I OVERVIEW OF RECENT ACTIVITY
i Asset management activity in the jurisdiction during the past year
Australia is one of the world's largest asset management markets, with the third-largest investment fund pool in the world.2 As of 31 March 2016, Australian asset management institutions held around A$2.6 trillion worth of assets.3 This is equivalent to around 3 per cent of global assets under management and around 75 per cent of the total financial assets of Australian banks.4
The Australian industry's assets under management have more than doubled over the past decade.5 The growth and strength of Australia's asset management industry has been underpinned by a sophisticated investor base, mature and innovative financial markets, participation by leading global financial institutions, the development of innovative investment products, an efficient regulatory environment and, significantly, Australia's compulsory retirement income (superannuation) system.
The 2007-2008 global financial crisis affected Australia considerably less than many other countries. The Australian economy has recorded better growth outcomes than most other developed economies, many of which have experienced severe recessions and rises in unemployment. The Australian financial system was also more resilient. Notably, Australian banks continued to be profitable, and did not require any capital injections from the federal government. This resilience has continued, sustained by sound macroeconomic policies, strong institutions and continued demand for hard and soft commodities from Asia. Australia is the only developed economy to have recorded no annual recessions during the past 23 years, placing it alongside high-growth economies such as China and India.
The past year has seen a number of important regulatory developments. Progress has been made on the implementation of the Asia Region Funds Passport, a model to facilitate more streamlined investment across participating jurisdictions in the Asia Pacific region, including Australia. This year also saw the announcement of two new types of collective investment vehicles, the purpose of which is to attract more foreign investment into the Australian market. Trends that continue to affect Australia's asset management industry include the rise of Asia, digitisation, an ageing population, and local and global volatility and uncertainty.
The main economic factors influencing the value of Australia's asset management industry over the past year were decreases in the S&P/ASX 200 by 13.7 per cent and in the price of foreign shares by 5 per cent, and the appreciation of the Australian dollar against the US dollar (by approximately 0.3 per cent).6
In the past few years, there have been significant reforms made to taxation laws to encourage foreign investment in Australia through Australian funds and to remove tax uncertainty facing investors.
To facilitate foreign investment in real estate, the government introduced special rules for eligible domestic investment trusts that are widely held, referred to as managed investment trusts (MITs). MIT investors resident in qualifying foreign countries are subject to concessional withholding tax rates of 15 per cent (rather than 30 per cent) on ‘fund distributions' (comprising rental income and net capital gain) made by MITs.
Following an extended period of industry consultation, the new Attribution Managed Investment Trust (AMIT) regime introduces an optional attribution model of trust taxation for qualifying MITs, which replaces the current trust taxation provisions based on ‘present entitlement' and codifies certain administrative practices relating to tax. Qualifying MITs have been able to elect into the new AMIT regime from 1 July 2016 (although they can opt to apply the rules retrospectively from 1 July 2015).
Following extensive industry consultation and review, Australia has also introduced an Investment Manager Regime (IMR), which took effect from 1 July 2015, with an option to elect for retrospective application from 1 July 2011. The main purpose of the IMR is to incentivise foreign funds to invest into Australian markets, and to engage Australian fund managers and intermediaries by providing relief from Australian tax with respect to most investments in Australia. The IMR has been developed following extensive consultation with industry and is based broadly on the UK Investment Manager Exemption (IME) model.
The scope of the tax reforms show the commitment of the government to creating greater tax certainty and attracting foreign investment into Australia with a view to increasing the size and strength of the asset management industry.
II GENERAL INTRODUCTION TO the REGULATORY FRAMEWORK
Outside the specific rules that apply to the regulation of the management of insurance and superannuation fund assets, the overriding regulatory framework applicable to asset management in Australia is that contained in securities laws. The primary regulation governing the Australian asset management industry is the Corporations Act 2001 (Cth) (Corporations Act) and its corresponding regulations. The Corporations Act is federal legislation that applies at a national and state level.
Australia's corporate, markets and financial services regulator is the Australian Securities and Investments Commission (ASIC). ASIC administers and enforces the laws, which apply to activities such as:
- a offers to investors of securities and other financial products in Australia;
- b establishing and operating investment funds; and
- c the provision of financial services in Australia and the licensing of financial service providers (e.g., fund managers).
ASIC is an independent statutory authority established by the federal government to administer and enforce the Corporations Act. ASIC is the principal regulator of asset managers in Australia, and is responsible for registration of Australian managed investment schemes, the licensing of fund managers, brokers, custodians and other financial services providers, as well as monitoring compliance with Australia's financial services laws.
