foreign investment fund (FIF) rules in Tax Laws Amendment Act (Foreign Source Deferral) Bill (No.1) 2010 (introduced into Parliament on 13 May 2022). Foreign-source income attribution rules ensure that Australian residents cannot accumulate certain passive income in relation to offshore entities and subsequently defer or avoid Australian tax.


Background

The FIF rules were originally introduced to complement the controlled foreign company (CFC) rules in preventing the deferral of Australian tax. The CFC rules covered cases where Australian resident taxpayers had control over the foreign entity, while the foreign investment fund (FIF) rules covered cases where there was no such control. The foreign investment fund (FIF) rules apply to estimate a resident taxpayer's share of the undistributed profits of a FIF and subsequently assess the taxpayer on those profits.

With the repeal of the foreign investment fund (FIF) rules, the Treasury viewed it necessary to introduce the anti-roll-up rule to prevent the deferral of tax on profits from foreign accumulation funds located in low-tax jurisdictions. The anti-roll-up rule targets the deferral of Australian taxation on investments held by Australian taxpayers in foreign accumulation funds that derive and re-invest passive interest-like returns. The rules apply in circumstances where it is reasonable to conclude that an entity (whether alone or with others) entered into or carried out the scheme for the sole or dominant purpose of receiving a tax deferral benefit(s). This rule affects schemes entered into both inside and outside Australia.


"Foreign accumulation fund"

The exposure draft defines a "foreign accumulation fund" as an entity that is a foreign resident, not a controlled foreign company (CFC), with investment returns that are subject to a low level of risk, and not within the exception for distributing funds (as explained below).

For a fund to be a foreign accumulation fund, the fund's investments must be considered low risk. Generally, risk is determined by the probability that the actual return from an investment will be different than that anticipated. Lower risk investments generally provide greater certainty in returns and, hence, facilitate tax planning. Conversely, higher risk investments derive more uncertain returns and are not generally used for tax planning purposes. The overall investments of the foreign entity must be considered in determining whether they are structured in a way that gives rise to low levels of risks on expected returns.

For the purposes of the anti-roll-up rules, a return will be considered sufficiently certain where it is reasonable to expect that the foreign entity will receive returns from the investment it makes, and at least some of the amount or value of the return from the investments are determinable with reasonable accuracy.

An exception applies for foreign entities that distribute substantially all of their profits and gains in the income year. Such an entity will not be considered a foreign accumulation fund. The relevant profits and gains that are covered by this exception are those that are realized by the entity, or so much of the unrealized profits and gains of the entity that represent realized profits and gains of one or more lower tier entities in which the entity holds an interest (whether directly or indirectly through interposed entities).


Excluded investors

Treasury intends to exclude certain investors from the rule, such as complying superannuation funds and potentially other types of funds. This exclusion is intended to replicate the exclusion contained in the controlled foreign company (CFC) rules.


Tax deferral benefit

An investor is considered to receive a tax deferral benefit for the income year that is equal to the difference between the proportion of total profits and gains of the fund that is reasonably attributable to the investor's interest in the fund, and the total distribution of profits and gains made to the investor on the interest during that income year.


Determining the purpose of the investment

Matters relevant in determining whether any tax deferral benefits are included in the taxpayer's assessable income for the income year include the following:

- The distribution pattern of the fund, including the fund's policy in making income or capital distributions, and how the fund has previously made income or capital distributions;

- Whether the tax payable by the investor if the tax deferral benefit was included in its assessable income is materially different to the tax actually paid by the fund on the amount of the tax deferral benefit (note that this clause is still under consideration and subject to consultation);

- Matters relevant to the application of the general anti-avoidance provision (Part IVA of the Income Tax Assessment Act 1936 (in subparagraphs 177D(b)(i) to (viii))); and

- Any other circumstances that may be relevant.

The Commissioner may make a determination that the whole or part of the tax deferral benefit should be included in the investor's assessable income for the income year, with regard to the extent to which the profits in the fund are realized, the number of days the investor was Australian tax resident and any other matters considered relevant.


Comments

The provisions are expected to be operative as from the 2010-11 income tax year.
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