In brief
Written by Partners Marc Kemp and Charles Armitage, and Associate Rebecca Sheehy
In July's edition of Unravelled, we reported on the Board of Taxation's report on tax arrangements applying to collective investment vehicles, released by the Federal Government on 4 June. Consistent with the 2009 Johnson Report, the report considers that offshore investors are dissuaded from investing in Australian funds because they do not understand unit trusts, and that access to a broader range of collective investment vehicles would help Australian fund managers to compete for capital with their offshore counterparts.
The Board of Taxation report advocates extending tax neutrality to three additional collective investment vehicles: corporates (modelled on the Luxembourg SICAV), limited partnerships and common contractual funds. In the September edition of Unravelled, we examined corporate collective investment vehicles, with a focus on Luxembourg SICAVs, English OEICs, and protected cell companies. In the October edition of Unravelled, we examined limited partnerships. In this issue, we look at common contractual funds, with which you may be less familiar.
Key features of Common Contractual Funds globally
The Common Contractual Fund (CCF) was first introduced in Ireland in 2003 to enable asset managers and investors to pool their investments in a tax efficient manner. CCFs are constituted under contract law and are regulated by the Central Bank of Ireland. The key feature of the CCF is its tax transparency: each investor is treated as if it owns a proportionate share of the underlying investments of the CCF, rather than units or other interests in the CCF itself.
CCFs are not separate legal entities and therefore do not have a separate legal personality. The CCF is established by a deed of constitution, under which the investors participate as co-owners of the assets. The CCF will have a management company and generally a custodian will hold the assets. The CCF may be established as a single structure or as an umbrella structure and a CCF established under an umbrella structure will be insolvency remote. Pooling investments and managing only one fund structure in this way allows for economies of scale and therefore lower administrative and accounting costs. This structure bears some resemblance to 'enterprise' or 'contract-based' schemes in Australia (familiar to investors in managed investment schemes operating agricultural enterprises such as timber, almond and olive farms), except that in those schemes the investors are more often than not tenants of the land on which the crop is grown. They bear little resemblance to trust-based schemes in Australia.
CCFs are treated as tax transparent under Irish law, and, in order for their tax transparency to be effective, similar tax treatment must be granted in the jurisdiction where the investor is resident and the jurisdiction where the income arises. Several jurisdictions currently recognise the tax transparency of the CCF.
Common Contractual Funds in an Australian context: what would they bring to the landscape?
The CCF is typically marketed as an attractive undertaking for investors who are seeking the benefits of investing via a pooled arrangement but the tax treatment of investing directly in the assets themselves. Traditionally this has appealed mainly to certain pension funds that are not subject to withholding tax. In the Australian landscape the CCF looks best suited to wholesale investors so it is perhaps surprising that it is one of the three collective investment vehicles focused on by the Board of Taxation when the Report's emphasis is on assisting Australian fund managers to compete for retail investment in Asia.
The Board notes that, while the CCF has success with certain classes of offshore investors, it has not proved as popular with Irish domestic investors. It also does not have the same wide appeal or prolific use as, for instance, the SICAV and the limited partnership. So why did the Board choose to single out this undertaking from among the suite of Irish and Luxembourg fund options? The Board points out that the CCF is more tax transparent than the managed investment trust, but it is arguable that much of what the undertaking purports to offer can already be achieved for investors in Australia – parties entering into contractual arrangements to co-own assets is not so far removed from the concept of a joint venture.
A regime which formally accommodates CCFs may also prove difficult to implement. The Board recognises that it took a number of years for the Irish regulatory and tax authorities to adapt CCFs to ensure that they worked effectively and so the Board recommends seeking to replicate that regime as closely as possible in Australia to benefit from this experience. If the Australian regime were to mirror the Irish one, consideration would need to be given to how investors would avoid liability for the debts of the CCF. This is done contractually for beneficiaries of trusts, and by statute for shareholders of companies; ideally limited liability would be conferred by statute (and, while they are at it, Parliament might consider doing the same for trusts operating as registered managed investment schemes). It will also be important to consider what amendments to the tax regime would be necessary in order to ensure the CCF is tax transparent and to maximise the chance that it is recognised as such in other jurisdictions, because this recognition by other jurisdictions would be important to the success of the Australian CCF. It seems likely that to achieve a complete 'look-through' to the investors, quite extensive amendments to the tax law would be necessary to accommodate a CCF compared with a corporate CIV or a limited partnership. It also seems that whereas the existing regulatory regime under the Corporations Act might be adapted for corporate CIVs and limited partnerships, it would seem that a purpose-built regulatory regime would need to be developed for a CCF.
Given these issues mentioned above, it is perhaps surprising that the Board did not, instead of the CCF, choose to explore the concept of giving managed investment schemes separate legal personality along the lines suggested in 2012 as part of a report by the Corporations and Markets Advisory Committee (CAMAC), referred to as the 'SLE Proposal'. In its 2012 report, CAMAC thought that this might simplify the regulatory structure and overcome some of the problems that have arisen when (as in trust-based or contract-based schemes) the responsible entity acts as principal to the agreements and holds legal title to the scheme assets itself. Like the managed investment schemes that the SLE Proposal refers to (and seeks to improve on), a CCF also has no separate legal personality and acts through a management company (functionally equivalent to a responsible entity). It is curious that the Board would put forward another vehicle (the CCF) that is beset by some of the same issues.
Of course, the Board's paper simply sets out its recommendations. It is entirely up to the Government, acting on the advice of the Treasury to decide what new CIVs it wishes to legislate for. It is possible that the Government could decide that there would be merit in choosing to accept the recommendations on corporate and limited partnership CIVs but reject or defer the introduction of a CCF on the basis that including a CCF, at this stage, might unnecessarily delay (further) the implementation of a new suite of CIVs.