Under the Corporations Act, any business or person carrying on a financial services business in Australia is required to hold an Australian financial services licence (AFSL) covering the specific financial services being provided unless an applicable exemption applies. Providing a financial service includes, inter alia, promoting an investment fund (e.g., by providing an offer document for a fund, such as a product disclosure statement or an information memorandum or making a recommendation about a fund), arranging for a person to invest in a fund, issuing interests in a fund and providing investment management services to a fund. An investment fund itself may also need to be registered with ASIC, particularly if it is offered to retail clients.
If a manager or promoter of an investment fund is regulated by a foreign recognised regulator (such as the Financial Conduct Authority in the United Kingdom or the Securities Exchange Commission in the United States), it may be able to apply to ASIC for an exemption from the requirement to hold an AFSL to, inter alia, promote a foreign investment fund in Australia, provided that the promotion is limited to ‘wholesale' clients (e.g., institutional, professional or high-net-worth investors).
Appropriately licensed fund managers offering interests in investment funds to Australian retail investors must do so on the basis of a prospectus or product disclosure statement, which is a regulated disclosure document, and the fund must be registered with ASIC.
The Australian Prudential Regulation Authority (APRA) is Australia's prudential regulator and has oversight of banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, private health insurance, friendly societies and most members of the superannuation industry.
If an investment fund is listed on a licensed financial market, the operator of the fund must comply with the rules of the relevant market, which is usually the Australian Securities Exchange (ASX). The applicable rules of the ASX include the ASX Listing Rules, ASX Operating Rules and the ASIC Market Integrity Rules (ASX Market).
Other regulatory and supervisory bodies relevant to investment funds include the following:
- a the Australian Taxation Office (ATO), responsible for administration of Australia's taxation legislation and the principal revenue collection agency. The ATO also regulates self-managed superannuation funds;
- b the Australian Transaction Reports and Analysis Centre, commonly referred to as AUSTRAC, responsible for administering Australia's anti-money laundering and counter-terrorism financing laws;
- c the Foreign Investment Review Board (FIRB), responsible for advising the government on Australia's foreign investment policy and its administration under the Foreign Acquisitions and Takeovers Act 1975; and
- d the Australian Government Takeovers Panel, responsible for regulating corporate control transactions in widely held Australian entities, primarily by resolving takeover disputes.
Australia has also introduced legislation and rules regulating over-the-counter (OTC) derivative instruments. Australia's OTC derivative reforms provide a framework for the regulation of OTC derivatives reporting, central clearing and trade execution, and affect almost all participants in the financial services sector who trade in OTC derivatives. Under the Australian regulatory framework, OTC derivative reporting and central clearing have commenced, with mandatory trade execution yet to commence.
III COMMON ASSET MANAGEMENT STRUCTURES
Investment funds (described as funds, managed funds, managed investment schemes or schemes) are typically structured in Australia as a unit trust, and would ordinarily come within the (broadly drafted) definition of a ‘managed investment scheme' under the Corporations Act. A unit trust is a trust where the assets are held and administered by the trustee of the trust on trust for the holders of units in the trust. Investment funds offered to retail investors typically have to be registered with the Australian corporate regulator, ASIC. In the case of registered funds, the operator of the fund, being the trustee, is known as the ‘responsible entity' of the fund. An investment fund structured as a unit trust may be open-ended or closed-ended.
Most managed investment schemes are structured and operated to meet the requirements of a MIT, particularly where there are foreign investors. In a MIT, the unitholders' entitlements are predetermined, which may be for income, capital or both.
Tax reforms introducing tax concessions for MITs have increased the popularity of the MIT, particularly for non-residents investing in assets such as property. The tax concessions available to MITs are discussed in Section VII, infra.
As noted above, from 1 July 2016, MITs that meet certain eligibility criteria will be able to irrevocably elect to be taxed under the AMIT regime rather than the general trust taxation provisions. The AMIT rules are the result of extensive consultation between government and industry and are intended to provide certainty and a number of benefits to qualifying MITs and their investors. The key feature of the AMIT regime is a taxable income attribution mechanism (see Section V, infra).
Listed investment companies (LICs) are incorporated as companies, and are closed-ended funds. This means they do not regularly issue new shares or cancel shares as investors join and leave the LIC. Instead, they issue a fixed number of shares on initial public offering, and investors must buy and sell those shares on the ASX. Occasionally, new shares may be issued to increase the size of the LIC, or shares may be bought back or cancelled to reduce the size of the LIC.
