Investing in Australia
With a flat corporate tax rate of 30% (applying to both revenue and capital gains), Australia is far removed from the zero or low tax jurisdictions traditionally considered to be "tax havens". Nonetheless, the Australian Government has long desired to establish Australia as a financial services hub and the past decade has seen some significant changes to Australia's domestic tax laws intended to facilitate foreign investment into Australia. An extensive treaty network also limits Australia's taxing rights over dividends, royalties, interest and business profits (except to the extent the business profits are attributable to a permanent establishment in Australia).
Particularly in the case of investments in Australian companies, Australia's domestic tax rules contain specific "bright line" tests for determining whether an investment is debt or equity for tax purposes and, consequently, whether a return on that investment is deductible but not "frankable" (like interest) or "frankable" but non-deductible (like a dividend). An investment which is legal form equity may be debt for tax purposes (often redeemable preference shares) and an investment which is legal form debt may be equity for tax purposes (eg, certain convertible notes). As such, some opportunities for tax arbitrage may exist where, eg, an investment in an Australian company is debt for Australian tax purposes (such that returns on the investment are deductible) but equity in the foreign investor's home jurisdiction (where a participation exemption may be available).
Subject to certain exceptions, dividends and interest paid to foreign investors will be subject to withholding tax - 10% in the case of interest and 30% in the case of dividends. Dividends will not be subject to withholding tax where they are derived from profits on which Australian corporate tax has been paid (that is, "franked" dividends) or which are sourced from "conduit foreign income". The Government is also proposing to phase down interest withholding tax paid by financial institutions on offshore borrowings. Interest and dividend withholding tax exemptions are also available for certain categories of investors (e.g. foreign superannuation funds and the Government is currently considering proposals to extend the exemption to sovereign wealth funds).
The rates of withholding tax may be reduced where the foreign investor is tax resident in country which has a comprehensive tax treaty with Australia. Under some of Australia's newer tax treaties (e.g., those with the UK, New Zealand and Norway), the rate of interest withholding tax is reduced to nil where the foreign investor is a financial institution and the rate of dividend withholding tax is reduced to nil where the foreign investor holds more than 80% of the Australian company and certain other requirements are met.
A foreign investor with an Australian subsidiary will benefit from the "conduit foreign income" (CFI) rules. The CFI rules were specifically enacted to promote Australia as a base for regional holding companies of multinational companies and, together with certain other provisions of Australia's domestic tax laws, ensure that the active foreign income of a foreign investor earned through an Australian subsidiary will be exempt from Australian tax. That is, not only will dividends paid to the foreign investor consisting of CFI be exempt from withholding tax but CFI derived by the Australian subsidiary will also be exempt from corporate tax. CFI includes the following amounts derived by an Australian company: non-portfolio dividends paid by an offshore company; foreign income and certain capital gains derived from carrying on business in a foreign country through a permanent establishment; capital gains on the disposal of shares in a foreign company with an underlying active business; dividends paid by an Australian company attributable to CFI which are ultimately paid to the foreign investor.
Where a foreign investor invests through a trust and the trustee operates through a permanent establishment in Australia, or is taken to have a permanent establishment in Australia because the trustee has engaged an Australian based investment manager, the foreign investor may also be deemed have a permanent establishment in Australia. As such, the foreign investor will be subject to Australian tax on distributions of Australian sourced income from those trusts (which may be levied by withholding or assessment). However, investment into Australia through trusts which are "managed investment trusts" will be subject to lower rates of tax (by withholding only) and may also benefit from exemptions available to foreign investors in respect of capital gains. In addition, recent amendments prevent the Commissioner of Taxation from taxing previously untaxed investment income of foreign managed trusts and under proposed measures income from certain investments of a foreign trust where the trustee has engaged an Australian based investment manager will be exempt from income tax.
Where an Australian investment is held on capital account, capital gains earned by foreign investors on exiting the investment will be exempt from Australian tax unless the investment is "taxable Australian property" which includes: Australian real property (including mining rights and leases); interests of 10% or more in entities where more than 50% of the value of the entity is attributable to Australian real property (held directly or indirectly); assets used at any time in carrying on a business through a permanent establishment in Australia; and options or rights to acquire any of those assets.
The Commissioner of Taxation has been reluctant to completely embrace some of the exemptions in certain circumstances and there are still some legacy issues which are yet to be completely resolved. Two particular issues which may still be of concern to foreign investors - especially those who favour a "private equity" style of investment - is that there are no definitive tests under Australian tax law for determining: whether a gain is on revenue or capital account and hence, able to benefit from the abovementioned exemption (where treaty protection is not available); and whether, or to what extent, a gain is Australian sourced income and hence, subject to Australian tax at all.
The Commissioner of Taxation has issued public determinations on these issues which potentially bring gains on the disposal of certain investments within the Australian tax net and also suggest that the Commissioner of Taxation may apply the general anti-avoidance rules where the tax consequences of a disposal have been manipulated through "treaty shopping". Although these determinations have been widely criticised, as matters currently stand foreign investors contemplating the disposal of Australian investments need to ensure that their investment exit structure is able to withstand scrutiny from the Commissioner of Taxation.
Robyn Schofield is a taxation partner in the Sydney office of Clayton Utz. She joined the Clayton Utz tax practice in 1999 and during her time at Clayton Utz has predominantly acted for large corporate clients. She advised across all areas of Australian tax including international tax, taxation of financial transactions, general corporate tax and tax audits and litigation. Robyn can be contacted on +61 2 9353 4649 or by email at firstname.lastname@example.org