Foreign Accumulation Fund (FAF) Rules

STOP PRESS:

The Assistant Treasurer, Bill Shorten, announced on 29 June 2011 that the proposed Foreign Accumulation Fund (FAF) rules would not apply for the 2010-11 income year. He advised that the Government was still in the process of developing the FAF rules and there is ongoing public consultation and made the following comment:

"The FAF rule is still under development and 30 June is fast approaching. The Government has received no evidence that deferral activity has emerged following the repeal of the FIF regime. We are therefore happy to provide certainty for industry and investors by confirming the FAF rule will not apply for the 2010-11 income year. The FAF rule will have application for income years starting on or after the date it receives Royal Assent."

As we have said elsewhere, if there is no evidence of deferral activity, it makes you wonder whether the effort (and confusion) is worthwhile. Meanwhile, we have retained the material below for background purposes - further amendments in the proposed rules are almost inevitable.

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The new Foreign Accumulation Fund (FAF) rules apply from 1 July 2010, but enabling legislation has still to be enacted. It will make the precise preparation of Australian income tax returns for the year ended 30 June 2011 difficult in certain situations and it is recommended that anyone potentially affected by the rules exercise caution and seek professional advice. The following is just a summary overview which is not intended as advice, or to supplant the need for specific advice.

Background
 

The proposed FAF rules were announced in May 2009 Federal Budget, with its predecessor, the Foreign Investment Fund (FIF) repealed with effect from 1 July 2010. No legislation immediately filled the void and by February 2011 the Assistant Treasurer had issued for public consultation a second set of Exposure Draft legislation on FAF rules, with submissions sought by 18 March 2011.

The main features of the FAF rules as contained in the Second Exposure Draft legislation are as follows:

• The FAF rule applies to a resident investor that holds an interest in a FAF at the end of the FAF’s accounting period.
• A FAF is a trust or company that is not a resident of Australia
• In addition the FAF must meet the following requirements:
  • Investment requirement. The market value of all debt instruments held by the FAF, at the end of the accounting period, must comprise 80% or more of the total assets the FAF and
  • Accumulation requirement. This requirement is met if the FAF does not distribute 80 per cent or more of its realised profits and gains.
• The notes accompanying the exposure draft indicate that “debt interests” are designed to capture returns that are interest like and are not linked to the performance of the underlying assets.
  • Consequently, and subject to the final legislation, it may be that foreign funds that invest predominantly in equities or other investments that do not offer guaranteed returns may not be caught by these rules.
• Where an individual is caught by the FAF rules, they will subject to Australian tax on an accruals basis.
  • The calculation will be based on the change in market value of the interest in the FAF plus distributions from the FAF.
• A foreign fund that does not satisfy either the Investment requirement or the Accumulation requirement will not be treated as a FAF
• The current exemption in respect of temporary residents will continue to apply.
   

In the Interim, until Legislation is enacted …

On 1 June 2011, the ATO announced that it will accept tax returns as lodged during the period up until the proposed law change is passed by Parliament.  

After the new law is enacted, the ATO has indicated that taxpayers will need to review their position for the income year commencing 1 July 2011.

• Those taxpayers who returned income in accordance with the changes do not need to do anything more.
• Those taxpayers who returned more income than they were required to can seek an amendment and if a reduction in liability results, interest on overpayment will be paid.
• Those taxpayers who returned less income than required by the changes will need to seek amendments. No tax shortfall penalties will be applied and any interest accrued will be remitted to the base interest rate up to the date of enactment of the law change. In addition, any interest in excess of the base rate accruing after the date of enactment will be remitted where taxpayers actively seek to amend assessments within a reasonable timeframe after enactment.
   

Commentary

This raises a number of significant questions:

•  How can professional advisors make effective recommendations in the absence of legislation:
• The Second Draft Exposure varies quite significantly from the First Exposure – that could be construed as reflecting significant differences within the ATO and Government on the most appropriate approach.  If so, this increases the chance of potential “surprises” in future legislation
• It isn’t clear how the legislation would treat overseas pensions, both defined benefit and accumulation, back principally by bonds and other debt instruments, and
• The uncertainty will lead to higher compliance costs for individuals