This closed-ended structure allows the fund manager to concentrate on selecting investments without having to factor in money coming into or leaving the LIC. This stability can be of assistance to managers who take a long-term approach to investing. As companies, LICs have the ability to pay franked dividends. Unlike a unit trust, an LIC is taxed as a company and is not a pass-through vehicle for tax. For this reason, LICs are a less popular investment structure than unit trusts.
On 3 May 2016, as part of the Federal Budget, the introduction of two new types of collective investment vehicles (CIVs) was announced. The corporate CIV, tailored to retail and wholesale investors, is expected to be operational from 1 July 2017. For more information see Section V, infra.
iii Limited partnerships
A limited partnership is also a relatively simple structure and costs to set up are fairly low. A limited partnership is not a legal entity separate from its partners under Australian law, meaning that the gains and losses of the private fund structured as such flow through to its limited partners. That said, limited partnerships may be treated as separate legal entities for certain purposes. For example, a limited partner may lend money to, and transact business with, the limited partnership. A limited partnership is required to have a general partner and at least one limited partner. A limited partner is not liable as a general partner unless, in addition to exercising rights and powers as a limited partner, the limited partner takes part in the control of the business. Limited partnerships are established under state-based rather than federal legislation. Partnerships are not a common investment structure, and are generally used for infrastructure or private equity investments.
At common law, a partnership exists when two or more persons or entities enter into a business with the view of making a profit. Taxation legislation defines a partnership more widely as ‘an association of persons carrying on business as partners or in receipt of income jointly, but does not include a company'. A partnership (as opposed to holding an investment in joint names) is a separate entity for taxation purposes, and as such requires its own tax file number and tax return. However, it does not pay tax but must distribute income to the partners. Partnerships offer limited distribution flexibility, as any income derived has to be split according to the partnership agreement. Forming a limited partnership is possible in some but not all states in Australia.
The Federal Budget of 3 May 2016 announced two new types of CIV (see Section III.ii, supra) would be introduced. A limited partnership CIV, tailored to wholesale investors, is expected to be operational from 1 July 2018. For more information see Section V, infra.
iv Service providers
The Australian asset management industry is well supported through a large number of service providers including asset consultants, custodians, fund administrators, distributors, prime brokers, rating agencies, trustee and responsible entity providers, and the legal and accounting professions.
Australia has a sophisticated and full-service custody sector. Typical of the global model, the custodian holds assets on behalf of the client, such as the trustee of a superannuation fund or managed fund. The custodian therefore has the legal title to the fund assets, but the powers of investment management remain with the trustees or its delegate (e.g., an investment manager). The main benefit of appointing a custodian is administrative and operational efficiency.
IV MAIN SOURCES OF INVESTMENT
As of March 2016, the size of the asset management market in Australia was A$2.63 trillion, representing a slight increase in size over the previous year7. The vast majority of this investment pool, about 96.6 per cent, is sourced from domestic investment.
Given that Australia has a universal compulsory superannuation regime, it is unsurprising that pension funds (more commonly known in Australia as superannuation funds) make up more than half (74.7 per cent) of the sources of investment into Australia's asset management industry. Australian superannuation funds are major investors in the domestic and global capital and investment markets. The total value of superannuation assets in Australia exceeds A$2 trillion, with almost three quarters of this amount invested into investment funds. This is expected to increase to over A$3 trillion by 2020.8 Australia was the second most rapidly growing pension market in the world during the past 11 years, behind Mexico.9
Other large investment sources for the Australian asset management industry include retail unit trusts (12.2 per cent) and life insurance companies (11.2 per cent). These are followed by investment from overseas, national government, state and local government, general insurance, cash management trusts, non-government trading corporations, common funds, friendly societies and charities.10
A significant institutional investor is the Future Fund, a government sovereign wealth fund that began investing in mid-2007. Future Fund had A$117 billion in assets as at 31 March 2016, making it one of the largest institutional investors in the Asia region.
Australia also has one of the world's highest percentages of individuals with direct and indirect exposures in the stock market. As at June 2015, approximately 6.5 million people (36 per cent of the adult Australian population) owned shares (either directly or via managed investment funds).11 A reflection of the size and sophistication of the retail investor market is the existence of more than 549,747 self-managed superannuation funds (SMSFs), worth a combined A$594 billion.12
V KEY TRENDS
i New collective investment vehicles
A tax and regulatory framework for a new suite of CIVs was announced, but not extensively detailed, in the Federal Budget on 3 May 2016. The government has committed to introducing two new types of CIVs - a corporate CIV and a limited partnership CIV.
The corporate CIV, tailored to retail and wholesale investors, is expected to be operational from 1 July 2017. The limited partnership CIV, tailored to wholesale investors, is expected to be operational from 1 July 2018.
