Foreign partnerships may benefit from Australian Tax Office ruling

The Australian Tax Office confirmed in taxation determination 2011/25 that foreign limited partnerships formed in countries with which Australia has not entered into a tax treaty are eligible to take advantage of Article 7 of Australia’s tax treaties, discussed below, if: (1) the partners of the limited partnership are resident in a country with which Australia has entered into a tax treaty; (2) for the purposes of the tax laws of the partner’s country of residence, the limited partnership is treated as fiscally transparent and the business profits of the limited partnership are treated as the profits of the partners.

TD 2011/25 applies before and after the date of issue. Accordingly, foreign limited partnerships that have previously adopted a conservative position may wish to review their previous years to see if Article 7 of the applicable tax treaty should apply to prevent Australian tax on business profits that are not attributable to an Australian permanent establishment.

TD 2011/25 and the proposed investment manager regime (IMR) should complement each other so as to provide greater tax certainty for limited partnerships that are also collective investment vehicles for the purposes of the proposed IMR (discussed below).

Where a partner is itself a limited partnership, Article 7 of a tax treaty should be available to the ultimate partner if TD 2011/25 would apply to each of the interposed limited partnerships. The Australian Tax Office notes that the onus is on the general partners of the limited partnership to demonstrate that a limited partner is a resident of a tax treaty country.

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Attracting foreign capital

The federal government has announced a three-stage change to the Australian income tax treatment of investment income of foreign funds – what is known as the IMR. The IMR is designed to improve investor certainty, make Australia-based fund managers attractive to foreign-based investment funds and thereby attract more foreign capital. The stage 1 amendment was announced on 17 December 2010, the stage 2 amendment was announced on 19 January 2011, and the stage 3 amendment was announced on 16 December 2011.

Under the proposed amendments:

• The Commissioner of Taxation is not permitted to assess certain widely held foreign collective investment vehicles on gains from portfolio investments (i.e. interests less than 10%) and income from certain derivatives if the foreign funds have not lodged an Australian tax return for 2009-2010 or prior income years (stage 1). This change is intended to address the concern created by the US FIN 48 accounting rules in relation to uncertain tax positions (which apply to a number of investment funds with assets in Australia, or managed from Australia).
• Certain passive portfolio investment income and capital gains of widely held foreign collective investment vehicles that would otherwise be within the Australian tax net will be exempt from income tax. Without the proposed amendment, the income may be caught within the Australian tax net because the collective investment vehicle is taken to have a permanent establishment in Australia solely as a result of engaging an Australia-based investment manager who habitually exercises a general authority to negotiate and conclude contracts on behalf of the vehicle (stage 2).
• Stage 3 of the IMR extends the scope of stage 2, by making gains made by certain widely held foreign collective investment vehicles from the disposal of non-portfolio investments (i.e. a holding of greater than 10%) in non-Australian assets exempt from Australian tax.

The second exposure draft bill containing the stage 1 and stage 2 amendments was released for consultation on 7 March 2012. No draft legislation has been released with respect to the stage 3 amendments. The explanatory memorandum to the exposure draft bill provides that a collective investment vehicle may be in the form of a limited partnership and the ATO has confirmed in an interpretative decision (ID 2011/4) that an Irish investment limited partnership would satisfy the equivalent definition in the existing provisions for managed investment trusts. Accordingly, TD 2011/25 in conjunction with the proposed IMR should provide great certainty in relation to taxation of income from Australian sources, particularly for limited partnerships that are also regarded as a collective investment vehicle under the proposed IMR and engages an Australia-based investment manager who habitually exercises a general authority to negotiate and conclude contracts on behalf of the limited partnership.

Some ambiguity

From a practical perspective it is not clear to what extent a limited partnership will be able to demonstrate that the limited partners are entitled to the benefits of a tax treaty, and that the limited partnership is fiscally transparent in the limited partner’s country of residence. The prudent approach may be to seek confirmation from the ATO that tax treaty benefits will apply. However, under the self assessment regime, it is open to a limited partnership to take their own position provided that they have sufficient information to prove the availability of treaty benefits in the event of an enquiry from the ATO.

We note that there is some ambiguity as to if and to what extent the application of TD 2011/25 will be impacted by whether the limited partnership is (or is not) regarded as a separate legal entity under the domestic laws of the limited partnership’s country of formation. Paragraph 28 of TD 2011/25 merely states that “the tax treatment of the [limited partnership] in its country of formation is not necessarily relevant …”

Further, in relation to the ATO’s comment in paragraph 5 that TD 2011/25 “does not apply where the fiscally transparent entity is not a partnership”, it is not clear whether the reference to “partnership” is referring only to partnerships under the Australian law, or also includes things that are treated as partnerships under foreign domestic or foreign international law (which are not a foreign hybrid company for the purposes of Division 830 of the Income Tax Assessment Act 1997). We note that a limited liability company, which does not qualify as a foreign hybrid company for Australian tax purposes due to ownership requirements, would not be able to rely on TD 2011/25.