These new CIVs are anticipated to act as ‘look-through' vehicles allowing investors to be taxed as if they had invested directly in the underlying investments. If legislated, the new CIVs will provide an alternative to the unit trust structure (currently the preferred Australian look-through vehicle). It is proposed that the CIVs will be required to meet eligibility criteria similar to those of MITs.
The reform is aimed at enhancing the international competitiveness of the Australian managed funds industry. However, until draft legislation is released, the eligibility criteria for and benefits of the proposed CIV regime remain unclear.
ii Mandatory OTC derivative reporting, central clearing and margining
On 8 September 2015, the Australian government introduced the Corporations Amendment (Central Clearing and Single-Sided Reporting) Regulation 2015 (Regulations) and rules for mandatory clearing of certain OTC interest rate derivatives, set out in ASIC Derivative Transaction Rules (Clearing) 2015 (Clearing Rules).
Both the Regulations and the Clearing Rules represent important steps in the implementation of Australia's OTC derivative reforms, in accordance with the government's commitments to the G20 OTC derivative reforms.
The single-sided reporting relief came into effect in September 2015, just before the reporting obligations commenced for Phase 3B entities in December 2015.
For major participants in the OTC interest rate derivatives market, mandatory clearing commenced on 4 April 2016.
On 1 June 2016, the Financial System Legislation Amendment (Resilience and Collateral Protection) Act 2016 came into effect, introducing internationally agreed margining requirements when dealing with OTC derivatives. This legislation supports the central clearing of OTC derivatives and aims to reduce the systemic risk, addressing the spillover effects associated with counterparty risk witnessed during the global financial crisis.
As previously mentioned, the government recently introduced the IMR, which is broadly modelled on the UK IME rules. The IMR reforms remove tax impediments to investing in Australia in order to attract foreign investment to Australia and promote the use of Australian fund managers.
The aim of the new provisions is to encourage eligible widely held foreign funds to invest into Australia either directly or through Australian fund managers and intermediaries by providing a wide range of exemptions for specific classes of income of qualifying foreign funds from Australian tax (referred to as an IMR entity). An IMR entity will be exempt from Australian tax on Australian-sourced revenue and capital gains derived from specified financial products that constitute passive portfolio investments (i.e., interests of less than 10 per cent). There are concessional rules that apply to an IMR entity that is starting up or winding down.
The exemption applies to specified income classes and does not extend to Australian real property. Income in the form of dividends, interest and royalties will remain subject to withholding tax.
iv Tax system for MITs
To encourage investment into Australia, especially Australian real estate, specific tax concessions apply to a trust that is an eligible MIT. Broadly, a MIT is a widely held Australian trust that is operated by an AFSL holder and that undertakes specific investment activities.
Under current laws, MITs are able to access concessional withholding tax rules such that distributions of Australian sourced income to foreign residents of countries with which Australia has an information exchange agreement are subject to withholding rates of 15 rather than 30 per cent. A lower withholding tax rate of 10 per cent applies where the MIT invests in energy-efficient buildings. Countries that currently qualify are the Bahamas, the British Virgin islands, the Cayman Islands, China, Japan, Singapore, the UK and the US. This concession does not affect the withholding tax rules that otherwise would apply to distributions of dividends, interest and royalties.
v Tax system for AMITs
The AMIT regime is a comprehensive new tax regime that applies to MITs that qualify as AMITs. Broadly, an AMIT is a MIT whose members have clearly defined interests in relation to the income and capital of the fund, and that has elected to have the new rules apply to it.
The new AMIT rules commenced on 1 July 2016 on an elective basis only (although eligible MITs can opt to apply the rules retrospectively from 1 July 2015).
Once an irrevocable election into the AMIT regime is made, the existing trust taxation provisions will generally not apply to the fund. Rather the AMIT adopts an attribution model of determining its tax liability and the tax liability of its investors. Broadly, the attribution method is based on investors being subject to tax on the taxable income of the AMIT that is allocated to them by the trustee on a fair and reasonable basis that is consistent with the AMIT's constituent documents.
The AMIT regime also permits a trustee of a multi-class fund to make an irrevocable election to treat different classes of membership interests as separate AMITs. Where such an election is made, attributes relating to one class of interests (such as gains and losses) will not affect the attributes of another class within the same fund. The AMIT regime also contains additional rules that codify previously unlegislated administrative practices adopted by the industry, such as the treatment of underestimates and overestimates of taxable income allocated to the fund's investors.
vi Foreign resident capital gains withholding
The new foreign resident capital gains withholding (CGW) regime commenced on 1 July 2016. The CGW regime is a collection mechanism that is designed to secure the collection of capital gains tax liabilities from non-resident taxpayers with respect to the sale of Australian real property interests. The rules achieve this by imposing an obligation on purchasers of Australian real property interests to withhold and remit 10 per cent of the purchase price to the ATO, unless the vendor is an Australian tax resident or covered by a specific exemption.
vii Focus on standards in the financial services industry
After a period of consultation and feedback in 2015, the federal government released the Corporations Amendment (Professional Standards of Financial Advisers) Bill 2015 (Draft Legislation), which is aimed at raising the education, training and ethical standards for financial advisers. The Draft Legislation proposes that financial advisers will need to complete a relevant degree, undertake a period of professional experience, pass an exam and undertake continuing professional development. The government will also recognise an independent industry-established standard-setting body under the Draft Legislation. The education and exam requirements are proposed to commence on 1 January 2019. Existing advisers will have until 1 January 2024 to reach degree equivalent status and until 1 January 2021 to pass the exam.
viii Actively managed exchange-traded funds (ETFs)
Australia has a growing exchange-traded fund (ETF) and listed investment company (LIC) sector. ETFs are managed funds that are traded on a stock exchange, such as the ASX. Traditional ETFs are ‘passively' managed and aim to track a particular benchmark or index. The last year has seen the growth of the active ETF market in Australia, consisting of ETFs that are ‘actively' managed by fund managers with the aim of outperforming a relevant benchmark. The increase in active ETFs, together with the growth of the ASX's mFund Settlement Service (a settlement service for unlisted managed funds), is expected to lead to a heightened interest in active funds management by retail investors.
VI SECTORAL REGULATION
APRA is the prudential regulator and ASIC is the consumer protection regulator for the insurance industry. General and life insurers and reinsurers carrying on business in Australia must be authorised by, or registered with, APRA.
APRA has the authority to set prudential standards for the life and general insurance industry. APRA has developed a detailed framework of prudential standards as well as prudential practice guides for the life and general insurance industry.
Insurers, insurance brokers, agents and distributors must hold an AFSL issued by ASIC, be authorised by a licensee or rely on an exemption from the licensing requirements.
March 2015 saw the release of a report prepared by the Life Insurance and Advice Working Group, chaired by John Trowbridge (Trowbridge report). The Trowbridge report signals the prospect of further reform to Australia's life insurance and financial advice sectors, particularly around adviser remuneration. Legislation to address the concerns raised in the Trowbridge Report has not been finalised.
Superannuation is the term used in Australia to describe the setting aside of income for retirement, generally known internationally as pension or retirement products. Australia's A$2 trillion superannuation system is the fourth-largest in the world and is a major driver behind Australia's globally significant funds management industry. This pool of assets is expected to grow to more than A$8 trillion, or around 130 per cent of GDP, by 2040.13
Superannuation funds are the largest sector of the Australian asset management industry and are prudentially regulated and supervised by APRA, except for SMSFs, which are overseen by the ATO.
APRA supervises regulated superannuation funds under the Superannuation Industry (Supervision) Act 1993 and associated regulations. In addition to this legislation, there are various prudential standards and guidelines that apply to registered superannuation licensees, including those relating to risk management, outsourcing, audit, governance and management of conflicts of interest.
Australia's current ‘superannuation guarantee' system was introduced in July 1992, requiring all employers to make tax-deductible superannuation contributions on behalf of their employees. The contribution rate increased from 9.25 to 9.5 per cent from 1 July 2014 as currently legislated. Recent government amendments to the legislation mean that the rate will remain at 9.5 per cent until 30 June 2021 and then increase by 0.5 per cent each year until it reaches 12 per cent.
In terms of benefits payable, the federal government announced in its Budget for 2016/2017 that it will enact legislation to enshrine the objective of superannuation as being ‘to provide income in retirement to substitute or supplement the age pension' where the age pension is funded by the federal government on a means-tested basis for all eligible Australians. Together with the federal government's review of retirement income streams released on 3 May 2016, and the government's earlier response to the Financial System Inquiry, this should lead to development of a broader range of comprehensive income products for retirement, taking the focus away from what has traditionally been an emphasis on the payment of lump sum benefits from superannuation funds.
Other announcements made in the federal government's Budget for 2016/2017 are yet to be finalised. They included proposals to limit the amount that can be paid tax-free in the retirement phase, to change the taxation treatment and caps on contributions to the superannuation system. Given the slim majority by which the federal government was returned to power in July 2016, there is some uncertainty as to whether all of these changes will proceed.
iii Real property
Australia has a large listed and unlisted property fund sector. In Australia there is currently very little regulation specific to property funds.
Fixed trusts have traditionally been the preferred vehicle for holding real estate investments in Australia. They are typically set up as a listed (public) or unlisted fixed unit trust (i.e., investors subscribe for units). Unit trusts are generally treated as transparent for Australian tax purposes. One of the key tax benefits arising for the investor from a trust structure is that distributions from the trust retain their tax attributes (‘flow through' entity), making an investment via a fixed trust generally comparable in most respects to a direct interest in the real estate. Unit trusts stapled to company structures are common in Australia.
Under Australia's foreign investment policy, certain acquisitions of Australian real property by non-residents must be notified to the FIRB. These include acquisitions of interests in:
- a vacant non-residential land;
- b residential real estate (some exemptions apply);
- c developed non-residential commercial real estate that is not vacant valued at or above A$1,094 million for Chilean, Chinese, New Zealand, United States, Japanese and Korean investors, or A$55 million for investors from other jurisdictions; and
- d agricultural land where the cumulative value of the rural land that the foreign person (and any associates) already holds exceeds, or immediately following the proposed acquisition is likely to exceed, A$15 million.
Unlisted property funds available to retail investors are also subject to heightened disclosure obligations imposed by ASIC.
iv Hedge funds
Along with other forms of collective investment vehicles, hedge funds are primarily regulated by the Corporations Act. In Australia, hedge funds may be offered to retail investors subject to the more onerous disclosure and licensing obligations required for retail investors. Both hedge funds and their managers that are domiciled in Australia, as well as those domiciled offshore and offered into Australia, need to meet the regulatory requirements of the Corporations Act. In Australia there is currently little regulation specific to hedge funds (other than specific disclosure requirements mentioned below).
The Australian regulatory requirements applying to hedge funds depend largely on the type of the entity used. Unit trusts (called managed investment schemes) are the predominant investment vehicle in Australia. These schemes must be registered with ASIC if they are offered to retail investors.
Most hedge funds operating in Australia are domiciled in Australia. A limited number of Australian managers operate foreign-domiciled funds, such as Cayman Islands funds, principally to raise capital from international investors familiar with these vehicles. Most foreign-domiciled funds marketed in Australia, however, are managed by foreign managers.14
Typically, foreign hedge funds may be offered to wholesale clients in Australia with little restriction (subject to the regulation of marketing activities). Before a fund can be offered to retail clients, the fund must have an Australian-compliant offer document (that is, a prospectus or product disclosure statement). If the foreign fund is not a corporate body, the fund itself will need to be registered as a managed investment scheme in Australia (see Section III.ii, supra) and offered under a product disclosure statement. In general, however, it is expensive and burdensome for a foreign fund to obtain registration. In practice, it is difficult and rare for a foreign fund (hedge or otherwise) to be offered directly to retail clients in Australia, and more usually foreign funds are offered to Australian retail investors using a feeder fund structure.
ASIC considers that hedge funds can pose more complex risks for investors than traditional managed investment schemes. Accordingly, where hedge funds are offered to retail investors, ASIC has provided guidance on benchmarks and disclosure principles for hedge fund operators to address in retail offer documents.
v Private equity
Australian private equity is generally accessed by the closed-ended unit trust or offshore limited partnerships. Alternatively, a structure may adopt either a venture capital limited partnership (VCLP), which is used by funds targeting smaller investments with assets of up to A$250 million, or an early stage venture capital limited partnership (ESVCLP), which is used by funds targeting smaller investments with assets of up to A$50 million.
VCLPs and ESVCLPs must be registered in Australia, both as a partnership and a VCLP or ESVCLP. Otherwise, the AFSL requirements described in this chapter are the main licensing requirements applicable to private equity fund managers.
Like hedge funds, there is currently very little regulation specific to private equity funds. Generally, there are no legal restrictions on investment periods, amounts or transfers of investments. However, there are restrictions if investing through a VCLP or an ESVCLP, or if seeking certain tax concessions.
vi Other sectors
Significant investor visa (SIV)
In 2012, the federal and state governments introduced a new migration visa stream for high-net-worth and ultra-high-net-worth foreign migrants seeking permanent residency in Australia. The SIV and premium investor visa provide a path for migrants who can invest a minimum of A$5 million and A$15 million, respectively, in certain Australian investments to obtain permanent residency visas for Australia.
SIV applicants are required to invest at least A$5 million in complying investments, which include:
- a at least A$500,000 in eligible Australian venture capital or growth private equity funds investing in start-up and small private companies;
- b at least A$1.5 million in an eligible managed funds or LICs that invest in emerging companies listed on the ASX; and
- c a ‘balancing investment' of up to A$3 million in managed funds or LICs that invest in a combination of eligible assets that include other ASX-listed companies, eligible corporate bonds or notes, annuities and real property (subject to the 10 per cent limit on residential real estate).
The SIV programme has resulted in A$6.98 billion in investments in Australia.15
Sovereign wealth funds
The Future Fund, Nation-building Funds and DisabilityCare Australia Fund (Funds) are key Australian sovereign wealth funds. The Future Fund Board of Guardians (Board) has responsibility for investments of these funds.
The statutory governance arrangements for the Funds are set out primarily in the Future Fund Act 2006, Nation-building Funds Act 2008 and DisabilityCare Australia Fund Act 2013. This core legislation sets out the roles and responsibilities of the government and of the Board and the Future Fund Management Agency. The Future Fund Management Agency is a non-corporate Commonwealth entity for the purposes of the Public Governance, Performance and Accountability Act 2013, and its employees are employed under the Public Service Act 1999.
The legislation provides the government, through the Treasurer and the Minister for Finance, with oversight of the Funds subject to arrangements that establish the independence of the Board. The government's role includes the appointment of Board members and the establishment of investment mandates for each of the Funds.
The legal framework retains beneficial ownership of the assets of each Fund in the Commonwealth. It also clearly states the purpose of each Fund and makes clear that contributions to the Funds are discretionary.
VII TAX LAW
Most domestic funds are structured as unit trusts. Unit trusts are usually managed so that they can be taxed on a ‘look through' basis so that the investors are taxed and not the fund. Investors are taxed on their share of the income earned by the fund according to their tax status. This applies to both the taxable income that is distributed to or reinvested by the investor and income that an investor is entitled to receive but that has not been distributed by the fund.
Tax losses incurred by a unit trust do not flow to the investors but rather remain at the fund level and, subject to the satisfaction of certain tests, may be applied to at the fund level against future income and gains. Capital losses can only be offset against capital gains.
Certain widely held trusts that undertake or control entities that undertake ineligible trading activities are not taxed on a ‘look through basis'. Instead, the trading activities are taxed at the fund level at the corporate tax rate of 30 per cent (currently) and are treated as companies for most tax purposes. Eligible trading activities that would not result in corporate style taxation include investing or trading in debt and equity securities and derivatives, and investing in commercial property for the purpose of deriving rent.
In addition to the general trust taxation provisions, Australian taxation law has specific rules that relate to MITs to encourage investment into Australia. Foreign investors making such investments receive a concessional withholding tax rate of 15 per cent (or 10 per cent for eligible clean building MITs), rather than a withholding rate of 30 per cent, for distributions of rental income and realised capital gains paid from a MIT to an investor that is domiciled in a country with which Australia has an exchange of information agreement.
Another advantage of making an investment through a MIT is that they may elect to hold certain assets, including shares, units and land, on capital account, ensuring that distributions arising from its disposal are taxed under Australia's capital gains tax (CGT) regime. Under this regime, individuals and trusts are entitled to a 50 per cent reduction, and superannuation funds are entitled to 33.33 per cent reduction, on a taxable gain on the disposal of assets that have been held for more than 12 months.
The taxation of AMITs has been noted above. Broadly, the taxation of AMITs is governed by an attribution model that requires the trustee to first calculate the total of all amounts associated with the various activities of the trust that attract different tax consequences (each a trust component of a particular AMIT character). Once the various trust components of particular AMIT characters for an income year are calculated, the trustee must attribute a share of the trust components to members on a fair and reasonable basis in accordance with the constituent documents of the trust. The trustee issues a statement to each member advising them of that amount. Under the attribution model, amounts derived or received by the trust that are attributed to members will retain the character they had in the hands of the trustee for tax purposes. Another feature of the new AMIT regime is that it allows trustees of AMITs with multiple classes of membership interests to make an additional irrevocable election to treat each class of membership interests as a separate AMIT. As a result, gains and losses relating to one class of interests are quarantined so that they do not affect the gains and losses of another class in the same fund.
i Taxation of companies
Generally, an Australian resident company is subject to income tax on its worldwide income. Foreign ‘non portfolio' dividends (at least 10 per cent of the voting power) and capital gains from the sale of active foreign business assets are treated as not subject to Australian tax. The corporate tax rate for the year 2016-2017 is 30 per cent.
A foreign resident company is subject to income tax only on Australian-sourced income. A company incorporated in Australia is generally considered to be resident in Australia for tax purposes. Foreign incorporated companies that also carry on business in Australia may also be Australian residents if their central management and control is in Australia or if the majority of voting power is in Australia.
ii Taxation of partnerships
Like trusts, partnerships are generally taxed on a ‘look through' basis (i.e., income is subject to tax in the hands of the partners).
Limited partnerships (where the liability of at least one of the partners is limited) are treated as separate entities and taxed as corporate entities. This extends to distributions being made by partnerships being treated as distributions of dividends.
For tax purposes, a limited partnership also includes a limited partnership incorporated as a separate legal entity and formed solely for the purpose of becoming a VCLP, ESVCLP, an Australian venture capital fund of funds (AFOF) or a venture capital management partnership (VCMP).
Special taxation rules apply to VCLPs, ESVCLPs, AFOFs and VCMPs for tax purposes. These entities are not treated as corporate partnerships and are generally taxed on a flow-through basis as ordinary partnerships. CGT and income tax exemptions may apply for profits and gains made by such entities on the disposal of their eligible venture capital investments. These concessions may be accessed by certain classes of non-resident investors investing in the entities.
The Australian financial services sector will continue to focus on ways in which it can deepen its financial connectedness and engagement with the Asia-Pacific region. The conclusion of three recent free trade agreements with China, Japan and South Korea, and Australia's participation in the establishment of the Asian Infrastructure Investment Bank, are expected to help foster greater financial integration between Australia and its neighbours in the Asia-Pacific region. However, the success of these free trade agreements and other intergovernmental measures will depend on how effectively they are implemented.
The arrangements for the long-awaited Asia Region Funds Passport (ARFP) initiative, under the auspices of the Asia-Pacific Economic Cooperation, were finalised with the signing of the Memorandum of Cooperation (MoC) in April 2016, with effect from 30 June 2016.16 The ARFP is a multilaterally agreed framework to facilitate the cross-border marketing of managed funds across participating economies in the Asia-Pacific region, and is intended to be the Asia-Pacific's alternative to the Undertakings for the Collective Investment of Transferable Securities. The MoC was signed by representatives from Australia, Japan, South Korea, New Zealand and Thailand. Signing the MoC gives participating countries 18 months to implement domestic arrangements to facilitate the ARFP. Once two participating countries complete implementation, the ARFP will be active and operational. The establishment of the ARFP is considered to be important to the growth and prosperity of the region's funds management industry and, in turn, its ability to support growth across the region.
With the implementation of the IMR and AMIT measures now complete, Australian fund managers and intermediaries would feel greater confidence in approaching foreign funds, as foreign funds can obtain greater certainty as to how investments will be treated for Australian tax purposes.
The government's commitment in the May 2016 Budget to introducing a broader range of collective investment vehicles that offshore investors are familiar with will assist Australian fund managers with attracting offshore investors. There is ongoing debate in Australia in relation to the OECD base erosion and profit shifting project, and global corporate taxation issues such as profit shifting and transfer pricing.
On the whole, and barring any catastrophic developments, the outlook for the asset management sector and the related regulatory environment in Australia is expected to remain comparatively stable.
1 Nikki Bentley and Jon Ireland are partners and Vinod Kumar is a senior associate at Henry Davis York. The authors gratefully acknowledge the contribution of the Henry Davis York tax team, led by Greg Reinhardt.
2 Investment Company Institute's Worldwide Mutual Fund Assets and Flows, Fourth Quarter 2014, Washington, DC, 2 April 2015.
3 Australian Bureau of Statistics (ABS) Cat No. 5655.0 Managed Funds, Australia, March 2016.
4 Bulletin, Reserve Bank of Australia, June Quarter 2015.
5 Reserve Bank of Australia, Recent Developments in Asset Management, June Quarter 2015.
6 See footnote 3.
7 See footnote 3.
8 The Association of Superannuation Funds of Australia Limited, Superannuation Statistics 2016.
9 Global Pension Study 2016, Willis Towers Watson.
10 See footnote 3.
11 Australian Share Ownership Study 2014, Australian Securities Exchange Limited, June 2015.
12 ATO Self Managed Super Fund Statistical Report, March 2016.
13 Treasury 2010 forecasts.
14 Snapshot of the Australian hedge funds sector, Australian Securities and Investments Commission, July 2015.
15 Significant Investor visa statistics, Department of Immigration and Border Protection, 31 May 2016.
16 Asia Region Funds Passport, ‘Asia Region Funds Passport's Memorandum of Co-operation Comes Into Effect', 30 June 2016.